Buying on margin means investors borrow funds through their brokerage accounts to invest, with the goal being to earn more money through your investment. But sometimes, you may lose money when the investment drops in value. At that point, a margin call may enter the picture. If you are on the fence about a margin account, consider talking it over with a financial advisor, who can help you map out the best investment strategy for your goals and risk tolerance.
What Is a Margin Call?
A margin investment account contains securities an investor buys with both his or her own money and borrowed funding. If the value of a margin account falls below the broker’s minimum required amount then a margin call will occur. At that point, the broker will require the investor to deposit additional funding or securities into the account. Typically, a margin call happens when a losing trade pushes down the value of an account.
How to Pay for Margin Call
While the margin call is required by the broker, you still get to decide how to pay for it, if you’re able to move fast enough. Any investor facing a margin call has a handful of ways to pay for it, including:
- Deposit additional cash: When your margin account drops below the required levels, the most expedient way to solve the problem is to deposit more cash.
- Transfer additional securities to the account: If you have securities in other accounts, a transfer of those holdings into your margin account could make up the difference between the required minimum level and your current balance.
- Sell securities within the account: Although you may have to sell your securities at a loss, this option could help you build up the cash required for your margin account.
The unfortunate reality is that when there is a margin call, you’ll be on a tight payment deadline. If you are facing a margin call and don’t have a way to pay it then your broker may have the authority to sell the securities in your account without permission to cover the costs. In general, you should expect to come up with the funds within two to five days. The exact timeframe will vary based on the terms of your particular margin account.
Reasons for a Margin Call
A margin call can happen for several reasons. In most cases, the two main things that trigger a margin call are when specific securities either lose or gain in value. When a stock you own loses value, it could push you below the required maintenance margin. At that point, the broker could issue a margin call. On the other side of the coin, if you are trying to short a stock that ends up appreciating, that can also push your account below the required maintenance margin.
How to Avoid a Margin Call
So, now you know the answer to what is a margin call, but how can you avoid this uncomfortable financial situation? Ultimately, a margin account is a risky proposition. So, if you open a margin account it’s not uncommon to face a margin call at some point. The three ways that many investors try to avoid margin calls are:
- Avoid margin accounts: A margin account is typically reserved for experienced investors. But even still, these accounts can come with increased risks. If you want to avoid a margin call altogether, then avoid margin accounts.
- Keep cash on hand: If you regularly monitor your portfolio, you’ll likely notice when your account is close to dropping below the margin maintenance requirements. Instead of waiting for a margin call, tap into your cash reserves to avoid a margin call.
- Diversify your portfolio: A diverse investment portfolio can help limit the volatility in your account. And with a more stable portfolio, you should be able to avoid an extreme decline that would unexpectedly prompt a margin call.
There’s no perfect way to avoid margin calls, but carefully monitoring a well-diversified account will go a long way to limiting this financial imposition.
A margin call occurs when a broker requires more capital to be invested into a margin account to cover a potential loss. Although many experienced investors can turn a profit with margin accounts, it’s not the right fit for a new investor. If you are wary of what a margin call could mean for your finances then avoiding a margin account could be the right move.
Tips for Investing
- Before moving forward with any investment it’s important to consider the potential risk to your overall financial health. A financial advisor can help you determine the right balance of investments and efficiently prepare for risk. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- In general, investing on margin is only a good idea for experienced investors. Before you jump in, start with the basics of building an investment portfolio.
- An appropriate asset allocation for your risk tolerance is critical for any investment portfolio. Use SmartAsset’s free asset allocation calculator to find the right mix for your situation.
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