ASIC’s announcement of its intention to instigate multiple legal proceedings involving the failed financial planning group Storm Financial will have a much wider impact than those involved in the actions and the many unfortunate Storm investors.
First, ASIC’s notice of an intention to begin legal action is a clear reminder that the Storm nightmare still has a long way to run despite being out of the headlines for a few months.
Second, it should serve as yet another reminder to investors about the dangers of borrowing to the limit to invest. (In fact, many Storm Financial investors had practised double-gearing by borrowing heavily against their homes to buy shares and then borrowing against those shares to the limit using margin loans.)
Third, the intended legal action may serve as a reminder that the Government has set in place new laws to crackdown on certain margin-lending practices that came to a head during the GFC and its aftermath.
This crackdown includes a provision that advisers and providers of margin-lending services to individual clients must hold appropriate licences. And from January next year, advisers must only provide margin-lending advice that is appropriate for a client’s circumstances.
Smart Investing always keeps a close watch on how the Reserve Bank’s quarterly margin-lending statistics are changing.
Since the amount outstanding in margin loans reached an all-time high of $37.8 billion in December 2007, the money owed has steadily been wound back to $17.8 billion this September (the latest figure available) – the lowest total debt since March 2005.
This trend in margin-lending borrowing shows that investors are generally being more cautious in their borrowing.
But sadly, lessons about the extreme dangers of borrowing too much to invest are typically soon forgotten by many investors or are never learned by new batches of investors before experiencing a severe financial setback.
Borrowing to invest is, of course, a standard and much-accepted investment strategy, but investors should fully understand the potential downside – not only the potential upside. This understanding should help keep their borrowing at a reasonable level and within their personal tolerance to risk.
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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.