At the height of the downturn in the Global Financial Crisis and in the months following Margin Lending received a battering in the media. The reason behind the bad press was questionable lending practices and lack of service from some providers and advisers, who when the market turned down they stopped speaking to their clients and stopped keeping them informed of what was happening.
I recall one day where the market dropped a further 2% after its official close due to margin calls causing stocks to be sold down. This resulted in more and more margin calls being triggered the following days and potentially led the market to a lower point than it should have gone.
This strategy of using other people’s money to invest can be a great way to enhance your returns however as with anything with the good comes the bad and this strategy also enhances the downside in returns.
How do you make margin lending work for you?
My advice is to stick to your chosen strategy even when it seems hard. I was reviewing a client’s portfolio recently and their performance over the last 12 months was positive 9.9% in a time where the share market had done a negative 15.87% return.
I wanted to know what this client had done differently to others to get such a solid result in a bad time in the market. This client had four margin calls during the time (which was a result of the portfolio going down during the correction and their need to provide more equity to the portfolio by paying down the loan).
But what they did during this time was average into the market and buy more stock.
Having the courage to buy when others were selling resulted in this client being able to produce a positive return during this period.
My advice if using a margin lending strategy:
- Keep a good cash buffer or have access to other funds in case of margin call.
- Keep your debt to equity ratio at 50% maximum to allow plenty of buffer to market volatility.
- Have the courage to stick to your chosen strategy and when others are selling look to buy or average into the market.
- Have a stop loss strategy in place and select a trigger point to take the emotion out of the investment process.
- Always understand what you are getting into and ask plenty of questions before signing a loan contract.
As the market has shown signs of recovery over the last few months it is a good time to be back in the market to take advantage of the upside. If you would like to review your wealth creation strategies please contact Money Mechanics today to discuss your needs.