Margin lending is borrowing money which you use, in addition to your own money, to invest in financial products such as shares and managed funds.
Essentially, you are "leveraging" the value of your investments through borrowing.
You must have adequate cash or existing shares to use as security for the loan. Only certain shares can be used as security and the amount that can be borrowed will vary for different shares.
- Margin lending can give you an opportunity to increase the size of your investments and to diversify your investments. Diversifying your portfolio can reduce your level of risk in the market.
- It can also provide an opportunity to increase the gross return on your own equity by achieving excess returns over tax and borrowing costs.
- Borrowing also allows you to invest at a time you want to invest, rather than having to wait until you have saved enough. This can help you avoid missing out on investment opportunities.
- Interest on borrowed funds is generally tax deductible provided the funds are invested in Australian assets for income-producing purposes.
Please note: Deriving a tax benefit should not be your core focus. You should seek qualified tax advice from a registered tax agent so that you fully understand your personal tax position.
Margin lenders generally only allow you to borrow up to a certain value, or percentage, of the shares you wish to buy.
Commonly, limits are set at a maximum of 75% (known as the Loan-to- Value Ratio or LVR) of the value of the shares (less if the share is more speculative or risky). This means you have to make up the difference (ie 25%) with your own cash or existing shares.
This difference is referred to as the “margin”; hence the term “margin lending”.
Any borrowing strategy should always be approached with caution.
While borrowing to invest has the ability to leverage returns from investments, it also heightens investment risk. This is because you have a greater amount invested, which will magnify your losses if returns are negative.
Margin lending should be implemented as a long-term investment strategy to allow time to overcome any market volatility and for the leveraging effects to work.
Borrowing to invest can be an effective long term strategy for wealth creation as long as you understand the risks and the impact gearing may have on your overall returns.
Contact a Morgans Warrnambool adviser to seek advice on whether utilising a margin lending strategy is appropriate for you.