What is a Protected Loan?

23rd of April 2008 | by RateCity Staff

Borrowing as a way to fast-track wealth creation is a strategy extolled by various financial experts. Indeed, few of us would ever own our own homes without borrowing money, so borrowing to invest in assets such as shares should, in theory, be okay. After all, it takes a lot less money to buy shares than it does to purchase a home.

Common sense tells you that borrowing to invest is a sound strategy when interest rates are low and the price of the assets is on the rise. However, in the current interest rate climate and volatile share market, predicting future movement is as easy as nailing jelly to the wall.

There is the view that in times of share market turbulence, good shares can be picked up cheaply. How can you take advantage of the market downturn, yet keep your investment from disappearing? One damage-limitation strategy to hedge against a fall is to use a Protected Margin Loan.

A Protected Loan offers investors a 100% loan-to-value (LVR) ratio on a portfolio of shares in return for charging a higher rate of interest. In this way, an investor’s investment is protected, while profits can still be multiplied through high gearing so that the only financial risk for the investor is a higher interest rate, typically around 15%. This means that (excluding trading costs and tax implications) your investments must gain an annual 15% in order for you to break even but for those willing to gamble their interest payments on markets rebounding sooner rather than later, this may be the low-risk strategy to adopt.

For investors who can risk a further downside hit during the current bear market, the gains could be significant should markets rebound to, or beyond, their 2007 levels. If the prospect of further market turmoil is not something that your investment strategy can withstand, then a Protected Loan may be the answer until markets settle down and the worst effects of the credit crunch have passed.

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