Stock & Options Trading

Invest With Margin Loan? Use It At Your Own Risk

John Waggoner at USA Today reminds us why it is not wise to invest on borrowed money. You may lose more than you want.

You can borrow up to 50% of a stock purchase for most stocks. Put another way, for every $1 you spend on a stock purchase, your broker will lend you $1. That loan is called a margin loan.

If you wanted to buy 1,000 shares of ExxonMobil, for example, you could use your money to buy 500 shares and borrow enough to buy another 500 shares.

The advantage, at least in theory, is that you can double your buying power. In a bull market, that's a good thing indeed. Suppose you had decided to buy ExxonMobil in October 2003. With the stock selling for $37.85, you bought 500 shares, for a total cost of $18,925. By October this year, your ExxonMobil holdings would have soared to nearly $35,000 (not including dividends).

But you could have bought 1,000 shares of ExxonMobil in October 2003, by using $18,925 of your own money and $18,925 borrowed from your broker. Your 1,000 ExxonMobil shares would be worth about $71,000 now. After you repaid your broker $18,925 you'd have roughly $50,000. (We say "roughly" because you'd owe interest on the loan.)

All well and good. But terrible things can happen if your margin bet doesn't pan out. Let's say that instead of buying ExxonMobil three years ago, you bought Intel, the giant microchipmaker. You bought 500 shares for $31.08 each, for a total of $15,540. You borrowed another $15,540 from your broker, to bring your total purchase up to 1,000 shares, for a $31,080 stake in Intel.

Unfortunately for you, Intel shares fell, breaking below $18 a share this year. Long before then, though, you would have received a margin call from your once-friendly broker. In a margin call, your broker tells you to pony up more money — quickly — or he'll sell shares to make up the difference. Your broker can sell your holdings to meet the margin call, and he doesn't even have to ask permission.