Margin loans in for rough ride

[wayneL]

There was this article on margin loans this weekend, basically raising the spectre of margin calls.

http://www.news.com.au/business/story/0,23636,20031125-462,00.html

Now most of the folks on this board would have the nouse to use margin lending responsibly and I doubt there would in fact be a margin call amongst those here. I believe they would act before that was ever necessary.

But there must be a ton of numpties out there, hocked up to the gunnels with margin loans taken on reletively recently in the piece.

I personally know on guy who pumped $400,000 of margined capital into the market earlier this year.

If the market does take another hit in the near future, this could become a big factor in tripping a waterfall of selling pressure as those investors who where residing in wonderland, pumped margined capital into the market at the top, get called in.

Thoughts?

 

[Judd]

Maybe but probably not but that is only my guess. The article states that there are 156k margin loan accounts. In the scheme of things that really is not a heck of a lot of individual accounts. In the scheme of shares held by individuals via margin loans as opposed to shares held by institutions it is hardly a blip.

Providers of margin loans are claiming that the average LVR of outstanding is 40% or so, ie very cautiously geared and at that gearing the market would need to fall by some 30% or more before a margin call was triggered (for every single account that averaged a 40% LVR and held exactly the same shares and in exactly the same quantities.)

If the historical peak of 7.8 margin calls per day was made it would take 20,000 days, ie 54 years, for all account holders to receive a margin call - most would probably be dead by then anyway.

That's my view of the matter for what it's worth.

 

[Knobby22]

I agree, Judd.

The Australian stockmarket is by no means as hot as the housing market.
I can't see the really big crash coming that would really cause a problem.

I.ve had margin lending for a few years now that has allowd me ti increase my investments greatly I have always been careful and have actually found due to the greater care I have taken that my margin loan shares have done better than my unmargined portfolio.

That given, it has been nearly twenty years since the last decent crash and there are too many overconfident players out there that could get really burnt even on a 25% fall.

 

[rozella]

This is my view.

If you have a $500,000 portfolio & it drops 10%, then you are down $50,000, whether you use marginlending or it is all your own capital.

Now if you are a "numpty" & allow stocks to freefall without any type of stoploss, then it is possible that you will lose considerably more....the bottom is when nothing is left, however, if your portfolio is margined, then there is a limit to your loss even if you are a "numpty" as the marginlender will call you & give you some options to bring your ratios into line....i.e. a wakeup call.

 

[Realist]

This is my view.

If you have a $500,000 portfolio & it drops 10%, then you are down $50,000, whether you use marginlending or it is all your own capital.
.

Ahh that is not correct.

If you are lucky enough to have $500,000 of your own money invested and you lose 10%, you still have $450,000.

If you have borrowed $500,000 at 10% and you lose 10% you are down $100,000.


The first guy has $450,000 (he was rich, is slightly less rich now)
The second has minus $100,000 (he was not rich, and is now poor)

Huge difference!!! which ever way you look at it.

Margin loans are very dangerous.

 

[rozella]

Can't agree Realist.

I assume we are talking about marginlending not CFD's

If you have borrowed $500,000 at 10% and you lose 10% you are down $100,000.

Marginlenders don't lend 100%, usually the top 20 stocks have a LVR of 75% & why have you allowed 12 months of interest ?

My point is that with marginlending "big brother" makes you do your job properly. If you are not capable of acting on stoplosses, "big brother" will do it for you....making you do your job. Marginlending teaches you disciplined trading.

How many rode AMP down from $18 & TLS down from $8.50.......this would not have happened with a margin loan ?

Margin loans are very dangerous.

This statement is usually made by those who have not used a margin loan or do not understand the instrument.

 

[Ageo]

Margin loans are very dangerous.

This statement is usually made by those who have not used a margin loan or do not understand the instrument.

Amen

 

[Realist]

This statement is usually made by those who have not used a margin loan or do not understand the instrument.

Yeah they are really complicated...

I stand by my comment that for most people margin lending is fraught with danger and should not be done!

How many rode AMP down from $18 & TLS down from $8.50.......this would not have happened with a margin loan ?

How many traders sold PDN when it dipped from $1.20 to 80 cents in early 2005?

It is now nearly $5.

It is traders who jump out of good stocks at the first sign of trouble that cost themselves money, and end up with big tax bills and large brokerage bills.

It is investors who hold through thick and thin who end up the richest people in the world.

Stop losses and margin lending do have a place in "investing". But for the majority of people they will end up losing money using them, or at best making less money using them. Without doubt most people are better off not borrowing money to "invest" and not selling good stocks when they go down.

 

[It's Snake Pliskin]

It is traders who jump out of good stocks at the first sign of trouble that cost themselves money, and end up with big tax bills and large brokerage bills.

It is investors who hold through thick and thin who end up the richest people in the world.

Stop losses and margin lending do have a place in "investing". But for the majority of people they will end up losing money using them, or at best making less money using them. Without doubt most people are better off not borrowing money to "invest" and not selling good stocks when they go down.

There is no such thing as a good stock.

 

[Realist]

There is no such thing as a good stock.

PRG is a good stock...

Well it is a good company, with stock you can buy...cheapish.

 

[professor_frink]

Yeah they are really complicated...

I stand by my comment that for most people margin lending is fraught with danger and should not be done!

Realist could you explain this comment please? How is a margin loan fraught with danger. I agree that using one irresponsibly can be dangerous, but then again, doing anything irresponsibly in regards to the financial world can be.

How many traders sold PDN when it dipped from $1.20 to 80 cents in early 2005?

It is now nearly $5.

It is traders who jump out of good stocks at the first sign of trouble that cost themselves money, and end up with big tax bills and large brokerage bills.

It is investors who hold through thick and thin who end up the richest people in the world.

Stop losses and margin lending do have a place in "investing". But for the majority of people they will end up losing money using them, or at best making less money using them. Without doubt most people are better off not borrowing money to "invest" and not selling good stocks when they go down.

Just to clarify something in regards to traders and trading. I think you are getting traders and punters slightly confused. I'm sure you'll argue that there is no difference between the two, but you've already stated that you don't know much about trading, so you probably shouldn't be commenting on it.

 

[Realist]

Realist could you explain this comment please? How is a margin loan fraught with danger. I agree that using one irresponsibly can be dangerous, but then again, doing anything irresponsibly in regards to the financial world can be. .

Borrowing money to invest in shares is unwise. And for amateurs it is fraught with danger.

Here's a paste from E-trade... showing how a margin call can screw you upwards, backwards and sideways at the same time.....

(I'm sure you're far too smart to ever lose money on shares Prof Frink , but others just might!)

The fact is that margin loans are risky. Unlike traditional forms of loan security, share prices move up and down every day. And when your shares are being held as security, you’d better hope they head up rather than down. Otherwise, you’ll get what’s known as a ‘margin call’. This is where, to maintain the lender’s required LVR, you have to stump up more money. That means finding more cash. If you can’t do that, the lender will start selling your shares, perhaps at the time when it’s least favourable to do so.

What banks and other lenders won’t tell you is that a stock can do very well in the long run but have a horrible time in the short term. And that’s the biggest risk with margin loans. You can be right picking stocks that do very well over the years but get your timing a little wrong and it won’t matter.

In fact, even Commonwealth Securities’ Woolies example would have worked differently in reality. If, as the example showed, you put in $30,000 and then borrowed $70,000 to acquire one stock””Woolworths””you’d already be on the maximum LVR of 70%. So when the shares went from $5.05 in March 1999 to $4.63 in February 2000, you would probably have received a margin call. If you didn’t have the cash, you’d have been forced to sell some shares at this low price. So, when you read about all the extra money you could have made with a margin loan, view it sceptically.

The example in the table (illustrating the effect of a 40% price fall on a $30,000 portfolio) shows how a margin loan can hurt. In this case, not only do you lose all your equity but you still owe the bank $10,000. This isn’t scare mongering either. Consider Aristocrat as a case in point. If you had followed our recommendation in issue 126/May 03 (Long Term Buy””$1.56) you’d be smiling about the current price of $7.03 Or would you?
If you’d used a margin loan to buy the stock, probably not. By the time the shares bottomed at 76 cents later that month, you may well have been margin-called out of your entire Aristocrat holding. So, while a debt-free investor has made four and a half times their money, you’re sitting on a big fat capital loss. That may seem like an extreme example but seeing a stock price drop by 30% or more, after you buy it, happens more often than most investors care to remember. But when your portfolio is ‘juiced up’ with a margin loan, you’re sure to remember these instances better than most.


Taking a ‘portfolio approach’ won’t always help either. Just because one or two stocks in your portfolio are getting hammered, doesn’t mean the others are nicely moving up to avoid the margin call. With margin lending, not only do you have to be right on the stock in the long term but also the short term. And that’s very, very difficult. The bank is happy to lend you plenty when things are looking good and stockmarkets are expensive but it can force you to sell at the exact moment that shares look cheap. That’s hardly sensible investing, is it?

Margin loans do have their place but too many investors fail to appreciate the risks inherent in them. If you do intend to use a margin loan facility, we suggest you spend more time thinking about what can go wrong than doing your sums on examples provided by brokers, bankers and other product spruikers.

Just to clarify something in regards to traders and trading. I think you are getting traders and punters slightly confused. I'm sure you'll argue that there is no difference between the two, but you've already stated that you don't know much about trading, so you probably shouldn't be commenting on it.

Prof, you know my thoughts on trading, I don't believe there is much more for me to learn about it. I've now read a few books on it, and traded a few stocks myself. Initially I thought I must not have understood it because I could not see how it works. Now I know I do understand it and I know it does not work as well as investing. I do not expect you or anyone to agree with me, everyone will try different methods and try and beat the market, a few lucky ones will succeed but not be able to help others replicate it, for one good reason - they got lucky, usually during a strong bullmarket.

To me the very notion of buying a stock because it has gone up or selling because it has gone down is the exact opposite of common business sense. The are few wealthy traders and even fewer that stay wealthy. I will have a punt myself on a few stocks (MTN, CQT, FDL) but under the knowledge it is a complete punt. I try to invest heavily in solid companies under the knowledge it is wiser than leaving my money in the bank and in no way am I gambling, I am investing.

There have been some traders who have done well, not nearly as well as investors of course but they have done better than me, and they do have some valid ideas. Richard Farleigh in particular has some particularly good points that investors need to heed. He is a trader. Although he call's chartists "astrologers". So I do have time for some traders, none have even a 10th of the respect I have for Graham and Buffett though.

 

[grumpee boi]

If an attitude of prudence is adopted then margin loans can be a terrific wealth creation vehicle. Just because there is a maximum LVR does not mean it should be taken. there is absolutely no need to be fully geared unless you are greedy. Building in a buffer should ensure no margin calls - that's a bold statement but it isn't rocket science to achieve.

It's funny how so many people hesitate at the idea of leverage with the sharemarket when they have no problem in borrowing 80-100% for an asset that has extemely poor liquidity - the family home. Add to that buying and selling costs along with maintenance costs and the investment does not look that good in my opinion. Obviously psychological factors have a great impact on decision making when it comes to your house purchase for the family. But should you get into difficulties with this type of leveraged 'investment' then the consequences can be nasty to say the least.

How do prudent people avoid this - don't borrow up to your maximum so that in prolonged sideways periods, instances of job loss and so on, they are able to maintain the investment. Same goes for margin lending.

And don't forget, there are two types of margin lending - lump sum gearing and instalment gearing. More conservative types should tend towards lump sum gearing for some experience before embarking on an instalment program.
Which situation would you prefer to be in - losing your job with a mortgage or after having started a lump sum gearing program?

One final factor to take into account is diversification. Sure, by diversifying you will never obtain the best returns but you will smooth out your journey a lot. It really does help you against investing in a dud company and losing a substantial part of your portfolio. the beauty of margin lending is that it gives people the opportunity to become even more diversified than otherwise possible. And what about gearing into managed funds? I love DFA funds and they are available to gear into. So you could establish a geared portfolio that includes exposure to small, value, large, emerging markets, international shares and even real estate stocks.

the whole idea with margin lending is to allow yourself the opportunity to take advantage of the biggest factor in investing - time. by starting with a portfolio that is larger than otherwise possible you will eventually reach the point where the annual return in year x is greater than the whole accumulated returns of the first x minus y years. The smaller your starting amount, the longer it will take to get to this point. But once you do, you have it made so to speak.

Adam

 

[professor_frink]

Borrowing money to invest in shares is unwise. And for amateurs it is fraught with danger.

Here's a paste from E-trade... showing how a margin call can screw you upwards, backwards and sideways at the same time.....

For amateurs, yes, margin lending is unwise. I don't agree that borrowing to invest is unwise for someone who has even a moderate amount of knowledge. The article you've posted shows it's one of it's main flaws- using too much leverage. Just because they offer to lend 70% doesn't mean it has to be used. If someone uses the maximum amount of leverage without access to extra cash then it's most definately a bad idea, and they probably deserve to be punished for it.

(I'm sure you're far too smart to ever lose money on shares Prof Frink , but others just might!)

Play nice realist

I may have lost the odd dollar every now and then

Prof, you know my thoughts on trading, I don't believe there is much more for me to learn about it. I've now read a few books on it, and traded a few stocks myself.

Yes I know your thoughts on trading. And I also know your level of knowledge of trading. That's why I said you probably shouldn't be commenting on it.

Initially I thought I must not have understood it because I could not see how it works. Now I know I do understand it and I know it does not work as well as investing.

It's been said that a little bit of knowledge is a dangerous thing. In regards to your knowledge of trading, I think it's a good thing- at least you haven't read a couple of books and thought you knew it all, and then gone off and blown all your money.

I do not expect you or anyone to agree with me, everyone will try different methods and try and beat the market, a few lucky ones will succeed but not be able to help others replicate it, for one good reason - they got lucky, usually during a strong bullmarket.

Trying to beat the market is a topic worthy of it's own thread! I'm sure alot of people are finding out how hard it can be now that times are a little harder. I couldn't beat the market without leverage, but that doesn't concern me much- there are leveraged instruments available to trade so I use them.

To me the very notion of buying a stock because it has gone up or selling because it has gone down is the exact opposite of common business sense. The are few wealthy traders and even fewer that stay wealthy. I will have a punt myself on a few stocks (MTN, CQT, FDL) but under the knowledge it is a complete punt. I try to invest heavily in solid companies under the knowledge it is wiser than leaving my money in the bank and in no way am I gambling, I am investing.

Precisely why you stick to talking about investing, and leave trading to the traders. If something doesn't make sense to you, then you shouldn't rubbish it. How would it look if I started ripping into investors because they were buying stocks that were heading down? I wouldn't expect to many investors to take me seriously.

There have been some traders who have done well, not nearly as well as investors of course but they have done better than me, and they do have some valid ideas. Richard Farleigh in particular has some particularly good points that investors need to heed. He is a trader. Although he call's chartists "astrologers". So I do have time for some traders, none have even a 10th of the respect I have for Graham and Buffett though.

Fair enough. Didn't Buffett use OPM? Just a thought.

 

[professor_frink]

well said grumpee boi

 

[Realist]

Trying to beat the market is a topic worthy of it's own thread! I'm sure alot of people are finding out how hard it can be now that times are a little harder. I couldn't beat the market without leverage, but that doesn't concern me much- there are leveraged instruments available to trade so I use them..

Indeed.

Everyone tries to beat the market. Of course they can not succeed because they are the market!

 

[professor_frink]

Indeed.

Everyone tries to beat the market. Of course they can not succeed because they are the market!

Well obviously some succeed. So if you can't beat the market without leverage, and refuse to use leverage to try to do so, why don't you just go and buy index funds?

 

[Realist]

Well obviously some succeed. So if you can't beat the market without leverage, and refuse to use leverage to try to do so, why don't you just go and buy index funds?

Actually, after tax, fees, and brokerage, very few beat the market.

And yes I would think most people should buy index funds - they would get better results longterm.

 

[grumpee boi]

thanks for the nice comment profink.

Incidentally, you can beat the market with index funds even after fees and management expense ratios. Nearly everybody thinks that they are above-average but by definition only half of us are. Beating half of everybody (including professional fund managers) is not something to be sneezed at. Imagine beating half of everybody and including a little bit of leverage - those average returns are starting to look pretty darn good hey guys?

I have a 40 page ebooklet on index investing that shows how certain portfolios can be structured to beat the market average - PM me if either of you want a copy. Though I don't know how interested you would be profink.

 

[professor_frink]

Actually, after tax, fees, and brokerage, very few beat the market.

And yes I would think most people should buy index funds - they would get better results longterm.

Realist,
I was referring to you buying index funds, not the general public.