More and more banks are offering their custodian clients securities loans. The loans convince by an uncomplicated supply, low interest rates and any use. However, securities loans entail considerable risk. Many borrowers are underestimating the effect of the financial lever, which in the worst case reduces depot.

Stocks within a short period of time

Stocks within a short period of time

The last ten years have shown what is possible at the stock exchange. Even blue chip stocks can lose 50 percent of their value within a short period of time, when fear dominates the markets and fundamental dimensions are no longer relevant. Anyone who invests in the stock market during a crash with borrowed capital suffers shipwreck.

It is a simple arithmetic example. If an existing stock portfolio with a market value of 100,000 euros is 80 per cent invested, the depot owner can invest another 80,000 euros in the stock market. If the stock market drops by 20 percent in the next six months, the shares in the portfolio are still worth 144,000 euros. As a result of the loan taken out and the interim interest of 2400 Euro, 61.600 Euro remains.

Loan in six months

Loan in six months

A loss in the range of 20 percent within six months is by no means one of the extreme scenarios on the stock market of the 21st century. In the example above, the borrower contributes 38.4 percent of his assets. He would then have to achieve an annual return of 7.2 percent after tax (and actually after inflation) over a seven-year period to return to his original asset status.

It should, however, expressly pointed out that the financial levers can also work in the other direction. If, in the above example, the borrower remains in the market after the loss and gains 15 percent of profits in each of the two subsequent years, the loss suffered will no longer be significant. However, if a securities loan – as is often the case – is used for private purposes, this opportunity does not exist.

Investors should be aware of how the financial leverage works. You should also realize that the “extra leeway” that banks like to advertise can quickly be reversed if prices fall and the bank releases positions in the custody against the will of the investor.

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