Taking out a loan for an investment property is a common strategy. In order to buy an investment property, we lend money from a bank to buy it. But what if you want to borrow money to invest in shares, ETFs or managed funds?
If you’re considering investing in shares, ETFs, or managed funds, you might be wondering if it’s a good idea to borrow money to do so. In the past, the most common way to do this was through a margin loan, which is a loan used to purchase shares or other investments, with the securities serving as collateral for the loan. However, a margin loan can come with risks and may not be the best option for everyone.
Margin Loans – Know the Risks
A margin loan is a loan used to purchase shares, ETFs, etc and is often taken out a higher rate than your traditional home loan with the shares you purchased secured against this loan.
The single biggest difference between this and your standard home loan is what is known as a ‘margin call’. A ‘margin call’ occurs when your invested amount differs negatively to their current value.
So, for instance, you purchase $100,000 worth of your favourite EFT and something happens with the value dropping $10,000 overnight. Your lender can perform what is known as a margin call, leaving you with two options. Offer up the $10,000 difference or sell your shares to recoup the difference.
Both of these scenarios are not great and should be avoided. Through having to sell your investment at $10,000 less than what you paid for them is called ‘crystalised’ losses.
This is when your losses are realised, and you are literally $10,000 out of pocket (plus selling fees). Chances are if you had the opportunity to keep your shares when the market dropped and not sell, they would’ve recovered over time.
Equity Loans – A Better Option?
Like property investing if you own a home, you can access the ‘equity’ which exists in your home. For an explanation of accessing your equity see my other article.
You can take out this equity to invest in shares, ETFs, managed funds much in the same way you would with property. When taking out the loan you would inform the bank of its intended use as many will ask.
It is the good practice to take this out as a separate loan, often in the form of an equity loan. With these funds you can then invest them as you see fit.
Through using a separate loan from your owner-occupied loan you are not ‘mixing’ your loans which is very important for claiming any negative gearing associated benefits. For a more depth explanation of the benefits of negative gearing read this article.
The loan will track transactions to your brokerage accounts (CommSec, Pearler, Vanguard etc), whilst also tracking the interest charged and any dividends or distributions paid (providing they are not auto-reinvested).
This will be very important come tax time when your accountant is lodging your claim. For tax purposes, it is important that clear lines of sight are maintained on what the money is being spent on.
Keep in mind, investing in shares is viewed as an income stream so any profits or losses are taken into account on an individual’s taxable income.
Before taking on debt to invest in shares, ETFs or managed funds, it’s important to consider your individual circumstances, goals, and objectives. Seeking financial advice can help you make an informed decision that’s right for you.
Remember, borrowing to invest comes with risks, so it’s important to have a solid understanding of the market and to be prepared for potential fluctuations in the value of your investments.
Whether you choose a margin loan or an equity loan, keeping clear records of your transactions can help you maximize any tax benefits and minimize your overall costs.
As with any investment, seeking professional advice can help you make the most of your opportunities while minimizing your risks.