Author Topic: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...  (Read 4188 times)

Gregmal

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #10 on: December 14, 2017, 08:25:00 AM »
Anyone who's ever taken out a mortgage, a student loan, or even a credit card has utilized leverage. It all comes down to risk management.

Some other theoretical. I know plenty of people who own big real estate portfolios and as such have shitty liquidity positions. Is borrowing against the real estate to buy stock crazy? What about if you have 100k equity balance but are levered 3:1, owning 300k in a stock portfolio. But have 50% LTV on a 750k house, 50k in a checking account, and 100k invested in various small businesses? Do we apply what we consider leveraged to just the stock portfolio or one's entire net worth? In the case of net worth, said person is levered 2:1 on their house. Many might consider that, plus 3:1 on a stock portfolio, plus illiquid investments in local businesses to be very risky with only 50k cash on hand. I personally, would not consider that risky.

I think the biggest thing when discussing margin and/or leverage are understanding and being clear about the parameters in which it is being used.


s8019

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #11 on: December 14, 2017, 09:07:49 AM »
Some other theoretical. I know plenty of people who own big real estate portfolios and as such have shitty liquidity positions. Is borrowing against the real estate to buy stock crazy?

Well, I don't know. Probably it depends. If we are speaking about situations when houses became a financial asset (i.e. rreal estate market depends mainly on various forms of borrowing) it does not sound as a good idea. Obviously house prices may correlate with stock prices during credit cycle downturn. From the standpoint of risk management I would rather sell real estate right away to boost my investment capital. However it's just me, I'm paranoid about the downside.

skanjete

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #12 on: December 14, 2017, 09:18:13 AM »
For me, the main thing with using leverage is structuring the duration of your financing with your type of asset.

If you have a long term asset like stocks or RE, you finance it with long-term financing as well. This means that the financing cannot be callable under no circumstance before the date that has been agreed upon. I consider margin on stocks as being risky, but mortgaging your house on a fixed long term (25y) to finance the purchase of stocks is not really risky.

You cannot afford to finance RE or stocks with funds that are callable in a short term even under certain unlikely circumstances. Most of the people investing in RE or stocks who went broke by leverage violated this rule. Plenty of people got broke not because of bad investments but because of a liquidity problem.

Buffett used plenty of leverage in his carreer, but always respected this rule. In the partnership days, it was the LP capital he used as leverage and margin leverage (=short term) on special situations which had a defined term.
In Berkshire he uses float which is not callable, or long term bonds in Midamerican or long term written puts (derivatives) which also are not callable before strike date.


K2SO

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #13 on: December 14, 2017, 10:23:51 AM »
For me, the main thing with using leverage is structuring the duration of your financing with your type of asset.

This sums it up.
I wouldn't use leverage for a typical common stock investment. But for fixed income, or preferred shares, or a rental, or anything with stable, reasonably predictable income, I don't see why you wouldn't, provided you're comfortable with the additional risk it introduces.

Psychology plays a large role in this. Having been subject to margin calls in the past, I know how badly it can mess with your decision making process and confidence. Use of any kind of margin is dangerous for this very reason, but as long as it forces you to do more due diligence on the investment in question and implemented with a large enough margin of safety, I don't think it's a horrible thing.

oddballstocks

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #14 on: December 14, 2017, 11:20:46 AM »
The key to using leverage is being creative in how you get it.

I think the lowest rung on the totem pole is margin leverage from a brokerage.  They will give it to you regardless, but they extract a high price in return.  They can take ANY of your assets if you have a margin call, no excuses.

Having suppliers finance you, or customers is another form of leverage.  Or extending payables beyond receivables in your business.

I personally prefer operating leverage.  Build a product once, sell it multiple times.

It's worth noting that very few to no one has become really wealthy from investing alone.  If you want to become wealthy create a business.  You'll note Buffett's business was managing money, same with Munger.  You need cash to be flowing in that you can re-invest.  If you start out with $10k and try to become a millionaire it is a tough slog.  Much easier to convince a bunch of friends you're some genius, get $1m from them, tear 1% off the top and take 10% of their gains and call it a day.  That's a business where the product happens to be investing.
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nodnub

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #15 on: December 14, 2017, 11:41:12 AM »
For me, the main thing with using leverage is structuring the duration of your financing with your type of asset.

If you have a long term asset like stocks or RE, you finance it with long-term financing as well. This means that the financing cannot be callable under no circumstance before the date that has been agreed upon. I consider margin on stocks as being risky, but mortgaging your house on a fixed long term (25y) to finance the purchase of stocks is not really risky.

You cannot afford to finance RE or stocks with funds that are callable in a short term even under certain unlikely circumstances. Most of the people investing in RE or stocks who went broke by leverage violated this rule. Plenty of people got broke not because of bad investments but because of a liquidity problem.

Buffett used plenty of leverage in his carreer, but always respected this rule. In the partnership days, it was the LP capital he used as leverage and margin leverage (=short term) on special situations which had a defined term.
In Berkshire he uses float which is not callable, or long term bonds in Midamerican or long term written puts (derivatives) which also are not callable before strike date.

I agree with Skanjete's point:

"You cannot afford to finance RE or stocks with funds that are callable in a short term even under certain unlikely circumstances."

I recall that in 2008/2009 some people had the terms of their HELOCs changed or they had unused credit lines were frozen or reduced.  You might think you will have access to liquidity from such a source and then it disappears right when you need it most.  During a financial crisis, unlikely circumstances become more common :)
 
During 2008/2009 didn't the list of marginable securities change?
Didn't the margin requirements at the brokers also change?



Devils_Shadow

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #16 on: December 15, 2017, 01:20:59 AM »
While duration matching is important, optimal leverage is more a function of your hit rate+payoff. It's a non linear curve where at a certain leverage, your capital grows optimally. At a certain higher level, you lose the benefits of leverage (and start performing as an unlevered portfolio would) and at an even higher leverage level your expected outcome is negative (/go broke). Higher hit rate/payoff = higher optimal leverage.

benhacker

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #17 on: December 15, 2017, 04:37:05 AM »
My advice for listening to anyone’s opinion here is to only take advice from someone who is “pro-leverage” (however they define it), if they held that view/approach through a major recession.

If that is not satisfied, I believe you will get a lot of nice sounding opinions but with little real world practicality. I had sold a few (puts) during the last downtown and though the “leverage” was minimal I can assure you it made me quite uncomfortable.

I think personally leverage (of many types) can be quite wonderful. I do tend to agree with Nate though that short term, broker provided, callable leverage is probably the worst kind (although it is cheap).
« Last Edit: December 15, 2017, 11:13:42 AM by benhacker »
Ben Hacker
Beaverton, Oregon - USA

scorpioncapital

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #18 on: December 16, 2017, 01:17:33 PM »
In countries where taxes are high, and especially have capital gains taxes, I imagine leverage equal to the tax hit would make sense, say 25% or 30%. There are ,of courses, countries of residence that neither tax capital nor in some cases many types of income and there I would feel leverage is less necessary.

TwoCitiesCapital

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Re: Safe(-ish) Margin Leverage - Tell Me I'm Wrong...
« Reply #19 on: December 16, 2017, 02:46:11 PM »
There are those who have rightly pointed out about duration matching. This is important.
There are others who have rightly pointed out callable/non-callable leverage should be determined by asset volatility. Also important.
Something similar could be said for the use of recourse/non-recourse debt.

Lastly, I think the correlation of the asset with the liability/leverage matters quite a bit. When do margin loans go bad? Typically when the market/name don't perform well. So what is appropriate use broker margin for? Shorting stocks, buying puts, buying long-duration bonds, etc. Items that would tend to do well in the environment that you'd expect to be called against. These would act as a natural hedge to the type of environment you'd expect margin calls to go bad in.

Something similar could be said about housing leverage. A mortgage is a short-position in interest rates. If you opt for the cheaper leverage in the form of a floating rate, when rates rise - the value of liability you're short rises AND the value of the asset held as collateral drops. A terrible situation for many in 2008 leaving many insolvent. A fixed rate mortgage may be more appropriate simply because it acts a natural counterweight to the asset volatility allowing for individuals to carry a significantly higher amount of debt more safely.