Margin Lending - the good, bad and the ugly.

Margin loans are simply an investment loan that is secured against the assets you are purchasing, such as shares and managed funds.   You don’t need to sign over your house and that is why so many people like them.    However, investors can get into trouble if their investment falls below a certain level, known as the loan to valuation ratio (LVR).

You may have heard of margin calls.   When these happen, investors are in a bind.  They can either sell down their investment to restore the LVR,  in other words forced to crystalize losses, or have to find the funds to top it up.  What a tough decision to make in this current economic climate.  You could be buying bargains, or perhaps throwing good money after bad.    Some institutions also allow you to assign other assets. 

Personally, I have never taken out a margin loan, because the interest rate is usually around 2% higher which will reduce the return on my investment.   I would prefer to use the equity in my home.  Plenty of fingers pointing to financial planners who loved them as it allowed their clients to have access to higher amounts of borrowings to invest.  They are now accusing them of recommending these products in order to receive higher commissions and fees (they also get a commission on the loans, plus sell extra insurances that people will need).    You be the judge.

Recently, a listener wrote to me asking whether a fee of $7,700 on a $30,000 margin loan investment and then 5.5% on extra contributions was reasonable.  This represents around 25% of the investment.  With a fall of around 40%, his $30K is probably now worth around $14K - he needs at least 120% return just to get his money back, plus has to pay interest on the loan.   My answer is yes, it is reasonable, if the adviser spent at least 35 hours developing the financial plan (using an hourly rate of $250).   Could easily argue it was a bit of an overkill anyway.   However, this particular investor was put on a travelator, until such time as he was convinced this was the most appropriate strategy to create wealth.   I call them ’financial planning factories’.  They go something like this:-

Step 1 - go to seminar to hear blurb - you know if you don’t do something now you will have a miserable existence in retirement.  After all the pension may not be there when you retire (a blatant lie).

Step 2 - you are so disturbed and emotionally drained, you decide you should come back to complete the data collection form, known as the fact find.

Step 3- make another appointment to review financial plan.  Surprise, surprise, they have recommended that you borrow money to invest into a managed fund - nothing really personal about it.    Did they discuss your short, medium and long term goals and explore the advantages and disadvantages of other strategies which could be utilised?   For example, salary sacrificing to super, extra repayments into mortgage where you receive a guaranted after tax return?  I could go on forever!

However, it is very important to emphasise, I am not suggesting that this strategy is not suitable under any circumstances.    Just wish investors would scrutinize the recommendation with a lot more vigour (a second opinion might be helpful).

In fairness to financial planners, plenty of people also did their own thing with margin lending as the banks enticed them - usually day traders on the stockmarket who think they are gurus in stock picking.    Not sure who they are blaming - perhaps greedy banking executives who need to meet targets in order to receive their generous bonuses.    Of course, they are not personally responsible for their actions.

Borrowing money to create wealth can be a sound and financially rewarding strategy, particularly when asset prices are rising.   A long term commitment is essential (at least 10 years +).  In the end if your cash flow can weather the storms along the way, i.e. good income and assets to back you up, then your chances of survival are quite high.   For those who cannot afford the downturns, panic selling sets in, and wealth subsequently shifts from those who are suffering to those whose financial position is sound (hopefully it is you).   In simple terms, they didn’t go over their head.

Remember … Watch out.  Everyone is after your money.  Learn how to outsmart them.   I have attached a couple of educational booklets on gearing and margin lending.    Most financial institutions will outline the positives and negatives.  Nothing is guaranteed.     Don’t hesitate to contact me if you have any questions or if you  have your own story to share.

gearing-guide-mlc

margin-lending-set-your-sites-higher-mlc-2008

margin-lending-case-study-40s-typical-investor-bt-08

Good luck working your way through the financial maze.

Josie Kay

YOU MUST READ THIS: Don’t forget that the above information is general in nature and not specific to your goals and objectives. It is recommended that you seek personal financial advice specific to your needs. Thanks for posting your question on www.josiekay.com.au.