What Is Stock Lending And Is It A Good Option?

One of the most common investment strategies is to purchase stock shares with the conviction that the value of those shares will increase over time. However, what if there was a way to earn passive income from those shares that you're holding for the long term? Well, there is, and it's called stock lending.

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Stock lending (securities lending) is when borrowers are allowed to access your shares for trading purposes. In return, the stock lender is paid a fee, which is often disbursed on a monthly basis. The lender still retains ownership of the shares and fully realizes any profit or loss when the shares are eventually sold. Typically, shares are borrowed by larger institutional investors, often for the reason of short selling. That is, betting that the price of a stock will decline, at which point, the shares sold short can be repurchased at a lower price, which yields a profit.

The amount of the monthly stock-lending fee can vary greatly depending on a stock's popularity and how many shares are available to borrow. However, a rough guideline is between 0.3% and 3% of the share price. For example, $100,000 worth of shares lent at a rate of 3% will generate $3,000 annual income, or $250 per month.

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You could owe additional income tax

The first caveat to stock lending involves securities that pay out a dividend. During the time that shares are lent out, you won't technically be receiving a dividend. Instead, the borrower will be paid the dividend. To be clear, the borrower will typically compensate the lender with a cash payment equivalent to the amount of the dividend so that source of income isn't lost, which would lessen the appeal of the stock-lending process.

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However, that cash payment from the borrower will be taxable at a different rate than a qualified dividend, which is taxed at 0%, 15%, or 20%, depending on your income tax bracket (here's how to tell which one you're in). Instead, the cash compensation from the stock borrower may be taxed at your regular income tax rate, which can be greater than the rate at which qualified dividends are taxed. If you're not careful and aware, you could get an unexpected income tax bill instead of a refund come April 15.

Besides a potentially higher tax obligation, lending your stock shares will also nullify any right that exists to vote on certain company issues. Of course, policies vary from company to company and not all shares carry voting rights. Even when they do, some shareholders don't care about votingĀ or bother to do so. Still, the loss of voting rights is a small factor to keep in mind prior to engaging in stock lending.

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Your brokerage will want its cut of the fee

An additional consideration of stock lending is the loss of SIPC insurance for securities that are lent out. Much like bank accounts are insured by the FDIC, investment accounts are protected against loss by the SIPC, or Securities Investor Protection Corporation. In the event your brokerage firm suddenly collapses, the SIPC will step in to protect investors up to $500,000 per person. However, securities that are currently being borrowed aren't eligible for this coverage. Granted, the unexpected failure of a brokerage isn't terribly likely; nonetheless, it's worth considering when weighing the costs versus benefits of stock lending.

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Finally, stock lending may not be appropriate for investors who frequently trade their account. That is, buying and selling securities within a short time frame. That's because lending stock will hamper an owner's ability to liquidate while the shares themselves are lent out. On the other hand, investors who are observed to hold long-term can earn some passive income through stock lending.

If you're interested in participating in stock lending, know you won't be required to get personally involved in every lending transaction. Instead, simply enable or opt-in to stock lending with your brokerage firm and it'll take care of the rest, if and when the opportunity presents itself. In exchange for facilitating the lending process, expect your brokerage to retain a portion of the fee. In fact, your brokerage (we rank the best investment apps for beginners here) may keep as much as half of the lending fee, but policies vary.

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