A history lesson in margin lending

Robin Bowerman, Head of Retail at Vanguard Investments Australia.
Robin Bowerman, Head of Retail at Vanguard Investments Australia.

THE recent intense sharemarket volatility will no doubt dampen the immediate appetite of investors for margin loans.

Interestingly, the Reserve Bank's latest margin-lending statistics show that the total debt for these loans had already dipped a little from $19.23 billion at December 31 to $19.17 billion by the end of March.

And the number of investors with margin loans had fallen by 11,000 over this three-month period. It seems that the downside of excessive borrowing to invest - as starkly illustrated during the bear market and by the collapse of Storm Financial, in particular - fortunately remains fresh in the minds of Australian investors.

The ever-changing amounts outstanding in margin loans and the number of margin loan borrowers have long provided a sometimes fascinating and nearly always lagging reflection of investor sentiment.

As Smart Investing has previously discussed, the margin lending debt reached an all-time high of $38 billion in December 2007. Then the debt progressively fell to a long-time low of $18.7 billion by March 31 last year, ironically, the month when the market began to fire back into life.

The number of investors with margin loans peaked at 206,000 in March 2008 and then progressively fell to 189,000 by March last year - the lowest number over the past 33 months. And one more statistic from the Reserve Bank vaults. The number of margin calls hit an all-time high of almost 10 a day for every 1000 borrowers in the December quarter of 2009.

What is the significance of this history lesson in margin loans? In short, plenty. Looking back over these margin loan statistics highlights how over-exuberance in the market can get investors into much trouble at times when the market may seem to be going only onwards and upwards.

Keep this in mind when the prevailing bout of extreme volatility has run its course. An investor should never forget that borrowing to invest can magnify both gains and losses.

Robin Bowerman, Vanguard Investments Australia's Head of Retail, has more than two decades of experience in the finance industry as a writer, commentator and editor.

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