Sunday, May 20, 2007

Buying on Margin

Today's WSJ article, "Keep the Debt Monkey Off Your Back", one section of the article caught my eye, buying stocks on margin. I was surprised that there are over $200 billion in margin loans given out for buying stocks. (Click here for a Wikipedia article about margin buying) Briefly, buying stocks on margin is the borrowing of money to finance the purchase of stocks, betting on a certain direction, which can significantly compound the gains OR losses associated with the stock.

This situation reminds me often about the general disconnect people have between going to the casino and going to wall street. Somehow, people enter a casino KNOWING they will lose money, but people go to wall street THINKING they will never lose money. I just don't understand this disconnect.

In a casino, people know the risks and rewards of any game. Casinos are required to tell you the rules of the game, and provide you a list of payouts. On wall street, the rules don't even have to be read. And yet, people think there is less risk of losing money on wall street. This is simply not the case.

Yet, with this increased risk, people are still borrowing money to bet on the stock market. If more people considered that the stock market was just like going to a casino, they would step back and realize, "If they are offering me this option, maybe its not because I can win money, but because they can" This is the situation with margin buying.

Brokerages are not altruistic entities. Don't believe for a second that margin buying is more beneficial to you than to them.

1 comment:

CT said...

Leverage is not inherently evil. Of course it's a risk, but in the long run stock market returns have been higher than margin rates.

Think about it this way: do you think mortgages are like a casino? The standard margin amount policy is that you if you have $20k you can borrow $20k, but with a mortgage if you have $20k you can borrow at least $80k, and even more. Real estate is a less risky investment, but you are still taking out a loan to get earnings on someone else's money.