This Risky Brokerage Feature Cost Me Thousands

It's just another word for a loan.

The market plunged. I had nothing left to invest. Desperate to take advantage of low prices, I borrowed money from my stock brokerage. I funneled all of it into my favorite stocks, thinking the market would bounce back to its highs. 

The market did not bounce back. From May 2021 to March 2023, my stock portfolio has dropped by over 50%. Rather than holding for at least five years -- part of my long-term investing strategy -- I was forced to sell while my stocks were down. Why? To pay off margin calls incurred by my loan.

Ouch. That's thousands of dollars down the drain. Since then, I've looked hard at what went wrong, and how a single risky brokerage feature cost me a hefty chunk of my savings account balance. 

What is margin?

Margin investing is taking a loan from your brokerage that you can put toward buying stock. It's financial leverage. The borrower must pay interest on the borrowed money.

Taking out a brokerage loan to invest is risky for three reasons: 

1. Loans make your portfolio more volatile. Potential gains are higher, but so are potential losses. In my case, I ended up losing double what I would have loan-free.
2. If your portfolio tanks, you risk a margin call. A margin call is when your brokerage forces you to sell your stocks to repay your loan. Because of margin calls, I couldn't hold my poor performers for the long term and was forced to sell immediately.
3. Interest rates change. When I borrowed on margin, the interest rate was low. Thanks to Federal Reserve rate hikes, it's more than 10x what it was in 2021. In response, my brokerage raised their interest rates, and the interest I paid skyrocketed.

At the time, I didn't know that margin calls were a thing. I definitely didn't consider that the Fed would increase rates more than 10 times from 2021 (0.08%) to today (5%). Though my brokerage Robinhood telegraphed its own rate hikes, I was still hit hard because it took me months to pay off the loan.

The big takeaway? You should know what you're getting into before you leverage investments. It's high-risk. It's also one of the only ways a smart investor can go broke, according to legendary investor Warren Buffett. In his 2017 investor letter, the Oracle of Omaha wrote that leverage causes anxiety, and anxiety leads to poor decision-making. I can confirm that being on the receiving end of a leveraged loss is majorly anxiety-inducing -- I spent much of a European vacation fretting about it.

At the very least, investors should only invest what they can afford to lose. Had I done that, I would have slept better in London…and the many months I spent biting my fingernails at home. 

Should beginners trade on margin?

No. Investing in the stock market is risky enough as it is. Beginners can make plenty from boring old index funds -- the market has returned a solid 10% per year on average for decades. Or they can dip their toes into stock trading, starting small and ramping up on a stock broker for beginners.

Financial gurus like Dave Ramsey and Suze Orman generally advise folks to avoid debt. Margin is just another form of debt, and it comes with potential risks (particularly now, with rates so high). Those who don't use margin are actually at an advantage: they have no/less debt to pay off!

Do your research before taking out a margin loan. Many brokers offer the ability to withdraw margin money, but it's optional. And why should you? Returns aren't guaranteed; interest payments are. I learned that the hard way -- but by doing your due diligence, you don't have to.