When you invest in a stock, you typically expect to make returns in one or two ways: dividends and/or profit from appreciation when you sell. But whether you’re a long-term investor or seeking extra income in the short-term, you can enhance your portfolio with another option: fully paid securities lending.
What is fully paid securities lending?
Securities lending is a practice where you lend a stock or other security to a financial institution. It’s a strategy that can be used by both individual and institutional investors to enhance the revenue on your portfolio by allowing you to potentially earn income on securities that would otherwise sit idle.
How does fully paid securities lending work?
To participate in securities lending, like Ally Invest’s Securities Income Program, your portfolio may need to meet certain requirements. You’ll also have to sign a lending agreement — that’s a contract between you (the lender), the financial institution (the borrower), and typically an intermediary party known as the lending agent. It outlines factors like the terms and conditions of the borrow-and-loan transactions and which types of securities are eligible (typically stocks and exchange-traded funds, or ETFs). And it may specify if the securities are “fully paid for,” meaning that they’re fully owned by you, the investor, and not held in part by a broker.
In a securities lending program, the borrower (a financial institution like a bank or brokerage firm) will review your portfolio to determine which securities are eligible for borrowing. This is automatic, and your securities may be loaned out at any time — but you don’t have to choose which ones or when. The borrower makes the decision.
Keep in mind, though, if you’re participating in a lending program there’s no guarantee your securities will be borrowed (we’ll explain why later on).
When a security is loaned, the borrower must provide collateral for the loan in the form of the security’s cash value — this gives the investor protection in case the borrower defaults. So, while you’ll still see your security listed in your account, it will be replaced by cash for the duration of the loan.
Wondering where the extra income comes into play? While your shares are on loan, you’ll accrue daily interest, which you’ll receive as a payment to your account once a month. The interest rate is determined based on the demand in the lending market and value of the security.
Are there any downsides?
Participation in a fully paid securities lending program is generally hassle-free and won’t cost you any fees. But, as always when it comes to investing, it’s important to be aware of any potential drawbacks.
Typically, if you loan out a dividend-paying security, you’ll receive cash-in-lieu of your regular dividend payment. It’s important to be aware of this because dividend income is taxed at a different — and often lower — rate than your marginal tax rate. If this is a concern for you, you may consider consulting with your tax advisor before enrolling in a securities lending program.
When your shares are lent out, you also forfeit your proxy voting rights to the borrower. While this probably won’t be a big deal to most retail investors, it may be more of a concern to larger institutional investors.
The good news is that even when your shares are borrowed, you can still sell them at any time. The collateral will be returned to the borrower, and you’ll receive the proceeds from your sale as you usually would.
And as we mentioned earlier, even if you enroll your Self-Directed Trading Account in a securities lending program, your shares won’t necessarily be borrowed. Financial institutions borrow securities for a variety of reasons, often related to trading strategies like facilitating short sales. Typically, the securities that are borrowed are those that are harder to borrow due to a high demand and limited supply.
Itching to ramp up your investment returns? If you’re sitting on stock or ETF securities that you aren’t actively trading, fully paid securities lending could be an investment strategy to consider. It could add extra income to your portfolio — with virtually no effort on your part.
Ready to earn a little extra?