Buying on Margin

Q.: How does buying stocks on margin work? -- Amy Johnson, San Antonio, Texas

A.: Buying on margin means you’re borrowing money from your brokerage firm and using it to buy stocks. What’s attractive about it is that you can turn a profit using money you don’t even have. For that privilege, you pay interest to the brokerage, just like you would to any other lender. (Actually, it’s a lot easier to open a margin account than to get a bank loan.) If the market turns against you, you either sell for a loss -- plus interest costs -- or hold on until the market picks up, paying interest all the while. Fools buying on margin and paying, say, 9% interest should be pretty sure their stocks will appreciate more than 9 percent. If your margined securities fall below a certain level, you’ll receive a “margin call,” requiring an infusion of additional cash.

Only experienced investors should be borrowing money to buy stocks. Although you’re currently allowed to borrow up to 50% of what your actual holdings are worth, many Fools think that 20% is the most you should borrow, if you borrow at all. You might remember some kind of market decline around 1929. Well, that was partly due to people buying too much on margin. The required collateral was a mere 10% then, not 50%. Things are considerably more controlled now.

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Q. How can a strong dollar be bad for stocks? -- Leslie Craigmyle, Oneonta, N.Y.

A.: Companies with extensive international operations can be stung by a strong dollar. McDonald’s may be raking in lots of rubles in Russia (60% of the firm’s sales are from overseas), but a strengthening dollar will mean Ronald gets fewer dollars for rubles when he exchanges currency. Fewer dollars means less income and thus lower earnings.