Lending stock or shares of an exchange traded fund (ETF) to a broker can earn you additional income, but it isn’t for everyone.
[Sign up for stock news with our Invested newsletter.]
Securities lending is common, and share lending programs are usually conducted by brokerages. The brokerage firms will lend 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. In return, the brokerage pays the owner of the shares interest, typically on a monthly basis.
Here are few aspects to consider when it comes to lending out stocks:
— Lending shares is straightforward.
— Earned interest varies with demand.
— Loaned securities don’t qualify for SIPC protection.
— You lose voting rights but keep your dividends.
— 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 and managing director of artificial intelligence and data analytics at DLA Piper. “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.”
You can lend out shares of individual stocks or ETFs by signing up to participate with a broker. 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 in Northville, Michigan. “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,” with earnings paid monthly.
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. You can opt out of these programs at any time. The broker can also end the agreement at any time by returning the shares to you.
“This is a very straightforward way to put your assets to use, earning an above-average return without very much additional risk,” Henn says.
Earned Interest Varies with Demand
When a stock is in high demand and becomes hard to borrow, investors could receive a higher interest rate. This can make some stocks and ETFs better candidates than others.
“Popular stocks will generate the highest income,” says Rick Miller, financial planner and investment advisor at Miller Investment Management headquartered in Manassas, Virginia. This is because their popularity makes them more likely to be borrowed.
The return is generally expressed as an annual percentage. For example, if you lend $10,000 worth of stock at a 3% interest rate, you could earn $300 over a year. But since interest rates vary by security and can change daily, it’s hard to predict exactly what you’ll earn.
One factor you need to know is that enrolling in a share lending program means all the securities in the enrolled account are put up for collateral — you cannot choose the stocks. As the owner of the shares, you do have the right to sell the shares at any time. Once you sell, the loan is terminated and you’ll stop earning interest.
[READ: 6 of the Best Companies to Invest in for 2025]
Loaned Securities Don’t Qualify for SIPC Protection
Another important consideration to keep in mind is that loaned securities are not protected by the Securities Investor Protection Corporation. This means you’ll have no insurance against a broker default.
“While such an event is unlikely, sticking with the best, most well-established brokerages would be prudent,” Miller says.
You may also want to ensure the broker provides adequate collateral. This collateral can come in the form of cash or securities backed by the U.S. government equal to the market value of the securities being lent.
“Other risks include discrepancies or lack of protection stipulated in the Securities Lending Agreement,” Thompson says.
You Lose Voting Rights But Keep Your Dividends
You’ll also lose voting rights on any shares you lend. However, if proxy voting is important to you, you could always recall your shares ahead of time.
On the upside, you will continue to receive dividend payments on loaned securities. These will be reimbursed by the brokers, and can help offset any potential tax burdens. However, you won’t be able to have these payments automatically reimbursed while the shares are on loan.
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.
Share lending is best for “larger, long-term hold positions that you don’t intend to sell,” Miller says. “If you are an active trader, this is not for you.”
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.
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 Corp. (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.
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 some brokers like Schwab require you to have at least $100,000 at the broker.
“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.
If you’re uncertain whether stock lending aligns with your financial goals, it’s always a good idea to consult a financial advisor for guidance.
More from U.S. News
The 5 Best 5-Star Stocks to Invest In
The Commercial Real Estate Outlook for 2025
8 Free Investment Classes and Resources for Adults and Teens
Why Lending Your Shares Is a Good Option originally appeared on usnews.com
Update 11/21/24: This story was previously published at an earlier date and has been updated with new information.
