What Are Non-Marginable Securities?
Explore investments that cannot be bought on margin. Understand why these securities have limitations and what it means for your portfolio.
A security represents a tradable financial asset, encompassing investment instruments like stocks, bonds, and funds. Stocks signify company ownership, bonds are debt instruments, and funds are pooled investments such as mutual funds or exchange-traded funds. Investing in these securities allows individuals to participate in financial markets, aiming for potential capital appreciation or income generation.
Understanding Margin Accounts
A margin account allows investors to borrow funds from their brokerage firm to purchase securities, differing significantly from a standard cash account where all purchases must be fully paid with the investor’s own funds. This practice, known as buying on margin, effectively increases an investor’s purchasing power beyond their available cash. The securities bought on margin serve as collateral for the loan, and investors are charged interest on the borrowed amount.
The mechanics of margin trading involve specific requirements. Federal regulations, particularly the Federal Reserve Board’s Regulation T, mandate an initial margin requirement of 50% for new stock purchases. Beyond the initial purchase, investors must maintain a certain equity level in their account, known as the maintenance margin. The Financial Industry Regulatory Authority (FINRA) sets this minimum at 25% of the total market value of the securities, although many brokerage firms impose higher internal requirements, often ranging from 30% to 40%.
If the equity in a margin account falls below the maintenance margin requirement, a margin call is issued. This demand from the brokerage firm requires the investor to deposit additional cash or marginable securities to bring the account back to the required equity level. Failure to meet a margin call can result in the brokerage firm liquidating securities in the account without prior notification, potentially at a significant loss to the investor.
Types of Non-Marginable Securities
Non-marginable securities are financial instruments that cannot be purchased using borrowed funds from a brokerage firm; investors must pay the full purchase price with their own capital. Several categories of securities are classified as non-marginable due to their characteristics. These restrictions aim to protect both investors and brokerage firms from heightened risks associated with certain assets.
One common type is penny stocks, which are low-priced, highly speculative equities trading for less than $5 per share. These stocks often trade on over-the-counter (OTC) markets rather than major exchanges. Initial Public Offerings (IPOs) are another category; newly issued stocks are frequently non-marginable for a period, often around 30 days, following their market debut. This restriction is due to the significant price volatility often experienced by new listings.
Illiquid securities, characterized by very low trading volume or limited market interest, are non-marginable. Their difficulty in being quickly bought or sold without impacting price makes them unsuitable for margin. Many securities traded on over-the-counter (OTC) markets fall into this category, lacking the transparency and regulatory oversight of exchange-listed securities. Options and futures contracts, while derivatives with their own margin rules, can also be non-marginable due to their complex nature and potential for rapid value changes.
Mutual funds are non-marginable for an initial period, often 30 days after purchase, due to their settlement periods. While some Exchange-Traded Funds (ETFs) are marginable, others, especially leveraged or inverse ETFs, or those newly issued, may have restrictions. Certain bonds, particularly those with lower credit ratings or nearing maturity, might also be deemed non-marginable, reflecting their specific risk profiles.
Reasons for Non-Marginable Classification
The classification of a security as non-marginable stems from risk management considerations for both investors and brokerage firms. Securities with high volatility, meaning they experience significant and unpredictable price fluctuations, pose a greater risk of substantial losses. If such assets were purchased on margin, rapid price drops could quickly deplete an investor’s equity, leading to margin calls that may be difficult to meet.
A lack of liquidity is another reason for non-marginable status. Securities that are difficult to sell quickly without significantly affecting their price increase the risk for brokerages, especially if they need to liquidate collateral to cover a margin loan. Illiquid assets can trap capital and exacerbate losses during market downturns.
Regulatory requirements play a significant role in determining margin eligibility. The Federal Reserve Board’s Regulation T sets the framework for credit extended by brokers, establishing initial margin requirements and influencing which securities can be margined. FINRA rules and other regulatory guidelines outline minimum maintenance requirements and govern the overall use of margin to protect market stability and investor interests.
Individual brokerage firms implement their own internal risk management policies, which can be stricter than the minimum regulatory requirements. These “house rules” allow brokerages to manage their specific risk exposure based on their client base and market conditions. A lack of publicly available, reliable financial information or market data for a security makes it challenging for brokerages to accurately assess its risk, contributing to a non-marginable classification. These classifications protect brokerage firms from the increased risk of an investor defaulting on a margin loan, particularly when highly speculative or unstable assets are involved.