When I first started investing I wondered what the difference was between a cash and margin account. I found out that cash accounts don’t let you use debt, while margin accounts do. But, then my next question was, does margin have to be used if you have that type of account?
No. Margin accounts do not require margin use. You can choose to buy stocks on margin if you don’t have enough cash for purchase, otherwise cash is used. Margin accounts are required if you want to trade options like calls and puts or short sell a stock.
Margin accounts have been getting a lot of attention lately. This is likely because of the many new types of brokerages that have been popping up recently. For example Robinhood and Webull are just two such brokerages that seem to throw you in the deep end with margin accounts.
The Use of Margin in a Margin Account
I only have a margin account on Webull currently, so I can’t really say much about the use of margin on other platforms. However, on Webull the margin is only triggered once I have bought more stock than I have cash currently in my account.
So in order to make sure that you don’t use margin you will need to have enough cash for all of your trades. Once you start using margin you will need to start paying the fees associated with your margin loan.
For Webull these fees look pretty steep currently sitting at ~7% annualized. That’s a lot more than my 30 year home loan. But, I’ve seen other brokerages like Interactive brokers only charge a 1.6% fee which is much better than my home loan. So in that case margin may be beneficial.
How to Open a Margin Account
In order to open a margin account you will need to first choose which broker you would like to use. Once you have chosen your broker you can then fill out the information like you would opening any brokerage account.
Then it will finally as you the big question. Account type: Margin account or cash account. In this case you will need to choose a margin account and you should be all set. There may be one more step where you need a signature, but I think many do digital signatures nowadays anyways.
There may be some extra steps brokers take in order to educate you on how to use your newfound margin account. A lot of the new brokerages require you to go through this educational information in order to use your margin account or call and put options since many investors have been getting into trouble using margin during 2020.
A Margin Account and Your Credit Score
Since margin is debt, I wondered if it would affect my credit score like other debt does. In fact it does, but only if you cannot pay back your debt in the event of a margin call.
In this case if you can’t pay back your outstanding margin loan it will affect your credit payment history, which is a huge part of your credit score. All other parts of your credit score are not affected by a margin account.
Margin accounts can only hurt your credit score, but never help it. So if your looking to build credit, then a margin account won’t work. Margin accounts use your stock portfolio as collateral to determine your credit worthiness. Brokerages will trigger a margin call if your account is greater than 50% margin debt.
Margin is Difficult For Value Investors
Margin can be a bit tricky when used to invest in stocks. Especially for value investors. ExploitInvesting.com is a value investing website so I like to look deeply at whether or not what I’m learning is viable with a value strategy. The answer, like many things, is it depends.
Margin rates are variable, this means that they can change along with interest rates. Not only that, but a large drop in your stocks could trigger a margin call driving your portfolio down fast. So margin can be great in your portfolio until suddenly it isn’t.
As a value investor I tend to invest over a longer time frame, and margin debt is best used for short term bets on the market. That isn’t to say that small amounts of margin can’t be useful, its just not worth the cost of failure. Some value investments can take years to turn around, and that uncertainty is why its difficult to use margin with a value investing strategy.
Investors like Warren Buffett actually did use leverage in their early years, but in those days I doubt it was specifically margin but instead good old fashioned debt.
Margin may effectively be used when deploying one of Warren Buffett’s workout strategies. These are typically events where you are taking over a company or engaging in share arbitrage with a company stock merger.
Benefits of a Margin Account Without Using Margin
The benefits of having a margin account don’t really outweigh the costs. So unless you want to sell stocks short or borrow to buy more stocks it doesn’t make too much sense to use. If you are a beginner a cash account should work just fine for your needs.
I have a cash account with Interactive brokers and don’t have to wait for the cash to clear before I can buy more stocks. However, if you want to withdraw money, it may take a bit longer. My margin account on Webull also lets me buy stocks immediately once I sell them.
There are many out there that believe you can’t turn around and buy a stock without a margin account. I have honestly never come across this problem. But, if I do I’ll certainly let you know, and if that’s the case you can simply get a margin account and not use the margin feature at all.
Paying Off Margin Loans Once Utilized
If you have a margin account especially on a brokerage like Webull you may not realize you have even utilized margin. This is because it doesn’t show you how much cash you have when buying a stock. I think this may be a tactic to push people into using margin without realizing it.
Whether it is or not, is beside the fact, if you end up going over your cash balance and have to use margin don’t fret, you can always sell some stock to bring your cash balance positive paying off all of your margin loan.
How the Rich Use Margin With The Best Rates
If you are ready to take your investing to the next level and want to juice your returns using margin then it’s important to find a broker with the best margin rates. Many brokerages will offer better rates if you borrow more money. This makes it especially beneficial for the rich.
If you can find a platform like Interactive Brokers with incredibly low margin rates then you can essentially borrow your way to riches and avoid taxes. Think of it this way, if your portfolio is increasing by 7% per year on average borrowing a small amount of your portfolio on margin won’t affect the overall portfolio value much. In turn you can avoid capital gains taxes you would normally have from selling your stock.
Not only will you be able to avoid capital gains taxes for the time being, but you also get a tax break from your margin loan! Debt, can be really useful for the rich you just have to know how to use it.