Margin Investing Explained: The Risks of Borrowing to Invest

Most people invest using their own money: they deposit cash, buy investments and hope they grow. But many brokerages, including Robinhood, also offer eligible customers a way to invest with borrowed money. It's called margin investing, and while it can boost your buying power, it's also one of the fastest ways for an investor to turn a manageable loss into a painful one.

Understanding how margin works, and exactly how it can go wrong, is essential before you ever consider using it.

How margin works

When you invest on margin, you borrow money from your broker to buy more securities than you could with your own cash alone. The securities in your account serve as collateral for the loan, much like a house serves as collateral for a mortgage. You pay interest on the borrowed amount for as long as the loan is outstanding, and you're responsible for repaying it no matter what happens to your investments.

Margin accounts are different from regular cash accounts, and opening one usually requires agreeing to additional terms. Brokers set their own requirements for who qualifies and how much you can borrow, within limits set by regulators.

Leverage cuts both ways

The reason people use margin is leverage: borrowed money magnifies the effect of price changes on your own money. When investments rise, your gains are larger than they would have been. But when investments fall, your losses are larger too, and they can grow surprisingly fast.

Notice the pattern. A 10% move in the stock became a 20% move in your money. A 50% drop wiped you out completely. Without margin, that same 50% drop would have cut your $1,000 to $500, painful, but survivable.

Margin calls: when your broker steps in

Because your investments are collateral, your broker requires you to maintain a minimum level of equity in your account, meaning the value of your investments minus what you've borrowed. FINRA, the industry's self-regulatory organization, sets a minimum maintenance requirement, and brokers often set higher requirements of their own, especially for volatile stocks.

If your account value falls below the required level, you may receive a margin call, a demand to deposit more money or sell investments to bring your account back into compliance. Here's the part that catches many investors off guard: brokers generally aren't required to give you notice or time before acting. They can sell your securities, choose which ones to sell and do it at whatever the current price is, which may be the worst possible moment, right after a sharp drop.

That means margin can force you to lock in losses that you might otherwise have waited out. An investor without margin can hold through a downturn and wait for a recovery. An investor on margin may be sold out at the bottom.

The cost of borrowing

Margin isn't free. You pay interest on what you borrow, and that interest is charged whether your investments go up or down. Margin rates vary by broker, by the size of the loan and over time as overall interest rates change, so check your broker's current rates and disclosures. Interest steadily eats into any gains and adds to any losses, which raises the bar your investments need to clear just to break even.

Who uses margin, and who shouldn't

Experienced investors and traders sometimes use margin strategically, for example, for short-term flexibility or specific strategies, and they typically monitor their accounts closely and keep their borrowing well below the maximum. Even then, sudden market moves can cause serious losses.

For beginners and most long-term investors, many financial experts recommend avoiding margin entirely. Long-term investing works because it gives investments time to recover from downturns. Margin removes that safety net by introducing the possibility of forced selling. The potential for higher gains rarely outweighs the risk of losing more than you can afford.

Safer ways to grow your investments

If your goal is to build wealth faster, there are lower-risk approaches. Invest only money you actually have, and build your positions gradually with recurring investments. Raise your contributions as your income grows. Keep a separate emergency fund so you're never tempted to borrow to cover a surprise expense. And give your investments time; consistency over years usually matters far more than any short-term boost.

Before you ever borrow

If you're considering margin, start by reading the SEC's investor bulletin on margin accounts, which explains the risks in detail, and read your broker's margin agreement and disclosures carefully. Ask yourself a simple question: if my investments dropped by half tomorrow, could I handle the result? If the answer is no, margin probably isn't right for you.

The rules behind margin: 50%, 25% and $2,000

A few numbers set the limits, according to the SEC's investor bulletin on margin accounts:

• Initial margin: Under the Federal Reserve's Regulation T, you can generally borrow up to half the purchase price of eligible securities.
• Maintenance margin: FINRA requires the equity in your account to stay at least 25% of the market value of your margined securities. Many firms require more, often 30% to 40%.
• Minimum deposit: You generally need at least $2,000, or 100% of the purchase price if that's less, before you can trade on margin. Some firms ask for more.
• No warning required: Your firm can sell your securities without consulting you to cover a shortfall, and you don't get to choose which ones are sold.

How far can a stock fall before a margin call?

Go back to the example above: $2,000 of stock, $1,000 of it borrowed. Your equity is the account value minus the loan. With a 25% maintenance requirement, a margin call hits once your equity drops below 25% of the account value. That happens when the stock is worth about $1,333, a drop of about 33%.

Now say your broker requires 40% for that stock, which is common for volatile shares. The trigger moves up to about $1,667, a drop of only about 17%. A quick way to estimate it yourself: divide your loan by (1 minus the maintenance percentage). For a $1,000 loan at 40%, that's $1,000 ÷ 0.60, or about $1,667.

That math is why margin is so unforgiving. A one-day drop of 15% to 20% isn't rare for individual stocks, especially around earnings, and it can be enough to trigger forced selling.

Related reading: How to start investing with small amounts using fractional shares, index funds explained and high-yield savings accounts explained.