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Tuesday, November 29, 2011

Margin Class: Everything you need to know about a margin broker account

Margin Class #1: Get use to the stock market BEFORE opening a margin account

I first open my margin broker account in 2008. I open the account at TD Waterhouse. At first, I didn’t have margin in my broker account. I wait until 2010 to add that wonderful margin feature in. If the stock world is all new to you, I strongly suggest skipping, at least at first, the margin part of the broker account. You’ll be able to add margin on later, once you’ll be use to be around stocks.

I began to invest in 2005. So we can say that I had wait 5 years before getting a margin account. Back in 2005, I wasn’t investing in stocks and I didn’t know back than what margin is. But I quickly learn. I began to invest in stock in 2008. And following what, I open my margin account in December 2010.

Fact is, the stock market alone is complicated enough, you should have a good sense of what the stock market is really is before even opening a margin account. Simply things like just following your investment, reading financial stuff every week, watching the TSX going up and down... Those simply things will help you to quickly have an overview of what the stock market is all about. Once you get in touch with that reality, you’ll be able to understand that the stock market is volatile.

Margin Class #2: Build up a nice investment portfolio with your own money BEFORE opening a margin account

In December 2010, my portfolio was pretty much established. I had all the big players in. Not all, but a lot of them. I had some very hot stuff like PPL, ENF, FTS etc. I had in my portfolio very good investments that bring very strong value and that value had been quite stable and reliable. And that gave me the opportunity to open a margin account. Because I was already established, when I open my margin account, my stock value was so strong that I had more than something 50k available coming from my margin account itself. 50k is quite some money. But I had been able to get that money from an already established portfolio. I truly believe that the best way to start margin is to start when you are already establish. That way, you get more a complete overview of what the stock market is, you get a better pulse of the market and more important, you know how to react to the stock volatility. And that’s by giving no reaction at all. But even there, you need to be able to recognize the difference between a normal stock volatility and a trouble stock.

My personal example of that kind of situation would be with Yellow Pages (YLO). I was an investor of YLO for a couple of years. But when the stock value declined, I quickly sell. YLO is a Quebec based company that had already a bad reputation. It wasn’t stable, the dividend income was excessively high, the company had a large amount of debt, investors complain about the lack of direction – they were not able to see the company vision, etc. You could easily tell that YLO was a Quebec company because of the extreme bad management. So when YLO decline in value, I did what I had to do. I sell. I experiment a capital loss of 300$, but 300$ only. How many investors had lost a fortune on YLO? Unfortunately many of them because they just ignore my blog. So continue ignoring me, continue to invest in Quebec companies and continue to lose your money. I don’t care. But I what I do know is that I had came with a technique to manage margin account and that stuff can help you if you are like me 100% fully invested and if, like me, you have a margin account situation.

Margin Class #3: BEFORE opening a margin account, set yourself some rules and ALWAYS follow them

Ok, for my part, I didn’t respect this third Margin class rule. Because when I open my margin account, I was supposed to use 30% of the available money on the margin account to pay off some credit lines of mine who are at higher interest than the margin. And that was supposed to be it. That was the plan. Pay off debt using margin. It wasn’t made for investment purposes. At least at first. No matter what, I did not respect the initial plan. I don’t regret my moves and what I did with my margin, but this expose myself to a very extremely high level of risk. The only reason why I sleep well at night is that I have an infinite confidence in the market. It’s a confidence that the stock market crash of 2008 did not destroy and it’s a confidence that the August 2011 stock crash did not destroy either. I wasn’t destroyed because my margin situation did not destroy my portfolio. But no matter what, that could change because I am fully exposed to stock. I don’t control the stock market, tomorrow or the day after, the economy worldwide could collapse. The only reason why I sleep well at night, actually, is that I strongly believed that the nightmare won’t ever happen. But it’s something I am totally aware of. You need to be aware of that reality and accept the risk. Margin is dangerous.

Margin Class #4: Follow the 30% using margin rule

No matter how much you have available in your margin account, you shouldn’t use more than 30% of the money available on the margin account. Let say that currently, your margin worth 50k, you shouldn’t use more than 15k of that 50k for investment purposes. In case of market volatility, you won’t be under a margin call. Fact is, the value of money available on your margin fluctuate. One day you can have 60k available, and the next day, just 40k. It’s something you need to realize; the margin value is not steady, you don’t have any control over it. Currently, I do not respect this 30% rule. That makes me confront to a high level of risk.

Margin Class #5: From the time you open a margin account, you need to understand that your broker now have control over you

This is very important. Let say we are living an in deep stock crash. TD Waterhouse has plenty of customers like myself who have margin account. Margin is money that the bank gave to you in form of a credit line kind of. And the money available on that “credit line” vary depending of your portfolio value. If the stock market crash, your portfolio will lose value immediately. If the situation is critical and the market take an in deep plunge, well, it could happen that because TD had borrowed money to a serial of investors like myself, well, it could happen that while facing a disaster, TD could sell my stocks without informing me first. There could be no margin call.

A margin call is when your broker call you because your stocks had lost so much value that you own in your account. Your account is negative. Let say I had borrowed 50k on my margin account. Because the market lost points let say today, my margin account do no worth 50k anymore, it only worth 40k. Well, at that time, I immediately need to put 10k in order to stabilize the situation.

While facing such situation, TD may or may not call. It’s under their discretion.
So you need to be aware of that.

Ok, you may say: if that investor babe had been able to manage her margin account properly, I can too. LOL. It is not that easy. It’s a miracle that I am doing that great on the stock market. Simply remind you of who I am. I am the Beauty Queen Next Door.


Before thinking of margin account, you need to have a good understanding of the stock market. Also, your portfolio needs to be established. If you really want a margin account, do it, but establish yourself with real cash first.

Learn how to deal in front of the market volatility before going further. Are you nervous while facing volatility in your portfolio? Is it a source of stress? If so, you should totally forget about margin.

Margin is what I will name a “product” that brokers like TD Waterhouse had came around with to make even more money from their business. You pay a commission to your broker each time you sell or buy stocks. Well, that was simply not enough for them. They decided to set up a loan service based on the value of your portfolio. And because your portfolio value varies every day, margin could quickly become a source of unnecessary stress. Margin is a risky loan. You are taking a huge amount of risk just to get a 4.25% interest rate. Does it worth it? Not at all.

Be careful with margin, realize the risk and, if possible, don’t open a margin account. It is not healthy and on the loan run, you’ll realize that only getting in control is hard enough. Everything regarding the stock market is not especially easy and margin is difficult. The only reason why it is remaining in my account is because I had been doing great. But great for how long?

Nothing is define when it come to the stock market, nothing is sure. With margin, you double the risk.

That's pretty much what I had to say about margin for today.

Despite owning a margin account situation in my very own broker account, I don’t recommend you to do the same. I hope my 2 cents about margin will help you to understand better what a margin account is all about in a broker account.


James said...

You do realize that stock market investing can be addictive. I wonder if not being able to follow your own rules is due to this.

SPBrunner said...

Great blog on margin accounts.


Sunny said...

Hi James,

It's true, the stock market is quite addictive and I am certainly addicted to the stock market :)

Is it a bad or a good thing? I don't know.

Tonight is pay night and, even while being an "addict", I don't know in what to invest in, even if I would very much like to invest in something.

I am an addict yes, but there's something left in term of intelligence. :)

Thanks Susan!

Anonymous said...

Your comment just confirms what I told you already. You recognize the risk but you feel you have control of the situation. Most have to witness first hand the effect of a margin account when we have a market crash like 2001-02 or 2008.

The reason the market is so volatile is because we have more gamblers playing the market using margins and that's why when things go bad, it unravels.

Anonymous said...

Why don't you try to average down on stocks you currently own to lower your ACB on those stocks.

James said...

Addiction is defenitely a problem when it makes you break rules you have laid out for yourself.

Why not pay down the margin account with your paycheck.

Lastly, I do not understand your desire to have an equity account of a certain value, but no consideration on the amount of money borrowed to acquire it.

I do not focus on my stock market performance too much because it is largely out of my control, instead I focus on my savings rate, whether that is put towards debt reduction or investing is another debate.

The bank pre-approved my wife and I for a 500k mortgage. Does that mean I need to buy that big a house, or if I do, I should focus on the fact that I own such a large asset? No, because until I build up equity, I just have a large risky asset on my hands that I don't own much of. For the record, we bought a place half-that size because that is what we were comfortable with.

I wish you luck on your journey.

Last thing, would you have the discipline to take all of your paychecks until Christmas and apply them to debt reduction if you wanted? Remember, there will always be stocks that you or other people think are good value.


Thank you

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