How Margin Borrowing Can Supercharge or Destroy Your Investments

Speaker 1 I live in LA now, but lately I have been craving the seasons. Snow, hot cocoa, the whole thing.

Speaker 1 I don't even ski, but I have been daydreaming about working remotely from somewhere really cozy on the East Coast, like a cute little ski town for a little bit.

Speaker 1 And whenever I know I'm going to be gone for a while, I always remind myself that my home can actually be working for me while I'm away because I host my space on Airbnb.

Speaker 1 It is one of the easiest ways to earn passive income from something you already have, and that extra income feels particularly helpful this time of year as we approach the holidays.

Speaker 1 A lot of my friends say that sounds amazing, but where do you find the time to manage guests and bookings? And that's when I tell them about Airbnb's co-host network.

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Speaker 1 I like to give a personal touch when I'm hosting on Airbnb. So I make a list of my favorite restaurants in the area and I hand write a note welcoming my guests to the property.

Speaker 1 My guests love it, but I also know that some of those little personal touches can take a lot of extra time. So this is the exact kind of thing that you would want your co-host to help you with.

Speaker 1 Whether you're traveling for work or chasing the snow or escaping it, or you've got a second place that just sits there empty more often than you'd like, your home doesn't have to just sit there.

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Speaker 3 Here's one piece of advice that I've given for years. Build an emergency fund.
Aim to stash away enough to cover at least three months of expenses in case your income suddenly drops.

Speaker 3 Sounds simple, right? But let's be honest, it's not. Saving even one month's worth of living costs can feel impossible.

Speaker 3 Just when you're making progress, that check engine light blinks on and derails your plans. Life already throws enough curveballs.
You don't need your bank adding to the chaos.

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Speaker 3 Work on your financial goals through QIIME today. Open an account in just two minutes at chime.com slash MNN.
That's chime.com slash MNN.

Speaker 3 chime feels like progress chime is a financial technology company not a bank banking services and debit card provided by the bank core bank n a or stripe bank n a members of the ic spot me eligibility requirements and overdraft limits apply timing depends on submission payment file fees apply it out of network atms bank ranking and number of atms according to u.s news and world report 2023 chime checking account required here's one piece of advice that i've given for years build an emergency fund aim to stash away enough to cover at least three months of expenses in case your income suddenly drops sounds simple right but let's be honest it's not saving even one month's worth of living costs can feel impossible.

Speaker 3 Just when you're making progress, that check engine light blinks on and derails your plans. Life already throws enough curveballs.
You don't need your bank adding to the chaos.

Speaker 3 That's why it's so important to choose one that makes savings easy and doesn't nibble away at your hard-earned money with ridiculous fees. QIIME understands that every dollar counts.

Speaker 3 That's why when you set up direct deposit through QIIME, you get access to fee-free features like free overdraft coverage, getting paid up to two days early with direct deposit, and more.

Speaker 3 With qualifying direct deposits, you're eligible for free overdraft up to $200 on debit card purchases and cash withdrawals. To date, QIIME has spotted members over $30 billion.

Speaker 3 Work on your financial goals through QIIME today. Open an account in just two minutes at chime.com/slash MNN.
That's chime.com slash MNN. Chime feels like progress.

Speaker 4 Chime is a financial technology company, not a bank. Banking services and debit card provided by the Bancorp Bank NA or Stripe Bank NA.
Members, FDIC.

Speaker 4 Spot me eligibility requirements and overdraft limits apply. Timing depends on submission of payment file.

Speaker 4 Fees apply at out-of-network ATMs, bank ranking, and number of ATMs, according to US News and World Report 2023. Chime checking account required.

Speaker 3 I'm Nicole Lapin, the only financial expert you don't need a dictionary to understand. It's time for some money rehab.

Speaker 2 Well, if you've been on your money rehab game for a while now, you know that making smart investments can grow your money year over year, and you don't need a lot of money to start investing.

Speaker 2 But because whatever you invest compounds, the more money you invest, the better. That's where margin borrowing comes in.

Speaker 2 Margin borrowing is a money move that can give your brokerage account a financial boost, but it's not as picture perfect as it seems. So what exactly is margin borrowing to begin with?

Speaker 2 You can think of it as your brokerage's way of saying, hey, you've got some amazing investment ideas. I can lend you some cash to make those happen.

Speaker 2 At a top level, you're borrowing money to buy stocks and putting the stocks that you already own up as collateral.

Speaker 2 So if you've got your eye on 10K worth of stock, but you only have five grand on hand, margin lets you borrow the rest to make the full purchase.

Speaker 2 It's like getting a bigger shovel to scoop up more of the market.

Speaker 2 It sounds a little weird to put your investments up as collateral, but it's no different than using your house as collateral for a loan or paying a security deposit on a hotel reservation.

Speaker 2 You're offering an asset as a guarantee to a lender.

Speaker 2 In the context of margin borrowing, it means that you're borrowing money from the brokerage and using your existing stocks or other eligible securities, depending on what you're investing in, as collateral.

Speaker 2 So your brokerage kind of becomes like the guy behind the counter at the pawn shop. But instead of your jewelry, you're using your stock holdings to secure a loan.

Speaker 2 You tell the broker, hold on to these shares for me. I promise to repay you what I borrow, but if I can't, these shares are all yours to sell to recover your money.

Speaker 2 You're essentially agreeing to let the broker use your current investments as a safety net. And by doing that, you're reassuring the brokerage that it won't be left in a lurch if things go south.

Speaker 2 This is a new way to think about your brokerage that is totally legit. Your brokerage isn't just the home of your investments.
Your brokerage can also lend you money.

Speaker 2 Just like your bank might lend you money to buy a house, your brokerage lends you money to buy securities. This service allows you to amplify your purchasing power in the stock market.

Speaker 2 Of course, this kind of lending isn't a free-for-all. You enter into a margin agreement when you set up a margin account.

Speaker 2 This agreement outlines what you can do, the interest rate on your borrowed funds, and the brokerage's terms for potentially selling your securities collateral if you can't meet a margin call.

Speaker 2 A margin call happens if the value of your collateral, the securities that you bought plus any others in your margin account, drops below a certain point, the brokerage will ask you to deposit more money or to sell some of your securities to balance out what you owe.

Speaker 2 This is the brokerage's way of ensuring that the loan remains secured. More mathiness in just a sec.
But first, I should mention your brokerage also isn't just going to give you money for funsies.

Speaker 2 It's a loan, which pretty much always means interest payments.

Speaker 2 The interest rate on margin borrowing for investments can vary depending on a whole mess of factors, like which brokerage firm you use, the amount you want to borrow, the market conditions.

Speaker 2 Generally, the interest rates on margin loans are calculated based on a broker's base rate plus a certain percentage that can increase as the amount of borrowed money goes up.

Speaker 2 That all translates to rates landing between below 2% to over 9%.

Speaker 2 For larger brokerages, you might see lower rates due to the ability to lend at more competitive terms.

Speaker 2 It is really important though for you to check specific rates offered by your brokerage as these often change based on shifts in the broader financial landscape, like changes to the Federal Reserve's interest rates, which by the way just kept steady this week.

Speaker 2 Hey yo. So playing on margin comes with some perks.
It supercharges your buying power and allows you to snatch up more shares than cash alone could grab.

Speaker 2 And that gives you a bigger shot at bigger returns. By doing all that, you're maximizing your investment opportunities.

Speaker 2 If you see a stock or a fund that you think is a great opportunity, but you're short on cash, margin has your back.

Speaker 2 And that enables you to act quickly and to snag those shares before the opportunity disappears. And you get ultimate flexibility with margin.

Speaker 2 You don't need to wait for the funds to clear like you would depositing cash from a bank. And you don't need to sell assets to wait for that transaction to post.

Speaker 2 You can get up and running pretty quickly with margin. And now that we've covered that base, let's talk about the risks because they are significant.

Speaker 2 Just like margin can amplify gains, it can also magnify losses too. A dip in stock prices might just be, oh, whatever in regular scenarios.
We know that, right?

Speaker 2 The stock market goes up, the stock market goes down, that's kind of its thing. But a dip in stock prices when you're borrowing money, that's not a oh, whatever.
That's more of a, oh, you know what.

Speaker 2 And then there's the dreaded margin call I alluded to earlier. This is definitely the worst case scenario of margin borrowing.

Speaker 2 If your investments dip below a certain value, your brokerage will call your debt asking you to add more cash or securities into your account pronto.

Speaker 2 If you can't meet a margin call, they might just sell your stocks to cover it, potentially causing you to cash out at the worst time.

Speaker 2 And brokerages typically have a hard and fast rule around how low your investments need to dip before they can issue a margin call.

Speaker 2 Typically, they require 30% for what's called a maintenance requirement. But this concept is a little easier to follow with a number trail.
So let's use your 10K investment again as an example.

Speaker 2 Say your brokerage requires that 30% maintenance requirement. You put in 5K plus another 5K from your brokerage as a margin loan.
So your brokerage has 50% equity in that investment, right?

Speaker 2 Half of your investment is theirs until you pay it back.

Speaker 2 If whatever you invested in drops and your 10K is now worth only 6K, the investor equity has also dropped to 1K or the 6K value minus the 5K loan or just 17% of your total investment.

Speaker 2 But your brokerage has that hard invest rule that they need to have at least 30% equity in your investment. So this drop would trigger a margin call.

Speaker 2 And when that happens, your brokerage is going to need you to give them 30% of that new 6K value, which is 1800 bucks. You do have some time to come up with this money, but it's not a lot of time.

Speaker 2 It's around two to five days.

Speaker 2 And in order to come up with that money, you could either deposit 1800 bucks into the account, or you could sell other investments in order to put money into the account, or you could deposit more marginable securities, which is a little bit more complicated.

Speaker 2 But the big picture here is you're going going to have to come up with the cash at a time when your investments are down.

Speaker 2 And if you needed to borrow on margin anyway, you probably don't have a lot of liquid cash. So this whole story adds up to being a pretty ugly picture at this point.

Speaker 2 To play it safe on the margin tightrope, you need to know your limits. Just because you can borrow a lot doesn't mean you should.

Speaker 2 Assess your own financial landscape and decide how much risk you can comfortably handle.

Speaker 2 And while I prefer less risky strategies where you don't need to keep your eyes glued on your brokerage account, with margin borrowing, you do need to keep a close eye on your investments and your account balance.

Speaker 2 Setting alerts for significant market moves can help you react quickly and wisely. For today's tip, you can take straight to the bank.

Speaker 2 If you do want to try a margin loan to get the best terms possible, you should compare margin rates at different loan amounts because the rates can be tiered based on the margin balance.

Speaker 2 But always, always remember that while borrowing on margin can amplify those gains, they can also magnify those losses.

Speaker 2 Money Rehab is a production of Money News Network. I'm your host, Nicole Lapin.
Money Rehab's executive producer is Morgan Lavoie. Our researcher is Emily Holmes.
Do you need some Money Rehab?

Speaker 2 And let's be honest, we all do.

Speaker 2 So email us your money questions, moneyrehab at moneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me.

Speaker 2 And follow us on Instagram at MoneyNews and TikTok at Money News Network for exclusive video content. And lastly, thank you.
No, seriously, thank you.

Speaker 2 Thank you for listening and for investing in in yourself, which is the most important investment you can make.