A pretty conservative co-worker came to me today and said it is ‘time to bet against the market President Obama is speaking on Thursday and the market consistently falls when he speaks about the economy’ and it got me to thinking about ‘betting against the market.’ I don’t short stocks, it isn’t that I am against betting against a particular stock or market sector via an ETF, rather, I am pretty conservative and simple when it comes to investing. Notwithstanding, I do bet against the market in a different way, I buy stocks that I feel are depressed usually in my Dividend Investing Portfolio, however, I rarely just have cash sitting in the account. My cash is sent over in $50, $100 or $200 increments over the course of the week as I make my side income. So this leaves me in a position where I want to buy a particular stock or ETF that has taken a bit hit that day, but with no cash to make the trade unless I wait 3 or 4 days.
When I presented the problem to the co-worker he looked at me funny, and asked why I just didn’t open a margin account?!
What is a Margin Account?
According to Investopedia a Margin Account is
A brokerage account in which the broker lends the customer cash to purchase securities. The loan in the account is collateralized by the securities and cash. If the value of the stock drops sufficiently, the account holder will be required to deposit more cash or sell a portion of the stock.
So I am technically taking on Debt? Technically, Yes. However, I am not planning to use the margin account to go deep into debt. My plan of account is simply to just purchase a couple hundred dollar lots when my money is in the midst of being cleared to take advantage of unusually low hits in the market.
Risks with Using a Margin Account
Of course there are risks when Investing and even more so when doing so on Margin. From Fidelity:
Two of the risks associated with margin borrowing are:
- Leverage risk
- Maintenance call risk
Leverage works as dramatically when stock prices fall as when they rise. For example, let’s say you use $5,000 in cash and borrow $5,000 on margin to purchase a total of $10,000 in stock. Suppose the market value of the stock you’ve purchased for $10,000 drops to $9,000. Your equity would fall to $4,000, which is the market value minus the loan balance of $5,000. In this instance, you could suffer a loss of 20% due to a 10% decrease in market value.*
Maintenance Call Risk
If the securities you hold fall below the minimum maintenance required, your account may incur a margin call. Margin calls are due immediately. It’s smart to leave a cash cushion in your account to help reduce the likelihood of a margin call.
Sometimes you may face higher maintenance minimums, especially when the securities you’re holding carry additional risks, such as concentration risk
Opening a Fidelity Margin Account
I have no idea what it is like with other discount brokers but it couldn’t be easier to open my Fidelity Margin Account. They just asked a few simple questions:
- Company Name
- Company Address
- Estimated Income
- Estimated Tax Bracket
I was shocked that they did not ask for my social security number or my permission to run a credit check. However, as stated earlier they use a portion of my brokerage account as collateral so I guess they don’t really need it! If I get in the hole and they want their money Fidelity will just sell my “stuff” lol.
Do you have a Margin Account? How do you use it?