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November 28, 2012

“Borrowing Against Yourself”

The following is based on Jason Zweig’s September 21st article.

“Margin loans’ allow an investor to borrow using their own investments as collateral.  Interest rates are often very attractive compared to other loans.  Although you seem to be borrowing from yourself, you are borrowing against the security market.  The amount that the investor can borrow increases as the market moves up.  The reverse is true.  The amount that the investor can borrow decreases as the market moves down.

There are regulatory restrictions and brokerage policies that limit the amount that can be borrowed.  The amount of the account and the nature of the investment are factors that determine how much can be borrowed from a brokerage account.   If your investments fall below the required amount, some of the assets may need to be sold (margin call) to maintain the required value in the account.  That is, you may be required to sell as the value of your securities drop.  For this reason margin loans are not generally a long-term strategy.

If you are a long-term investor, you hold your investment for the long-term.  An unexpected drop in the market could eliminate a portion of your portfolio, regardless of your intent to be a patient long-term investor.  If you are using margin, be sure to adjust your allocation of your portfolio for this.
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