Borrowing to buy shares

Typically, when you buy a house, you borrow money and pay the bank back. Over time as the price of the house rises and you pay off your debt, the amount that you own increases. The same theory can be applied to investing in shares but there are various ways to use other people’s money to invest. Below will outline the advantages and disadvantages of each method.

Margin Lending

Using your existing shares as security, you can typically borrow up to 70%. For example, if you have a portfolio worth $30k, you can borrow $70k, so that your total portfolio is $100k. The advantage is that you can invest using other people’s money and the interest that you pay on the borrowed funds is tax deductible (assuming that you make a profit). The disadvantage is that you need an existing portfolio or cash to secure the loan, and the existing portfolio to be included in the security must consist of a certain type of stock, which is typically stable and established.

Also, if your portfolio loses value, to establish the same ratio of 70% borrowed funds and 30% security, you will need to deposit additional cash or shares. This increase in security is called a margin call. The problem with this type of gearing is that if you do not have additional cash or shares, the bank or stockbroking firm will require you to liquidate some of your existing portfolio to pay.

Some financial institutions and stock brokers, which provide margin lending, only allow you to purchase stable, less speculative stocks. Most Australian domestic banks have margin lending available. For more information on margin lending, E*Trade and Commsec have good information.

Using the equity in your home

This is effectively borrowing funds, using the equity in your home to secure the debt (assuming you own a sufficient portion of your house, even if it is mortgaged). The danger in this is that if you find your investments performing poorly, you may lose your house. Also, because debt multiplies your losses, this might not be a good idea when starting out.