Pros and Cons of Using Margin Loans in a Portfolio

So you’ve heard about tech founders and high-net investors using margin loans and are wondering if this strategy could work for you. It might. But like anything that uses leverage, it’s worth understanding what you’re getting into before you borrow against your portfolio.

Let’s walk through what a margin loan is, why you might use one, and where the risks are hiding.

What is a Margin Loan?

A margin loan is a type of borrowing that lets you use your investment portfolio as collateral to access cash without selling your assets — but it’s not without some risks. 

Whether you need extra money for a short-term financing need or buying more securities, a margin loan may help you get the money you need. With a margin loan, your brokerage lends you money based on the value of the securities you already own, typically up to 50% of your portfolio’s value. (Fidelity offers a pretty concise overview.) 

A margin loan strategy allows you to invest more or access liquidity without triggering capital gains taxes. However, if the value of your portfolio drops too much, you may face a margin call and be required to deposit more cash or sell assets to maintain your loan.

Pros of Using Margin Loans:

Used carefully, margin loans can be an effective tool. Here’s what makes them appealing for some investors:

• Leverage can increase returns if investments perform well.
• Quick access to liquidity without selling investments.
• No immediate tax consequences, unlike selling appreciated assets.
• Interest rates may be lower than those for personal or credit card loans.
• Flexible repayment schedule, as long as margin requirements are met.

If you’re a high-earning tech employee in Seattle with a diversified portfolio and a relatively high risk tolerance, this kind of short-term borrowing might fit into your broader financial strategy. But please, talk to your financial advisor first.

Cons of Using Margin Loans:

Of course, leverage works both ways. And in volatile markets or during economic downturns, a margin loan can quickly become a burden. 

Here are the main concerns:

• Magnifies losses if investments decline in value.
• Margin calls can force asset sales at inopportune times.
• Interest costs reduce net returns over time.
• Market volatility increases the risk of breaching margin requirements.
• Not suitable for all investors, especially those with low risk tolerance.

Our philosophy: Margin loans only work when rates are low. You need the margin rate to be below the long-term after-tax return of the portfolio. Further, the portfolio should not have any major liquidity needs. (If the market goes down and you need to withdraw cash, you’ll have to sell a lot of assets, potentially at a loss.) Also, you should never borrow anywhere close to the limit, especially when the collateral consists of volatile investments.

Talk to Your Financial Advisor About Margin Loans  

While margin loans offer a way to access capital without disrupting your portfolio, they’re far from risk-free. If you’re considering this strategy, make sure you understand the rules, the risks, and your repayment options.

At Northern Lights Advisors, we can help you determine whether a margin loan is suitable for your unique financial situation. We can also recommend alternatives that are better aligned with your goals, risk tolerance, and long-term strategy. Have questions? Schedule a consultation today.

Northern Lights Advisors is a fiduciary, fee-only Registered Investment Advisor (RIA) firm based in Seattle, Washington. The information in this article is not intended as tax, accounting, or legal advice. Read the full disclosure here.