How margin loans work
If you already have a regular cash account for trading stocks, you may want to consider getting a margin account as well.
You can also convert your existing cash account into a margin account.
There is no additional risk in doing this. You only take on more risk IF you buy more than what you can afford and borrow the excess “on margin.”
Other than that margin accounts work the same way as regular cash accounts.
If you’ve never used margin before, Fidelity has a useful guide here for how to use a margin account.
Example with margin
I bought some Apple stocks last month right after their dividend announcement. Here’s what happened.
First, I ordered some Apple stocks. This is the same as buying stocks in a regular trading account.
Next, I made sure my order went through. It did. My broker confirmed I bought 3 Apple shares on March 20th for $595.08 each.
So let’s take a look at my account today. The information shown about my Apple stocks are the same as if I bought them in a regular cash account except for one difference; In a margin account, I have something called “Loan Value” which in this case means I can borrow up to 70% of the market value of my Apple shares if I choose to.
The loan value of $1,307 above is how much 3 shares of Apple will allow me to borrow. Since I have many other stocks in this margin account, I can borrow a total of $19,016 if I wanted to. But I’m only borrowing about $14,439 of that right now (as you can see from my negative cash balance,) which means I have $4,577 margin available.
The $19,016 changes everyday depending on how much my stocks are worth. I don’t want to borrow the full $19,016 because if my stocks drop in value tomorrow I would get a margin call, hence the $4,577 buffer.
The total market value (in yellow) is what my account is worth today if I sold all my shares and paid back the margin loan. The total book value (also in yellow) is how much of my own money I’ve put into this account. So if I sold everything today I would make close to 10% profit on this entire account. But the real value of my stocks didn’t even appreciate by 10%.
I was able to buy $26,335 worth of securities by combining $11,897 of my own money (total book value) with $14,439 of borrowed margin money. Today my stocks have a market value of $27,505. Which means they’ve only appreciated by 4.4% on average.
The power of leverage
This is the benefit of a margin account. Apple’s share price only increased by 4.5% since I bought it last month, but I’ve actually made more than 10% on it by using leverage. You can double your returns by borrowing other people’s money. But at the same time you can also just as easily double your losses if stocks move downwards. So be careful.
You can also margin debt to pay off student loans, credit card debts, or anything else.
All you have to do is withdraw cash from your margin account. For example, at this moment my cash balance in the margin account is -$14,439. I can withdraw $1,000 from this account into my savings account. Then my margin account cash balance would say I owe -$15,439. And my additional margin availability will drop from $4,557 to $3,557.
As long as I don’t exhaust my margin requirements I will not receive a margin call or have any of my stocks automatically sold. 🙂