April 24, 2000 -
Securities Officials Caution Investors
About the Risks of Buying Stock on Margin
Securities officials at the Connecticut Department of Banking cautioned investors today about the risks of buying stock on margin, or with borrowed money, especially during times of market volatility.
"While margin can give you leverage to increase your purchasing power when stocks are rising, it also exposes you to greater risk and the potential for higher losses when your stocks go down," Banking Commissioner John P. Burke said.
The growth of margin debt has accelerated over the past several months, reflecting a generally bullish sentiment about Wall Street and the influx of new investors into the stock market.
Margin rules allow investors to borrow up to 50% of the value of their stock portfolios from brokers, using their investments as collateral. After purchasing stock on margin, investors are required to keep at least 25% of the total market value of their portfolio in their margin account as a "maintenance requirement." (Many brokerage firms establish higher "house" maintenance requirements depending on particular securities or customer accounts; certain securities may not be purchased on margin).
If stocks go down in value, investors may receive a "margin call" from their brokerage firm, requiring them on short notice to either deposit more cash or securities into their account. If investors are unable to meet the margin call, their firm may sell their securities - potentially at a sizable loss - to increase the account's equity up to the firm's maintenance requirement.
"Margin is a legitimate option for investors. Our concern is that investors who open margin accounts may not fully understand the risks inherent in leveraging their portfolios," Burke said.
"Persons using margin should realize that they can lose more money than they initially invest in their margin account. Depending on a firm's policy, your broker may not even be required to make a margin call, and the broker may be able to sell your stock without telling you," Burke added.
The Banking Department urged investors to carefully read their brokerage firm's margin agreement before opening a margin account and to consider whether margin is appropriate for their financial situation, investment goals and risk tolerance. In addition, investors need to consider the costs of margin loans and the effect of interest payments on their portfolio returns. Investors should contact their stockbroker if they have any questions about how a margin account works or what may happen if their stocks go down.
Persons interested in more information on investor education topics may call the Department of Banking, Securities Division at (860) 240-8230 or toll-free 1-800-831-7225, or visit the agency's Web site.