Saturday, March 11, 2006

Leverage

Some posters on NetWorthIQ have criticized my use of margin or said: "well it's not for me - good luck". Leverage through margin loans, options etc. as well as funds that have built in leverage is both dangerous and useful. It needs to be used judiciously. In today's markets I don't think you want to buy stocks for the long-term on margin. That worked in the 1980s and 90s but expected rates of return are just not good enough now. But when the market is in rally mode as it was from late 2002 to 2004 or 2005 depending on the index some leverage can add to returns. In Australia the standard model is to set the loan so the interest equals the dividend earned and then you are basically looking for capital appreciation and in Aus. surplus tax credits from the dividends (unfortunately the US still has double taxation of dividends instead). Margin also allows you to short either to hedge your long holdings or to speculate which should be done cautiously. At the moment I am using little and fluctuating margin depending on what trades I am doing. Soros' model was to invest one's net worth in longer term investments and then borrow a little against it to trade which is roughly what I am doing at the moment.

However, if the market should crash I would then have a lot of reserve firepower to buy stocks cheap... that is something to think about. You don't have to use a margin facility just because you have it.

What I certainly will do then is move most of my mutual funds and retirement funds from the bond dominated diversified funds they are currently in to a fund called CFS Geared Share Fund which is a leveraged stock fund. Rydex provides somewhat similar products in the US. The difference is the CFS fund is actively managed and Rydex is an index product.

3 comments:

StealthBucks said...

Leverage is not bad and I guess I was too generic. I use levered closed end funds all the time but that kind of takes the risk off my back and on to the hopefully competent management team. I also have margin on the family taxable accounts and am not afraid to use it for very short periods of time. Sorry if I offended. I just think levering up is pretty brutal and not well understood.

mOOm said...

OK - you said you abhorred margin. I agree most people don't understand it one way or the other either they are naively optimistic about it or overly fearful of it. Or just plain don't know it can be done... Someone else posted that I should stop gambling with margin and options and buy real estate. That person didn't have their net worth posted... As I hear calls for non-citizens to be banned from buying US real estate that certainly gets me thinking... Real estate is in my mix but just a few percent held through financial instruments. My Mom too only has 5% of her net worth in real estate - her apartment... We are still waiting for a second payment on the real estate our family owned in Eastern Germany before the Second World War. A couple of months back we got our first payout... So our family isn't too keen on being very undiversified in real estate....

StealthBucks said...

In short, real estate is A LOT of work. Great personal gain in real estate is almost entirely based on leverage. OK, the last few years in most U.S. markets it's been like shooting fish in a barrel but I was around when L.A. and Orange County went down 35%. I have friends who were foreclosed on and sprinted out of the state. At this point in the game, I'd stick with the devil you know (investments) and avoid the one you and or we don't. Finally, as I have written, I'm not much of a Tech guy but I have a personal mentor who (and I kid you not) has manually charted multiple indicators for 50 years. I listen to him and absorb but do not always act. :-) Good luck

Finally, I don't care who owns the house next to me. I kind of like the diversity and wouldn't mind hoisting a real Aussie Beer (not all the export crap) with a good steak. I kind of liked Victoria Bitter in it's time at a Hotel pub on the harbor in Sydney. Feels like yesterday....