Did you know it is possible to lend your stock for extra income? Well, it is possible, but there are cautions.
What It Is
When people “sell short,” they must have a stock in their account to do this. To get stock for this purpose, they “borrow” from a broker. This borrowing comes with a charge that is paid to the owners of the stock from whom they borrow (and to the broker). So an owner of a stock can “lend” it, via their broker, to someone who is borrowing it. Telling your broker that your stock is available for borrowing is the way to get this in motion.
Upside and Downsides
Descriptions of the mechanics of leaning securities are detailed on various websites. Here is one from Investopedia. Anyone lending securities should be aware of the advantages and disadvantages of doing so.
Considerations
1. Dividends ae paid to the person holding the stock, in this case the borrower. The borrower then owes the dividends to the lender. In addition, these “cash-in-lieu” amount owed to the lender are taxed as regular income, not dividend income. As we know, dividend income has a lower tax rate than ordinary income rates.
2. Stock lent is not insured by the Securities Investor Protection Corporation (SPIC). Some brokers might cover losses. It is important to note a bankruptcy of the borrower or borrower’s broker could prevent or hinder recovery. (While I do not have all the facts, I understand that those whose stocks were lent to Lehman Brothers in 2008 got caught in Lehman’s bankruptcy.)
3. Voting Rights. While the stock is lent, the holder of the stock holds voting rights, not the lender.
Risk?
While lending stock seems like a simple and easy way to garner some additional income, the risks dissuade me. As dividend investor, I do not wish to give up the dividend reinvestment feature of the stocks I hold. I do not wish to relinquish the dividend tax treatment.
On The Other Hand
From my perspective, lending stocks could be appropriate for an investor who is not interested in dividend reinvestment. Ideally, investors in non-dividend paying stocks who are long volatile companies. Companies that are stable and boring do not vary much, so as a result there is less interest in shorting them. Investors who are long non-dividend but volatile stocks could consider this option.
Do you allow lending of your stocks? Let me know here.
“View of a Town House Garden in The Hague” is from 1775, and was painted by Paulus Constantijn la Fargue. Courtesy Minneapolis Musem of Art.
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