WHEN INVESTORS LEND their shares to a broker, they can receive more income over time.
Loaning a stock or another asset such as an exchange-traded fund to a brokerage firm can yield investors more income passively. Securities lending is common, and these share lending programs are usually conducted by brokerages. The brokerage firms will lend out the stocks for traders that plan on shorting stocks of various companies that they believe have dismal profit margins, declining sales or investors who are speculating on the outlook of the price.
Here are few aspects to consider when it comes to lending out stocks:
— Lending Shares Is Straightforward.
— Earned Interest Varies With Demand.
— Lending Isn’t for Everyone.
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Lending Shares Is Straightforward
Investors can lend out their shares of individual stocks or from an ETF by signing up. The rest of the work is automated and conducted by a brokerage such as E-Trade, Interactive Brokers, Charles Schwab or Fidelity. The fees are split equally with the broker.
The securities are lent out to traders who want to sell the stocks short, says Andrew Wilkinson, director of trading education at Interactive Brokers. Individual retirement accounts can also participate in stock lending programs.
“It is an excellent idea,” says Charles Trzcinka, a finance professor at Indiana University’s Kelley School of Business. “If you believe that a stock will rise over say two to five years, why not make the rebate rate in addition to the return? Long holders are optimistic, and if they can make money from idiot short sellers, then go for it.”
While the short sellers can push stock prices down and increase volatility, having negative information about a company such as GameStop (ticker: GME) or Tesla ( TSLA) is also helpful, along with having access to positive data, he says. The short sellers help keep the stock market “honest” and create more efficiency for capital allocation. Shorts can cause volatility and possibly create a downward run on a stock, Trzcinka says.
Brokerages can either pay a fixed or variable rate. Fidelity pays a variable lending interest rate that can change based on various market conditions. Investors can opt out of these programs at any time.
The share lending program is beneficial for investors who want to earn extra income from stock that is sitting in an account and idle, Wilkinson says.
“Each day that stock is on loan, participants in the program will be paid interest on the cash collateral posted to their accounts for the loan based on market rates,” he says.
Determining the amount of short interest from Wall Street and traders on a stock can be challenging. The short interest on some stocks such as GME only lasts several weeks or months, while some stocks such as Tesla or Apple ( AAPL) are shorted for several years. As of Feb. 25, the short interest on GME was valued at $1.42 billion from 15.47 million shares of the stock being shorted. The fee was 1.32%.
[READ: What Is Shareholder Value?]
Earned Interest Varies With Demand
When a stock is in high demand and becomes hard to borrow, investors could receive a higher interest rate.
“What the investor earns in return really depends — if the security they are loaning is hard to borrow, meaning in high demand, then they could get a higher rate and of course the inverse is true, says Chris Larkin, senior vice president at E-Trade. “When it comes to fees, your broker-dealer will generally split 50% of the earned income. That said, just because you enroll in these programs, it’s not a guarantee that the securities from your portfolio will get picked. It all goes back to the demand there is on the Street.”
One factor investors need to know is that enrolling in a share lending program means all the securities are put up for collateral — you can not choose the stocks. As the owner of the shares, investors do have the right to sell the shares at any time, he says.
The securities that have been loaned out are not protected by the Securities Investor Protection Corporation. But the cash collateral received for the securities is typically protected by the SIPC for up to $250,000.
Investors can still receive their regular dividend payments that are reimbursed by the brokers, and they can help offset any potential tax burdens.
Generating additional income from share lending is beneficial for investors, says CJ Brott, founder of Capital Ideas, a registered investment advisor in Dallas.
“The lender may also charge a premium to borrowers on securities that are in short supply and therefore hard to borrow,” he says. “The firms are willing to split the short credit with you, the client, in order to entice you to make your securities available for lending.”
[READ: Dividend Rate vs. Dividend Yield: The Difference Investors Should Know.]
Lending Isn’t for Everyone
Lending shares may not be appealing to all investors. People who trade stocks or ETFs often in their brokerage or retirement accounts may not find this option attractive or a helpful investment strategy. If you’re not sure how often you might buy or sell a security, then lending your shares out to your brokerage can help you easily net extra income every month.
That profit can be used to dollar-cost average your current or additional investments or provide you the extra income to buy shares of a stock or ETF you have been wanting to add to your portfolio. The money you receive from lending your shares can help you increase the amount of diversification to a portfolio or add stocks from a sector that is riskier or more volatile such as robotics, cannabis or psychedelics.
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Why Lending Your Shares Is a Good Option originally appeared on usnews.com
