Earning Passive Income With Securities Lending

While most securities provide value through price appreciation and dividends, there's a third way to potentially profit from these assets: securities lending.

Brokerages frequently need to borrow specific securities to facilitate short sales or settle complex trades. "When there's more short interest in a stock than there are available shares to borrow from traditional sources, brokerages look to their clients' portfolios to help fill the shortfall," says Joseph Yockey, a senior manager in Schwab's securities lending group.

If you hold these "hard-to-borrow" securities—often found in specialized tech, biotech, or mid-cap sectors—you possess a rare source of truly passive potential income.

Most brokerage, IRA, and trust accounts are eligible to participate in securities lending programs, though account eligibility varies by broker and minimum balances apply. That said, because brokers are looking to borrow specific securities, enrollment in lending programs tends to be by invitation only.

• Once in a program, you're allowing your brokerage firm to lend out your shares to other investors in exchange for a cut of the interest payments, which are set based on demand. Interest accrues daily, including weekends and holidays, and is paid out monthly. "Schwab aims to split all daily interest 50/50 between the investor and the broker," Joseph says.
• You remain the owner of the securities, capturing all market upside, and retain the right to sell your shares at any time.

Lending out shares is not without risks and trade-offs. Be sure to consider:

• Asset protection: While on loan, securities are not insured by the Securities Investor Protection Corporation (SIPC). To bridge this gap, reputable firms post cash collateral—typically 102% of the assets' value—held at a third-party company. "Investment firm failures are rare," Joseph says, "but this cash collateral is essential to protecting your assets in the event of a default."
• Taxes: If a stock on loan pays a dividend, you receive a substitute payment—but it is taxed as ordinary income rather than at the more favorable qualified dividend rate. For those in the top brackets, this tax treatment could erode the lending profit.
• Voting rights: While your stock is on loan, you temporarily forfeit voting rights. "If an investor has an extremely concentrated position and wants to vote, they must recall the stock to regain that power," Joseph says.

Securities lending is most effective for investors who are committed to their positions and can weather volatility. "You're essentially lending shares to people who are betting the stock will go down, so the program is best suited to those who intend to hold, regardless of short-term pressure," Joseph says. "If the lending fee comfortably exceeds any additional taxes owed on the dividend substitutes, it can be a simple way to ensure no stone is left unturned when it comes to profiting from your portfolio."