When you borrow money to invest, the stocks you buy may lose value. You’ll have greater losses, because you’ve purchased more shares, and you also have to pay interest on “margin” loans.
If those stocks fall by 25-30 percent, you may get a “margin call.” Your broker will demand you put more cash or securities into your account. If you don’t comply within a short time period, your broker can sell your securities and use the proceeds for loan repayment.
To reduce this risk, borrow 20 percent or 33 percent of the stocks’ value to invest, instead of the maximum 50 percent that’s allowed. At many brokerage firms, users of such moderate leverage won’t get a margin call until the stock bought on margin drops by 50 percent or even 70 percent.
If you’ve bought a stock on margin and it loses value, you can sell long before it drops by 50 percent or more, avoiding a margin call. If you sell after a 20 percent loss, say, you can reinvest the sales proceeds in another stock. This will give you a capital loss, which may be valuable for tax purposes, as well as a possible tax deduction for the interest paid on the margin loan.
