The SEC recently published an Investor Bulletin with important information about interest charges on margin accounts. Trading on margin is not free. Like other borrowed money, broker-dealers that lend money to investors to trade on margin charge interest. These interest charges increase risk, reduce an investor’s return, and increase the amount of money an investor must earn to break even.
An investor should understand the interest rate charged by the broker-dealer and also whether the firm uses netting. A broker-dealer that uses netting may sweep cash in an investor’s cash account to the investor’s margin account, reducing the margin loan and the amount of interest that the investor pays. In contrast, a broker-dealer with a no netting policy charges interest on the full amount of the margin loan, while paying what is most likely a lower interest rate on the investor’s cash account. In the no netting scenario, the money in the investor’s cash account does not reduce the amount of the margin loan.
The investor’s margin agreement with the broker-dealer should specify how interest is calculated and whether the broker-dealer uses netting.
The SEC’s Investor Bulletin has a list of questions for investors to ask about interest charges on margin accounts. They are:
- What is the interest rate on margin loans?
- Can this interest rate vary? If yes, then how often does it change and where can you find those changes?
- How often do interest charges accrue on the margin loan balance (daily, weekly, monthly)?
- How can you reduce the margin loan balance?
- Does the firm net your cash account balances and margin account balances to reduce the interest you pay on margin loan balances? Does it matter whether your cash and margin accounts are set up in a certain way (e.g., as separate accounts or as “sub accounts” with one master account)?
- If so, how does the firm’s netting policy work with your accounts?
- How do cash or money market sweep programs (where your extra cash is swept into a bank account or money market account) impact the firm’s netting practices?
For more information about margin accounts, an earlier Investor Bulletin, Understanding Margin Accounts, is a good starting point.