Can You Lose More Than You Invest in Stocks? In Some Cases, Yes

Investing always comes with some level of risk. Unlike a savings account, where your money is backed by federal deposit insurance, the value of your stocks depends on the whims of the market. You could build wealth, but you also risk losing some or all of your money, too.

Whether you can lose more than you put into it depends on whether you use borrowing to invest. Strategies like trading on margin or short-selling a stock use borrowing, and both run the risk of losing more money than you invested in the stock. The type of account you have (cash or margin) determines the kinds of trades you can make, and whether or not you risk losing more than you invested. Learn how it works and how to minimize your risk.

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Can you lose more than you invest in stocks?

The short answer is yes, you can lose more than you invest in stocks – but only with certain accounts and trading types.

In a typical cash brokerage account, it’s possible to lose your entire investment, but no more. You only start to risk more than you spent when you use borrowed money or borrowed securities to buy shares.

For instance, short-selling stocks or trading on margin both use borrowing, and you run the risk of losing more than you invested with these methods.

That’s why I think it’s important for beginner investors to first practice “paper trading” before they move on to real trades, and to save the high-risk strategies for savvy, experienced traders. I also recommend that beginner investors do what they can to diversify their portfolios to reduce the risk of any one stock decline having an outsized effect on their investments.

Although you cannot lose more than you invest with a cash account, you can potentially lose much more than you invest with a margin account. Let’s go over the differences between these two types of trading accounts so you understand the risk of trading with each account type.

Cash accounts

What you risk: Your total investment

A cash account is a type of brokerage account that requires you to pay the entire amount of a security using cash (or settled proceeds from the sale of other securities). With a cash account:

You must have the cash available to purchase the stock.

You can’t borrow money from the broker for the purchase.

All trades must abide by settlement rules.

If you’re simply buying stocks and holding them in your regular brokerage account, you can’t lose more than you spent to buy the shares. The price of a stock can fall to zero, but you would never lose more than you invested. Although losing your entire investment is painful, your obligation ends there. You will not owe money if a stock declines in value. For these reasons, cash accounts are likely your best bet as a beginner investor.

Cash account example

Say you bought 10 shares of a $100 stock: you spent $1,000. Suppose the company goes under, and the shares are now worth $0: you lost $1,000, which was your total investment, but no more. That $1,000 was the most you could lose.

Although losing your entire investment is painful, your obligation ends there. You will not owe money if a stock declines in value. For these reasons, cash accounts are likely your best bet as a beginner investor.

Pros of cash accounts

You can’t lose more than you invest. Stocks purchased with a cash account are purchased outright using settled funds. Not only does this save you from spending beyond your means, but you also can’t lose more than you invest in the stock.

It poses less risk than a margin account. Because you can’t lose more than you invest, cash accounts carry less risk than trading on margin. This gives you more control over your losses, even when stock prices fall.

You have the freedom to hold stocks as long as you want. If you purchase stock using cash, you can hold onto it as long as you want. You can ride the ups and downs without fear of being forced to sell your positions if your account value drops too low, which is a risk you take with a margin account.

Cons of cash accounts

Cash proceeds from a sale are tied up until the trade settles. For most stock trades, settlement occurs one business day after the order executes. This is known as “T+1,” or “trade date plus one day.” Only after the trade settles will you be able to withdraw the proceeds from your account.

There is no short-selling option. Short selling is the sale of stock you don’t own, and it’s a strategy frequently used by investors who believe the stock’s price is going to decline. The investor borrows stock from the broker and sells the stock on the market. If the price drops, the investor buys back the stock at the lower price, returns the borrowed shares, and makes a profit on the difference. Investors must have a margin account in order to short a stock.

You need to consider settlement periods when you’re making trades. Although unsettled funds can be used to purchase stock, selling the newly purchased stock before the funds have settled will result in a good faith violation. After several good faith violations, you may be restricted to trading only with settled funds.

Tips to minimize your risk with a cash account

Cash accounts are generally less risky than margin accounts, but they are not immune to risk. Here are a few ways to minimize your investment risk with a cash account:

Diversify: When you hold only one type of stock, sector, or asset class, a decrease in value puts your whole portfolio at risk. Diversifying your holdings across many different types of industries and asset classes offers protection when one goes down. I strongly recommend that beginner investors find a diversification strategy that works for them, whether that’s with the help of an advisor, a robo-advisor, or a pre-built portfolio.

Understand your investments: Whether you’re investing in an individual stock or a mutual fund, it’s important to understand your investments and how they work. Don’t buy anything you don’t 100% understand.

Only speculate with money you can afford to lose: Know the difference between investing and speculating. Investing involves relatively stable assets, held for the medium or long term, whereas speculating involves taking on more risk for a potentially greater return. It’s possible to lose all the money you invest in stocks, regardless of how stable the asset is. If you’re speculating, only use money you can afford to lose.

Avoid account violations: Trades take a day to settle and transfer the cash to your account. Understand stock settlement times and make sure you have settled cash in your account to pay for purchases to avoid account violations.

Margin accounts

What you risk: Your total investment, the amount borrowed, and interest

You risk losing more than your initial investment when you use a margin account.

A margin account is a type of brokerage account that allows you to borrow money to purchase securities, using your account as collateral. Under the Federal Reserve Board’s Regulation T, you can borrow up to 50% of the purchase price of the stock using a margin account. This can give you much more purchasing power than you’d get with a cash account, but it also exposes you to the potential for greater losses. Your broker will also charge you interest for borrowing money, which will affect the total return on your investment.

With a margin account, you’re essentially borrowing money from the broker and incurring interest on the loan. If the stock you purchase declines in value, not only do you lose money because of the declining share price, but you also have to repay the borrowed money plus interest.

Margin account example

Say you have $1,000 in your margin account: you might be able to borrow an additional $1,000 to buy 20 shares of that same $100 stock we mentioned in our cash account example.

Suppose the stock value increases to $150. For each share, you paid $50 and borrowed $50 from the broker. You’ve spent a total of $1,000 and borrowed a total of $1,000 (because you bought 20 shares: 20 x 50 = 1,000). Because of the $50 increase in the stock’s price, you earn a 100% return on the money you invested (the $50 gain for each share is 100% of your initial investment of $50. At 20 shares, you’ve gained $1,000).

A declining stock, on the other hand, can quickly result in substantial losses. For example, let’s say that the same stock you bought for $100 falls to $50. After paying back your broker the $50 you owe them for each share (times 20 shares), your proceeds are zero. Plus, you’ll also owe interest on the borrowed funds – let’s say the rate is 10%.

If the value of the stock drops to $0, you’ve lost not only your original $1,000, but now you’ve also lost the $1,000 you borrowed and the $100 (10% x $1,000) in interest it cost to borrow it: you’re out $2,100, instead of $1,000. Instead of losing 100% of your investment, you’ve lost 210% of it – more than you put in.

Call risk

Another risk investors face when trading on margin is the margin call. The Financial Industry Regulatory Authority (FINRA) requires you to keep at least 25% of the total market value of the securities in your margin account at all times. This is known as the maintenance requirement. If your stock loses value and causes your equity to fall below this requirement, you may receive a margin call, which requires you to deposit cash or sell securities to increase your equity.

Although the potential for greater returns is attractive, the downsides of investing on margin make it a riskier option.

Margin account pros

You have more purchasing power. Investing on margin allows you to purchase stock with borrowed money. This gives you more purchasing power and reduces the amount of cash you need on hand.

You’ll see potentially magnified returns. Buying on margin makes it possible to amplify your returns more than you could with a cash account.

You’ll have the potential ability to profit from declining shares. With a margin account, you can short a stock if you believe the price of the stock will decrease in value. This allows you to take advantage of price movements in either direction.

Margin account cons

You can lose more than you invested. Just as profits can be magnified, so too can losses. If you purchase stock on margin and it loses value, you still have to repay the borrowed money plus interest.

High interest charges. Borrowing money comes with the added cost of paying interest. Depending on the interest rate, this can significantly eat into your returns.

Debt risk. As with any debt, borrowing money adds an additional layer of risk. Your obligation with a cash account ends with the trade execution. With a margin account, however, you still have to repay the broker the amount borrowed, plus interest, regardless of which direction the stock price goes.

You may be forced to sell your securities. Your broker may force you to sell the securities in your account if declining stock prices bring your account value too low.

How to minimize risk with a margin account

Investing with borrowed money is riskier than using only the cash you have available. If a stock purchased on margin declines in value, your losses can be substantial.

If you decide to trade on margin, here are some tips to minimize risk:

Keep some cash in your account. This can help you prepare for market volatility and avoid a margin call. It’s also a good idea to make sure you have cash on hand in case you need to move additional money into your account quickly.

Pay the interest you owe regularly: Ensure you’re paying off the interest each month in addition to the principal you owe. Monthly interest charges on margin accounts can add up over time if you aren’t paying down interest regularly.

Use strict buy-and-sell rules: Because trading on margin can be risky, establishing conservative buy-and-sell rules can help protect your money.

FAQs

Bottom line

Any type of investment is subject to some degree of risk, and stocks are no different. Depending on the type of account you use, it’s possible to lose more than you invest in stocks.

For most people learning how to invest, a cash account will likely be your best bet. With a cash account, you trade only with the cash you have available, and that should be enough as you’re getting started with investing. You might still see great returns, but you don’t carry the risk of magnified losses.

As you learn and gain more experience, you may find that a margin account is the next step in your investment strategy. If you feel comfortable trading on margin, I recommend starting with small positions at first to limit your risk.