A Margin Loan (also known as a 'Margin Account Loan' or, more broadly, 'Leveraged Investing') is a loan from your brokerage that allows you to buy more securities than you could with just your own cash. Think of it like a mortgage for your portfolio: you put down some of your own money, and the broker lends you the rest. The securities you buy, along with any other assets in your account, serve as collateral for the loan. This practice, known as using leverage, is a classic double-edged sword. It can amplify your potential gains if your investments go up, but it will just as powerfully magnify your losses if they go down. While it sounds tempting to supercharge your returns, margin loans introduce a level of risk that is fundamentally at odds with the patient, risk-averse principles of value investing. They can turn a temporary market downturn into a permanent loss of your capital, a cardinal sin for any long-term investor.
To get a margin loan, you first need to open a special type of account with your broker called a margin account. Brokers have rules about how much they'll lend you. The first key rule is the initial margin, which is the percentage of the purchase price you must cover with your own funds. In the U.S., Regulation T of the Federal Reserve Board typically sets this at 50%. Let’s use a simple example: You have $10,000 and want to buy shares of a company.
In this scenario, your personal investment, or equity, is $10,000. If the stock's value rises by 10% to $22,000, your equity grows to $12,000 ($22,000 total value - $10,000 loan). That's a 20% return on your original $10,000, double what you would have made without margin! But this sword cuts both ways.
This is where the real danger lies. After you've bought your securities on margin, you must maintain a certain level of equity in your account, known as the maintenance margin. This is typically between 25% and 40% of the total value of the securities. If your investments fall in value and your equity dips below this threshold, your broker will issue a dreaded margin call. Let's revisit our example. You bought $20,000 of stock with $10,000 of your own money and a $10,000 loan. Now, imagine the stock market has a bad week and the value of your holdings drops 30% to $14,000. Your loan is still $10,000, but your equity has plummeted to just $4,000 ($14,000 - $10,000). Your equity is now only about 28.5% of the portfolio's value ($4,000 / $14,000). If your broker's maintenance margin is 30%, you'll get the call. When you receive a margin call, you have two choices, neither of them pleasant:
The most terrifying part is that if you can't meet the call, your broker has the right to sell your securities without your permission. They will sell whatever is necessary to protect their loan, often at fire-sale prices, locking in your losses permanently.
Legendary investors Warren Buffett and his partner Charlie Munger have built their fortunes on a simple principle: avoid catastrophic errors. And for them, using leverage is one of the easiest ways to court disaster. Buffett has famously said, “My partner Charlie says there is only three ways a smart person can go broke: liquor, ladies, and leverage.” He believes it is insane to risk something you have and need (your existing capital) for something you don't have and don't need (extra returns via leverage). A core tenet of value investing is the margin of safety – buying an asset for significantly less than its intrinsic value. This buffer protects you from errors in judgment and bad luck. A margin loan does the exact opposite: it removes your margin of safety. It forces you to sell during market panics, precisely when a true value investor should be calmly looking for bargains.
For the vast majority of individual investors, the answer is simple: never. The risk of a permanent loss of capital from a forced sale far outweighs the allure of boosted returns. The market is unpredictable in the short term, and even the best companies can see their stock prices temporarily plummet. A margin loan turns this normal market volatility into a potential knockout blow to your financial future. While some highly sophisticated hedge funds or professional traders may use leverage in complex strategies, this is a game that ordinary investors should not play. Your goal should be to compound your capital steadily and patiently over many years. Let the power of compounding do the heavy lifting, not the treacherous power of a margin loan. Your greatest allies are time and discipline, not debt.