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Margin refers to an investor’s use of leverage relative to his or her own assets. In other words, it’s “borrowing from your broker,” with your portfolio assets serving as collateral for the loan.

How it Works

  • Per the Federal Reserve’s Regulation T, each marketable security in your investable account is given a “maintenance rate” which stipulates the maximum borrowing rate. For example, a maintenance rate of 50% indicates that an investor can borrow up to half of the security’s value. Note that retirement accounts are not eligible to be margined.
  • Once you have activated the ability to take margin on your account, it works seamlessly – any purchases or withdrawals from the account will automatically draw from margin in the absence of cash.
  • You are charged a “margin rate” which is the interest owed on the loan. This rate is variable, meaning that it fluctuates with LIBOR relative to the broader interest rate environment. Interest accrues daily but is added to your outstanding balance on a monthly basis, and investors can exercise substantial flexibility with regard to paying down the balance (periodically, or all at once).
  • Some custodians offer “aggregated” margin which means that you have one margin account whose loan is supported by the underlying assets of multiple investment accounts.

Potential Uses

  • As a “bridge loan.” This is a short-term loan used to cover cash flow needs before an expected liquidity event occurs or a permanent source of financing is secured. The most common scenario arises when clients are closing on a new home, but have not yet sold their former residence. If not for the availability of margin, they might be forced to liquidate other securities, which could create taxable gains or occur at an inopportune time (market dip).
  • As a loan that can pay down a higher interest rate loan, such as a student loan with no other low-rate options available.
  • For short-term credit needs that otherwise would go on your credit card. For example, one might purchase artwork at auction using a checkbook linked to an investment brokerage account, later repaying the loan by either liquidating other assets or allowing income/dividends from the portfolio to pay off the margin balance.
  • Finally, margin can be used to leverage your portfolio by purchasing additional securities. This strategy, though risky in nature, makes sense if you believe your investments will out-earn the margin interest rate.  In this case, margin interest may be tax-deductible – but as with all other tax issues, the burden of proof (as to the use of margin) lies with the taxpayer.

Risks

  • Because of the potential for margin rate fluctuation, we do not advise using margin as a long-term financing solution.
  • The more you borrow, and the closer you get to your minimum margin maintenance rate, the riskier the loan. A market downturn could trigger a “margin call” – a situation in which one would be forced to sell securities or bring in cash from another source in order to secure the balance. For example, if you had margined 50% of your portfolio’s value and then the securities in your account decreased in value by 30% due to a dramatic market downturn, you could receive a margin call and be forced to transfer in cash from elsewhere in order to meet the broker’s minimum maintenance rate, assuming it was greater than 20%. (This is just one more reason we recommend broad diversification across asset classes, which provides some shelter from such a precipitous drop.)

Ultimately there are many situations in which margin is an appropriate and hassle-free source of borrowing. However, one must regularly re-evaluate its suitability in light of changing interest rates, the availability of more permanent structured debt products, and the risk appetite of the individual investor.

 

For more about the benefits of borrowing on margin, see our whitepaper.

Wealthspire Advisors LLC is a registered investment adviser and subsidiary company of NFP Corp.
Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification marks CFP®, Certified Financial Planner, and CFP® (with plaque design) in the United States, which it authorizes use of by individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. © 2021 Wealthspire Advisors

Natalie Truty, CFP®

Natalie is a wealth advisor in our New York City office.