For most investors, building a large, well-diversified portfolio can take a significant amount of time. Spotting an investment opportunity is one thing, but having access to enough cash at the right time can also be a challenge. One of the ways investors can potentially grow their portfolio faster is by borrowing to invest.
Borrowing to invest might sound risky, but the reality is many investors already do it to invest in property. If you needed to save 100% of a property’s value before you could purchase it, many of us would be saving for decades. Instead, we can take our deposit to the bank and negotiate a loan to cover the remaining amount. The bank is comfortable with loaning us this amount because it’s secured against the property.
Borrowing to invest in equities is similar in concept. A margin loan, equity loan or home line of credit gives investors access to funds they can use to invest in equities assets, and the loan is secured against cash, their home or the investor’s existing shares.
Why invest in equity markets vs property?
The property market has delivered impressive returns in the last few years, and plenty of investors have chosen to put their dollars into housing. But there’s a good deal of upside to consider in choosing equity markets over property. It’s more cost-effective to buy and hold shares compared to property, and it’s relatively simple to offload them if you need to sell.
|Investing In Property||Investing In Equities|
|Start-up capital required||10-20% deposit of the total property value||Minimum share purchase $500 plus brokerage|
|Purchase transaction costs||Stamp duty, lenders mortgage insurance, conveyancing and legal fees||Brokerage is charged per trade|
|Ongoing costs||Mortgage repayments, home and contents insurance, council rates, strata fees||None|
|Investment income||Rent, capital gains||Dividends, distribution, capital gains|
|Diversification||Low||High (as long as you buy across different sectors|
|Ability to sell quickly if needed (liquidity)||Difficult||Easy|
Benefits of a margin loan
Potential to amplify your returns
The main benefit of a margin loan is it can increase your returns. With access to more funds, an investor can buy more shares, meaning they can earn more income via dividends and capital growth. A margin loan also gives you the ability to diversify your investment portfolio by buying across more sectors, countries, and asset classes.
Unlock the equity in your existing assets
Say you want to buy some listed/unlisted funds when Rocky & Steve say the market is ‘cheap,’ but you don’t have enough cash on hand to do so. You might normally sell some of your existing investments or eat into your ‘emergency fund’ to generate enough cash to finance the new investment. However, with a margin/equity loan, you can unlock the equity in your existing assets without having to sell them (and without potentially triggering another capital gains tax event, or being with an emergency fund).
There’s no obligation to draw down on a margin/equity loan – if you don’t use it, you won’t need to make repayments or pay interest charges. In this way, it’s almost like a line of credit rather than a loan.
If you do use the loan, you’ll be charged interest. However, there’s some flexibility in the way you pay interest. You can choose to fix your interest rate or leave the loan on a variable rate. On a fixed rate, you have the option to pay your interest in advance, or to pay it monthly in arrears.
Interest paid on a margin loan is often tax-deductible. You might be able to pay interest before the end of the financial year to bring the tax deductions forward. Please talk to your accountant regarding this.
Risks of a margin loan
- As well as amplifying your returns, a margin loan can also amplify your losses if your investments perform poorly.
- If the value of your portfolio falls too much relative to your loan value, you will receive a margin call. To resolve a margin call, you’ll need to top up your loan with cash or sell some of your investments on short notice.
- If your margin loan is on a variable rate and there is an interest rate increase, the cost of running your loan will go up.
- Make sure you understand the risks before you use a margin loan, and familiarise yourself with the ways to manage margin loan risks. Benefits of a margin/equity loan
If you would like to discuss further, please feel free to get in touch!
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