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Wednesday, June 8, 2011

The pros and cons of opening a margin account with online commodity broker TD Waterhouse

When I first open my broker account at TD Waterhouse in 2008, I didn’t apply at the time for a margin account, just a regular cash account. It’s only in December 2010 that I decided to bring in margin to my broker account. At the time I open my margin account, my non registered Canadian stock portfolio had a value of over 72 000$. The 72 000$ portfolio brought in 43 653.66$, 60% value of my non registered portfolio value. In the following, I will try to explain the pros and cons of a margin account, for what I had experimented so far.

What’s a margin account?

A margin account is cash generate on the value of the investment portfolio. In my case, a 72 000$+ portfolio value had generated a 43 653.66$ margin account. You can see a margin account as money that the bank borrows you according to the value of your portfolio, perfect to trade commodities online.

A margin account can only be hold outside a register account, outside a RRSP and TFSA. A margin account can be hold in Canadian and US dollars, as long as it’s non registered, there’s no problem. Both of my Canadian and US non registered account have the margin account in.

The pros of a margin account

A margin account brings more flexibility in the way an investor can handle its investments. As for my part, my margin help me to extend my portfolio and invest in different companies that, if it wouldn’t be for my margin, I wouldn’t have been able to invest in. In my case, margin bring in diversification to an existing already diversify portfolio.

Say hello to extra cash!

A margin account does also bring in extra cash. The cash generate by the margin account can be use at any purposes. It can be withdraw or transfer to a credit line or credit card as payment.

Low interest rate: 4.25% at TD Waterhouse

Currently, the interest rate on my margin account is of 4.25%. This means that the interest I pay on the money I borrow from the margin is of only 4.25%. Nice!

Margin account as credit solutions: no minimum payment is required

A margin account is not like a credit card or a credit line. Interest money is being add to the money that been borrowed on the margin every month, but no minimum payment on the margin account is required, as long as the broker account is in good standard.

The cons of a margin account

The money available on the margin account is as volatile as the portfolio you hold. This mean that the money generates by the margin will vary on a daily basis.

The risk of a margin call

If on a certain day, your portfolio loses a lot in value, it could significantly decrease the value of the margin account. Such case could result in a margin call. A margin call is when your broker calls you to say: hey bro, you own money on your margin account! Simple is that.

Bye bye stocks!

But here’s the tricky part: in case of an extreme situation, it could happen that the broker, at its own discretion, decide to sell some of your assets to cover the money borrow on the margin. TD Waterhouse had been very clear on that part. By extreme situation, we could imagine something similar to the 2008 stock market crash. It happens in 2008, and it could happen again. Such eventuality needs to be taking into consideration and it’s something you should always keep in mind while borrowing money on a margin account. The risk is always there and exists; no matter how strong can appear your investment portfolio.

For that reason, use part of the margin account money, not more than 30%-40%, to pay off some debt could be a good solution. In case of an emergency, funds can quickly return on the margin account. And of course, ultimately, paying off debt using real cash instead of margin account money would be the best solution of all.
So far, I had been lucky with my investment choices and I never got stuck in a situation where I absolutely needed to sell my assets in order to cover the margin account. But never say never. I am currently using 41 000$ of my margin account money. 5 000$ went to pay a credit line, the rest had been invested. This mean that I am playing 36 000$ on money that is not really mine and I that I don’t physically hold in real cash. Dangerous? Yes, it is. But knowing where the money is, I don’t have any fear, but I certainly know I cannot go deeper on my margin account usage.

For that reason, I am currently following the stock market on daily basis. I had in many occasions used my margin money on “day trading”. Making quick gain on money that I don’t have had been too tempting. I did some day trade, made a bit of profit. The overall experience had satisfied my taste of danger and I won’t be day trading on margin anymore. Persistence could make me loss all I had build so far. Sometimes, experiences are required to understand what really mean to have a net worth of more than 80 000$.

It takes some dangerous experience to be able to appreciate. 80 000$ is not a million, but I am not running for the million either. On the long run, a 100k will be as fine as a million. It doesn’t take me more to be happy, just to know I have money to quit my job whenever I want and go job free for a little while if I really want to: the feeling is priceless. But of course, that won’t happen now. Especially not now.

One last thing: if considering margin account, never use it fully. Maximizing a 30% usage should be more than enough. Remember that money is not yours and, despite being monopoly money, it’s real money that your discount futures broker may request you one day to pay off.


Anonymous said...

TD Waterhouse is not an online commodity broker.

Sunny said...

Key words my dear, key words :0)

Anonymous said...

basically, she will just write anything, even if it's wrong or meaningless, just to get more hits.

Sunny said...

It was just a joke...

Ask yourself: can you purchase commodities using TD Waterhouse as broker? The answer being yes. I myself mostly trade commodities using TD Waterhouse platform.

I like to write about my personal finance. What I post as info is all related to my experience. I think I post good info. It's what I want to share with my readers.

Anonymous said...

You've never traded a commodity in your life. You don't even know what commodities are.

Max Thunder said...

I don't understand how a margin account is not exactly like a line of credit. I don't really have to do monthly payments on my line of credit, since I use the LOC itself to pay for the interests. And if you can get cash out, then it's exactly like a LOC secured by your equity.

However, I have a question. The % to keep to avoid margin calls, is it for the whole account or for individual stocks? Let's say I already have $50,000 invested, can I buy $10,000 worth of stocks by investing only 50% of it, and my % will actually be 55,000/60,000, i.e. 92%, so only 8% on margin with little risk of a margin call?


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