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May 06 newsletterAdding rocket fuel to your investments
One of the great boons of residential property investment is leverage. By using the bank's money, many property investors have experienced substantial gains in their investments. Yet leverage can actually be the boon of a number of investment opportunities.
Apart from residential property investment, it is possible to leverage other investment options: I am specifically referring to shares. You are unlikely to get 100% financing, but you can certainly give a share portfolio a little rocket fuel.
The common approach is to use a specialist margin trading company, which is generally part of a stock broking company. The concept is similar to property investment, in which you put down a deposit and borrow the rest from the margin trading company. Your dividends are used to pay your interest. The amount you can borrow, which is generally around 50 to 70% of the investment, is based on the individual share or managed fund.
How it works
that margin trading is different to taking out an ordinary loan. However, the security on your loan is the share or managed fund investment. That is, you won't be putting the family home on the line. But you do have to keep a certain level of equity in your investment.
Let's look at a simple example, in which you have purchased an investment for $100, with $30 of your own money and $70 of borrowings. In this example, the maximum borrowings are 70% of the investment. If the investment falls to $95, the maximum that you can now borrow is $66.50 (70% of $95). You would be required to boost your equity, or reduce your loan, by $3.50 ($70 - $66.50).
What's the risk?
Is this form of investment risky? It is recommended by the Shape of Money as part of your overall investment portfolio rather than as just a single investment. Shares are subject to relatively higher levels of volatility than other investments and this volatility will be magnified by the levels of debt. This will obviously increase your potential return, but it will always increase the potential loss. The investment is for investors who have the capacity for greater levels of risk, for example investors who have good cash flows.
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