One month later, the stock price rose to $12 per share. The stocks in your portfolio now stand at $12,000 in total and you wish to sell the shares now to realise the paper gains.
Recall that you borrowed $5,000 from the brokerage firm at the start, so after repaying that amount, your take home money becomes $7,000. Accordingly, you earned a profit of $2,000 ($7,000 – $5,000) which gives a ROI of 40% ($2,000/$5,000)!
Comparatively, if you had bought those shares entirely out of your own pocket, you still earn a profit of $2,000 but at a ROI of 20% ($2,000/$10,000).
Buying on margin allows you to double your return on investment by starting off with a smaller capital. It allows investors to leverage and to buy stocks that they would otherwise not be able to afford to. This is the same reason as why businesses choose to take up bank loans to inject more funds so that they can capitalise on a larger pool of funds to expand their business through ways that would not have been possible without the loan.
Furthermore, it allows investors to utilise their money more efficiently. Sometimes, it is not that these investors have no money to buy the shares. It is that they see this as an opportunity to grow their money. By borrowing $5,000 from the brokerage firm, they can put their own $5,000 into another investment stock B to earn returns.