Leverage and Margin Explained: The Power and Peril of Borrowed Money

I'm Andy Temte and welcome to Money Lessons! Join me every Saturday morning for bite-sized lessons that are designed to improve financial literacy around the world. Today is May 2, 2026.

Last week we wrapped up our exploration of preferred stock and noted where we're headed next: leverage and margin, or what happens when investors borrow money to buy stocks. I want to start with a simple idea that frames everything we'll cover today.

Leverage is a tool. Like any tool, it amplifies the skill of the person using it. A disciplined investor can use leverage to enhance returns. But for someone chasing a get-rich-quick dream without fully understanding the risks, leverage can turn a bad decision into a financial catastrophe. The difference between those two outcomes almost always comes down to understanding — and that's what I want to give you today.

What Is Leverage?

At its core, leverage means using borrowed money to control more than you could with your own cash. Two weeks ago we defined capital structure as the mix of debt and equity a company uses to finance itself. Leverage is what happens when investors apply that same principle to their own portfolios.

Here's an everyday example most of us already understand. When you buy a house with a mortgage, you're using leverage. You put $100,000 down on a $500,000 house and borrow the other $400,000. If the house rises to $550,000, you've made $50,000 on a $100,000 investment — a 50 percent return on your cash. That's the appeal. Leverage magnifies your gains.

But here's the part too many people overlook: leverage magnifies your losses with equal force. If that house drops to $450,000, you've lost 50 percent of your investment — and the bank still expects you to repay the full loan. Leverage doesn't care which direction the market moves.

When Leverage Had No Limits

To see why this matters so deeply in the stock market, we need to go back to the 1920s — territory we covered in our November 15, 2025 episode on the crash that sparked modern market regulation.

During the Roaring Twenties, investors could buy stocks by putting down just 10 percent of the purchase price and borrowing the remaining 90 percent. If you had $1,000, you could control $10,000 worth of stock. A 10 percent gain meant a $1,000 profit — a 100 percent return on your money.

But the math worked both ways. A 10 percent decline wiped out your entire investment. And a decline beyond that meant you owed your broker more than you'd started with. When the crash hit in October 1929, millions of margin investors received demands to deposit more cash or sell immediately. Most couldn't come up with the money. Brokers sold their positions into a falling market, driving prices down further, triggering more selling. The cascade turned a correction into one of the worst financial crises in American history.

The lesson was brutal and unmistakable: leverage without limits is a recipe for disaster.

The Rules That Followed

The regulatory response was swift. The Securities Exchange Act of 1934 gave the Federal Reserve authority to set margin requirements, and on October 1, 1934, the Fed adopted Regulation T. Between 1934 and 1974, the Fed adjusted the initial margin requirement 23 times. Since 1974 it has held steady at 50 percent — meaning if you want to buy $20,000 worth of stock on margin, you must put up at least $10,000 of your own money. In the 1920s, that same investor could have controlled $20,000 worth of stock with only $2,000.

But the initial purchase is only part of the story. FINRA — the Financial Industry Regulatory Authority — sets a maintenance margin requirement: the minimum equity you must hold in your account at all times. FINRA's floor is 25 percent of the current market value of your holdings, though many brokerages set their thresholds higher.

When your equity falls below that maintenance level, your broker issues a margin call — a demand to deposit more cash or sell securities immediately. And here's what catches many investors off guard: your broker isn't required to give you advance warning before liquidating positions to cover the call.

How a Margin Call Works

Let me walk you through a simple example, because the math is what makes this real.

You have $10,000 in cash and borrow another $10,000 from your broker to buy $20,000 worth of stock. Your equity — what you actually own after subtracting what you owe — is $10,000, or 50 percent of the portfolio's value.

Now imagine the stock drops 35 percent. Your portfolio is worth $13,000, but you still owe your broker $10,000. Your equity has fallen to $3,000 — just 23 percent of the portfolio's value. If your broker's maintenance requirement is 30 percent, you've fallen below the threshold and you'll receive a margin call. Most brokerages require you to restore your equity all the way back to the initial margin level — in this case 50 percent. That means you need $6,500 in equity on a $13,000 portfolio, so you must come up with $3,500 in additional cash or your broker will sell enough of your stock to close the gap.

Here's the cruel irony I want you to sit with: margin calls almost always arrive at the worst possible moment — when the market is falling and your losses are mounting. You're forced to sell into weakness or come up with cash you may not have, precisely when patience might be the better long-term decision.

What This Means for You

Leverage is neither inherently good nor inherently bad. It's a tool — one that experienced investors use thoughtfully and one that has destroyed fortunes when used recklessly. The 1920s taught us what happens when leverage has no limits. The rules that followed exist because of the wreckage that unchecked borrowing left behind.

If you ever consider using margin, I want you to pause and ask yourself a few honest questions. Do I really understand how the math works on the way down, not just on the way up? Could I cover a margin call tomorrow morning if one arrived? Am I borrowing because I have genuine conviction, or because I'm impatient? Would I make this same investment if I had to use only my own cash?

If any of those answers give you pause, that's information worth listening to.

Next week, we'll zoom out and look at the broader landscape of equity risk — the different types of risk that come with owning stocks and why understanding them is essential to making sound investment decisions. And in the weeks ahead, we'll come back to margin from a different angle entirely: what happened in January 2021 when a video game retailer called GameStop revealed that margin calls don't just affect individual investors — they cascade through the financial plumbing of modern markets in ways that surprised almost everyone watching.

Until next week...

Grace. Dignity. Compassion.