Investing with margin

Capital at risk. The value of your investments can go up and down, and you may get back less than you invest.

When it comes to investing, using ‘margin’ refers to borrowing money from your broker to buy securities, like stocks or bonds.

As with other loans, you have to pay back the money you borrowed plus interest. In this instance, you’re using cash or securities you already own as collateral (assets the lender can sell in case you can’t repay the loan) to invest more in the hope of making a bigger profit. The idea is to increase your initial investment to give it more opportunity to grow, then pay back the loan and keep the returns.

It’s important to flag that margin trading comes with risks, though. If the amount you borrowed gets too large relative to the value of your securities, you will have to deposit more funds or sell securities to reduce your margin loan. Otherwise, your broker may sell off some of your assets. And remember, even if you lose your entire investment, you’ll still have to repay what you borrowed, with interest.

You need to weigh up the pros and cons, and understand the risks you’re taking. What you do with the money you borrow is your decision but, ultimately, you’re on the hook for that amount plus any interest. If your investments rise in value, great - that could multiply your profits. But if your investments fall in value, margin could multiply your losses.

Tell me more…

• What is margin trading?
• How does margin trading work?
• Why would you buy on margin?
• Margin calls
• How do you buy stock on margin?
• How much does it cost to invest on margin?
• Is buying on margin a good idea?

Buying on margin involves using a combination of your cash or other assets and borrowed funds from your broker to buy securities like stocks and bonds. For example, you may pay 60% of the cost, and your broker may lend you the other 40% to make a purchase. You pay interest on the amount you borrow. When you sell the securities, you pay back the loan. If the assets have gone up in value, you make a profit. If not, you may lose money on the investment, and you still have to pay back what you borrowed.

With Robinhood, margin investing access isn’t automatic - you have to apply and will only have access if you meet eligibility requirements.

Profit example

Let’s say you deposit $5,000 in cash and borrow $5,000 on margin, for a total of $10,000. Each share in the company you’re interested in costs $100.

If you buy and the stock price increases to $125 per share, your holding is now worth $12,500. Since $5,000 of your initial purchase was bought on margin, you now have $7,500 in portfolio value and you owe $5,000 in margin, plus any fees incurred.

In this scenario, there’s an unrealised profit of $2,500 as opposed to $1,250 if you hadn’t invested on margin.

Loss example

Just like in the previous instance, let’s say you deposit $5,000 in cash and borrow $5,000 on margin, for a total of $10,000, in order to buy 100 shares worth $100 each.

If you buy and the stock price falls to $75 per share, your holding is now worth $7,500.

In this scenario, there’s an unrealised loss of $2,500 as opposed to $1,250 if you hadn’t invested on margin.

People choose to buy on margin to own more of a security than they would be able to with their current budget. One reason to use margin instead of naturally increasing a holding over time might be if you believe the price of a security will rise in the near future, and you want to buy more of it now in order to benefit from a potential price change. However, buying on margin, like investing in general, does not guarantee a gain and carries significant risks, including the potential for this outcome to not happen. Another reason to use margin might be to diversify a concentrated portfolio without selling a holding.

Other than the risk of increasing your losses, as we talked about above, there are some other aspects of using margin you should know about.

What is a margin call?

A margin call is a request from your broker to increase the amount of cash in your account. It happens when you fall below the required maintenance margin. In other words, you owe the broker more than brokerage and FINRA rules allow, relative to the value of your stocks or bonds. The broker will ask you to deposit funds or securities to bring the account up to the margin maintenance minimum. If you can’t deposit the assets quickly, the broker may sell some of your securities. Note that your broker doesn’t necessarily have to tell you before they start selling your assets.

Margin investing is an optional product. You have to apply, meet eligibility requirements, and pass an appropriateness test to get access.

The first step is to find a brokerage that offers accounts that allow you to buy on margin. When you apply for a margin account, the broker may consider your income, net worth, credit history and other factors when deciding whether to issue approval. It is wise to read the margin account contract carefully to make sure you understand all the terms.

Once the broker has approved your margin account, you’ll need to deposit funds. The Federal Reserve Board, which governs the US central banking system, requires a minimum 50% initial margin (meaning you can fund half of the purchase price and borrow half), but brokerages can choose to require more.

The Financial Industry Regulatory Authority (FINRA), a government-authorised regulator of brokerage firms, mandates that investors deposit at least $2,000 in cash or securities before trading on margin, but your broker can require a higher amount. You also need enough cash to cover your share of the purchase.

If you buy on margin, FINRA also requires you to keep at least 25% equity in your account with the brokerage, known as the maintenance margin. You can calculate your equity by taking the value of securities you own and subtracting the amount you owe to the broker. Your brokerage may require a higher maintenance margin than FINRA does. If you fall below this floor, you can’t continue buying on margin. You may also have to repay the amount borrowed quickly if the value of the security purchased on margin, or of your entire portfolio of assets continues to drop. This is known as a margin call.

Just like a normal cash loan, margin carries its own interest rates for the borrower. You can check out Robinhood’s margin rates here.

Interest is calculated daily at the end of the day based on settled margin balances.

Example

If you use $3,000 of settled margin, we’ll calculate daily interest as follows (using an illustrative 6.25% rate):

• $3,000 settled margin is subject to interest
• $3,000 * (6.25% / 360) = $0.52 per day

Note, a $3,000 margin loan is equivalent to £2,419 based on the average exchange rate of 1.24 in 2023. The daily interest charge would be $0.52 which is the equivalent of £0.42 based on the same rate. We’ll charge the margin interest to your investing account every 30 days at the end of your billing cycle.

The margin interest rate may change at any time without notice and at Robinhood UK’s discretion.

Given margin involves increased risk, it’s important to consider your personal situation, financial goals and risk tolerance. This means it might be a useful route for some investors but not others. Your ability to withstand losses and your level of understanding about how margin works also play a role in whether this strategy is right for you.

When buying on margin goes well, you might make a profit while investing less money. But risks can be significant. If your securities lose value, you not only lose money on the investment but still have to pay back the money borrowed with interest. You also run the risk of a margin call, which requires you to pay funds back quickly or have your securities sold off to cover the debt. Even if your investments don’t drop in value, you still have to pay interest for borrowing funds, which you wouldn’t have to do if you only invested money you had.

Important information

When you invest your capital is at risk. Past performance is not a reliable guide to future gains. Your investments and the income you receive from them may go down as well as up so you may get back less than you invest.

This article is meant for educational purposes only. Make sure to do your own research on what investments are right for you before investing or consider seeking expert advice.

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