A margin account allows you to borrow money to buy investments, such as stocks. Margin accounts have significant benefits, including limited capital outlay, leverage, the availability of loans and certain tax advantages. However, margin accounts also amplify the risk of your portfolio. If the value of your investments goes down in a margin account, you may have to contribute additional money to the account.
Limited Capital Outlay
Since you borrow money to buy your investments in a margin account, you don't have to contribute the full amount of your purchases when make them. The Federal Reserve Board's Regulation T only requires you to provide 50 percent of the cost of any margin purchases you make. For example, if you want to buy $10,000 of stock, you only have to put up only $5,000. With a margin account, you can effectively buy twice as much stock as you want with the same amount of money.
The main investment benefit of a portfolio margin account is the leverage of your gains. Since you don't contribute the full purchase price of your securities, any stock movements are amplified. For example, Regulation T allows you to buy $20,000 of stock for just $10,000. If that stock rises 25 percent in value, the stock will be worth $25,000. Since you only invested $10,000, that $5,000 price gain amounts to a 50 percent gain on your investment, even though the stock itself only rose 25 percent. Leverage does work both ways, however, meaning a 25 percent decline in the stock's value amounts to a 50 percent loss on your investment.
You can use the provisions of Regulation T to take a loan on your margin account, rather than using that money to purchase stock. For example, if you have $20,000 worth of stock in your account that is fully paid for, you can borrow up to $10,000 for any purpose you like. You will pay interest on that loan, just like with any other type of loan, but you may be able to find more favorable rates on your margin loan than on other types of loans you may find, such as credit cards.
While you cannot take a tax deduction for investment losses in a margin account, you can usually deduct the interest you pay on your margin loan. Typically, the amount of your deduction is limited to the amount of investment income you earn in the account, such as interest and dividend payments. You may want to work with a tax adviser to determine if margin interest tax deductibility applies to your specific tax situation.
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