Borrowing to invest in shares can accelerate wealth building. If your investments return more than the cost of the loan, gearing magnifies the gain. But it magnifies losses in exactly the same way, and in a sharp market fall a geared investor can be forced to sell at the worst possible time.
Most of the damage done by borrowing to invest does not come from the market falling. Markets have always recovered from falls over time. It comes from investors who did not understand how their loan worked, how close they were to a margin call, or what they would do if one arrived.
This guide explains how margin loans and other investment loans work in Australia, how loan to value ratios and margin calls operate, what goes wrong, and how to borrow in a way that survives a downturn. It focuses on the mechanics and risks, rather than the tax treatment of investment interest.
Borrowing to buy shares at a glance
Australian investors typically borrow to buy shares in one of three ways. The table below compares them.
| Margin loan | Home equity investment loan | Internally geared fund | |
|---|---|---|---|
| What secures the loan | The shares and managed funds you buy | Your home or other property | The fund borrows, not you |
| Margin calls? | Yes, if the portfolio falls far enough | No, while repayments are met | No personal margin calls |
| Typical interest cost | Higher than home loan rates | Usually close to home loan rates | Built into the fund, alongside management fees |
| What you can lose | Your equity in the portfolio, and potentially more if a shortfall remains after a forced sale | Your equity, plus your home is security if you cannot repay | Your investment in the fund |
| Forced selling risk | High in a sharp fall | Low, unless you cannot meet repayments | The fund may sell internally, but you are not called on for cash |
| Flexibility | High, borrow and repay as you go | Depends on the loan structure | Limited to the fund’s strategy |
| Typically suits | Experienced investors with cash reserves to meet calls | Homeowners with equity and stable income | Investors wanting gearing without managing a loan |
Each approach trades one risk for another. A margin loan avoids putting your home on the line but brings margin calls. A home equity loan avoids margin calls but puts your home behind the debt.
How gearing magnifies returns and losses
Gearing simply means investing with borrowed money as well as your own. Its effect is easiest to see with numbers.
Suppose you invest $50,000 of your own money and borrow another $50,000, buying a $100,000 share portfolio.
- If the portfolio rises 20% to $120,000, your equity grows from $50,000 to $70,000, a 40% gain before interest.
- If the portfolio falls 20% to $80,000, your equity falls from $50,000 to $30,000, a 40% loss.
- If the portfolio falls 50% to $50,000, your equity is gone entirely, while the full $50,000 loan remains.
Interest has to be paid in every scenario. That means the portfolio must return more than the loan’s interest cost just to break even, and in a flat or falling market, gearing adds losses rather than gains.
Over long periods, diversified share portfolios have generally returned more than the cost of borrowing. Over short periods, they can fall by a third or more. Our guide on what happens to shares during a market crash shows how deep and how quick those falls can be. Gearing works only if you can hold on through them.
How a margin loan works
A margin loan is a loan from a specialist lender, secured against the shares, ETFs and managed funds you buy with it. You contribute some of your own money or existing investments, the lender provides the rest, and the portfolio is held as security.
Approved securities and lending ratios
Lenders only accept certain investments as security, known as approved securities. Each one is assigned a lending ratio, which is the maximum percentage of its value the lender will lend against.
Large, well-diversified investments attract higher lending ratios. A broad Australian share ETF or a large listed company might carry a lending ratio of 70% or more. Smaller companies attract lower ratios, and speculative or illiquid investments may not be accepted at all. Your portfolio’s overall maximum loan to value ratio (LVR) is a weighted average of the lending ratios of everything you hold.
This is one reason diversification matters even more in a geared portfolio. A concentrated portfolio of a few stocks usually supports less borrowing than a diversified ETF portfolio, and it is more exposed to a sharp fall in a single holding. Our guide comparing ETFs and individual shares covers that trade-off.
Your current LVR
Your current LVR is your loan balance divided by the value of your portfolio. If you owe $50,000 against a $100,000 portfolio, your LVR is 50%.
Your LVR changes every trading day, even if you do nothing. If the portfolio falls in value, your LVR rises. If interest is added to the loan rather than paid, your LVR rises. If you withdraw cash or buy more on credit, your LVR rises.
The buffer
Most lenders allow your LVR to drift slightly above your maximum before taking action. This allowance, usually around 5 percentage points, is called the buffer. While you are inside the buffer, you cannot borrow more, but you will not face a margin call. Once your LVR moves above the maximum plus the buffer, a margin call is triggered.
What is a margin call?
A margin call is a requirement from your lender to bring your LVR back down to your maximum. It is triggered when the value of your portfolio falls far enough that the loan is no longer adequately secured.
How far does the market have to fall?
The answer depends on how heavily you are geared. The table below assumes a portfolio with a maximum LVR of 70% and a 5% buffer, so a margin call is triggered at an LVR of 75%.
| Starting LVR | Fall that triggers a margin call |
|---|---|
| 30% | 60% |
| 40% | 47% |
| 50% | 33% |
| 60% | 20% |
| 70% | 7% |
An investor geared at 70% can receive a margin call after a fall that happens in an ordinary bad week. An investor geared at 30% would only face one in a severe, prolonged crash. This single table explains most of the difference between borrowing that survives a downturn and borrowing that does not.
The figures are illustrative and assume the lending ratios stay the same, interest is paid rather than added to the loan, and all investments fall by the same amount. In practice, any of those assumptions can fail.
How a margin call can be met
When a margin call is made, you generally have three options:
- Deposit cash to reduce the loan balance.
- Add approved securities you already own to increase the value of the security.
- Sell part of the portfolio and use the proceeds to reduce the loan.
The difference between these options is larger than most investors expect. Continuing the earlier example, suppose the $100,000 portfolio falls to $60,000 with a $50,000 loan outstanding, an LVR of about 83%. To restore the LVR to 70%:
- By depositing cash, you would need about $8,000, reducing the loan to $42,000.
- By selling investments, you would need to sell about $26,700 of shares, because every dollar sold reduces both the loan and the portfolio value.
Meeting a call by selling means crystallising losses on more than three times as much of the portfolio, at a time when prices are already low. This is why a cash reserve is the most important safeguard a margin lending investor can hold.
How quickly you need to act
Lenders typically require a margin call to be met within a short window, commonly by a set time on the next business day. The exact timeframe is set out in your loan agreement. You are responsible for being contactable, and for knowing which phone number and email address the lender will use. Missing a notification while travelling or unwell does not stop the clock.
What happens if you cannot meet it
If a margin call is not met in time, the lender can sell investments in your portfolio without further consent, choosing what to sell and when. Forced sales typically happen in falling markets, often at poor prices. If the proceeds do not cover what is owed, you remain liable for the shortfall.
Other things that can trigger a margin call
Market falls are the obvious cause, but not the only one.
The lender cuts a lending ratio. Lenders can reduce the lending ratio on a security at any time, for example after a company reports poor results or becomes more volatile. Your LVR can jump overnight without any change in price.
Interest is capitalised. Adding interest to the loan instead of paying it steadily raises the balance and pushes your LVR higher.
One holding falls sharply. A concentrated position in a single stock can trigger a call even when the broader market is steady.
Approved status is removed. If a security is removed from the approved list, its lending value can drop to zero.
Investment loans secured against property
Many Australians borrow to invest in shares using equity in their home, through a separate loan split or line of credit. This is also the structure used in debt recycling.
Because the loan is secured against property rather than the shares, there are no margin calls. A market fall does not force you to sell. That is a significant advantage, and it is why many advisers prefer this structure for long-term gearing.
But the risk has moved, not disappeared. If the portfolio falls and your income stops, the loan still has to be repaid, and your home is the security. There is no automatic mechanism that tells you when the position has become dangerous, so discipline has to come from you rather than the lender. If you are weighing borrowing against simply reducing your mortgage, our guide on whether to pay off your mortgage or invest covers that decision.
What can go wrong
The global financial crisis offered a painful lesson. As markets fell more than 50% from their peak in 2007 to 2009, many Australian investors who had geared heavily, in some cases combining home equity loans with margin loans on top, faced repeated margin calls and lost both their portfolios and, for some, their homes. The collapse of Storm Financial in 2009 became the most prominent example and led to margin lending being brought under specific regulation from 2010, including responsible lending obligations for margin lenders.
The common patterns behind geared investing going wrong are consistent:
Gearing too high. Borrowing close to the maximum LVR leaves no room for a normal market fall.
No cash reserve. Investors with no cash to meet a call have only one option, which is to sell, and selling at low prices locks in losses.
Concentration. A geared portfolio in a handful of stocks or one sector is exposed to sharp falls that a diversified portfolio would absorb.
Income risk ignored. Interest has to be paid whether or not you are working. Redundancy, illness or a business downturn can turn a manageable loan into a forced sale.
Panic. Even investors with no margin call sometimes sell in a fall because borrowed losses feel heavier than losses on their own money. Our article on why investors make emotional decisions explains why that instinct is so strong.
Warren Buffett has long warned that leverage is one of the few ways a smart investor can be ruined, because it can force you out of good investments before they recover. Our article on Warren Buffett’s timeless lessons covers that principle.
How to borrow to invest more safely
None of the following removes the risk of gearing, but each one improves the odds of getting through a downturn without being forced to sell.
Keep your LVR well below the maximum. Many advisers suggest gearing at no more than 30% to 50%, even where the lender would allow more. The table above shows why that headroom matters.
Hold a cash reserve for margin calls. Keep money in a separate account, outside the strategy, that could meet a call in a severe fall without selling. A margin call met with cash costs far less of your portfolio than one met by selling.
Diversify. Broad, low-cost funds and ETFs reduce the chance that a single holding drags the whole portfolio into a call. Our comparison of managed funds and ETFs may help.
Pay interest as you go. Paying interest from your income keeps the loan balance stable and stops your LVR creeping upward.
Gear in gradually. Investing borrowed money in stages rather than all at once reduces the risk of borrowing heavily just before a fall. Our guide on lump sum investing versus dollar cost averaging discusses the same timing question.
Monitor your position. Check your LVR regularly, set up alerts if your lender offers them, and keep your contact details current.
Have a plan before you need it. Decide in advance what you would do at an LVR of 60%, 70% and in a margin call. Decisions made in a falling market, under time pressure, are rarely good ones. Our guide on how to stay invested during volatility covers the behavioural side.
Who borrowing to invest suits
Gearing into shares generally suits investors who have a long investment horizon of at least seven to ten years, stable and secure income, a cash reserve held outside the strategy, a genuine tolerance for watching borrowed investments fall in value, and a diversified portfolio rather than a few concentrated bets. It is generally less suitable for people near or in retirement, those with variable income, anyone who would need to sell investments to meet living costs, and investors who have not yet experienced a major market fall with their own money.
Gearing is also a portfolio decision, not just a loan decision. It increases your effective exposure to growth assets, so it should be considered alongside your overall asset allocation. The tax treatment of investment loan interest is a separate question, covered in our guide to tax on investments.
Where professional advice adds value
Borrowing to invest is one of the few strategies where the cost of getting the structure wrong can exceed the benefit of getting it right. The choice between a margin loan and a property-secured loan, the right level of gearing, the size of the cash reserve, and how the strategy fits with your income, insurance and timeframe all need to be worked through before the first dollar is borrowed.
A financial adviser can stress test a geared strategy against realistic market falls, help you decide whether gearing suits you at all, and build a portfolio designed to be held through a downturn rather than sold in one. Gearing should sit inside a complete investment portfolio plan, not be added to one as an afterthought.
If you are considering borrowing to invest, or already hold a margin loan and want a second view on your position, our investment advice and portfolio structuring team in Adelaide can help. You can also read more about how Money Path approaches investment strategy.
Frequently asked questions
What is a margin call?
A margin call is a requirement from your margin lender to reduce your loan to value ratio back to the permitted maximum. It is triggered when your LVR rises above the maximum plus the buffer, usually because the value of your portfolio has fallen. You can generally meet it by depositing cash, adding approved securities, or selling part of the portfolio.
How long do I have to meet a margin call?
The timeframe is set by your loan agreement and is usually short, commonly by a set time on the next business day. You are responsible for being contactable through the details you have given the lender. If the call is not met in time, the lender can sell investments without further notice.
What happens if I cannot meet a margin call?
The lender can sell some or all of your portfolio to reduce the loan, choosing what to sell and when. Forced sales usually happen in falling markets at poor prices. If the proceeds do not cover the amount owed, you remain responsible for the shortfall.
Can my lender change the LVR on my shares?
Yes. Lenders can reduce the lending ratio on any approved security at any time, or remove it from the approved list. A cut can increase your LVR overnight and trigger a margin call even if share prices have not moved.
Can I lose more than I invested with a margin loan?
Yes. If your portfolio falls far enough and is sold for less than the amount owed, you still owe the lender the difference. In a severe and rapid fall, losses can exceed your original equity.
Is a margin loan or a home equity loan better for buying shares?
Neither is better in every case. A home equity loan usually has a lower interest rate and no margin calls, so you are not forced to sell in a downturn, but your home is security for the debt. A margin loan keeps your home separate but brings margin call risk. The right choice depends on your equity, income stability, cash reserves and tolerance for risk.
What is a safe level of gearing?
There is no level that is risk free. A lower LVR gives far more room to absorb a market fall before a margin call. At a 30% LVR, a portfolio with a 75% call trigger would need to fall about 60% before a call, while at 60% it would only need to fall about 20%. Many advisers suggest staying well below the lender’s maximum and holding cash in reserve.
General advice warning. This article contains general information only and does not take into account your objectives, financial situation or needs. It is not a recommendation to borrow or to invest in any financial product. Borrowing to invest is a high-risk strategy that magnifies losses as well as gains, and you can lose more than your initial investment. Examples are illustrative only and based on simplified assumptions. Loan terms, lending ratios, buffers and margin call timeframes vary between lenders and can change. You should read the relevant loan documents, consider whether the information is appropriate for you and seek personal financial advice before acting on any of it. Money Path Pty Ltd is a Corporate Authorised Representative (No. 001306822) of Australia National Investment Group, AFSL 522028.
