Dave Ramsey Has This Big Warning About Margin Trading

Don't start trading on margin until you've read this advice. 

When you start to invest money, you may be eager to get as much of your cash into the stock market as you can so you can hopefully begin making a big profit on your investment. In fact, it may even seem attractive to trade on margin.

Margin trading means you borrow from your brokerage firm in order to invest more money (usually in the stock market). Typically, the margin loan is guaranteed by the value of your other invested assets. You pay interest on your margin loan and eventually you have to pay back what you borrowed. The goal, of course, is to make more money than you spend on interest so when you repay the loan, you get to keep the gains the money made while it was in the market.

Margin trading may seem like a good idea if you're confident in your investment picks, but personal finance expert Dave Ramsey has issued a stern warning about using this technique. Here's what he had to say. 

This is Dave Ramsey's opinion on margin trading

On the Ramsey Solutions blog, Dave Ramsey's position on margin trading is made very clear. When discussing a margin brokerage account, Ramsey said: "Listen to us, never borrow money to invest. Not only is it extremely risky, but you’ll also have to pay interest on what you owe."

Ramsey warned that margin loans are a form of debt, and he's generally not a proponent of people borrowing -- even if the ultimate goal of doing so is to try to grow your net worth. And he's also explained that margin loans are an especially dangerous way to borrow because of the possibility of having to pay back what you owe immediately. 

See, if you've borrowed on margin and the total value of your investment account falls below a set level, your broker could demand immediate repayment of the loan. This is called a margin call. It could force you to sell some of your assets at a loss (when they might have otherwise recovered if you held onto them) or to deposit more money quickly into your accounts. 

This is exactly what Ramsey is cautioning about when he explains why you shouldn't ever borrow using a margin loan in order to invest. The interest costs you'll end up paying (which could reduce your potential returns and make it harder to make a profit) combined with the risks of margin loans have prompted Ramsey to recommend cash accounts only, rather than margin accounts with a brokerage firm. 

Should you listen to Ramsey?

Ramsey is absolutely right that it can be harder to make profitable investments when you invest on margin because of the money you lose to interest, and because there is a risk of having to sell at an inopportune time if your investments lose value and your brokerage issues a margin call.

But these risks don't necessarily mean you should never trade on margin under any circumstance. Margin gives you the chance to invest more than you otherwise could and it has paid off for some successful traders. Ultimately, it comes down to your confidence level in your investments and your skill in picking assets to buy. Margin trading can make you a lot of money if you're a great investor -- and can lose you a lot of money if you aren't.