Margin Loans: A Savvy Way to Use Your Brokerage Account?

Posted: Updated:

Many investors are not even aware they can borrow against a portfolio, much less the implications of doing so. This tool can be a saving grace or a wrecking ball when it comes to your assets. So, could it help you? It all depends on the timing and the conditions.

How Does a Margin Loan Work?

As a general rule, individual investors are able to margin their brokerage account and borrow as much as 50 percent of the value of the assets in the account. But, brokerage firms can have different policies, and the amount you can borrow is based on the type of assets you own.

Riskier assets may offer lower borrowing amounts than more conservative assets. In this scenario, you can take your cash out as a loan or keep the cash in the account and use it to purchase more investments. The borrowing rate (margin rate) can vary, but if the additional investments outperform the costs of the loan, you could earn greater profits.

One thing to keep in mind: The margin rate you are quoted might be negotiable, particularly if another borrowing option has a better rate. Always ask for more competitive rates. Your brokerage firm might not budge, but it doesn’t hurt to ask!

When Might Margin Loans Pay Off?

Going the non-traditional route by borrowing against your brokerage account and using the cash for a non-investment purpose can be a useful strategy. For example, it can prevent selling appreciated assets to fund a temporary need. And, that means you’ll avoid incurring capital gains taxes.

Some situations where it may be worth it to borrow from your brokerage account include the following:

  • Bridge loan for home construction until a traditional mortgage can be put in place
  • New home purchase while you’re waiting for your existing home to sell


Tax Treatment of Margin Interest

Another consideration is that your margin rate might be low enough that borrowing against your investments is cheaper than a traditional mortgage or home equity loan – particularly since it isn’t as easy to deduct interest from home equity loans as it was last year.

And here’s a tidbit you may not have thought about: The interest charged on a margin loan can offset income earned in your portfolio, making the interest indirectly tax-deductible. Please consult your tax advisor before making any decisions based on the tax deductibility of different loans.

Nothing’s Guaranteed

As mentioned earlier, you can invest borrowed money within your account, thus leveraging the investment(s). If your investment outperforms the cost of borrowing the money, your portfolio gains some extra profit.

Here’s an example: Let’s say you borrow $250,000 at 6 percent on a $500,000 account and invest the loan back into the same investments. If you earned 10 percent, the gross return would be 12 percent, or an extra $10,000 versus your non-margined account.

That sounds good, right?  But keep in mind that your losses also amplify. In the example above,

If you earned 30 percent or lost -30 percent, your gross returns would be 42 percent and -48 percent, respectively. If you want to get back to even after losing -48 percent, you must earn 92 percent going forward! 

Caution Is Your Friend

Brokerage firms are very careful not to lose money on a margin loan. The assets in the account are used as collateral for your loan. If the value of your investments falls below the amount of the loan, you could walk away from the loan leaving the brokerage firm under water. To avoid this, brokerage firms will make “margin calls”. When the value of your loan reaches a specific threshold, say 70 percent of the account’s investment value, the brokerage firm will force you to sell assets and pay down a portion of the loan. If you don’t act quickly enough, they will sell the assets of their choosing, which may or may not match your desires.

Selling assets as they are going down is generally not a recommended investment strategy. Not only are you losing money in your portfolio and enduring a borrowing cost, you are potentially selling assets at exactly the wrong time and limiting the ability of your portfolio to recover.

Summary

This article isn’t meant to scare, but if you feel skittish, then I’ve met my goal. Margin loans can be useful, but when they are used for simply leveraging an account to juice the returns, margin loans can be risky.

Bill Wendling, CFA, is Chief Investment Officer and Senior Portfolio Manager at Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.BedelFinancial.com or email Bill at bwendling@bedelfinancial.com.

  • Perspectives

    • Big Data's Role in Site Selection

      In the world of site selection, companies assess the pros and cons of various factors to identify the location that best fits their current and future business needs. The list may seem endless: labor availability, utility needs and costs, real estate options, tax climate, incentives, quality-of-life considerations, even an area’s weather patterns and the likelihood of natural disasters. With the emergence of big data and the use of data analytics in all facets of business...

    More

Subscribe

Name:
Company Name:
Email:
Confirm Email:
HTML
INside Edge
Morning Briefing
BigWigs & New Gigs
Life Sciences Indiana
Indiana Connections
INPower
Subscribe
Unsubscribe

Events



  • Most Popular Stories

    • $25M Behavioral Hospital Coming to Central Indiana

      Danville-based Hendricks Regional Health is partnering with US HealthVest to develop a stand-alone behavioral center on the Hendricks campus in Plainfield. Known as the Indianapolis Behavioral Hospital, the facility will provide specialized inpatient and outpatient mental health care to patients of all ages.

    • Demand Fuels $120M Convention Expansion, Hotel Plans

      A $120 million proposal to expand the Indiana Convention Center and build two hotels at Pan Am Plaza in downtown Indianapolis, the city's travel and tourism association says, will put Indy in play for a bigger share of the lucrative convention business. Visit Indy Chief Executive Officer Leonard Hoops says the plans, which include 1,400 new rooms in two Hilton-branded hotels -- one of which will rise 38 stories -- and 300,000 square feet of convention and ballroom space, will help...

    • Bill to Fix Tax Issue For Trailer and Camper Dealers

      U.S. Senator Joe Donnelly (D-IN) has introduced a bill designed to fix what he calls a mistake in the 2017 McConnell-Ryan tax bill that has led to an adverse effect on RV trailer and camper dealers. Donnelly says the tax bill "significantly reduced" a tax deduction for dealers, which has led to higher inventory financing costs.

    • 'Heartbreaking' End For Nashville House

      The 91-year-old Nashville House restaurant is closing. The Brown County family dining staple will serve its last meal at the end of the month. In a post on Facebook, Gina Sarah Rogers, daughter of late-owners Andy and Fran Rogers, said it is "the end of an era and very heartbreaking." The restaurant is known for its country-style fried chicken and ham meals. Business on the property dates back to the late-1860s when an inn opened. It was acquired in...

    • CIB OKs $120M Convention Center Expansion, Two Hotels

      The Capital Improvement Board of Directors in Indianapolis, Visit Indy and Indianapolis-based Kite Realty Group Trust (NYSE: KRG) have unveiled $120 million plans to expand the Indiana Convention Center and add 1,400 rooms. The proposal, approved Friday morning by the CIB, involves two new hotels, including a 38-story property, and extending the convention facilities to the current Pan Am Plaza site. In January, the CIB released a request for interest for a convention center...