What is Margin?
Margin is an account feature that most brokerage firms offer to their customers whereby the customer can borrow money against the value of their securities portfolio. The borrowed money can either be used to purchase additional securities or, in some cases, withdrawn for personal use.
Most brokerage firms allow customers to borrow money using margin. Margin is essentially a loan from your brokerage firm that is secured by the value of your investment portfolio. You pay the brokerage firm interest on the amount you borrow. The amount of margin interest paid by you to the brokerage firm becomes a second profit center. In addition, to the extent margin is used to purchase additional securities, it creates the opportunity for the brokerage firm and financial advisor to earn additional commissions.
You can see, then, why brokerage firms like margin trading:
- They make money from the interest you pay them.
- They make money again from their commission when you use the margin to buy one or more securities.
- They can protect themselves using the investments in your account.
What are the Risks of Using Margin?
The amount of money borrowed is collateralized by the investments held in the account. While using margin carries the potential to enhance an investor’s return, it also magnifies the risk in the account. If the securities that collateralize the margin loan decline in value, the investor may experience a margin or maintenance call. In the event of a margin or maintenance call, the investor must either deposit additional assets into the account or liquidate securities to reduce or altogether eliminate the margin balance.
Similarly, non-purpose loans and lines of credit have also become commonplace at brokerage firms. Financial advisors often recommend that their clients secure lines of credit to finance outside business interests or the purchase of real estate. However, financial advisors fail to adequately disclose that these non-purpose loans or lines of credit are also collateralized by their investments. Any decline in the value of the investments may result in calls for additional collateral.
There are significant risks inherent in the use of securities backed lending through margin or lines of credit. In fact, investing on margin is a speculative investment strategy and is suitable for a limited number of investors who fully understand and appreciate the aforementioned risk factors.
Have You Experienced Losses Resulting From Margin Trading or Margin Calls?
The Wolper Law Firm has extensive experience handling matters involving securities backed lending. If your financial advisor has recommended a strategy that involves the use of margin or lines of credit, and you have experienced losses in your investments, please contact the Wolper Law Firm for a free consultation and case evaluation.
Call (954)-406-1231 to schedule a free, no-obligation consultation with an elder abuse lawyer today