Margin Account

How a margin account works

In an ordinary cash account, you can only buy what you can pay for. A margin account adds a built-in loan: your broker lends you money and takes your holdings as collateral. The result is leverage in its purest retail form, more market exposure than you have money.

A round-number illustration: deposit $10,000 of your own cash, and depending on what you buy, your broker might let you purchase $20,000 of stock. You now control twice the position. If the shares rise 20%, your $10,000 of equity grows to $14,000, a 40% gain. If they fall 20%, your equity drops to $6,000, a 40% loss. The loan amplifies both directions with perfect indifference.

Not every security supports the same loan. Brokers assign each holding a lending value based on its price, liquidity and volatility: large, stable, liquid securities can support relatively generous borrowing, while cheap, thinly traded or volatile ones support little or none. Those requirements are the broker's to set within regulatory minimums, and the broker can tighten them at any time, including in the middle of a market panic.

The margin call

The defining moment of margin investing arrives when prices fall. As your holdings lose value, your equity, the part of the account that is actually yours, shrinks while the loan stays the same size. When equity falls below the broker's requirement, you receive a margin call: deposit more cash or securities, promptly, or the broker will sell your positions to bring the account back onside.

The part investors underestimate is that the broker does not have to wait. The account agreement typically lets the broker sell at its discretion, without notice and without asking which positions you would prefer to keep. In a fast decline, positions can be liquidated before you have read the email.

This is the classic wealth destroyer of leveraged investing: forced selling at the lows. An unleveraged investor who rides a 40% crash down and back up ends where they started. A margined investor may be sold out near the bottom, locking in the loss permanently and missing the recovery. The margin call converts a temporary decline into a permanent one, and it tends to arrive at the exact moment everything else in the market is also going wrong.

The interest meter

A margin loan is not free money. Interest accrues daily on the borrowed balance at a rate that floats with the broker's base rate, itself tied to the prime rate. When rates rise, the cost of carrying a margin position rises with them, and the hurdle your investments must clear just to break even rises too.

One tax note, held loosely: when you borrow to earn investment income in a taxable account, the interest may be deductible, the same principle that powers the Smith Manoeuvre on the mortgage side. The rules have real conditions, so treat deductibility as a question for a tax professional, not an assumption.

What margin is reasonably for

Registered accounts are excluded from all of this by design: a TFSA or RRSP is a cash account and cannot carry a margin loan, so margin lives only in taxable accounts.

Used sparingly, margin has legitimate jobs: bridging a few days between a purchase and a deposit, avoiding an untimely sale to raise short-term cash, or enabling strategies such as short selling that require it structurally. What it is not reasonably for is doubling a long-term portfolio, because a strategy that cannot survive a bad year without forced selling is not a long-term strategy at all. If a market drop of a third would trigger a call you could not meet, the position is too big, whatever the expected return.