Ask An Advisor

Hello and welcome back to Ask An Advisor.

With the goal of owning a home becoming more and more challenging for many Australians we often get asked about using leverage in the stock market as an alternative way to accelerate building wealth.

While it’s certainly not for everyone, we wanted to put the idea to one of our advisors to get their thoughts.

Have a great day!

- Bryce and Alec (Ren)

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The week’s question

“Is leverage in the stock market a good idea? How can I do it?”

- Ian, NSW

This week’s advice

This week’s advisor is Ellie Fordham, from Verse Wealth. Here’s what she said in response to Ian’s question:

Using leverage can accelerate growth in any investment strategy, and the most popular way to do this in Australia is investing in property.  Leverage provides scale in the market which can assist with increasing investment returns.  It’s also popular in Australia as using debt to purchase income producing assets can provide you with a tax deduction on interest costs.

Investing in property provides easier access to debt (usually via a bank), because the bank will use the security of the property to provide the loan, however it requires a bigger deposit (usually 20% of the purchase price).  

You can use a much smaller deposit to utilise debt and invest in the stock market, and it also allows you to manage the amount of debt you take on.  In comparison when you are investing into property the purchase price of the market will determine the deposit you need and therefore the debt you take on. 

However, using leverage to invest into the stock market is not for everyone. It significantly amplifies the risk you are taking on. Given the volatility associated with the stock market, investing in these assets combined with debt requires you to have a long-term investment strategy, as unwinding the strategy can magnify losses. It is vital that you have sufficient income to continue to fund loan costs throughout the strategy.  

How to do it

It’s not as common to access debt to invest into the stock market, but there are a number of ways you can do it.  There are many geared ETF’s and managed funds available which allow you to access the benefits of leveraged investments, without having to manage the loan yourself.  The fund manager takes on the debt, makes the investments and funds the interest costs, which are all deducted from your returns.  

Margin lending has in the past been a popular tool for borrowing to invest but also comes with its own risks.  This allows you to utilise your existing investments as security to take out a loan and purchase more investments, but there is a limit of how much you can borrow, known as the loan to value ratio (LVR).  This is often set at 70%. If your share portfolio drops in value, this causes the loan to value ratio to increase (for example to 80%) and the difference (or the margin) needs to be made up – either through paying down debt or increasing your security (stocks).  

The use of debt in any investment strategy always needs to be evaluated in line with your personal financial objectives, investment time frame and exposure to risk.  Leverage in stock markets can be a very useful tool to grow wealth but can unwind many years of investment strategy when not managed correctly. 

You can listen to our recent Ask An Advisor episode with Ellie here

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About Ellie Fordham

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