BERLIN – Though budgets are always where your financial strategy begins, they’re never where it ends. Unplanned expenses always manage to crop up somehow, and they can put your long-term goals at risk. Therefore, it’s crucial to have a flexible strategy for managing your debt as well as your assets. One source of help you may not realize you have is the borrowing power of your portfolio.
Using your assets as the basis for a margin loan gives you access to a virtually limitless menu of opportunities, and the degree of risk may not be as high as you think. The proceeds can be used for diversifying investment holdings, implementing hedging strategies or financing the exercise of stock options. The liquidity in a portfolio can also be used to acquire artwork and real estate or to cover emergency expenditures. Margin debt can also substitute for home equity loans.
“More and more investors are realizing that margin borrowing remains a convenient way to achieve a number of financial goals without disrupting a long-term investment strategy or triggering a taxable event,” said Jim Gildea, Vice President with Merrill Lynch’s Global Securities Based Lending Group.
So how do margin loans work? Margin loans are collateralized by the securities held in an investment account. Unlike traditional bank loans, they do not require an application or special fees, and the funds are made available immediately. For those with large portfolios, the interest rates can be significantly lower than those on standard bank loans.
Traditionally, margin loans have been used most often in connection with investing — often purchasing securities either to reduce the borrower’s cash outlay or to increase the amount of securities purchased and, in turn, the potential return on investment. However, in recent years, as investors are discovering how versatile this form of loan can be, more and more of them are taking advantage of margin.
Today, 67 percent of the Merrill Lynch clients who use margin do so for temporary and noninvestment reasons, such as tuition and home renovations. Margin can be employed for something as simple as protection from overdraft charges. Consider this: Anyone who charges, wires, journals or writes a check for an amount greater than the credit balance in a bank checking account or a brokerage firm cash account will incur overdraft charges — in addition to a per-incident fee, depending on the financial institution. With a margin account, there are no additional fees and no repayment schedule.
Borrowing on margin does involve additional risk, but the degree of added risk depends on how the proceeds are used. Using a margin loan to purchase securities, for example, exposes an investor to a higher degree of risk than paying for home repairs. That’s because newly purchased securities may decline in value, requiring additional funds in a margin account or the forced sale of the securities.
Even if you’re borrowing on margin for noninvestment purposes, it’s still worth noting that the securities you use as collateral are subject to market fluctuations. You can reduce risk by borrowing less than the maximum amount available, maintaining a well-diversified portfolio and weighting the stock portion of your portfolio toward high-quality equities while holding investment-grade debt securities.
“As long as the risks are managed, leveraging the power of the eligible securities in a portfolio can simplify investors’ access to funds, enhance their financial strategy and get them closer to their goals,” Gildea says.
(The writer is a Merrill Lynch Senior Financial Advisor. She can be reached at 410-213-9084.)