In my regular scanning of the financial media I have come across an interesting piece published on the Money Management website - Follow the money to the margin lending scandal - written by Paul Resnik and peter Worcester. It is timely in that I am certain there are a number of more aggressive investors contemplating whether now is the time to be jumping into a margin loan.
The authors have taken a look at the previous 28 years of data on the Australian share market to see whether investors have been rewarded for taking on the extra risk of utilising a margin lending strategy. Their conclusions:
"We think it is reasonable to expect rolling five-year returns of at least 5 per cent after tax to compensate for the risks of using a margin loan to purchase shares, but our data shows this outcome is not even close to being achieved on a regular basis in one of the best bull market runs in history.
Margin lending looks to be a gambler's strategy. With a less than one in four shot of success, it cannot be considered an investment strategy.
We would argue that the vast majority of investors are not natural margin lending clients. Our understanding of financial risk tolerance suggests that the majority of investors would be more comfortable with a more balanced portfolio.
At the very least, before taking on a margin loan, investors must have the risks properly explained to them so they can actively and consciously decide to take on those risks. Going forward this would be a minimum obligation for both direct and advised margin lending clients.
It's time for the education on the benefits and risks of margin lending to be independently delivered."
Our firm's approach is that investors should indeed be careful in using debt in order to build wealth, especially margin loans. The key question to be asking is whether you need to take on debt to reach your financial goals. If it is, then it is this firm's position that if an investors wants to use debt to build wealth they do so prudently, with low loan to value ratios and using debt with lower interest rates such as home equity loans or the like and loans with less devastating potential impacts than those provided by a margin loan. We have all seen evidence of hte potentialdevastation throughout 2008 and the beginning of 2009.
PS - The same article was published in Alan Kohler's Eureka Report on the 16th April 2009.