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 THE ABC OF... |
Margin lending
Why do you need a margin lender?
CS journalists
Margin lending used to be a scary sounding concept, but not any more. Most people have come to terms with the fact that, just as you can borrow money from the bank to buy a home, you can borrow money from the bank to buy shares or managed funds. That's what margin lending is about.
But people often get tongue-tied and twisted over finance jargon like margin calls, loan to value ratios (LVR) and the like, and then confuse margin lending with something altogether more sinister. Sorry to ruin the party, but margin lending isn't quite so riveting.
The nice thing about margin lending is that a rising share price can be rocketed higher by using a margin loan. Had your shares risen by 50 cents and you'd invested $1,000, then you would have made $500. Had you invested $10,000 instead by using a margin loan, you would have made $5,000. Now you can see why people use margin loans.
Another nice thing about margin lending is that interest costs on the loan may be claimed as a tax deduction. This can be handy for those who - come tax time - struggle to get their taxable income down, especially away from the perils of the top tax bracket. Check it out with your accountant.
Of course, margin lending is not all sunny and that's why we outline the risks in our story Are margin loans risky? But to answer the question now, if you are use borrowed funds to invest then you are taking a risk. So yes, margin lending is risky. But so is taking out a loan to buy a house, or land, or to set up a business. In fact, spending up big on your credit card without the means to pay for it later is also risky.
So if you want to leverage your share investments then margin lending is one way to do it. Derivative products such as contracts for difference (CFDs), options, warrants and futures are an alternative avenue, but as a rough guide, if you are a longer-term buy-and-hold type of share investor - you like to hold shares for at least five years - then margin lending is probably more suitable.
Most people take out a margin loan to buy blue chips like the big banks and miners. The reason for this is twofold. Blue chip stocks are generally less volatile - swinging share prices can propel you into margin call territory (see our story Are margin loans risky?) - and blue chips usually pay out fat dividend cheques, which can be used to pay off the interest on your margin loan.
This latter point is one of the true sweeteners of margin lending. If set up correctly, share dividends can cover off the interest costs on the margin loan - which basically means that the investment is self-funding. This all hinges on a couple of factors, however, such as the level of gearing you adopt, the interest rate on your margin loan and the shares you buy. Too much to digest? Check out the ABC of Margin Lending.
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