Recently, I opened a margin financing account with my stockbroking company, on top of my normal trading account with them. Before I opened this account, I did some research and identified a few benefits for me. Thought I will share it here with you in case you see the same benefits and opportunities …
In a nutshell, a margin financing account is like having a credit line provided by stockbroking firm to us to finance the purchase of securities/stocks. However, we will have to pledge either cash and/or “marginable” securities as collateral. Take for example, Maybank Kim Eng, from its website, through this means, we can get financing of up to 3.5 times the amount of cash pledged, or up to 2.5 times the amount of securities pledged. Hence, we are technically borrowing money to invest to get a higher yield => “blink” “blink” => its HIGH RISK !!!!
The approach is quite similar (though not the same) from you loaning money from the bank to invest in a second property to earn rental income or the REITs as we are familiar with.
What is different with margin financing account that makes it high risk is that we are using the money to purchase shares which can go down unexpectedly and even swiftly based on Mr Market’s mood of the day, changes in the company financials or leadership or even just pure rumors. I am sure those of you who have a long experience in the stock market would have known of companies share price that just collapsed overnight.
The issue is when the market collapses, the value of the shares dropped. Based on the agreement we have with the stockbroking firm, it will only lend us up to a certain ratio, like 2.5 times of the total value of securities pledged mentioned above. When the value of our shares drops, the “available” loan to us will also reduce. If we have already maxed the loan, then the stockbroking company will ask us to top up cash to make up the difference or if we cannot cough up the cash, they will sell our shares at market shares …. remember at that point, the market is collapsing so the price is lousy! I am sure some of you would have heard of “margin calls”. It is no fun at all if you are in that situation. Hence, in my opinion, don’t over stretched yourself in financing, don’t max out your margin financing … make sure your loan quantum is such that you are comfortable to repay partially or (best) fully as and when the emergency need arises.
The risk aside, margin financing is useful as a credit line. As and when you need it, you can call upon it to purchase shares that you feel are undervalued for no reasons and/or for a small speculative punt. That is my purpose for opening the account – to get ready for a sharp downturn and swoop some shares at low price.
The interest rate offered by stockbroking firms differs. For the one I am having, I am charged 2.88% per year. My plan is to use it to purchase Reits or high dividend stocks.
To illustrate, say I place $10,000 cash with the stockbroking company
The total available margin financing is $35,000
I use it to purchase Singtel at $3.12/share. I will get 11,200 Singtel shares.
Assuming current dividend rate of $0.175/share , I will get $1,960 worth of dividends.
The interest I have to pay at 2.88% is $720. Nett income will be $1240
If I don’t have the margin account, I can only purchase 3,200 Singtel shares. My gain will be $560. By leveraging, I will double my income with the same amount of capital ….
BUT again, warning its HIGH RISK!!
Shares price is not likely to stay constant. If Singtel share price drops overnight to $3/share (not unthinkable right), the total value of Singtel share is only worth $33,600.
The stockbroking company that I use has this margin ratio of (total value)/(amount of loan) and it must be > 140%.
Hence, in this hypothetical case, the margin ratio = 33,600/25000 = 134%. The stockbroking company would immediate call me to top up the margin. Scary right?
But in this case, it is extreme because I technically borrow to the max and therefore, a minor drop in share price will have already triggered the margin call. Therefore, always remember don’t over-stretched yourself … and by the same token, you won’t maximise your profit … so, its back to the same rule => high risk high return.
No harm getting an account to ready for opportunities that may appear suddenly but just remember to exercise prudence when you put it to use. If used wisely, margin financing can help to increase your return. For my case, I will use it to buy blue chips with stable dividend income – lower my risk.
Hope you find this useful.