01.Borrowing to invest
- Borrowing to invest — for example, a margin loan — can be a very effective strategy to build your wealth, but it’s not for everyone. You need to have excess income, be a savvy investor and happy to take risks.
- Because you’ve more money to invest, your investment gets a 'turbo boost' and gains are magnified. But if your investment loses money, losses are magnified too. Not only have you made a loss but you still have to pay back the loan.
- Be aware of the current volatile share market environment, get financial advice and have a strategy in place for meeting a margin call.
A margin loan allows you to borrow money to invest. The margin loan is secured against the investment you make with it and/or other investments you have.
You’re not allowed to borrow the full amount of your investments but just a percentage called the LVR – Loan to value ratio. This is usually between 30% and 70% of the value of your investment in shares or managed funds.
For example, if your lender sets the LVR for a range of shares at 70%, it’ll lend you up to $70,000 to buy $100,000 worth of those shares. So by investing just $30,000 of your own money you could build up a portfolio worth up to $100,000, investing in shares spread over different share market sectors and managed funds.
But if you borrow up to the limit and the value of your investment falls you may receive a margin call and have to make up the difference. You may have to sell part or all of your investment at a loss. And if this happens at a time when the sharemarket suffers huge losses like in late January 2008, it may be the worst time to sell.
Please note: this information was current as of February 2008 but is still a useful guide to today's market.
Is a margin loan suitable for you?
Borrowing to invest is a high-risk strategy. You need to be a savvy investor or get good advice from your adviser or broker to find a good investment in the current volatile share market climate.
Before committing yourself to a margin loan, ask yourself if you have the following:
- Enough excess income to cover the interest payments, even if the interest rate suddenly goes up or your investment makes a loss.
- A long-term investment perspective and the ability to cope with making a loss for some time.
- A secure job — or the ability to cover the interest payments if you lost your job.
Equity loans — an alternative
Have you already paid off a big chunk of your mortgage? If so, a home equity loan/line of credit may be a better way for you to borrow to invest, as the interest rate is generally cheaper. However, the same risks apply as with other forms of borrowing, and your house is on the line too.