Gearing – Costs and risks of margin lending
Margin lending is a form of gearing. Gearing involves borrowing money for investment purposes. The purpose of gearing is to increase your investment returns and wealth accumulation through investing
Borrowed funds in addition to your own capital.
Although gearing can deliver benefits, it can mean risks associated with gearing inappropriate for you. These risks must be carefully considered before proceeding with it Gearing strategy.
How it works
Borrowing money to invest is called gearing. Margin lending is a type of gearing facility where you Use assets like shares, managed funds or cash as security to borrow funds.
The amount you borrow is limited to the percentage of investments that have been used A security, which can be a combination of investments you already own and investments purchased with it
This percentage is known as loan to value ratio (LVR). Highest Margin Lending Providers allow LVRs up to about 70%. This means if you already have a valuable investment
At $30,000 (to be used as security) you can borrow up to $70,000 to buy additional investments. Margin Loans. Loans are then secured across the portfolio. The loan amount represents 70% Total investment.
Gearing is generally only suitable for investors who have a growth-oriented risk profile. for In order to be effective, the overall return from the investment must exceed the cost
Investments, including cost of loans.
This will usually be achieved through investment Growth oriented assets like shares and property. So you don’t just have to be comfortable together
The risk of borrowing also increases with the risk of investing in these asset types The level of fluctuation in the value of such investments.
You should also meet all of the following criteria before considering gearing:
• Have a long-term investment horizon of at least seven years
• Have sufficient disposable income to comfortably cover interest expenses as well as any margin
Calls (repayment) if the value of the investment falls (see below), and
• Create a strategy to pay off outstanding loans at some point in the future.
As with any debt, it is important for you to have the right insurance coverage to pay off the debt or Covers ongoing investment expenses in case of death, critical illness or total and permanent condition
Features of Margin Loans
Every margin lender has a list of approved investments where the borrowed money and assets are.
Investments can be offered as security. These typically include managed funds and shares
A margin lender will set a ‘lending ratio’. For example, if the credit ratio is 70% and you have You can borrow up to $70,000 of your own money to invest.
The lending ratio may vary according to the type of investment. For example, blue-chip shares and
Many managed funds often have high leverage ratios of 65-75%, while higher risk assets such as
Small Australian companies may have a leverage ratio of only 40-50%.
Margin loans can be taken in lump sum or in installments. A lump sum margin loan provides you With a lump sum to invest. An installment margin loan lends you a small amount on a regular basis,
Which you use to gradually add to your own contribution to buy the investment. An installment margin Loans can reduce your risk and provide benefits from dollar cost averaging. Dollar cost avg
It involves investing a certain amount at regular intervals. By investing in this way you are not Trying to pick a market low or high but investing a fixed dollar amount instead Regardless of investment market trends.
Double gearing involves borrowing funds and using those funds to purchase investments. This The investment is then used as security for further borrowing through margin loans. A double gearing strategy increases both the total amount you owe and the investments you make. Consequently, the double gearing strategy carries more risk than any investment gain and investment Losses will be significantly increased over standard gearing strategies. With this strategy, It is important to know that both of you will be responsible for the ongoing obligations for the loan. Any loss This can affect your ability to repay the loan within your investment portfolio. This can affect Viability of your investment strategy.
A margin call can occur if your loan balance exceeds your maximum loan limit (ie when the lender Maximum Loan to Value Ratio (LVR) is exceeded). This can happen as a result of a downturn in the market
This leads to a reduction in the value of your portfolio or to the point where interest has accrued on your loan LVR has been exceeded. A margin call is a lender’s demand that you take steps to restore your standing Acceptable LVR.
To meet a margin call, you will need:
• Pay off a portion of the loan to restore the credit ratio, or
• Take additional investments as security to increase total portfolio value, or
• Sell part of the portfolio and use the proceeds to repay part of the loan.
If you don’t meet the margin call, the lender may sell some investments to meet it. Selling assets to meet margin calls can result in capital losses. Therefore, to reduce the risk a
With a margin call coming, consider borrowing so that there is a generous buffer between lenders LVR and your actual LVR. For example, if your LVR was 50%, and the maximum LVR allowed is 70%,
Your assets would need to fall by more than 30% to trigger a margin call.
Advantages of margin lending can include:
Loans enable you to increase the size of your investment portfolio. A large portfolio enables you to diversify investments. You may be eligible to claim a tax deduction for some or all of the loan costs to help To offset borrowing costs or reduce taxes on other income. Consider risks, consequences and other important considerations This includes:
The tax benefits of negative gearing should never be the sole reason for establishing it Gearing strategy. You must ensure that your employment and cash flow are secure so that you are not forced out Sell some or all of your investment portfolio when markets are down. An unexpected event, such as an injury or illness that prevents or changes your ability to work Employment circumstances can make it difficult to meet interest payments. risk of Loss of income due to injury or illness can be mitigated by incorporating asset protection Measures including income protection, critical illness cover and total and permanent Disability cover.
Margin lending however provides the potential to increase capital gains when the markets are By increasing, it is also prone to increased losses when markets are falling.
A margin call may force you or allow your lender to sell some or all of your investments. A portfolio that suffers when markets are down. It is important that Avoid this situation and consider making sure your employment and cash flow is secure Borrow so that there is a generous buffer between the lender’s LVR and your actual LVR.
You should consider the impact of a rise in interest rates or a cut in dividends, Distributions, or other income from investments. You should make sure you have enough Cash flows to increase interest rates and decrease investment income.
Your investment portfolio may decline in value until the sale proceeds Not enough to pay the debt. So even if you are entitled to tax Deductible over time, it is possible that you can carry the debt once The investment portfolio has been sold.
Double gearing involves more risk, as any investment losses will be significantly magnified More than a standard gearing strategy. Losses can affect your investment portfolio Your ability to repay the loan used to double gear. You will continue to be responsible for Ongoing liabilities for both loans, regardless of any investment losses. Law may change in future regarding tax deductibility of interest payments.
This document has been prepared by GWM Advisor Services Limited (ABN 96 002 071 749, AFSL 230692) (‘GWMAS’). Member of National Australia Bank Limited (‘NAB’) Group of Companies (‘NAB Group’), Registered Office 105-153 Miller St North Sydney NSW 2060, GWMAS, for use and distribution by representatives and authorized representatives of NAB,
Godfrey Pembroke Limited, Apogee Financial Planning Limited, Maritum Financial Group Pty Limited and Australian A financial services license with which it has a commercial services agreement.
The information in this document is of general nature only and does not take into account your objectives, financial situation or requirements. You should seek personal financial, tax, legal and such other necessary or appropriate advice before relying Information in this document or any financial investment, insurance or other decision. If this is the document Any personal financial advice relating to finances is provided in conjunction with a Statement of Advice (‘SOA’) to you The planning concept/strategy specified in this document will be contained in that SOA.
The information in this document reflects our understanding of the relevant regulatory requirements and laws etc. issue, which may be subject to change. While care has been taken in preparing this document, no liability is accepted GWMAS or any member of the NAB Group, or their agents or employees for any loss arising out of any reliance thereon document. If any financial product is mentioned in this document, you should refer to the relevant PDS or other advertising material. Before making an investment decision in relation to that financial product.