Why is leveraging property good but leveraging stocks bad?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
gmaynardkrebs
Posts: 887
Joined: Sun Feb 10, 2008 11:48 am

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

Post by gmaynardkrebs » Mon Jul 16, 2018 11:07 pm

SpeculativeTrader wrote:
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.
I don't agree that "leveraging into property is not any better than leveraging into stocks," and I think the more thoughtful posts explain exactly why. As far as my own investment portfolio, I don't see the need for messing with leverage and never have.

randomguy
Posts: 6292
Joined: Wed Sep 17, 2014 9:00 am

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

Post by randomguy » Mon Jul 16, 2018 11:30 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?

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.
Personally I would have leveraged up to the point where I could handle the debt payment. Basically instead of saving 3k/month, I would have 3k in debt payments. I have plenty of confidence that over 30 years, I am going to get more than 3% return out of stocks. Probably need to hold 1-2years of savings in cash to handle things like job loss. So basically I would have had like 800k portfolio and a month debt payment of 3k versus investing 3k month. How lets compare these cases starting in 1988 (i.e. 30 year term. Granted I would have started with like a 9% loan back then)

800k with 3k payments, 100% US stocks. 800k-->16.7million.
3k month investing-> 8.1 million

Obviously leveraging up worked great here since it gave me a big portfolio during some really good market years. If you do the same math starting in 2000
800k with 3k payments, 100% US stocks. 800k-->2.262million. Note I still owe some money the loan
3k month investing-> 1.7 million
You are looking at pretty much identical results right now and it you would expect the 3k of investing to win out over the next 12 years. I basically paid 360k (a good chunk of it in interest) and got no return for 10 years which defeats the whole purpose of having a big portfolio early.

Obviously those are both really simplified cases. Reality is that you probably would never lump sum in 800k but would do some DCA over 5 years (partly as a result of income ramp up. Partly to reduce sequence of return risks) which would narrow the spread of returns a bit. And at some point when you start thinking about adding in bonds, things change up some more.

WanderingDoc
Posts: 1100
Joined: Sat Aug 05, 2017 8:21 pm

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

Post by WanderingDoc » Tue Jul 17, 2018 12:14 am

gmaynardkrebs wrote:
Mon Jul 16, 2018 11:07 pm
SpeculativeTrader wrote:
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.
I don't agree that "leveraging into property is not any better than leveraging into stocks," and I think the more thoughtful posts explain exactly why. As far as my own investment portfolio, I don't see the need for messing with leverage and never have.
Its like they conveniently believed what they wanted to, despite the evidence carefully and repeatedly outlined to the contrary.

Leverage is almost the sole reason why investing in real estate is so attractive. Otherwise, those people may possibly accept the mediocre 7% returns, a salary reduction plan (401k), and a poorer tax treatment.
Don't wait to buy real estate. Buy real estate, and wait. | Rent where you live, buy where others pay your mortgage for you.

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

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

Post by SpeculativeTrader » Tue Jul 17, 2018 12:25 am

whodidntante wrote:
Mon Jul 16, 2018 10:54 pm

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.
If I'm comprehending correctly then I think I agree.

Futures is the most cost effective and most attractive however, I think the structure makes it harder for most of us to compare it directly to a mortgage.
gmaynardkrebs wrote:
Mon Jul 16, 2018 11:07 pm
I don't agree that "leveraging into property is not any better than leveraging into stocks," and I think the more thoughtful posts explain exactly why. As far as my own investment portfolio, I don't see the need for messing with leverage and never have.
Sorry I think I worded it poorly. I think that leveraging property is not inherently better than stocks.

With 20% down payment, a 20% drop in house price can still technically wipe out your money. Even flat returns could mean it was a poor use of money.

But what makes property a better choice for leverage is the favourable terms of mortgages and that housing is a need.
randomguy wrote:
Mon Jul 16, 2018 11:30 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?

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.
Personally I would have leveraged up to the point where I could handle the debt payment. Basically instead of saving 3k/month, I would have 3k in debt payments. I have plenty of confidence that over 30 years, I am going to get more than 3% return out of stocks. Probably need to hold 1-2years of savings in cash to handle things like job loss. So basically I would have had like 800k portfolio and a month debt payment of 3k versus investing 3k month. How lets compare these cases starting in 1988 (i.e. 30 year term. Granted I would have started with like a 9% loan back then)

800k with 3k payments, 100% US stocks. 800k-->16.7million.
3k month investing-> 8.1 million

Obviously leveraging up worked great here since it gave me a big portfolio during some really good market years. If you do the same math starting in 2000
800k with 3k payments, 100% US stocks. 800k-->2.262million. Note I still owe some money the loan
3k month investing-> 1.7 million
You are looking at pretty much identical results right now and it you would expect the 3k of investing to win out over the next 12 years. I basically paid 360k (a good chunk of it in interest) and got no return for 10 years which defeats the whole purpose of having a big portfolio early.

Obviously those are both really simplified cases. Reality is that you probably would never lump sum in 800k but would do some DCA over 5 years (partly as a result of income ramp up. Partly to reduce sequence of return risks) which would narrow the spread of returns a bit. And at some point when you start thinking about adding in bonds, things change up some more.
If I'm interpreting correctly, you make a good point. Leveraging is always going to be a double-edged sword, it is not a free source of extra return. The risk of leveraging into a bear or flat market is there.

I think I kept thinking that everyone thinks "safe as houses" because I only hear of the good stories, the winners who became wealthy from leveraging into property.

I would say the additional benefits of a mortgage is that as long as you can service the loan, no matter the price of your property, at least it provides you with shelter. So the worst case is that you underperform relative to the market but hopefully it doesn't leave you destitute.

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

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

Post by SpeculativeTrader » Tue Jul 17, 2018 12:30 am

WanderingDoc wrote:
Tue Jul 17, 2018 12:14 am
gmaynardkrebs wrote:
Mon Jul 16, 2018 11:07 pm
SpeculativeTrader wrote:
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.
I don't agree that "leveraging into property is not any better than leveraging into stocks," and I think the more thoughtful posts explain exactly why. As far as my own investment portfolio, I don't see the need for messing with leverage and never have.
Its like they conveniently believed what they wanted to, despite the evidence carefully and repeatedly outlined to the contrary.

Leverage is almost the sole reason why investing in real estate is so attractive. Otherwise, those people may possibly accept the mediocre 7% returns, a salary reduction plan (401k), and a poorer tax treatment.
I'm not sure if you're referring to me but if you actually read my posts, I pretty much agree with what you say about property.

I believe one keyword would have made it more clear though. In my mind, leverage is not inherently better for property.

It can still hurt you financially or make you wealthier than you could have been without borrowing.

Despite thinking that leverage is not inherently better with properly, I think it is better in practically because of the loan structures and because at the worst case scenario (excluding job loss), at least you have a roof over your head.

JBTX
Posts: 4039
Joined: Wed Jul 26, 2017 12:46 pm

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

Post by JBTX » Tue Jul 17, 2018 1:15 am

AlohaJoe wrote:
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?
My mortgage is 3.25. It is a 15 year.

I'm not at all an expert on margin loans. Just from basic googling it seemed they are higher.

https://www.fidelity.com/trading/advanc ... lsrc=aw.ds
* ​ 5.00% rate available for debit balances over $1,000,000. Fidelity's current base margin rate, effective since 6/15/2018, is 8.075%.

AlohaJoe
Posts: 3751
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

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

Post by AlohaJoe » Tue Jul 17, 2018 1:52 am

SpeculativeTrader wrote:
Tue Jul 17, 2018 12:25 am
I would say the additional benefits of a mortgage is that as long as you can service the loan, no matter the price of your property, at least it provides you with shelter. So the worst case is that you underperform relative to the market but hopefully it doesn't leave you destitute.
Obviously, the worst case is that you can't service the mortgage and you lose everything.

One nice thing about margin is there is no monthly payment. If you don't pay the interest for six months, they don't seize the collateral. The same isn't true for a mortgage.

Ben Mathew
Posts: 96
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle
Contact:

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

Post by Ben Mathew » Tue Jul 17, 2018 2:42 am

In principle, it should be okay for people who are highly risk tolerant to leverage stocks. We don't criticize people for increasing their stock allocation from 80% to 85% to match their risk preferences. Moving from 100% to 105% should be the same sort of thing. It's all part of the risk-return spectrum, and if your tastes lie beyond 100%, then why not go there!

But in practice, there are some roadblocks that make the move from 100% to 105% more problematic than the move from 80% to 85%:

(1) Retirement accounts, where a lot of our savings lie, don't allow margin loans. 100% is the most you can go.

(2) As mentioned by the OP and others, leveraging through margin loans entails the risk of margin calls. You're borrowing short term to invest long term. The duration mismatch creates an added risk. If it's not a lot of leverage, you might be able to ride out a temporary downturn without margin calls. But if you are more leveraged, then a temporary downturn can wipe you out.

(3) Rebalancing while you're leveraged would force you into the wrong sort of timing--you'll have to buy during booms and sell during crashes to maintain your asset allocation. It would therefore be best if you didn't rebalance. Your stock/bond ratio should be allowed to rise beyond your long term target during busts and fall below your long term target during booms. Managing this would be intellectually challenging, psychologically difficult, and time consuming.

(4) When you move from 80% to 85%, you're selling bonds with low interest rates. When you move from 100% to 105%, you're borrowing money at a margin loan rate, which will generally be higher. So it's more expensive to move from 100% to 105% than it is to move from 80% to 85%. There is a price increase beyond 100% stocks.

Given all of this, even highly risk tolerant people might decide that 100% stocks is good enough for them.

Valuethinker
Posts: 35968
Joined: Fri May 11, 2007 11:07 am

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

Post by Valuethinker » Tue Jul 17, 2018 3:13 am

zaboomafoozarg wrote:
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.
;-)

His academic work had convinced MT that this was a good strategy. When reality collides with theory, reality is the usual winner.

What was dangerous is that he was at the beginning of his career and had substantial additional resources, to which you allude.

Whereas the average reader here probably does not. You lose your roll of cash on the tables at Vegas, and you are out, out, out. Lose decades (forever in effect) in recovering.

Given that stocks have done so well the last 10 years, the chance that you have missed one of those periods of high returns, and are confronted with long run lower (and volatile) stock returns makes this an even more risky strategy.

User avatar
nisiprius
Advisory Board
Posts: 36641
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 » Tue Jul 17, 2018 5:27 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...
There is another can of worms that needs to be opened: the "Kelly criterion." The best thing I've read on the subject is a book with a very misleading title: Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street, by William Poundstone. Another description is in Wikipedia,Kelly criterion

The subject has been discussed at length and inconclusively in the forum from time to time. It is really difficult.

Basically, traditional financial economics--well, MPT, anyway--does not think much about the situations you get when you parlay bets over a long period of time, even though that is exactly what we do when we let investments "compound." The result of compounding a fluctuating investment over many years is really hard to think about, because the distribution of outcomes is so skew. Normally, we think about it on the basis of e.g. a single year, and the effect of leverage is to increase both standard deviation and expected return--without limit. In the forum people are always asking "why not 100% stocks," but an equally good question is "why not 200% stocks," "why not 1000% stocks," why not 100X leverage (some real-world situations, like LTCM, come close to that), etc.

An answer of sorts--I can explain the parts I think I understand, but not the whole thing--is that there is an argument to be made that the goal should be to optimize the mean of the logarithm of the final value of the portfolio. As I understand it, at least some people in the Kelly criterion paradigm are very insistent that this has nothing at all to do with assuming a logarithmic utility function, but actually comes out of a reasoned probability-based argument.

The problem with leverage is that if you invest in a highly leveraged investment year after year, the probability of experiencing a truly horrific loss compounds with time, too, and when you do the math they way they do it, even if you are extremely risk-tolerant, the optimum is not to use as much leverage as possible.

Usually, the criterion is discussed in the context of betting, as in a casino, where the odds are known.

In the case of the stock market, the numbers that go into the formula can only be estimated, but my understand is that the estimates are that for the stock market, the Kelly criterion says that the optimum is at about 140% stocks, i.e. only 40% leverage. For whatever it is worth, this provides an upper limit on the amount of leverage that should be used with stocks no matter how risk-tolerant you are.

Or something like that.
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.

User avatar
vineviz
Posts: 1689
Joined: Tue May 15, 2018 1:55 pm

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

Post by vineviz » Tue Jul 17, 2018 5:39 am

AlohaJoe wrote:
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.
I was referring to equity margin accounts, where the regulatory minimum maintenance is 25%.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

michaeljc70
Posts: 3572
Joined: Thu Oct 15, 2015 3:53 pm

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

Post by michaeljc70 » Tue Jul 17, 2018 5:55 am

AlohaJoe wrote:
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."
Here is data going back to the 60s and it shows no such NATIONAL drop in 1987 or 1970 on an annual basis: https://fred.stlouisfed.org/series/ASPUS

"The chart below tracks median home prices from 1968 to 2004 and shows an average yearly increase of 6.4%, without a single decline during the 36-year period." https://www.investopedia.com/articles/m ... market.asp

What data are you using? What level do you consider a crash?

User avatar
market timer
Posts: 5943
Joined: Tue Aug 21, 2007 1:42 am

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

Post by market timer » Tue Jul 17, 2018 6:17 am

nisiprius wrote:
Tue Jul 17, 2018 5:27 am
The best thing I've read on the subject is a book with a very misleading title: Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street, by William Poundstone. Another description is in Wikipedia,Kelly criterion
Agreed, this is a great book.
An answer of sorts--I can explain the parts I think I understand, but not the whole thing--is that there is an argument to be made that the goal should be to optimize the mean of the logarithm of the final value of the portfolio. As I understand it, at least some people in the Kelly criterion paradigm are very insistent that this has nothing at all to do with assuming a logarithmic utility function, but actually comes out of a reasoned probability-based argument.
The counterargument to this is Samuelson's famous monosyllabic paper: http://www.nccr-finrisk.uzh.ch/media/pd ... BF1979.pdf

Also, Kelly criterion assumes no cash inflows or outflows. The whole point of early leverage is that you expect to add additional savings over the years. So even if your goal is to maximize expected log of terminal wealth, you'd leverage beyond the Kelly criterion value in the early years.

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

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

Post by SpeculativeTrader » Tue Jul 17, 2018 6:48 am

nisiprius wrote:
Tue Jul 17, 2018 5:27 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...
There is another can of worms that needs to be opened: the "Kelly criterion." The best thing I've read on the subject is a book with a very misleading title: Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street, by William Poundstone. Another description is in Wikipedia,Kelly criterion

The subject has been discussed at length and inconclusively in the forum from time to time. It is really difficult.

Basically, traditional financial economics--well, MPT, anyway--does not think much about the situations you get when you parlay bets over a long period of time, even though that is exactly what we do when we let investments "compound." The result of compounding a fluctuating investment over many years is really hard to think about, because the distribution of outcomes is so skew. Normally, we think about it on the basis of e.g. a single year, and the effect of leverage is to increase both standard deviation and expected return--without limit. In the forum people are always asking "why not 100% stocks," but an equally good question is "why not 200% stocks," "why not 1000% stocks," why not 100X leverage (some real-world situations, like LTCM, come close to that), etc.

An answer of sorts--I can explain the parts I think I understand, but not the whole thing--is that there is an argument to be made that the goal should be to optimize the mean of the logarithm of the final value of the portfolio. As I understand it, at least some people in the Kelly criterion paradigm are very insistent that this has nothing at all to do with assuming a logarithmic utility function, but actually comes out of a reasoned probability-based argument.

The problem with leverage is that if you invest in a highly leveraged investment year after year, the probability of experiencing a truly horrific loss compounds with time, too, and when you do the math they way they do it, even if you are extremely risk-tolerant, the optimum is not to use as much leverage as possible.

Usually, the criterion is discussed in the context of betting, as in a casino, where the odds are known.

In the case of the stock market, the numbers that go into the formula can only be estimated, but my understand is that the estimates are that for the stock market, the Kelly criterion says that the optimum is at about 140% stocks, i.e. only 40% leverage. For whatever it is worth, this provides an upper limit on the amount of leverage that should be used with stocks no matter how risk-tolerant you are.

Or something like that.
I must admit, I think I get the "take-home message" but I'm not smart enough to understand the minutia of the concept.


How does Kelly Criterion explain why 500% property isn't ruinous? Is it because principal is constantly being repaid?

AlohaJoe
Posts: 3751
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

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

Post by AlohaJoe » Tue Jul 17, 2018 6:59 am

michaeljc70 wrote:
Tue Jul 17, 2018 5:55 am
What data are you using? What level do you consider a crash?
I was looking at: http://www.multpl.com/case-shiller-home ... -adjusted/

User avatar
vineviz
Posts: 1689
Joined: Tue May 15, 2018 1:55 pm

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

Post by vineviz » Tue Jul 17, 2018 7:12 am

michaeljc70 wrote:
Tue Jul 17, 2018 5:55 am
Here is data going back to the 60s and it shows no such NATIONAL drop in 1987 or 1970 on an annual basis: https://fred.stlouisfed.org/series/ASPUS
That data series reflects only new constructions (i.e. "New Residential Sales").
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

michaeljc70
Posts: 3572
Joined: Thu Oct 15, 2015 3:53 pm

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

Post by michaeljc70 » Tue Jul 17, 2018 7:47 am

vineviz wrote:
Tue Jul 17, 2018 7:12 am
michaeljc70 wrote:
Tue Jul 17, 2018 5:55 am
Here is data going back to the 60s and it shows no such NATIONAL drop in 1987 or 1970 on an annual basis: https://fred.stlouisfed.org/series/ASPUS
That data series reflects only new constructions (i.e. "New Residential Sales").
The chart is labelled "Average Sales Price of Houses Sold for the United States". "New Residential Sales" is the category it is filed under. The citation is "U.S. Bureau of the Census and U.S. Department of Housing and Urban Development, Average Sales Price of Houses Sold for the United States [ASPUS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/ASPUS, July 17, 2018." which makes no mention of new construction, but it is a little confusing.

Look at this: https://fred.stlouisfed.org/series/USSTHPI. Same thing -prices didn't drop except in the financial crisis.

michaeljc70
Posts: 3572
Joined: Thu Oct 15, 2015 3:53 pm

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

Post by michaeljc70 » Tue Jul 17, 2018 7:48 am

AlohaJoe wrote:
Tue Jul 17, 2018 6:59 am
michaeljc70 wrote:
Tue Jul 17, 2018 5:55 am
What data are you using? What level do you consider a crash?
I was looking at: http://www.multpl.com/case-shiller-home ... -adjusted/
That is an index, not actual prices and it is adjusted for inflation which makes a big difference especially in times of high inflation. We don't adjust the major stock market indexes for inflation, do we?

User avatar
vineviz
Posts: 1689
Joined: Tue May 15, 2018 1:55 pm

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

Post by vineviz » Tue Jul 17, 2018 7:52 am

michaeljc70 wrote:
Tue Jul 17, 2018 7:47 am
vineviz wrote:
Tue Jul 17, 2018 7:12 am
michaeljc70 wrote:
Tue Jul 17, 2018 5:55 am
Here is data going back to the 60s and it shows no such NATIONAL drop in 1987 or 1970 on an annual basis: https://fred.stlouisfed.org/series/ASPUS
That data series reflects only new constructions (i.e. "New Residential Sales").
The chart is labelled "Average Sales Price of Houses Sold for the United States". "New Residential Sales" is the category it is filed under. The citation is "U.S. Bureau of the Census and U.S. Department of Housing and Urban Development, Average Sales Price of Houses Sold for the United States [ASPUS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/ASPUS, July 17, 2018." which makes no mention of new construction, but it is a little confusing.

Look at this: https://fred.stlouisfed.org/series/USSTHPI. Same thing -prices didn't drop except in the financial crisis.
“New Residential Sales” is the category for new construction.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

trueblueky
Posts: 1345
Joined: Tue May 27, 2014 3:50 pm

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

Post by trueblueky » Tue Jul 17, 2018 7:54 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 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.
Biltmore seems to be Ego.
No comment on more recent houses of that ilk.

User avatar
nisiprius
Advisory Board
Posts: 36641
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 » Tue Jul 17, 2018 7:57 am

SpeculativeTrader wrote:
Tue Jul 17, 2018 6:48 am
...How does Kelly Criterion explain why 500% property isn't ruinous? Is it because principal is constantly being repaid?...
I don't know. It would be an interesting discussion.

First of all, I keep being bothered by your characterization of the difference as being solely the difference in asset class. I don't think it is. The difference between a homebuyer with a mortgage and a daytrader is not that the first buys real estate and the second buys securities.

So one possibility is that the difference is that a homebuyer with a mortgage makes a single bet, and the Kelly criterion applies so long sequences of parlayed bets in which some of the proceeds of each bet are immediately staked on a new bet.

In other words, the Kelly criterion would apply to house-flipping, in which the speculator makes several complete round-trip purchases-and-sales every year.

The Kelly criterion is simple enough to calculate. The problem is evaluating the inputs to the equation: the probability of losing, the probability of winning, and the odds.
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.

randomguy
Posts: 6292
Joined: Wed Sep 17, 2014 9:00 am

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

Post by randomguy » Tue Jul 17, 2018 8:38 am

SpeculativeTrader wrote:
Tue Jul 17, 2018 6:48 am


I must admit, I think I get the "take-home message" but I'm not smart enough to understand the minutia of the concept.


How does Kelly Criterion explain why 500% property isn't ruinous? Is it because principal is constantly being repaid?
At a high level the Kelly Criterion is about bet sizing so that you can keep playing the game. Imagine you are playing a video poker game that is EV+ (i.e. you will make money over time). The problem is you need to hit some royal flush (call it a 1:100k hand) to make the money. You need to size your bets so that you can play 300k hands (made up) to ensure that your odds of hitting that Royal Flush at 99.9%. But you also want the largest bet possible to make sure you maximize your winnings.

When you buy a house, you are placing 1 bet and as long as you can make the payments it will not be called. The house price could drop 50% and it doesn't matter. In theory putting nothing down works fine. In the real world, you have to deal with selling before paying off the mortgage which exposes you to market pricing. Most of the time house prices don't drop by more than 10-15% so putting 20% down was enough so that people could cover the loss and real estate fees and not be ruined.

And it should be pointed out that leveraging property can be ruinous. See all the 2007-10 people who could no longer make their payments and lost everything they put into their house. Now to some extent the risk was asymmetric. They were only risking what they put down (and got free rent when they lost) while they were able to gain all the potential upside.

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 » Tue Jul 17, 2018 8:56 am

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.
One thing you should consider is whether or not it is necessary to use leverage, i.e. a loan. It's easy to buy $1,000, $5,000, or even $12,223 worth of equities. This is not generally true with property, which is more like buying a corporation outright, one large, indivisible thing with a high cost. It is not unusual to use a loan to start or buy a business. If people could buy a house in small increments as they do businesses by means of equities, they might prefer to do so over taking out a loan. So part of it is necessity as people inevitably justify what is necessary.

Something else to consider in why loans and leverage are frowned on for stocks more so than for property is simply history.

Mortgages in the U.S. evolved in the 20th century from low leverage (general maximum of 50%) to high leverage (general maximum of 95%) and from a small proportion of household income to a much larger proportion. This paper gives a good, brief overview of that:

https://repository.upenn.edu/cgi/viewco ... iur_papers

During the 1920s when 50% leverage on housing was the common maximum, 80-90% leverage on equities was very common. The history of stock margin is much more well-known because of its contribution to the 1929 crash and the Great Depression. That had a lingering effect on opinion of the use of leverage on stocks. Property loans and leverage played a role in the 2008-2009 financial crisis and affected the general opinion on and regulation of them, though not to the same degree the 1929 crash did with equity margin.

trueblueky
Posts: 1345
Joined: Tue May 27, 2014 3:50 pm

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

Post by trueblueky » Tue Jul 17, 2018 10:02 am

michaeljc70 wrote:
Tue Jul 17, 2018 5:55 am
AlohaJoe wrote:
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."
Here is data going back to the 60s and it shows no such NATIONAL drop in 1987 or 1970 on an annual basis: https://fred.stlouisfed.org/series/ASPUS

"The chart below tracks median home prices from 1968 to 2004 and shows an average yearly increase of 6.4%, without a single decline during the 36-year period." https://www.investopedia.com/articles/m ... market.asp

What data are you using? What level do you consider a crash?
If real estate values in the neighborhood where your house is crash (fall so far that many homes are underwater, e.g., Las Vegas and parts of Florida around 2008), it does not matter what is happening in the rest of the world.

It is similar to having all your retirement fund in one stock. (Great if that has been Apple for the last twenty years. Not so great if it was Enron.) You can lose big without the entire market collapsing.

Few of us can diversify in the single family housing market. How many houses in how many cities (globally?) would it take?

My take has been to buy only as much house as we need, not as much as some banker says we can afford. Too conservative?

wrongfunds
Posts: 1812
Joined: Tue Dec 21, 2010 3:55 pm

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

Post by wrongfunds » Tue Jul 17, 2018 10:05 am

Trivial (but correct) Answer to the original question.

If you could get 30 year fixed low interest loan (possibly subsidized by tax payers) to purchase Google/Apple stock from your local (or commercial banker), just go for it!

User avatar
vineviz
Posts: 1689
Joined: Tue May 15, 2018 1:55 pm

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

Post by vineviz » Tue Jul 17, 2018 10:11 am

Ben Mathew wrote:
Tue Jul 17, 2018 2:42 am

But in practice, there are some roadblocks that make the move from 100% to 105% more problematic than the move from 80% to 85%:

(1) Retirement accounts, where a lot of our savings lie, don't allow margin loans. 100% is the most you can go.

(2) As mentioned by the OP and others, leveraging through margin loans entails the risk of margin calls. You're borrowing short term to invest long term. The duration mismatch creates an added risk. If it's not a lot of leverage, you might be able to ride out a temporary downturn without margin calls. But if you are more leveraged, then a temporary downturn can wipe you out.
These two challenges can be easily overcome in a brokerage IRA (or 401k that has a brokerage option) with the use of 2x and 3x leveraged ETFs (e.g. http://www.proshares.com/funds/upro.html).

The following portfolio, for instance, would have a nominal equity exposure of 150% * and a combined expense ratio of less than 35 bps.

25% UltraPro S&P500 (UPRO)
50% Vanguard Total International Stock ETF (VXUS)
25% Vanguard S&P Small-Cap 600 Value ETF (VIOV)

*Note: Using a daily leveraged ETF will provide something less than the nominal leverage when used as a long-term investment based on volatility and portfolio rebalancing frequency.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

golfCaddy
Posts: 704
Joined: Wed Jan 10, 2018 10:02 pm

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

Post by golfCaddy » Tue Jul 17, 2018 10:20 am

nisiprius wrote:
Tue Jul 17, 2018 5:27 am
In the forum people are always asking "why not 100% stocks," but an equally good question is "why not 200% stocks," "why not 1000% stocks," why not 100X leverage (some real-world situations, like LTCM, come close to that), etc.
If not for daily margin calls, 100x leverage would make a lot of sense at a certain point in your life. Imagine someone offers you a bet with these odds:
A) 40% chance of losing everything
B) 20% chance of breaking even
C) 20% chance of a 10x return
D) 20% chance of a 30x return

Your expected value is 0.4*0+0.2*1 + 0.2*10 + 0.2*30 = 8.2x. or a 720% return. You get the reward, but in some sense, whoever is lending you the money takes most of the risk. I wouldn't take that bet at 60, but at 25, definitely.
Last edited by golfCaddy on Tue Jul 17, 2018 6:09 pm, edited 1 time in total.

barberakb
Posts: 50
Joined: Fri Apr 21, 2017 11:14 pm

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

Post by barberakb » Tue Jul 17, 2018 10:59 am

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.
Its amazing how many people don't understand this concept...

I have sat several people down at work and showed them how they have spent over $50K in rent in the last few years that they could have owned a house and at least built some equity in it. Market depending of course

User avatar
Meg77
Posts: 2392
Joined: Fri May 22, 2009 1:09 pm
Location: Dallas, TX
Contact:

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

Post by Meg77 » Tue Jul 17, 2018 10:59 am

I'm a private banker, and I find this discussion very thought provoking.

In my view, it is not the thing or investment being purchased that makes leverage "good" or "bad" - or more advantageous or more risky. It's the loan structure. If the only way to borrow to buy a home was on a high interest rate short term loan that the lender could change or cancel any time, that wouldn't be a good idea simply because the underlying asset value is relatively safe. Similarly, if you could borrow at 4% fixed over 30 years and the lender couldn't adjust the terms as long as you make your payment, I'd take that loan and invest it in stocks or a business venture, or simply lend the money back out at a higher rate.

Mortgages are "good" or at least acceptable because the government regulates and subsidizes them to have terms that are very favorable to the borrower. These loans offer a very high degree of long term certainty as to the terms; very few other loans are like this.
"An investment in knowledge pays the best interest." - Benjamin Franklin

KyleAAA
Posts: 6719
Joined: Wed Jul 01, 2009 5:35 pm
Contact:

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

Post by KyleAAA » Tue Jul 17, 2018 11:56 am

Meg77 wrote:
Tue Jul 17, 2018 10:59 am
I'm a private banker, and I find this discussion very thought provoking.

In my view, it is not the thing or investment being purchased that makes leverage "good" or "bad" - or more advantageous or more risky. It's the loan structure. If the only way to borrow to buy a home was on a high interest rate short term loan that the lender could change or cancel any time, that wouldn't be a good idea simply because the underlying asset value is relatively safe. Similarly, if you could borrow at 4% fixed over 30 years and the lender couldn't adjust the terms as long as you make your payment, I'd take that loan and invest it in stocks or a business venture, or simply lend the money back out at a higher rate.

Mortgages are "good" or at least acceptable because the government regulates and subsidizes them to have terms that are very favorable to the borrower. These loans offer a very high degree of long term certainty as to the terms; very few other loans are like this.
Exactly. Indeed, many people take a mortgage even when they could pay cash in order to gain those favorable terms.

User avatar
Ged
Posts: 3595
Joined: Mon May 13, 2013 1:48 pm
Location: Roke

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

Post by Ged » Tue Jul 17, 2018 12:08 pm

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.
One of the aspects of home ownership is where it fits in the family life cycle. People want to raise their children in a stable environment. The American standard for that is a single family home in a suburb that has a good public school system. Generally people who are just starting a family simply cannot afford such a thing without borrowing. So they borrow.

Equities are a different thing altogether. The are nearly infinitely divisible. Starting an investment account is affordable for people early career without the need to borrow.

Ben Mathew
Posts: 96
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle
Contact:

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

Post by Ben Mathew » Tue Jul 17, 2018 1:57 pm

vineviz wrote:
Tue Jul 17, 2018 10:11 am
Ben Mathew wrote:
Tue Jul 17, 2018 2:42 am

But in practice, there are some roadblocks that make the move from 100% to 105% more problematic than the move from 80% to 85%:

(1) Retirement accounts, where a lot of our savings lie, don't allow margin loans. 100% is the most you can go.

(2) As mentioned by the OP and others, leveraging through margin loans entails the risk of margin calls. You're borrowing short term to invest long term. The duration mismatch creates an added risk. If it's not a lot of leverage, you might be able to ride out a temporary downturn without margin calls. But if you are more leveraged, then a temporary downturn can wipe you out.
These two challenges can be easily overcome in a brokerage IRA (or 401k that has a brokerage option) with the use of 2x and 3x leveraged ETFs (e.g. http://www.proshares.com/funds/upro.html).

The following portfolio, for instance, would have a nominal equity exposure of 150% * and a combined expense ratio of less than 35 bps.

25% UltraPro S&P500 (UPRO)
50% Vanguard Total International Stock ETF (VXUS)
25% Vanguard S&P Small-Cap 600 Value ETF (VIOV)

*Note: Using a daily leveraged ETF will provide something less than the nominal leverage when used as a long-term investment based on volatility and portfolio rebalancing frequency.
The last line is the problem. Leveraged ETFs aren't actually recreating a simple long term leveraged portfolio of borrowing at 3% and investing in stocks for 30 years. They behave differently than people might expect.

Expenses are high too--not just the fees the funds charge us, but also how much their trades cost them (bid-ask spreads they pay, and so on).

The complexity of their synthetic positions is also worrying to me. Maybe the fund managers have a handle on how their positions will behave under stress. Or maybe they don't. Not sure I want to find out. If I'm leveraging myself by borrowing and investing, at least I know what's going on.

michaeljc70
Posts: 3572
Joined: Thu Oct 15, 2015 3:53 pm

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

Post by michaeljc70 » Tue Jul 17, 2018 2:02 pm

trueblueky wrote:
Tue Jul 17, 2018 10:02 am
michaeljc70 wrote:
Tue Jul 17, 2018 5:55 am
AlohaJoe wrote:
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."
Here is data going back to the 60s and it shows no such NATIONAL drop in 1987 or 1970 on an annual basis: https://fred.stlouisfed.org/series/ASPUS

"The chart below tracks median home prices from 1968 to 2004 and shows an average yearly increase of 6.4%, without a single decline during the 36-year period." https://www.investopedia.com/articles/m ... market.asp

What data are you using? What level do you consider a crash?
If real estate values in the neighborhood where your house is crash (fall so far that many homes are underwater, e.g., Las Vegas and parts of Florida around 2008), it does not matter what is happening in the rest of the world.

It is similar to having all your retirement fund in one stock. (Great if that has been Apple for the last twenty years. Not so great if it was Enron.) You can lose big without the entire market collapsing.

Few of us can diversify in the single family housing market. How many houses in how many cities (globally?) would it take?

My take has been to buy only as much house as we need, not as much as some banker says we can afford. Too conservative?
I agree. Historically though (not counting the financial crisis), a lot of the big booms/busts have been pretty concentrated geographically (mostly in 2 states).

User avatar
vineviz
Posts: 1689
Joined: Tue May 15, 2018 1:55 pm

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

Post by vineviz » Tue Jul 17, 2018 2:22 pm

Ben Mathew wrote:
Tue Jul 17, 2018 1:57 pm
The last line is the problem. Leveraged ETFs aren't actually recreating a simple long term leveraged portfolio of borrowing at 3% and investing in stocks for 30 years. They behave differently than people might expect.
The behavior of these leveraged ETFs is slightly more complicated than an unleveraged fund (or possibly than other means of achieving the same leverage), but not by much.

That said, factoring in the drag of volatility and the expenses involved there are definitely long periods of time during which a leveraged portfolio using these ETFs underperformed an unleveraged portfolio. It's not something I'd undertake lightly.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

ThrustVectoring
Posts: 496
Joined: Wed Jul 12, 2017 2:51 pm

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

Post by ThrustVectoring » Tue Jul 17, 2018 2:28 pm

Leverage in general is good as long as you don't take too much risk. Banks have departments dedicated to making sure they don't lend to people taking too much risk, because if they do then the bank loses money. So you generally have to try pretty hard to take out too much leverage on real estate.

In stocks, on the other hand, they can just sell your stuff in a liquid market to cover your loans. If you are 2x leveraged that's too much risk, and brokers are more than willing to lend that to you.

Also, the terms you get on a mortgage are absolutely fantastic. The 30 year mortgage is essentially shorting a long-term bond, plus you get embedded options with prepayment and refinancing. Long-term bonds suck as long term investments, so shorting them with good terms is a great choice.

runner540
Posts: 736
Joined: Sun Feb 26, 2017 5:43 pm

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

Post by runner540 » Tue Jul 17, 2018 2:43 pm

ThrustVectoring wrote:
Tue Jul 17, 2018 2:28 pm
Leverage in general is good as long as you don't take too much risk. Banks have departments dedicated to making sure they don't lend to people taking too much risk, because if they do then the bank loses money. So you generally have to try pretty hard to take out too much leverage on real estate.
These statements are just not correct about mortgage lending. People can definitley get overleveraged on "approved" mortgages.

-Non-bank lenders are playing a huge role in mortgage lending post-2008, and they are not risk regulated the way banks are.
-the median down payment for all mortgages is 5%. Many loans are getting done at 1-3% down.
-lenders don't hold the risk on many mortgages - they are insured by Fannie/Freddie
More info/stats are here http://www.aei.org/publication/national ... r-q1-2018/

User avatar
aj76er
Posts: 583
Joined: Tue Dec 01, 2015 11:34 pm
Location: Portland, OR

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

Post by aj76er » Tue Jul 17, 2018 9:16 pm

Stormbringer wrote:
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.
With a 1031 exchange, I think you will eventually need to pay capital gains tax including the depreciation recapture if the property is ever sold, right?
"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" - John C. Bogle

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

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

Post by SpeculativeTrader » Wed Jul 18, 2018 12:15 am

nisiprius wrote:
Tue Jul 17, 2018 7:57 am

First of all, I keep being bothered by your characterization of the difference as being solely the difference in asset class. I don't think it is. The difference between a homebuyer with a mortgage and a daytrader is not that the first buys real estate and the second buys securities.
I regret choosing what I thought to be a funny name because I think it's clouding people's perception of me and my question.

The intention of my question, which I admit may not have been clear in the OP, is to try to figure out if it is equally as good to leverage:

1) A personal home with 15-30 mortage OR 2) Mortgage-like loan to invest in a Boglehead-style index fund

What I mean is If one has $40,000. Is it better or equal if one borrows to buy a $200,000 home, or a $200,000 diversified index portfolio. If loan terms are like a mortgage where you pay P & I over the life of the loan and slowly pay it back for 15-30 years.
Pajamas wrote:
Tue Jul 17, 2018 8:56 am


One thing you should consider is whether or not it is necessary to use leverage
That is a very good point. People are mostly forced to leverage to own a home, whether or not it is a good investment or not is another thing.
wrongfunds wrote:
Tue Jul 17, 2018 10:05 am
Trivial (but correct) Answer to the original question.

If you could get 30 year fixed low interest loan (possibly subsidized by tax payers) to purchase Google/Apple stock from your local (or commercial banker), just go for it!
I would maybe make a slight change and say that I would consider going for it if it was into Vanguard index fund.
Meg77 wrote:
Tue Jul 17, 2018 10:59 am
I'm a private banker, and I find this discussion very thought provoking.

In my view, it is not the thing or investment being purchased that makes leverage "good" or "bad" - or more advantageous or more risky. It's the loan structure. If the only way to borrow to buy a home was on a high interest rate short term loan that the lender could change or cancel any time, that wouldn't be a good idea simply because the underlying asset value is relatively safe. Similarly, if you could borrow at 4% fixed over 30 years and the lender couldn't adjust the terms as long as you make your payment, I'd take that loan and invest it in stocks or a business venture, or simply lend the money back out at a higher rate.

Mortgages are "good" or at least acceptable because the government regulates and subsidizes them to have terms that are very favorable to the borrower. These loans offer a very high degree of long term certainty as to the terms; very few other loans are like this.
I really appreciate input from an industry expert.

If there is a mortgage-like product for equity index funds, what would be the fair price for financing?

Where I am it is 100-150 bps over mortgage rates as an introductory offer for the life of the loan but normally could be 400 bps. Although the special seems to be always ongoing.

Stormbringer
Posts: 581
Joined: Sun Jun 14, 2015 7:07 am

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

Post by Stormbringer » Wed Jul 18, 2018 1:17 am

aj76er wrote:
Tue Jul 17, 2018 9:16 pm
With a 1031 exchange, I think you will eventually need to pay capital gains tax including the depreciation recapture if the property is ever sold, right?
Not if you hold the property until death. Your kids inherit it, and then get a step-up in tax basis, wiping out the capital gain. Plus they get to start the depreciation cycle all over again. It's quite a racket. :)
"Compound interest is the most powerful force in the universe." - Albert Einstein

CurlyDave
Posts: 699
Joined: Thu Jul 28, 2016 11:37 am

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

Post by CurlyDave » Wed Jul 18, 2018 3:10 am

Stormbringer wrote:
Wed Jul 18, 2018 1:17 am
aj76er wrote:
Tue Jul 17, 2018 9:16 pm
With a 1031 exchange, I think you will eventually need to pay capital gains tax including the depreciation recapture if the property is ever sold, right?
Not if you hold the property until death. Your kids inherit it, and then get a step-up in tax basis, wiping out the capital gain. Plus they get to start the depreciation cycle all over again. It's quite a racket. :)
This is exactly my current plan with our investment properties.

As much as there are some aspects of denying the tax man his due by dieing that I don't like, the strategy works.

User avatar
aj76er
Posts: 583
Joined: Tue Dec 01, 2015 11:34 pm
Location: Portland, OR

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

Post by aj76er » Wed Jul 18, 2018 10:44 am

Stormbringer wrote:
Wed Jul 18, 2018 1:17 am
aj76er wrote:
Tue Jul 17, 2018 9:16 pm
With a 1031 exchange, I think you will eventually need to pay capital gains tax including the depreciation recapture if the property is ever sold, right?
Not if you hold the property until death. Your kids inherit it, and then get a step-up in tax basis, wiping out the capital gain. Plus they get to start the depreciation cycle all over again. It's quite a racket. :)
okay, thanks for clarifying. The only downside to this plan is being forced to manage properties late in life (80s, 90s, etc..), which seems like it could be hard to do. But one could always hire a property manager I guess.
"Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth" - John C. Bogle

Stormbringer
Posts: 581
Joined: Sun Jun 14, 2015 7:07 am

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

Post by Stormbringer » Wed Jul 18, 2018 12:21 pm

aj76er wrote:
Wed Jul 18, 2018 10:44 am
okay, thanks for clarifying. The only downside to this plan is being forced to manage properties late in life (80s, 90s, etc..), which seems like it could be hard to do. But one could always hire a property manager I guess.
You can also do a 1031 exchange into an UPREIT if you want to be hands off.
"Compound interest is the most powerful force in the universe." - Albert Einstein

michaeljc70
Posts: 3572
Joined: Thu Oct 15, 2015 3:53 pm

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

Post by michaeljc70 » Wed Jul 18, 2018 1:29 pm

aj76er wrote:
Wed Jul 18, 2018 10:44 am
Stormbringer wrote:
Wed Jul 18, 2018 1:17 am
aj76er wrote:
Tue Jul 17, 2018 9:16 pm
With a 1031 exchange, I think you will eventually need to pay capital gains tax including the depreciation recapture if the property is ever sold, right?
Not if you hold the property until death. Your kids inherit it, and then get a step-up in tax basis, wiping out the capital gain. Plus they get to start the depreciation cycle all over again. It's quite a racket. :)
okay, thanks for clarifying. The only downside to this plan is being forced to manage properties late in life (80s, 90s, etc..), which seems like it could be hard to do. But one could always hire a property manager I guess.
That is an issue. I have a close friend that owns many rental properties. He is in his 60s. His heirs are also 60s and 70s. He doesn't want to sell due to taxes. I told him I would be worried his heirs (his sisters) are going to be old and do not have a clue what any of it is worth, how to take care of them, etc. and asked if he was worried they might unload them quickly for much less than they are worth.

LFKB
Posts: 513
Joined: Mon Dec 24, 2012 7:06 pm

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

Post by LFKB » Wed Jul 18, 2018 1:55 pm

I don't think using leverage is a bad thing for stocks as long as it's done so prudently. It is worth noting though that those stocks you are buying are already levered at the company level. So there is already leverage at play which is amplifying those equity returns up or down for each stock you own or each stock in an index.

grok87
Posts: 8372
Joined: Tue Feb 27, 2007 9:00 pm

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

Post by grok87 » Wed Jul 18, 2018 7:10 pm

LFKB wrote:
Wed Jul 18, 2018 1:55 pm
I don't think using leverage is a bad thing for stocks as long as it's done so prudently. It is worth noting though that those stocks you are buying are already levered at the company level. So there is already leverage at play which is amplifying those equity returns up or down for each stock you own or each stock in an index.
yep
Keep calm and Boglehead on. KCBO.

User avatar
nisiprius
Advisory Board
Posts: 36641
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 » Wed Jul 18, 2018 7:48 pm

vineviz wrote:
Tue Jul 17, 2018 2:22 pm
...
The behavior of these leveraged ETFs is slightly more complicated than an unleveraged fund (or possibly than other means of achieving the same leverage), but not by much...
Many leveraged ETFs don't go back very far. UPRO, for example, began in 2009 and thus has only been available during a bull market.

The 2X S&P leveraged mutual fund, ULPIX, enables us to look at the real-world behavior of one of these vehicles going back to 11/26/1997.

"Slightly more complicated" seems like an euphemistic way to describe what happened.

Portfolio 1: 100% ULPIX (2X leveraged S&P 500), blue.
Portfolio 2: 100% Vanguard 500 Index, red.

From inception to the present, the leveraged not only failed to earn double the earnings of a "straight" S&P mutual fund, it actually earned less than the unleveraged fund.

While the unleveraged fund was growing $10,000 to $42,707, ULPIX only grew it to it to $39,356.

Note, too, that from inception through the end of 2011, ULPIX actually lost $3,500 while VFINX made $6,700. Since then, during six years of a bull market, it has yet to make up that loss.

Roughly speaking, the behavior of ULPIX has been that when the market went down, ULPIX went down, but by more than 2X the market; and when the market went up, ULPIX went up, but by less than 2X the market.

Source
Image

Furthermore, while ULPIX was utterly failing to double the return of VFINX, it did succeed in doubling the standard deviation. It experienced a drawdown of an astonishing -87% (a sixth of its former value) while VFINX only dropped -50%. And thus, of course, it had a far lower risk-adjusted return.
Last edited by nisiprius on Thu Jul 19, 2018 12:42 pm, edited 1 time 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.

Stormbringer
Posts: 581
Joined: Sun Jun 14, 2015 7:07 am

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

Post by Stormbringer » Wed Jul 18, 2018 8:20 pm

JoMoney wrote:
Sun Jul 15, 2018 11:56 am
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?)
This is partly why I think people should avoid owning a single rental property. If you're going to get into it, plan on owning a portfolio of them.

I have 15 buildings now, and I've seen everything -- vacancies, leaky roofs, cracked foundations, boiler replacements, ornery building inspectors, slip and fall accidents, fires, all of it. If you own a single property, those things can be devastating. But if you have a portfolio of them, there is always something going on at one property or another, but there are others that doing just fine. It is similar in some respects to owning a basket of stocks rather than piling all you money into one.

Real estate is very capital intensive, so unless you have bucket of cash coming in from somewhere else, leverage is usually necessary (and highly desirable, in my experience) to build a larger portfolio.
"Compound interest is the most powerful force in the universe." - Albert Einstein

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 » Wed Jul 18, 2018 8:32 pm

nisiprius wrote:
Wed Jul 18, 2018 7:48 pm

From inception to the present, the leveraged not only failed to earn double the earnings of a "straight" S&P mutual fund, it actually earned less than the unleveraged fund.

While the unleveraged fund was growing $10,000 to $42,707, ULPIX only grew it to it to $39,356.
ULPIX and similar leveraged ETFs are very misunderstood in general. They are only intended for day trading. ULPIX is not expected to even approximately double the return of the S&P 500 over any period longer than one trading day because it is "reset" each day.

https://www.schwab.com/public/file/P-9287115

https://www.sec.gov/investor/pubs/lever ... -alert.htm

Stormbringer
Posts: 581
Joined: Sun Jun 14, 2015 7:07 am

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

Post by Stormbringer » Wed Jul 18, 2018 8:40 pm

nisiprius wrote:
Sun Jul 15, 2018 3:51 pm
Maybe it "usually" is, but what is the magnitude of the consequences when it isn't?
Well, in my state (a non-recourse state) the consequence could be your entire investment. But that's sort of gets into where real estate should be a looked at as a business, not just an investment. You have to manage and mitigate that risk -- selecting the right property, getting it inspected before you buy, maintaining adequate cash reserves, not over-leveraging yourself, knowing how to price your units, finding a good manager, etc.
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.
Interesting aside, this is called the martingale strategy. This is why casinos put limits on all the tables, so you can only double your bet a limited number of times before hitting the max. In college, I was a blackjack dealer. :)
"Compound interest is the most powerful force in the universe." - Albert Einstein

User avatar
grabiner
Advisory Board
Posts: 22684
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

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

Post by grabiner » Wed Jul 18, 2018 9:31 pm

AlohaJoe wrote:
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?
You are comparing short-term to long-term rates. A 30-year mortgage locks in a 4.37% rate (current rate from bankrate.com) for 30 years, and a 15-year mortgage locks in a 3.79% rate for 15 years. The 3.1% rate could become 6% in the future, and should be compared to a 1-year ARM. And with margin calls, the margin loan is actually probably slightly safer for the lender than a mortgage with 20% down.
Wiki David Grabiner

Post Reply