Most investors are primarily concerned with the value of their holdings, the potential for their current holdings to increase or decrease in value, and their buying power. Buying power, or the ability to purchase more bonds and securities, is based on the amount of cash assets available as well as the current value of the investor’s portfolio.
While it seems like a simple calculation, there are a number of variables that influence the precise buying power an investor has at any specific point in time. Investors should familiarize themselves with buying power and the various factors that can influence this figure, especially if they plan to be active investors.
Passive investors tend to make long-term investments. In other words, they purchase stocks with the intention of holding them indefinitely while they increase in value over time. Active investors, on the other hand, constantly monitor their portfolios and frequently buy and sell stocks with the aim of increasing the value of their portfolio over a shorter period of time. Active investors, therefore, must be constantly aware of their buying power.
Buying Power Variables
Buying power is rarely constant in the investing world. The number fluctuates from day to day based on market conditions, world economics and investor margins. EquityScholar.com points out that most investors define buying power as the amount available to purchase additional securities without adding additional funds to the investment account.
- The value of a monetary unit. Inflation decreases the value of a single U.S. dollar, so buying power decreases as inflation rises.
- Executed buy or sell orders. A sale of securities held by an investor increases the individual’s buying power, while an executed buy order decreases buying power accordingly.
- Margins. If an investor is making a margin trade, buying power reflects not only the amount of cash in an investment account, but the additional margin that can be spent without generating a margin call.
- The value of individual securities. The value of individual securities fluctuate based on stock value and current trading price. If a security loses value, the total value of an investor’s portfolio will decrease accordingly. Buying power, as a result, will decrease based on the margin lost.
Cash Trades Vs. Margin Trades
In terms of cash trades, buying power simply reflects the total cash assets available to an investor to purchase securities. In the case of margin trades, the calculation is a bit more complex. In general, investors can calculate total buying power by doubling the amount of assets in a margin account (minus the minimum margin) and adding this figure to the total cash assets available in a brokerage account.
Individual brokers vary on specific terms, such as minimum margin requirements and the percentage of a stock purchase price that may be borrowed. These individual variables will impact the total buying power.
Combining Assets to Increase Buying Power
Some investors choose to pull their resources with other like-minded investors. By combining their assets, they have more buying power together than each would have individually, enabling the group to purchase securities that may otherwise have been out of reach. While this tactic reduces the individual risk, it also reduces the potential profit for individual participants.
The Bottom Line
In short, buying power is the primary indicator of how active an investor can be in the market. Buying power dictates what securities an individual can invest in and to what extent. For instance, an investor without sufficient buying power may have to pass on an opportunity should there be insufficient assets to make a purchase.
Buying power is a relatively simple concept on the surface. True calculations, however, are dependent on a number of variables. Brokers have different rules and policies regarding margin accounts, so investors must become familiar with these details before calculating actual buying power.