Borrowing to invest can multiply your investment returns in a rising market. However, it can also multiply your investment losses if the market declines and your investments perform poorly. Some of the risks of using a margin loan include:
- Returns will be magnified, for both positive and negative returns;
- Interest rates may rise, increasing interest costs;
- Borrowing limits may be reduced, increasing the potential for a Margin Call;
- Margin Calls may require the sale of assets at unfavourable prices;
- Taxation legislation may change.
Managing the risks of a margin loan
There are a number of things you can do to reduce the risks associated with a margin loan. They include:
- Don’t borrow to the maximum permitted gearing level (ie the Base LSR)
- Ensure that your portfolio is adequately diversified
- Reinvest distributions and dividends
- Pay your interest costs instead of capitalising them
- Don’t rely on investment income to cover your interest costs
- Have a cash reserve available to avoid or cover Margin Calls
- Regularly review your portfolio and gearing level
- If your account is in buffer, use the time to be proactive and avoid a margin call
Your financial adviser can help you plan the best way for you to manage margin calls.
Control your LSR before triggering a margin call
It is important to regularly monitor the status of your margin loan. A downturn in the market or a reduction in the borrowing limit of a listed security or fund securing your margin loan may move your Current LSR closer to your Base and Margin Call LSRs.
Investors should always aim to keep their Current LSR below the Base LSR – the maximum permitted level of gearing. Once the Current LSR moves above the Base LSR, the margin loan is in the ‘Buffer’. If the Current LSR reaches and exceeds the Margin Call LSR the investor will be in Margin Call and will be required to bring the Current LSR back below the Base LSR. This is usually done by reducing the loan balance and/or adding approved securities to the portfolio.
Example
Colonial Margin Loan is one of the products under the Colonial Geared Investments brand which are provided by the Commonwealth Bank of Australia ABN 48 123 123 124, administered by its wholly owned but non-guaranteed subsidiary Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814. This information has been prepared without taking account of the objectives, financial situation or needs of any particular individual. For this reason, any individual should, before acting on this information, consider the appropriateness of the information, having regard to their objectives, financial situation and needs and, if necessary, seek professional advice. Applications are subject to credit approval. Fees and charges apply. Please consider the full terms and conditions available on application on this website. Only investors who fully understand the risks associated with gearing into investments should apply.