Can You Lose More Than You Invest in Stocks?
Investing involves risk and stock trading is one of the trickiest investment paths to follow. Investments are generally divided into low and high risk. Putting your money in a savings account is an example of the former.
This is because, in most cases, your money with any financial institution is insured by Federal Deposit Insurance. That way, even if anything happens, you can recover some if not all of your money. Stock trading, on the other hand, is a high-risk investment.
Like high-risk investments, there is the possibility of making a maximum profit when you get into trading stocks. However, conversely, you can also lose massively. This is traceable to the market volatility the stock market is famous for.
The market fluctuates rapidly, which means that a person could wake up a millionaire and will be broke at the close of the stock market. You could end up not just losing money but even owing money on the shares you invested. This happens when the value of the stocks you invested in falls into a negative value.
Granted, it is possible to lose in the stock market. However, is it possible to lose more than you invest in stocks? This guide answers that question and lets you know the key things to bear in mind before you begin trading.
Can You Lose Money in the Stock Market?
Let’s dive right into the question. Can you lose more money than you invest? The short answer is yes. However, a lot depends on the type of brokerage account that you decide to run. Generally, there are two popular options: a cash account and a margin account.
While it is possible to potentially lose money when you use any brokerage accounts, the risk is higher with margin accounts. This is because, with a margin account, you are borrowing money from a brokerage firm to buy stocks.
The borrowed money incurs interest and eventually, you will have to pay back the entire amount and the interest accrued if the stock drops. In any case, let’s look at the two accounts individually.
Understanding How a Cash Account Works
A cash account is a type of brokerage account where you have to pay in full for any security and it has less risk. You can either pay in cash or use the proceeds from selling other securities in your personal portfolio as the initial investment.
Cash accounts have to follow some rules. One of them is that it takes two days after a transaction for it to settle. During that window, you are not officially a stock owner yet. So, although you will still have to make full payment, you will have to wait till the trade settles completely before ownership of the shares transfers to you.
You will not lose more money than you invest in a stock if you operate a cash account. However, you will not lose more than you invested, even though it is possible to lose all your investment. Another benefit is that you get to hold stocks for as long as you want. But you will not be forced to sell due to fluctuations in the market.
However, you cannot engage in short selling with a cash account. Short selling occurs when an investor borrows and sells the same stock, or just a portion of the stock, with the expectation that the price will fall when the stock drops. Once it does, they can then back buy the borrowed stock at a profit. Unfortunately, you will need to operate a margin account to be eligible for this.
Understanding How a Margin Account Works
A margin account is another type of brokerage account. With a margin account, you are essentially borrowing money to purchase securities. The Federal Reserve Board’s Regulation T allows you to borrow up to half the purchase price of any stock when you run a margin account.
This practice gives you the flexibility to find and buy shares. However, it also exposes investors to risks. When you borrow money for margin trading, interest accrues with it. Hence, not only do you owe money, but you also owe interest. Furthermore, if an unforeseen circumstance arises, you will lose more cash than you invested because you will have to pay more than you invested, making it harder to save money.
Another way margin investing causes new investors to lose money is through the margin call. The Financial Industry Regulatory Authority stipulates that a stock owner should always have at least 25% of the value of their securities in the margin account.
If at any point you fall below this maintenance requirement, for instance, if your stock falls and loses value. If it falls below the threshold required, you will receive a margin call. This will need you to deposit cash or sell your securities to meet the equity requirement stipulated by the Financial Industry Regulatory Authority.
Just like with cash accounts, there are several pros and cons of the margin account. On the benefits side, you get increased purchasing power and even have the option of profiting from declining shares. However, on the other hand, a margin account predisposes you to debt.
As a result, you could end up owing money to your broker, affecting your personal finance. If you are one of the vast majority of retail investors, you can avoid losing money by getting advice from a financial advisor. Do this before you begin investing, even if it’s penny stocks, to mitigate your losses.
What Affects Stock Price?
When a company goes public, the value and price of its shares get impacted by the market forces of demand and supply. Thus, where there is a high demand for any company’s shares, its stock price will increase.
The reverse is the case if demand drops and people lose money. However, a couple of factors could affect the demand and supply of a company’s shares. This invariably affects the share prices too. Below are a few of them.
The level of competitive advantage a company has will surely impact the value of its shares. This is why a company’s stock prices shoot up after they announce dividends. But, unfortunately, some dishonest companies sometimes declare spurious dividends, which could end up misleading customers into buying shares. This would, in turn, increase the value of the shares, albeit erroneously.
The interest rates a company employs impact both its share prices and the request for loans. When the interest rates are high, people tend to shun loans. Thus, this gives the company an avenue to sell securities because shares will be in high demand.
On the other hand, if the interest rate is low, people will typically want funds and not shares. Hence, great financial advice would be to ramp up the interest rate for high company demand.
The Economy and Political Climate
The economic conditions prevalent in any given location could affect the share price of its companies and the number of people who buy stock. Generally, the market price for shares is favorable if the economy of any place is doing alright. The reverse is the case when the economy takes a nosedive.
Similarly, political factors both within a country and outside it could affect the price of shares of its indigenous companies. Internal political factors include government policies, while international political factors include bilateral agreements, wars, etc.
Tips for Responsible Investing
There is hardly anything you can do about the volatility of the stock market. However, you could take active steps to hedge the risks associated with trading, and increase your risk tolerance. Here are a few tested and trusted tips to employ when opening your own individual taxable brokerage account.
Have an Investment Plan
One solid piece of investment advice that could help you minimize more risk and improve future results is developing a plan from the start. In your plan, include what risk you intend to take, how long you want to keep up the investment, and when to stop. Factor in that you may have to stop investing at some point, especially if you run into losses.
Beyond making a plan, it is also important to stick to your project. You can only deviate from it if you think it is in your best interest to do so. Hence, your plan should also be flexible because that is the only way to survive in the stock market.
Invest With Your Own Money
As a general rule, you should only invest to the degree of the risk you can handle. Thus, whether your investment is in real estate, stock, or any other area, a good percentage of the total value of your assets should be your own cash. If anything goes awry, the worst-case scenario will be that you lost money. However, if you borrow from others to invest, you will have to pay back the borrowed money and pay interest.
Also, when trading, try as much as possible to operate a cash account. A margin account could force you to owe money to your broker.
Diversify Your Investments
It is wrong to sink your entire investment into one asset. As mentioned earlier, the market is very unpredictable. Hence, if you put all the money you have into one asset class, you could end up losing more. Rather you should invest in a diversified portfolio. Here, you put some part of your money into different assets at the same time.
You could even explore fractional shares. Fractional shares give you ownership over some parts of a whole share. You’ll own only a piece and so have risks only up to the amount you invested. Remember, regardless of how attractive the stock’s price appears, do not invest all your money into it. This is one way to lose more money, so avoid it.
You can decide to go solo and start off investing without help. However, that is a much slower route to take if you want to become proficient. It is more advisable to find someone well-versed in the market and have them guide you. An experienced person will help you analyze your past performance and market data, tell you the best times to get into the market, and even how to recoup your investments after a loss.
You’ll be lucky if you can get a Securities and Exchange Commission (SEC) registered investment adviser. However, someone like that would most likely charge for their services. So you should only explore the option if you want to become a professional trader.
You can also try using an app designed to help traders at all stages. One of the best is Robinhood. Robinhood enables you to find your investment strategy and suitable investments, hence reducing the chances that you will start losing money from the start. Robinhood has no account minimums and does not charge commissions or maintenance fees. You get a completely free stock when you sign up.
Another app you can use is Stash Invest. It is an offering from Stash Investments LLC. Stash Investments LLC is a company well versed in offering financial products to a vast range of users. It provides investment advice to individuals looking to purchase stock. It provides different account options, including retirement accounts.
Unfortunately, it does not manage the personal portfolio of any particular investor. Stash customers have access to tools such as Round-Ups, Smart Stash, Set Schedule, and a Stash debit card. You can use the card to make a qualifying purchase to be eligible for rewards. Money orders and cash withdrawals are unfortunately not counted as qualifying purchases.