With the current market pullback recently, some people have got a “margin call”. They have to, either add more money or liquidate their investment (meaning sell in low price).

For those who don’t know, “margin” basically means borrow money from your broker to invest. On the one hand, using a margin can accelerate our return. On the other hand, there is a greater risk when we have market pullback, just what we had recently.

Let’s take an example: suppose that we invest $10,000. Using a 2:1 margin ratio, we can invest up to $20,000. Let’s assume that we invest the whole $20,000.

Scenario 1: Our investment goes up by 50%. Our balance is now $30,000. It means we have a profit of $10,000; so our return of investment is 100%. Remember that our original principal is $10,000.

Scenario 2: Our investment goes down by 50%. Our balance is now $10,000. Since we still “owe” our broker $10,000. we lost all of our principal money. In other words, our return is –100%.

Usually, you won’t be able to lost all of your principal when investing using a margin. Your broker usually will do “margin call” if your margin ratio dropped below a certain level. For example, if your broker allows up to 3:1 margin ratio, once your principal is less than 33% of your total investment; they will call you.

Getting a margin call is always not a good experience. Sometimes, we have to sell our investment in a very low price.

(Picture is from stock.xchng.)

Suppose that we have $10,000. We’ll compare two investment cases.

Case 1:

• Invest $10,000 in an investment vehicle with an average return of 5% annually.
• After 10 years, our money will grow to $16,288.

Case 2:

• Divide $10,000 into 4 and invest them in 4 different investment vehicles with the following returns:

• The first $2,500 is invested in a company that went bankrupt, so we lost everything.
• The second and third $2,500 are invested in companies that did “so-so”.
• The last $2,500 hit a “home-run”. The company did very well with the annual return of 20%.
• After 10 years, our money will grow to $22,051.

As we can see, if we’re willing to take more risks, we’ll get higher return. Even if we lost everything in one of our vehicles, as long as we hit home-run in another vehicle, we should be more than fine.

The big question is, of course, how to hit the “home-run”….