If you’re like those DAMN KIDS these days, you want things now, dammit. You impatient people sicken me so much. I DON’T HAVE TIME FOR YOUR GARBAGE GOD.
Aside: there are approximately 4,392,991 emojis out there and not one is an old man shaking his fist at teens? There really needs to be. Get on that, Facebook. Like you guys have anything else to do.
Anyhoo, one of the trademarks of an impatient investor is they use debt to get ahead. Margin, in case you don’t know, is the cash a brokerage lets you borrow on top of what you already to invest in stocks, bonds, or whatever the hell it is you kids are into these days. Marijuana? BE CAREFUL THAT STUFF KILLS.
SEMI RELATED – How RRSP loans actually make sense
Back in the day (i.e. the roaring 20s), margin wasn’t regulated. As long as your banker was cool with the amount you borrowed, life was good. Many allowed people to leverage up to 20-t0-1 on stocks, meaning you could buy $100 worth of stocks with just $5 down. When the market crashed, people desperately sold stocks to pay down these loans, which drove the market down further
Margin has been reined in since then. These days, you can only borrow a standardized amount that’s been set by regulators, which in Canada is IIROC (International Institute of Really Old CRAZIES). Many people don’t know what these rules are, so I’m here to explain it to y’all with only a minimal amount of cuss words.
First we’ll cover going long stocks, i.e. when you buy a stock in a traditional manner. AH HELL YEAH WE WILL.
Two sentences. That’s how long I lasted without unnecessarily swearing. I’m terrible in every way.
(Note: these are the guidelines for TSX margin only. Other exchanges can be different.)
So here’s how it works.
- If the stock sells for $2.00 per share or more, you need 50% of the market value as equity.
- If a stock is between $1.75 and $1.99 per share, you need 60% of the market value as equity.
- If a stock is between $1.50 and $1.74 per share, you need 80% of the value as equity.
- If a stock is under $1.50 per share, you are shat out of luck, son. No margin for you.
(Keep in mind this is minimum margin. Some brokerages may have more onerous rules than the minimums.)
Let me run through some real life examples. Say you wanted to put 100% of your portfolio into Hammond Manufacturing (TSX:HMM.A), one of my picks for the stock picking contest. Shares currently trade hands at around $2.50 each. Say you have a total of $10,000 to invest.
The margin calculations are relatively simple. You need 50% equity in the stock, which means you can borrow $10,000 to go with your original $10,000. A $20,000 investment would get you 8,000 shares, excluding commission.
If shares go up, that’s a good thing and you have nothing to worry about. But say they go down to $2.00 each. You’d owe $10,000 on an investment now worth $16,000. You’d either have to sell enough shares to get yourself back to the 50/50 debt and equity split or find some cash.
By selling $4,000 worth of stock, you’d get back to the point where you had an equal amount of debt and equity. You’d be down to $6,000 owing on a $12,000 investment. But since margin requirements become more onerous below $2 per share, you’d probably want to lighten up a little more.
We can all figure out the problem with that. You’re forced to physically take losses at what could be the worst possible time. That’s the big danger of margin, right there. Well, that and losing all your money.
After explaining all that, let me tell you a little secret. No, not that. Or that. WHY DO Y’ALL THINK I’M A PERVERT JEEZ.
Most stocks you’ve heard of are classified as reduced margin eligible securities, which means all you need to maintain is 30% margin.
Another example? Don’t mind if I do. Say you had $10,000 you wanted to invest in Royal Bank. You could use margin to leverage that investment into something worth $33,333.33, which would get you 434.7027 shares. Remember, don’t trust any calculations unless they’re done to more than three decimal places.
The same rules apply as before. If Royal Bank goes down, you’ve got to either put up more cash or sell some shares. But since the loan-to-value ratio is much higher, that means you’d be forced to sell more shares.
Shorting is where many investors will actually use margin. Here are the requirements for being short.
- Reduced margin eligible stocks require 130% margin.
- Stocks selling for $2 or more per share require 150% margin.
- Stocks for between $1.50 and $1.99 per share require $3.00 per share in margin.
- Anything from $0.25 to $1.49 per share requires 200% of market value.
- Anything less than $0.25 per share requires the market value plus $0.25 per share in margin.
Let’s go back to the Hammond example. You have $10k and you want to short the hell out of it. Since you require 130% margin, you’d only be eligible to short $7,000 worth of Hammond shares.
There are a few reasons why short margin is more onerous than when you go long. Stocks do tend to go up over time. Shorting is riskier than going long because you have no defined downside limit (i.e. stocks can go up forever). And (puts on tinfoil hat), I truly believe the exchanges do not want to encourage short sellers. People hate shorts.
Should you use margin?
Most people shouldn’t bother with margin. It adds risk to an already risky activity. I don’t see stocks being particularly attractive at this point anyway. Leveraging to get more exposure to a fairly valued market is dumb.
Saying that, here are a few more tips on how to not get ripped off by margin.
Most brokerages view margin as a profit center, and will charge you high interest rates to access it. I’ve never actually used my brokerage’s margin, but I’ve heard it’s Prime + 4%. That’s not very attractive.
Oh hell, let’s make a chart.
|TD||4.25% CDN/4.75% USD|
|Interactive Brokers||2% on the first $140k, 1.5% to $1.4M, 1% past $1.4M|
|Questrade||Prime+3.5% on margin accounts (P+2.5% on balances over 100k)
Prime+8.1%(!) on RRSP accounts
|Qtrade||5.65% to 6.2%, depending on the amount in the account|
|BMO||2.95% for $100k+, 3.45% for $25k-$99k, 3.95% under $25k
Drops to 2.7%/3.45%/3.7% for $500k to $10M in assets
|CIBC||4.25% CDN/4.75% USD|
|Scotiabank||Prime+1.65% up to $25k, P+1.6% to $100k, P+1.55 for $100k+|
|Royal Bank||2.85% ($100k+) to 4.1% (less than $25k)|
|Virtual Brokers||Prime + 1.5%|
As you can see, Interactive Brokers is the big winner. Nobody else even gets close. A hearty thumbs up to Qtrade, which does not publish its rates anywhere on its website. You’re not fooling anybody, guys.
The other thing I want to stress is you shouldn’t borrow up to your margin limits. If you only need 30% down to buy something, maybe limit your debt ratio to 50%. That’s just smart planning. And if you get dividends from said investment, keep them in your account to help pay down the debt.