The once heralded super product, Margin Lending, became the bad boy of the financial markets in the lead up to, and throughout the carnage that was the Global Financial Crisis. Having steadily and then frantically grown in volume up until the GFC, investors willingness to take out a margin loan in recent years has been up there with teeth extraction without aesthetic.
However, in the past few months, margin lending volumes have started to rise. Why is this? Confidence in the markets. It’s one of the vital steps on the road to recovery when people are not only happy to invest their own money, but they’re happy to risk someone else’s while putting their hand up and taking responsibility for it.
Margin lending is very similar to borrowing money to buy a property – you put down a deposit, and borrow the rest to buy a share or managed fund portfolio. Similarly, you can put up shares or managed funds that you already own and use them as security for a loan to go buy more shares and/or managed funds.
Where margin loans differ from housing loans is due to the word “Margin”. Margin loans are lent out at a margin – that margin being the difference between what your secured assets are worth, and the size of the loan. While things are going up, everyone is happy. However should the value of your shares or managed funds fall, the bank that lent you the money is going to start getting a little bit nervous – and should their value fall to the point where the margin between your loan and security value is below a predefined level, the bank can call in part, or all, of the loan – this is known as a “Margin Call”. Through the early days of the GFC, margin calls were very common occurrences and accounted for the downfall of quite a few well known business people and businesses themselves. The time when are you least likely to want to sell assets is when the market is falling, yet that is what may investors were faced with doing. Quite simply, you don’t borrow money to invest if you have your own – that’s why you borrow. So, rather than just paying back the loan, you’re forced to sell. Not good.
However, stay sufficiently far enough away from that threshold and you’ve got a much better chance of surviving a fall in the market, and that’s what we’re seeing investors doing more of these days. Borrowing, but more conservatively. People are “pressure testing” their investments more to see what would happen in certain scenarios. Do you feel confident that a certain outcome may or may not happen? If you think it’s a possibility, and that puts you in margin call territory, then maybe it’s time to rethink your investment strategy.
As always, borrowing money is always for the long term, it’s not a get rich quick idea. While you will hear stories of people that borrowed and made a killing – much like poker machines you’re more than likely to hear about peoples wins rather than losses. Proceed with caution, however if you’re up for it, with proper due diligence and some time and care, you can build a geared portfolio with margin lending that, over time, could yield some solid results.