Margin trading is the practice of buying securities with borrowed money. Like most brokers, Vanguard offers this feature to qualifying clients. No matter what broker you use, margin trading can be extremely risky. You may want to avoid this practice if you are an inexperienced investor, and especially if you do not have the assets on hand to cover your loan. If you do want to margin trade with Vanguard, here’s how to open an account.
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What Is Margin Trading?
With a margin trade, your broker lends you a portion of the purchase price for an investment. For example, say you want to buy $1,000 worth of shares in a given stock on the margin. Your broker might lend you $500, while you put up the other $500.
A margin loan is secured by the underlying assets. In our case above, for instance, the loan would be secured by the bundle of stocks that you bought. For this reason a broker will not lend the full purchase price of the investment. They will typically lend up to 50% of the total costs of investment, with the amount based on the risks and nature of the underlying investment.
As with all loans, your broker will charge interest for a margin trade. You make interest payments while you hold the position open. When you sell your investment your broker takes back the value of the loan, then you keep any remaining gains. Ideally you will make more money than you borrowed and invested, but remember: You still need to repay your margin loan even if the investment loses value. If you cannot repay the loan by selling the underlying assets, you must do so with other cash.
Risks and Calls in Margin Trading
At its best, margin trading can maximize your liquidity. By borrowing money instead of cashing out of current positions, you can invest in new opportunities without having to sacrifice existing gains.
However, margin trading is also an extremely high-risk activity. There are two main reasons for this. First, as noted above, you must repay this loan regardless of the investment’s performance. This creates the potential to lose more money than you initially invested, a risk known as “active loss.”
Second, you must keep a minimum equity in your margin portfolio. Equity is expressed as either a minimum value or a minimum proportion of any given position that you own. If your investment loses value, your proportional equity in the investment will drop.
For example, say that you buy $1,000 worth of stocks, with $600 of your own money and $400 in margin. Your starting equity is 60%. Then, say that these shares fall to $900 in total value. The value of your loan is still $400, leaving you with just $500 in equity and a lower proportional value of 56% equity, compared to 44% borrowed.
For any given position, your broker will have a minimum equity that you must maintain. If your equity in this position drops below this minimum they will issue a margin call. This means that you must add new cash or assets to the margin portfolio in order to increase your equity back to minimum. In the worst case, your broker may force a sale, liquidating the margin portfolio in order to collect their money back.
It is also important to note that the interest rates on margin trading can be quite high, even though this is a secured loan. For example, at time of writing, Vanguard published interest rates between 11.75% and 13.75% per month for a margin loan.
Opening a Margin Account With Vanguard
To open and maintain a margin account with Vanguard, you must have at least $2,000 in cash and assets in your account at all times. This must exceed the value of any margin loans. So if you take a $3,000 margin loan, your account must have at least $5,000 worth of cash and assets. As you borrow more, you may have to increase your account’s equity to meet this minimum.
Vanguard does not permit margin trading with certain categories of accounts. Most notably, you cannot add margin trading to a retirement portfolio or UGMA/UTMA accounts.
If you have a qualifying account, you can add margin trading to this account by completing a Margin Account Application with Vanguard. You can find the application form on their general service forms database, searchable under “Margin Account Application.” Once you submit the application for your account, Vanguard will review it and notify by mail if you’re approved or denied.
If your account is approved, you may begin margin trading immediately from within the trading screen of the relevant account. You must submit an independent application for each account you would like to add this feature to.
Like most, if not all brokers, Vanguard limits the range of assets you can buy with margin funds. With this broker, you can buy exchange-listed stocks, bonds, some ETFs and mutual funds, warrants, and some over-the-counter securities on a situational basis. This can change over time though, so check with Vanguard before making any final calls.
If you’re interested in margin trading with Vanguard, you can add this feature to your account by filling out an application and sending it in. They require a minimum $2,000 net-positive balance in your account, and you cannot conduct margin trading in a retirement account and some others. Also, the brokerage limits which types of investments you can invest in using this method.
Margin Trading Tips
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