CHOICE guide to margin loans

Borrowing to invest can make your money work harder but it's a risky strategy in a volatile market.
 
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03.Reduce the risks

Checklist — what you need to know

Make sure you fully understand your loan features and the details of the contract. For example:

  • The lender may be able to change the LVR at any time or even take your investments from their approved list — this could trigger a margin call.
  • The lender may be able to sell your investments without your go ahead, for example, if you can’t meet a margin call, if they can’t contact you after a margin call or if there is a significant fall in the sharemarket as a whole.
  • Check establishment, transaction, and early termination fees that may apply to the loan.
  • How does the interest rate compare?
  • What's the buffer margin? Typically a lender may allow you to exceed the LVR by a percentage such as 5 to 10% before a margin call is triggered. Once a margin call is made you'll need to top up your investment and may have to also restore the full amount of the buffer.
  • How and when will the lender contact you? A lender may already contact you when you’ve reached the buffer which allows you to take action before you get a margin call. Lenders may use email, sms and phone.
  • Are all the investments you want to invest in on the lender’s approved list?

How to reduce the risks

The most effective strategy is to reduce your borrowing level. For example, if the lender allows you to borrow up to 70% of the value of the shares you could just borrow 50% or even only 35%.

Other strategies to consider:

  • Pay interest regularly Margin lenders may allow you to add the interest to the loan, but of course this simply increases it and thus your borrowing level.
  • Reinvest Credit your investment income (such as dividends) to your loan, or reinvest it.
  • Closely monitor your investments and your borrowing level This gives you the opportunity to intervene (for example, by paying back part of the loan) before it comes to the margin call.
  • Diversify your portfolio If you only buy shares in one company your investment will be very volatile. By diversifying your portfolio into shares from different sectors and managed funds, you decrease this volatility and might have a better return in the long term.
 

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