If only it were dimes. Alas, many investors are investing with thousands of borrowed dollars as they snap up securities "on margin." According to our friends at the NASD, the amount of debt taken on to buy securities topped $175 billion in July 2004, up 33% since January 2003. The increase may indicate increased speculation among investors, which isn't a smart way to allocate hard-earned dollars.
Buying stocks on margin isn't necessarily a bad thing that you should never do. It can be an effective way to apply leverage to your investments. Want to buy more shares of Lucent
The NASD issued an alert about trading on margin last year, because "we are concerned that many investors may underestimate the risks of trading on margin and misunderstand the operation and reason for margin calls. Investors who cannot satisfy margin calls can have large portions of their accounts liquidated under unfavorable market conditions. These liquidations can create substantial losses for investors." It goes on to warn that, "You can lose more money than you deposit in a margin account" and "your [brokerage] can sell your securities without contacting you."
Know what you're doing, and get a good grasp of the risks involved before you wade into margin. On our discussion boards, one of the most read and recommended posts is from a reader named "globalstreamer," detailing how he lost his entire portfolio ($60,000) in two weeks -- by getting carried away with margin.
Only experienced investors should use margin. Although you're currently allowed to borrow up to 50% of what your actual holdings are worth, it's smart to limit yourself to no more than around 20%, if you borrow on margin at all. Many highly successful investors never use margin, so don't think that it's necessary.
Meanwhile, consider learning more about your brokerage's margin rules. Drop by our Broker Center, too -- where you can also find out how to evaluate brokerages in general and how to make sure you've got the best one for your needs. Here are some recent Fool articles on brokerages:
- Which Brokerage Is Best?
- The Return of Chuckie
- Brokerage Statement Bewilderment
- Don't Get Blindsided by Your Broker
- Rating the Low-Cost Brokerages
Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article.