Risky Margin

Q What is buying stocks “on margin”? — A.J., Santa Maria, California

A It’s when you invest with money borrowed from your brokerage — and pay interest on the loan. Margin’s appeal is that it will turbocharge your gains — but it also turbocharges your losses. Imagine, for example, that you have $100,000 worth of stocks in your account and you borrow $100,000 on margin to invest in more stocks. If your $200,000 portfolio doubles in value to $400,000, you’ll have earned an extra $100,000 (less interest expense), thanks to margin. But if your holdings drop by 50 percent instead, they’ll be worth $100,000 — and you’ll still owe $100,000 (plus interest). That will leave you with … nothing. Your holdings dropped by 50 percent, but thanks to margin, it became a 100-percent loss. Margin cuts both ways. The interest expense can add up, too. If you’re borrowing on margin and paying 8 percent interest, your borrowed stocks had better appreciate more than 8 percent. Your brokerage won’t want your portfolio’s value to fall below the sum you valued, so if it drops a certain amount, the brokerage will expect you to add more money or sell some shares — or it will sell them. Using margin is risky, and only experienced investors should use it. You can do very well without it.

Q What’s a payout ratio? — T.N., Kalamazoo, Michigan

A It’s the percentage of a company’s earnings paid out in dividends. Boeing, for example, pays out $6.84 per share annually, and its trailing 12 months of earnings total $10.85. Divide the former by the latter, and you’ll see that 63 percent of Boeing’s earnings go to its dividend. Payout ratios near or above 100 percent can be worrisome.

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