Learn how experienced investors comfortable with the risk of margin trading can view a margin account as a “reserve fund.”
If you’ve been investing for a while, you’ve probably heard of margin, and you might know that buying (or trading) on margin means buying securities with borrowed money. You might even know that Regulation T — often referred to as Reg T — says that brokers may lend qualified clients up to 50% of the purchase price of a marginable security, with the balance being posted by the client as cash or securities.
But have you ever thought of margin buying power as a “reserve fund” that might help you diversify your holdings? It’s an interesting concept, and one that carries certain risks, but here it is in a nutshell.
Let’s imagine this hypothetical scenario. You’re an experienced investor who’s heavily invested in 3 out of 11 stock market sectors. Why only three? You know these companies well, and they happen to fall within a narrow range of market exposure. Up to now you were comfortable with the concentration, as you had identified it as the early stages of a bull market favoring those sectors.
Suppose your assessment has worked out in your favor over the last several years, and now you’re sitting on a fat unrealized gain.
But now you’re at a potential crossroads. Like every experienced investor, you’ve seen your share of market cycles, from bull to bear and back. Here’s your current assessment:
Enter margin. In this scenario, your initial account deposit of $50,000 is still invested in your positions. But you also have a margin account, meaning you have twice the buying power of the current value of your portfolio. Since, in this scenario, the account value has risen above the initial $50,000 deposit, your buying power should be in excess of $100,000.
You can look at this margin buying power as “reserve capital.” Perhaps you could consider using it. But first, take note: Margin is leverage, and leverage can be a double-edged sword. It can magnify your gains, but also your losses. It’s possible to lose more than the initial amount used to purchase the stock. If price fluctuations cause margin equity to fall below a certain amount, your broker will issue a margin call. The broker may try to give you some time to meet the margin call, but also can close out your positions without prior notice to you. So, if you understand and are comfortable with the risks and potential rewards of this strategy, read on.
Not sure if you have margin privileges in your account? See figure 1 below.
FIGURE 1: APPLYING FOR MARGIN PRIVILEGES. Log in to your account at tdameritrade.com and under My Profile > Elections & Routing > Margin trading check to see if margin trading is enabled. If not, a green Apply button will appear. Source: TDAmeritrade.com. For illustrative purposes only.
With a standard margin account, your capital is essentially double the amount of your cash deposit. You’re borrowing money from the brokerage in order to double your buying power. But just because you have more buying power doesn’t mean you always have to use it. And in your case, margin has been a reserve for special purposes and circumstances. Diversification is one of them, you’ve decided.
When you initially deposited your $50,000 cash, your total margin buying power was double, or $100,000 ($50,000 cash + $50,000 margin). With your initial cash invested, you can decide whether you want to deploy part or all of your remaining margin buying power. Keep in mind you must maintain a minimum of 30% of the total value of your position as equity at all times.
Now it’s time to diversify. But diversify into what, and where? You’ve decided that you need some kind of a market map that lays out where you are in relation to the broader market; a tool that can penetrate the “noise” with a visual assist that cuts down to the raw data driving the surface; something that functions somewhat like an “X-ray” aimed at your portfolio exposure.
If you’re a TD Ameritrade client, you can use Portfolio X-Ray, a tool that lays out your market exposure across several different angles, including:
See figure 2 below.
Portfolio X-Ray provides you with a quick snapshot of your exposures—where you are and are not invested in terms of stocks, sectors, asset types, and world regions. It’s a starting point from which you can begin constructing a more diversified or more defensive strategy.
So, if you should find yourself in the above scenario (or one similar), and you’re comfortable with the risks of margin trading, you can consider tapping into the “reserve buying power” of your margin account. The leverage that margin provides can allow you to be more flexible in managing your portfolio.
Is margin trading appropriate for your financial profile, risk tolerance and financial goals? Contact a TD Ameritrade representative to help you make the assessment. For additional videos, resources and support on margin trading, visit the TD Ameritrade margin page or watch the video below. For additional hands-on support, trade desk associates are available day and night to assist you with your margin trading. They can help you get comfortable with TD Ameritrade trading platforms, answer your toughest questions, and more. Call 866-839-1100.
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Margin trading increases risk of loss and includes the possibility of a forced sale if account equity drops below required levels. Margin is not available in all account types. Margin trading privileges subject to TD Ameritrade review and approval. Carefully review the Margin Handbook and Margin Disclosure Document for more details.
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