Simple Adjustment For The Biggest MTF Risk

Introduction

Today, let’s talk about a critical challenge in using the Margin Trade Funding (MTF) strategy and a straightforward adjustment you can make to address it.

If you’re not familiar with MTF, it’s a tool brokers offer that allows you to buy more stocks than your current funds would allow, essentially giving you a loan for stock investments. While it’s great for long-term investors, MTF does come with risks.

In this article, we’ll focus on the biggest risk of using MTF: the square-off risk. Don’t worry—there’s a simple way to manage it and safeguard your portfolio.

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 What Is the Biggest MTF Risk?

The biggest risk with MTF is a square-off. But what does that mean?

When you invest with MTF, your broker loans you money to buy shares. In return, they hold the stocks you purchase as collateral. If the stock prices rise, everything is fine. But if the prices fall, your broker’s “safety margin” shrinks.

Here’s an Example:

• Imagine you purchase stocks worth ₹5,00,000 using MTF.

• You pay ₹1,00,000 from your pocket, and the broker loans you ₹4,00,000.

• At first, the broker is comfortable because they have a 20% margin (₹1,00,000 from you) and ₹5,00,000 worth of pledged shares as collateral.

Now, let’s say the stock price drops, and your portfolio’s value falls below ₹4,00,000. Suddenly, your broker doesn’t have a sufficient safety margin. At this point, they’ll ask you to:

1. Add more funds to maintain the margin, or

2. Pledge additional assets like other stocks or mutual funds.

If you can’t do either, your broker will square off your position by selling your shares—likely at a loss. Even if you planned to hold the stocks for the long term, you’ll be forced to sell.

Why Do Brokers Enforce Square-Offs?

Brokers act quickly to reduce their own risk. If markets correct sharply, brokers handling thousands of investors could face huge losses.

Stock exchanges like NSE and BSE hold brokers accountable for any shortfalls, so they enforce strict square-off policies whenever your portfolio drops below the required margin (usually 20%).

A Simple Adjustment to Handle the Biggest MTF Risk

The good news? You don’t have to give up on MTF! By making a few small adjustments, you can reduce the risk of square-offs and protect your portfolio.

1. Invest Gradually

Don’t invest all your funds at once. Instead, spread your investments over multiple installments.

Here’s how:

• Say you’ve set aside ₹2,50,000 for investment. Instead of using it all at once, start with ₹50,000.

• With a typical 75% margin from your broker, this ₹50,000 allows you to buy stocks worth ₹1,50,000.

• After the first installment, your portfolio will be worth ₹2,00,000 (₹50,000 of your money + ₹1,50,000 on margin). The remaining ₹2,00,000 from your funds stays in reserve.

By investing in smaller steps, you’ll have enough funds left to handle margin calls during market downturns. This approach reduces the likelihood of a forced square-off and ensures you’re prepared for volatility.

2. Use Liquid Mutual Funds as a Buffer

Instead of keeping cash on hand for emergencies, invest in liquid mutual funds.

These are low-risk, short-term investments that can easily be converted into cash. Brokers accept liquid mutual funds as collateral and typically give you 90% of their value as margin.

For Example:

• If you invest ₹2,00,000 in liquid mutual funds, you can pledge them to your broker to get ₹1,80,000 as margin coverage.

This way, your broker feels secure, and you avoid square-offs even during market corrections. Plus, liquid mutual funds earn you returns on your idle funds, unlike cash.

3. Maintain a 20% Margin Buffer

Always keep at least 20% of your portfolio value available as a margin buffer.

For Example:

• Suppose your portfolio is worth ₹10,00,000.

• Out of this, ₹2,50,000 is your own money, and ₹7,50,000 is on margin.

• To stay safe, set aside ₹2,00,000 as a buffer. This could be in the form of cash, liquid mutual funds, or unpledged stocks.

This buffer ensures you can weather short-term market dips without worrying about forced sales.

Benefits of These Adjustments

These three simple adjustments offer significant advantages:

1. Avoid Forced Square-Offs: By maintaining adequate margin coverage, you prevent your broker from selling your shares at a loss.

2. Seize Market Opportunities: If the market dips, you’ll have funds available to buy more shares at lower prices, reducing your average cost.

3. Earn Returns on Spare Funds: Investing in liquid mutual funds ensures your emergency funds grow while remaining accessible.

Conclusion

Managing the biggest risk in MTF doesn’t have to be complicated. By following these steps, you can handle square-offs effectively:

1. Invest Gradually: Spread out your investments over several installments.

2. Use Liquid Mutual Funds: Pledge them as collateral instead of keeping idle cash.

3. Maintain a Margin Buffer: Keep 20% of your portfolio value readily available.

With these adjustments, you’ll reduce the risk of square-offs, protect your portfolio, and set yourself up to take advantage of market corrections.

Remember, investing isn’t just about avoiding losses—it’s about staying prepared to seize opportunities.