Margin Call: The Silent Killer of Investor Portfolios

In the high-stakes world of investing, margin calls are the silent killers that can wipe out portfolios in the blink of an eye. These calls, issued by brokerage firms, demand that investors deposit additional funds or securities to meet margin requirements. But what exactly triggers a margin call, and how can investors avoid this financial landmine?



Margin calls occur when the value of securities in a margin account falls below a certain level, known as the maintenance margin. This typically happens when the market value of the securities in the account drops, reducing the investor's equity percentage. For example, if an investor has a margin account with a maintenance margin of 30%, and the value of the securities in the account drops below this level, a margin call will be issued.

But margin calls aren't just triggered by market downturns. They can also occur when a stock goes up in price and losses start mounting in accounts that have sold the stock short. This is because the value of the securities in the account is used as collateral for the margin loan, and if the value of the securities drops, the loan becomes undercollateralized.

So, how can investors avoid a margin call? The first step is to understand the specific margin requirements of their brokerage firm. Different brokerage firms have different margin requirements and maintenance levels. For example, Merrill requires a 30% equity level for fully marginable securities, while the New York Stock Exchange (NYSE) and the Financial Industry Regulatory Authority (FINRA) require that investors maintain an equity level of 25% of the total value of their securities when buying on margin.

Once investors understand the specific margin requirements of their brokerage firm, they can employ several strategies to avoid a margin call. The first strategy is to monitor their account regularly. Frequent monitoring of positions and portfolio can help investors stay in compliance with margin requirements. This is especially important for investors trading on credit, as frequent monitoring allows them to act accordingly to stay in compliance.

The second strategy is to diversify their portfolio. Building a well-diversified portfolio can help limit margin calls because a single position is less likely to decrease the account value. This strategy is supported by the advice to "Manage your risk: Don't concentrate your account in one security, position or a single sector, where a drop in just one of them could put you at risk of a margin call."

The third strategy is to maintain a cash cushion. Keeping excess equity in the margin account can protect against a sudden drop in its value. This is achieved by not utilizing the full margin buying power, as advised: "Have a cash cushion: Keep excess equity in your margin account to protect against a sudden drop in its value. This is also achieved by not utilizing your full margin buying power."

The fourth strategy is to have a liquidity plan. Knowing what accounts to tap for cash or which positions or securities to liquidate in the event of a margin call can help investors act quickly. This plan should be in place to ensure that investors can meet margin calls promptly, as advised: "Have a liquidity plan: Know what accounts you will tap for cash or which positions or securities you would liquidate in the event you receive a margin call."



In conclusion, margin calls are a silent killer that can wipe out investor portfolios in the blink of an eye. But by understanding the specific margin requirements of their brokerage firm and employing strategies such as regular monitoring, diversification, maintaining a cash cushion, and having a liquidity plan, investors can avoid this financial landmine and protect their portfolios from the silent killer of margin calls.