Margin Benefits are Marginal at Best

Margin is one of those things that novices find puzzling about the stock market, but the concept is really quite simple. Still, with understanding the basics of using margin accounts, determining the wisdom of using margin can be quite a conundrum.

A margin account is a traditional investment account with margin privileges.

This means your broker has set up what amounts to a line of credit secured by the stocks and bonds in your account. Often this margin credit line is used to buy more stocks in the same account. But the account can also be borrowed against to buy real estate, make other kinds of investments, or simply to pay personal bills. The simple requirement is that enough assets must be kept in the account to maintain a certain value as collateral for the loan.

This is where trouble comes in. It's easy enough to maintain that collateral level when all is well, but when the economy becomes difficult and you are strapped for cash, this is also often the time when the market may drop. When the market drops temporarily, your equity value may fall, but the value of your debt doesn't change; you may encounter a "margin call" when you can least afford it.

A margin call is similar to any other loan being called in. You must pay up immediately. If you don't have the cash, your stocks and bonds are sold automatically to pay your debts. This compounds your problem: you end up selling your stocks when they are down, usually the worst possible time. Remember, the idea is to buy when prices are down and sell when they are up. So, in addition to all the other problems, margin loans can force you to make poor investment moves. In times of market crashes, a heavily margined account might be completely lost when the market drops only a fractional amount.

This leads to the idea of leverage, which is what margin accounts represent. Anytime you borrow to invest, you leverage your investment, or buying more than you can afford for a fractional down payment. Since one is buying stocks with borrowed money, or borrowing against stocks already owned, this is the result. Buying a home with a mortgage is a very similar process, but since the bank doesn't typically call your loan if home prices dip temporarily, many of the problems listed above do not arise. Still, a 95% mortgage is a highly leveraged deal, and it is very easy to lose your entire investment with even a small change in real estate prices. Even a typical 80% mortgage can wipe out the entire investment in a poor market.

Despite the many risks associated with margin or other forms of leverage, there definitely are advantages. Certainly, we've emphasized the opportunity to lose money faster, but you can also make money faster using these tools. If half of your equity comes from margin, you can gain money twice as fast. As stocks go up, your profits are compounded, because you own twice as many shares as you could normally afford. Thusly, when the market drops, you lose twice as fast.

Also, some people benefit simply by having a margin credit line available, without making use of it at all, or by only using it for short-term turnover. If used judiciously by a disciplined investor, there is virtually no risk in having access to a margin account. It is the use of the debt obligations that carry the costs. Imagine having a credit card that is never used, but the credit line is available in case of major emergencies.

In the end, leverage simply means that your gains or losses will be multiplied. Each investor must consider for him/herself the acceptable level of risk. However, we firmly believe that there are other risks, which carry better payoffs than simple use of leverage. While it is good for most investors to have access to margin, it may not be wise to use it often. In addition to interest costs, the added risks may end up causing more harm than good.

To send comments or to learn more about Scott Pearson's Investment Advisor Services, visit http://www.valueview.net

Scott Pearson is an investment advisor, writer, editor, instructor, and business leader. As President and Chief Investment Officer of Value View Financial Corp., he offers investment management services to a wide variety of clients. His own newsletter, Investor's Value View, is distributed worldwide and provides general money tips and investment advice to readers both internationally, and in the U.S.

---

Google News Updated : Fri, 05 Sep 2008 08:05:30 GMT Stocks: A Terrible Thursday - BusinessWeek Washington Post Stocks: A Terrible Thursday BusinessWeek - 2 hours ago Major US indexes each tumbled nearly 3% as worries intensified over the health of the economy. All eyes are on Friday's jobs report Market players were probably wondering Thursday why they bothered to come back from their summer vacations. Stocks Are Broadly Lower Tracking Falls on Wall Street Wall Street Journal Stocks slide on economic worries CNNMoney.com Seattle Times - Los Angeles Times - Forbes - New York Times all 821 news articles Publ.Date : Fri, 05 Sep 2008 05:53:27 GMT Kilpatrick's rise and fall - Detroit Free Press Washington Post Kilpatrick's rise and fall Detroit Free Press - 37 minutes ago BY BILL McGRAW • FREE PRESS STAFF WRITER • September 5, 2008 Kwame Kilpatrick entered the mayor's office with extraordinary gifts -- charisma, savvy, flair, pedigree, connections, ambition and chutzpah -- everything a 31-year-old needed to make a ... Video: A Timeline of Detroit Mayor's Text Scandal AssociatedPress Detroit’s Mayor Will Leave Office and Go to Jail New York Times Chicago Tribune - San Jose Mercury News - DetNews.com - Wall Street Journal all 5,822 news articles Publ.Date : Fri, 05 Sep 2008 07:27:50 GMT Arthritis Drugs Linked to Risks From Infection - New York Times WNCT Arthritis Drugs Linked to Risks From Infection New York Times - 6 hours ago By AP WASHINGTON (AP) - The Food and Drug Administration ordered stronger warnings Thursday on four medications widely used to treat rheumatoid arthritis and other serious illnesses, saying they can raise the risk of possibly fatal fungal infections. Deaths Heighten Arthritis Drugs Warning WebMD Nation Digest 4 arthritis drugs get tougher warnings Seattle Times U.S. News & World Report - Reuters - Bloomberg all 491 news articles Publ.Date : Fri, 05 Sep 2008 01:38:34 GMT House committee widens probe of Vytorin safety - International Herald Tribune ChattahBox House committee widens probe of Vytorin safety International Herald Tribune - 7 hours ago AP TRENTON, NJ: A House committee investigating the safety and effectiveness of the popular cholesterol drug Vytorin and one of its components is turning up the heat on the drug's makers. Many Questions About Vytorin New York Times Drug Scare Shenanigans FOXNews Reuters - U.S. News & World Report - Forbes - MedPage Today all 547 news articles Publ.Date : Fri, 05 Sep 2008 00:32:18 GMT UN warns of Haiti flooding crisis - BBC News BBC News UN warns of Haiti flooding crisis BBC News - 1 hour ago Several hundred thousand people need help in Haiti, which is suffering severe flooding after being hit by a series of tropical storms, the UN says. Attempts to Aid Desperate Haitians Hindered by Floodwaters Washington Post Storms line up to slam western Atlantic, southeastern US AFP Telegraph.co.uk - The Associated Press - Chicago Tribune - Bradenton Herald all 2,575 news articles Publ.Date : Fri, 05 Sep 2008 07:05:26 GMT Tropical Storm Hanna aiming for Massachusetts - Boston Globe ABC News Tropical Storm Hanna aiming for Massachusetts Boston Globe - 3 hours ago By Andrew Ryan and Martin Finucane, Globe Staff Tropical Storm Hanna is expected to churn up the Atlantic coast and lash Massachusetts this weekend with winds gusting up to 50 mph near the coast and up to four inches of rain. Video: Hanna Nears US, but Stronger Ike Looms AssociatedPress Area departments gearing up for Hanna's arrival Attleboro Sun Chronicle Sun-Sentinel.com - Opelousas Daily World - The Associated Press all 5,279 news articles Publ.Date : Fri, 05 Sep 2008 04:23:14 GMT Jesse Jackson hospitalized for stomach pains - Chicago Tribune United Press International Jesse Jackson hospitalized for stomach pains Chicago Tribune - 1 hour ago By Jeremy Gorner | Chicago Tribune reporter Rev. Jesse Jackson was being treated Thursday in Northwestern Memorial Hospital in Chicago after falling ill. Video: Rev. Jesse Jackson Hospitalized AssociatedPress Jesse Jackson hospitalized after stomach pains USA Today Atlanta Journal Constitution - Entertainment Tonight News - CNN Political Ticker - AHN all 328 news articles Publ.Date : Fri, 05 Sep 2008 07:00:48 GMT Add RSS Feeds To My Web Pages Website Traffic Promotion

PARLOT::Ebooks, Scripts, Websites, and more...

Adsense websites

Retirement is Never Urgent Until

If you're like many people, your retirement savings have not... Read More

Investing in New Zealand - Learn how to Find Unique Investment Opportunities

Investing in New Zealand might be much easier than investing... Read More

Investor Guide to Financial Health

Step 1: Spend less than you earnPerhaps the simplest financial... Read More

Making It Second Nature

Not long ago I was laying on my son's floor... Read More

Shareholders Meeting Changing With Times

A significant number of corporations that settled accounts in the... Read More

Investment Rowing

You have rowed a boat at some time haven't you?... Read More

Dumb Money

Many people have, at one time or another, taken some... Read More

Protecting the Tax Advantage of Your Deferred Compensation

The American Jobs Creation Act of 2004 imposed strict new... Read More

Copy Cat or How to Use a Successful Trading System

How many books have you read about successful traders? How... Read More

Can Your Annuity Do This?

Okay, so I can tell you I have sat in... Read More

Selecting Rules for Investing and Trading

There are three important differences between investing and trading. Overlooking... Read More

Trading Is Not Rocket Science!

Despite what some people may lead you to believe; day... Read More

Commodities - The Next Big Wave of Fortune Building

Have you often wished you could have got in on... Read More

Getting Started In Investing

Are you ready to open your pathway to financial independence?Well... Read More

Franchise Investing, Franchise Opportunities and Franchising Renewals

Have you considered buying a franchise instead of trying to... Read More

25 Ways to Find Companies to Buy

When you start your program to purchase your "ideal" company,... Read More

Lobster Trapping for Investment Ideas

Recently, my family and I took a trip to Maine... Read More

The Myth of the Earnings Yield

AbstractA very slim minority of firms distribute dividends. This truism... Read More

401(k) Plans

I've been in and interested in the stock market so... Read More

Financial Planners

"Financial planners are like dentists: they may occasionally inflict pain,... Read More

Justify Social Security ... Dont Save for Retirement

It is a common question when investors review their retirement... Read More

Investing Offshore for Retirement

As an expatriate you are in a privileged savings and... Read More

The Basics of Tax-Free UK Financial Spread Betting

Financial Spread Betting (or Trading) offers a tax free method... Read More

Making Your Investment Dollars Work for You

Investments are scary for some people, especially those who have... Read More

The Arrow-Debreu Contingent Claims Model of Investment

Throughout the discussion of speculation and stability, we emphasized that... Read More