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Borrowing money to buy shares - not for the beginners!
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Margin loans are both exciting and risky - and definitely not for the fainthearted! While it’s possible you’ve never heard of them, by the end of this episode, you’ll have a clear understanding of what they are and whether they might fit into your financial strategy.
What Exactly is a Margin Loan?
A margin loan allows you to borrow money for investments, typically in managed funds or the stock market. Essentially, you leverage your existing investments as collateral, which means you can magnify your profits—but equally, your losses. Much like using the equity in your home to buy another property (also known as leverage), margin loans work on the same principle. Here, you might invest $100,000, perhaps from inheritance or a windfall, and take out a margin loan with a 50% loan-to-value ratio. This setup allows a lender to match your investment, totalling $200,000 for stock market ventures. If the market rises, your gains skyrocket. But when the market tumbles, your losses escalate too.
Understanding Margin Calls
So what happens when the market decides to do a nosedive? Enter the margin call—a uniquely unsettling consequence of margin lending. Should your investment falter and violate the bank’s loan-to-value ratio limit, you could expect a call informing you to fortify your account within 24 hours, or they might start liquidating your share portfolio. The size of the margin call will hinge on factors like your loan size, investment value and market conditions when you initiated the loan.
The Risks and Rewards of Margin Lending
While margin lending can exponentially boost your potential profits, the risks are real. Unless you've got a fallback strategy to manage abrupt market shifts, your investments might be sold under distressing conditions. That’s why margin lending fits seasoned investors more than novices; those with high-risk tolerance, a diversified portfolio and a plan to handle unexpected margin calls.
So, if you’re ready to find out whether a margin loan is suited to your circumstances, make sure to reach out to your financial advisor. Otherwise, feel free to shoot me a message and we can get started on working towards your financial goals together.
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