Key Takeaways
- Increased Buying Power: A margin loan allows you to borrow against existing securities to purchase a larger portfolio than you could with cash alone.
- Diversification Opportunities: Leveraging your equity can help you spread your capital across more assets, potentially reducing specific stock risk.
- Magnified Returns and Losses: While gearing can significantly increase potential gains, it also amplifies losses if the market moves against you.
- Risk Management: Understanding margin calls and having a strategy for interest rate changes is essential for long-term success.
- Tax Considerations: Interest paid on a margin loan may be tax-deductible if the funds are used to produce assessable income.
A margin loan, sometimes known as an investment loan, is a secured line of credit that allows you to borrow funds to invest. The loan is secured over your existing shares, ETFs, or managed funds, which will all have an assigned Loan to Value Ratio (LVR). This ratio determines exactly how much you can borrow based on the quality and liquidity of your underlying assets.
At Morgans, we provide margin lending and gearing strategies designed to help you build wealth by using the equity in your current portfolio.
Benefits of Using a Margin Loan
Using leverage can be a powerful tool in your financial strategy when managed with discipline. By amplifying your investment capacity, you can achieve outcomes that might otherwise take years of manual saving.
Ability to purchase a larger investment portfolio
By borrowing to invest, you can control a much larger amount of assets. If your chosen investments grow in value, you benefit from the capital gains on the entire portfolio, both the portion you funded and the portion funded by the loan.
Additional funds can be used to diversify your investments
Many investors find their wealth concentrated in just a few stocks. A margin loan allows you to use those existing holdings as security to branch out into new sectors or asset classes without having to sell your current positions. This is a core part of effective wealth management.
Opportunity to increase gross returns
Leverage gives you the opportunity to potentially increase the gross return on your own equity. If the return on your investment exceeds the cost of the loan (interest and fees), your net profit is higher than it would have been if you had only used your own capital.
The Risks of Margin Lending
Before incorporating margin loans into your strategy, it is vital to understand that leverage is a double-edged sword. Just as it increases your potential for profit, it also increases the potential risk associated with your investment.
- Bigger losses: Borrowing to invest increases the amount you will lose if your investments fall in value. You are required to repay the loan and interest regardless of how the market performs.
- Capital risk: The value of your portfolio can fluctuate. If you are forced to sell an investment quickly during a downturn, it may not cover the outstanding loan balance. It is important to note that a margin loan is a “full recourse” loan; you remain liable for the debt even if the value of your security falls to zero.
- Investment income risk: The income from your assets, such as dividends, may be lower than expected. You must ensure you have a cash buffer to cover interest repayments if your investment income dries up.
- Interest rate risk: If you have a variable rate loan, your interest payments can increase. You should consider whether you could still afford repayments if rates were to rise by 2% or 4%.
Understanding Margin Calls
A margin call occurs if the value of your portfolio reduces below the acceptable LVR. When this happens, the "buffer" provided by the lender has been exhausted, and you must act quickly to restore your equity levels.
The acceptable LVR is dependent upon the type and number of shares within your portfolio. Higher-quality, less volatile stocks typically attract a higher LVR, while more speculative holdings may have a lower limit or not be accepted as security at all.
How to Manage a Margin Call
Should a margin call be made, action must be taken within 24 hours to rectify the situation. You generally have three options:
- Contribute cash: Pay down a portion of the loan to bring the LVR back to an acceptable level.
- Provide additional security: Transfer more shares or ETFs into the margin loan account.
- Sell shares: Liquidate a portion of your portfolio to reduce the total debt.
Maintaining a conservative gearing level, well below your maximum LVR, is the most effective way to avoid the stress of a margin call during market volatility.
Gearing can be an effective long-term strategy for wealth creation, provided you understand the impact of leverage on your overall returns. Our team at Morgans can help you determine if a margin lending strategy is appropriate for your financial goals and risk profile.
Contact a Morgans adviser today to discuss your options or find a financial adviser at a branch near you.
If you would like to discuss how you can use Margin Lending as part of your portfolio, please contact Simon at [email protected] or via (02) 4325 0884.
Simon Tarrant is a Private Client Adviser at Morgans Gosford. Simon is passionate about creating quality financial strategies that are tailored and customised to an investor’s individual lifestyle, financial goals and risk profile.
General Advice warning: This article is made without consideration of any specific client’s investment objectives, financial situation or needs. It is recommended that any persons who wish to act upon this report consult with their investment adviser before doing so. Morgans does not accept any liability for the results of any actions taken or not taken on the basis of information in this report, or for any negligent misstatements, errors or omissions.
Frequently Asked Questions
What is a margin loan?
A margin loan is a facility that allows you to borrow money to invest in shares, ETFs, or managed funds, using your existing investment portfolio as security. It is a form of "gearing" or leverage.
How does a margin call work?
A margin call is triggered when the value of your investments falls below a certain percentage of your loan. The lender will require you to either deposit more cash, provide more shares as security, or sell assets to reduce the loan balance.
Is interest on a margin loan tax-deductible?
In Australia, the interest on a margin loan is generally tax-deductible if the borrowed funds are used to invest in assets that produce assessable income, such as dividends. You should consult a tax professional for advice specific to your situation.
What is a Loan to Value Ratio (LVR)?
The LVR is the percentage of an investment's value that a lender is willing to lend you. For example, if a stock has an LVR of 70%, you can borrow up to $70 for every $100 worth of that stock you hold.
Can I lose more than I invested with a margin loan?
Yes. Because margin loans are full recourse, if your investments lose significant value, you may end up owing the lender more than the total value of your portfolio.
How do I avoid a margin call?
You can reduce the risk of a margin call by gearing conservatively (e.g., only borrowing 40% when you are allowed 70%), diversifying your portfolio, and keeping a cash reserve to pay down the loan if the market dips.
Can I use my margin loan to buy international shares?
Many margin lenders allow you to buy approved international shares. However, the LVRs for international stocks may differ from domestic ones, and you must also consider currency risk.
What happens if I don't respond to a margin call?
If you do not meet a margin call within the required timeframe (usually 24 hours), the lender has the right to sell your shares at the current market price to recover the loan, potentially locking in losses.
