This issue’s Back to Basics looks at a range of investment products which you can use to assist your tax planning and how they can also help you with your investment goals.

There has been a lot of press on margin lending recently. With the recent falls in the market forcing lenders to make margin calls many investors are reconsidering who they use for their margin lending. We look at what margin lending is, how you can use this as part of a tax effective investment strategy and how to make sure you don’t get caught out with a margin call.

Investment offer

As an investment discount broker working on behalf of a large number of clients, we can in most cases, reduce the rates offered on margin loans. If you have an existing loan or are looking at a new loan, just call us on 1300 55 98 69 to see how we can reduce your interest rates.

Margin Lending (Borrowing to invest)

One of my many criticisms of the financial services industry is the terminology. Alienating investors with jargon means that they are less likely to invest in financial products and leave their savings sitting lazily in a bank account. The term “Margin Lending” has to be up there as one of the least descriptive phrases in the industry.

If you are not already familiar with the term, Margin Loans are loans for investment purposes, ie you borrow to invest. The term ‘margin’ is a financial term for collateral/security a loan provider requires in order to ensure that their money is covered by some security.

The principal is the same as investing in your own home. Margin loans allow you to purchase managed funds or shares and only put down a percentage of the purchase price and borrow the rest from a margin lender.

Why use a margin loan?

Similar to when you buy a house, by borrowing to invest, a margin loan allows you to buy a much larger portfolio of funds and shares than you would otherwise be able to.

Benefits include:

Increasing your income & growth – By far the biggest attraction to margin lending is by doubling or trebling the size of your investments you benefit from a doubling or trebling of the growth and income of your portfolio.
Diversifying your portfolio – For investors with smaller investment portfolios that are unable to diversify across a wide range of shares and funds, raising additional funds for investment canreduce the overall risk of your portfolio by spreading the risk across a range of additional investments.

Low interest rates – Margin loans are secured on your portfolio and as a result interest rates are typically lower than those of a personal loan alternative. As a result, investors with an existing portfolio of investments can find them an attractive alternative to unsecured personal loans.

Tax benefits – Unlike interest payments on a personal loan, interest payments made on your margin loan are tax deductible and offer a range of interest payment options such as annually in advanced or monthly in arrears.

Risks:

Whilst doubling or trebling the size of your investment portfolio has the potential to increase your gains it also has the potential to increase your losses.

Using a margin loan as part of a tax effective strategy
A simple way of looking at a margin loan is that if you are borrowing at a certain rate, say 10%, as a top rate taxpayer, you are able to claim a 46.5% deduction, giving you an effective loan rate of 5.35% (effective rate of 7% for 31.5% taxpayers). Since capital gains on investments held for more than 12 months are reduced by 50%, investors only need to return of 7.68% pa (8.43%pa for 31.5% taxpayers) for this strategy to grow their wealth.

However, if you’re a conservative investor or don’t feel that you can achieve these returns, margin lending is likely to end up costing you money.