Step 5: Power investing
Just as a property investor puts down a deposit on a house and borrows the rest, investors can buy a portfolio of shares with as little as a 20 per cent deposit by taking out a margin loan or borrowing against the equity in their home.
The theory is that the bigger the portfolio, the bigger the potential investment return. Of course, the flip side is that any losses are also magnified.
And with margin lending, once the value of the shares in the portfolio falls below a certain point, a margin call will be made requiring the borrower to restore their loan-to-valuation level (or the percentage you've been allowed to borrow) – generally within 24 hours.
Borrowers can do this in one of three ways: by coming up with more cash, by selling some shares (and if margin calls are being made it's probably not a great time to sell) or by contributing additional shares to top up their equity.
Fail to act and the lender may invoke their right to sell shares without consulting you.
That's why it pays to borrow conservatively – say, for only half the shares in the portfolio (50 per cent gearing) – and to regularly review your ability to meet interest payments and any margin calls.
Beyond shares, there are any number of other ways to attempt to get more out of your equities investments, such as options, warrants, futures and contracts for difference.
The Australian sharemarket represents just 2 per cent of the value of global sharemarkets, so if you want to have a truly diversified portfolio you'll need some exposure to overseas markets, either by purchasing foreign stocks through your broker or investing in a global equities fund.
When it comes to direct investment, though, you need to consider that it's harder to make well-informed choices about listed companies operating on the other side of the world than about businesses at home.
And then there's the currency risk: a change in exchange rates affects the value of your investment returns in Australian dollars – sometimes for the better, sometimes for the worse.
If the Australian dollar strengthens against the US dollar, for instance, your US-dollar investment returns will be worth less when converted into the local currency.
Perhaps the easiest way to invest overseas is through managed funds. Fund managers specialising in international equities should have better research on individual stocks and can tap into expertise in 'hedging' the currency risk.
Speculative investments should only be made with money you don't mind losing and should never amount to more than about 10 per cent of your total portfolio.
When considering a margin loan, think about:
- Your ability to service the loan
- Your ability to meet a margin call
- How diversified your portfolio is
- What assets you have in reserve
- What level of gearing you are comfortable with
- How high your marginal tax rate is