Generally it is regarded that exceeding 50% margin is getting very risky...
We can minimize margin call risk by being selective, buying only stocks with high LVR ratio. When this is done correctly then 50% margin can be manageable.
How LVR works
I'll use Paladin Resources (PDN) as an illustration: At 40% LVR, Comsec will lend up to $0.40 for every $1.00 of stock value.
This means for every $0.60 of equity we can borrow $0.40, or, for every $1.00 of equity we can borrow $0.67.
The table will look like this:-
- At 40% LVR, for every $1.00 equity we can borrow $0.67
- At 60% LVR, for every $1.00 equity we can borrow $1.50
- At 70% LVR, for every $1.00 equity we can borrow $2.33
- At 75% LVR, for every $1.00 equity we can borrow $3.00
Important observation:-
1. Buy high LVR stocks to increase borrowing capacity
- By moving from 60% to 75% LVR stocks, the borrowing capacity is doubled (from $1.50 to $3.00)
- By moving from 70% to 75% LVR stocks, the borrowing capacity increases 28% (from $2.33 to $3.00)
- 75% LVR stocks include most major banks (CBA, SGB, NAB, WBC, ANZ), some insurance (AMP, QBE, SUN), some properties (SGP, GPT, WDC), some resources (BHP, RIO, WPL)
- 70% LVR stocks covers most stocks on the ASX 100
2. Avoid stocks with low LVR for the above reason
- I mostly trade 70% stocks and some 60% (like gold stocks NCM, LHG). 75% stocks are good for borrowing but tend to grow slower.
3. At time of stress, we can sell low LVR stocks first to increase the overall LVR ratio of the whole portfolio
- Another option is to swap low LVR with higher LVR stocks (to allow us buying more stocks for the same equity amount or to have a larger $ buffer until the margin call limit is hit)
Back to the question: Is an portfolio with 50% margin risky?
This depends on what stocks are held in the portfolio:
- If this portfolio consists of stocks averaging at 60% LVR, it can sustain 17% value drop to hit maximum LVR limit and be called at 23%
- At 70%, it can sustain 29% value drop and be called at 34%
- At 75%, it can sustain 33% value drop and be called at 38%
As a guide, the XAO dropped 13% over the 9/11 period and 9% over the May 2006 correction.
PS. All of this is of general discussion, not advice.
)
