I saw a sexy advertisement from a brokerage firm bragging about its rock bottom borrowing rates.
“While the Fed is lending money at almost zero interest rates, why not take advantage of it? Our company will lend $1 million at 1.3% for every $200,000 in a portfolio margin account.”
Instead of proceeding with caution, many investors are diving in head first.
During the first and second quarter of 2012, the Federal Reserve reports that brokerage margin loans increased 9% to its highest level since 2008. (Does anybody remember what happened that year? Help me out, because I forgot.)
Margin or “margin loans” allow investors to buy additional securities by borrowing money from their broker and using the value of their brokerage account as collateral.
Here’s an example: Let’s say you buy a stock or ETF for a client at $50 and the price of the stock rises to $75. If you bought the stock in a cash account and paid for it in full, your client will earn a 50% return on the investment. But if you bought the stock on margin—paying $25 in cash and borrowing $25 from the broker—they’ll earn a 100% return on the money they invested. Of course, they’ll still owe the broker $25 plus interest.
The broker’s advertisement continued: “See our high dividend scanner for the many hundreds of stocks that yield over 5%.”