Margin loans: powerful tool or dangerous trap?
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What exactly is a margin loan and how does it work?
Welcome to How Do They Afford That, the podcast that peeks into the financial lives of everyday Australians. I'm Michael Thompson. I'm an author and the co-host of the business news podcast, Fear and Greed. And as always, I'm with financial planner, Canna Campbell, the founder of the financial literacy platform, Sugar Mama TV, and my co-author on our upcoming book, 12 Months to Financial Freedom. It is out on the 1st of September. Hello, Canna. Good morning. How are you? You know what? I'm a little bit wary about today's episode. Why? Because it is a topic that can be controversial. Right. Okay. So you're with me so far. We are talking about one of the more controversial tools in investing, I would say. Margin loans. So I would say we fear what we don't understand. That is controversial. Okay. All right. That's probably also fair. Some investors swear by them. Others won't go near them. So today I ask you,
Are margin loans a powerful wealth-building tool or a dangerous trap? Bring it on because let's just – we're going to –
diffuse any fears. People are going to have a very informed, educated opinion after this episode as to whether a margin loan is powerful or whether it's a dangerous trap and tool and whether it's maybe right or wrong for them or perhaps something they can consider further down the track.
Indeed. And of course, as you're listening to this today, know that everything that we're talking about is general in nature. It is never personal investment, strategic or product advice. It is purely for financial education purposes only. You need to see a financial planner to get advice tailored to your circumstances. If you're listening to this and going, oh, this is something I'd like to explore, talk to a professional and get some advice. Let's start with the basics.
What is a margin loan? Is it a dangerous trap? No, no, no. Just tell us the margin loan bit and then leave the rest for later. No, it's a very powerful tool. It is a risky tool, but when it's used for the right reasons and the right time, the right goals, it can be powerful. So essentially it is a loan that you borrow, well, sorry, the amount of money that you borrow, obviously through a loan that's secured against existing investments, right? So say, for example, I have $50,000 worth of shares and I really want to grow my portfolio and I want to start being a bit more savvy and strategic in building my wealth. I would go to a margin loan provider, normally through the online share trading accounts, and apply, for example, for a $50,000 margin loan.
And I would, assuming it's approved, I would have $50,000 to go and buy $50,000 worth of shares. So now my portfolio is worth $100,000 from a gross value point of view. Obviously, the net position is still $50,000 because I've got a $50,000 loan. And I would just take that out and invest it for long-term growth opportunities. And so the initial value of your portfolio was $50,000. And so you have borrowed that full amount again. Full amount, yes. Okay. All right.
A lot of questions coming off that for me, but why would someone use one?
Lots of reasons, but predominantly to be more efficient in building wealth and creating wealth. Obviously, you're borrowing money at a cost and expense to then try and get that money to grow at a faster rate than what you're paying. It's also a great tool for diversification. For example, I have had situations where clients had impressive portfolios, but it was mainly held in one particular stock. or just a couple of stocks. You know, particularly it was very common with employee share plans where they can't actually sell the stock necessarily because it's part of their contract. So this was a way of actually allowing us, you know, if they didn't have the cash flow or the cash flow was going elsewhere, to use the shares that they already owned as equity to borrow money and then go and invest in other assets to help diversify the portfolio and reduce risk as well as help and support their financial goals and risk profile.
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Chapters
6 chapters
1
What exactly is a margin loan and how does it work?
0:01–4:21
2
Why do investors use margin loans to grow their portfolios?
4:21–8:54
3
How does leverage amplify both gains and losses in a margin loan strategy?
8:54–13:19
4
What is a margin call and how can investors avoid being forced to sell shares?
13:19–18:14
5
Which investors should stay away from margin loans and why?
18:14–22:18
6
What five checklist questions should you answer before taking out a margin loan?
22:18–23:05