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What if you could double your returns on a 5% increase in stock price with no extra work? Sounds good right? That is the sales pitch you often hear from some stock brokers when they try to convince the average investor to buy stocks using margin – or borrowed money to purchase investments. When things go well, margin has the wonderful impact of multiplying your gains sometimes to the tune of doubling your returns. However, what brokerage houses don’t tell you is that when things go bad they also can double your losses and take you to the dark side.
Take a look at this chart that was published in an April edition of the Investor’s Business Digest (Insert aff link). In this chart, the first column highlights various returns an investor could see on a stock holding. The second column shows what your return would be if you do not use margin and use only the money you have to buy the stock. The third column shows what your return is if you use margin to buy that stock.
Click to EnlargeEverything looks awesome when the shares price rises. However, have a look at what happens when the stock you hold starts to turn to the dark side. If your stock tanks by -15% and you are loaded up on margin, then your actual return on the stock will be -30%. Essentially you have lost that 30% in stock value but you also have to pay back that money you borrowed to buy the stock with. When one of my holdings drops by 30% I feel dumb enough as it is (thanks Citigroup) – I don’t need to feel like a full-on dumba$$ by doubling that loss because essentially I made a bet on the stock price going up.
As long term dividend investors, margin is probably something that I would suggest we stay away from. Perhaps it has a place, but I honestly can’t think of one. Let me know if you have used margin and how it worked out for you using the comments section.
Dividend Guy,
If you use a smaller margin percentage like 25%, you will be wiped out not at a 50% loss, but at 80%. If you own a diversified portfolio of ETF’s and can afford to pay as little in margin interest as possible, then you might be able to come out ahead in the very long term, assuming of course that stocks continue going higher..
Buying on margin is good even for buy-and-hold investors during a market correction, when many stocks are “on sale” and it’s a good opportunity to use the margin as a short-term “buffer” until you get more cash.
I have bought $20k worth of dividend stocks on margin in an account that had over $100k of equity– so, i.e., I had only about a 20% margin percentage.
I did it because I thought the stocks were well priced (not screaming buys) and were paying a 3.7% yield when the margin interest rate was quite low (about 1.4%).
It worked out– not spectacularly, but solidly.
I’m messing around with Margin right now for the first time. I have about 220K Equity in my account so they have given me that much to use for Margin Buys.
So far I have used 150K of my Margin to buy 50K each of MFA, HTS, and ANH. Those 3 stocks paid 15% Divs last year and should continue this year since they pay Divs based on low Mortgage Rates.
My plan is to migrate the rest of my account over to Those 3 stocks as well as add to the account throughout the year. The Divs will be 22500 for the year assuming I can’t make the migration and I’m only working with 150K at 15% (Also assuming that rate will be the same).
What I want to see happen by the end of the year is to have 350K in those 3 stocks, that will gross 52500K in Divs, and I can continue to use my margin account to load up on those 3 at attractive times in the future to either average down my positions or simply add more shares and rely on the Divs to pay for it all.
If anyone has any comments I’d love to hear them.
Jason- you’re going to lose your shirt. It is never a good idea to consolidate your account into a single sector. You are counting only the gains and not the potential losses. If anything- anything- rocks the boat on your stocks your losses will increase exponentially. You will get a margin call, be unable to cover it, be forced to sell shares at a major loss and so on. It will cascade into an avalanche of disaster. Just my .02
Take 10% of your profits and put it on put options to insure your losses, common you guys have to be smarter than this?