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 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.
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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.
Lending Shares Is Straightforward
“Many popular brokerage firms have programs where owners of securities can lend those securities to short sellers,” says Stephen Henn, an economics professor at Sacred Heart University. “The attraction of lending securities is that the loan draws interest at a rate generally higher than typical money market investments, and you do not jeopardize any appreciation in the securities themselves because you will be repaid the securities.”
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. Generally, the fees are split equally with the broker.
“The concept of lending shares of stock or funds you own is a lot like renting a home you own to a tenant,” says Ronnie Thompson, investment advisor representative and owner of True North Advisors. “You can lend shares of stock and funds to a borrower through a contract called a Securities Lending Agreement.”
The borrower then pays a fee, typically on a monthly basis, during the time the shares are lent and may also provide collateral for the amount of stock being borrowed, Thompson says. “The fee varies but will typically fall somewhere between 0.3% to 3% of the value of the stock borrowed.”
Brokerages can either pay a fixed or variable rate. Fidelity and Schwab pay a variable lending interest rate that can change based on various market conditions. Investors can opt out of these programs at any time.
“This is a very straightforward way to put your assets to use, earning an above-average return without very much additional risk,” Henn says.
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Earned Interest Varies with Demand
When a stock is in high demand and becomes hard to borrow, investors could receive a higher interest rate.
“The primary source of income for stock owners who lend their stocks is through the receipt of a monthly fee from borrowers,” sys Suman Banerjee, associate professor of finance at Stevens Institute of Technology. “Estimating your earnings from stock lending can be challenging, as it often hinges on the demand from borrowers.”
Stocks in short supply and high demand tend to generate more earnings for the lender since they’re more likely to be borrowed, he says.
“The direct return is the lending fee, usually expressed as an annualized percentage of the borrowed shares’ value,” he says. “For example, if an investor lends $10,000 worth of shares at a 2% fee, they will earn $200 over a year, assuming a constant fee rate and loan value.”
One factor investors need to know is that enrolling in a share lending program means all the securities are put up for collateral — you cannot choose the stocks. As the owner of the shares, investors do have the right to sell the shares at any time. That said, “there could be delays or challenges in reclaiming the shares, especially during periods of high market volatility,” Banerjee 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.
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 don’t buy or sell often, however, lending your shares out to your brokerage can help you easily net extra income every month.
But there are other requirements you must meet as well. For instance, “the securities need to be in demand by short sellers, that is, investors who believe the stock will decrease in value,” Henn says. “If you have a stock that pays dividends or has other benefits, you may transfer them as well depending on the lending agreement.”
While the short sellers can push stock prices down and increase volatility, they help keep the stock market honest and create more efficiency for capital allocation. 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 GameStop (ticker: GME) only lasts several weeks or months, while some stocks such as Tesla Inc. (TSLA) or Apple Inc. (AAPL) are shorted for several years.
“If you have a stock that pays dividends or has other benefits, you may transfer them as well depending on the lending agreement,” Henn says.
Similarly, you will lose your voting rights on any lent shares, which “can be a concern for investors seeking active involvement in the governance of their invested companies,” Banerjee says.
Brokerages may also require you to have a certain asset level to participate in their lending program, Henn says. Fidelity requires participants to have at least $25,000 in the account they wish to enroll, but he says some brokers may require you to have more than $100,000.
“Lending stock does add value to the ownership beyond the growth of the stock, but if you consider doing this, do your due diligence on the party borrowing the stock and ensure that all your bases are covered when it comes to establishing the securities lending contract,” Thompson says.
While stock lending could help you earn “extra income from your existing holdings, especially those idling in your account, it comes with nuances, notably in terms of tax implications and the risk of borrower default,” Banerjee says. If you’re uncertain whether this aligns with your financial goals, it’s always a good idea to consult a financial advisor for guidance.
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Why Lending Your Shares Is a Good Option originally appeared on usnews.com
Update 11/13/23: This story was published at an earlier date and has been updated with new information.
