Explore the Lesser-Known Benefits of Borrowing on Margin

It is often surprising to find so few investors and financial professionals that are aware of the possibilities and advantages of borrowing on margin (a practice I will refer to here as “margin”). Some consider margin taboo, or do not have a clear understanding of benefits, risks, drawbacks or mechanics. This will discuss the basics of the margin process for those looking for new ideas to manage cash flow.

What is margin and what are the benefits?

Margin is the act of borrowing cash from a financial custodian by using current portfolio assets as collateral. The major benefits, if used responsibly and appropriately, are immediate liquidity, administrative simplicity, flexibility, and potential cost savings. Margin rates vary by custodian but are often lower than rates for mortgage or other bank loans, and may be further negotiated by advisory firms for their clients. Additionally, the Tax Cuts and Jobs Act of 2017 retained the margin interest expense deduction. This means that when following specific guidelines and uses, margin interest expense may be deducted against net investment income in certain circumstances. As always, please consult with your tax professional before proceeding.

Who are ideal candidates for margin?

Corporate executives, business owners, real estate developers, and other investors most often appreciate the flexibility, potential lower borrowing costs and tax savings. Margin may be best suited for those that have substantial collateral in a brokerage account and who wish to solve or bridge liquidity issues.

How much can be borrowed?

Margin capacity is calculated based on a percentage of the collateralized assets’ fair market value. A general rule-of-thumb for the amount of margin capacity is to use 50% as the loan-to-value ratio. In dollar terms, an account with $1 Million of assets as collateral could borrow a maximum of $500k. The loan-to-value ratio could vary by custodian and based on the type of asset being used as collateral. Using Charles Schwab as an example, the loan-to-value borrowing percentage differs based on whether the positions to be used as collateral are mutual funds, ETFs, individual bonds or stocks. Charles Schwab is also capable of aggregating assets across numerous accounts of the same registration for purposes of calculating margin capacity, with some exceptions.