When you begin to invest, you may be enticed to borrow against your stocks in order to… well… buy more stocks. Investing on margin can afford you some oversized gains vs baseline. However, don’t be lured by these easy to acquire loans.
Investing on margin with more money than you have, with substandard risk management, can find you owing thousands of dollars to your broker. Not only this, but in the wake of online brokers cutting their commissions per trade to zero to match Robinhood and other discount brokers, margin rates have skyrocketed. E*Trade, who used to charge just 5% as their highest rate loan, now charges nearly 10%.
I cannot stress this enough- your broker is NOT your friend. They are there to facilitate a transaction and that is all. If you are looking for an advisor, you will be paying them a fee based on their advice and recommendations. Your goal needs to be to cut costs as much as possible- not make your broker rich.
And just for a quick analysis on margin in the case you need further convincing; at a rate of 10% on a $50,000 margin loan, you will be paying roughly $420 a month. Let’s say you have a $50,000 portfolio, use full margin ($50,000) and invest in the S&P, with an average return of 8% per year. Your $50,000 portfolio will have returned just 6%, and made your broker five thousand dollars, vs 8% and made your broker nothing. One is clearly more advantageous than the other.
One alternative to margin trading is to use leveraged products. There are 2x and 3x instruments that can provide you with gains that mimic margin, without the cost. These come with substantial risks, which are outlined here.
What do you think? Leave a comment below, I’d love to hear your thoughts.