Non-marginable securities are financial instruments that cannot be purchased on margin, meaning investors must pay the full purchase price without borrowing funds from their brokerage. This restriction is typically due to the inherent risk or volatility associated with these securities, which most commonly include certain stocks, mutual funds and options. The inability to leverage these investments with borrowed money can impact an investor’s strategy, particularly for those looking to maximize their buying power. However, it also serves as a protective measure, reducing the potential for significant losses that can occur with margin trading.
An experienced financial advisor can help you assess whether buying securities on margin or sticking to non-marginable assets are suitable strategies for you.
How Non-Marginable Securities Work
The classification of certain securities as non-marginable is largely a protective measure for both investors and brokerage firms. Highly volatile securities or those that lack liquidity pose a greater risk of significant price fluctuations. By requiring investors to pay the full amount, brokerage firms mitigate the risk of potential losses that could arise from margin calls. This practice also encourages investors to carefully consider the risks associated with these investments, promoting more responsible trading behavior.
For investors, the inability to purchase non-marginable securities on margin can influence their overall investment strategy. Without the leverage that margin provides, investors may need to adjust their portfolios to accommodate the full cost of these securities. This could mean allocating more capital to these investments or diversifying into other marginable securities to maintain a balanced portfolio.
Who Decides What's Non-Marginable?
The Federal Reserve and the Financial Industry Regulatory Authority (FINRA) play an important role in determining which securities are classified as non-marginable. These bodies' regulations are designed to protect investors and maintain the stability of financial markets. By setting clear guidelines, regulatory authorities help ensure that investors are aware of the risks associated with certain securities so they are better equipped to make informed investment choices.
Marginable vs. Non-Marginable Securities
Marginable securities are those that investors can purchase using borrowed funds from a brokerage, allowing them to leverage their investments. This can amplify potential returns but also increases risk, as losses can be magnified. Common types of marginable securities include most stocks, bonds and ETFs that meet specific criteria set by brokerage firms and regulatory bodies.
Non-marginable securities differ in that they cannot be purchased on margin, and investors must use their own funds to buy these assets. These securities are typically deemed too volatile or illiquid to be eligible for margin trading, which helps protect both the investor and the brokerage from excessive risk. While this can limit the amount they are able to invest, it also reduces the risk of incurring debt.
Investing in marginable securities offers the potential for higher returns, but it also comes with significant risks. When using margin, investors are essentially borrowing money to increase their purchasing power, which can lead to substantial gains if the market moves in their favor. However, if the market moves against them, they may face margin calls, requiring them to deposit additional funds or sell assets to cover the losses. This can lead to a rapid depletion of their investment capital.
Types of Non-Marginable Securities
When it comes to investing, understanding the types of securities that can be used as collateral for margin loans and the securities that fall into the non-marginable category can help investors make informed decisions and manage their portfolios effectively.
These are the most common types of non-marginable securities.
- Penny stocks: Penny stocks are typically low-priced, small-cap stocks that trade at less than $5 per share. Due to their high volatility and low liquidity, they are considered too risky to be used as collateral for margin loans. As a result, brokerage firms classify them as non-marginable securities.
- Initial public offerings (IPOs): Newly issued stocks from IPOs are often non-marginable for a certain period after they begin trading. This restriction is in place because IPOs can experience significant price fluctuations, making them a risky option for margin accounts.
- Over-the-counter (OTC) securities: OTC securities are traded outside of formal exchanges and often lack the transparency and regulatory oversight of exchange-listed securities. Their limited liquidity and higher risk profile make them unsuitable for margin trading.
- Mutual funds: While mutual funds are a popular investment choice, they are generally non-marginable for the first 30 days after purchase. This restriction is due to the settlement period required for mutual funds, which differs from that of stocks and bonds. Some ETFs are also non-marginable for 30 days.
- Options contracts: Options are derivatives that provide the right, but not the obligation, to buy or sell an asset at a predetermined price. Due to their complex nature and potential for rapid value changes, options are typically non-marginable.
Bottom Line
Non-marginable securities, which cannot be purchased on margin, typically include penny stocks, initial public offerings (IPOs), mutual funds and certain over-the-counter (OTC) stocks. The primary reason these securities are non-marginable is due to their inherent volatility and lack of liquidity, which pose higher risks to both investors and brokerage firms. By recognizing the limitations and characteristics of non-marginable securities, investors can make more informed decisions and better manage their investment strategies.
Tips for Investing in Non-Marginable Securities
- Non-marginable securities cannot be used as collateral for margin loans, so ensure you have sufficient liquidity elsewhere to meet potential financial needs or obligations without relying on these investments for quick access to cash.
- If you’re unsure what to invest in, consider working with a financial advisor. These investment professionals can help you build a portfolio that aligns with your financial objectives, time horizon and risk tolerance. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
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