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Help From an Unlikely Source

With hurricane season upon us, the Fool wants you to be ready for anything. We've got lots of useful advice to help you prepare in case disaster strikes.

Cliches can get really annoying. I particularly loathe "any port in a storm."

I've watched the Bering Sea fisherman of Deadliest Catch ride out some awful waves. You don't see them turning tail for Dutch Harbor at the first sign of weather.

We viewers know why. A docked crab boat isn't making money. Heading for shore is an extreme measure, taken only when the boat is crippled or lives are at stake. For these fishermen, any port won't do.

When the storm hits your wallet
Now, what if you faced a financial crisis and needed money? Would you borrow from your credit card at 20% or more? Only if you were facing a Bering Sea-sized wave of bad luck, right?

Right. Often, the worst thing you can do is turn to the most convenient option; it can be be costly enough to plunge you right back into crisis. Don't believe me? Check out the Aspire VISA card. I'd be rather hunt opilio crab in January than carry this wealth-destroyer.

A surprisingly safe harbor
Similarly, as a Fool, I'm always reticent to trust brokers. But in an emergency, that suspicion is probably a mistake. A margin account can be a surprisingly useful tool for getting cash quickly and cheaply.

Here's how it works. First, you'll need a taxable brokerage account, which you'll have to specify as a "margin account," for borrowing funds, investing in options, and the like. Cash accounts can't do any of that.

Once that's done, you can begin adding leverage, typically no more than 70% of the equity in your account. If you have $10,000 invested in funds and cash with Fidelity, you may be able to borrow as much as $7,000.

Sounds good, right? Sure, but there are catches. Here are three tips for getting the most from your margin account in an emergency:

  1. Borrow as little as possible. There's no rule that says you have to borrow the maximum, so don't. The more you borrow, the greater the chance you'll be subject to a margin call. (More on that next.)

  2. Leverage funds first, stocks second. Margins are like rogue waves; they can destroy a portfolio. Your broker will subject you to a margin call when your account's equity falls below the minimum, which is determined by dividing your loan balance by the value of the collateral in your account.

    Need an example? Let's say your margin limit is 50%. Let's also say you have $10,000 invested in Pulte (NYSE: PHM  ) , Ryland (NYSE: RYL  ) , and KB Home (NYSE: KBH  ) , and that you've borrowed $5,000. If the housing downturn turns ugly and cuts your stocks in half, you'd be forced to pay off $2,500 of your loan immediately, or forfeit your shares. ($5,000 of equity remaining * 50% margin limit = $2,500 maximum loan amount. Since you've borrowed $5,000, your margin call is the difference, or $2,500.)

    Hey, I know that sounds extreme, but volatility is part of the risk you take when investing in stocks. If you must borrow, use index funds, stable managed funds, or steady blue chips like Deere (NYSE: DE  ) or Procter & Gamble (NYSE: PG  ) as equity.

  3. Repay your broker quickly. Margin loans are often cheaper than credit cards, but not by much. Fidelity currently charges 11.075% for loans of as much as $10,000. Schwab charges 10.75% for loans of $25,000 or less. Pay these debts off quickly, so that you can let your portfolio get back to its primary job: creating a comfy retirement for you.

Follow the money
Disaster often strikes suddenly, bringing with it confusion, chaos, and devastation. In such times, it's easy to follow the cliche. Don't. You have many more options than you think. Including, believe it or not, your broker.

Want more financial advice? Try Motley Fool Green Light, our personal finance service, for 30 days. Co-advisors Dayana Yochim and Shannon Zimmerman have packed more than $1,000 worth of tips in the June issue. Get your free copy right now.

Fool contributor Tim Beyers writes weekly about personal finance and investing basics. Have a Foolish money tip? Tell him. Tim didn't own shares in any of the companies mentioned in this article at the time of publication. Tim's portfolio holdings can be found at his Fool profile. His thoughts on personal finance, Foolishness, and investing in general may be found in his blog. The Motley Fool's disclosure policy is making Bering Sea-sized waves on Wall Street.

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