Margin Lending
For leveraging your financial potential??

Margin lending, or a margin loan, is the term used to describe a loan for the purpose of buying shares where your current portfolio provides the equity (financial backing) to support the loan.

The purpose of a margin loan is to be able to enlarge your portfolio at a greater rate than what you would otherwise be able to do and hence leveraging profits if your investment strategies are successful.

It unfortunately also may mean that it magnifies your losses if your investment decisions are not sound, or if there is a major market downturn across the board.

The beauty? of margin lending is that the leveraging equity (financial backing) required is obtained from your current portfolio based on a Loan Valuation Ratio (LVR) applied to each share in the portfolio, rather than from other equity that you may not have available - or may not have.

The LVR for each share depends on the lender’s view of the company’s financial soundness and may vary from 75% for ‘safe’ or large well-regarded companies down to 40% for smaller companies with a shorter operating history.

Quite a number of smaller companies with little operating history may not be given an LVR. Hence you cannot borrow against them.

As a simple example to show how to calculate the lending value of a portfolio, if you had shares in five companies whose current market prices were $1,000 each, where two had a LVR of 70%, two had a LVR of 60% and one had an LVR of 50%, then the total lending value of the portfolio ($3,000) would be calculated as follows:

So for a portfolio amounting to $5,000, an additional $3,000 would be available to invest via the margin loan. However, if there is a downturn in the market, the loan may be subject to what is known as a margin call.

This means that either additional external funds would need to be provided to support the loan, or that some shares would need to be sold to provide the additional cash to support the loan.

By the way, if you get a margin call, you are required to do something about it quickly, commonly within 24 hours. Otherwise the lender will do something about it for you by selling off some of your shares to get you back within your new LVR.

Of course, having the lender sell off some of your shares after there has been a significant drop in the market is not a good idea from your point of view. So avoiding margin calls is always a better idea.

Lenders recommend to keep the loan to security ratio (gearing) of the portfolio below the maximum loan to security ratio allowed (usually about 70%) in order to provide a buffer to guard against a significant market downturn.

I keep the loan to security ratio (gearing) on my margin loan below 50% for this reason.

Some investing experience in direct share investing over a number of years should be gained first in order to develop confidence in your investing ability before considering margin lending.

Due to the net cost of margin-loan interest, after deductions, a higher portfolio return is required for the margin-lending strategy to break even. So it is important to have confidence in your share-investing ability.

Experience in riding a downturn is the best experience of all. As they say - no gain without pain! It is easy to develop a false belief that share markets will keep rising – especially in an extended ‘bull’ market.

But share markets do not defy the law of gravity. What goes up can also come down!

Keep in mind that while margin lending can magnify profits, it can also magnify losses. This is why some advise against it. So develop confidence first or leave it to the not so faint-hearted.

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