Margin Accounts Dangerous For Voyagers

MP900387264In reading the headline of this post, you could be forgiven for thinking that I have completely lost my mind and decided to leave the nautical arena to become an investment blogger. Not so. Almost everyone out there voyaging is relying on their savings, to at least some extent, and most of you who are planning to go cruising are saving to do so. Here at AAC we warn you about poor anchors and other nautical dangers, this post is just an extension of that.

The Danger

Here’s the danger: If you have an investment account that allows you to use margin it is possible, maybe even likely, that your broker is using your securities to gamble for their benefit.

I’m no finance expert, but as I understand it, what the broker does is rent your securities out to people shorting the market and/or uses your securities as collateral to back their own bets. And if one of those shorts goes bust, or your broker does, you lose—maybe everything. Think MF-Global.

Worse

It gets worse: this may be true whether or not you actually use the margin facility.

Worse Still

And worse: your broker may be able to gamble with all of the securities in your account, even the ones that are not margined.

Don’t Assume

You may have a margin account, even if you never consciously asked for one since some brokers will set your new account up that way by default.

It’s International

Apparently this is happening in the UK, Europe, the USA and Canada, at least, and probably in many or even most other places.

They Take The Profit, You Take The Risk

What makes this so heinous is that the broker is reaping all of the benefits of this activity and you are taking all of the risk. It’s just like being a taxpayer: the finance industry reaps all the profits and you get stuck with the losses—oops, who said that?

It’s Not Paranoia If…

Of course, when you tackle your broker about this, they will, as mine and several other people’s did, pat you on the head and tell you not to worry your little old yachty head about such things. They would never do such a thing. Yea, right, and I’m still waiting for the fat guy in the red suit to deliver presents.

Don’t ever forget that many, perhaps most, of the people in the “wealth management business” are really in the wealth transfer business…from you to them. One of the reasons that Phyllis and I are still voyaging is because we remind ourselves of this fundamental truth before any dealings with the finance industry.

My Source

How do I know about this? By pure luck. One of my oldest and best friends is a risk management and securities custody expert with thirty years of experience in keeping money and securities safe.

But I Need Margin

Some of you may say that you need margin to support your trading activities and so that you don’t have to leave a large cash balance in your account to fund your next investment. Fine, if you want to take this risk, that’s up to you. But for me, the benefit of making a tiny amount of interest, by the improvement in cash management that a margin account allows, is not worth the risk of losing everything in a crash.

How Can You Check?

I urge all of you to immediately check your broker statements and contracts (you may have to ask for the latter) and make sure that you do not have a margin (type 2) account.

The Smoking Guns

Look for the following:

  • Any indication on your statement that the funds available to you are more than the actual cash balance.
  • Any use of the word “margin”.
  • Any use of the words “hypothecate” or “re-hypothecate”.

Further Reading

For more, from an industry insider, on this danger, I urge you to read this blog post. Also, Wikipedia has a good definition of hypothecation here.

Disclaimer

I have no qualifications whatsoever in the finance or investment industries. This post is not investment advice, but purely a warning about a danger that I believe to be real, but could, of course, be wrong about.

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John was born and brought up in Bermuda and started sailing as a child, racing locally and offshore before turning to cruising. He has sailed over 100,000 miles, most of it on his McCurdy & Rhodes 56, Morgan's Cloud, including eight ocean races to Bermuda, culminating in winning his class twice in the Newport Bermuda Race. He has skippered a series of voyages in the North Atlantic, the majority of which have been to the high latitudes. John has been helping others go voyaging by sharing his experience for twenty years, first in yachting magazines and, for the last 18 years, as co-editor/publisher of AAC.

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