What is Margin? When can you use margin? Is using margin right for you?
by Karen Didde
Margin is a powerful tool that allows investors to borrow from their investment accounts. There are many uses for margin, but we most often recommend it to cover large short-term cash needs. By using margin, investors can leverage their investment assets without selling securities, thus avoiding being out of the market, locking in losses, or incurring capital gains resulting in tax consequences. One of the most common uses for margin is when a client wants to buy a property but is waiting on the cash from the sale of another property to cover the purchase. Once cash is available, margin can be simply paid off by depositing the cash into the investment account.
The ins and outs of using margin:
Margin is only allowed on taxable investment accounts. It is not available on retirement accounts. If a client is considering adding margin to their accounts, the first step would be to contact Harbor to discuss. Because of our relationship and our level of Assets Under Management with Schwab, we are able to negotiate a lower rate than the published rate. This becomes very important once margin is utilized since interest will be charged on the margin balance in an account. The interest rate consists of two components: The fixed rate paid to Schwab and a variable rate that is based on the Fed Funds rate.
- The fixed rate is based on account size. Households are not taken into consideration. For example, if a husband and wife each has a taxable account, margin interest will be considered for each account balance, not on the consolidated balance.
The amount available to be borrowed is generally calculated by adding the cash balance and 50% of the value of eligible securities. Additionally, Schwab’s basic maintenance requirement is 30% of the current market value. For example, if a client has $50,000 worth of marginable securities in their margin account, a minimum amount of $15,000 must be maintained in the account. The client would be hit with a margin call if the value of the securities falls below the maintenance margin. In this case, the client would need to sell a security or infuse cash into the account to cover the margin call. For this reason, we do not recommend that clients borrow the maximum amount of margin available in case there is a significant market pullback.
- Some securities are not immediately marginable. While ETFs and stocks are immediately marginable, mutual fund purchases are subject to a 30-day waiting period before they can be applied to the margin availability. Therefore, it is important to be mindful of your margin availability when buying mutual funds to avoid a margin call.
Margin also has interest rate risk. Even though Schwab’s preferential margin rate is lower than the published rate, the fixed rate is locked in only for a year and can increase after that. Since the variable component of the rate is tied to the Fed Funds rate, clients can expect to pay more in a rising rate environment.
Should you use margin?
If you believe you would benefit from adding margin to your accounts, please contact your Harbor team to discuss. We can talk about the process, benefits, and risks in your situation. Since it may take up to 2 weeks for Schwab to apply the preferred margin rate to an account, we recommend planning ahead.