Why Do People Buy Stocks on Margin, Even Though It Costs Them to Do So?

Buying stocks on margin can result in big losses, but when done correctly, it can mean big earnings too. While it may seem that the risks of buying on margin far outweigh the advantages, there are many reasons why people buy stocks on margin, even though it may cost them in the long run.

What Does Is Mean to Buy On Margin?

Buying stocks on margin, to put it simply, is doubling your buying power buy borrowing up to 50% of a stock's price from your broker. In order to buy stocks on margin, there are a certain number of things to keep in mind. First of all, certain stocks can't be bought on margin. For example, any stock that is less than $5 a share (also called penny or micro-cap stocks) cannot be purchased on margin. In addition, IPOs (Initial Public Offerings, or companies that have recently gone public) also can't be purchased on margin until they've been on the market a certain amount of time.

If you plan on buying stocks on margin, your broker will set you up with a margin account. Let's say you put $5,000 in it. That gives you $10,000 of buying power, since you can borrow up to 50%. If you decided to spend $4,000 on a certain stock, that would leave you with $6,000 worth of buying power - $1,000 in cash and $5,000 in your margin account (excluding commissions). The money isn't borrowed until the cash is gone.

What Are the Costs?

The costs associated with buying on margin can be hefty. If the stock plummets, you could end up owing more than your initial investment. If it falls below 75% of its original value, the broker will issue what is referred to as a margin call since the investor must have at least 35-55% equity in his account at all times. A margin call means the investor much put more money into the account. If he can't do this, however, he'll have to sell the stock, pay the broker the amount owed, which might even be more once commissions are figured in. This can result in stresses and increased costs to the investor.

So What Are the Benefits?

Despite the costs, there are many benefits to buying on margin as well. These include:

• Increase buying power. With a 50% margin, you can buy up to 50% more stock than you initially could with the cash account. If the stock goes up, you can make twice as much money twice as fast.
• Opens you up to new investment opportunities. With 50% more buying power, buying on margin affords opportunities you may not have had otherwise as a result of not having enough cash equity.
• Ability to invest more. For people who have a talent of picking stocks and make a good deal of money buying on margin, they can use the profits they get to invest in even more profitable stocks.

In the long run, buying on margin can be a great advantage to investors who know how to pick stock wisely and keep a close eye on their stocks. By consulting your broker, properly researching, and not investing more than you can afford to lose, you can buy stocks on margin and reap a considerable gain.