A margin call occurs when you no longer own enough of the investment to keep the lender confident they’ll get their money back. If you receive a margin call you are asked to either:
- Add more security for the loan – this can be cash or other approved investments
- Reduce the loan balance – either through cash or by selling some of the investment
Neither of those remedies can be particularly pleasant so when you have a margin loan it is important to understand how much your portfolio value can fall before you receive a margin call.
The formula for calculating the percentage fall to trigger a margin call is shown below:
LVR stands for Loan to Value Ratio. It is calculated based on the amount you owe (the loan) divided by the total value of the security (the investment). For example an $80,000 loan against a $100,000 investment has a LVR of 80%.
The abbreviation in the margin call formula are:
- Base LVR% = maximum allowed LVR% based on the quality of the lodged security (the investments)
- Current LVR% = your loan ÷ your current portfolio value
- Buffer% = the allowed buffer before triggering a margin call
Generally lenders won’t call you as soon as your Current LVR hits the Base LVR. Since the investments often fluctuate in value daily they give you a bit of leeway – know as a buffer. Many lenders give you a buffer of 5% but some have a buffer up to 10%.
For example if your Base LVR is 75% and the lender’s buffer is 5% they will call you when your Current LVR hits 80%.
Below is an example calculation of how much your portfolio needs to fall to trigger a margin call. The parameters in the calculation are:
- Base LVR% = 75%
- Current LVR% = 50%
- Buffer% = 5%
If you choose to gear conservatively (at 50%) against quality assets with an allowed LVR of 75% (base) then your portfolio value can fall 37.5% before you trigger a margin call. That has happened but it is rare, which should give you confidence to consider margin lending.
If you can’t be bothered doing the calculation the following table gives you some examples of the percentage fall required. Note the buffer in this table is 10%. (Source: Leveraged Equities.)
From the above table you can see that when your buffer is 10% rather than 5% in the earlier example then for a current LVR of 50% and base LVR of 75% then your portfolio can fall by 41% before a margin call is triggered.