How to manage margin loan risks

CommSec CommSec

26 June 2018


Using a margin loan to invest can amplify your potential gains. However, it can also amplify your potential losses. Fortunately, there are things you can do to reduce the potential risks that come with a margin loan. Setting a strategy for how you’ll use the loan can go a long way towards reducing your chance of losses or margin calls.

Keep your gearing level low

A lender might offer a maximum LVR of 75%, but actually borrowing up to the full 75% wouldn’t leave a lot of room for market movements in your portfolio. Market prices fluctuate regularly, and lenders have the right to reduce their LVRs at any time. At a 75% maximum LVR and a 5% buffer, a portfolio's value would only need to fall by 6.25% to trigger a margin call.

Borrowing less than the maximum LVR can ease the pressure as it allows more room for market movements (which are bound to happen if you’re investing with a medium to long-term view). If you only borrow up to 50% (and the maximum LVR is 75%) your portfolio value would have to fall by 37.5% before you reach a margin call.

A low gearing level means you’ll have less funds to play with, but it’s a sensible way to reduce your risk of a margin call.

How to manage margin loan risks

Diversify your portfolio

Borrowing to invest can magnify your losses as well as your gains, so it’s wise to keep following the same prudent rules of any investor trying to minimise potential losses. Diversify your investments across different companies, assets, and industries, so that a fall in one particular asset class or sector might be offset by a rise in another. Use dollar cost averaging to reduce your risk of mis-timing the market and buying at peak prices. Avoid particularly volatile stocks, and look to invest with a medium or long-term growth view. Fortunes are rarely made overnight, and markets can fluctuate day-to-day, so it’s sometimes better to think of investing as a marathon rather than a sprint.

Keep an eye on things

A margin loan isn’t a “set and forget” investment product. You must stay below your maximum LVR to avoid a margin call, so you’ll need to regularly monitor your portfolio. A significant fall in the value of even one of your investments could affect your LVR – and LVRs may be revised from time to time. Keep a close eye on your portfolio, and take action early if you believe your LVR is creeping too high.

Keep some cash on hand

If you do reach a margin call, you’ll need to top up your loan, so it’s a good idea to make sure you have access to some cash. If you don’t have enough cash on hand, you’ll need to sell some of your investments, and you might end up with unwanted capital gains.

Plan your interest payments

Margin loans with a variable interest rate will be affected by interest rate changes, and an interest rate rise will increase the cost of using your margin loan. However, you can transfer to a fixed rate loan to lock in an interest rate. This protects you from interest rate increases (but it also means you won’t benefit from an interest rate decrease).

Consider how much risk you’re comfortable with

Every investor has a different appetite for risk. Consider your investment goals and what kind of risks you are prepared to take to get there. Understanding the risks will help you decide on the best way to manage them.

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CommSec Margin Lending facilities are provided by the Commonwealth Bank of Australia ABN 48 123 123 124, AFSL 234945 (the Bank) and administered by its wholly owned but non-guaranteed subsidiary Commonwealth Securities Limited ABN 60 067 254 399, AFSL 238814 (CommSec), a Participant of the ASX Group and Chi-X Australia. Please obtain and consider the Product Disclosure Statements (PDS) available from commsec.com.au before making any decision about the CommSec Margin Loan. Applications for Margin Loans are subject to approval. Fees and charges apply. Only investors who fully understand the risks associated with gearing into investments should apply. 

Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 ("CommSec") is a wholly owned, but non-guaranteed, subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945 ("the Bank") and both entities are incorporated in Australia with limited liability.

This information is directed and available to and for the benefit of Australian residents only and is not a recommendation or forecast.

This information has been prepared without taking account of the objectives, needs, financial and taxation situation of any particular individual. For this reason, any individual should, before acting on the information on this site, consider the appropriateness of the information, having regards to their own objectives, needs, financial and taxation situation, and, if necessary, seek appropriate independent financial, foreign exchange and taxation advice. CommSec, and its related bodies corporate, do not accept any liability for any loss or damage arising out of the use of all or any part of this information. We believe that this information is correct as at the time of its compilation, but no warranty is made as to its accuracy, reliability or completeness.

 

Disclaimer

This site is directed and available to and for the benefit of Australian residents only. © Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 ("CommSec") is a wholly owned, but non guaranteed, subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 234945 and both entities are incorporated in Australia with limited liability.

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