Why is leveraging property good but leveraging stocks bad?

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

Post by fennewaldaj » Sat Jul 14, 2018 9:22 pm

The book Successful investing is a process has a pretty good chapter on the effects of volatility drag on leveraged stock investments.

https://www.amazon.com/Successful-Inves ... +a+process

grok87
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Re: Why is leveraging property good but leveraging stocks bad?

Post by grok87 » Sat Jul 14, 2018 9:29 pm

AlphaLess wrote:
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.
Right. If you don’t want to risk the hassle of a reverse mortgage then don’t pay off your original mortgage but defease it, ie hold duration matched treasuries or other low risk bonds instead. That was point 2) of my first post on this thread..

If you do a different strategy instead with this house money then you are taking additional risk and you could end up underwater on the house.
Keep calm and Boglehead on. KCBO.

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

Post by AlphaLess » Sat Jul 14, 2018 9:43 pm

grok87 wrote:
Sat Jul 14, 2018 9:29 pm
Right. If you don’t want to risk the hassle of a reverse mortgage then don’t pay off your original mortgage but defease it, ie hold duration matched treasuries or other low risk bonds instead. That was point 2) of my first post on this thread..

If you do a different strategy instead with this house money then you are taking additional risk and you could end up underwater on the house.
I see what you are saying. I think I understand you much better.

But then, what you are saying is simply an exercise in asset allocation.

Instead of having x% in stocks, and 100-x in bonds, you now have y% in stocks, vs 100-y in bonds.

y-x, in dollar terms, need not be your house price, mortgage notional, but could be a function of it.
"You can get more with a kind word and a gun than with just a kind word." George Washington

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

Post by vineviz » Sat Jul 14, 2018 10:06 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.
Using futures or margin may have some advantages over using leveraged ETFs, possibly including cost (I’ve never directly compared the expense of one versus the others).

Leveraged ETFs also have some advantages, so I suspect the ‘best’ approach is likely to vary from one circumstance to another.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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

Post by munemaker » Sat Jul 14, 2018 10:15 pm

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?
Well yes! If you have a home mortgage or car loan and are invested in the market, you are leveraged. You could have paid down the loan but you invested in the market instead. Basically you are investing with borrowed money.

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

Post by WanderingDoc » Sat Jul 14, 2018 11:00 pm

1. Walk into a Bank of America and ask to buy a house or apartment, 20% down, 5:1 leverage. They will say "you can". Ask them to give you an 80% loan to buy actual stock in Bank of America, their own company. They may laugh you out of the bank. Makes you wonder what they think the risk of one is vs. the other.
2. Leverage is a huge diversification benefit in real estate. Buying 5 houses each 20% down, vs. one house 100% down. The former is significantly less risky. You can diversify among asset types, tenant types, different real estate niches, or even geographically.
3. You have a legal benefit to use leverage in real estate. Take two investors in CA. One owns his $1M property outright, the other only had 5% equity in the same $1M property. Well, say they get sued. Now, who do you think the attorney will come after? You got it, the one who isn't leveraged.
4. Leverage is a fantastic inflation hedge in real estate. You pay the lender in dollars that are worth less and less every day. You pay them the same fixed dollar amount over 30 years. To me, that is almost like getting away with murder.

I can list many more but, that should suffice for now. Thats why when I frequently read on here " you should compare leveraged real estate returns to leverages stock returns, apples to apples right" I can't help but laugh. Usually out loud. Totally a different animal. Leverage in real estate has so many benefits, you discover more the longer you do this. In most cases, it actually lowers your risk. Ill-informed individuals will assume that levered stocks = leveraged real estate in terms of risk. This sounds great in theory, but is not accurate in the real world. Thats the world I like living in. And a sweet one it is :D

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.
I'm not looking to get rich quick (stocks), I'm not looking to get rich slow (indexing), I'm looking to get rich, for sure (real estate) | Don't wait to buy real estate. Buy real estate.. and wait.

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

Post by gmaynardkrebs » Sat Jul 14, 2018 11:12 pm

munemaker wrote:
Sat Jul 14, 2018 10:15 pm
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?
Well yes! If you have a home mortgage or car loan and are invested in the market, you are leveraged. You could have paid down the loan but you invested in the market instead. Basically you are investing with borrowed money.
I see the point, but leverage is a legal term as well as an economic term. So while an economist might say any borrowing is leverage if the borrower owns other marketable assets, the law does not treat leveraging in similar fashion. For example: leveraged equity transactions are subject to SEC rules, whereas home loans are not; a creditor on a defaulted non-recourse mortgage would be laughed out of court if he tried to go against against the debtor's equity holdings on the economists view of leverage. These legal distinctions regarding leverage have great financial implications, which is why arguing that leverage is fungible between and among different classes is rather beside the point for most investors and homeowners.

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

Post by Park » Sat Jul 14, 2018 11:44 pm

AlphaLess wrote:
Sat Jul 14, 2018 5:29 pm
The best way to get leverage is via futures.
In a taxable account, are futures better than margin at IB?

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

Post by randomguy » Sun Jul 15, 2018 12:07 am

WanderingDoc wrote:
Sat Jul 14, 2018 11:00 pm
1. Walk into a Bank of America and ask to buy a house or apartment, 20% down, 5:1 leverage. They will say "you can". Ask them to give you an 80% loan to buy actual stock in Bank of America, their own company. They may laugh you out of the bank. Makes you wonder what they think the risk of one is vs. the other.
2. Leverage is a huge diversification benefit in real estate. Buying 5 houses each 20% down, vs. one house 100% down. The former is significantly less risky. You can diversify among asset types, tenant types, different real estate niches, or even geographically.
3. You have a legal benefit to use leverage in real estate. Take two investors in CA. One owns his $1M property outright, the other only had 5% equity in the same $1M property. Well, say they get sued. Now, who do you think the attorney will come after? You got it, the one who isn't leveraged.
4. Leverage is a fantastic inflation hedge in real estate. You pay the lender in dollars that are worth less and less every day. You pay them the same fixed dollar amount over 30 years. To me, that is almost like getting away with murder.

1) But they will sell you some 10:1 options:)

2) yep but you have also added risk. You are now liable for 5x as much in loans. So with a 20% market decline, you have now lost 100% instead of 20%. The good news is the bank doesn't do margin calls so can hope to outlast it. Of course if you just happened to buy in a market in a death spiral, that might not happen in your investment time frame

3) It doesn't matter. If you have 1 million in 1 property or 1 million in 20 properties you are still getting sued. The fact that in one case you control 20 million dollars worth of properties instead of 1 doesn't matter. And if it your personal home, you might be happier with a 1 million dollar house that is paid off versus a 1 million dollar house that you owe 900k on and a 1.5million portfolio. Not really up on CA homestead exemption laws

4) Yep. You do run deflation risk but in general that is a pretty asymmetric risk as we have only had a couple periods in the past 150 or so years where it is an issue. How to value that risk is up to you.

Leverage is a tool. You need to evaluate your situation and decide if it is worth while or not. If I could borrow at 4% fixed for 30 years and not have margin calls, I would seriously think about leveraging up my stock portfolio. Since I can't do it that cheapily, I just don't pay off my house.

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

Post by privatefarmer » Sun Jul 15, 2018 12:25 am

technically, if you have a mortgage and own stocks you are using leverage to own those stocks... you're using leverage to own the home AND using leverage to own stocks - could you not sell the stocks to pay of the mortgage?

a 30 yr, tax deductible, low-interest fixed rate mortgage is far better than a variable-rate loan that can be called during a bear market. but unless you sold all your stocks to pay down your mortgage, you ARE using leverage on your stocks when holding a mortgage and owning stocks.

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

Post by CurlyDave » Sun Jul 15, 2018 1:18 am

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.
+1

Even in retirement (maybe I should learn to say I am "independent" rather than "retired") DW and I carry 4 mortgages one on my residence and 3 on multi-family rental properties. The payments on the mortgages are covered by our pensions and SS and we live on the cash flow from the properties plus portfolio distributions.

Now we could have paid for the properties outright but it would have taken our portfolio to near zero 10 years ago. Instead we used mortgage leverage to buy the properties and preserved our portfolio. It is an open question whether the leverage is on the properties or on the portfolio, but it has benefitted us greatly.

BTW, this is how I inflation adjust a non-adjustable pension -- use it to pay the fixed mortgage on an income property and let the inherent inflation adjustment in rents compensate for inflation. Of course someone is going to say: "but you are cheating, that is not really true. SS is inflation adjusted and you are using that also." Well, let me tell you the real truth. My SS benefit has decreased every year since I turned 65. Oh sure, the benefit itself had increased at a miserably slow rate, but the medicare deduction has taken off like one of Elon Musk's rockets. The amount that goes into our bank account has gotten smaller every year, and not by pennies, or by single-digit dollars.

If it were not for the fact that both rents and portfolio values have increased substantially over the last decade DW and I would be decidedly worse off. But, I think that both increases were perfectly predictable and we positioned ourselves to take advantage. Rents increase with inflation (although choosing location wisely is also part of increases), and equity CAGR is frequently better than bonds.

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

Post by WanderingDoc » Sun Jul 15, 2018 3:09 am

CurlyDave wrote:
Sun Jul 15, 2018 1:18 am
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.
+1

Even in retirement (maybe I should learn to say I am "independent" rather than "retired") DW and I carry 4 mortgages one on my residence and 3 on multi-family rental properties. The payments on the mortgages are covered by our pensions and SS and we live on the cash flow from the properties plus portfolio distributions.

Now we could have paid for the properties outright but it would have taken our portfolio to near zero 10 years ago. Instead we used mortgage leverage to buy the properties and preserved our portfolio. It is an open question whether the leverage is on the properties or on the portfolio, but it has benefitted us greatly.

BTW, this is how I inflation adjust a non-adjustable pension -- use it to pay the fixed mortgage on an income property and let the inherent inflation adjustment in rents compensate for inflation. Of course someone is going to say: "but you are cheating, that is not really true. SS is inflation adjusted and you are using that also." Well, let me tell you the real truth. My SS benefit has decreased every year since I turned 65. Oh sure, the benefit itself had increased at a miserably slow rate, but the medicare deduction has taken off like one of Elon Musk's rockets. The amount that goes into our bank account has gotten smaller every year, and not by pennies, or by single-digit dollars.

If it were not for the fact that both rents and portfolio values have increased substantially over the last decade DW and I would be decidedly worse off. But, I think that both increases were perfectly predictable and we positioned ourselves to take advantage. Rents increase with inflation (although choosing location wisely is also part of increases), and equity CAGR is frequently better than bonds.
You were wise to buy real estate and hold it. Real estate is a very forgiving investment. I've found that you could make a lot of mistakes, not run the numbers that well, but if you hold on - rent growth, principal paydown, and equity happens :) Well done!
In my case, I just bought a few properties, never wrote a business plan or had any intent of being financially independent (didn't even know of the concept), then boom! 4 years later that's exactly what I am. Cannot stop now. This is too fun :beer
I'm not looking to get rich quick (stocks), I'm not looking to get rich slow (indexing), I'm looking to get rich, for sure (real estate) | Don't wait to buy real estate. Buy real estate.. and wait.

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

Post by Valuethinker » Sun Jul 15, 2018 5:03 am

fennewaldaj wrote:
Sat Jul 14, 2018 9:22 pm
The book Successful investing is a process has a pretty good chapter on the effects of volatility drag on leveraged stock investments.

https://www.amazon.com/Successful-Inves ... +a+process
Thank you!

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

Post by Valuethinker » Sun Jul 15, 2018 5:14 am

grok87 wrote:
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...
Apple and a few of the tech stocks are unique in holding so much cash and investments.

Most financial stocks have huge leverage. For every 10 dollars Of loans, say, a bank borrows 9 dollars from its depositors bond holders or money markets

Car compamies like Ford have leverage in their customers in effect. They supply their dealerships w credit to buy the cars.

Netflix is a high growth tech stock. So is Tesla. Both have a lot of debt and negative cash flow.

Of course US REITs are quite highly leveraged.

grok87
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Re: Why is leveraging property good but leveraging stocks bad?

Post by grok87 » Sun Jul 15, 2018 6:45 am

AlphaLess wrote:
Sat Jul 14, 2018 9:43 pm
grok87 wrote:
Sat Jul 14, 2018 9:29 pm
Right. If you don’t want to risk the hassle of a reverse mortgage then don’t pay off your original mortgage but defease it, ie hold duration matched treasuries or other low risk bonds instead. That was point 2) of my first post on this thread..

If you do a different strategy instead with this house money then you are taking additional risk and you could end up underwater on the house.
I see what you are saying. I think I understand you much better.

But then, what you are saying is simply an exercise in asset allocation.

Instead of having x% in stocks, and 100-x in bonds, you now have y% in stocks, vs 100-y in bonds.

y-x, in dollar terms, need not be your house price, mortgage notional, but could be a function of it.
Yes I agree.

So as you put it, y-x is the additional amount you have in bonds to notionally defease or match your mortgage, whether in whole or in part.

But I also think this y-x should be in high quality bonds like treasuries, tips, maybe certain munis, that are duration matched to the duration of your mortgage.

In general I think liability matching strategies are not used enough or recommended enough on this forum. I don’t know if you were interested in reading my post on the 3-legged stool approach to retirement saving that I linked to a couple of comments ago.
viewtopic.php?f=10&t=245377

Would be grateful for any thought or comments.

Cheers,
Grok
Keep calm and Boglehead on. KCBO.

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

Post by nisiprius » Sun Jul 15, 2018 7:06 am

SpeculativeTrader wrote:
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... Maslow's Hierarchy of Needs...
...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.
I've been brooding on whether or how to reply. To begin with, the screen name "SpeculativeTrader" and the tendentious thread title "Why is leveraging property good but leveraging stocks bad?" give me the impression that you've actually made up your mind. You've decided to be, or are hoping to be a speculative trader leveraging stocks.

Now, there are two ways to deal with a decision to do something risky. One is to consciously accept the risk. "I know it's risky and it suits me." In the famous inspirational poem "If," Rudyard Kipling counts the ability to take big risks as part of what it takes to "be a man:"
If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breathe a word about your loss;...
The other way is to deny or dismiss the risk. And it is that which bothers me. There is such a thing as a "calculated risk" but you want to do the calculations correctly.

Why try to draw any kind of analogy between short-term stocks-on-margin speculative apples and long-term home-ownership oranges? It sounds to me like the kind of argument salespeople make when they are trying to sell something risky to a risk-averse person. ("You trust bonds. Bonds create an income stream. These dividend stocks create an income stream. Therefore, these dividend stocks are the same as bonds.") ("You fear leverage. But, look! you're already leveraged anyway, and one leverage is just like any other leverage because money is fungible...")

The "money is fungible" argument leads to the conclusion that there isn't any distinction to be made between any kind of financial risk. It also denies the reality of psychological factors. But happiness itself is a psychological factor, and fortunately, thanks to the behavioral economists, it is now acceptable to acknowledge that we are not rational, and that decision-making as if we were is dysfunctional. The reality is that we do mental accounting and partition our financial life into separated compartments.

More broadly, I feel that some financial sophisticates, having grasped complex multi-step interactions between assets and money flow, are much too eager to use that knowledge and to exaggerate their reliability and causality. They believe a Rube Goldberg machine will really work reliably, because they can visualize the multistep process and understand how each step works. Nassim Nicholas Taleb has commented--I hope this is the gist, I don't have the exact quotation--that economists like leverage because it theoretically creates more efficient systems, and systematically underestimate the degree to which it increases the fragility of systems.

People who use leverage often have arguments as to why it isn't really all that risky. "It's not that risky if you know what you're doing." "It's not that risky the way I'm using it because my long and short positions are market neutral and if the market crashes my losses of the long side will always be made up by my gains on the short side." "LTCM teaches us nothing, it was a long time ago, and it was the bad luck of a ten-sigma event that can't happen oftener than once in a quadrillion years, and they were stupid, and what I'm doing is completely different."

When it is time to open a margin account, I think there is a special form to sign. I'm not sure, anyone know, but I think it is a real paper form requiring a physical signature and mailing, not just a box to check off online. It will say something like "Trading on margin is only for sophisticated investors with high risk tolerance. You may lose more than your initial investment." You don't need to sign anything like that to take out a mortgage.

Now, if you are a Jesse Livermore, and you love risk and you don't mind making and losing fortunes repeatedly, that's one thing. I would just say that when you get to the place where you are signing your name to say you are totally cool with losing more than everything you have, don't just say "Oh, lawyers." Take it seriously. Don't sign it if you don't agree with it in your heart, or if you don't really believe it could happen to you.
Last edited by nisiprius on Sun Jul 15, 2018 7:18 am, edited 4 times in total.
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grok87
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Re: Why is leveraging property good but leveraging stocks bad?

Post by grok87 » Sun Jul 15, 2018 7:12 am

Valuethinker wrote:
Sun Jul 15, 2018 5:14 am
grok87 wrote:
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...
Apple and a few of the tech stocks are unique in holding so much cash and investments.

Most financial stocks have huge leverage. For every 10 dollars Of loans, say, a bank borrows 9 dollars from its depositors bond holders or money markets

Car compamies like Ford have leverage in their customers in effect. They supply their dealerships w credit to buy the cars.

Netflix is a high growth tech stock. So is Tesla. Both have a lot of debt and negative cash flow.

Of course US REITs are quite highly leveraged.
This data source suggests that current equity reit leverage, debt to total capitalization is 33.5%
https://www.reit.com/data-research/reit ... l-snapshot
Which I think is lower than it has been historically.
https://www.reit.com/news/blog/nareit-m ... o-20-years
Definitely something to watch...
Keep calm and Boglehead on. KCBO.

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

Post by gmaynardkrebs » Sun Jul 15, 2018 7:46 am

WanderingDoc wrote:
Sun Jul 15, 2018 3:09 am

You were wise to buy real estate and hold it. Real estate is a very forgiving investment. I've found that you could make a lot of mistakes, not run the numbers that well, but if you hold on - rent growth, principal paydown, and equity happens :) Well done!
In my case, I just bought a few properties, never wrote a business plan or had any intent of being financially independent (didn't even know of the concept), then boom! 4 years later that's exactly what I am. Cannot stop now. This is too fun :beer
I really do like your positive thinking, and that you are having fun -- so important never to lose that aspect of investing. But re the fun aspect, many people find dealing with properties and irksome tenants the opposite of fun. You've probably answered this somewhere along the line, but I'm a slow thread scanner so please forgive: do you manage your properties yourself, or hire a prop manager? If the latter, how how hard is it to find a responsible person to do that job? I haven't done a survey or anything, but the few I've met in my neck of the woods did not impress.

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

Post by grok87 » Sun Jul 15, 2018 7:51 am

whodidntante wrote:
Sat Jul 14, 2018 8:37 am
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.
You may be right as far as your approach goes. But I think it WAS his conclusion. He referenced this quote of fishers (see conclusion of article)
“Fisher” wrote: I fancy that over-confidence seldom does any great harm except when, as, and if, it beguiles its victims into debt.”
https://www.economist.com/news/special- ... urn-normal

I think he also posted that he is in a better place financially but that he has zero equity exposure
Keep calm and Boglehead on. KCBO.

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

Post by SGM » Sun Jul 15, 2018 8:56 am

A house mortgage had the advantage in that the interest was tax deductible. I don't know if interest paid for buying on margin was or is deductible. Another advantage of a mortgage is that you have to pay to rent anyway.

For many years I had a very high stock allocation. Most BHs would find this reckless, but I had job security, disability insurance and good health. I had not wanted to increase my risk by adding leverage. Consistent investing regardless of valuations did the job for me.

I have a buddy who has shown me his margin account. He is way behind on retiring. At age 70 he may never retire and he is in a high paying field. I have seen so many people over extend themselves with loans. Obviously I have my own biases. Seeing the increased value of my parents home while I was growing up is probably a form of bias. I have also seen others who have bought in mill towns in 1946 see no gain 60 years later.

I haven't had any debt for many years and would not trade that for any potential gain accompanied by increased leverage.

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

Post by Tanelorn » Sun Jul 15, 2018 9:03 am

nisiprius wrote:
Sun Jul 15, 2018 7:06 am
In the famous inspirational poem "If," Rudyard Kipling counts the ability to take big risks as part of what it takes to "be a man:"
If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breathe a word about your loss;...
I think the emphasis should be on the last line from your quote. It's not that you should take big risks necessarily, but that when you do and you lose, take responsibility for your actions and don't go whining about it to others.

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

Post by zaboomafoozarg » Sun Jul 15, 2018 9:08 am

whodidntante wrote:
Sat Jul 14, 2018 8:37 am
"Leverage is bad" is not a reasonable conclusion from his story.
From his thread, I did learn that having someone that can bail you out on the order of six figures makes things safer.

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

Post by CurlyDave » Sun Jul 15, 2018 11:05 am

gmaynardkrebs wrote:
Sun Jul 15, 2018 7:46 am
WanderingDoc wrote:
Sun Jul 15, 2018 3:09 am

You were wise to buy real estate and hold it. Real estate is a very forgiving investment. I've found that you could make a lot of mistakes, not run the numbers that well, but if you hold on - rent growth, principal paydown, and equity happens :) Well done!
In my case, I just bought a few properties, never wrote a business plan or had any intent of being financially independent (didn't even know of the concept), then boom! 4 years later that's exactly what I am. Cannot stop now. This is too fun :beer
I really do like your positive thinking, and that you are having fun -- so important never to lose that aspect of investing. But re the fun aspect, many people find dealing with properties and irksome tenants the opposite of fun. You've probably answered this somewhere along the line, but I'm a slow thread scanner so please forgive: do you manage your properties yourself, or hire a prop manager? If the latter, how how hard is it to find a responsible person to do that job? I haven't done a survey or anything, but the few I've met in my neck of the woods did not impress.
In the past, I have used property management companies. IMHO this is only appropriate when I am living in a location remote from the property and need short-term management. In general, they will eat your lunch for you and ask for desert. High costs, no incentive to get good tenants, and they don't care.

I have three multi-family units located close together and I have found that I can choose the most responsible tenant and offer them the property management position and this works out well. To me, a responsible mother with young children is the perfect property manager. She is at the property far more time than I can be, has a strong incentive to get good tenants (this is the environment her children are growing up in) and has a strong incentive to keep the job simply because it is one of the few around that lets her work from home. She fields all of the "nuisance" calls and passes on the real emergencies to me. She knows who is who, what other tenants are responsible and who isn't, and if anyone tries sneaking an extra occupant in she tells me right away.

Vacancies last days, not months, and we have a pre-screened waiting list of new potential tenants. I make all of the financial decisions except for a small amount of petty cash which she keeps for very minor expenses. Typically $100 in petty cash lasts for months.

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

Post by Stormbringer » Sun Jul 15, 2018 11:28 am

KlangFool wrote:
Sat Jul 14, 2018 11:45 am
All leverages are bad.
Our friends at the Wharton School would disagree with this statement. In finance, it is taught that debt can lower a firm's cost of capital, allowing it to be more profitable. This is the reason why companies such as AAPL issue bonds to buy back shares of stocks. They are boosting the return on equity for the remaining shareholders.

For example, it can be shown that given a choice of owning one apartment building free and clear or two apartment buildings with 50% leverage, the leveraged option is usually more profitable in the long run.
"Compound interest is the most powerful force in the universe." - Albert Einstein

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

Post by Stormbringer » Sun Jul 15, 2018 11:45 am

SpeculativeTrader wrote:
Sat Jul 14, 2018 5:50 am
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.
Investment property comes with favorable tax treatment -- the IRS allows you to depreciate a (hopefully) appreciating asset. Leveraging your holdings and buying more gives you an even larger tax benefit. Then when you've built up enough equity or fully written off the property, you do a 1031 tax-deferred exchange into a larger one and start all over again, never paying a nickel in capital gains.

I know of no way to do anything like that in stocks using a taxable account.
"Compound interest is the most powerful force in the universe." - Albert Einstein

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

Post by JoMoney » Sun Jul 15, 2018 11:56 am

Stormbringer wrote:
Sun Jul 15, 2018 11:28 am
KlangFool wrote:
Sat Jul 14, 2018 11:45 am
All leverages are bad.
Our friends at the Wharton School would disagree with this statement. In finance, it is taught that debt can lower a firm's cost of capital, allowing it to be more profitable. This is the reason why companies such as AAPL issue bonds to buy back shares of stocks. They are boosting the return on equity for the remaining shareholders.

For example, it can be shown that given a choice of owning one apartment building free and clear or two apartment buildings with 50% leverage, the leveraged option is usually more profitable in the long run.
It only works as long as the 'investment' is earning more than the cost to borrow. Owning one apartment building free and clear that is earning nothing is better than two with a loan payment due.
Interest rates might change, or even if the debt is at a fixed rate there is no guarantee the apartments will stay rented. It's intrinsic to the investment that there are no guarantees as to how much or how little it will earn, but the lenders will be entitled to extract their pound of flesh regardless (and how much will that apartment collateral be worth at that moment if it can't be rented?)
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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

Post by Phineas J. Whoopee » Sun Jul 15, 2018 12:01 pm

AlphaLess wrote:
Sat Jul 14, 2018 1:23 pm
...
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).
Presuming you or somebody else would pay the same amount to keep the same house livable and the taxes paid, the return for owning includes the profit portion of the rent you won't have to pay to a landlord. "Lousy" is subjective.

PJW

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

Post by WanderingDoc » Sun Jul 15, 2018 12:17 pm

gmaynardkrebs wrote:
Sun Jul 15, 2018 7:46 am
WanderingDoc wrote:
Sun Jul 15, 2018 3:09 am

You were wise to buy real estate and hold it. Real estate is a very forgiving investment. I've found that you could make a lot of mistakes, not run the numbers that well, but if you hold on - rent growth, principal paydown, and equity happens :) Well done!
In my case, I just bought a few properties, never wrote a business plan or had any intent of being financially independent (didn't even know of the concept), then boom! 4 years later that's exactly what I am. Cannot stop now. This is too fun :beer
I really do like your positive thinking, and that you are having fun -- so important never to lose that aspect of investing. But re the fun aspect, many people find dealing with properties and irksome tenants the opposite of fun. You've probably answered this somewhere along the line, but I'm a slow thread scanner so please forgive: do you manage your properties yourself, or hire a prop manager? If the latter, how how hard is it to find a responsible person to do that job? I haven't done a survey or anything, but the few I've met in my neck of the woods did not impress.
I have a mix of those I use a PM and those I manage myself. I spend 2-3 hours (maybe less) per month in totality on real estate related activities. I for sure have spent a lot more time on this forum - therefore more time on index funds. You're correct, it's not easy in some markets to find a good PM, I prefer a few reliable friends or pros in the field that you can hire as needed.
I'm not looking to get rich quick (stocks), I'm not looking to get rich slow (indexing), I'm looking to get rich, for sure (real estate) | Don't wait to buy real estate. Buy real estate.. and wait.

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

Post by munemaker » Sun Jul 15, 2018 12:22 pm

gmaynardkrebs wrote:
Sat Jul 14, 2018 11:12 pm
munemaker wrote:
Sat Jul 14, 2018 10:15 pm
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?
Well yes! If you have a home mortgage or car loan and are invested in the market, you are leveraged. You could have paid down the loan but you invested in the market instead. Basically you are investing with borrowed money.
I see the point, but leverage is a legal term as well as an economic term. So while an economist might say any borrowing is leverage if the borrower owns other marketable assets, the law does not treat leveraging in similar fashion. For example: leveraged equity transactions are subject to SEC rules, whereas home loans are not; a creditor on a defaulted non-recourse mortgage would be laughed out of court if he tried to go against against the debtor's equity holdings on the economists view of leverage. These legal distinctions regarding leverage have great financial implications, which is why arguing that leverage is fungible between and among different classes is rather beside the point for most investors and homeowners.
Here's the dictionary definition:
1.use borrowed capital for (an investment), expecting the profits made to be greater than the interest payable.
Yes, the government has rules about leverage, but regardless, investing with borrowed money is leverage no matter how you look at it.

And yes...money is fungible. So whether you borrow money on a margin account or max out a home equity line of credit to invest in Apple stock, you are leveraged.

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

Post by alex_686 » Sun Jul 15, 2018 2:05 pm

Sigh, I had meant the use of the 2008 housing crash as a ironic aside. That real estate was low risk, but not risk free. And then people used that to sneak in other edge cases. Not my intention.
SpeculativeTrader wrote:
Sat Jul 14, 2018 9:11 am
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?
Consider this:

Case 1: A asset returns 10% year 1, 10% year 2, total returns of 21%

Case 2: A asset returns 30% year 1, -10% year 2, total returns of 17%

Case 3, A asset returns 110% year 1, -100% year 2, total returns of -100%.

Note, all 3 cases have a average annual return of 10%. Leverage means both higher returns and higher volatility.

So, volatility drag affects all assets. Yeah, direct real estate has measurement issues. However just because we can't measure it out to 2 decimal places does not mean it is not affected. There has been a fair amount of work done in this space. I will point you to Case-Shiller as a place to start.

In my reckoning, leveraging real-estate by 5-1 improve the risk-return profile of real-estate and your entire portfolio. i.e., the higher return of the leverage asset beats the increased volatility drag. As others have pointed out on this thread, perhaps modest leverage of equities does this as well. I don't think it does.

At this point we get into the relatively poor data on real-estate and tail risk. Tail risk is the fact that statics suggests that large negative events should be very rare, but these large negative events in investing seems way to common. This tends to throw a monkey wrench into many of the above calculations.

I am not going to spend any times picking apart futures or leveraged ETFs. They don't work as advertised. I will instead point you to value and momentum factors. If you want to increase your risk and returns, this is the path I think you should explore.

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

Post by grok87 » Sun Jul 15, 2018 3:33 pm

The other way to think about how much leverage to use, assuming you have a choice, is how much do you believe in the underlying investment that you are leveraging up?

there is a leveraged fund that gets talked about here a lot, QSPIX, the aqr style premia fund. That thing is levered 6.3x.
https://funds.aqr.com/~/media/files/fun ... s/spaf.pdf
In other words if you give them a dollar they will invest in $6.30 worth of long and short positions with it.


All I can say is with that kind of leverage those who invest in the fund had better really really really really really really believe in those style premia like momentum and value. (Note the six “really”’s to go with the 6.3x leverage).

Alternatively one could invest in the less levered version of this fund, QSLIX which is only 3.2x levered.
https://funds.aqr.com/-/media/files/fun ... /spalv.pdf

Then you would only have to really really really believe in style premia like momentum and leverage.

These days i’m Trying not to use a lot of leverage. I’m agreeing more and more with William Goldman who said “nobody knows nothing”

Keep Calm and Boglehead on!(KCBO)


Cheers,
Grok
Keep calm and Boglehead on. KCBO.

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

Post by nisiprius » Sun Jul 15, 2018 3:51 pm

Stormbringer wrote:
Sun Jul 15, 2018 11:28 am
KlangFool wrote:
Sat Jul 14, 2018 11:45 am
All leverages are bad.
Our friends at the Wharton School would disagree with this statement. In finance, it is taught that debt can lower a firm's cost of capital, allowing it to be more profitable. This is the reason why companies such as AAPL issue bonds to buy back shares of stocks. They are boosting the return on equity for the remaining shareholders.

For example, it can be shown that given a choice of owning one apartment building free and clear or two apartment buildings with 50% leverage, the leveraged option is usually more profitable in the long run.
Maybe it "usually" is, but what is the magnitude of the consequences when it isn't?

It can be shown mathematically that gambling systems "usually" work. Yes, you can "usually" win money at a casino by doubling up your bets until you win (usually in the form of a complicated and obfuscated "system" that conceals that it is just doubling until you win). You will "usually" win, and you will "usually" do better than the gambler who doesn't follow that kind of system. Furthermore, since the longer you can keep doubling bets after losses, the lower the probability of failure. Therefore, you can lower the probability of failure if you can borrow money to bet with. Unfortunately, your mathematical expectation is still negative. Even though you can win almost all the time, the overwhelming sizes of the losses, when they finally occur, statistically more than wipe out all the "steady" winnings.

So, at the casino and in the financial markets, you can engineer situations in which you re-shape the distribution of outcomes, so that you "normally" have steady wins, and experience catastrophic losses only when the seemingly impossible happens. I can't lose unless the roulette wheel comes up red ten times in a row. I can't lose unless Russia defaults on its sovereign bonds, which is impossible because a sovereign nation can always print money. And then after you are wiped out, you can always rationalize that it wasn't the result of imprudent risk-taking. It wasn't my fault, it was the Global Financial Crisis. It wasn't my fault, it was a "ten-sigma event."

Leverage helps provide the scope for that kind of engineering.
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.

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

Post by SpeculativeTrader » Sun Jul 15, 2018 7:37 pm

nisiprius wrote:
Sun Jul 15, 2018 7:06 am
SpeculativeTrader wrote:
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... Maslow's Hierarchy of Needs...
...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.
I've been brooding on whether or how to reply. To begin with, the screen name "SpeculativeTrader" and the tendentious thread title "Why is leveraging property good but leveraging stocks bad?" give me the impression that you've actually made up your mind. You've decided to be, or are hoping to be a speculative trader leveraging stocks.

Now, there are two ways to deal with a decision to do something risky. One is to consciously accept the risk. "I know it's risky and it suits me." In the famous inspirational poem "If," Rudyard Kipling counts the ability to take big risks as part of what it takes to "be a man:"
If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breathe a word about your loss;...
The other way is to deny or dismiss the risk. And it is that which bothers me. There is such a thing as a "calculated risk" but you want to do the calculations correctly.

Why try to draw any kind of analogy between short-term stocks-on-margin speculative apples and long-term home-ownership oranges? It sounds to me like the kind of argument salespeople make when they are trying to sell something risky to a risk-averse person. ("You trust bonds. Bonds create an income stream. These dividend stocks create an income stream. Therefore, these dividend stocks are the same as bonds.") ("You fear leverage. But, look! you're already leveraged anyway, and one leverage is just like any other leverage because money is fungible...")

The "money is fungible" argument leads to the conclusion that there isn't any distinction to be made between any kind of financial risk. It also denies the reality of psychological factors. But happiness itself is a psychological factor, and fortunately, thanks to the behavioral economists, it is now acceptable to acknowledge that we are not rational, and that decision-making as if we were is dysfunctional. The reality is that we do mental accounting and partition our financial life into separated compartments.

More broadly, I feel that some financial sophisticates, having grasped complex multi-step interactions between assets and money flow, are much too eager to use that knowledge and to exaggerate their reliability and causality. They believe a Rube Goldberg machine will really work reliably, because they can visualize the multistep process and understand how each step works. Nassim Nicholas Taleb has commented--I hope this is the gist, I don't have the exact quotation--that economists like leverage because it theoretically creates more efficient systems, and systematically underestimate the degree to which it increases the fragility of systems.

People who use leverage often have arguments as to why it isn't really all that risky. "It's not that risky if you know what you're doing." "It's not that risky the way I'm using it because my long and short positions are market neutral and if the market crashes my losses of the long side will always be made up by my gains on the short side." "LTCM teaches us nothing, it was a long time ago, and it was the bad luck of a ten-sigma event that can't happen oftener than once in a quadrillion years, and they were stupid, and what I'm doing is completely different."

When it is time to open a margin account, I think there is a special form to sign. I'm not sure, anyone know, but I think it is a real paper form requiring a physical signature and mailing, not just a box to check off online. It will say something like "Trading on margin is only for sophisticated investors with high risk tolerance. You may lose more than your initial investment." You don't need to sign anything like that to take out a mortgage.

Now, if you are a Jesse Livermore, and you love risk and you don't mind making and losing fortunes repeatedly, that's one thing. I would just say that when you get to the place where you are signing your name to say you are totally cool with losing more than everything you have, don't just say "Oh, lawyers." Take it seriously. Don't sign it if you don't agree with it in your heart, or if you don't really believe it could happen to you.
Hi nisiprius :happy

Actually I made the username as a tongue-in-cheek joke. I am a Boglehead at heart. I have some individual stocks from my early uninformed days but all I have been doing now is putting money into basically a Vanguard Total Market index fund.

So please don't misunderstand my intent.

You're right in one aspect though, I have been tempted to leverage index funds and I haven't done it because my gut-feeling tells me I am missing something.

I have read almost all the posts and I was hoping to reply individually but I don't think I can pull that off.

I will post again with my overall thoughts and to clarify my question.

EDIT: However, I do still think that a personal home is still an "investment" in that it provides you a return equal to how much you would have consumed in rent as long as you don't "overbuy".

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

Post by market timer » Sun Jul 15, 2018 10:53 pm

This question tends to get asked when P/E ratios are stretched and risk premiums are low. That alone should give you some pause.

As others have noted, margin calls are the biggest difference. But those can be avoided if you maintain relatively low leverage and have cash inflows. For new investors with a low ratio of net worth to annual savings, I think there is some merit in the Lifecycle Investing approach.

One key difference between a mortgage and a leveraged portfolio, not mentioned above, is that a mortgage tends to have a well-defined end point. If you pay $x, your obligation to the bank is satisfied. However, a leveraged investing strategy is really only limited by your greed, which is potentially boundless. Depending on your psychology, a margin loan can be a debt that you are unable to repay with any amount of money. The greater your net worth, the more you borrow. Tolstoy wrote a famous short story related to this topic: How Much Land Does a Man Need?

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

Post by SpeculativeTrader » Sun Jul 15, 2018 11:11 pm

market timer wrote:
Sun Jul 15, 2018 10:53 pm
This question tends to get asked when P/E ratios are stretched and risk premiums are low. That alone should give you some pause.

As others have noted, margin calls are the biggest difference. But those can be avoided if you maintain relatively low leverage and have cash inflows. For new investors with a low ratio of net worth to annual savings, I think there is some merit in the Lifecycle Investing approach.

One key difference between a mortgage and a leveraged portfolio, not mentioned above, is that a mortgage tends to have a well-defined end point. If you pay $x, your obligation to the bank is satisfied. However, a leveraged investing strategy is really only limited by your greed, which is potentially boundless. Depending on your psychology, a margin loan can be a debt that you are unable to repay with any amount of money. The greater your net worth, the more you borrow. Tolstoy wrote a famous short story related to this topic: How Much Land Does a Man Need?
Wow, the legend, himself!

Funny you mention that, I do not think of myself as anything but an average investor (hence index funds) and sometimes I use myself a gauge for the market. The fact that I'm thinking about it and that products are more available, does it mean that the average person is exuberant right now?

The reason I'm also asking is I'm trying to not make a big financial mistake because there is a product at the moment in my country that is basically a mortgage for index funds. 10 to 15 year loans with LVR 70% and regular P & I repayments to gradually pay it off. No margin calls.

The thing stopping me is that the rates are 100-150 bps above mortgage rates and that I'm trying to work out if even under these circumstances if leverage is still as "safe" leveraging into a home.

grok87
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Re: Why is leveraging property good but leveraging stocks bad?

Post by grok87 » Sun Jul 15, 2018 11:22 pm

market timer wrote:
Sun Jul 15, 2018 10:53 pm
This question tends to get asked when P/E ratios are stretched and risk premiums are low. That alone should give you some pause.

As others have noted, margin calls are the biggest difference. But those can be avoided if you maintain relatively low leverage and have cash inflows. For new investors with a low ratio of net worth to annual savings, I think there is some merit in the Lifecycle Investing approach.

One key difference between a mortgage and a leveraged portfolio, not mentioned above, is that a mortgage tends to have a well-defined end point. If you pay $x, your obligation to the bank is satisfied. However, a leveraged investing strategy is really only limited by your greed, which is potentially boundless. Depending on your psychology, a margin loan can be a debt that you are unable to repay with any amount of money. The greater your net worth, the more you borrow. Tolstoy wrote a famous short story related to this topic: How Much Land Does a Man Need?
Thanks for the Tolstoy link. Will read in full when I have time. I think there is a Plato quote in gorgias to the effect that humans are like bottomless vessels whose desires cannot be filled.
http://www.perseus.tufts.edu/hopper/tex ... page%3D493
“Tolstoy” wrote: Though a peasant’s life is not a fat one, it is a long one. We shall never grow rich, but we shall always have enough to eat.”
It seems to me, IMHO, that you have become wise.
Cheers,
Grok
Keep calm and Boglehead on. KCBO.

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

Post by JBTX » Sun Jul 15, 2018 11:58 pm

Agree that leveraging for stocks per se isn't bad. But margin loans are. Margin loans are typically higher than mortgage rates plus you have margin calls.

We could easily pay off our modest mortgage by tapping into a small portion of retirement portfolio but I'd rather retain the 3.25% loan and keep the retirement accounts. If the mortgage rates were comparable to margin loan rates I may rethink that.

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

Post by SpeculativeTrader » Mon Jul 16, 2018 5:41 am

My intention was to reply to each comment individually but I didn't realise I would get such a response.

After reading through all the comments, I do have a few points of clarification.

I am not a speculative trader despite the username I chose. I am an Boglehead who uses the equivalent of a Vanguard total market index fund.

I am agnostic about investments as long as it provides me with enough return for my retirement.

What is niggling at the back of my head is why even the proponents of leveraging a stock portfolio would only recommend 2x or 3x leverage (where 3x leverage is actually 2x after-tax) and 5x leverage is irresponsible.

It's safe to say that a lot of us will need to use 5x leverage or so to buy a property however, this is never touted as irresponsible.

Is that down to just the risk of margin calls? So if there was a non-callable, mortgage-like product for a something like a 3-fund portfolio then it would be okay to leverage 5x as well?

I am sort of just playing devil's advocate here. I'm trying to resolve doubts I have in my mind.

I don't apply leverage to my portfolio and yet to have my own home, and I'm just trying to bounce some ideas around to clear my thoughts.

EDIT: I also haven't made up my mind about this and truly open to ideas and explanation. It is a pet peeve of mine where people ask for advice only to disregard all advice because they have already made up their mind.

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

Post by KlangFool » Mon Jul 16, 2018 8:07 am

SpeculativeTrader wrote:
Mon Jul 16, 2018 5:41 am

It's safe to say that a lot of us will need to use 5x leverage or so to buy a property however, this is never touted as irresponsible.
SpeculativeTrader,

This is not true. I consider all leverage as bad. So, as per my (KlangFool) housing rule.

A) Use a 20% down payment and 30 fixed mortgage to buy a house.

B) Only buy a house priced at X when your asset excluding the house is 2.5X or bigger. So, if someone wants to buy a 400K house, he/she needs to have an asset of 1 million or greater.

My rule limits the risk of the mortgage.

KlangFool

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

Post by michaeljc70 » Mon Jul 16, 2018 9:17 am

Until recently, home values had never fallen nationally. Stocks have fallen many, many times.

It is also much easier to panic and bail on stocks based on emotion (you just login to a website or make a call). Houses don't sell and close quickly and presumably you won't have anywhere to live if you do sell it.

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

Post by bottlecap » Mon Jul 16, 2018 9:36 am

Answer:

It’s not, but few people can buy a house without financing. You can invest small amounts regularly without financing.

JT

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

Post by vineviz » Mon Jul 16, 2018 9:53 am

SpeculativeTrader wrote:
Mon Jul 16, 2018 5:41 am
What is niggling at the back of my head is why even the proponents of leveraging a stock portfolio would only recommend 2x or 3x leverage (where 3x leverage is actually 2x after-tax) and 5x leverage is irresponsible.
At least with regard to margin loans, 2x to 4x leverage is pretty much the regulatory maximum amount of leverage brokers are allowed to provide under Regulation T with initial margin requirements of 50% and maintenance margin requirements of 25%.

Prior to the market crash in 1929, investors could borrow up to 90% of the security purchase price but Reg T has put a limit since 1934 of between 40% and 60% I think. It's been 50% since 1974.

Reg T was primarily designed, IIRC, to protect financial institutions and markets. I don't know the origin of the 50% initial margin requirement but I feel confident in assuming there was some empirical basis for it and that such a basis probably relies more on macroeconomic savings dynamics than the risk to individual investors. I know that bank failure rates have been studied and that failure rates of banks go up dramatically as capital leverage ratios increase.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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

Post by Caduceus » Mon Jul 16, 2018 10:18 am

Leverage wouldn't be bad if you could borrow at a proper interest rate. If I could borrow significant amounts of money at 0% for an extended period of time, I would leverage up to the hilt. That would be entirely rational. At 1% interest rates, I would still borrow the money. At 5%, I wouldn't touch it, and so on.

Technically, there's no reason that property is a safer investment. It may well be that leveraging up to buy an undervalued security is much safer than leveraging up to buy an overvalued house.

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

Post by market timer » Mon Jul 16, 2018 8:45 pm

SpeculativeTrader wrote:
Sun Jul 15, 2018 11:11 pm
The reason I'm also asking is I'm trying to not make a big financial mistake because there is a product at the moment in my country that is basically a mortgage for index funds. 10 to 15 year loans with LVR 70% and regular P & I repayments to gradually pay it off. No margin calls.

The thing stopping me is that the rates are 100-150 bps above mortgage rates and that I'm trying to work out if even under these circumstances if leverage is still as "safe" leveraging into a home.
That's very interesting. I've never heard of such a product. Is there a prepayment penalty? When LVR is 70%, maybe paying 100-150 bps above mortgage rates is worthwhile to eliminate the risk of margin call. However, as the LVR declines over time, you'll probably find this premium uncompetitive with other ways of achieving leverage, such as futures and options, with a lower leverage ratio. I'm assuming you are in a country where mortgage rates are floating, so another potential risk is that short term rates increase and you end up having to pay more interest than you initially planned.

If you decide to go this route, keep us posted, You might become a legend in another 10 years :)

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

Post by SpeculativeTrader » Mon Jul 16, 2018 9:05 pm

market timer wrote:
Mon Jul 16, 2018 8:45 pm
That's very interesting. I've never heard of such a product. Is there a prepayment penalty? When LVR is 70%, maybe paying 100-150 bps above mortgage rates is worthwhile to eliminate the risk of margin call. However, as the LVR declines over time, you'll probably find this premium uncompetitive with other ways of achieving leverage, such as futures and options, with a lower leverage ratio. I'm assuming you are in a country where mortgage rates are floating, so another potential risk is that short term rates increase and you end up having to pay more interest than you initially planned.

If you decide to go this route, keep us posted, You might become a legend in another 10 years :)
I've learned that the implied interest rate on futures is very low, lower than mortgage rates which is the lowest rate a retail investor can access where I'm from. From the last time I checked, implied financing rates of futures is half that of this equity product that's being offered. And from what I also understand, the cost of rolling futures in an agnostic long strategy would only add maybe 20bps so futures are the most cost effective.

From what I can gather, margin calls can cause a wipe out so does paying double the financing rate to have no margin calls make it a better choice?

More about the product. It's offered by one of the biggest banks and only allows you to use the loan to purchase approved stocks. The good thing is that the approved list is basically all Boglehead-style diversified index funds. Pretty much all the Vanguard funds and ETFs are on the approved list.

All my peers are leveraging into purchasing a home right now but property prices are so rich. The ROI would be negative unless there are high capital price appreciation which has been happening and home owners have been getting wealthier. I'm torn because I am no market prognosticator and have no idea if housing markets will continue to rise. I could be folling all the lemmings off the cliff or I could look very stupid by missing out.

All the sensible advice always points me towards just leveraging to buy the home.

Edit: Just to clarify, all of this is hypothetical as I'm not in a financial position to do anything. I just wanted to work things out in my mind regarding this topic with the help of wiser heads and legendary posters.

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

Post by AlohaJoe » Mon Jul 16, 2018 9:16 pm

michaeljc70 wrote:
Mon Jul 16, 2018 9:17 am
Until recently, home values had never fallen nationally.
You mean other than in the national housing crashes of 1890, 1915, 1942, 1978, and 1987?

Housing prices didn't reach their 1915 levels again until 1945. 30 years just to break even.

Housing prices didn't reach their 1890 levels again until 2000. 110 years just to break even.

"Those who ignore history are doomed to repeat it."

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

Post by AlohaJoe » Mon Jul 16, 2018 9:24 pm

vineviz wrote:
Mon Jul 16, 2018 9:53 am
At least with regard to margin loans, 2x to 4x leverage is pretty much the regulatory maximum amount of leverage brokers are allowed to provide under Regulation T with initial margin requirements of 50% and maintenance margin requirements of 25%.[/quote[
I can borrow 5.1x margin from my broker (equivalent to putting 19% down to buy a house). Regulation T hasn't been a limiting factor for a decade, since April 2007.

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

Post by AlohaJoe » Mon Jul 16, 2018 9:26 pm

JBTX wrote:
Sun Jul 15, 2018 11:58 pm
Margin loans are typically higher than mortgage rates plus you have margin calls.
My margin loan rate is currently 3.1%. What's your mortgage rate? I thought mortgages were currently at 4.6% or so?

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

Post by SpeculativeTrader » Mon Jul 16, 2018 10:04 pm

I feel like some doubts in my mind have been resolved. I'm not sure it is clear completely but this is my understanding from the thread so far.
  • Leveraging into property is not any better than leveraging into stocks.

    First principles still apply, leverage will give you higher gains and losses.

    Highly leveraging into property is more common and acceptable because it is a need and that most popeple can't afford to buy a home without leverage.

    Perhaps a home loan can be considered safe because of loan structure. No margin calls.
One more question I would like to resolve. I'm assuming most of us Bogleheads have some configuration of a stock/bond index fund portfolio. If one were offered a no margin call loan with rates equivalent to home mortgage rates, would one take it if still in accumulation phase?

Would some say no because a stock/bind portfolio is not a need like housing?

If one would do it, how much leverage would you apply?

Haha seems like that was more than one question.

Also this isn't me asking for advice, just curious to know what others would do and the rationale behind the decisions.

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

Post by whodidntante » Mon Jul 16, 2018 10:54 pm

SpeculativeTrader wrote:
Mon Jul 16, 2018 10:04 pm

One more question I would like to resolve. I'm assuming most of us Bogleheads have some configuration of a stock/bond index fund portfolio. If one were offered a no margin call loan with rates equivalent to home mortgage rates, would one take it if still in accumulation phase?
If I'm not going with the "money is fungible" approach to leverage that I described upthread, but instead I'm actually leveraging my portfolio, I would go for the cheapest all-in cost for the exposure I want. Sometimes the lowest cost is accomplished via futures since they have an implied financing rate that is typically lower than explicit financing costs.

The downside of futures is you can never write off that implied financing rate, and the capital gains cannot be deferred for as long as I like and will partly be short-term. So for some people it will be cheaper, others more expensive. It's also a slight effort and a slight cost to roll the contracts. But these concerns only show up for the part of your exposure you got through futures.

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