# Conservative Margin Lending?



## thecaptain (25 October 2009)

Hi all,

This is my first post.  Great site - lots of good info!  

After a few years on the sideline im looking at getting back into the share market with (for the first time) a margin loan.  I'm looking for some feedback on my stratagy:

My investment 200k
Margin loan 300k
Total 500k 

500k to be split evenly between 10 shares (which will be various blue chip shares all having LVR's of 75% with CommSec)

My LVR would be 60% - pretty conservative i think.
I will have cash available to service loan if the market goes south.
And am planning on using dividents to offset some of the interest on the loan.

Any suggestions to my stratagy?


----------



## drsmith (25 October 2009)

thecaptain said:


> I will have cash available to service loan if the market goes south.



In what form is this cash and how much ?

Margin lending interest rates are higher than deposit rates so it is better to use this cash as well to purchase your $500k portfolio and borrow less.


----------



## thecaptain (25 October 2009)

drsmith said:


> In what form is this cash and how much ?




100k in a high interest savings account earning 5%.  However i plan to use this money on a separate investment (in property).  It's renovation money that will be gradually used over a 12month period.


----------



## So_Cynical (25 October 2009)

I wouldn't call at 40% equity / 60% debt strategy conservative, even if it is put into ASX 50 stocks.


----------



## Judd (25 October 2009)

thecaptain said:


> Hi all,
> 
> This is my first post.  Great site - lots of good info!
> 
> ...




I hate the acronym LVR when it comes to shares.  The margin lender has an LVR against shares which are on its approved security list.  You are gearing not LVRing.  And you propose to gear at 60%.  And you consider it is conservative.

Bear in mind that some people just before things went pear shaped for a bit "conservatively" geared at 50% against blue chip shares including the CBA and other high LVR shares.  They got a margin call.

Safety is not gearing above 20% and starting to sweat a little on how to get the gearing down if it reaches 30%.

But, but if you have cash to put in should things go south, you are not really geared to that extent in any event.

However, should you wish to be all hairy chested, tearing sheep balls off with your teeth, go for it.


----------



## drsmith (25 October 2009)

thecaptain said:


> 100k in a high interest savings account earning 5%.  However i plan to use this money on a separate investment (in property).  It's renovation money that will be gradually used over a 12month period.



In that case use it to purchase the shares and borrow $200k instead of $300k. This will reduce your overall gearing to 40% and your net interest cost.

You can then draw down the $100k from the margin lending facility as you renovate. Note however that once these funds are spent on property renovations (regardless of the starting point) they obviously cannot be applied to cover margin calls in a falling market.

Another point to consider is cashflow from all sources. If this is high relative to the interest on the loan then over time the loan will be paid down quicker and a higher initial gearing can be tolerated. I generally would not gear a margin facility beyond 30% and this is with cash flow from an alternative source such as salary income to reduce the loan over time.

If you have access to credit from equity in property this is a better source of borrowings as the interest rate is typically lower and you don't have to worry about margin calls in a falling market.


----------



## drsmith (25 October 2009)

Judd said:


> However, should you wish to be all hairy chested, tearing sheep balls off with your teeth, go for it.



Slightly off topic but as a lad in high school I can recall an ag-science teacher that did just that.

He slit the ball bag of a lamb with a knife and in turn popped each testicle out, bit it off and spat it out with military precision. 

I won't go into the details of a class mates attempt at it as that was, well, somewhat more gruesome.

I cannot confirm whether or not the teacher was hairy chested as he had a shirt on.

Sorry,
Back to normal transmission.


----------



## Knobby22 (25 October 2009)

drsmith said:


> Slightly off topic but as a lad in high school I can recall an ag-science teacher that did just that.
> 
> He slit the ball bag of a lamb with a knife and in turn popped each testicle out, bit it off and spat it out with military precision.
> 
> ...




Gross

Regarding margin calls, play railroad tycoon. It is amazing how you can lose your wealth quite quickly, I'm sure many felt the same thing during the latest crash.


----------



## geea (26 October 2009)

I'm in a very similar situation as to what you have asked about. I have a few more than 10 shares to share the load though. As long as you have access to $$$ in case things head south i reckon its a good strategy. All the interest is tax deductable which helps aswell.

Geea.


----------



## wayneL (26 October 2009)

1/Proposed gearing could be seen as conservative with a robust trend trading system with relatively lowish drawdown. 

2/On a buy and hold basis.... well, I would read Taleb first.

<edit to add - On second thoughts on point one, it's still not conservative, but manageable if one knows what they are doing.

Read Taleb anyway>


----------



## drsmith (26 October 2009)

Knobby22 said:


> Gross



What did you think happened to lamb before it was marinated ?



Knobby22 said:


> Regarding margin calls, play railroad tycoon. It is amazing how you can lose your wealth quite quickly, I'm sure many felt the same thing during the latest crash.



Perhaps that ag-science teacher still had a shirt on his back because he resisted the temptation to get involved with margin lending.


----------



## Wysiwyg (26 October 2009)

Risk per position and position sizing.


----------



## drsmith (26 October 2009)

geea said:


> I'm in a very similar situation as to what you have asked about. I have a few more than 10 shares to share the load though. As long as you have access to $$$ in case things head south i reckon its a good strategy. All the interest is tax deductable which helps aswell.
> 
> Geea.



Better to use those $$$ instead of borrow as noted above. Also, tax deductability of interest should never be the primary reason behind investment.


----------



## Sir Osisofliver (26 October 2009)

thecaptain said:


> Hi all,
> 
> This is my first post.  Great site - lots of good info!
> 
> ...




What is your view on the market?  This is crucial to your gearing decision.  I have the exact numbers around somewhere but I'm too lazy/busy to fish them out.  Roughly (and from memory) speaking therefore...

If you are geared at 75% ($25,000 of your own money in a $100,000 portfolio). The Market (or more correctly the value of your shares held in the margin loan) needs to fall between 6 and 10% before you are in a margin call.

If you are geared at 50% ($50k of your own money in a $100K portfolio), the market needs to fall between 32 to 36% before you are in margin call.

If you are geared at 25% ($75k of your own money in a $100K portfolio), the market needs to fall 75 - 79% before you are in margin call.

Given that our market has seen some substantial rises from it's bottom are we more or less likely to have a corrective pattern in the near term?

Is it therefore in your best interest to gear heavily (yes I consider a 60% gearing to be aggressive), at this time?

Cheers

Sir O


----------



## geea (26 October 2009)

drsmith said:


> Better to use those $$$ instead of borrow as noted above. Also, tax deductability of interest should never be the primary reason behind investment.




In my own case i have very little $$$ not invested. I have however made sure i can meet any margin calls should they arise.


----------



## drsmith (26 October 2009)

geea said:


> In my own case i have very little $$$ not invested. I have however made sure i can meet any margin calls should they arise.



How ?


----------



## geea (26 October 2009)

drsmith said:


> How ?




I have a very high income and i also have credit facilities. I've calculated i could deal with a 60% drop in the market. ( i hope this isn't nessecary) 

Geea


----------



## Sir Osisofliver (26 October 2009)

geea said:


> I have a very high income




Enough to get you out of a margin call in the required 24 hours? You do know how  margin Loan works in the event of a margin call right?  Most margin lenders allow a *10% buffer* of the value of the portfolio. A million dollar portfolio therefore has a $100,000 buffer attached to it. If you exceed your security value and enter into a margin call, you are then required to pay the call within 24 hours.*including bringing the account completely out of the buffer*.  Unless your portfolio is very small it would be difficult for your job to provide you with the ready cash to pay the call. 







> and I also have credit facilities.




Um margin lenders would not accept a credit card. I ASSUME therefore you are talking about a line of credit, overdraft facility or other means of credit other than a credit card that you can access quickly.  In which case I would say that keeping some of your borrowing capacity aside as a reserve in case of emergency is a wise choice and makes for a much more secure long-term strategy.

If you are talking about a credit card however because it is an unsecured loan to you your margin lender would not accept payment in this way.  You would have to draw a cash advance from your credit card, deposit and transfer the funds into your Margin Lenders account.  Needless to say if you are doing this you are in BIG TROUBLE.




> I've calculated i could deal with a 60% drop in the market. ( i hope this isn't necessary)
> 
> 
> Geea





Cheers 
Sir O


----------



## cutz (26 October 2009)

geea said:


> I have a very high income and i also have credit facilities. I've calculated i could deal with a 60% drop in the market. ( i hope this isn't nessecary)
> 
> Geea




FWIW i wouldn't bother with a margin loan, the banks charge what i consider to be an excessive amount of interest for a safe loan, i say safe because it's safe for the banks, they can dump everything and recoup their cash at the blink of an eye. Check out the storm thread to see what i mean.

If your really do have a high amount if income you can normally negotiate with the banks to give you a line on favorable terms ( i assume you own a home).


----------



## thecaptain (26 October 2009)

wayneL said:


> 1/Proposed gearing could be seen as conservative with a robust trend trading system with relatively lowish drawdown.
> 
> 2/On a buy and hold basis.... well, I would read Taleb first.
> 
> ...




Can you expand on why a buy and hold basis wouldnt be advisable?

(Im doing some reading on Taleb!)


----------



## thecaptain (26 October 2009)

Sir Osisofliver said:


> What is your view on the market?  This is crucial to your gearing decision.  I have the exact numbers around somewhere but I'm too lazy/busy to fish them out.  Roughly (and from memory) speaking therefore...
> 
> If you are geared at 75% ($25,000 of your own money in a $100,000 portfolio). The Market (or more correctly the value of your shares held in the margin loan) needs to fall between 6 and 10% before you are in a margin call.
> 
> ...




I concur with the majority that gearing at 60% is aggressive.  What do i think the market is going to do...who knows, but i hope its going forward.    

When is a good time to be aggressive in the market then?

Im quite young and considering my age to be an influencing factor in how aggressive i might consider being with my money.  Its certainly not the be and end all.  But i certainly wouldnt be as aggressive later in life, when i might not have the opportunities to bounce back from a hit.


----------



## wayneL (26 October 2009)

thecaptain said:


> Can you expand on why a buy and hold basis wouldnt be advisable?
> 
> (Im doing some reading on Taleb!)




1/ There is no guarantee that the market won't take another swan dive in the near future. Roubini has floated this very idea only last week 



> Nouriel Roubini believes that a "wall of liquidity" is chasing all kinds of assets, yet once the economy disappoints expectations, it will all come crashing down.




2/ The object of buy and hold is the buy and... ummm, hold... through thick and thin. IF, the market does go into the crapper again, you may be forced to sell via a margin call; perhaps at the worst possible time.


----------



## Lone Wolf (26 October 2009)

At the market highs I was geared at 60%, which my financial adviser at the time told me was quite conservative for someone my age with a long term outlook. His recommendation was that I have time up my sleeve to wait for the market to recover should it fall, so gear up now while I'm young.

I must say that after sweating out the market lows I don't feel so young anymore. I've even got a post on here from the start of the year asking how to hedge against further losses because I thought I was heading for financial destruction. I had cash on the side for a margin call, enough for a few actually, but for a while it looked like it wouldn't be enough. And as drsmith pointed out, does it make sense to keep lots of money in a bank on a lower interest rate than the money you borrow to invest? 

You might think that we've had the crash now, the worst is over and so 60% gearing is much safer now than it was before. Maybe, but you should prepare for the possibility that the worst is yet to come. What do you have planned in case of another market drop that takes us to new lows? When will you sell? Or will you hold until the bitter end? How much are you willing to lose?

Out of interest, why 10 individual stocks instead of an index tracking ETF like STW? Do you have individual stops on the stocks to limit your risk? Or is this a buy and hold forever strategy? I'm not saying buying 10 individual stocks is a bad way to go, I'm just interested.

I'm not here to talk you out of it. My only advise on your strategy is to have a plan in place for the worst case scenario. Any strategy looks great when you're winning. What's important is how your strategy protects you during the bad times.


----------



## Rainmaker2000 (26 October 2009)

I'm someone who does not invest without a margin loan............

And the concept of 'conservative margin lending' is only talked about by financial planners.....

I love margin.......but prefer to take Benjamin Graham's view on things........anyone who uses margin is basically a 'professional investor' and is introducing speculation into his/her method.

If you are new to margin.......you are the perfect customer to get ripped off.............do you know the special conditions??????? 

During the correction, Comsec deciding with no warning that they would take back LVR.........that is secuirty valuation.......on perfectly good stocks......without any warning or reason.......they were doing this weekly

Do you know what happens to 60% LVR when the lender deems a security worthless for lending purposes??????

I thank god I had the balls to stick to my method and keep the ship on track.........because the bottom of the market was littered with margin lending defaults.........with lenders literally killing stock prices and their customers


----------



## skc (26 October 2009)

Lone Wolf said:


> At the market highs I was geared at 60%, which my financial adviser at the time told me was quite conservative for someone my age with a long term outlook. His recommendation was that I have time up my sleeve to wait for the market to recover should it fall, so gear up now while I'm young.




Personally I think that's one of the BS amongst the financial advise industry. It should actually be the opposite. When you are young, you are in no hurry to gear up. Every $1 you lose now by taking an aggressive stance is many dollars of compounding lost in the future.



Lone Wolf said:


> I'm not here to talk you out of it. My only advise on your strategy is to have a plan in place for the worst case scenario. Any strategy looks great when you're winning. What's important is how your strategy protects you during the bad times.




Wise words. Just like BNB and Storm. Your car would go a lot faster if you don't install any brakes, airbags, seatbelts and safety cell.


----------



## wayneL (26 October 2009)

Rainmaker2000 said:


> ....do you know the special conditions???????
> 
> During the correction, Comsec deciding with no warning that they would take back LVR.........that is secuirty valuation.......on perfectly good stocks......without any warning or reason.......they were doing this weekly
> 
> Do you know what happens to 60% LVR when the lender deems a security worthless for lending purposes??????




This is perfectly reasonable. Watch what happens to futures margin when the market gets volatile. It's the same principle.

It's to protect both the broker and the investor.... though it might not actually work that way for the investor.


----------



## Rainmaker2000 (26 October 2009)

How do you think it protects the investor to have a perfectly good collateral termed useless by the banker without predictability, warning or rationale????

How many people do you think could satisfy the bank if it 'called in a mortgage on a home loan'...........what do you think would happen if banks just all of a sudden called in mortgages asking them to be immediately paid back cause the collateral is no longer valued???

I'm thinking the value of housing would fall very, very quickly.....and for what....the banks change of attitude....

I wonder why the banks are always 75% LVR when they are the most assetless businesses in the market.......funny that

Comsecs attitude in the bear market just 9 months ago was absolutely stupid............and they completely changed their risk methodology following it.......but what will happen in the next bust???


----------



## wayneL (26 October 2009)

Rain,

Please note my last comment.


----------



## Judd (27 October 2009)

Sir Osisofliver said:


> Most margin lenders allow a *10% buffer* of the value of the portfolio. A million dollar portfolio therefore has a $100,000 buffer attached to it. If you exceed your security value and enter into a margin call, you are then required to pay the call within 24 hours.*including bringing the account completely out of the buffer*.




Yes, I have read that the theory by the "pundits" is to have $1,000 in cash set aside for every $10,000 borrowed.  However, what the "pundits" don't say is what is the situation if you receive multiple margin calls.  As you imply Sir O, has thecapitain considered *all* aspects.  And LoneWolf has described what such a situation may feel like.

I can attest that it ain't no fun.  Fortunately in our case, other assets outside of the margin loan were especially useful to prevent and mitigate total damage.


----------

