Using Margin Loans to Increase Your Investment Potential
Are you certain that you could earn more with your investment strategies, but you donâ€™t have more capital available to invest? If so, borrowing for investments (or â€œgearingâ€) by taking out a margin loan may be your best option.
Margin loans can be risky â€“ youâ€™re essentially gambling with someone elseâ€™s money. Because of this risk, youâ€™ll have to provide some kind of security before being granted a margin loan â€“ this can be existing shares, managed funds, or cash, and will depend on being approved by the lender. Youâ€™ll also be responsible for paying interest during the life of the loan.
Despite the risks, using margin loans to invest in stocks or managed funds can help you reach your financial goals much more quickly than waiting until you have that investment capital on-hand. Unlike other types of investment loans (such as mortgages when buying and selling property), margin loans can be acquired in amounts as large or small as you feel comfortable with, giving you more control over your risk and reward.
In addition to increasing your investment opportunities, a margin loan may also offer you tax benefits. For example, the interest you pay on a margin loan may be tax deductible. Because margin loans allow you to use other investments as security without having to sell those shares, you can also avoid paying capital gains tax, which you would otherwise incur if you had to sell the stocks for cash as a security.
While the possibility of earning greater returns more quickly is certainly alluring, there are a few things you should keep in mind to ensure that you donâ€™t run into trouble with geared investments.
First, you should invest more conservatively than you might with your own cash. For example, you may want to create more diversity in your portfolio to protect yourself against sudden share price drops with any one company.
You should also only take out a margin loan for investments if you have a cash reserve or steady cash flow to handle all interest payments (including potential interest rate increases if you donâ€™t go with a fixed rate loan). Donâ€™t count on a sudden increase in earnings to cover your interest payments.
As your larger investments bring in more income, set aside more funds to protect you from any potential large-scale share price drops. Whether or not the stock market crashes, youâ€™ll still be responsible for repaying the principal and interest on your margin loan (having emergency funds available for a worst case scenario can protect your other assets).
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