It was just over two years ago that I first decided to use a margin loan to buy a multimillion pound Dream Home. It seems I’m one of very few folks, worldwide, to explicitly make this decision. So how’s it turned out? This post describes my journey so far. If you have no interest in margin loans or debt then this post isn’t for you – be warned.
What was I thinking?
The full story of that house purchasing whim is told in various posts (starting here), but it’s worth recapping a moment on my logic for using a margin loan.
The decision to buy the Dream Home arose very suddenly. I am not joking when I say it was a whim. All I knew for sure when I committed to the transaction was that I had liquid assets of a value significantly in excess of the Dream Home™, and that a mortgage wouldn’t be of much use to me. So I assumed that I could, worst case, sell assets to raise the funds necessary.
I needed to raise about 110% of the value of the Dream Home, to cover the purchase price, the stamp duty, and transaction costs.
My plan was to sell my Previous House shortly after buying the Dream Home (but not in a chain transaction). I assumed the Previous House was worth about 60% of the Dream Home. I also assumed the Previous House would be difficult to sell until after the Brexit referendum was behind us, at which point we would be safely confirmed as remaining in the EU. Hah. But even in my fantasy scenario, there were going to be many months between the purchase of the Dream Home and any sale of the Previous House, so I needed to ignore the Previous House when finding funds to complete the Dream Home transaction.
At around the same time, I was also expecting a windfall sum from the partial sale of one of my illiquid investments. This sum was going to be more than enough to pay for the stamp duty, i.e. a very significant windfall, of over 10% the value of the Dream Home. But I didn’t have control over the transaction timing and I knew that the deal could be delayed by weeks/months or, worse still, derail completely.
So, in crude terms, I thought that I could, over a few months and with a bit of risk, find about 70% of the ~110% I needed without needing to touch my portfolio, and that the balance of about 40% would come from liquidating a suitable slug of my portfolio. But in the meantime I would need to find potentially all 110% my liquidating the portfolio; this was going to be painful, but, hey, wasn’t the whole point of my liquidity-seeking investment strategy to be able to use the portfolio tactically when unexpected situations arose?
What should I have been thinking?
Once I thought about the funding requirement in more detail, in December 2015, a couple of things became clear.
Avoiding tax is probably the best-known investment advice, and the mission that unites even the least sophisticated investors with the most financially literate.
How the government wants you to avoid paying tax
As a wise blogger (SHMD, I think it was, but I can’t find the link) pointed out recently, the UK offers unusually generous investing tax breaks (and that’s even before we get onto SEIS and EIS angel investing tax breaks). There’s almost no point in calling Panama.
For most UK investors, the simplest way to avoid taxes involves two manoeuvres, each done annually:
- Topping up your ISA(s). ISAs remain the biggest potential tax break in the UK, but they require multi-year patience; there is an annual ‘use it or lose it’ allowance so to maximise the benefits you need to act annually. The limit these days is £20k per adult, so £40k per couple – which is a lot of money to find from disposable income but not enough to squirrel a large inheritance/windfall/25% pension drawdown away all in one go.
- Making pension contributions. For most retail investors, pensions are a fairly straightforward tax break; in exchange for locking my money up until I’m c.60, I avoid any tax on the money from now until I start accessing it. For more affluent but nowhere-near-retirement-age investors, such as me, the UK policy is pretty crazy, because knowing whether your pot is going to breach the ceiling 20+ years out is a mad Monte Carlo guessing game. A 30 year old expecting to retire at 70 and expecting annual returns of 7% should be careful about taking their pot above £60k.
It is worth stating the obvious that not only are these two manoeuvres both 100% legal but they are in fact actively encouraged by government policy.
Practically all the readers of this blog are at least higher rate tax payers – i.e. their marginal income tax rate is 40% or more. For them the two key rates on offer are 40% and 0%.
This is the third in my annual posts about my ISA (tax-free) portfolio. I’ve written before about how there is an outside (~10%) chance of my ISA portfolio reaching $100m, if I live for another 40+ years. Yet, as of my last post a year ago, the total FvL ISA pot was worth ‘only’ £355k (~$500k, back then!). So how am I feeling about multiplying my ISA 200x?
My $100m assessment was based on a scenario analysis over the next 40+ years. Making various assumptions (no withdrawals, regulation changes, etc), if I maintain contributions at £20k x2 per year, and achieve an ‘Above Average Risk’ level of return (>9% per year average, quite a high level of volatility), then in about 10% of predicted outcomes my total pot would reach $100m.
There are a couple of simple mental tricks that help me get my head around this growth. First of all, contributing £20k x 2 per year is quite a lot of money; over 30 years this is £1.2m. To make it easier to think about the growth of this annually-topped-up portfolio, let’s simplistically assume it isn’t annual top ups, but instead is a lump sum of £600k ($750k) in year 14.
Secondly, remember the rule of 70. Assuming I average returns of 7% then my portfolio doubles in 70/7=10 years. At an average return of 10% it takes about 7 years to double. So if I start with $0.5m, and averaged 10% return, after 35 years I have doubled 5 times, and I’m at $16m. But if I add (see previous paragraph) $750k in year 14, this $750k then doubles three times; this adds a further $6m. The two together get me to $22m in 35 years. Now assume I last a further 14 years , which takes me to the average life expectancy for UK males of my age, and I double my combined $22m pot 2 more times. $88m. Not quite $100m, but not far off.
Before you say that 10% per year is unrealistic, I am citing everything here in nominal ‘money of the day’ figures. This is before allowing for inflation. Historic returns for a diversified portfolio can easily achieve 5% per year on top of inflation. This works out as 7-8% per year in nominal figures. 10% is high, I will accept, but not absurdly so. If you have significant fees then you can forget it, but if you hold low-cost passive trackers this is not that unusual.
In the meantime, there I was a year ago with £355k. At today’s exchange rate this is barely $450k. How have I fared since then?