## There are two types of margin when it comes to your money. One is good; the other is bad.

The good kind of margin is in your *budget*. It’s money leftover after paying all of your bills and obligations. We sometimes call it discretionary income.

You need *this* margin so that you can save for emergencies and invest for the future. That’s why we call it good, and so does God’s Word. Proverbs 21:20 says, *“Precious treasure and oil are in a wise man's dwelling, but a foolish man devours it.”*

The other kind of margin involves your investments; it’s really a form of gambling and that’s why we call it bad. Thankfully, margin investing is generally prohibited in qualified retirement accounts, such as your 401k or IRA.

That still leaves regular brokerage accounts, however, where margin investing is not only allowed, in many cases it’s encouraged by brokerages.

According to [Yardeni Research](https://www.yardeni.com/pub/stmkteqmardebt.pdf), investors who used margin currently owe around $750 billion dollars. That figure is down from a year ago, so the trend is heading in the right direction, but that still leaves an enormous risk for margin investors, especially when there’s market volatility.

## What exactly is margin investing? It’s when you borrow money from your brokerage to invest more than you could with your *own* money. You’re actually betting that the stocks you buy with margin money will increase in value. If they do, you’re a winner, but if they *don’t*, you’re in for trouble.

Let’s say you inherit $50,000 from your rich uncle. You can’t put the money in your 401k or IRA, because you can only fund those accounts with *earned* income. Instead, you open a regular brokerage account, as with Fidelity, Vanguard or Schwab.

Then you hear about this amazing opportunity to invest “on margin.” The Federal Reserve allows investors to borrow from their brokerage up to 50% of the purchase price of stock.

That means with your $50,000, you can actually buy $100,000 worth of stock, doubling your holdings. If the stock increases in value, your gains would be twice what you’d make with just the $50,000.

That’s a big *if*, however. If the stock declines, you’re on the hook for the losses. In theory, you could lose your entire portfolio if the stock went to zero because your initial $50,000 is collateral against what you borrowed.

If you don’t think a stock can decline that much, or nearly so, consider that In 2000, Enron stock was selling for around $90 a share. A year later, after a horrific accounting scandal, it sold for $.26 a share. Investors lost billions.

## Why would a brokerage want you to invest on margin? When you think about it, it’s much like borrowing chips from a casino to gamble with. You wouldn’t dream of doing that, but investing on margin is really the same thing.

Also, brokerages make it easy to do, because they charge interest on the margin money they loan, increasing their revenues. Since your loan is collateralized by the money you put in, their risk of losing is practically nil.

Of course, you must *apply* to invest on margin and provide financial details just as you do when applying for a mortgage, but that’s not much of a barrier.

One popular investing platform, Robinhood, has gotten something of a bad reputation for *pushing* margin investing too hard, and earning 5% interest on the money it loans. 

Of course, when the value of stocks bought with this leveraged money goes up, everyone is happy. When it drops, however, investors are losers and potentially, big losers.

## If the value of the stock bought with borrowed money drops low enough, as it certainly did with Enron, investors experience what is known as a “margin call.” That’s when the brokerage suddenly demands more money to hold the investment.

In the example we used, that will happen automatically when the value of your total $100,000 investment drops to $25,000, the 25% maintenance margin required by law. However, many brokerages will issue a margin call well before that.

If you can’t come up with the additional funds within what is usually a short time frame, the brokerage can then liquidate your investment, meaning they take the money you put in to cover their losses.

The key to successful investing is to have a well-balanced portfolio and to hold it for a very long time. Investing requires patience, so we can’t urge you enough, never invest with margin. The risk is simply too great.

__Proverbs 21:5 tells us that, *“Steady plodding brings prosperity; hasty speculation brings poverty.”*__

You can also __[listen](https://www.moneywise.org/search?q=The%20Perils%20of%20Margin%20Investing&videos=true&articles=true&podcasts=true&posts=true&groups=true&events=true&support=true)__ to the related podcast on this topic.

FaithFi

Articles

There are two types of margin when it comes to your money. One is good; the other is bad.

INVESTING | Jul 18, 2022

The Perils of Margin Investing

By: Rob West & Jim Henry

Where Faith Meets Finance

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