Low interest rates and a rebounding stock market have caused more investors to seek out a highly risky investing tool: The margin loan. As reported May 29 by the Wall Street Journal, margin accounts let investors borrow against the value of the securities held in their brokerage portfolios. While appealing, borrowing on margin can be a dangerous investing strategy.
Says the Wall Street Journal article:
“When investors put borrowed money in the stock market – the traditional use for margin loans – it magnifies gains and losses. For example, by borrowing $50,000 against a stock portfolio of $100,000, and investing it back in the market, an investor boosts potential returns by half. If the market climbs 10%, he gains $15,000 (minus the cost of interest on the loan), rather than $10,000. But the losses would be just as large if the stock dropped.”
Moreover, many investors are unaware that a brokerage firm or bank can sell their stocks and other securities at rock-bottom prices in order to satisfy a margin call, and they can do so without giving any notice to the investor. Indeed, in certain emergency situations, brokerages can cash out customers’ stocks with little or no notice to protect themselves.
Earlier this month, Green Mountain Coffee Roasters disclosed that founder Robert Stiller had sold $120 million worth of the company’s stock in a single day in order to meet a margin call. Green Mountain shares had plunged by nearly 50% to $25 from $50.
As of the end of March, margin accounts totaled more than $330 billion, according to the Financial Industry Regulatory Authority (FINRA). That’s a 65% increase since 2009.