When it hits the fan!

[yadreamin]

There seems to be a lot of investors who have geared up to purchase shares/managed funds.Margin loans seem to be popular.
Does anyone buy shares/managed funds with cash?
Now the share market has crashed and inevitable will again.
[sorry don,t know when].
My query is when there is a crash, what happens to those who have borrowed to buy? [heavily]
Do they loose the lot!!
If your ppor or an ip has been used as security is that under threat as well?
It appears that after a fairly big crash it can take years for the market to recover, at least with ips you still have rent to help cover the payments.
What do investors do to protect themselves from such big losses? or any loss for that matter.
I am trying to learn about this type if investing,l dare say it is not for the faint hearted.
Look forward to your replies
cheers yadreamin

[Simon]

If the value of someones portfolio drops below a specified amount the margin lenders may ask that more equity be produced as cash or more shares or that some share be sold to reduce the loan.

It would be very unlikely that a person loses the lot. Esp as margin lenders usually only lend against solid shares.

Worst case is that someone could lose a large chunk of their portfolio if a crash was enormously severe and they were heavily geared.

In order to reduce severity of crashes stock exchanges can be closed to find time for people to think rationally as happened in New York after 9/11.

If you use your PPOR as security and the gearing is high then you may be at threat as well. Those who borrow $100K to buy shares against their home loan with a standard mortgage are fine - you can use those funds for a holiday or whatever, however if you give property security to a margin lender and gear heavily then there can be some risk.

Selling down quickly can reduce that exposure or hedging etc.

I have a margin loan and I try to stick to about 50% gearing with my shares. I also have other shares I can offer as security should I need to. The market would have to drop an amazing amount for me to lose the lot - as long as I watch it go down doing nothing. If I sell quickly then I can buy in later!

Crashes are followed by.........

You fill in the blank :)

Margin lending is very very similar to IP investing. In the perspective of your question I think the major difference is that once an IP is bought the lender doesn't value it again whilst shares are valued every second of the trading day. This gives some additional risk but also some fantastic opportunities. I like to explain that an IP or a portfolio of shares are both a money box that can be pos or negative geared. Both yielding a similar amount, both having tax benefits and both having capital gain potential.

I think an educated investor needs to understand what is available and then choose whatever suits. Well done on you for doing some research.

Cheers,

[RichardC]

There seems to be a lot of investors who have geared up to purchase shares/managed funds.Margin loans seem to be popular.
Does anyone buy shares/managed funds with cash?
What makes you say "a lot"? Margin loans are used by a number of investors, it is true, but have you any evidence that there are many of them or that they are "maxed out"?

Now the share market has crashed and inevitable will again.
[sorry don,t know when].
Do you have any evidence that it will be in my lifetime? Remember, in the long run we are all dead. Remember also that those who think there will be a property crash probably exited the market three years early and missed most of the gains.

My query is when there is a crash, what happens to those who have borrowed to buy? [heavily]
Do they loose the lot!!
Changing "when" to "if... in my lifetime" most investors will suffer an annoying paper loss and a few will find a particular stock may fail but remember an "investor" diversifies. Even those on margin would normally stay below their max and lenders give a 10% buffer.

If your ppor or an ip has been used as security is that under threat as well?
Who is this madman?

It appears that after a fairly big crash it can take years for the market to recover, at least with ips you still have rent to help cover the payments.
Those shares that margin lenders recognise all pay divs, most fully franked and some with 5% return WITH NO PM's, RATES, INSURANCE, DAMAGE or TENANTS so the gross is also the net. Why is a share investor at more risk than a property investor?

What do investors do to protect themselves from such big losses? or any loss for that matter.
Through careful stock selection, keeping abreast of world economics and diversification there will be no big losses. What's left is managable.

I am trying to learn about this type if investing,l dare say it is not for the faint hearted.
Look forward to your replies
cheers yadreamin
Why not for the faint hearted? I can assure you I don't have big cojones but find share investing both fun and profitable.

To believe, as you seem to do, that shares are risky and property is safe is a Somersoft myth. Just because we have not seen a bank make a "call" on a property loan that is underwater, doesn't mean it can't happen. If we reverse this argument and speak of a property crash how many could survive if their bank did indeed insist on you maintaining a +ve LVR?

The big risk here is total economic destruction of the individual, and it could happen with a 25% "crash". A100% crash of my chare portfolio would just mean I've got to go back working harder.

[vandalic]

Great posts RichardC and Simon. Just a few follow on comments I wanted to add regarding shares.

I am a long-term share investor who has only just starting learning about the detailed aspects of property investment over the last 12 months.

I think like every aspect of investing, their is risks of investing in shares. Although, if you have a solid strategy based on sound logic and experience of others you should do well both in shares and property. I personally have followed the share investing techniques of Warren Buffett (world's 2nd richest man), George Soros and Benjamin Graham for a number of years, with limited worry about losing my money. If you buy any investment, based of both solid quantitative and qualititative critiera, in the long-term it should reward you kindly.

Just a quick high-level run down on shares in terms of a long-term holding position. When you buy shares you are literally buying a part of that company. If you are buying into a company which has a long track record of solid finanical and strategic growth (earnings per share, dividends per share, return on capital, return on equity, sufficient Net Profit to Debt ratio levels, etc the list goes on) as well as solid business fundamentals such as competitive advantage (i.e. niche market, differentiated product/service or cost leadership) in the grand scheme of things there is minimal risk of losing your money. If there is a substantial crash in the market, as long as you continue to hold through the downturn, a solid investment will eventually bounce back.

Shares are regarded as a more liquid asset than property, so the ability to sell and buy quicker is a bonus.

Just to answer a few of your initial questions directly.

Does anyone buy shares/managed funds with cash?
Yes, I certainly do.

My query is when there is a crash, what happens to those who have borrowed to buy? What do investors do to protect themselves from such big losses? or any loss for that matter.
- You can insure your shares
- Dollar cost averaging
- Create a buffer around your shares by ensuring margin calls are less likely to be called by borrowing say 15-20% less than your maximum leverage.
- Not all shares will crash to the same degree - a mixed portfolio will help - i.e. retail, mining, banking, etc.

I hope this overcomes a bit of your risk concern yadreamin. If you would like me to recommend some reading material let me know.

Josh

[yadreamin]

Thankyou Simon and Richard C
Both of you have answered my questions and given me more questions to find answers to.!!!
RichardC you are obviuosly someone who knows the share game well.Good on you.
I am just starting to learn it. Well trying anyway.The few books l have read or tried to read on the subject are hard to follow for a beginner.
Getting my head around margin loans and borrowing for the shares/managed funds seems to be my stumbling block.
Borrowing for bricks and mortar l am used too and understand reasonable well.Still always something to learn.
RichardC if one doesnt use their ppor or an ip for security to buy/borrow shares what do they use?

I read this highlighted paragraph in Peter Spanns book.


How to Build a 10 Million Property Portfolio in just 10 Years.
"A well run commercial property trust can generate a positive cash flow, but more exciting, it can fund any cash flow negative amounts from investing in prime property.For example, if you were to purchase a $200,000 investment property for the cost of $35 per week, it would take an additional investment of just $15,000 in a diversified range of commercial property trust averaging 12% yield per annum to fully fund that negative cash flow."

This idea what l am trying to educate myself on.As l have -cf ips l am exploring avenues on how to fund these.Would this idea work in todays share market and ip market?
Would you borrow the additional $15,000 againts the ip?
Or buy the shares outright with cash?

I am sorry if l sound ignorant in this thread but l have L plates on with this.

Simon, you say if the value of the shares start to fall you sell out to buy in later.To do this, you would have to watch the markets pretty closely?

This thread really isn,t about shares its about finding or learning of a way to offset the cost of holding -ips.
Looking forward to your replies
cheers yadreamin

[yadreamin]

Thankyou Josh.
Your explanations were easy to follow.Great! [l am on L plates here]
I would really apreciate your sugestions of some reading material.
With everything "online" these days does anyone still use a broker to do their share trading?
cheers yadreamin

[Mark Laszczuk]

yadreamin',

First off, don't ever apologise for coming across as a 'learner' we were all there at one point - as you were with property. You're more courageous than most, in that 'you know what you don't know' and are willing to ask the questions you want answered. Success is indeed fairly assured for you, I reckon.

Anyway, I don't know a whole lot about shares myself, but I have read a few books. Those being 'The Warren Buffett Way' (read this probably five times now) and 'Buffettology'. I've read a number of others, but these two are the ones I found very easy to follow and understand.

Personally, I have zero interest in trading shares myself. I am happy giving my money to the pro's who invest it with zero emotion. If you're looking for income from shares, there are plenty of funds out there that perform reasonably well, just gotta do your research (assuming you don't wish to trade yourself).

Let me give you a bit of perspective re: margin loans. Let's take the example of Company X. Jim's Margin Lending has researched Company X and they are happy with the company, so they decide they will lend up to 70% total LVR. Let's say you take a margin loan of the full 70%. The stock would have to fall approximately 9% before there was a margin call.

Let's say though that you're a fairly conservative investor. So you only lend up to 50% LVR. That stock would then have to fall approximately 33% before a margin call was raised. So the figures might look scary to the untrained eye, but if you plan ahead, then you should be fairly safe.

Note also that for a fund or share to get a 70% LVR it needs to have a pretty good track record.

Mark

[RichardC]

Yad, I can't offer you much except that it ain't rocket science, but that it is very different to property.

This is not the forum for shares and you may get a better perspective from ,,, http://www.aussiestockforums.com/ ,,,, which is low key with patient posters as here. Don't even think about Hotcopper till you know more than you do now.

The best beginners advice I can give is NOT to play with borrowed money. By this I am definately not saying to pay off all your debts before buying your first shares just find some "lazy" dollars. This means that, by necessity, you start small.

I first bought some Simpson shares (remember washers?) in the '60s and it came to nought. I didn't have any cash to invest in the Posiedon boom but bought Ariadne shares halfway down the '87 crash. In the '90s I did OK with industrial stocks till I came unstuck with ERG. I worked at it though and made back the 10 big ones I lost. (Great learning experience but wasted a couple of yrs) I'm still not a good trader and tend to hold losers too long and even sometimes average down but I am now playing with 50% their money (no excuse to be reckless). I am trading over 100k of stock (our savings go into the pot too) and hope to have half a mil when I retire.

Here's the rub. Half a mill is a deposit in real estate but actively traded/invested in the market, it might be able to maintain my modest lifestyle. By then I may have a margin a/c but at the moment it is ZERO.

I have bared my soul this way simply as an example. A more determined investor could/should compress the time line by decades. Good investing.

ps. To be fair to me, the web is what makes it all possible and was not around for most of my life.

[The Y-man]

How to Build a 10 Million Property Portfolio in just 10 Years.
"A well run commercial property trust can generate a positive cash flow, but more exciting, it can fund any cash flow negative amounts from investing in prime property.For example, if you were to purchase a $200,000 investment property for the cost of $35 per week, it would take an additional investment of just $15,000 in a diversified range of commercial property trust averaging 12% yield per annum to fully fund that negative cash flow."

This idea what l am trying to educate myself on.As l have -cf ips l am exploring avenues on how to fund these.Would this idea work in todays share market and ip market?
Would you borrow the additional $15,000 againts the ip?
Or buy the shares outright with cash?

cheers yadreamin

Hi There,

Just curious how you managed to link the concept of Commercial Property Trusts to share markets?

While it is true that you can buy some trusts on the stock exchange (called Listed Property Trusts) and through fund managers, they are generally a differently behaving beast to shares and share based managed funds.

Cheers,

The Y-man

[The Y-man]

What do investors do to protect themselves from such big losses? or any loss for that matter.


I agree with RichardC - diversification has worked for us (yes, yes, I know WB said to put all your eggs in one basket!!)

I've always been a bit of a diversification fan (fund managers must love me!).

To give you some idea, at present, our investments contain:
1. Residential property - -cf, cap growth types
2. Commercial Property Trusts - +cf, not much CG types
3. Share based funds - "Income type"
4. Share based funds - CG type
5. Share based funds - index
6. Direct shares - for trading
7. Gold
8. Hedge/Non-correlated Funds

Our main thinking was "When one market is quiet, generally something else is moving".

Note there is no "cash" - other than basic transactions, we hold very little cash at present due to performance in other markets. We were fully intending to hold a cash buffer reserve for "emergencies" but we ended up buying gold instead (after a mention by our financial planner last year).


Oh, and as to the question of when you have borrowed heavily to buy shares (which we have) and the market goes down? If you're a nutter like me, you borrow more and hope for the best :D

Cheers,

The Y-man

[vandalic]

Your last comment about buying more is exactly the train of thought that has served me well with shares for years Y-man. Funnily enough people do still buy when prices are high, which if you related to retail may suggest they'd rather buy clothes at full price then go in season sales :D

[topcropper]

G'day Yadreamin.

You say,

"Now the share market has crashed."

Umm, no it hasn't crashed. It did drop by 4% in 2 days here over a month ago. It dropped by nearly 10% in April/May. But it's nearly at all time highs again. These are just normal fluctuations with shares. You just have to get used to it, or if your clever, profit from it.

One thing your forgeting, in a big crash, generally the dividends stay the same. In October 1987, when the share market was terribly expensive, shares were probably only paying a 2% or 3% dividend. The market halved in just a few weeks. Remember, the dividend stayed the same, but for an investor buying in after the lows, the investor would be getting double the yield. It's just like Sydney property now. As prices drop, the yield gets better.

The other noteable crash was the tech crash in April 2000. Tech shares just about disappeared, but anyone holding "old economy' profitable companys, weren't effected. For example, in April 2000,

Woolworths..... was $4.80 in April, $7.70 at end of 2000, and now $17.
BHP..............., was $8.90 in April, $9.50 at end of 2000, now $21.50
Commonwealth, was $22.50 in April, $31.60 at end of 2000, now $42.


These companys have all payed increasing dividends along the way. I've picked some gems here. What about the dogs? Well two companys who did badly were Newscorp and Telstra, but these were caught up in all the silly hype. They were regarded as high tech growth stocks.

Newscorp, was $56, and is now about $20. But in April 2000, it was trading at about 80 times earnings. Thats crazy!

Telstra, was $9, and now just above $4. But in April 2000, it was trading at 26 times earnings.
The really interesting thing about Telstra, is that it's earnings now are higher than in April 2000. 29c per share, verses 35c now. The difference is that Telstra is now valued as a boring utility, rather than as an exciting growth stock.

edit in...[actually News corp is the same. Newscorp was earning less per share in 2000, than now, despite the shares more than halving]


I have a level of gearing that varies between 30% and 50%. Nearly all my stocks pay a good dividend. The only one's that don't are some oil companies that are not yet making cash, and my BHP and RIO's. These two companies choose not to pay a big dividend, but they could pay a huge dividend if they wanted to.

My average dividend yield, even including the no or low payers would be nearly 5% fully franked. That's at current prices. The dividend is much higher at my purchase prices. The dividend from all my shares easily pay for my borrowings. So they pay for themselves. In March 2003, when shares were very very cheap, it was possible to positively gear into quality companies, and I did this myself. I will stay invested in shares while I think they have value. Currently I think shares are much better value than property, but that's just my opinion. Property is the better method of wealth creation due to much higher, safer gearing levels.

I've said on this forum that I've been heavily into resouces and energy. Well, I still am overweight in those sectors, but not as much as before. I've cut some riskier smaller companies, used some stop losses, and bought up the blue chips, including banks.

See ya's.

[vandalic]

Just to clarify on dividends for yadreamin's benefit, from the opposite side of thinking.

It's not always a good thing if a company is paying a large dividend. The main purpose of shareholder equity is to help grow and expand a business, alongside net profit generated by business activities. A strong net profit may not necessarily mean larger dividends for the shareholders. If the company believes it can provide shareholder's sufficient capital gain through the share price by keeping more of business equity for acquisitions, investments, expansion activites, etc it will pay a smaller dividend. Westfield comes to mind.

Consequently, you will find some 'rocky' companies paying large dividends to try and entice shareholders in the short-term, whilst the underlying long term sustainability of those companies usually suffers.

PS Rio Tinto shares will be helping your portfolio nicely ;) I picked up a large sum of Aristocrat shares in the $1 days.

Josh

G'day Yadreamin.

You say,

"Now the share market has crashed."

Umm, no it hasn't crashed. It did drop by 4% in 2 days here over a month ago. It dropped by nearly 10% in April/May. But it's nearly at all time highs again. These are just normal fluctuations with shares. You just have to get used to it, or if your clever, profit from it.

One thing your forgeting, in a big crash, generally the dividends stay the same. In October 1987, when the share market was terribly expensive, shares were probably only paying a 2% or 3% dividend. The market halved in just a few weeks. Remember, the dividend stayed the same, but for an investor buying in after the lows, the investor would be getting double the yield. It's just like Sydney property now. As prices drop, the yield gets better.

The other noteable crash was the tech crash in April 2000. Tech shares just about disappeared, but anyone holding "old economy' profitable companys, weren't effected. For example, in April 2000,

Woolworths..... was $4.80 in April, $7.70 at end of 2000, and now $17.
BHP..............., was $8.90 in April, $9.50 at end of 2000, now $21.50
Commonwealth, was $22.50 in April, $31.60 at end of 2000, now $42.


These companys have all payed increasing dividends along the way. I've picked some gems here. What about the dogs? Well two companys who did badly were Newscorp and Telstra, but these were caught up in all the silly hype. They were regarded as high tech growth stocks.

Newscorp, was $56, and is now about $20. But in April 2000, it was trading at about 80 times earnings. Thats crazy!

Telstra, was $9, and now just above $4. But in April 2000, it was trading at 26 times earnings.
The really interesting thing about Telstra, is that it's earnings now are higher than in April 2000. 29c per share, verses 35c now. The difference is that Telstra is now valued as a boring utility, rather than as an exciting growth stock.


I have a level of gearing that varies between 20% and 50%. Nearly all my stocks pay a good dividend. The only one's that don't are some oil companies that are not yet making cash, and my BHP and RIO's. These two companies choose not to pay a big dividend, but they could pay a huge dividend if they wanted to.

My average dividend yield, even including the no or low payers would be nearly 5% fully franked. That's at current prices. The dividend is much higher at my purchase prices. The dividend from all my shares easily pay for my borrowings. So they pay for themselves. In March 2003, when shares were very very cheap, it was possible to positively gear into quality companies, and I did this myself. I will stay invested in shares while I think they have value. Currently I think shares are much better value than property, but that's just my opinion. Property is the better method of wealth creation due to much higher, safer gearing levels.

I've said on this forum that I've been heavily into resouces and energy. Well, I still am overweight in those sectors, but not as much as before. I've cut some riskier smaller companies, used some stop losses, and bought up the blue chips, including banks.

See ya's.

[Twitch]

How to Build a 10 Million Property Portfolio in just 10 Years.
"A well run commercial property trust can generate a positive cash flow, but more exciting, it can fund any cash flow negative amounts from investing in prime property.For example, if you were to purchase a $200,000 investment property for the cost of $35 per week, it would take an additional investment of just $15,000 in a diversified range of commercial property trust averaging 12% yield per annum to fully fund that negative cash flow."

This idea what l am trying to educate myself on.As l have -cf ips l am exploring avenues on how to fund these.Would this idea work in todays share market and ip market?
Would you borrow the additional $15,000 againts the ip?
Or buy the shares outright with cash?

In that example ,it was to buy the units with cash from your own pocket. A few of comments on that strategy:-
1) IMHO the idea is a good one, one that I've done (but not using LPTs)
2) that yield for a LPT is not realistic today
3) you don't have to use LPTs, instead you can use income share funds (eg Navra)
4) you can still borrow and implement the strategy, it's just that you need more than $15k worth. For example, say you needed $3k per year to cover a shortfall, and you thought that the Navra income fund would deliver 10% income, and your borrowing costs were 6.5%. This means using 100% borrowing, you would need to borrow $3,000 / (0.1 - 0.065) = $85,714

[ren-A]

Filtering & analysis software based on Buffett filters by a Professor of Maths & Finance from Sydney Uni:

www.conscious-investor.com

A readling list, plus commentary of share strategies:

http://www.travismorien.com/FAQ/main.htm

and a personal recommendation would be "Motivated Money" by Peter Thornhill. It emphasises buying industrial shares for their dividends, available from:

http://www.motivatedmoney.com.au/

Enjoy!
:)

[yadreamin]

Thanks for the replies so far.All interesting and food for thought.Thankyou

Firstly what l should have originally typed
The share Market has crashed BEFORE and inevitable will again.

mdk92 l don,t follow yours maths at the end of your post could you please explain it for me.
are you saying l would only need to borrow 3k to earn 3k from say Navra at 10% income?
I see there is another thread started on making up the short fall of -ips, while l am reading/learning on income funds l will keep a close eye on that.

The Y-man
I thought commercial property trusts were linked to the share market.See l have learnt something already Thankyou.
Anyway thanks for the replies l am learning even if it is s-l-o-w-l-y.
Cheers yadreamin

[Twitch]

mdk92 l don,t follow yours maths at the end of your post could you please explain it for me.
are you saying l would only need to borrow 3k to earn 3k from say Navra at 10% income?

You need to borrow $85,714 to generate $3,000 a year given the return (10%) and cost (6.5%) I used.

amt_to_borrow = cash_needed / (income_return - borrowing_cost)

So ...
$85,714 = 3000 / (0.1 - 0.065)

[yadreamin]

You need to borrow $85,714 to generate $3,000 a year given the return (10%) and cost (6.5%) I used.

amt_to_borrow = cash_needed / (income_return - borrowing_cost)

So ...
$85,714 = 3000 / (0.1 - 0.065)


Thanks mdk92
That paints a different picture.
But l am sure it is better than a lot of funds out there.
cheers yadreamin

[Mark Laszczuk]

yadreamin',

Keep in mind, that's at 10%. If the fund does better than that, then the erturn is better also. Keep in mind that if the fund does less than 10% well, you could find yourself out of pocket.

Mark

[MichaelW]

Mark,

As you and others over at InvestEd would know, I've taken a leveraged position in Navra. I've got $560K in there, of which $310K is a LOC on my PPOR and $250K is leveraged through LE. My holding costs on those funds is about $40K pa at about 7.1% being a mix of the interest rates on the two loans.

My leveraging is under 50% so the risk of a margin call is much reduced. If the fund returns 10% pa then I make about 3% profit on my investment. This works out to be about $17K more towards paying off my PPOR. Now, if the fund does 20% as it did last year, then that's about 13% profit or an additional $73K odd towards paying down my PPOR debt.

There's always the risk of downside, but Steve's approach to my mind mitigates this well by his blue chip stock selection and trading methodology.

Cheers,
Michael.

[The Y-man]

The Y-man
I thought commercial property trusts were linked to the share market.

They are indirectly linked in that, when the share market is doing well, this is a sign that businesses are doing well, and as a result commercial prpoerty rentals do well.

A good commercial property manager tries to get long term tenants who may not be hit as badly by market (and economic) downturns - eg. Government Dept, Government owned companies, etc.

Cheers,

The Y-man