Equity derivatives provide an opportunity to seek enhanced income returns from share investments, while managing risk and providing portfolio hedging
Using debt to build wealth is a well established path. Taking that strategy into an equities portfolio is not so well understood, but it can transform long-term outcomes
By Bernard Hope
Competition for capital in a phrase often associated with how corporations manage competing priorities to grow a business, but it also applies to individuals trying to achieve life goals. That new home, car or luxury holiday may mean an investment opportunity is missed. However, there are strategies like a margin loan that are designed to allow your wealth to grow, while maintaining funds to pursue your passions.
A popular strategy is utilising bank-supplied finance to build an investment portfolio of listed securities or managed funds. You do this by taking out a margin loan, also known as an investment loan. The amount you can borrow will be determined by a review of your financial position.
How it works
Like a home loan you will pay regular interest payments on a margin loan, and the loan facility is not designed to acquire higher risk investments like small cap miners. However, loan providers will have a list of approved investments. For instance, in the NAB offering there are over 2500 approved investments, including over 1000 approved international equities. It provides the long-term investor with ample choices to build a diversified portfolio.
As the loaned funds are being used for investment purposes your interest payments may also be tax deductible, and by having funds available to increase your portfolio you may also defer capital gains normally accrued in an actively traded share portfolio where you sell one share to purchase another.
By having additional funds on hand, investors have the capacity to build a more balanced and diversified share portfolio, which lowers the risk that poor performance in a particular sector will lower overall total returns.
At the end of the margin loan term, and if your portfolio has performed as you expected, you may be able to refinance the loan and continue to expand your portfolio. Alternatively, you may set a timeframe to liquidate the portfolio, repay the borrowed funds and keep any profit.
Of course, like any investment there are risks
At the time you take out finance, there will be a maximum loan to value ratio (LVR) applied. An LVR is simply the value of your loan divided by the value of your investments. Typically, margin lenders require the LVR remain below 70%.
For example, if you wanted to borrow $1000,000 to invest and the LVR was 70%, you would be required to have $300,000 in cash or a share portfolio equivalent to support the loan application.
The difference between the value of the loan and the current value of your stocks is referred to as the “margin”. This difference must be maintained at a minimum level. If the value of your portfolio falls below this ratio it could trigger a margin call, meaning you would be required to top up your account with cash or sell some of your portfolio to get back under the minimum LVR.
If the margin call is not met, the lender may sell your portfolio and seek payment for any shortfall between the sale proceeds and your loan amount.
There are strategies that can be deployed to limit any potential losses, although they may also cap your gains. These can be discussed when setting up your margin loan.
Margin lending can help you build your wealth over the long term by increasing the size and diversity of your portfolio. Diversification can reduce your market risk.
You have the flexibility to invest when you consider the timing is right, and you know the funds are on hand and cannot be re-directed to other funding requirements you may have.
Tax deductions are generally available on interest paid for income producing purposes.
It may be possible to defer taxation on potential capital gains, as you do not have to sell your existing investments to make new investments.
Allows your existing capital to be deployed elsewhere.
Opportunity to generate higher returns on your capital (and potential for higher losses)
While borrowing to invest can potentially increase your return, it can also work in reverse in periods of high market volatility.
Just as the value of your investment is amplified, your losses can be as well, if the value of your portfolio falls.
There may be an increase in borrowing costs, i.e. interest rate increases.
The more you borrow the greater the risk. Whatever the amount you borrow, ensure you have a sufficient buffer to maintain the required margin in the event of a market correction. Keep your buffer liquid and easily accessible.
A margin loan is a financial tool that provides investors with a way to invest in stocks with an aim 0f growing wealth over the long term. While there is the potential for losses, there are strategies that can be deployed to limit any downside. It’s an option worth considering for investors who want to build a strong and enduring investment portfolio.
To find out more about NAB’s capability visit NAB Private Wealth
The information contained in this article is gathered from multiple sources believed to be reliable as of the end of May 2023 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on the information in this article you should consider whether it is appropriate for your objectives, financial situation or needs. NAB and JBWere recommend that you seek independent legal, financial and taxation advice before acting on any information in this article. JBWere Limited ABN 68 137 978 360 AFSL 341162 (JBWere) is a wholly owned subsidiary of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686 (NAB). NAB doesn’t guarantee the obligations or performance of its subsidiaries or the products or services its subsidiaries offer.
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