You can increase your buying power by borrowing money. It is one of the most efficient ways for those who want to buy priced items such as properties that they cannot afford with cash. However, very few people know that they can do that using stocks.
As an investor, you can increase your buying power using stocks. You can also fund your business and do many other things using stocks. This, however, depends on your balance and the type of brokerage account you have.
This leads us to margin trading. Financial experts refer to it as leveraging your capital. However, is margin trading a good idea? Should you use margin finance to fund your business?
Here is what you should know.
What Is Margin Finance?
Margin finance can be defined as the collateral deposited by an investor with their exchange or broker and used to cover the investor’s credit risk for the exchange or broker. Investors create credit risks when they borrow money from brokers for different purposes, maybe funding their businesses.
If you have heard about margin finance, chances are high that you have also heard about buying on margin. This is what happens when you borrow part of the required money from a broker. You make the initial payment to a broker and then use marginable securities as collateral.
Margin finance is used when buying an asset that you cannot afford. Some investors use it to fund their businesses. Depending on what you want to do, it is important to understand the risks and benefits of borrowing on your existing securities.
Example of Margin Finance
Let us assume that you have $50,000 in your investment portfolio. You want $10,000 to fund your business. Unfortunately, you do not have this money. Looking at other borrowing options, you find that they are expensive and would not make sense.
You, therefore, decide to go for margin lending. Through your margin account, you withdraw $10,000 to fund your business.
By doing this, you will get the money you need to fund your business. In addition, then $10,000 remains as an investment in your portfolio. You will not miss out on any market returns since your securities remain intact.
Getting a Margin Loan
You will need to open a brokerage margin account before using margin finance to fund your business. In addition, you will also need a specific minimum equity in the account. This allows you to borrow against your investment portfolio.
However, it is important to note that your securities have to be marginable for you to use them as collateral. Different brokerages have different terms and conditions for margin finance.
This might include things like the portfolio value percentage one can borrow, equity requirements, and marginable securities.
Benefits of Borrowing on Your Existing Securities
Borrowing on your existing securities comes with more flexibility especially on repayment compared to mortgages, personal loans, or fixed-term loans. It allows you to gain liquidity without affecting your existing investment portfolio.
Looking at the example discussed above, for instance, you can fund your business while still retaining your portfolio. You get the money you need for your business without affecting your securities. Your investment objectives remain on track even though you borrowed money against your securities. It also helps you avoid catastrophes when investing your money.
Borrowing on your existing securities increases your buying power. With margin finance, you can invest more money than you can afford. If, for instance, you want to invest in high-share-priced stocks, then margin finance might be the only way for you.
It also allows you to diversify. If you decide to use cash, you might be able to invest in a few stocks. However, if you borrow on your existing securities, you can buy many stocks without liquidating your existing portfolio. This allows you to spread your risks.
Risks of Borrowing on Your Existing Securities
No matter how good a financial product might look, it must have some risks. One of the notable risks of borrowing on your existing securities or margin finance is a margin call. It is also referred to as a maintenance margin call.
Depending on the market, you might find yourself in a situation where the value of your portfolio’s securities fluctuates. When this happens, the value of the money you have borrowed against your existing securities does not change.
When your portfolio’s value falls to a certain point, you might have your brokerage issuing a margin call. This requires you to increase your marginable securities or add money to your margin account in a bid to get your equity to the required or accepted level.
You, therefore, need to keep checking your margin loans since they increase your risk levels. Your portfolio’s value can fall or rise depending on the market. In case of a fall, you might be forced to sell your securities, buy more eligible securities, or deposit cash into your margin account. This makes margin finance suitable for short-term investments.
Is Margin Finance the Best Option?
A bigger percentage of business owners borrow money to fund their businesses. They find themselves in situations where they need funds that they do not have in cash. When this happens, they can borrow considering things like good interest rates, repayment terms, and easier access to funds. Margin finance could be a good option for business owners.
