As you surely know, there's good debt and not-so-good debt. Good debt can help you go to school or buy a home (provided you do so with a sensible, appropriate mortgage, and don't buy more house than you can afford). Not-so-good debt is sadly familiar to anyone burdened with hefty credit card bills. But there's another kind of debt that's just as worrisome to a growing number of people, though you might not think much about it: purchasing stocks with borrowed money, also known as "buying on margin."
In The Wall Street Journal's MarketBeat blog, David Gaffen noted that margin debt has hit an all-time high, exceeding even the lofty levels seen during the tech bubble. According to the New York Stock Exchange, margin investments totaled a record $286 billion in January, above the March 2000 level of $279 billion. (Note that as a percentage of gross domestic product, the 2000 figure remains higher, at 2.9% of GDP versus 2.1% today.)
Margin and investing
Buying on margin means you're buying stocks with money you've borrowed from your brokerage firm. It's attractive because you can turn a profit using money you don't even have (a technique known as leverage). For that privilege, you're paying interest to the brokerage, just as with any other loan. Interestingly, it's a lot easier to open a margin account than to apply for a bank loan -- many brokerages will give you margin accounts automatically, unless you specifically tell them not to. If the market turns against you, you either sell for a loss -- plus interest costs -- or hold on until the market picks up, paying interest all the while.
Margin isn't necessarily bad. When used in moderation, it offers the opportunity to juice your gains a bit. But since some people go overboard with it -- say, borrowing 40% of their portfolios' value -- and since it can also compound their losses, it does have a major downside. That's why it pays to think twice before using margin. You won't go wrong if you decide to avoid it entirely, as many successful investors do. (Learn more in "Margin Buying Explained.")
So what should we investors make of the recent spike in margin? I'd advise you to consider it alongside other economic indicators. High levels of margin may suggest an increase in reckless investing in the market, which might possibly lead to some kind of market meltdown. Perhaps it's just a new trend in investing, signaling that high margin levels will become the norm from now on. Or maybe it's a passing fad. Stay tuned -- and stay alert.
On our boards
You can read about others' opinions of margin all over our Foolish discussion boards. On the whole, the Foolish community is fairly conservative about using margin. Here are a few comments I ran across:
- In September 2000, one community member asked if it was a good time to buy Intel
(NASDAQ:INTC)on margin. A response: "Don't even think about buying INTC on margin here, PAL!! Margin should be used only when you've determined that a stock has bottomed, and INTC has yet to STOP being a falling knife."
- In February 2007, another member on the Fool boards asked about buying Berkshire Hathaway
(NYSE:BRKa)on margin. A response: "I purchased Berkshire on margin in the past and lost heavily when I received a margin call. Furthermore, the constant drip, drip, drip of interest charges can take a fearful toll over time. If married, I suggest not telling your spouse." (Read the whole discussion for some other points of view.)
If you're interested in an investing account that offers margin, learn more about your brokerage options in our Broker Center.