Buying On Margin

Published Aug 6, 2023

Definition of Buying on Margin

Buying on margin is a type of investment strategy in which an investor borrows money from a broker to purchase an asset. That means the investor only has to put up a fraction of the purchase price, and the broker finances the rest. The investor then pays back the loan with interest over time.

Example

To illustrate this, let’s look at an example. Assume an investor wants to buy 100 shares of a company at $50 per share. That means the total purchase price is $5,000. Now, if the investor has only $2,500 in his account, he can use margin to finance the rest. That means he can borrow the remaining $2,500 from the broker and pay it back with interest over time.

In this case, the investor has to pay a margin interest rate of 5%. That means he has to pay $125 in interest for the loan. In addition, the broker may also charge a margin maintenance fee of $25. Thus, the investor has to pay a total of $150 in interest and fees for the loan, assuming they pay it back in one year.

Why Buying on Margin Matters

Buying on margin is a popular investment strategy for investors who want to increase their potential returns. That means it allows them to leverage their capital and buy more assets than they would be able to with their own money.

However, it also comes with a certain amount of risk. That means if the value of the asset decreases, the investor may have to sell it at a loss to pay back the loan. Therefore, it is important for investors to understand the risks associated with buying on margin before they decide to use this strategy.