How to Buy Dividend Stocks on Margin

How do you buy dividend stocks on margin, and should you? These are great questions, especially for beginning investors. If you think you might want to buy stocks on margin, how might you decide and get started on the process? Let's go over the definition of dividend stocks, an overview of margin, the pros and cons of buying dividend stocks on margin, and the steps to buying stocks on margin. 

Let's get started so you know the ins and outs of buying dividend stocks on margin and don't forget to pay serious attention to the pitfalls as well, which we'll go over in this piece.

What Are Dividend Stocks?

First, what exactly are dividend stocks? Dividends are payments that a company makes to shareholders in order to share profits with them, and they do this as a reward for investing in the company.

Stockholders get paid on a regular basis, usually in the form of cash payments, though a company might pay you in other ways. For example, a company might offer real estate or other physical assets. They might even give you a choice about whether you want cash or company stock — this is called a scrip dividend. Companies might also offer special dividends, a more unexpected dividend that you might receive if a company has great sales or makes money through a sale of a portion of the company.

Here's a quick summary of how dividend investing works. Let’s say you buy 50 shares of ABC stock. The company authorizes dividend payments to go to shareholders on what is called a declaration date. Let's say in this case that the company decides to pay 30 cents in cash dividends annually. 

The ex-dividend date (ex-date) decides who of shareholders are eligible to receive dividends. You’ll qualify to receive the dividend payment if you've purchased shares by the ex-date. The record date is the final date that you must be considered a shareholder by the company in order to receive the dividend. These dates are set in place in order to make it extremely clear who can and cannot receive a dividend payout. Companies also declare a payment date or the date that shareholders will receive payment by companies.

In the scenario above, you'll receive $15 in annual dividends from that company.

You can do what you want with your dividends, including reinvesting them back into the company to buy more shares, live off the money you receive, or buy a completely different type of investment. 

What is Margin?

Buying on margin means that you get a loan from your brokerage. You can then use the money from the loan to invest in more securities. Buying on margin helps you try to increase your returns, but it's only possible to make money if the investments outperform the cost of the loan itself. 

The brokerage firm uses the securities in your margin account as collateral for the money it lends to you to buy these securities, and as is the case with most loans, you pay interest on the money you borrow. 

You can receive dividends even when you trade on margin. Whether you pay cash to buy the shares or borrow money from your broker, you'll receive the dividend payment. When the company puts cash into your brokerage accounts, you get a dividend payment for all the shares you hold.

Pros and Cons of Buying Dividend Stocks on Margin

So, what are the pros and cons of buying on margin? Let's walk through the pros and cons of buying dividend stocks on margin.

Pros of Buying Dividend Stocks on Margin

First, the benefits of buying on margin include: 

• Can increase your investment: You can use leverage to your advantage to increase your investment and possibly increase your returns. The Federal Reserve Board Regulation T allows you to use margin to elevate 50% of the value of a securities purchase. In other words, let's say you want to double your purchase after buying $2,500 worth of stock — you'd also use a margin loan to borrow $2,500 for a total of $5,000.
• Easy-to-access line of credit: You don't have to go to major extremes to get a loan. As long as you get approved for margin, your broker can help you access extra money, and you don't have to go through a lot of extra hoops to access extra money to invest.
• Short selling opportunities: You can benefit from short selling by profiting from a declining share price. Short sellers believe that the stocks sold short will drop in price. After you borrow shares, you sell and buy them back at a lower price and return them to the lender. The difference between the selling price and the buy price (minus the amount required to buy back the shares) is your profit. 
• Lower interest rates: You'll have to pay interest for a loan but margin rate loans are pegged to the federal fund's target rate, which means they're likely lower than what you'd pay for a bank loan, second mortgage, etc. (without the application process and possible closing costs as well).

Cons of Buying Stocks on Margin

There are also downsides to buying stocks on margin, and it's important to understand that margin loans aren't risk-free. The biggest risks involved in buying stocks on margin include leverage risk and margin call risk. Let's walk through the challenges of both of these factors:

• Leverage risk: Margin can magnify your losses just as dramatically as it can boost returns. The minute you borrow money from a brokerage account to finance your stock purchase, you give up control of your account because you're borrowing money. It's smart to consider never buying stocks you can't pay cash for. If you think you must buy on margin, it's a good rule of thumb to never let your margin debt equal 10% of your account value. In other words, it's true that you'll gain access to more purchasing power, but you could also face larger losses.
• Inability to meet a margin call: You'll have to meet a specific amount of equity in your account. For stock positions, the minimum equity maintenance requirement is typically a 30% base but it could be higher. Here's the important thing to know: If the value of the securities you use as collateral for your margin loan falls below the brokerage's equity maintenance requirement, you may face a margin call. In other words, you'll need to add more cash to your account to increase your equity. If you don't, the brokerage might sell your securities to increase equity.

You may want to leave a cash cushion in to reduce the chance of a margin call and invest in assets with return potential (more than the cost of interest on the loan). 

How to Buy Dividend Stocks on Margin

How exactly do you buy dividend stocks on margin? Let's take a look at the exact steps. 

Step 1: Choose a brokerage account.

First, you'll need to have a brokerage account that offers a margin. If you don't already have a brokerage account, shop around for the right type of account for your needs. You'll need to fill out the application for the brokerage, which typically will ask you the following: your name, Social Security number, address, phone number, email address, birth date, government-issued identification, employment status, annual income, net worth and other information.

Step 2: Fund your account.

Your margin account will outline a minimum margin amount, and a minimum amount of cash you’ll need in your account. You'll typically need to have at least $2,000 to fund a margin account, and at the same time, determine how much margin you can access. Your broker will explain how much you can borrow, which you'll find outlined on your brokerage's website. 

Step 3: Make your trade.

Take a look at dividend stocks history and fundamentals in order to decide which dividend stocks you want to purchase. You can typically make your trade just like you would with a regular brokerage account, but in this case, you can access more money than you would with a cash account. Make sure you have enough money in your account to meet your maintenance margin. If you can’t maintain this minimum, you'll get hit with a margin call. 

Do You Want to Buy Dividend Stocks on Margin?

Finally, it's important to decide whether you really do want to buy dividend stocks on margin. Consider all the pros and cons of your decision and decide whether you'll actually want to take on the downsides and advantages of buying dividend stocks on margin.

Remember that you could face increased losses if the securities you purchase go down in value. You could also face margin calls or liquidation of securities as well as face losses larger than your initial investments. Furthermore, you might also experience increased interest rates, which could mean that your loan will cost you more.

If you're not sure you want to take on the risks of dividend investing on margin, you can simply invest in cash dividends and skip margin altogether.

Recommended: Are Dividend Stocks Worth It?