Folly or fortitude?

[BIRMANBOY]

How do other investors view a strategy of borrowing from the bank to fund share purchases? On another thread I read someone had borrowed several hundred thousand (mortgage on their home) )to buy shares. To me this just seems so foolhardy and risky. The purchase was for a relatively new entrant but is not a speculative share and does pay a decent dividend so I can see why they have done it but I don't see that this strategy as being something I would ever try myself or recommend as being part of an investment regime. How many others have had success (or failure) doing this? I/m not expecting many to fess up but somewhat curious.. I mean the margin of profit cannot be much between mortgage and returns from dividends so I can see how you could be consequently left very exposed in a downward or sluggish market. Seems very close to gambling to me?

[zb3]

Borrowing to invest at nz mortgage rates isn't wise, esp for individual stocks. However while young, borrowing at better rates and investing in widely diversified etfs actually reduces risk over time.

[BIRMANBOY]

I'm not sure I agree with you however I suppose it depends on what rates you can borrow at, what returns you get and of course whether the margin of difference is worth the risk. I suppose a mathematical study could do a theoretical sample of its effectiveness but I just don't believe that borrowing to invest is what they had in mind when the term "investment" was coined. Somehow seems contradictory in concept. But then I aint young..maybe that's my problem.

Borrowing to invest at nz mortgage rates isn't wise, esp for individual stocks. However while young, borrowing at better rates and investing in widely diversified etfs actually reduces risk over time.

[zb3]

I'm not sure I agree with you however I suppose it depends on what rates you can borrow at, what returns you get and of course whether the margin of difference is worth the risk. I suppose a mathematical study could do a theoretical sample of its effectiveness but I just don't believe that borrowing to invest is what they had in mind when the term "investment" was coined. Somehow seems contradictory in concept. But then I aint young..maybe that's my problem.

There has been research done that shows that low levels of leverage are prudent even into your early 50s. There is a correlation between returns on asset classes but no correlation between returns of different years. In order to achieve the best chance of success basic probability says you want to have the same amount invested in the stock market every year, otherwise the years where you have larger amounts invested (ie when you're older) will dominate your payoff. If the stock market performs badly in these years your return will end up far lower. Through leveraging while young you better spread your risk over time, and can ramp down your equity exposure closer to retirement. Employing such a strategy actually reduces volatility of expected outcomes. Check out the book lifecycle investing by Ian ayres and Barry nalebuff if you are interested. It's a very interesting read and will totally change your perspective on leverage.

[BIRMANBOY]

Totally change my perspective huh...I shall certainly look forward to that ..not. However always like a good read so will check it out. Thanks.

There has been research done that shows that low levels of leverage are prudent even into your early 50s. There is a correlation between returns on asset classes but no correlation between returns of different years. In order to achieve the best chance of success basic probability says you want to have the same amount invested in the stock market every year, otherwise the years where you have larger amounts invested (ie when you're older) will dominate your payoff. If the stock market performs badly in these years your return will end up far lower. Through leveraging while young you better spread your risk over time, and can ramp down your equity exposure closer to retirement. Employing such a strategy actually reduces volatility of expected outcomes. Check out the book lifecycle investing by Ian ayres and Barry nalebuff if you are interested. It's a very interesting read and will totally change your perspective on leverage.

[Harvey Specter]

I have a margin lending account from ASB (less than 20% of investments) which varies from 0-100% drawn down, and also a small loan secured over my PPOR (less than 20% of investments) which is fully drawn (this is a legacy loan from a rental property which I sold but didn't have to repay as the security was over the PPOR, not the rental). I am happy with less than 30% gearing.

The margin lending account is floating rate +50bp and the small loan is floating rate -75bp. By having the margin account, I do get a free nominee service from ASB (not sure if it is more hassle than doing it myself). Due to the difference in interest rates, I keep the margin account as low as possible.

I have a lot of stable yield stocks (power co's etc) and a bit of growth. I monitor to ensure my return on the portfolio is greater than the interest rate.

[Biscuit]

I think for most people, you cannot get rich without borrowing. Most of us initially borrow for property and get ahead that way as there is probably less volatility in property and you are less likely to end up jumping out the 8th floor window in despair when everything goes South. I've bought shares effectively on debt using property as collateral, when the opportunity was too good to miss, but don't need or want to now. I wouldn't borrow anything I couldn't easily afford to lose.

[Harvey Specter]

I think for most people, you cannot get rich without borrowing. Most of us initially borrow for property and get ahead that way as there is probably less volatility in property and you are less likely to end up jumping out the 8th floor window in despair when everything goes South. I've bought shares effectively on debt using property as collateral, when the opportunity was too good to miss, but don't need or want to now. I wouldn't borrow anything I couldn't easily afford to lose.

Agree.

I wouldn't say property has less volatility, just less visibility. Property is very illiquid so I'd say its volatility is much higher, you just cant see it.

Thats one think I am trying to do with my investing. In the past, I wouldn't cut my losses early. If you are borrowing money to invest, you cant afford to hold on waiting for a stock to recover. Even if you have to buy back a year later at (say) 5% higher than what you can sell it for today, you are still in the money due to the interest saved.

[Biscuit]

Agree.

I wouldn't say property has less volatility, just less visibility. Property is very illiquid so I'd say its volatility is much higher, you just cant see it.

There may be truth in that. A diversified portfolio of shares may have less volatility than an undiversified property investment. The bank would probably see the later as less risky than the former, so borrowing may be easier and cheaper.

[fungus pudding]

Agree.

I wouldn't say property has less volatility, just less visibility. Property is very illiquid so I'd say its volatility is much higher, you just cant see it.

Sort of. With property when things are tight listings dry up, so less supply keeps prices up to some extent. Would be sellers wait for better times. When the market recovers - boom - along come the vendors. The same thing happens of course with stocks, but to a far lesser degree. Many novice investors just bail according to a broker I know, and that compounds or heightens drops. That rush to all get out at once is far less likely with real estate.