Finance: What are margin account, margin debt, margin interest and margin limits when trading?

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Transcript

00:21

grand Bessie Mae dies You need Bessie Mae two point

00:25

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

00:28

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

00:30

fifteen percent interest that the auto dealer offers you generously

00:34

loaning you the money And if you sell twenty five

00:37

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

00:39

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

00:42

Duff forty grand to net the twenty five grand after

00:45

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

00:49

Oh with the round wheels and air conditioning and windows

00:53

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

00:55

sell stock The vastly cheaper solution is to borrow money

00:59

from yourself All right Well how do you perform this

01:02

magic Well your brokerage account is set up as a

01:06

margin account That is when you set it up You

01:08

checked and signed all the boxes that claimed you knew

01:11

what you were doing were of sound mind when you

01:14

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

01:17

limit on your account which is standard practice these days

01:19

So what does all that mean Well it means that

01:21

on your hundred grand of stocks in your brokerage account

01:23

you can borrow twenty five thousand dollars like tomorrow by

01:26

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

01:31

and pay interest to Morgan Stanley or Schwab or whoever

01:34

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

01:36

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

01:39

three four percent if something like that nothing like that

01:42

fifteen ish percent egregious amount that the auto dealer would

01:46

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

01:48

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

01:52

to be really easy to track down the deadbeat right

01:54

Morgan and Schwab happy to pledge or Chi pa Tha

01:57

Kate your stock to a bank and provide you whatever

02:00

cash liquidity you need by Bessie Tuo Morgan and Schwab

02:03

will pay maybe two percent or less on the money

02:06

They let you borrow for three percent or more so

02:09

they make a one ish percent spread for doing almost

02:12

nothing Nice work if you can get it And that

02:14

fifty percent margin limit thing Well what does it mean

02:16

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

02:19

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

02:22

sat there And then we had a really bad bear

02:24

market Like a mortgage crisis market that went down by

02:28

half or the individual stocks he loaned in there simply

02:30

went down by half And all of a sudden one

02:32

day you wake up and you have fifty thousand dollars

02:35

in change in the value of stocks in your account

02:39

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

02:42

have atleast double in value in your account that money

02:45

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

02:48

willy nilly Whatever assets you have to be certain that

02:51

you in fact keep it least double coverage right Why

02:54

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

02:56

liquidity at a very low price So they understandably expect

03:01

very low risk And if the market then goes down

03:03

another ten percent and your value is down to forty

03:06

five grand and you still have twenty five thousand dollars

03:09

in margin or borrow their well Then the brokerage can

03:12

and will immediately pick whatever stocks they want to sell

03:15

an anger behalf They will sell five grand worth of

03:17

stock just to get you to that magic half zone

03:20

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

03:22

they sell five thousand dollars worth of stocks to pay

03:25

down your twenty five thousand dollars of borrowing to then

03:27

be just twenty thousand Well in a margin account you

03:30

have forty grand now in value But those were stocks

03:33

that were gifted to you or maybe stocks you owned

03:36

a long time So now not only has the brokerage

03:39

soul chairs at a low price but you will owe

03:41

taxes on the gains from that five grand of sales

03:45

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

03:47

to pay the kindly loving people of the I R

03:49

s bottom line Margin accounts are great if you manage

03:53

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

03:55

managing you