Margin Loans - A Brief Introduction

By Sandy Naidu | June 29, 2008

Margin Loans is borrowing money to invest in shares and managed funds. Existing cash or securities or both is used as security when you borrow money. Since you are borrowing to invest, the total amount of your investment increases and thus increasing the size of your investment returns - your returns are multiplied by gearing.

The Beauty Of Margin Loans

The lender will not lend you the entire amount of money. They will usually lend you between 70% and 100% of the total value of your investment. The percentage of money they are willing to lend you is called the ‘Loan To Value Ratio’ (LVR). Lets assume the LVR of a lender is 75%. If you wish to invest in a share portfolio worth 100,000 then you need to put $25,000 and the lender will lend you $75,000. So you see how with just $25,000 you have now have a share portfolio of $100,000.

Margin Loan is similar to borrowing to invest in property - and hence ‘negative gearing’ applies to margin loans as well. And so you can claim the interest you paid on this investment as a tax deduction.

A Couple Of Points To Be Aware Of Before You Sign On

Margin Loans are high risk investments. You should be fully aware of what you are getting into before you sign up for a margin loan. Just as gearing multiplies your investment returns, it can also multiply your losses.

Margin Calls: If your LVR falls below a certain specified level, then the lender will sell a part of your portfolio to bring up the LVR to the specified level. You will be forced to sell whatever the current market price is (if it is less than what you bought them at). It is a probably a good idea not to invest the exact amount but slightly more than what you are required to - example if LVR is 75% then invest more than 25%…This way there is always a buffer (if the value of the portfolio falls - because of price falls in the market) - ‘Borrow Conservatively’…

Interest Payments: Make sure you have additional cash to make your interest payments - enough to cover any sudden increase in interest rates as well.

Diversified Portfolio: Don’t invest all the money in one fund or share…Have a diversified portfolio.

Margin loans can prove to be a good investment strategy if you exercise caution and invest wisely.