In most cases, one may also use the loan as a cash advance, for instance with a debit card or check written against the account. We routinely pay our annual tax bills, for instance, using margin debt. (The amount we borrow is normally repaid within a few months as retirement annuity checks are received.)

"Margin debt" is the leverage one has thus used to obtain an advance or acquire securities, over and above what can be bought in a brokerage account with cash reserves alone or by first selling other holdings.

The advantages of margin debt, sometimes abbreviated as simply "margin," include convenience (as with the speedy payment of taxes) and the possibility of nice profits if by using margin one leverages an equity purchase and the assets in question subsequently go up in price.

Now, if one would have gained 10% a year, after all brokerage fees, on the original $100,000 investment and invested the second $100,000 just as successfully, one's return on the second $100,000 would be less the interest paid in a year on the margin loan. If the interest on the loan were, for example, 5% a year, in this simplified instance, the overall total return would be 10% (return on the equities owned outright) plus 10% (return on the new equities) less 5% (interest on the debt) = 15% ($15,000). That looks pretty good! (This example was closer to reality a few years ago, when interest rates were low and yet the market tended to go up in most every 12 period.)

By contrast, the maximum margin leverage or debt allowed now in a brokerage account is 50%. Prior to the Great Depression, stock could be purchased with levels of margin similar to those prevalent for real estate today. The maximum margin level is variable. The Chairman of the Federal Reserve has as one of his or her tools the capacity to raise or lower the max equity margin percentage. Though it has been many years since that tool was last employed, if we again have a period of runaway inflation combined with a stock bubble, it is likely the then Fed Chief will dampen down the markets' "irrational exuberance" by reducing permissible top margin rates.

Margin calls may be triggered by other events as well. If the Fed Chief does at some point in the future lower the maximum margin level, say from 50% to 40%, highly leveraged stock investors could face margin calls, since they would have already been investing at close their highest legal levels prior to the change and so, with little or no warning, they may be required to come up with multiple thousands of dollars they had not anticipated would be required. There is nothing legally to require that the Federal Reserve must lower the max margin level gradually. It is not probable but conceivable that under certain national emergency conditions down the road it might be cut in half, resulting in sudden, enormous disruption of the margin borrower's finances.

For its own reasons, the brokerage may also lower maximum margin levels, independent of the Fed and with little or no advance notice, perhaps if it finds that investor activity seems more and more risky or that the prices of certain classes of stocks are becoming too frothy or volatile for its underwriters to sleep well at night.

If investing a lot in margin debt securities, the risks of losing big are also naturally increased. Again using the illustration initially presented above, if, instead of gaining 10% a year, the investor's assets drop 20% one year, a not uncommon event from time to time, the actual return will be -20% (on his shares owned outright), and then -20% (on the shares bought with a margin loan), and -5% (the interest on the margin debt) = -45% or -$45,000 (assuming one did not lose still more due to margin calls and selling securities at a loss, with the net proceeds even lower after subtracting commissions).

My father appeared for many years to be addicted to margin purchases, generally staying leveraged to the hilt, then facing huge margin calls when the market would plummet, as occurred in the 1973-1974 period and, to a lesser extent, again in 1987 and 1990.

Although he was a fairly good stock picker, his average profits were so reduced by losses during margin call selling that he likely would have done better, and with lower stress for all concerned, had he merely invested the same amounts in Treasury Bills, Certificates of Deposit, or Money Market Accounts, which during much of the period of his investing career were yielding 6% or higher, even as much as 12% a year for awhile.

The founder of value investing, Ben Graham, was heavily invested using margin debt during the Depression and was virtually wiped out financially as a result. It took him many years then to recover his lost fortune. Afterward, the only margin he would consider for himself, or recommend to clients, was what he termed a "margin of safety," his phrase for the difference between what a company was conservatively worth, on a per share basis, and the much lower per share price he would advise paying for it.

Even as savvy an investor as Warren Buffett of Berkshire Hathaway tends to avoid margin investing as too risky and recommends strongly that others do as well.

The final disadvantage of margin investing is that, before any profits may be calculated from such activities, it is necessary to pay the broker's interest on the margin loan. Usually this is set a few percentage points higher than the prime rate. Currently, I believe the margin loan rate for the average individual investor is between 10-11% a year. Yet that is also the average yearly total return for stocks. If one cannot reasonably expect to earn much more on borrowing than what must be paid out in interest, what is the point of the extra risk?

But if, despite such cautions, one is inclined to try margin investing in a big way, it is best to do so with a strategy or strategies (if one can discover them) that are virtually foolproof.

(Many thanks to Ann, whose several donated articles and financial newsletters helped inform and inspire this essay!)

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)