Lombard loan when buying ETFs: a booster for your return on equity or playing with fire?

This time we are addressing a very controversial topic: leveraging return on equity using equity ETFs on credit. Yes, even more: for many investors, including the blogger community, credit-financed investments are a no-go. Not for us. In this blog post, we report on our experiences with Lombard loans, show you how to avoid the “margin call” horror scenario with confidence and when you should definitely steer clear of securities loans.

Let’s start with a short, tempting thought experiment: “If global ETFs yield a good 8 percent per year in the long term and lending rates are significantly lower, then investing in leveraged funds is a great deal, a no-brainer.”

What is a Lombard loan?

A Lombard loan is a securities loan. This means that in return for pledging your liquid securities, such as shares (ETFs) or bonds, you receive a credit line from your custodian bank that you can draw on flexibly. The pledged securities remain your property and you continue to benefit from any increases in value and dividend payments.

You pay interest on the loan you take out. This interest rate is often significantly lower than for a personal or consumer loan. This is because the bank receives additional collateral in the form of your pledged securities (similar to real estate financing with a mortgage loan). This considerably reduces the default risk for the lending bank. This means that if you are no longer able to repay the interest and loan, the bank can simply sell your pledged securities. In summary, the Lombard loan has the following features:

• Pledging of custody account assets
• The maximum credit amount depends on the pledged securities (as a general rule, the safer the securities to be pledged are assessed by the bank, the higher the credit line granted).
• Obligation to make additional contributions or forced sale in the event of a shortfall (“margin call”)
• Can be mutually terminated at any time

What types of Lombard loans are there?

According to our research, current account loans and, less frequently, fixed advance Lombard loans are frequently offered on the Swiss market. In contrast to the fixed advance, the current account variant usually has neither a fixed term, nor a fixed loan amount, nor a fixed interest rate. Instead, with the current account variant, you can usually cancel the loan at any time and use the credit line flexibly according to your actual needs (and only pay interest on it!). Finally, the interest rate is also flexible, i.e. it can vary on a daily basis depending on the market situation. In this article, we will focus on the “current account Lombard loan” variant.

The explanations in the section above are a simplification of the securities lending business. Before taking out a Lombard loan, you should carefully study the individual contractual conditions and the small print of your lending custodian bank.

Why should I take out a Lombard loan at all?

You can pursue various goals with a Lombard loan. In any case, you receive additional liquidity without having to sell your securities. You can use this additional cash for various purposes: for example, for a trip around the world, a new kitchen or for additional investments.

We focus on additional investments (in equity ETFs), because only in this case can youleverage your return on equity. In other words, when you invest with leverage, you are basically always pursuing the same goal: to move large sums of money with a small amount of capital.

From a sober or financial point of view, a Lombard loan is always worthwhile if the price gains, including dividends, are higher than the interest on the loan.

What is a loan-to-value ratio?

The pledged assets are mortgaged at a percentage of the respective market value. This so-called loan-to-value ratio (LTV) varies depending on the risk, tradability of the security and the bank.

Let’s assume you have a global equity ETF portfolio with a market value of CHF 100,000 and want to take out a Lombard loan. Your custodian bank first carries out a risk assessment of your portfolio. Based on this, it determines the loan-to-value ratio, which must not be exceeded, otherwise a margin call is imminent. But more on this later.

The safer your portfolio is valued by the bank, the higher the maximum loan-to-value ratio will be. In this article, including the example below, we assume a maximum LTV of 50%, which is realistic for a broadly diversified equity ETF portfolio.

This means that in addition to your self-financed securities worth CHF 100,000, you will receive a maximum of another CHF 100,000 as borrowed capital. If you draw down the entire credit line and invest it in securities, you have a leverage of two.

The higher the loan-to-value ratio or LTV, the more leverage potential you have. So the LTV formula is:

LTV = Loan / Value = Lombard loan / Deposit value

Deposit value = 200,000 (current market value consisting of equity and loan)

Equity = 100’000

Loan = 100’000

LTV = 100,000 / (200,000) = 0.50 = 50%

Based on an LTV of 50%, the following chart shows the interplay between share price performance and LTV. As a general rule, if the share price or portfolio value increases, the LTV decreases and vice versa.

Thanks to the rising prices at the beginning and for the most part thereafter, the LTV never reached the critical “margin call” danger zone during the entire 14-year period, which in our example would have meant an LTV of over 50%. (As we will show later, we strongly advise against using the entire credit line of LTV 50% right from the start).

How does the loan-to-value ratio affect my return on equity?

In short: very direct, both when prices are rising and falling. This leverage is therefore a double-edged sword.

Specifically, using the example above: If your securities portfolio increases by 10% to CHF 220,000 after one year, you will double your return on equity to 20% thanks to the loan leverage (20,000 price gains on securities / 100,000 invested equity). Without the Lombard loan, however, your return on equity would only be 10%.

In the event of price losses, things look correspondingly bleak: With a 10% stock market plunge, your portfolio value drops to CHF 180,000. Your leveraged negative return on equity doubles and thus amounts to -20% (20,000 price losses / 100,000 invested equity) instead of -10% without a Lombard loan.

What interest rates should I expect?

The interest rates for Lombard loans vary greatly from provider to provider. But even among the more attractively priced online brokers, the conditions can differ quite significantly, as the following table shows:

Credit currency	DEGIRO	Interactive Brokers	Swissquote
CHF	4.00%* - 5.50%	1.772%**	3.51%
EUR	5.00%* - 6.50%	4.383%**	6.07%
USD	5.25%* - 6.90%	5.830%**	7.54%

Different margin conditions depending on currency and provider as at 14.1.2025. *Fixed advance, i.e. interest accrues on the entire amount allocated, regardless of how much is actually used. **Up to 90,000 CHF/EUR or 100,000 USD, thereafter gradually more favorable.

The current Lombard loan conditions of the three providers can be found in the following links: DEGIRO | Interactive Brokers | Swissquote

On our new recommendation page you will find the most important features and conditions (including bonus credit) of these three online brokers.

In our experience, Interactive Brokers has also offered extremely attractive conditions for Lombard loans over longer observation periods. Nevertheless, it is worth doing your own research and checking the conditions of your existing custodian bank first. This is because the securities to be pledged must be in the custody account of the lending bank.

What are the risks of a Lombard loan?

Risk and Lombard loans are closely linked, which is why we would like to devote particular attention to this topic. In particular, you should understand and keep an eye on the following three risks:

Risk “Realization of price losses through margin calls”

We see the risk with the greatest financial impact in the forced sale of collateral by the broker. How can this happen? Basically, whenever the deposit value of your margin account (i.e. an account that is partially financed with securities credit) falls below the minimum amount required by the custodian bank (maintenance margin), which means that the LTV exceeds the maximum permissible limit.

Although the term “margin call” is still in common use and has been known to a wider public since the 2011 film of the same name, it has not been used literally for a long time.

This means that your bank advisor will not pick up the phone as in the past, but will send you a written request to inject additional capital or sell your positions within a certain period of time.

Otherwise, or if you do not comply with the margin call, your bank advisor will close the corresponding positions himself. He therefore sells the securities that have fallen in value at an extremely unfavorable time from the investor’s point of view.

To avoid a margin call, you should consider the following preventive countermeasures:

• Pledge “good securities” to the bank, e.g. broadly diversified equity ETFs. Reason: The safer the bank considers the pledged securities to be, the more generous the loan-to-value ratio (LTV) will be, which gives you a larger margin of safety (see next point).
• The bank may not fully utilize the credit line or start with a low LTV (e.g. 20%), which is significantly lower than the LTV granted by the bank. In the case of broadly diversified equity ETFs, the bank usually calculates with a maximum LTV of 50% or more.
• Do not borrow at all-time highs, but only in bear markets. The ideal time would be at the beginning of a longer recovery phase. But catching such a perfect timing is of course pure luck and can only be determined with certainty in retrospect. (Later, we will explain a rule-based approach to borrowing in detail).

“Rising interest costs” risk

The interest rates for Lombard loans can change depending on the market situation and currency. The key interest rate, which is determined and regularly reviewed by the Swiss National Bank (SNB), is decisive for the development of Lombard loans in local currency.

The higher the prime rate, the higher the Lombard loan interest rate and the higher the ongoing interest costs. In addition to the prime rate, the margin of the lending bank also influences the interest costs. As we have already seen above, the conditions for Lombard loans vary greatly from provider to provider.  

Despite these recent interest rate increases, interest rates in Switzerland are currently significantly lower than abroad (USA and eurozone) and have generally been lower in the past. This is reflected in the Lombard interest rates, which vary greatly depending on the currency.

Nevertheless, to avoid the risk of excessive interest costs, you should consider the following countermeasures:

• Avoid financial distress thanks to careful budget planning using an imputed interest rate of 5% (i.e. budgeting with a safety margin similar to the mortgage business)
• Taking out a Lombard loan only in the home currency CHF to avoid currency risks and to benefit from a generally lower and more stable interest rate level compared to foreign currencies
• Setting an interest rate limit for borrowing

“Own nerves of steel” risk

The two risks mentioned above can be managed with a rule-based approach. We are convinced of this. We will go into this in more detail later. However, the situation is completely different when emotions get the better of you and panic spreads after high (book) losses.

In other words, you should honestly answer the following question: How have I reacted to price losses so far? If you have always remained cool and have always (rule-based) replenished your portfolio at low prices, Lombard loans could be an option for you.

If, on the other hand, you suffer from loss aversion, like most investors, we think you should generally steer clear of Lombard loans. An intact quality of life, which includes a good night’s sleep, is definitely a more important value than maximizing profits!

In which market phases is leverage with Lombard loans suitable?

Irrespective of the general stock market situation, the question arises as to whether the interest rate environment described above should decide whether or not to take out a Lombard loan.

While Stefan would only consider taking out a loan if the Lombard loan interest rates were moderate (below 3%), the interest rate level only plays a subordinate role for Toni and hardly influences his decision to take out a loan.

Either way, fortunately Switzerland is traditionally a low-interest country, which is why Lombard loans in local currency are comparatively cheap.

In practice, Lombard loans are often used for short-term speculative investments. Anyone wishing to speculate on profits in the short term therefore leverages in bull markets or stock market bull markets in particular.

The speculator hopes that the price of a promising share will soon go through the roof.

In other words, he uses momentum. In the financial context, momentum describes the tendency for shares with comparatively strong increases in value in the recent past to continue to perform above average in the near future.

An opposing trend is expressed by the term “regression to the mean” from statistics. This is a phenomenon that influences the long-term development of investment returns.

Statistically speaking, the return on shares and other investments always fluctuates around the so-called mean average over a longer period of time. This means that the gross return on your investment will sooner or later return to a long-term market average – regardless of whether the initial returns were positive or negative. However, this mainly applies to medium to long-term periods. For periods of less than 5 years, the regression to the mean does not apply.

Based on this phenomenon, it again seems sensible to leverage in bear markets by means of securities loans. The best time to do this is when the prices of an MSCI World Index, for example, are well below the all-time high.

MSCI World performance by lows

Start	End	Duration in days	Drawdown	after 1 year	+/- peak*
20.11.1980	12.08.1982	630	-28%	47%	6%
27.08.1987	26.10.1987	60	-24%	25%	-5%
04.01.1990	28.09.1990	267	-26%	21%	-10%
20.07.1998	05.10.1998	77	-21%	36%	7%
27.03.2000	09.10.2002	926	-51%	36%	-33%
31.10.2007	09.03.2009	495	-59%	70%	-30%
21.05.2015	11.02.2016	266	-19%	24%	0%
26.01.2018	25.12.2018	333	-20%	31%	5%
12.02.2020	23.03.2020	40	-34%	74%	15%

The table uses the MSCI World Index to show all stock market crashes (corrections of at least 20%) over the last 40 years as well as the impressive price increases just one year after the stock market dives. *This column shows how high the price is after 1 year of recovery above or below the high since the start of the drawdown. (Source: MSCI World, financial flow, own calculation)

Interim conclusion: We are not interested in short-term speculation. That’s why we believe that if we do take out a Lombard loan, it should only be at stock market prices that are well below the all-time high and – as far as Stefan is concerned – at a moderate interest rate level.

When is the ideal time to amortize Lombard loans?

Mortgage debts are not usually fully amortized in Switzerland. What is the situation with a Lombard loan?

We have developed a strictly rule-based exit strategy based on the key finding for us in connection with Lombard loans that in the past above-average market recoveries have occurred only one year after price dips (see table above). This set of rules includes the following three rules:

• Rule no. 1:
  The custodian bank should – based on the pledged securities – grant Lombard loans up to a maximum LTV of 50% or higher . (Reason: The higher the maximum LTV granted by the bank, the more safety margin you have in the event of price falls).
• Rule no. 2:
  Borrowing is staggered, i.e. a maximum of three times at prices 25% (up to LTV 20%), 40% (LTV 30%) and 50% (LTV 40%) below the last all-time high of the MSCI World Index, a comparable index or an ETF based on it.
• Rule no. 3:
  In turn, the loan amortization always takes place in full when the last all-time high is reached again, i.e. when the share price recovers by 33%, 67% and 100%.

These three rules ensure that even in the event of an extreme stock market crash of 60%, there is no threat of forced selling at the worst possible time as a result of a margin call.

In the following table, we have run through four exit scenarios S1 – S4 with the respective amortization times.

The table should be read as follows: If a price correction of 25% (up to <40%) follows, this is scenario 1 (S1). If there is a price correction of 40% (up to <50%), this is scenario 2 (S2). Scenario 2 includes all the white lines above it, i.e. also the first three of S1. It continues in the same way with extreme scenarios 3 and 4, which address massive price losses of 50% and 60% respectively and will therefore occur very rarely. Each scenario is highlighted in green and consists of two events (separate rows): Price recovery to peak and Credit amortization.

We have again assumed that the custodian bank will grant Lombard loans up to a maximum LTV of 50%. If this threshold is exceeded, there is a risk of a forced sale or a margin call.

If you want to have more safety margin in the event of a price correction of -60% or want to push the LTV below 50%, you do not take out the third loan in the event of a price correction of -50%. This simple measure would result in an LTV of 45% after a stock market crash of 60% (instead of 50% according to the table).

What does this mean for your return? Below we have compared the return on equity of scenario 1 (S1) with that without credit leverage. It should be noted that we have used the same equity in both calculations, namely the equity at the time of borrowing. We have also assumed 3% borrowing costs and a loan term of 1 year.

Calculation of return on equity WITHOUT credit leverage

Equity used = CHF 75,000 (deposit value at the same time as the loan was taken out)

Exchange rate gain = CHF 25,000 (CHF 100,000 – CHF 75,000)

Return on equity = 33.3% (CHF 25,000 / CHF 75,000 = profit / equity employed)

Calculation of return on equity WITH credit leverage

Equity used = CHF 75,000 (value of equity at the time of borrowing)

Price gain = CHF 31,250 (CHF 125,000 – CHF 93,750)

Credit costs p.a. = 563 CHF (=18,750 CHF * 3%)

Profit after borrowing costs = 30,687 (= 31,250 CHF – 563 CHF)

Return on equity = 40.9% (= 30,687 / 75,000 = profit / equity employed)

What are the advantages and disadvantages of Lombard loans?

As mentioned, you can use the additional liquidity you receive from the Lombard loan for various purposes. For example, if you “consume” the loan, the main advantage is that you don’t have to sell your securities to obtain the necessary liquidity. You also generally benefit from lower interest rates than with a personal loan.

However, at this point we are only interested in Lombard loans that are invested in additional securities. The advantages and disadvantages listed correspond to our subjective opinion and are to be understood in comparison to a classic, non-leveraged investment.

What leverage alternatives are there to the Lombard loan?

Below we present two other ways in which you can invest with leverage.

Alternative 1: Leverage through leveraged ETFs

With this variant, you invest in special leveraged ETFs which, like traditional ETFs, track an index, but whose price performance is amplified by a certain factor. For example, if a factor of two is applied and the benchmark index rises by 2% in one day, the leveraged ETF will rise by 4%. In contrast to a lombard loan, you do not receive any additional liquidity with a leveraged ETF and the offer is still quite modest. Nevertheless, we find the concept behind leveraged ETFs exciting, which is why we will devote a separate article to this investment opportunity.

Alternative 2: Leverage through structured products

Structured products with leverage are complex financial products that can be used to react to a price movement in the underlying asset. Popular underlying assets are individual shares, indices, commodities and currencies. We reject structured products with leverage because, in our opinion, they are too expensive and not transparent enough. The latter is particularly evident in their often opaque construction.

Conclusion

It’s obvious: taking out a securities loan is only suitable for investors with strong nerves and should be carefully considered. This is because the leverage associated with borrowing works on both sides: Price gains and losses are amplified. In addition, interest rates on loans can rise in the short term, which can put additional strain on your nerves.

Furthermore, you should only consider a Lombard loan if you have already invested existing cash or other, more favorable equity.

If you are aware of these points, you should now arm yourself against the risks associated with a Lombard loan.

And this brings us back to our introductory thought experiment. Unfortunately, investing with debt financing is not a no-brainer, even if the returns on the stock market are likely to be higher than the interest on Lombard loans in the long term – especially in our home currency, the CHF.

Unlike with self-financed ETFs, with debt-financed securities you cannot simply sit out heavy price losses in the tried-and-tested buy and hold manner. The reason for this is the margin call and the associated risk, which means you have to sell your securities at the worst possible time.

To avoid the financial losses associated with the margin call, you should never fully utilize the credit line granted by the bank. This will provide you with an important safety margin – and peace of mind.

You should also make sure that your interest costs don’t get out of hand. Specifically, this second safety measure could consist of carefully calculating the expected interest costs (i.e. with a safety margin or a high, imputed interest rate of 5%) based on serious budget planning. Another measure against high interest costs could be to set yourself an interest rate limit when taking out the loan.

Conclusion: Leveraged equity ETFs boost your return on equity when prices rise. Lombard loans become a gamble with fire for you if you have not taken any rule-based safety precautions – and therefore fall into a margin call.

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Updates

2025-01-14: Margin rates for Lombard loans from DEGIRO, Interactive Brokers and Swissquote updated.

2024-07-02: Margin rates for Lombard loans from DEGIRO, Interactive Brokers and Swissquote updated.

Disclaimer

Transparency note: Unlike Stefan, at the time of publication of this article Toni had leveraged his portfolio with a Lombard loan from Interactive Brokers. Previously, both had gained initial experience with Lombard loans from DEGIRO.

Disclaimer: Investing involves risks. You must decide for yourself whether or not you want to take these risks.

Errors excepted: We have written this article to the best of our knowledge and belief. Our aim is to provide you as a private investor with the most objective and meaningful financial information possible. However, should we have made any errors, forgotten important aspects and/or no longer have up-to-date information, we would be grateful if you could let us know.