I posted recently about my proposed 2016 goals for my portfolio. On reflection, I think I need to rewrite the first goal – about the loan that I am taking out against my portfolio.
In my article I suggested the goal about my portfolio loan was: “Continually reduce my margin loan’s Loan-To-Value (LTV) ratio“. On reflection, I don’t think this goal works, as the market’s recent declines have illustrated.
I’m taking out this loan to help me buy a Dream Home. My alternative to this would have been to sell my previous home – something I couldn’t have achieved in the timescales available – or to sell off my investment portfolio instead. I have chosen to take out a loan because I prefer to maintain a long term bet on my investment portfolio, rather than sell it, and because the cost of the loan is very low in relation to that bet.
The issue with my loan, with any loan, is risk. And my intention with my ‘reduce my LTV’ goal was to maintain that risk relative to the portfolio.
The problem with a ‘reduce LTV’ goal is that a key parameter in that goal – the value of the portfolio – is not under my control. If Mr Market drops his prices by 20%, then my LTV deteriorates and I breach my goal. My only remedy at that point is to sell to Mr Market at his low price. This isn’t my intention. Obviously, in extremis, I may need to liquidate assets to stay solvent. But buy and hold only works if one can do that when markets fall, and selling assets to maintain an LTV is the exact opposite of ‘buy and hold’. .
With hindsight what I want to achieve is that the loan falls consistently with time. In absolute terms. Inflation will do some of this for me, but with inflation very low at present, this is a very slow burn strategy. It is possible that currency fluctuations may help too – but with my strategy of mixing my loan roughly equally between GBP and USD this could as easily go against me as in my favour. So the best way for my loan to fall with time is that I repay it.
My loan will start off at about 35% of my portfolio value. My intention is to repay the loan in three ways:
- Asset disposal 1: I am selling an illiquid asset in February (touch wood). The proceeds will amount to about 30% of my loan, or about 10% of my portfolio value. I plan to use half the proceeds to pay down my loan, and half the proceeds to increase my invested portfolio. This should reduce my LTV to under 30%.
- Asset disposal 2: I plan to sell my former Dream Home. Here I am subject to the vagaries of Mr Market too. I won’t sell at any price, but there is a good chance I will get a reasonable price. The house price I regard as reasonable will enable me to fully pay off my portfolio loan. In practice I intend to reduce the loan to about 10-15% LTV, and keep it at this level – here is provides me with some modest leverage at a level of risk I consider entirely manageable. The remaining proceeds I will reinvest in my portfolio.
- Regular monthly repayments. Both of the asset disposals above are slightly outside my control. What is under my control is what I do with my regular income. I intend to reinvest some of it in the portfolio, but I also plan to use some of it to repay the loan. This will be a very slow burn activity. My intention is to pay off £10k per quarter. This will amount to about 2% of the principal per year, which is not going to move the needle very quickly, but it is still a tidy amount of money to be saving and it will slowly derisk me in the event that the portfolio suffers prolonged falls.
The risk that my portfolio suffers steep or sustained falls is the big risk I run with a margin loan. If the portfolio falls to a level where the lender is nervous it might not be sufficient to recoup their loan, then they can hit me for a ‘margin call’ or, at really low levels, close out the portfolio completely. Such an event would obviously reduce the LTV of my loan, but it would be outside my control and it would leave me unable to benefit from a subsequent market recovery. I want to avoid margin calls if at all possible.
This reasoning leads me to a revised goal: for my net loan to shrink by £10k per quarter, without any margin calls occurring. This goal is measurable, under my control, specific and time-bounded. I much prefer it to my original proposal. Can it be improved further?
5 thoughts on “Revising my 2016 margin loan goal”
It seems sensible to treat the loan as a (low interest) bridging loan, and pay most of it off, otherwise you are borrowing to invest, which seems unwise for the amateur. Selling your current home seems the best way to reduce your exposure to the London property market, and leaving a small loan to give you some leverage sounds good, as you seem to be more than an amateur.
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Watching and reading this caper with interest. 🙂
Perhaps another thing you could do is to have some portion of the investment portfolio that’s more of a ‘firewall’, and more earmarked against the outstanding loan? And the new money that you add to the portfolio (such as when you sell your illiquid asset) could go towards bolstering that portion of the portfolio?
For instance, say you had a sub-portfolio of government bond or possibly investment grade corporate bonds that mature in 5-10 years (as opposed to a fund) or other lower risk elements of your portfolio… maybe you could try to ensure that’s provisioned against the loan value?
Have you thought about tax? Is the investment portfolio’s returns all sheltered?
The only other thing that occurs to me is some sort of hedging strategy (e.g. Shorting high-end London house builders, or maybe you can do so directly via a spread bet) but obviously this will have a cost ramifications.
I have a visceral hatred of debt, mind, so probably not the best person to comment. 🙂
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@monevator – glad you are enjoying Car Crash Finance!
What would be the benefit of a firewall of £X, versus an unsegregated portfolio of £3X of which £X is bonds/low volatility investments?
Yes I increasingly think about tax! But my investment portfolio is mostly unsheltered. For various reasons the tax burden hasn’t been too onerous for me. However I find it irritating that borrowing to invest in companies isn’t tax deductible at all, whereas buy to let landlords are squealing about ‘only’ being able to deduct borrowing costs at basic tax rates.
Hedging is an interesting idea. Thank you for it.
And you are one of the best people to comment – particularly with your visceral hatred of debt! Thank you again.
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[…] 2016. To make this more complicated, I ended up funding the purchase very significantly through a margin loan – basically a loan secured on my equity portfolio, rather than a loan secured on the […]