Can You Use MTF for Long-Term Investing?

Key takeaways

A Margin Trading Facility (MTF) allows investors to buy securities by paying a portion of the total purchase price, and the broker pays the balance and charges interest on the amount funded.
MTF is widely used by short-term traders who aim to take advantage of short-term market trends.
MTF is not usually preferred for long-term investments because the interest on the amount borrowed adds up significantly over time, decreasing the net returns.
Margin calls are also a possibility with MTF positions. During margin calls, investors either have to add more funds or their MTF position gets liquidated by the broker.
Investors with long-term investment plans often opt for cash equity investments or mutual-fund SIPs based on their investment objectives and risk appetite.

Among the various tools available to investors seeking to maximise their returns, the Margin Trading Facility (MTF) is one that often catches the attention of investors. It allows investors to purchase more shares than their available funds permit, offering them the potential for amplified profits. This leads retail participants to a common question: can they use MTF for long-term investing?

Leverage can be tempting on paper, but it comes with hidden costs, growing liabilities and a lot of psychological stress that most investors don't fully appreciate when they use it for a long-term investment time horizon. In this blog, we will discuss the key details about MTF, the real-time cost of MTF and whether it is suitable for a long-term wealth creation plan.

What is a Margin Trading Facility (MTF)?

Margin Trading Facility is a funding facility provided by the stockbroker to the investor to buy securities more than their upfront capital permits. The investor pays only a fixed percentage (the initial margin), and the broker pays the remaining amount.

MTF is often used by short-term traders because if you hold an MTF position for a short period, the interest you pay is not significant, and it offers the opportunity to make quick gains with limited capital.

For example, with MTF, you can buy shares worth ₹1,00,000 with a personal investment of only ₹25,000. The broker pays the balance ₹75,000. For funding the remaining amount, the broker charges an interest rate on the amount borrowed.

On Dhan, the interest rate on the MTF-funded amount starts at 12.49% per year, and it offers an MTF limit of up to ₹5 crore. There is no fixed holding period. You can hold the MTF-funded position as long as you maintain the margin requirement and pay the interest.

How does MTF work in the Indian stock market?

Here is how investors can use MTF to gain a larger exposure with limited capital:

Select an eligible stock: MTF is only available on certain securities (listed as approved securities, generally SEBI Group I securities). Choose an eligible security after considering its risk and suitability for your strategy.
Place the MTF order: In your trading account, when you are placing a buy order, choose MTF as the product type. The margin requirement and the broker's contribution will be displayed.
Pay the initial margin: You fund the initial margin, usually 25% of the trade amount, with your own money. The broker pays the rest.
Shares credited: After the trade is executed, the shares will be credited to your demat account. You will be the beneficial owner of the shares. The shares will be pledged automatically to your broker till the borrowed funds are repaid.
Interest accrues daily: The broker will charge a daily interest on the amount funded until the position is closed.
Issue a margin call: The broker will issue a margin call as soon as the value of the stock declines and the required margin coverage falls below the minimum maintenance level.
Respond to a margin call: You are required to fund more capital or deposit additional securities within the stipulated time when you get a margin call. Otherwise, the broker will sell off your securities to recover the funded amount.
Close the position: When you close the position, the amount funded by the broker, including interest, will be paid back first. Your account will then receive the remaining balance.

Risks of using MTF for Long-term Investing

MTF works well for short-term swing positions. But using it to hold positions over three, five, or ten years often turns it into a growing financial liability. Here are the primary reasons that make MTF unsuitable for long-term investing:

Compounding interest burden

When you hold a long-term MTF position, its interest costs build up on a daily basis. Brokers typically charge an annual interest rate ranging from 12% to 15% on the funded amount.

Historically, the Nifty 50 Total Return Index (TRI) has provided an average 10-year CAGR of around 12% to 13%. This implies that the cost of borrowing in MTF and the average market returns are nearly the same. Thus, leading to nominal or no net returns for investors.

Market volatility and margin calls

The Indian equity market is inherently volatile. Even the blue-chip stocks can fall during a market correction. During these times, if you had invested 100% of your upfront capital in buying these shares, you can still hold your positions until the market turns around.

However, in an MTF position, the same decline in stock prices will breach your maintenance margin and trigger a margin call. If you don't fulfil those new margin requirements, the broker will automatically liquidate your shares to recover its borrowed amount. This can turn a temporary correction into a realised loss.

Psychological pressure

Patience and emotional stability are the foundation of long-term wealth creation. To gain healthy returns over the long term, it requires investors to hold their investments through different market cycles without being compelled to act. MTF holding fundamentally undermines this approach.

Each market correction brings with it the worry that a margin call is just around the corner. Investors have to keep a constant watch on the portfolio, which adds to psychological stress and often results in hasty and emotion-driven decisions, which is the exact opposite of what one needs to do during long-term investments.

Conclusion

Margin Trading Facility (MTF) is best suited for investors with a short-term investment horizon who intend to take short-term positions based on market movements, but using MTF for long-term investments often works against the core principle of wealth creation, i.e patience.

The burden of daily interest, combined with the risk of forced liquidation, makes holding MTF positions for the long term a risky and costly endeavour. Therefore, investors with a long-term investment horizon often prefer cash delivery or SIP in mutual funds as their long-term investment options.

FAQs

Can I hold MTF positions for more than a year on Dhan?

On Dhan, investors can hold their MTF positions as long as they maintain the required margin and pay the required interest. However, holding MTF positions for the long term is not economically attractive because the interest expense eats into the net returns.

What happens if an MTF stock falls sharply?

If an MTF stock's price plummets, your margin coverage will fall below the maintenance margin, and you will receive a margin call from your broker. If you don't add additional funds to meet required margins, the broker will liquidate your pledged shares to recover the funded amount.

Are dividends credited for shares bought under MTF?

Corporate benefits such as dividends, bonus shares, and stock splits are credited to the investor's account for shares purchased under MTF. The investors remain the beneficial owner of the pledged shares throughout the holding period and are therefore entitled to all applicable corporate actions.

Can I use MTF to purchase mutual funds?

The Margin Trading Facility is only available for exchange-traded equity shares and selected Exchange Traded Funds (ETFs). It cannot be used to buy mutual fund units.

What is the difference between MTF and a loan against shares?

Under MTF, the broker funds a specific percentage of the total purchase value, and those shares are pledged as collateral. In a loan against shares, you pledge your existing holdings to the broker for a credit line without buying new securities.