Margin debt is a sometimes-overlooked but key part of the stock market that is particularly pertinent right now.
It is the money that investors borrow from stockbrokers to buy securities when they can’t or don’t want to fund the entire purchase with cash. Say an investor wants to purchase 100 shares at $50 each for a total of $5,000 but has only $2,500 to invest. That individual could buy the rest of the shares on margin. The same process can be used to buy exchange-traded funds.
Investors frequently use margin to get more bang for their investing buck. “The pro of margin is that it increases your purchasing power,” says Jeff Deiss, director of wealth planning at ACM in Ridgewood, N.J.
The downside is that brokers typically charge interest on borrowed money. And if the individual starts losing money on the investment, the stockbroker might ask for additional cash as security or collateral. That decision and how much cash will be required will depend on a variety of factors, including the remaining value of the investment, how much money the investor owes the broker and the requirements of the broker.
“Buying on margin comes with a lot of risk, and if you are going to use margin, it is probably a good idea to have some cash on the side,” says Mr. Deiss. Investors who don’t have the required additional cash may be forced to close out their positions at a loss.