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Stock-Based Loan Basics

stock-based loansThe equity markets have returned from the crisis of 2008 and 2009. This means more people are returning to shares as a viable investment vehicle. These investments have consistently proven to generate the best returns over the long-term. Placing capital in any type of investment is governed by basic financial principles that should always serve as important guides to the investor. Issues such as return on investment, risk versus return and preservation of capital are fundamental to successful investing for professionals and individuals alike. One concept of investing is the use of leverage to generate better returns. It has proven to be a successful wealth creation tool for many investors. When dealing with shares, the concept of leverage is employed in margin trading. In this common and well-accepted practice, you are allowed to borrow money against your current holdings to provide funds for the purchase of more shares. This is not much different from borrowing to purchase real estate as an investment. With the funds created by borrowing, you are able to buy shares that can multiply the returns you generate in your portfolio if its value increases. Companies such as ETrade Australia have straightforward ways to set up your shares to use for margin.

If additional shares are bought this way, you incur the expense on the borrowing. At today’s historically low interest rates, these expenses are minimal. On the other hand, the shares that are leveraged allow significant cash-on-cash returns since they are not actually capital. Once returns are created, the shares can be sold and the debt paid off. Aside from generating additional leveraged returns, borrowing on shares can create other benefits. One of these is increased portfolio diversification. With additional funds available, an investor is better able to apply this important investment concept and have a wider range of shares or other investment types in their portfolio. Tax planning is yet another important advantage made possible by use of margin. Tax deductions on the interest paid can provide savings, especially if the interest is prepaid for up to 12 months. You may also find that borrowing on shares to defer sales of securities is a wise tax decision. This can often help you to defer capital gains taxes based on tax calculators. The maximum that you can borrow against a security is set and is called Security Value. That is established by the Loan to Value ratio set for a security. Professional advice can help you evaluate if borrowing against shares is right for you.

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About the Author Grayson Bell

I'm a business owner, blogger, father, and husband. I used credit cards too much and found myself in over $75,000 in debt ($50,000 in just credit cards). I paid it off, started this blog, and my financial life has changed. I now talk about fighting debt and growing wealth here. I run a WordPress maintenance and support company, along with another blog, Eyes on the Dollar, which is another great personal finance blog.

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Leave a Comment:

Dividend investing Martin says August 12

Grayson, great review. I have a great experience with margin trading. I believe that every beginning investor should use it in early years (when you have little money available) and slowly deleverage in later years of your investing career. If done properly you can easily avoid margin calls when fully invested. I’ve been using margin for 7 years and it helped me a lot so far.

    Grayson says August 13

    Thank you for your feedback Martin. I really appreciate you offering your experience with margin trading.

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