You may be able to borrow money from your investment firm to pay for part of your investments. This is called buying on margin. Buying on margin allows you to buy more shares than you would normally be able to afford – it’s a way of using leverage. This may mean potentially greater returns. But it also comes with greater risks – you can lose more money than you originally invested.
6 things to know about buying on margin
- Margin account – You have to open a margin account to buy on margin.
- Minimum investment amount – The investment firm sets the minimum amount you must deposit in a margin account. This is sometimes called the minimum margin.
- How much you can borrow – This depends on the price of the stocks you’re buying. Your investmentInvestment An item of value you buy to get income or to grow in value.+ read full definition firm may lend you up to 70% of the money you investInvest To use money for the purpose of making more money by making an investment. Often involves risk.+ read full definition. This is called your maximum loan valueMaximum loan value The most a dealer can lend you through your margin account. Based on a set percentage of your margin investment.+ read full definition.
- Interest charges – The interest charges on the loanLoan An agreement to borrow money for a set period of time. You agree to pay back the full amount, plus interest, by a set date.+ read full definition are applied to your accountAccount An agreement you make with a financial institution to handle your money. You can set up an account for depositing and withdrawing, earning interest, borrowing, investing, etc.+ read full definition. Depending on what you invest in, you may be able to deduct the interest on money you borrow to invest.
- CollateralCollateral Property or assets that you pledge as a borrower as a guarantee that you will repay the loan. You may lose your collateral if you don’t pay back your loan.+ read full definition for the loan – The stocks you buy are used as collateral for the loan. You have to keep enough assets in your margin accountMargin account An account you open to buy investments using money borrowed from a stockbroker. Limits apply to what you can borrow. Not available from companies registered only as mutual fund dealers.+ read full definition to cover the loan value at all times.
- Margin callMargin call A call that a broker makes to an investor when the margin in their account gets too high. This can happen if the value of your investments drops below a certain level. You will have to put more of your own money into your account to set it right.+ read full definition – If your stocks drop in value, your investment firm may ask you to put more money into your account to maintain your marginMargin A way to buy investments by borrowing money from a stockbroker. You must also invest some of your own money first. The extra that you borrow is your margin. Some rules apply about the size of margin that you can have.+ read full definition. This is known as a margin call. If you don’t put in more money, the firm has the right to sell your stocks and other investments in your account to cover the margin call.
Read your margin account agreement
When you open a margin account, you sign a margin agreement. Read it carefully to understand how the stocks you buy serve as collateral for the loan, your responsibilities for repaying the loan and how interest is calculated.
How much you can borrow
The Investment Industry Regulatory Organization of Canada (IIROC) sets minimum standards based on the price of a stockStock An investment that gives you part ownership or shares in a company. Often provides voting rights in some business decisions.+ read full definition. Your investment firm may impose more stringent requirements in certain situations.
|ShareShare A piece of ownership in a company. A share does not give you direct control over the company’s daily operations. But it does let you get a share of profits if the company pays dividends.+ read full definition price||Maximum loan value|
|Less than $1.50||No loan allowed|
|$1.50 to $1.74||20%|
|$1.75 to $1.99||40%|
|$2.00 or more||50%|
|Eligible for reduced margin*||70%|
* Stocks with low volatilityVolatility The rate at which the price of a security increases or decreases for a given set of returns. A stock price that changes quickly and by a lot is more volatile. Volatility can be measured using standard deviation and beta.+ read full definition and high liquidityLiquidity Refers to how easy it is to change an investment or asset into cash, without affecting the price. Liquid assets include most stocks, money market instruments and government bonds. Your home or other property is not very liquid.+ read full definition, making them easier to buy and sell
Example – You have $10,000 to invest and you want to buy shares of ABC Company at $10 a share. Your investment firm agrees to lend you another $10,000 on margin.
You invest the entire $20,000 in 2,000 shares at $10 a share. You agree to keep $10,000 in assets in your account at all times to cover this loan.
What happens next? Let’s look at 2 scenarios.
Scenario 1: The stock rises to $12 a share
- You sell the shares for $24,000 – a 40% return on your original $10,000 investment. If you had paid cash for the shares, you would have made $2,000 on your $10,000 investment or 20%.
- You pay back the loan and interest, and pay trading commissions to your investment firm.
- After costs, your profit would be still higher than if you had invested without borrowing.
Scenario 2: The stock drops to $8 a share
- Your investment falls to $16,000 and you have a loss of $4,000 on paper. You could sell the shares and take the loss, but you decide to hold onto them in the hope that they may go up again in the future.
- You have to keep paying interest on the loan.
- You also have a margin call. That’s because your investment firm is only allowed to lend you up to 50% of the current market valueMarket value The value of an investment on the statement date. The market value tells you what your investment is worth as at a certain date. Example: If you had 100 units and the price was $2 on the statement date, their market value would be $200.+ read full definition of your investment. Since your shares are now worth $16,000, you can only borrow $8,000 on margin. Your current loan is $10,000, which means you’ll have to add $2,000 to your account to make up the difference and maintain your margin.
Practise before you buy on margin
Buying on marginBuying on margin A way to borrow money to buy investments.+ read full definition is complicated and comes with many risks. To learn more, try this margin account simulation from the North American Securities Administrators Association.
3 key risks
- You can lose more than you invested – If your investments go down in value, you still have to pay back your loan and interest. You may have to put up more margin to maintain your account. If you don’t, your investment firm can sell your investments to cover the margin call. You could lose more money than what you originally invested.
- It costs more to invest – In addition to trading commissionsCommissions What you pay to a broker or agent for their services. Often called a “sales commission”. For example, you pay a fee to someone who buys or sell stocks or real estate for you.+ read full definition, you have to pay interest on the loan. But depending on what you invest in, you may be able to deduct the interest on money you borrow to invest.
- The interest rateInterest rate A fee you pay to borrow money. Or, a fee you get to lend it. Often shown as an annual percentage rate, like 5%. Examples: If you get a loan, you pay interest. If you buy a GIC, the bank pays you interest. It uses your money until you need it back.+ read full definition can go up – The interest rate on your margin account can change at any time. It may cost you a lot more than you thought to pay back what you borrowed.
Buying on margin can be very risky — you can lose more money than you originally invested. Read your investment firm’s margin disclosure agreement to understand all the risks involved.