Investing is a scary prospect because it always comes with some level of risk. Investing in stocks is no exception. Stock investment has a high level of risk and you could lose more money than the total amount you have invested in stocks. Whether you would lose more money than your investment depends on what type of account you are using for stock investment. If you invest with a margin account then there are chances that you might lose more money than you invest in stocks.
Can You Lose More Money Than You Invest In Shares?
The answer to this question depends on how you are investing in stocks and what type of accounts you are using for the investment. If you’re using your own money to invest in shares, and you are not using any advanced techniques then the answer to this question is “No.” This way you won’t lose more money than you invest. So, if you invest in a company’s stock and it goes bankrupt and stops trading then the price of stocks will only drop to zero and you will only lose money that you have invested in stocks. On the other hand, if you invest in stocks via a margin account then it means you are borrowing money from the broker and incurring interest on the loan. So, if your invested stocks lose value then you will lose your investment as well as you have to repay the borrowed money plus interest. So, investing through a margin account has the possibility that you might lose more money than your total investment.
Ways You Can Lose More Money Than You Invest
Many professional investors use several advanced techniques which could lose more money than the total investment. Let’s check them out!
1. Short Sale
A short sale is a stock investment technique where the seller borrows the stock from a broker-dealer who has a sell order. Here, a “sell order” is an obligation to buy the stock back in the future. According to this method, you don’t put up all the money. You just put forward $2 for a $10 share for example. Then you have to hope that the price of a stock will fall. If the price doesn’t fall but rise then you could lose more money than you initially invested because you have to return the shares or the money borrowed.
2. Leveraged Investment
This is another method that many professional investors use to gain more profit. However, with this method, there is also the chance of greater losses. It allows you to invest a greater amount and amplify your profits. However, you should also remover that the more you invest in stocks the more your loss could be if the price of the stocks falls. For example, you could put in $500,000 and borrow $1,000,000 to purchase $1,500,000 worth of stocks. Here the repayments of the loan could be $50,000 and are due at the start of each year. Now if the price of the stocks increases 20%, then the total investment could be worth $1,800,000. After paying the total debt and interest the profit would be £250,000. However, if the price drops 20% from the buying price, then you could lose $ 350,000.
Advantages And Disadvantages Of Cash Account
Advantages Of Cash Account
1. You won’t lose more than you invest. In a cash account, the stocks are purchased outright using settled funds.
2. A cash account prevents investors from spending beyond a limit
3. This type of account has less risk than a margin account
4. Cash account gives more control over losses, even when stock prices fall
5. A cash account gives investors the freedom to hold stocks as long as they want
Disadvantages Of Cash Account
1. Cash account trades with the “T+2” method where the stocks are tied up until the trade settles, it takes two business days to settle the order.
2. A cash account doesn’t have any short-selling option, so you can’t sell stocks immediately if the price falls.
3. While making trades with a cash account you have to consider settlement periods. Though, you can use the unsettled funds to purchase stocks.
Advantages And Disadvantages Of Margin Account
Advantages Of Margin Account
1. Margin account gives you more purchase/investment power. With a margin account, you are allowed to purchase stock with borrowed money.
2. Margin account will give you potentially magnified returns. This type of account amplifies your returns more than you could with a cash account.
3. You will have the ability to profit from declining shares. A margin account allows you to short a stock if you believe the price of the stock will decrease in value.
Disadvantages Of Margin Account
1. With a margin account, you might lose more than you invested. There are chances that your losses could be magnified.
2. There might be high-interest charges and it can become cost-prohibitive. You have to pay interest for the borrowed money and the interest rate could be high.
3. There is an added layer of risk in the margin account because regardless of the market condition you have to pay the full borrowed amount as well as the interest.
4. In a margin account, you might be forced to sell your securities. Usually, the broker forces the investor to sell the stocks if declining stock prices bring your account value too low.
How To Protect The Money While Investing In Stocks
While investing in stocks there are many risks that you have to be aware of. So, when you are planning to invest in stocks there are several things that you could do to protect your investment. Here is some advice from professional investors that you can follow!
1. Consider Diversifying Your Investments
While investing in stocks make sure you invest in different stocks. Don’t invest all your money in one stock. If you invest in various stocks then if the price of one stock fall, then you won’t lose all your money. In fact, you can minimize the loss if the price of other stocks improves significantly. However, before investing money make sure, you analyze the stocks and then pick several stocks that might have a good future.
2. Think For The Long-term Investment
Day trading might be attractive but if you are planning to invest a large amount of money then you should consider the long-term investment options. Investing for the long term could help you avoid any market dips and see your investments flourish. A recent study showed that long-term investment has an 89% chance of making a profit!
3. Consider How Much You Invest
Stock investment has the risk that your money could reduce in value. Therefore, you should think about how much you invest to avoid over-stretching yourself on investments that you won’t be able to afford. The investment amount varies from man to man therefore consider everything before deciding how much you will invest.
FAQs About Can You Lose More Money Than You Invest In Stocks
Can You Lose All Your Money In Stocks?
Yes, you can lose all your investments in stocks. A company can lose all its value and become bankrupt. If this happens then the value of the company’s stock will become zero and you will lose all your money.
Do I Owe Money If A Stock Goes Down?
If you invest in stocks via a cash account then you don’t owe money when the price of the stocks goes down. However, if you buy stock using a Margin account then you will owe money if a stock goes down
What Are Some Common Mistakes That A Beginner Stock Investor Can Make?
According to many professional stock investors below are some common mistakes a beginner stock investor can make –
1. Buying Out-the-money (OTM) Call Options
2. Misunderstanding Leverage
3. Having No Exit Plan
4. Not Being Open to New Strategies
5. Trading Illiquid Options
6. Waiting Too Long to Buy Back Short Options
7. Failure to Factor in Upcoming Events
8. Legging Into Spreads
9. Not Knowing What to Do When Assigned
10. Ignoring Index Options for Neutral Spreads
Can A Stock Run Out Of Shares?
Yes, stock can run out of shares. This can happen if there is a radical imbalance between the respective prices demanded by buyers and sellers. There are lots of incidents where a stock “runs out” of shares to buy or sell.
Do You Lose Money When Stocks Go Down?
If you invest in stocks and if the price goes down then you’ll have a “paper loss.” If the price of the stocks remains less than the buying price and you sell the stocks then you will lose your investment.
What Happens If A Stock Goes To Zero?
If the price of a stock goes to zero then there are chances that the stock will be delisted by its stock exchange. For example, if a stock trading on the Nasdaq exchange falls below $1 for 30 consecutive days, then Nasdaq gives the company 180 days to regain the value. If the company fails to regain the price within 180 days then Nasdaq will delist the company.
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.