Trading Stocks on Margin is a Losing Strategy

Buying on margin is best defined as borrowing money from a stock broker to purchase stock. Basically, the brokerage provides you with a loan so that you can buy more stock than you would be able to without that loan. The potential gain is greater because you have a larger pool of money to work with, but the risks certainly outweigh the possible positives in this case.

As with anything else in life, borrowing money to trade on margin doesn't come without some significant costs. Currently most of the base rates of trading on margin are set at about 8%. You may wonder why the brokerage would charge such a high percentage to borrow for investing. The truth is it makes a whole lot of sense. The brokerage is allowing you to borrow money to invest, and both the brokerage and the individual investor are taking on increased risk because of that. The higher the risk associated, the higher the charges will be.

As someone who works in the financial field I understand that individuals want to trade or invest on margin to try to make some quick bucks, but I think they need to understand how the costs associated make this a losing game in the long run. The greatest investor of them all, Warren Buffett, has a clear #1 rule that all should try to follow in investing, "Never lose money." In fact, Buffett is so serious about this goal that he says the second most important rule is to never forget the first rule. Obviously Mr. Buffett believes that in order to get ahead when investing you can't dig a big hole. This rule definitely explains why Buffett has long spoken out against investing on margin, since investing on margin makes you start out losing your money. Since you are paying such high fees just to invest, you are starting out in the negative; which is never a good thing.

Stock markets and economies go in cycles, sometimes things will be great and at other times they will be terrible. I truly believe there is never a stock market cycle where it is wise to make yourself get into debt just to get into the stock market. The first rule of personal finance is to pay off your debts, then use the money you have saved up to invest and build for your future. Investing on margin breaks all the rules of wise investing and wise personal finance behavior. Resist the urge to borrow money to invest, because over the long run it simply isn't a winning strategy.