I met a billionaire recently. I say billionaire, but I don’t know for sure. He was definitely a paper billionaire at one point before the dot com crash – whether he still is I’m not sure, but it seems like a fair bet. He is a serial entrepreneur who made his money by selling his tech business for >>$1bn (in an all-stock deal), a long time ago. He is now a Euro-elite type, being based on the continent and travelling frequently around Europe.
As it happens, I got into a brief conversation with this chap about how he manages his money. I found it quite interesting. Here are a few snippets as I remember them. Let’s call him David.
David has set up a Family Office which is where the money is managed from. He doesn’t have a ‘day job’ any more, but is clearly a busy guy.
David thinks of his investments in three pots, and takes a specific approach for each:
- Public equities. While David is well aware of the ‘textbook’ investing approach (low fees, diversified assets, don’t try to beat the market, rebalance regularly) he doesn’t directly follow this; he employs some investment professionals to manage the money. I believe he diversifies widely, taking in commodities, hedge funds et al.
- Private equities. David specialises in ‘value-added’ angel investing, mostly (or possibly exclusively) in the tech sector. His investments vary in size from $500k to €10m+. He has 30+ such investments and is reasonably hands-on with several. My impression is he is looking for visionary, ambitious businesses based in Europe, where he can put some serious money to work – and he is not afraid of being the biggest shareholder.
- Real estate. He looks for real estate to ‘double or triple’. I asked ‘so, IRRs of 5-7%?’ and was firmly put in my place – “no; 5% would take 14 years to double; I am talking doubling in 1-2 years”. He is prepared to put in a bit of development/planning / etc effort to create value. He owns at least one large (100+ unit) residential block. Interestingly, he said “if I was simply trying to maximise net worth for least effort/risk, I would invest 100% in real estate”. He doesn’t appear to consider his c.£10m primary residence part of his investment portfolio.
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%.