Why is leveraging property good but leveraging stocks bad?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
SpeculativeTrader
Posts: 12
Joined: Sat Jul 14, 2018 5:17 am

Why is leveraging property good but leveraging stocks bad?

Post by SpeculativeTrader » Sat Jul 14, 2018 5:50 am

Hello fellow Bogleheads, I come in peace. I need some pointers from the wiser heads around here because I’m having some trouble internally reconciling a concept.

That concept is leverage.

I understand the basic concept and mechanic of leverage and how it acts as a double-edged sword, magnifying both gains and losses.
What I don’t understand is why leverage is frowned upon for stocks but not for property where leverage is usually 5x.

I read MarketTimer’s legendary thread and countless articles warning about the dangers of leverage with stocks.

Please don’t misunderstand my intentions, I’m not here to convince anyone that leveraging stocks is a good idea, I am simply trying to understand myself.

I tried to brainstorm what the reasons leveraging stocks is bad compared to property:

• A home can provide you with shelter no matter if the price drops
• Higher financing costs for leveraging stocks
• Volatility drag? (this is a bit out of my scope of knowledge)
• Risk of margin calls

The more I think about it, is the main reason the risk of margin calls?

As long as you can service your home loan, the bank won’t call your loan so you can weather the storm, however you could be wiped-out if margin called for stocks.

User avatar
9-5 Suited
Posts: 241
Joined: Thu Jun 23, 2016 12:14 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by 9-5 Suited » Sat Jul 14, 2018 7:38 am

Very efficient - a post that neatly answers its own question :sharebeer

Margin calls are a huge risk with a volatile asset like stocks, and of course not everyone has the iron constitution to see through the worst of times. The leverage on the home is also risky, but avoiding disaster is more manageable. Still, one should proceed with caution there to avoid getting in too deep.

grok87
Posts: 8504
Joined: Tue Feb 27, 2007 9:00 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by grok87 » Sat Jul 14, 2018 7:51 am

Some other thoughts.

1) think in general you want to reduce your mortgage, your home property leverage over time. You start out at 5x leveraged as you say-ie 20% down payment or 20% equity. Arguably by the time you retire you should be 100% equity or 0x leveraged.

2) that does not necessarily mean you have to actually pay off your mortgage. You can “defease” it instead. Ie put the money you would use to pay off the mortgage into duration matched treasuries or other low risk bonds. There is a cost to this obviously. But it gives you better liquidity in an emergency situation.

3) as far as stocks remember that they are already leveraged, sometimes a lot. So if you buy on margin you are piling leverage on top of leverage.
Keep calm and Boglehead on. KCBO.

gmaynardkrebs
Posts: 937
Joined: Sun Feb 10, 2008 11:48 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by gmaynardkrebs » Sat Jul 14, 2018 8:04 am

SpeculativeTrader wrote:
Sat Jul 14, 2018 5:50 am
Hello fellow Bogleheads, I come in peace. I need some pointers from the wiser heads around here because I’m having some trouble internally reconciling a concept.

That concept is leverage.

I understand the basic concept and mechanic of leverage and how it acts as a double-edged sword, magnifying both gains and losses.
What I don’t understand is why leverage is frowned upon for stocks but not for property where leverage is usually 5x.

I read MarketTimer’s legendary thread and countless articles warning about the dangers of leverage with stocks.

Please don’t misunderstand my intentions, I’m not here to convince anyone that leveraging stocks is a good idea, I am simply trying to understand myself.

I tried to brainstorm what the reasons leveraging stocks is bad compared to property:

• A home can provide you with shelter no matter if the price drops
• Higher financing costs for leveraging stocks
• Volatility drag? (this is a bit out of my scope of knowledge)
• Risk of margin calls

The more I think about it, is the main reason the risk of margin calls?

As long as you can service your home loan, the bank won’t call your loan so you can weather the storm, however you could be wiped-out if margin called for stocks.
It's not the leverage, it's the person doing the leveraging. Most home-buyers have no choice but to use leverage, and are thinking conservative and long term. Stock speculators using leverage tend to think short term, laboring under the delusion that they know something the market doesn't.

User avatar
whodidntante
Posts: 4309
Joined: Thu Jan 21, 2016 11:11 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by whodidntante » Sat Jul 14, 2018 8:37 am

Leverage is not bad for stocks. I am unapologetically leveraged. I didn't chose a margin loan to do it, instead, I have four fixed rate loans with APRs of 0%, 0%, 1.89%, and 3.125%. I carry this debt for cheap leverage, tax deferral, and the three lowest rate loans are a profitable investment in themselves at current levels of inflation. Overall my cost of leverage is slightly negative in real terms. I took advantage of what I concluded were anomalously low interest rates with reasonable expected returns, and I did have to overcome my leverage aversion to do it.

While I don't currently use margin, options, or futures myself, I do think those are useful tools in the right hands. Most Bogleheads will avoid them all and that's fine too. Markettimer has a brilliant mind but he started with poor liquidity and shot for the moon, and he dug in deeper on the way down into the worst broadly downtrending market most of us experienced with significant skin in the game. Read the whole story. He was lucid, analytical, and developed self awareness about his mistakes. "Leverage is bad" is not a reasonable conclusion from his story.

alex_686
Posts: 4052
Joined: Mon Feb 09, 2015 2:39 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by alex_686 » Sat Jul 14, 2018 8:45 am

Stocks tend to have higher volatility. That is they can move down faster than homes? Every heard of the phrase "As safe as houses"? When was the last time you heard of house prices falling? :twisted: So that is why I use the word "tends". For something more in-depth you can look at the many real-estate bankruptcies that our President has filed.

This takes me to 2 subpoints.

The first is geometric growth and volatility drag. The higher the volatility the lower the geometric growth. Leverage increases volatility. One can increase volatility where one has positive annual returns but negative long term growth.

The second is that real-estate may be non-recourse. If the property fails the bank can only go after the mortgage property, not after your personal property. This is not true for brokerage loans.

Next, stocks tend to move faster. No banker is going to call you at 8 a.m. and ask you to deposit $50,000 by the end of day tomorrow or they will sell off your property. I have done that with brokerage accounts. I think this leads to other behavioral issues. I have seen quite a few people treat stock loans as akin to gambling and few who treat real estate that way.

Lastly, what you really want to do is look at your portfolio. When I have a little extra cash I throw it towards my IRA and buy equities instead of paying down my mortgage, a negative bond. I am using leverage here.

101
Posts: 29
Joined: Tue Dec 01, 2015 9:10 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by 101 » Sat Jul 14, 2018 8:52 am

You also don't need to make money on the home purchase; you just have to lose less money than you would have paying rent.

User avatar
nisiprius
Advisory Board
Posts: 37065
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Why is leveraging property good but leveraging stocks bad?

Post by nisiprius » Sat Jul 14, 2018 9:11 am

You can play around with language and no categories are precise. However:

1) I don't think a mortgage on the house you live in is "good," it's more of a "necessary evil."

2) Is a mortgage on the house you live in "leverage?" It's debt, it's borrowing, but is it "leverage?" A dictionary defines "leverage" as "The use of credit or borrowed funds, often for a speculative investment, as in buying securities on margin." A mortgage on the house you live in doesn't fit that definition very well.

3) A mortgage is a risky financial move that is taken to serve a non-financial purpose. And that purpose is "necessary," or at least very important. A leveraged investment is risk taken for its own sake. The purpose of leverage in investment is to increase the risk in order to increase return if the risk pays off. Or, perhaps, to increase the mathematical, statistically expected return.

If I try to place these in terms of Maslow's Hierarchy of Needs, I put them about here. Where would you put them?

Where would you put them?

Image

P.S. I don't think leveraging, as used by large-scale real estate developers, or house flippers, is any different from leveraging stocks. It's not the asset, it's the financial and life context.
Last edited by nisiprius on Sat Jul 14, 2018 9:21 am, edited 3 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

SpeculativeTrader
Posts: 12
Joined: Sat Jul 14, 2018 5:17 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by SpeculativeTrader » Sat Jul 14, 2018 9:11 am

9-5 Suited wrote:
Sat Jul 14, 2018 7:38 am
Very efficient - a post that neatly answers its own question :sharebeer

Margin calls are a huge risk with a volatile asset like stocks, and of course not everyone has the iron constitution to see through the worst of times. The leverage on the home is also risky, but avoiding disaster is more manageable. Still, one should proceed with caution there to avoid getting in too deep.
Thanks :D I don't have any financial educational background unlike a lot of posters on Bogleheads so I was hoping to see if I'm missing something.

Everyone around me is leveraging into property and think of shares as "gambling" and naturally being an index investor, I thought if if people leverage 5x into property, why does doing the same into an index fund not make sense as well.

I read as much as I could and I couldn't find a clear cut answer even though it just seemed like it was a bad idea.

Hypothetically, if there was a non-callable loan product that lets you buy index funds as you would with a home mortgage with 20% down, would that then be a sensible idea?
grok87 wrote:
Sat Jul 14, 2018 7:51 am
Some other thoughts.

1) think in general you want to reduce your mortgage, your home property leverage over time. You start out at 5x leveraged as you say-ie 20% down payment or 20% equity. Arguably by the time you retire you should be 100% equity or 0x leveraged.

2) that does not necessarily mean you have to actually pay off your mortgage. You can “defease” it instead. Ie put the money you would use to pay off the mortgage into duration matched treasuries or other low risk bonds. There is a cost to this obviously. But it gives you better liquidity in an emergency situation.
Oh wow Grok87, you were one of the original members who replied to that legendary thread!

1) Hypothetically if there was an identical loan structure as with home mortgages for index funds, would that then be a sensible strategy for leverage?

2) I have read strategies where people pay their mortgages back as slowly as possible while investing any excess into stocks as a form of "leverage"
gmaynardkrebs wrote:
Sat Jul 14, 2018 8:04 am
It's not the leverage, it's the person doing the leveraging. Most home-buyers have no choice but to use leverage, and are thinking conservative and long term. Stock speculators using leverage tend to think short term, laboring under the delusion that they know something the market doesn't.
Playing devil's advocate, what if the user of leverage isn't a degenerate speculative trader and someone who is just trying to leverage their long-term Boglehead-style index portfolio?
whodidntante wrote:
Sat Jul 14, 2018 8:37 am
Leverage is not bad for stocks. I am unapologetically leveraged. I didn't chose a margin loan to do it, instead, I have four fixed rate loans with APRs of 0%, 0%, 1.89%, and 3.125%. I carry this debt for cheap leverage, tax deferral, and the three lowest rate loans are a profitable investment in themselves at current levels of inflation. Overall my cost of leverage is slightly negative in real terms. I took advantage of what I concluded were anomalously low interest rates with reasonable expected returns, and I did have to overcome my leverage aversion to do it.

While I don't currently use margin, options, or futures myself, I do think those are useful tools in the right hands. Most Bogleheads will avoid them all and that's fine too. Markettimer has a brilliant mind but he started with poor liquidity and shot for the moon, and he dug in deeper on the way down into the worst broadly downtrending market most of us experienced with significant skin in the game. Read the whole story. He was lucid, analytical, and developed self awareness about his mistakes. "Leverage is bad" is not a reasonable conclusion from his story.
Hence my confusion as to why leverage isn't treated as "bad" in all aspects. It seems to be okay or good to leverage to buy property, albeit, most people wouldn't be able to afford a home without leverage.

I think you have sort of demonstrated why, if you have access to cheap and non-callable loans then leverage into stock isn't bad.
alex_686 wrote:
Sat Jul 14, 2018 8:45 am
Stocks tend to have higher volatility. That is they can move down faster than homes? Every heard of the phrase "As safe as houses"? When was the last time you heard of house prices falling? :twisted: So that is why I use the word "tends". For something more in-depth you can look at the many real-estate bankruptcies that our President has filed.

This takes me to 2 subpoints.

The first is geometric growth and volatility drag. The higher the volatility the lower the geometric growth. Leverage increases volatility. One can increase volatility where one has positive annual returns but negative long term growth.

The second is that real-estate may be non-recourse. If the property fails the bank can only go after the mortgage property, not after your personal property. This is not true for brokerage loans.

Next, stocks tend to move faster. No banker is going to call you at 8 a.m. and ask you to deposit $50,000 by the end of day tomorrow or they will sell off your property. I have done that with brokerage accounts. I think this leads to other behavioral issues. I have seen quite a few people treat stock loans as akin to gambling and few who treat real estate that way.

Lastly, what you really want to do is look at your portfolio. When I have a little extra cash I throw it towards my IRA and buy equities instead of paying down my mortgage, a negative bond. I am using leverage here.
I did come across volatility drag and geometric returns over the course of my own self-research on this topic. I think I sort of understand it as a layman but I wouldn't be able to explain it technically to anyone.

To me one thing I can't reconcile. I would think that property is volatile too but because it is illiquite and price discovery is inefficient then we don't see its true volatility. Would volatility drag apply to property too then?

What if stocks didn't have constant price quotes and one just constantly paid off principal and interest to pay off a mortgage of index funds. Why does this not have the same outcome as a home mortgage?

I'm not good at writing and conveying tone so just know I'm not being antagonistic, these are just some of things I can't figure out and hope that you or someone can explain to me. :happy
101 wrote:
Sat Jul 14, 2018 8:52 am
You also don't need to make money on the home purchase; you just have to lose less money than you would have paying rent.
It's probably more complicated than a layman like me thinks about it but a home does or should make you money.

Using the concept of imputed rent, a home can be thought of as another asset that provides a return. You just so happen to consume that return as housing expenses.

No different than if dividends or consuming your stock portfolio capital gains to fund your rent.

Of course there are aspects such as hedging rent etc that we're not taking into account.

SpeculativeTrader
Posts: 12
Joined: Sat Jul 14, 2018 5:17 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by SpeculativeTrader » Sat Jul 14, 2018 9:21 am

nisiprius wrote:
Sat Jul 14, 2018 9:11 am
You can play around with language and no categories are precise. However:

1) I don't think a mortgage on the house you live in is "good," it's more of a "necessary evil."

2) Is a mortgage on the house you live in "leverage?" It's debt, it's borrowing, but is it "leverage?" A dictionary defines "leverage" as "The use of credit or borrowed funds, often for a speculative investment, as in buying securities on margin." A mortgage doesn't fit that definition very well.

3) A mortgage is a risky financial move that is taken to serve a non-financial purpose. And that purpose is "necessary," or at least very important. A leveraged investment is risk taken for its own sake. The purpose of leverage in investment is to increase the risk in order to increase return if the risk pays off. Or, perhaps, to increase the mathematical, statistically expected return.

If I try to place these in terms of Maslow's Hierarchy of Needs, I put them about here. Where would you put them?

Where would you put them?

Image
Once again, please take my reply as bouncing ideas off each other and not antagonistic.

I replied to 101 before seeing your reply which has a few common themes.

To me, I think that how we fund our needs are fungible. So we need shelter and a place to live. It would cost $X to rent a place. To me it is equivalent if we have a portfolio of stocks/bonds that pay $X which in turn pays for rent, or if one buys a home where you get the benefit of an implicit $X.

I didn't know that was the definition of leverage but I do think that a mortgage on a home with 20% down has the same effect as leverage. You end up getting the benefit of imputed rent of $X which you would not be able to have on the amount of your down payment. You have thus increased the return you have gotten on that amount of money through debt.

Hypothetically, what if one was to going into debt to buy a stock/bond portfolio that pays $X which you use to pay for rent.

I know there are benefits to home ownership but I just wanted to clear it up in my head.

I am happy if my thoughts end up being wrong if I can just reconcile it in my head.

Sorry if some of this is a bit incoherent as it's past midnight where I am.

gmaynardkrebs
Posts: 937
Joined: Sun Feb 10, 2008 11:48 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by gmaynardkrebs » Sat Jul 14, 2018 9:25 am

SpeculativeTrader wrote:
Sat Jul 14, 2018 9:11 am
Playing devil's advocate, what if the user of leverage isn't a degenerate speculative trader and someone who is just trying to leverage their long-term Boglehead-style index portfolio?
Ever seen one?

not4me
Posts: 473
Joined: Thu May 25, 2017 3:08 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by not4me » Sat Jul 14, 2018 9:33 am

I don't think there is one clear cut answer. Most will defend what they do -- if they don't see it as defensible, they wouldn't do it. Houses we live in become personal...house we rent out less so. As mentioned earlier, margins, futures, etc have their place "in the right hands" -- they aren't (in my mind) pure evil regardless. I think some of this is a result of learning from those who have gone before us & leverage (rightly or not) was associated with the stock market crash & Great Depression.

grok87
Posts: 8504
Joined: Tue Feb 27, 2007 9:00 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by grok87 » Sat Jul 14, 2018 9:40 am

SpeculativeTrader wrote:
Sat Jul 14, 2018 9:11 am
grok87 wrote:
Sat Jul 14, 2018 7:51 am
Some other thoughts.

1) think in general you want to reduce your mortgage, your home property leverage over time. You start out at 5x leveraged as you say-ie 20% down payment or 20% equity. Arguably by the time you retire you should be 100% equity or 0x leveraged.

2) that does not necessarily mean you have to actually pay off your mortgage. You can “defease” it instead. Ie put the money you would use to pay off the mortgage into duration matched treasuries or other low risk bonds. There is a cost to this obviously. But it gives you better liquidity in an emergency situation.
Oh wow Grok87, you were one of the original members who replied to that legendary thread!

1) Hypothetically if there was an identical loan structure as with home mortgages for index funds, would that then be a sensible strategy for leverage?

2) I have read strategies where people pay their mortgages back as slowly as possible while investing any excess into stocks as a form of "leverage"
Yep. Tried to get him to stop too. See the 22nd post on this page in the summer of 2008 right before Lehman
viewtopic.php?f=10&t=5934&start=200
SpeculativeTrader wrote:
Sat Jul 14, 2018 9:11 am
gmaynardkrebs wrote:
Sat Jul 14, 2018 8:04 am
It's not the leverage, it's the person doing the leveraging. Most home-buyers have no choice but to use leverage, and are thinking conservative and long term. Stock speculators using leverage tend to think short term, laboring under the delusion that they know something the market doesn't.
Playing devil's advocate, what if the user of leverage isn't a degenerate speculative trader and someone who is just trying to leverage their long-term Boglehead-style index portfolio?
Leveraging stocks is bad because you are leveraging something that is already leveraged. Corporate balance sheets have a lot of debt these days...
Last edited by grok87 on Sat Jul 14, 2018 9:44 am, edited 1 time in total.
Keep calm and Boglehead on. KCBO.

User avatar
Kenkat
Posts: 4448
Joined: Thu Mar 01, 2007 11:18 am
Location: Cincinnati, OH

Re: Why is leveraging property good but leveraging stocks bad?

Post by Kenkat » Sat Jul 14, 2018 9:40 am

Housing is typically less volatile than equities, so the risk of leverage is lower overall. However, as we saw in the 2008 housing bubble, housing can still experience large drops and we witnessed many people who were over leveraged get wiped out in the subsequent crisis.

thx1138
Posts: 784
Joined: Fri Jul 12, 2013 2:14 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by thx1138 » Sat Jul 14, 2018 9:41 am

gmaynardkrebs wrote:
Sat Jul 14, 2018 9:25 am
SpeculativeTrader wrote:
Sat Jul 14, 2018 9:11 am
Playing devil's advocate, what if the user of leverage isn't a degenerate speculative trader and someone who is just trying to leverage their long-term Boglehead-style index portfolio?
Ever seen one?
Every single person on this forum that has a taxable investment account and a mortgage at the same time...

FireProof
Posts: 591
Joined: Thu May 05, 2011 12:15 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by FireProof » Sat Jul 14, 2018 9:51 am

Simplest answer (though not necessarily correct) is that leverage is not good for property, it's just (generally) a necessity to afford one. People who can pay in cash usually do.

gmaynardkrebs
Posts: 937
Joined: Sun Feb 10, 2008 11:48 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by gmaynardkrebs » Sat Jul 14, 2018 9:59 am

:thumbsup
thx1138 wrote:
Sat Jul 14, 2018 9:41 am
gmaynardkrebs wrote:
Sat Jul 14, 2018 9:25 am
SpeculativeTrader wrote:
Sat Jul 14, 2018 9:11 am
Playing devil's advocate, what if the user of leverage isn't a degenerate speculative trader and someone who is just trying to leverage their long-term Boglehead-style index portfolio?
Ever seen one?
Every single person on this forum that has a taxable investment account and a mortgage at the same time...
Very clever. :thumbsup

Dottie57
Posts: 4794
Joined: Thu May 19, 2016 5:43 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by Dottie57 » Sat Jul 14, 2018 10:08 am

A mortgage for a home is backed by the property itself. What is a margin loan backed by? I would think it isn’t the stock itself, but your financial accounts. So you can’t pay the loan for the house? You lose the house, but not your money (at least in a non-recourse state).

A margin loan is called and you need to pay it off right now! What happens if you can’t pay it off? Sell your leveraged equity? Or takeout of savings ? Or Bankruptcy? But you need to come up with a better plan for the leverage you have to pay back. This definitely seems more precarious.

A home has utility while it is leveraged. I don’t think that is true of leveraged equities..

randomguy
Posts: 6624
Joined: Wed Sep 17, 2014 9:00 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by randomguy » Sat Jul 14, 2018 10:22 am

FireProof wrote:
Sat Jul 14, 2018 9:51 am
Simplest answer (though not necessarily correct) is that leverage is not good for property, it's just (generally) a necessity to afford one. People who can pay in cash usually do.
Nah people that don't want more money pay cash. That is a different subset than the ones that can pay cash. There is a segment of bogleheads that hates debt. There is also the segment that uses it as a tool. You need to decide which group you fall into.

MarketTimer was an example of leverage gone bad. But he was also using high levels of it and basically picking gambling instruments (i.e. leveraging up to play roulette:)). How that maps to someone who is taking on say additional 30% leverage to eke out another 1% return is hard to say.

dharrythomas
Posts: 897
Joined: Tue Jun 19, 2007 4:46 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by dharrythomas » Sat Jul 14, 2018 10:45 am

Debt/leverage is dangerous. Take it from someone who lives in a house bought in a short sale from a tax attorney, when the economy or market turns, unless you've got funds sitting in low return cash investments, you are at risk. It doesn't matter how smart you are (see LTCG) the leverage that has the potential to multiply your returns, multiplies your risk. That is neither good nor bad, it just is. Some people can handle it, most can't. Most people are lucky because the economy generally grows, others aren't.

Debt for a primary residence in the US is generally a long term non-recourse debt. There is also an element of enforced savings as you pay down the mortgage. So there is less risk, but we still paid off the house as fast as I could, while still investing a little. I don't really think of our primary residence as an investment but as a lifestyle expense. If I tried to think about it as an investment, the return is lousy. The mortgage interest deduction helped a little but very little after you get past the standard deduction.

Nate79
Posts: 3722
Joined: Thu Aug 11, 2016 6:24 pm
Location: Delaware

Re: Why is leveraging property good but leveraging stocks bad?

Post by Nate79 » Sat Jul 14, 2018 10:53 am

dharrythomas wrote:
Sat Jul 14, 2018 10:45 am
Debt/leverage is dangerous. Take it from someone who lives in a house bought in a short sale from a tax attorney, when the economy or market turns, unless you've got funds sitting in low return cash investments, you are at risk. It doesn't matter how smart you are (see LTCG) the leverage that has the potential to multiply your returns, multiplies your risk. That is neither good nor bad, it just is. Some people can handle it, most can't. Most people are lucky because the economy generally grows, others aren't.

Debt for a primary residence in the US is generally a long term non-recourse debt. There is also an element of enforced savings as you pay down the mortgage. So there is less risk, but we still paid off the house as fast as I could, while still investing a little. I don't really think of our primary residence as an investment but as a lifestyle expense. If I tried to think about it as an investment, the return is lousy. The mortgage interest deduction helped a little but very little after you get past the standard deduction.
I believe only about 12 states have non-recourse laws and even within those 12 it is not black and white and can have some restrictions and so forth. And those laws change over time. Definitely it is not something that is as common as some on here make it seem.

dharrythomas
Posts: 897
Joined: Tue Jun 19, 2007 4:46 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by dharrythomas » Sat Jul 14, 2018 11:03 am

Nate79 wrote:
Sat Jul 14, 2018 10:53 am
dharrythomas wrote:
Sat Jul 14, 2018 10:45 am
Debt/leverage is dangerous. Take it from someone who lives in a house bought in a short sale from a tax attorney, when the economy or market turns, unless you've got funds sitting in low return cash investments, you are at risk. It doesn't matter how smart you are (see LTCG) the leverage that has the potential to multiply your returns, multiplies your risk. That is neither good nor bad, it just is. Some people can handle it, most can't. Most people are lucky because the economy generally grows, others aren't.

Debt for a primary residence in the US is generally a long term non-recourse debt. There is also an element of enforced savings as you pay down the mortgage. So there is less risk, but we still paid off the house as fast as I could, while still investing a little. I don't really think of our primary residence as an investment but as a lifestyle expense. If I tried to think about it as an investment, the return is lousy. The mortgage interest deduction helped a little but very little after you get past the standard deduction.
I believe only about 12 states have non-recourse laws and even within those 12 it is not black and white and can have some restrictions and so forth. And those laws change over time. Definitely it is not something that is as common as some on here make it seem.
Thanks. I learn stuff here often, another reason to limit mortgage debt and pay it off early.

Turbo29
Posts: 216
Joined: Tue May 01, 2018 7:12 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by Turbo29 » Sat Jul 14, 2018 11:21 am

I live in a non-recourse state. Add that the the reasons I don't pay off my mortgage. In a worse-case scenario, I hand the keys to the bank.

User avatar
JoMoney
Posts: 6289
Joined: Tue Jul 23, 2013 5:31 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by JoMoney » Sat Jul 14, 2018 11:23 am

If you set the "leverage" as a percentage, then it requires rebalancing and suffers what some describe as "volatility drag". By keeping it at a fixed percentage, you might be able to avoid a margin call, but can still run the risk of a bad sequence that diminishes a portfolio to a point where it's too small to ever meaningfully recover:
Image
http://www.cfapubs.org/doi/pdf/10.2469/cp.v2004.n2.3379
...the leveraged portfolio performs dismally. Why? Although it does have the highest monthly expected return, it has such high variability that the likelihood of losing a substantial proportion of capital is so high that it likely will cause the investor to rebuild from a low base and never really recoup losses...
Edward Thorp wrote a paper analyzing the stock markets historical returns and used the Kelly Criterion to come up with a theoretical leverage amount to optimize growth while avoiding risk of ruin. It is however based on applying probabilistic constraints to the market based on historical returns, which is not necessarily representative of reality:
http://www.edwardothorp.com/wp-content/ ... Market.pdf
"...maximal average real growth will occurr (should margin at the T-bill rate be available) if one invests 117%..."
"...a hypothetical immortal investor continually wagering an amount greater than 1.7 times current resources, ruin is certain..."
"...somewhat artificially constructed probability distributions may not be fully taking into account ... numerical results we have obtained must be interpreted in light of the limitations inherent in any applied probabilistic model."
If you keep it limited to a small amount, it might be possible to safely use some small amount of leverage.... but is it really worth it? Most people on here caution against even a 90% stock portfolio that Warren Buffett suggested he would use for a bequest to his wife.
I suppose you could think of it as an asset allocation decision like any other. To modify a quote I've see elsewhere, I hold 90% of my portfolio in stocks so that half the time I wonder why I hold 10% in cash, and the other half I wonder why I'm not 180% stocks :wink:
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

User avatar
Pajamas
Posts: 6015
Joined: Sun Jun 03, 2012 6:32 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by Pajamas » Sat Jul 14, 2018 11:26 am

I think using reasonable leverage in equity investing is good as a long-term strategy.

Link was posted yesterday to an interesting video with Jack Bogle discussing this briefly:

https://youtu.be/k6ra5POdsYg?t=623

Investing is to a large degree about managing risk.

KlangFool
Posts: 10686
Joined: Sat Oct 11, 2008 12:35 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by KlangFool » Sat Jul 14, 2018 11:45 am

OP,

All leverages are bad. This applies to both property and stock. The relevant question is how much risk is the person taking. And, whether the gamble works out.

In term of the mortgage, many people buy more houses than their existing rent. And, they buy the house with a mortgage. So, many mortgages aka property leverage are bad too. Many folks are one short-term unemployment away from losing their houses.

The only exception is the folks that

A) Buy the same house as what they are renting.

B) The PITI of the mortgage (20% down payment and 30 years fixed rate) is 20% to 30% lower than their existing rent.

In those cases, the housing expense was reduced or about the same as their existing rent.

But, those folks are the exception rather than the norm. You will see many counter-arguments against my post to know how unpopular this view is.

KlangFool

runner540
Posts: 768
Joined: Sun Feb 26, 2017 5:43 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by runner540 » Sat Jul 14, 2018 11:48 am

SpeculativeTrader wrote:
Sat Jul 14, 2018 9:11 am

1) Hypothetically if there was an identical loan structure as with home mortgages for index funds, would that then be a sensible strategy for leverage?


Hence my confusion as to why leverage isn't treated as "bad" in all aspects. It seems to be okay or good to leverage to buy property, albeit, most people wouldn't be able to afford a home without leverage.
Lots of good comments up thread addressing the callability, volatility, and recourse on margin loans. Before and during the Great Depression, mortgages were also callable (and were much shorter term)

If people couldn't borrow for a home, prices would be lower. Incomes haven't gone up much in the last 5/10/20 years, but house prices have, due to increasing leverage.

It is culturally aceptable in the US to borrow a lot for a house. The "typical" mortgage loan structure (30 year, fixed rate, with as little as 3% down) is NOT a market product. It exists because it is insured by the govt/taxpayers. It's not generally available in other countries.

golfCaddy
Posts: 728
Joined: Wed Jan 10, 2018 10:02 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by golfCaddy » Sat Jul 14, 2018 12:21 pm

Simplest answer (though not necessarily correct) is that leverage is not good for property, it's just (generally) a necessity to afford one. People who can pay in cash usually do.
+1

If most people waited until they could pay cash for their house, their kids would be in college by the time they could make that happen. KF would argue most people overspend on housing, but that's more a lifestyle/saving choice than an investment decision.

Tanelorn
Posts: 1552
Joined: Thu May 01, 2014 9:35 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by Tanelorn » Sat Jul 14, 2018 1:08 pm

SpeculativeTrader wrote:
Sat Jul 14, 2018 5:50 am
What I don’t understand is why leverage is frowned upon for stocks but not for property where leverage is usually 5x.

I tried to brainstorm what the reasons leveraging stocks is bad compared to property:

• A home can provide you with shelter no matter if the price drops
• Higher financing costs for leveraging stocks
• Volatility drag? (this is a bit out of my scope of knowledge)
• Risk of margin calls

The more I think about it, is the main reason the risk of margin calls?
I think the main difference is that mortgage debt is non-callable regardless of home values, while margin debt is subject to margin calls based on mark to market stock prices. Some states mortgages are also non-recourse, which is an additional advantage although I'm not sure how aggressively brokers pursue collections outside of the assets in your brokerage account. Typically if there's a margin call, there are still plenty of assets vs the size of the margin loan (just not quite as many as they would like for their comfort level), and they will sell your stocks to pay down the loan. It would be quite usual to end up actually negative (requiring huge overnight moves and a concentrated portfolio or options or something), where you would potentially owe outside assets.

Margin financing rates are quite attractive compared to mortgages, although the former is short term floating while the latter is long term fixed so you have to make whatever adjustments. Good margin rates are around 2.25% currently, while 15-30 year mortgages are almost double at 4.5% or so. You could look up the interest rate swaps to try to compare these, but broadly competitive margin rates are cheap.

Volatility drag refers to the difference between compounding arithmetic and geometric rates of return across multiple time periods. This isn't particularly relevant here, as it applies to any investment. Geometric rates are what matter. I suppose if you employed a dynamic leverage strategy of something like 1.5x, and so borrowed more as assets appreciated or deleveraged as asset values fell, you might have to worry about convexity issues.

Housing as a consumption item, either via home ownership costs or rent, is largely separate from these discussions. Presumably you're going to pay about the same amount for a place to live regardless of your investments and as long as you can pay for those monthly costs out of your wage income, your investments' performance is pretty much separate.

I do agree that people who take out 0-20% down loans are taking a big risk buying a house. 5-10x leverage on an illiquid highly concentrated portfolio - what could go wrong? It's not like home prices haven't fallen 30-40% in the last 10 years, but I guess you can wait it out without a margin call at the bottom, but all your equity can be easily wiped out with a modest downturn in the RE market when you're leveraged a lot. Even with a responsible 20% down, a 20% drop in home values is a 100% loss in your home investment.

I think a reasonable take away here is that you want to avoid the risk of margin calls and not to pay too much in interest. If you use only a modest amount of leverage, say 20-30% more in borrowing than your portfolio equity (i.e. 1.2-1.3x), you are very unlikely to see a margin call situation outside of a 1929 scenario. Even 2008 should probably be ok, barely, especially if you have a diversified portfolio. You may be interested in this thread discussing leveraging a balanced index portfolio, if you haven't seen it:

viewtopic.php?f=10&t=143037
Last edited by Tanelorn on Sat Jul 14, 2018 1:18 pm, edited 1 time in total.

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 1:16 pm

Without reading other responses (so as not to be biased by them, these are my thoughts):

1. First of all, who said that leveraging property is good? Just because we do it already, it does not mean that it is good.

But the reality is that we all do it, so let's discuss why we do it.

2. Real Estate prices have lower volatility than stocks, generally speaking,

3. In employment-population centers, real estate prices appreciate about 1% above inflation,

3. Carrying costs from owning property would otherwise go to rental expenses. Perhaps not 100%, but to a large degree. Thus, not much additional expenditure is required to finance the mortgage (and pay for property taxes, etc),

4. If you go underwater, you won't be subject to a margin call, unlike stocks. This breaks down when selling, but then again, you don't have to sell.

5. Financing costs are *RIDICULOUSLY* low. They were even lower pre 2017 tax law. This point interacts with #3.

Someone would counter-argue by presenting the 2006-2008 housing debacle. But let's admit it: the principle of homeownership was not broken. Rather, the details became murky: (1) CCC was violated (Credit, Capacity, Collateral), (2) Irrational exuberance kicked in.

Another point to make is this: in ones earlier career years, an asset allocation that is more than 100% equities might make sense!
"You can get more with a kind word and a gun than with just a kind word." George Washington

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 1:17 pm

grok87 wrote:
Sat Jul 14, 2018 7:51 am
Some other thoughts.

1) think in general you want to reduce your mortgage, your home property leverage over time. You start out at 5x leveraged as you say-ie 20% down payment or 20% equity. Arguably by the time you retire you should be 100% equity or 0x leveraged.
Why?
"You can get more with a kind word and a gun than with just a kind word." George Washington

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 1:19 pm

alex_686 wrote:
Sat Jul 14, 2018 8:45 am
When was the last time you heard of house prices falling?
All the time. In 2006-2008, they fell 50%. In some cities, even more.

The more relevant points are the following:
- housing is not subject to 'noise' volatility (like stocks),
- even if housing prices fell, you don't need to top-up your downpayment (unlike in stocks, where you would be subject to a margin call).

If housing traded like a real-time index futures, then you would see housing prices go up and down, like stocks.

But such an index futures would need to be neighborhood specific.

E.g., some developer buys land to put a Whole Foods in the neighborhood: the R/E futures for that neighborhood will immediately pop up a few percent.
Last edited by AlphaLess on Sat Jul 14, 2018 1:29 pm, edited 1 time in total.
"You can get more with a kind word and a gun than with just a kind word." George Washington

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 1:21 pm

Turbo29 wrote:
Sat Jul 14, 2018 11:21 am
I live in a non-recourse state. Add that the the reasons I don't pay off my mortgage. In a worse-case scenario, I hand the keys to the bank.
Upvote x 100!
"You can get more with a kind word and a gun than with just a kind word." George Washington

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 1:23 pm

dharrythomas wrote:
Sat Jul 14, 2018 10:45 am
Debt for a primary residence in the US is generally a long term non-recourse debt. There is also an element of enforced savings as you pay down the mortgage. So there is less risk, but we still paid off the house as fast as I could, while still investing a little. I don't really think of our primary residence as an investment but as a lifestyle expense. If I tried to think about it as an investment, the return is lousy. The mortgage interest deduction helped a little but very little after you get past the standard deduction.
Excellent comments! Each sentence is a gem of its own.
I love this part: "the return is lousy". That needs to be a required statement to be placed on top of every R/E and Mortgage Brokerage company sign!

ReMAX Realty
Housing is a Lousy Investment(TM).
"You can get more with a kind word and a gun than with just a kind word." George Washington

User avatar
whodidntante
Posts: 4309
Joined: Thu Jan 21, 2016 11:11 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by whodidntante » Sat Jul 14, 2018 1:31 pm

AlphaLess wrote:
Sat Jul 14, 2018 1:19 pm
alex_686 wrote:
Sat Jul 14, 2018 8:45 am
When was the last time you heard of house prices falling?
All the time. In 2006-2008, they fell 50%. In some cities, even more.
A house is an undiversified risk asset. Some people buy a "bad" property that ends up having a major issue affecting it's value, or even something happens nearby that affects the value. You cannot always foresee this in advance. My friend had a grocery store buy up the adjacent land, and back up the hideous, loud, and smelly loading and garbage collection area directly against his backyard. Trucks would arrive at all hours, and some would sit there idling overnight. Sure, you can call the cops at 2 am every night, and you can sue, but he decided to sell at a loss and move on.

And America is full of towns where the economic engine fell apart, and most of the properties in the town fell into disrepair. The risk is lower in a larger city, but it is not zero. Detroit is an extreme example, but there are others.

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 1:35 pm

whodidntante wrote:
Sat Jul 14, 2018 1:31 pm
AlphaLess wrote:
Sat Jul 14, 2018 1:19 pm
alex_686 wrote:
Sat Jul 14, 2018 8:45 am
When was the last time you heard of house prices falling?
All the time. In 2006-2008, they fell 50%. In some cities, even more.
A house is an undiversified risk asset. Some people buy a "bad" property that ends up having a major issue affecting it's value, or even something happens nearby that affects the value. You cannot always foresee this in advance. My friend had a grocery store buy up the adjacent land, and back up the hideous, loud, and smelly loading and garbage collection area directly against his backyard. Trucks would arrive at all hours, and some would sit there idling overnight. Sure, you can call the cops at 2 am every night, and you can sue, but he decided to sell at a loss and move on.

And America is full of towns where the economic engine fell apart, and most of the properties in the town fell into disrepair. The risk is lower in a larger city, but it is not zero. Detroit is an extreme example, but there are others.
Bingo!
"You can get more with a kind word and a gun than with just a kind word." George Washington

Dottie57
Posts: 4794
Joined: Thu May 19, 2016 5:43 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by Dottie57 » Sat Jul 14, 2018 1:44 pm

Real estate is a lousy investment if you buy too much home. I don’t Really think of it as an investment.

I love owning my home. Hated renting.

runner540
Posts: 768
Joined: Sun Feb 26, 2017 5:43 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by runner540 » Sat Jul 14, 2018 2:23 pm

whodidntante wrote:
Sat Jul 14, 2018 1:31 pm
AlphaLess wrote:
Sat Jul 14, 2018 1:19 pm
alex_686 wrote:
Sat Jul 14, 2018 8:45 am
When was the last time you heard of house prices falling?
All the time. In 2006-2008, they fell 50%. In some cities, even more.
A house is an undiversified risk asset. Some people buy a "bad" property that ends up having a major issue affecting it's value, or even something happens nearby that affects the value. You cannot always foresee this in advance. My friend had a grocery store buy up the adjacent land, and back up the hideous, loud, and smelly loading and garbage collection area directly against his backyard. Trucks would arrive at all hours, and some would sit there idling overnight. Sure, you can call the cops at 2 am every night, and you can sue, but he decided to sell at a loss and move on.

And America is full of towns where the economic engine fell apart, and most of the properties in the town fell into disrepair. The risk is lower in a larger city, but it is not zero. Detroit is an extreme example, but there are others.
+1
The WSJ had an article last week about how when the FAA changed flight patterns, previously quiet areas had a huge increase in airplane boise that affected quality of life and values. Some of the examples were upscale areas in cities like Chicago and San Diego.

User avatar
vineviz
Posts: 2313
Joined: Tue May 15, 2018 1:55 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by vineviz » Sat Jul 14, 2018 2:42 pm

Pajamas wrote:
Sat Jul 14, 2018 11:26 am
I think using reasonable leverage in equity investing is good as a long-term strategy.

Link was posted yesterday to an interesting video with Jack Bogle discussing this briefly:

https://youtu.be/k6ra5POdsYg?t=623

Investing is to a large degree about managing risk.
I agree. In Lifecycle Investing, Ian Ayres and Barry Nalebuff made a pretty compelling case that young investors should use leverage to increase their equity exposure as a form of diversification across time.

http://lifecycleinvesting.net/index.html

They argue that margin is probably the cheapest way to accomplish it but in tax-advantaged accounts you could use an ETF like ProShares UltraPro S&P500 as part of a portfolio to achieve 1.5x or 2x leverage for extended periods of time.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

Valuethinker
Posts: 36691
Joined: Fri May 11, 2007 11:07 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by Valuethinker » Sat Jul 14, 2018 5:27 pm

vineviz wrote:
Sat Jul 14, 2018 2:42 pm
Pajamas wrote:
Sat Jul 14, 2018 11:26 am
I think using reasonable leverage in equity investing is good as a long-term strategy.

Link was posted yesterday to an interesting video with Jack Bogle discussing this briefly:

https://youtu.be/k6ra5POdsYg?t=623

Investing is to a large degree about managing risk.
I agree. In Lifecycle Investing, Ian Ayres and Barry Nalebuff made a pretty compelling case that young investors should use leverage to increase their equity exposure as a form of diversification across time.

http://lifecycleinvesting.net/index.html

They argue that margin is probably the cheapest way to accomplish it but in tax-advantaged accounts you could use an ETF like ProShares UltraPro S&P500 as part of a portfolio to achieve 1.5x or 2x leverage for extended periods of time.
I thought they were negligent to the point of malpractice urging such a strategy on investors.

Here we debated the argument in at least one thread.

The leveraged ETFs don't behave like one thinks they do, btw. Again we debated here.

As I recall we had Nalebufs book and market timer's implementation of the strategy and *then* we had the Lehman Crash.

Not too much talk of leveraging to buy stocks, then.

It is a symptom of a bull market that these strategies come back into vogue.

Btw I recall people doing this in the late 70s and early 80s and losing all their money. Even at the begining of the biggest bull market in history.

Fwiw I am seeing something similar in cryptocurrency as well. Lot of talk about borrowing to leverage investments in crypto.

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 5:29 pm

vineviz wrote:
Sat Jul 14, 2018 2:42 pm
They argue that margin is probably the cheapest way to accomplish it but in tax-advantaged accounts you could use an ETF like ProShares UltraPro S&P500 as part of a portfolio to achieve 1.5x or 2x leverage for extended periods of time.
I strongly disagree with using ultra funds for leverage.
You are buying not JUST leverage.
You are also buying gamma exposure, at high fees.

The best way to get leverage is via futures.
"You can get more with a kind word and a gun than with just a kind word." George Washington

Valuethinker
Posts: 36691
Joined: Fri May 11, 2007 11:07 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by Valuethinker » Sat Jul 14, 2018 5:36 pm

Dottie57 wrote:
Sat Jul 14, 2018 10:08 am
A mortgage for a home is backed by the property itself. What is a margin loan backed by? I would think it isn’t the stock itself, but your financial accounts. So you can’t pay the loan for the house? You lose the house, but not your money (at least in a non-recourse state).

A margin loan is called and you need to pay it off right now! What happens if you can’t pay it off? Sell your leveraged equity? Or takeout of savings ? Or Bankruptcy? But you need to come up with a better plan for the leverage you have to pay back. This definitely seems more precarious.

A home has utility while it is leveraged. I don’t think that is true of leveraged equities..
I am not clear if you are just speaking rhetorically?

But to be clear, stock margin (or futures trading margin) is given against your portfolio value. If that falls and you exceed your margin percentage you either put additional cash in the account or the broker sells securities. I believe SEC rules require them to do this, and they are regulated on total margin exposure to their clients. You are marked to market at least daily in assessing your exposure.

Since the Crash of 1987 and the 1998 failure of Long Term Capital Management a lot of attention is paid to security dealers' client margin exposure.

Valuethinker
Posts: 36691
Joined: Fri May 11, 2007 11:07 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by Valuethinker » Sat Jul 14, 2018 5:38 pm

AlphaLess wrote:
Sat Jul 14, 2018 5:29 pm
vineviz wrote:
Sat Jul 14, 2018 2:42 pm
They argue that margin is probably the cheapest way to accomplish it but in tax-advantaged accounts you could use an ETF like ProShares UltraPro S&P500 as part of a portfolio to achieve 1.5x or 2x leverage for extended periods of time.
I strongly disagree with using ultra funds for leverage.
You are buying not JUST leverage.
You are also buying gamma exposure, at high fees.

The best way to get leverage is via futures.
Can you remind me what gamma exposure is?

Delta is change in option value with respect to price? So gamma is change in option delta wrt price?

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 5:49 pm

Valuethinker wrote:
Sat Jul 14, 2018 5:38 pm
AlphaLess wrote:
Sat Jul 14, 2018 5:29 pm
vineviz wrote:
Sat Jul 14, 2018 2:42 pm
They argue that margin is probably the cheapest way to accomplish it but in tax-advantaged accounts you could use an ETF like ProShares UltraPro S&P500 as part of a portfolio to achieve 1.5x or 2x leverage for extended periods of time.
I strongly disagree with using ultra funds for leverage.
You are buying not JUST leverage.
You are also buying gamma exposure, at high fees.

The best way to get leverage is via futures.
Can you remind me what gamma exposure is?

Delta is change in option value with respect to price? So gamma is change in option delta wrt price?
First, Yes to both of your questions.

Delta is the first derivative WRT to underlying.
For example, in this scenario:
- interest rate zero,
- stock current price: $100,
- no dividends,
- strike price: $100 call,

The call will have a delta of 0.5 (50%).
That is: with every infinitesimal change in the price of the stock, the option will appreciate half as much.

Gamma is the SECOND derivative.

So, say, when the stock moves UP $1, to $101, the delta is no longer EXACTLY 0.5. Let's say, it is 0.55.
The change in delta: (0.55 - 0.5) divided by the stock price move, $1.0, is the gamma.
https://en.wikipedia.org/wiki/Greeks_(finance)#Gamma
Last edited by AlphaLess on Sat Jul 14, 2018 8:39 pm, edited 1 time in total.
"You can get more with a kind word and a gun than with just a kind word." George Washington

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 6:00 pm

^^^^
Following that, let me illustrate two really simple scenarios.

In both scenarios, you buy a 2x leveraged SP.500 fund (ETF or whatever), *DAILY* rebalanced, let's call this SSO (https://www.morningstar.com/etfs/arcx/sso/quote.html). SPY is the underlying.

1. In the first scenario, the underlying goes up 1% for 20 days straight.

So, SPY would go from $100 to $122, or a 22% increase.
SSO would go from $100 to $148, or a 48% increase.
(Ignore fees, rebalance effects, slippage, etc).

So you made 48% instead of 22%, right? Pretty awesome!

2. In the second scenario, the underlying alternates between a 1% gain and loss, for 20 straight days.
So, SPY would go from $100 to $99.90, or 0.1% loss.
SSO would go from $99.60, or 0.4% loss.

In reality, the up-down moves are a lot more common than straight up moves.

Stock market volatility is, let's say 15% a year, which is 1% daily (so, on average, up 1%, down 1%).
But the stock market does not go up 250% a year. You can expect it to go up, say, 10% a year.

That's why the second scenario is always present, and is effectively decaying your asset.
Thus, if you do this math: ((1 + 02) * ( 1 - 0.2)) ^ 125 = 0.95, you see that the drag is quite a lot from up-down movements.

Triple leveraged is even worse: ( (1 + 0.03) * ( 1- 0.03) ) ^ 125 = 0.89
"You can get more with a kind word and a gun than with just a kind word." George Washington

KyleAAA
Posts: 6800
Joined: Wed Jul 01, 2009 5:35 pm
Contact:

Re: Why is leveraging property good but leveraging stocks bad?

Post by KyleAAA » Sat Jul 14, 2018 6:02 pm

You can leverage real estate more cheaply and on much more favorable terms than stocks. Fixed rates and no margin calls are big advantages compared to adjustable margin rates that are aggressively called when the market turns down.

jalbert
Posts: 3923
Joined: Fri Apr 10, 2015 12:29 am

Re: Why is leveraging property good but leveraging stocks bad?

Post by jalbert » Sat Jul 14, 2018 6:12 pm

Most stocks are for companies that already are levered (issuing corporate bonds or taking on other business loans).
Risk is not a guarantor of return.

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 8:40 pm

KyleAAA wrote:
Sat Jul 14, 2018 6:02 pm
You can leverage real estate more cheaply and on much more favorable terms than stocks. Fixed rates and no margin calls are big advantages compared to adjustable margin rates that are aggressively called when the market turns down.
:moneybag
"You can get more with a kind word and a gun than with just a kind word." George Washington

grok87
Posts: 8504
Joined: Tue Feb 27, 2007 9:00 pm

Re: Why is leveraging property good but leveraging stocks bad?

Post by grok87 » Sat Jul 14, 2018 8:43 pm

AlphaLess wrote:
Sat Jul 14, 2018 1:17 pm
grok87 wrote:
Sat Jul 14, 2018 7:51 am
Some other thoughts.

1) think in general you want to reduce your mortgage, your home property leverage over time. You start out at 5x leveraged as you say-ie 20% down payment or 20% equity. Arguably by the time you retire you should be 100% equity or 0x leveraged.
Why?
Well the way I think about it, during your working career one should be saving for retirement and paying off your house or equivalently defeasing the mortgage (my point 2).

But it’s hard to know exactly how much to save for retirement or what withdrawal strategy to use. I actually have a post about that-the three legged stool approach.
...
viewtopic.php?f=10&t=245377
...
If your retirement savings fail, either due to bad returns or unexpected expenses or a combination of the two, the paid off house provides an alternate source of funds. You can always get a reverse mortgage to help out.
Keep calm and Boglehead on. KCBO.

AlphaLess
Posts: 1060
Joined: Fri Sep 29, 2017 11:38 pm
Location: Kentucky

Re: Why is leveraging property good but leveraging stocks bad?

Post by AlphaLess » Sat Jul 14, 2018 9:00 pm

grok87 wrote:
Sat Jul 14, 2018 8:43 pm
If your retirement savings fail, either due to bad returns or unexpected expenses or a combination of the two, the paid off house provides an alternate source of funds. You can always get a reverse mortgage to help out.
I disagree with that line of thinking.

If you take the pay-off amount of the house, and put it into some investing strategy, you have the exact same situation, without the headache of having to get a reverse mortgage.

The decision to keep the mortgage or not should be driven by marginal cost / benefit analysis.
For example, imagine the following:
- I have a low, lock-ed in mortgage rate (say, 2.75%),
- I am getting a tax savings on mortgage interest (say, to the tune of 35% marginal deduction on Federal taxes),
- other investments have higher expected yields (say, a 5-year CD yielding 2.75%).

Then I definitely keep the mortgage.

Of course, my 3 bullet points are intentionally making maintaining of the mortgage look good.
You can also create a situation when the reverse is true.
"You can get more with a kind word and a gun than with just a kind word." George Washington

Post Reply