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The pros and cons of margin lending

The pros and cons of margin lending

Before you consider a margin loan to sink your money into shares or managed funds, take a minute to consider the pros and cons of your investment choice.  

Pro – Entry level investment

Unlike purchasing a property as an investment, margin lending lets you commit to borrowing a much smaller amount – allowing you to test the investment waters without sinking a mortgage-size amount into it. 

Pro – Diversification  

If you only have a small amount of money to invest you will be limited when it comes to diversification opportunities. Margin lending will allow you to borrow the funds needed to invest more – and potentially diversify your portfolio.

Why do you want diversification? Diversification is a common investor’s strategy used to reduce investment risks by spreading your exposure over a selection of investments, rather than sinking everything into one.

Pro – Access to your funds

Although property investment is an Australian favourite, if property investors did need to access funds fast – a large stake will be tied up in the investment, selling isn’t quick or easy and it can be a costly investment mistake to sell up too soon.

On the other hand, if you do find you need access to your funds you can generally sell your assets, which will free up some of your cash.

Con – Market declines

The fate of your investment funds lie at the hands of the market so market volatility has to be taken into account. If the market sees a sharp decline – so too will your investment portfolio. There are always going to be fluctuations but to avoid the brunt of market decline try to diversify your portfolio to lower your risks.

Con – Margin calls

A margin call can arise if your outstanding loan balance surpasses the borrowing limit by more than the buffer. In this case your margin loan lender will ask you to put forth additional funds or another asset to bring the loan back up above the buffer. There are a few circumstances when this may occur;

  • Interest rate rises: If interest rates rise, the interest you pay on your loan balance may exceed the dividends you earn on your investment.
  • The loan-to-value ratio (LVR) is not set in stone, which means if it changes to zero percent you may wind-up in borrowing trouble.
  • If the value of your portfolio declines due to bad investment choices or market volatility it may stop providing the security you require for your margin loan.

Con – Full recourse loan

You are completely responsible for paying off your margin loan amount regardless of your investment portfolio, so if the value of your security portfolio falls to zero, you may still need to sell off other assets to get yourself out of debt.

As with any investment decision you make, always balance up the pros and cons, while taking into account your personal and financial circumstances.

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