As margin debt builds, investors should be wary By Shawn Langlois Last Updated: 5/21/2004 12:23:00 PM SAN FRANCISCO (CBS.MW) -- Just a few short years after highly leveraged portfolios caused the fiscal ruin of so many unsuspecting investors, margin debt is on the rise again. There's reason to believe, however, that this time around will be different. Maybe. Of course, never underestimate the power of greed and the thirst to recoup the steep losses of the market implosion of yesteryear. But the brokerage industry and its clients seem focused on avoiding the painful traps of 2000. The climate is currently ripe for margin, and investors are certainly taking notice. Interest rates have remained extremely low, although the Federal Reserve maintains that could be changing. And the stock market, until the past few weeks, has enjoyed a steady rally. "The rise in margin debt suggests that investors have become less risk averse or (more likely) they have become more confident that the downside risk in this market is, at worst, moderate," said Roger Tutterow, professor of economics at Kennesaw State University in Kennesaw, Ga. Margin debt piles up At Ameritrade, margin balances have more than doubled to $3.4 billion from $1.5 billion in the past year alone while accounts have risen from 3.06 million to 3.4 million. E-Trade's clients have pushed their margin debt up 22 percent over the past quarter ending March 31 and a whopping 139 percent from a year ago to $2.1 billion. The total amount of margin debt held by NASD and NYSE firms was $191.5 billion in March, up from a post-bubble low of $136.1 billion in September 2002 but still below $299.9 billion, the all-time high set during the tech peak in March 2000. That doesn't mean, however, that a renewed frenzy is under way, according to Bryce Engel, vice president and managing director of Ameritrade Clearing. "Clients are much smarter about how they use margin to leverage their portfolio than they were in 2000," he said. "You won't see the same people leveraging up in one stock or even one sector." Instead, investors are spreading out their investment across many different sectors ranging from real estate to financials to high tech in a diversification effort to weather any downturns. Brokerages like Ameritrade, E-Trade and Schwab are becoming proactive in an attempt to keep clients from making the same mistakes that forced countless investors to come up with cash or sell stock positions to cover margin calls just four years ago Nowadays, investors pushing the limits of their margin accounts or becoming too heavily weighted in one sector might get a call from a financial adviser alerting them to that fact. "We've been extremely careful to make sure we do a good job in our own risk-management process," Engel said. "If a client's account becomes too concentrated or leveraged in one stock, we'll call and talk about it." Proceed with caution Be wary of the messenger when discussing your account with a financial adviser. Clients that trade on margin are a lucrative asset for brokerage houses, which reap income from both the loan and the investment cost. "That, in and of itself, is a good reason to be skeptical," said Rocky Boschert, a self-proclaimed liberal money manager for Austin, Texas-based Arrowhead Asset Management. Boschert firmly believes that margin should be reserved only for professionals and that increased borrowing by the individual investor over the past year is a bad sign. For the green trader, another margin-call fiasco could be in the making. "Any individual investor (with rare exception) contemplating margin investing at this time is either a head-in-the-ground, neo-conservative Republican or someone needing to go to a 12-step compulsive gambling program," Boschert said. Whatever your tea leaves may tell you about interest rates, politics and the direction of the stock market, buying stocks on margin will always be a risky proposition. Don't forget the lessons it cost so many so much to learn the last time the red-hot market turned ice cold. © 1997-2004 MarketWatch.com, Inc.