This post drills in to the niche that I have found myself in – of having an uncomfortably high level of leverage margin during a bear market. None of this is worth trying at home so for you to continue reading I assume you are anticipating some schadenfreude, car crash blogging, or perhaps some material to share with your crazy crypto mates.
I have become quite a fan of margin lending. Just reviewing first of all the journey I’ve taken…
Normal mode: 10% leverage
I first dabbled with margin lending, literally on the margins, about 10 years ago. More recently, about five years ago, I decided to use the lending strategically, and for several years I set my target asset allocation to include approximately a 10% level of margin – i.e. I own assets amounting to 111% of my portfolio value, having borrowed 11% to fund the purchase; the 11% loan is 10% of the total asset value. I consider this level of leverage to be minimal risk, because the dividend yield off such a portfolio will, under auto pilot, pay off about a third of the loan every year, even if the markets suffer significant falls.
For completeness, I should mention the rest of the debt I hold. I have a modest level of mortgage debt on investment properties, on a mixture of interest-only and repayment arrangements. These investments generate significant free cash flow, which is mostly used to (over)pay down mortgage principal. I have no other significant debts. Unless otherwise stated, I ignore the mortgages when talking about my leverage level.
In terms of affordability ratios, in normal mode my total loans (including mortgages) amount to about 4x my income (including investment income), and about 10% of my net worth (including properties). Nothing here that would give my bankers too much trouble.
Unorthodox procedure 1: buying House 1
A key moment for me was when I took a large risk in 2016 by buying my Dream Home with a margin loan. I pushed my Loan To Value temporarily up to almost 40%. To be fair the Value here wasn’t my entire household net worth, it was only my own liquid portfolio, but it was still a level of leverage that could have caused me trouble. Fortunately, for a reason of anticipated reasons (windfalls I was expecting) and unanticipated reasons (Brexit hitting the pound, which reduced the value of my loan against my global portfolio) and the extended stock market boom, I never looked back from that initial high level of leverage, and four years’ later I had my leverage back down to 10% again.
It is worth highlighting the simple arithmetic behind my leverage fall from 38% to 10% over four years. Falling from 38% to 10% is a drop of almost 75%. And indeed during that time, my loan shrank significantly, but ‘only’ by 55%. At the same time my gross assets increased in value by 51%. The combination reduced my loan as a % of total value by ~75%, to 10%. Rising markets hide naked swimmers, and they rapidly reduce leverage (which is why we should expect western governments secretly to support inflation for a few years yet).Continue reading “Life on the margin”