Money Advice Guide

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.

Tags: Buying stocks, finance, financial advice, investing, investment advice, money tips, stock marketBuying stocks, finance, financial advice, investing, investment advice, money tips, stock market

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When this president’s father was in the Oval Office, he was fond of singing the praises of the “New World Order” that was to arrive. The phrase carried a lot of baggage, especially with conservatives who had long heard the term associated with a one-world government with little room for individual rights. Some believe the first George Bush’s attachment to this term hurt his chances for re-election, and contributed to the movement that brought Ross Perot into the fray and split the conservative vote.

The current president has steered clear of the specific terminology, but only an ostrich with his head in the sand would say that we are not moving headlong toward a reorganization of the world system, and it has become clear that individual rights are at risk. The war in Afghanistan was not only inevitable, but was probably desirable. Iraq was no ones’ friend, and even those of us who questioned the wisdom of invasion had difficulty opposing the end of such an abusive regime. However the trend is disturbing as we now speak casually of invading Syria, Iran, or North Korea. Not only does the war posturing make us globally unpopular (and therefore unable to extol the virtues of free markets), wars also bring with them serious limits on freedom at home. We’ve begun to see some of that.

Laws like the Patriot Act are so comprehensive that most of us are likely violating a half dozen edicts without knowing it. The difference this time is that conservatives are largely supportive of all these actions. Strangely, all the things that Bill Clinton could never have gotten past the Republican Congress are sailing through with little forethought.

Meanwhile, we have lost the attention of nations around the world. We imagined that the menace of communist based philosophies died with the Berlin Wall, but now we are faced with socialists winning elections worldwide. The new look of the “World Order” is not a pretty one, and clearly not one that values freedom. Yet we have no voice in world affairs, where many smaller nations have begun to view America as a bully. The fact that we are “in the right” isn’t important in this area, as one cannot force freedom’s acceptance. It is a tenuous choice that a nation must make for itself. The approach we’ve taken recently has limited our ability to offer our wisdom.

In light of these world changes, it may be wise to consider our investment strategies. It is fair to say that investing overseas may meet with some difficulty, but if trends continue, we may see trouble here as well. Alas, so much of American business success is due to exports, yet we’re faced with protectionist barriers coming up against us in many nations. Some of this is justified, because although other nations tend to have much higher barriers, America has recently begun to impose rather restrictive tariffs as well. The idea of a free-trade zone, such as NAFTA, actually is an enemy to true free trade, because it actually prevents free trade with nations outside the limited trade bloc.

All of this may eventually impact American companies, as they find international trade opportunities severely restricted. The past two decades were a time of relative freedom internationally for travel, trade, and discussion. That may change, and if it does, the impact could be devastating. The last time we restricted world trade to this extent, the period culminated in the great depression. We’re a long way from that today, but without some wise leadership, we may find ourselves facing further difficulties. Thus far, sadly, this administration has shown little strength in economic issues.

Changes in the world make our investment strategies critical to our future. More than ever, a careful plan is vital to our ability to weather the storms that may come in the economy.

To send comments or to learn more about Scott Pearson’s Investment Management Service, 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.

Tags: economy, finance, financial advice, future, investing, investment advice, stock market, value stockseconomy, finance, financial advice, future, investing, investment advice, stock market, value stocks

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