ShmoopTube

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Finance Allah shmoop what is a margin account I think

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the bank of you you have one hundred grand in

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stocks saved in a margin account set up at your

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kindly loving Morgan Stanley or Schwab brokerage Lots of lawn

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mowing and rich Uncle dying went into getting that hundred

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grand Bessie Mae dies You need Bessie Mae two point

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Oh the kind with round wheels this time Yeah she'll

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cost twenty five grand You don't want to pay the

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fifteen percent interest that the auto dealer offers you generously

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loaning you the money And if you sell twenty five

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grand worth a stock well you'll pay almost ten thousand

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dollars in taxes so you'd have to sell something closer

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Duff forty grand to net the twenty five grand after

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tax And wow that's expensive for Bessie Mae Two point

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Oh with the round wheels and air conditioning and windows

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that actually work So you really don't wanna have to

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sell stock The vastly cheaper solution is to borrow money

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from yourself All right Well how do you perform this

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magic Well your brokerage account is set up as a

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margin account That is when you set it up You

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checked and signed all the boxes that claimed you knew

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what you were doing were of sound mind when you

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signed and you realize that there's a fifty percent margin

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limit on your account which is standard practice these days

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So what does all that mean Well it means that

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on your hundred grand of stocks in your brokerage account

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you can borrow twenty five thousand dollars like tomorrow by

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writing a check against it too dishonest Dean's discount dealership

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and pay interest to Morgan Stanley or Schwab or whoever

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has your brokerage account But you'll only pay about one

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hundred basis points over prime rates or in today's world

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three four percent if something like that nothing like that

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fifteen ish percent egregious amount that the auto dealer would

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want And this makes sense right when you're borrowing from

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yourself If you ever don't pay yourself back while going

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to be really easy to track down the deadbeat right

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Morgan and Schwab happy to pledge or Chi pa Tha

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Kate your stock to a bank and provide you whatever

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cash liquidity you need by Bessie Tuo Morgan and Schwab

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will pay maybe two percent or less on the money

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They let you borrow for three percent or more so

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they make a one ish percent spread for doing almost

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nothing Nice work if you can get it And that

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fifty percent margin limit thing Well what does it mean

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Well let's say you've borrowed that twenty five thousand dollars

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and weren't disciplined to pay it off And it just

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sat there And then we had a really bad bear

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market Like a mortgage crisis market that went down by

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half or the individual stocks he loaned in there simply

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went down by half And all of a sudden one

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day you wake up and you have fifty thousand dollars

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in change in the value of stocks in your account

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Oh this is a problem Why Because if you don't

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have atleast double in value in your account that money

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you've borrowed the brokerage has the right to just sell

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willy nilly Whatever assets you have to be certain that

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you in fact keep it least double coverage right Why

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Well they're letting you borrow money or at least borrow

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liquidity at a very low price So they understandably expect

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very low risk And if the market then goes down

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another ten percent and your value is down to forty

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five grand and you still have twenty five thousand dollars

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in margin or borrow their well Then the brokerage can

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and will immediately pick whatever stocks they want to sell

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an anger behalf They will sell five grand worth of

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stock just to get you to that magic half zone

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So think about it There's a big big problem Why

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they sell five thousand dollars worth of stocks to pay

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down your twenty five thousand dollars of borrowing to then

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be just twenty thousand Well in a margin account you

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have forty grand now in value But those were stocks

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that were gifted to you or maybe stocks you owned

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a long time So now not only has the brokerage

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soul chairs at a low price but you will owe

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taxes on the gains from that five grand of sales

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so you'll have to sell more shares down the line

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to pay the kindly loving people of the I R

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s bottom line Margin accounts are great if you manage

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them and if you don't well yeah they end up

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managing you

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