What is the advantage of buying stock on margin?

Question

Say you invest $500 of your margin account money and borrow $500 from your broker to buy 100 $10 shares for $1000. The shares go up to $15 so you sell them and have $1500. You pay back your broker the $500 and, subtracting your original $500 investment of your own money, you have $500 left for yourself. If you invest $1000 of your own money in the same stock and sell it for the same price again and $1500 back, you subtract your original investment ($1000), and you still have $500 in profit left. What is the advantage of buying on margin?

Answer 1

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True. In this example you invested $500 and made $500, giving you a profit of 100% of your investment.



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True. In this example you invested $1,000 and made $500, giving you a profit of 50% on your original investment.



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Most people would rather make a 100% profit than a 50% profit.



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Let's try reworking your example a little bit. Assume each of three sisters inherited $1,000 from their parents. Each of them wanted to invest in a company that had stock selling for $10 per share.



LaVerne stuffed $500 of the $1,000 under her mattress and used the other $500 to buy 100 shares of the stock using margin debt to pay for half of the shares.



Maxene used her $1,000 to buy 100 shares without using any margin.



Patty used the her $1,000 to buy 200 shares of using margin debt to pay for half.



When the stock hit $15 per share all three sold their stock. LaVern made a profit of $5 x 100 = $500. Maxene made a profit of $5 x 100 = $500. Patty made a profit of $5 x 200 = $1,000.



Using margin allows you to make more per dollar invested. If you have cash stuffed under your mattress it would make more sense to take the cash out from the mattress instead of using margin. (remember if you use margin you pay interest of the loan.) However, assuming you do not have cash (figuratively) stuffed under your mattress, you can make more money on the same investment with the same amount of money invested using margin. That is called "leverage" or "gearing" depending on where you live.



Just remember that any type of leverage or gearing is a two-edged sword. If you use the same example but assume the stock suddenly fell to $5 instead, LaVern and Maxene would only have lost $500 each, while Patty would have lost $1,000.

Answer 2

Why give us an example where you switch the numbers. You need a lesson in logic. You're comparing apples and oranges when you do that. First you invest $500 of your own money and $500 on margin and get X result. Then you invest $1000 of your own money and and NONE on margin and get Y result. X does not equal Y. You would answer your own question if you compare your first premise to $500 invested without margin.



The simple answer is leverage. But you can also short stock in a margin account. You can also trade options.



Once you have a track record and proven you're no longer a novice, you can even get 4:1 leverage. Wow, you can make four times as much money as you have in your account if the stock price doubles. But you can also lose everything with a 25% decline in the stock price. This is not recommended for novices.

Answer 3

Because you would only do it if you only had $500 and not $1000. If you had $1000 you would invest $2000. This gets you 2:1 gearing or leverage.