Wednesday, June 15, 2016

Koon’s Investment Lesson #6: Margin Finance

Koon’s Investment Lesson #6: Margin Finance

Posted on June 8, 2016

In all business schools, MBA students are told that they would be considered inefficient if they trade with only their own capital. They must borrow money from banks to leverage their profit. As long as they can make more than the interest they have to pay, they should not be afraid to borrow. Also they must remember that 90% of the graduates failed in their first attempt in doing business if they did not partner someone with experience.

Similar to doing business, in share investing, unless you have a minimum of one year experience, you must not borrowing money to buy shares.

In Malaysia all the banks have a branch to promote share investment. They are currently offering margin finance at about 5% per year interest rate. You can borrow up to a maximum of 50% of the total collateral value of your holdings. For example, if you have say Rm 100,000, you can buy up to a maximum of Rm 200,000 worth of shares.

As you know, all share prices often fluctuate up or down. To avoid margin call you should not buy up to its maximum permitted limit.

If your selected shares continue to go up in price, you can borrow more money to buy some more shares because your collateral value has increased.

However, for some unforeseen reasons, your shares might drop more than you expected and you would have a margin call. You are given 3 day to top up with cash or shares. Do not top up with cash. If you do, you are retaining some not so good shares. The best thing to do is to sell some of the not so good shares to meet the margin call.

I know some investors prefer to sell the good shares and retain the bad ones. They do not like to recognize their mistakes and take the losses. They prefer to sell the good one.

In any case, you will not lose money even if you have to sell some shares to meet margin call because your average cost of your holdings should be lower than the price you are forced to sell. For example, if you have been following my advice in buying Latitude which had gone up from Rm1.00 to above Rm 8.00 within 24 months, your average cost would be about Rm 4.00. When the price drops suddenly for some unforeseen reasons and if you are required to sell, the price should be higher than your actual cost.

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