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Investor Education > Margin Lending > Understanding the risks

UNDERSTANDING THE RISKS OF MARGIN LENDING

Although there are many advantages with gearing an investment portfolio, there are also risks. It is important to be aware that while margin lending has the potential to magnify capital gains, it also has the potential to magnify capital losses.

Your margin lender will apply a gearing ratio (or LVR) to each investment you hold in your margin lending portfolio which determines the amount you may borrow against that investment. As the value of investments can fluctuate, lenders will generally apply a buffer (usually 10%) to allow for market movement. When this buffer is breached, or if there are changes to the gearing ratios then you may exceed the maximum gearing ratio for the loan and receive a margin call.

The following examples from St George Margin Lending illustrate the effect of market changes on your investments
 

Assumptions
Client equity $30,000
Gearing ratio 70%
Amount borrowed $70,000
Borrowing limit $70,000
Portfolio market value $100,000
Amount borrowed as a % of market value 70%
Buffer 10%

Example 1: Effect of a 5% fall in the value of your portfolio. In this scenario the amount borrowed as a percentage of market value is above the gearing ratio but remains within the 10% buffer.



Within the buffer
Initial portfolio value $100,000
Current portfolio value $95,000
Gearing ratio 70%
Client equity $25,000
Amount borrowed $70,000
Borrowing limit $66,500
Amount borrowed as a % of market value 73.68%

Example 2: Effect of a 15% fall in the value of your portfolio. In this scenario, the market fall will trigger a margin call.



 

Margin call
Initial portfolio value $100,000
Current portfolio value $85,000
Gearing ratio 70%
Client equity $15,000
Amount borrowed $70,000
Borrowing limit $59,500
Amount borrowed as a % of market value 82.35%

A margin loan may not suit every investor and potential investors should understand the risks involved when considering gearing. Click here for more on managing margin calls and how to avoid them.

 

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