Exciting life on the margins
Margin lending can mean boom or bust, so watch out for the pitfalls, writes Craig Binnie
WANT to get rich quick? Then get into margin lending.But don't forget the catch. Margin lending — borrowing to buy shares or units in managed funds — is not only a way to boost profits, it is also a way to lose huge sums of money.
Margin lending magnifies both your gain and your loss. It works simply. You buy some blue-chip shares or invest in a managed fund. You give them to a margin lender — usually a bank, investment company or stockbroker — who gives you access to even more cash to buy even more shares or fund units.
It is a great way to get your hands on bundles of cash. Margin lenders, who mostly do not carry out any credit checks, will lend you more than twice as much money as you have. So someone with $30,000 could feasibly buy $100,000 of shares.
The head of HSBC's Investdirect stockbroking service, Richard Kimber, says an investor — we'll call him Fred — who puts $30,000 into shares which rise 10 per cent in value makes $3000.
Another investor — Harry– who takes out a margin loan and ends up with $100,000 in shares makes $10,000. Based on their initial $30,000, this is a 33 per cent return. Obviously, there is the cost of the loan to consider.
Kimber says margin loans are generally cheaper than personal loans but a little more expensive than a home loan.
Many people who have equity in their homes withdraw money from their mortgage to invest because it is cheaper.
Fans of margin lending point out that any money borrowed to buy an income-producing investment can be claimed on tax. This means someone on the top rate of tax can get back almost half the interest they pay. When you consider most companies pay regular dividends that are at least partially tax paid, the cost of owning shares or managed funds though a margin loan can be minimal.
The Commonwealth Bank's Paul Rickard says increasing your shareholdings through a margin loan can also reduce your risk.
FOR example, he says someone who owns only Telstra shares has suffered a loss recently.
However, if they have access to more money they may own a stock such as News Corp or even BHP, which have both risen substantially.
But there is a down side and it is huge. This is what makes margin lending a tool that should be used only by educated investors.
If the market goes the other way and the shares fall 10 per cent, our first investor, Fred, loses $3000, while Harry loses $10,000 — 33 per cent of the initial investment. When shares fall in value, the margin lender can require you to put up more money or shares as security or sell the shares you own.
When looking for a margin lender, there are several guidelines. The most important is the minimum amount you are forced to borrow without facing penalties or higher interest rates.
Check the interest rate you pay — the amount varies between lenders.
Also, if you intend to use your margin lending facility to pay for shares secured in floats, check if there are penalties for selling shares on the first day.
Also be aware brokers receive commissions for shares they buy that are paid for with a margin loan. They may have a vested interest in recommending a particular lender.
If you are considering a margin loan, ask two or three margin lenders to send a brochure and compare the fine print.
Caption: Margin lending benefits, Margin lending Pitfalls
Illus: Graphic Table