Leveraging + Geared Funds

Anyone here invest by leveraging into a high growth managed fund or chosen a dozen of their own stocks.

I'm thinking of investing $30,000 with a $70,000 loan.

If I choose this option rather than buy an ip, which atm I think I'll struggle to afford plus also sanf. In 10 years after building up some capital and I will also have a higher income too, I would then get into property.

Here is one example

ANZ OA - VANGUARD AUSTRALIAN SHARES INDEX

Kim5 said:

Anyone here invest by leveraging into a high growth managed fund or chosen a dozen of their own stocks.

I'm thinking of investing $30,000 with a $70,000 loan.

If I choose this option rather than buy an ip, which atm I think I'll struggle to afford plus also sanf. In 10 years after building up some capital and I will also have a higher income too, I would then get into property.

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I'm assuming you're talking about external gearing such as margin lending. The only problem in the current credit environment with this strategy is with 10.5% average margin lending risk, your underlying asset will need to perform better than this on a total return basis (income + capital) for you to be ahead. A year that gives you 5% means you will need 16% the following year just to break even.

Ask yourself are the risks justified? Keeping in mind that fund fees are not cheap which means your assets have to work that much harder. Plus price growth in general will be limited in itself because the credit markets have pretty much seized up. Businesses trying to grow and expand rely on cheap funding to generate healthy internal returns. Growing organically is the old fashion tortoise way. Hard pill to swallow for CEOs who are used to being the hare...

If you are serious about this, invest in a chart program or use those on the ASX site (there are other freebees) and look how things are going first. (My chart program is always running on one of my 'puters.) You may be surprised at just how bad things look, especially my pet hate, the banks.

Then do a search here on Taleb or black swan and read some of my thoughts on risk, you may decide this is not really the time to be brave.

But 70% leverage is too high anyway and if you are thinking of stocks such as the banks, WOW, HVN, LLC, PBL, AMP etc then buy a fund, preferably an international one. I may be able to put a portfolio together which would do OK but BHP/RIO, WPL and AGL might be the only household names on it. Others would include conventional and alternate energy, drill rig services, established junior miners and other smaller sectors. (But I haven't done too good recently. ) You won't be offered 70% leverage on these.

Me? I reckon I should pull money out of investments and put it in my business and only because it is a "safe" one. I am just not "sure" of anything now.

asdf said:

I'm assuming you're talking about external gearing such as margin lending. The only problem in the current credit environment with this strategy is with 10.5% average margin lending risk, your underlying asset will need to perform better than this on a total return basis (income + capital) for you to be ahead. A year that gives you 5% means you will need 16% the following year just to break even.

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Yep margin lending

Yes I understand that, but I'm talking about a long term investment (at least 10 years) the short term volatility is not too much of a factor. I am looking to average around at least 15% pa calculated over the 10 years.

I see your point about the credit climate. Perhaps it would be better to save for another year so that I have $70,000 in the bank. Then go with a 50 - 50 LVG. Buy $50,000 with my money and get a margin loan of $50,000

I'll ensure I have a $20,000 buffer to allow for margin calls, higher IR and other general life expenses.


How does it work??

For instance say the Interest Rate for the margin loan is 9% and I have a $50,000 loan.

Does that mean I pay $4500 a year in interest for the loan?
$375 a month I think I could afford.


What other expenses will I have to factor in?

I can think of Margin calls, Interest Rate rises, management expenses (I wander what I would have to outlay in managers fees)

Is there anything else I have missed?

Ask yourself are the risks justified? Keeping in mind that fund fees are not cheap which means your assets have to work that much harder. Plus price growth in general will be limited in itself because the credit markets have pretty much seized up. Businesses trying to grow and expand rely on cheap funding to generate healthy internal returns. Growing organically is the old fashion tortoise way. Hard pill to swallow for CEOs who are used to being the hare...

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To lower the management costs perhaps index funds are the way to go then. I have read that most funds perform at the same level anyhow, especially the large organisations. Index funds over the long term do pretty well.

Kim5 said:

Yep margin lending

Yes I understand that, but I'm talking about a long term investment (at least 10 years) the short term volatility is not too much of a factor.

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Kim, I'm trying to say this nicely, but you look ill prepared for this. It doesn't matter how long your time span is, your margin lender's is 24hrs max. Will do intra-day calls in volatile times.

"The market can stay illogical longer than you can stay solvent."

The XAO fell from 6873 peak last year to 5222 on Jan 22 this year. By then you would have a call for $25k cash on $100k of index funds. (extreme case, I know) (BTW I've never done this calc before so I'm doing it on the fly) but you only have 30% equity so divide the $25k by 30% and you will get $3k cash for every $10k being sold so you need to sell $80k to meet your obligations. IE you have a $20k portfolio with $6k of your original $30k left. Now remember that if you lose 50% of your capital you must make 100% on the remainder to break even so the XAO would need to go to 25,000 before you break even ignoring interest. Allowing for that you may never get back to scratch in your life time, definitely wouldn't in inflation adjusted terms.

That is awkward, rough and taking recent data to the extreme but I think it shows how much damage leverage can do in a bear market. A 25% drop (happened just lately, worse in '87 ) can virtually wipe you out and 30% will do it. Your banker will not allow you to "ride it out".

Sunfish said:

Kim, I'm trying to say this nicely, but you look ill prepared for this. It doesn't matter how long your time span is, your margin lender's is 24hrs max. Will do intra-day calls in volatile times.

"The market can stay illogical longer than you can stay solvent."

The XAO fell from 6873 peak last year to 5222 on Jan 22 this year. By then you would have a call for $25k cash on $100k of index funds. (extreme case, I know) (BTW I've never done this calc before so I'm doing it on the fly) but you only have 30% equity so divide the $25k by 30% and you will get $3k cash for every $10k being sold so you need to sell $80k to meet your obligations. IE you have a $20k portfolio with $6k of your original $30k left. Now remember that if you lose 50% of your capital you must make 100% on the remainder to break even so the XAO would need to go to 25,000 before you break even ignoring interest. Allowing for that you may never get back to scratch in your life time, definitely wouldn't in inflation adjusted terms.

That is awkward, rough and taking recent data to the extreme but I think it shows how much damage leverage can do in a bear market. A 25% drop (happened just lately, worse in '87 ) can virtually wipe you out and 30% will do it. Your banker will not allow you to "ride it out".

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Yeah this is the stuff I need to hear. Yes I look ill prepared cos I am still learning.

Perhaps 30% LVG then

Sunfish said:

Kim, I'm trying to say this nicely, but you look ill prepared for this. It doesn't matter how long your time span is, your margin lender's is 24hrs max. Will do intra-day calls in volatile times.

"The market can stay illogical longer than you can stay solvent."

The XAO fell from 6873 peak last year to 5222 on Jan 22 this year. By then you would have a call for $25k cash on $100k of index funds. (extreme case, I know) (BTW I've never done this calc before so I'm doing it on the fly) but you only have 30% equity so divide the $25k by 30% and you will get $3k cash for every $10k being sold so you need to sell $80k to meet your obligations. IE you have a $20k portfolio with $6k of your original $30k left. Now remember that if you lose 50% of your capital you must make 100% on the remainder to break even so the XAO would need to go to 25,000 before you break even ignoring interest. Allowing for that you may never get back to scratch in your life time, definitely wouldn't in inflation adjusted terms.

That is awkward, rough and taking recent data to the extreme but I think it shows how much damage leverage can do in a bear market. A 25% drop (happened just lately, worse in '87 ) can virtually wipe you out and 30% will do it. Your banker will not allow you to "ride it out".

Click to expand...

I was at the casino once and watched Red come up 15 times in a row on roulete, when I would've bet a buck or six, that it was blacks turn each consecutive spin

Put the "doubling-up" system in perspective (I would've gone bust/Hit the table limit)

Kim5 said:

Is there anything else I have missed?

.

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Kim,

With your level of experience, you may wish to consider internally geared funds which will not open you to margin calls (the funds generally gear in a way that will pay their margin interest with dividend income)

Cheers,

The Y-man

The original poster changes her mind a lot!

Kim5 said:

Yeah this is the stuff I need to hear. Yes I look ill prepared cos I am still learning.

Perhaps 30% LVG then

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Kim,

I didn't have a lot of time to write this morning so a few more thoughts now:

I personally like shares as a means of growing your capital (especially over a 10 year time frame), and I also support the use of managed funds (hmmmm... starting to sound like a FP....)

My reasons: If you are a novice in the share market, get someone else to do it for you, until you figure it our for yourself. Don't just put you money with the fund manager and forget about it though - find out what they do - the shares they buy etc. Then you can learn about what/what not to do.

When we first started investing, I had jack idea about anything, so I put my money into a manged fund that sounded "safe" - capital guaranteed with a rising profit lock in etc. I must have been a bit lucky as well For your info, the $5,000 we put in, in 1997 is over $25,000 today (nothing added to that fund in the meantime). Now I am not for one minute suggesting this sort of performance can be repeated year in year out....but to me it was a starting point, and gave me an idea of how markets moved (and didn't move).

The really funny thing is, that over 10 years later, with lots of trading (we are talking buying and selling over $100,000 in a day), big margin loans (I had LVR's over 95% at one stage), and lots of pain in the past 12 months, I am going back to the managed funds I used right back at the start! Figure that out...... (well, the reason is simple - they outperformed me over the long term)

A few things I look for in managed funds (rightly or wrongly) - low or no entry fees (go thru a low/no fee broker), low or no exit fees.

Cheers,

The Y-man

The Y-man said:

The really funny thing is, that over 10 years later, with lots of trading (we are talking buying and selling over $100,000 in a day), big margin loans (I had LVR's over 95% at one stage), and lots of pain in the past 12 months, I am going back to the managed funds I used right back at the start! Figure that out...... (well, the reason is simple - they outperformed me over the long term)

A few things I look for in managed funds (rightly or wrongly) - low or no entry fees (go thru a low/no fee broker), low or no exit fees.

Cheers,

The Y-man

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Y-man,

Two words...index funds!

And props to Kim5 for suggesting this fund as an option at the start of the thread:

ANZ OA - VANGUARD AUSTRALIAN SHARES INDEX

Very wise choice actually, but most people only realise this in hindsight and after a lot of lost $.

JIT said:

Two words...index funds!
.

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I am just a bit concerned if Kim is going to jump into an index fund with leveraging, with no downside protection.

I have index funds ungeared and geared. Where they are geared, I have put options against them.... Also I am a bit of a diversification nut so it isn't just Australian indices I have money in either....

Cheers,

The Y-man

Put options make sense, or just be very conservative in your gearing.

I think 30% LVR seems fine...with 50% as an absolute max.

The Y-man said:

I am just a bit concerned if Kim is going to jump into an index fund with leveraging, with no downside protection.

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That was my concern too. In fact I think this is exactly the wrong time to be considering them at all, no matter how widely diversified.

There is a real likelihood that in five or less years the XAO, DAX, DOW and the FTSE will all be well down on today's price. As I also think property will do the same on many continents so investing has just become a lot harder. There will always be something going up but the days of the scatter gun are over.

Sunfish said:

That was my concern too. In fact I think this is exactly the wrong time to be considering them at all, no matter how widely diversified.

There is a real likelihood that in five or less years the XAO, DAX, DOW and the FTSE will all be well down on today's price. As I also think property will do the same on many continents so investing has just become a lot harder. There will always be something going up but the days of the scatter gun are over.

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I think you are overly pesimestic sunfish.

If you are buying shares with a solid yield base now, in large companies with a history of payout growth it will take a severe recession for this income stream to be reduced.

If there is a severe recession interest rates will be cut to very low levels and geared investment into the next cycle will look very attractive once more.

On what scenario do you see all major indices falling for the next 5 years?

Trogdor said:

I think you are overly pessimistic sunfish.

......

On what scenario do you see all major indices falling for the next 5 years?

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Maybe..... but I tend to agree with Sunfish. He didn't say how much it might fall by, but my gut feel is another 20% down on today's prices is a possiblity in the 5 year timeframe mentioned.....

Here's a "stab in the dark" scenario - a major hiccup in the Chinese economy (on their journey up and up)......

Cheers,

The Y-man

Sunfish said:

That was my concern too. In fact I think this is exactly the wrong time to be considering them at all, no matter how widely diversified.

.

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Agree. I won't be adding exclusively to index funds (except for my super) in the coming year. The managed funds I mentioned in my previous posts involve bonds, currency, oil, and gold.

I also see there are several soft commodities funds coming out (in view of rising agri product prices) with cap protection (and up to 100% gearing if you are game!) which I will consider.

Cheers,

The Y-man

I think you need to consider how you would react if the market fell further and you lose money. Some of the shares I have have lost 30% of their value, one has lost 80%. It's not a pleasant thing for a new investor to experience and when you have plans for your capital in the future, your instinct will be to preserve it. Just something to think about. Dallee

Trogdor said:

I think you are overly pesimestic (sic) sunfish.

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It is your right to disagree. But consider the responsibility to yourself and your family not to go down with the ship. You have an obligation to consider the future in more detail than simply accepting the two beliefs so common here: "Property doubles every 7-10 years" and "Man's intelligence and ingenuity will get us cheap energy again".

When things can't go on forever, they don't.