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What are margin calls and how can I reduce their likelihood?

I am interested in borrowing to buy shares to lower my tax but I am worried about margin calls after the stories of the GFC. What exactly are they and can you take out safeguards to reduce the likelihood of a call?

A margin calls happens when the value of your shares fall and that takes you out of the agreed loan-to-valuation ratio.

Say you had $100,000 worth of shares and you wanted to ramp up your portfolio. You might be able to borrow another $100,000 to buy shares, so your loan is $100,000 and your portfolio is worth $200,000, so your loan-to-valuation ratio (LVR) is one-half or 50 per cent. If the shares dive in value, this could push the LVR up to 60 per cent or 70 per cent and the bank would want you to bring the LVR back to 50 per cent and that’s why a margin call comes about.

You either have to put money in to reduce the loan or buy more shares to maintain the deal with the bank. Some people put in a buffer of cash out of the loan so they won’t face a margin call out of their own funds but it means being more conservative with your LVR.

Always work out what could happen if the portfolio fell by 20 per cent, 30 per cent, 40 per cent and even 50 per cent. Many people got caught out with the GFC as they did their sums on a 20 to 30 per cent slump but never imagined a 50 per cent whitewash!

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Thursday, March 03, 2011

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