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Margin Shock Josephine Lee. Forbes. New York:Jun 12, 2000. p.

P342

Abstract (Summary)
It's great that your broker will lend you half the money needed to buy a stock, which lets you buy more and magnify your potential gains. But remember that margin lending is a profit center for him, not a favor he's doing you. Make sure it doesn't kill your profits. First, recognize that interest rates matter. The bigger the loan, the less you pay. Online brokers, eager to sign up business, charge less than full-service brokers.

Full Text
(798 words) (Copyright Forbes Inc. 2000) Here's how to avoid the pain of a margin call the next time the market takes a dive. THE APRIL MARKET DOWNTURN WAS DOUBLY HORRIBLE if you borrowed money to buy stocks. As your holdings tanked, your broker told you to put up more money within a couple of hours. Maybe he didn't even pay you that courtesy and, without your knowledge, sold shares out from under you. Well, given the market's skittish state nowadays, count on another margin call in your future. Smart investors know how to navigate this treacherous terrain. It's great that your broker will lend you half the money needed to buy a stock, which lets you buy more and magnify your potential gains. But remember that margin lending is a profit center for him, not a favor he's doing you. Make sure it doesn't kill your profits. First, recognize that interest rates matter. As our table on page 346 shows, you pay varying amounts of interest, depending on your broker and your loan size. The bigger the loan, the less you pay. Online brokers, eager to sign up business, charge less than full-service brokers. Mind you, this makes a difference. Let's say you borrow $50,000 from Merrill Lynch to buy $100,000 worth of a great stock that gives you a 30% total return over the following year. If you haven't paid back the borrowing, you must subtract Merrill's 10% interest from your $50,000 loan--or $5,000. But if you borrowed from Suretrade, which charges just 7.75%, the bite is only $3,875. Second, watch the minimum maintenance. The trigger point for a margin call differs by broker, but they all fall in the 25% -to-35% range. What this means is the equity value of your stock (current market value minus outstanding debt), as a percent of market value, must not drop below the maintenance level. Example: You buy IBM at $100 per share, borrowing $50. The stock sinks to $60. Your equity value is now a mere $10 ($60 minus the $50 debt) and that's only 17% of the stock's $60 price-far below maintenance. A margin call is on the way. With a 30% maintenance level, you suddenly have to kick in $8. In a market crash like the one on Apr. 14, you may have only hours to come up with the money. Discount brokers tally your maintenance levels throughout the

trading day, so you could get a margin call at 2 p.m. and be obliged to meet it even though your stock recovers later in the session. Full-service brokers are more likely to wait until the closing bell. Brown & Co. is one of the rare discount firms that waits until day's end. Underdo it. Don't push anywhere close to the legal limit of buying stocks worth twice your account equity. Have a plan. Decide in advance which stocks you will lighten up on if your account equity falls into a danger zone of 40% to 50%. That way you can make sure that when it's time to do some selling from the account, it's you doing it, not a margin desk on autopilot. Combine assets in one account. It would be a shame to suffer an involuntary liquidation in your heavily margined $100,000 speculative account while across town you have another $100,000 in blue chips in a cash account. Combine them into a single account with $200,000 in equity. Assuming you have the mental discipline to borrow as if you had only $100,000 to play with-meaning, you would never, ever borrow more than $50,000--then the blue-chip cushion means you will almost certainly never have a margin call. (To be sure, if the second $100,000 were invested not in blue chips but in Treasury bills, you would be extremely well protected--but presumably you are not so dumb that you borrow money from your broker at 7.75% while lending to the U.S. Treasury at 6.5%.) Pay attention to the rules. Your broker may yank some of your thinly traded over-the-counter stocks from the list of assets that it will count toward your account equity. Maintenance margins differ from broker to broker and even from stock to stock. If you are close to the limit, a rule change would put you in danger of a sudden margin call. Don't use a margin loan for other kinds of speculation. Perhaps you're in a bidding war for a terrific house with someone who can pay cash. You can get a margin loan in a jiffy and stay competitive. But what if you win and it takes a while to line up a mortgage--and just then the market goes south? Consider buying puts. An out-of-the-money put option (see "Hedging Your Bets") might be an affordable shield against a sudden price collapse putting you in the margin danger zone.

Indexing (document details)


Subjects: Online securities trading, Brokers, Investment policy, Margined securities, Margin requirements, Margin accounts

Classification 3400, 9190, 8130 Codes Locations: Author(s): Document types: Section: United States, US Josephine Lee Feature On The Cover

Publication title: Source type: ISSN:

Forbes. New York: Jun 12, 2000. pg. P.342 Periodical 00156914

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