I try not to use leverage in stock trading even if theoretically you can get better risk-adjusted returns from leveraging a portfolio on the efficient frontier.
On the other hand, I have a mortgage for real estate. Since, debt is debt, I wonder, am I being illogical here?
Well, first I try to spell out some differences:
The mortgage debt is with a long term fixed rate and so I am not exposed to short term interest rate risk
While it is theoretically possible for the bank to issue a margin call, in practice, this is unlikely
So if I could increase my mortgage debt, and use the funds to invest in the stock market, would I do it (i.e. debt fund on same terms as the mortgage)? Iâm not sure. It does somehow feel more âriskyâ, but it also feels irrational.
I do both, debt is debt. The margin rate from my broker (IB) is just slightly higher than the mortgage rate, less than 0.1%.
I have a benchmark target for my stocks where I theoretically would pay back my mortgage. But I will do this just âvirtuallyâ, reducing the margin debt by the amount of the mortgage. So I still enjoy the cheaper rate but have the flexibility of the margin credit.
You probably wonât remember, but banks do issue âmargin callsâ on mortgages, seen it. They usually take away the house, sell it for cheap (often to employees or the bank itself buys it) and you are left with debt under a bridge. This situation is way worse than a margin call for stocks, as you cannot sell one room of your house but you can sell one share of stock. Last time this happened about 45 years ago after the pop of the last real estate bubble. The actual bubble is still growing, but wonât foreverâŠ
Yes, I am aware that it has happened. I think in the 90s was the last Swiss housing crash. However, I see the risk as small as banks are reluctant to do it and I will have equity in the house and even if more margin is required, I can margin out the stock portfolio to reduce the mortgage margin.
This basically boils down to buying stocks on leverage. How you fund that debt is up to you.
You are framing it in different way because mortgage increase is making the above possible. But the reality is if you believe that buying stocks on leverage is not a good idea then it cannot become a good idea just because funding mechanism is different
I have a big chunk of cash(-equivalent) on the side because I have basically a non-funded pillar2, donât like bond, and donât have a risk tolerance to invest 100% in stocks or other volatile assets.
I own a paid-off house, not my primary home though - a @cubanpete_the_swiss -like abroad stuff, but having own RE without debt is not a common setup here, so I guess itâs interesting looking at it from a debt-is-debt total accounting.
So Iâm debt-free. Leveraging (cheap) debt would also be mental accounting since I have cash. Wouldnât it ?
On the other side thatâs free money in current conditions (I have 0.5%, considering I can deduct them from taxes and current yield on the cash side, itâs a small positive carry just considering the chf part - but wonât last), and any financial advisor considering my balance sheet would say I âlackâ debt.
On the other hand I like @finalcountdown approach, I think theyâre debt-free, rich, and as far as I understand, illiquid-asset-free as well.
(The house for me is multi-purposes, incl. Post-retirement non-digital life, but I am deeply emotionally detached from the object and Iâm quite the opposite of a homebody).
We need to remember debt is always coming against the collateral. If the value of collateral reduces then there is a request to add additional collateral.
If real estate market were to crash in Switzerland, the value of the collateral will reduce and this would mean you will be on the hook to increase your contribution.
So I donât think anyone says âhere is your 1 million for 0% interestâ. They say âhere is your 1 million for 0% interest if the value of your property remains the same which you put as collateral â
I am not saying that taking debt is bad idea. It depends on personal situation. But most bankruptcies are caused by debt and not by making bad investments. Hence one needs to be careful
I have typically not used debt to fund equity purchases but I can imagine doing so (e.g. getting a Lombard loan) if I was working full time with bonus/equity grants and thus enough capacity to absorb any exposure.
Having said that, what I do a LOT is leverage my equity portfolio is collateral (conservatively) for writing options. The premium income is tax free and it provides an opportunity to buy stocks at a lower price (in case of written put options). Not quite debt, but still using leverage in a way.
Regarding the use of the mortgage on the home to increase leverage in other asset classes (i guess mainly stocks), to what extent can the Pillar 2 be considered a âliquidâ asset which can used to satisfy a margin call on the family home mortgage?
I would call that enhanced risk, not leverage. Limited loss (100% minus premium) and very limited gain (premium). And the real (and unlimited) loss is the gains you donât make on rising stocks, they are limited to the premium.
And you may be wrong about tax, you could be taxed as professional investor because of using derivatives for other matters then risk reduction. The same may happen with any leverage.
I use leverage but in a contrarian way; when everybody else deleverages. That is the moment you can make real risk-adjusted money. It must feel very bad, then it brings money.
The risk-reward is not the same. I think you have to include that:
In other words: you have more or less the same risk, actually options are better on a losing stock because you get the premium. But on a heavy rising stock you have basically the same risk but do not get the gains. One extreme case every 20 years or so and you are probably losing. In my momentum strategy I have one every year, but then I trade in volatile stocks.
In other words stocks (on margin or not) have limited risk and unlimited reward while option writing has limited risk and limited reward. That is quite an important differenceâŠ
I think you answered that for yourself. No debt, no need to.
Holding cash and debt initially makes no sense, you always pay the interest difference. That said, this is exactly what I do but just for spending cash; if my debt and cash equal out I have no inflation risk. If I invest the money in dividend stocks I have a positive cash flow, but added risk. If you donât want more risk donât take on debt.
What I described is something I primarily do with writing Put options (not so much Calls).
In any case, weâve had this discussion before. You refer to the âheavy rising stockâ as a missed opportunity. Iâd counter that you conveniently assume that youâd be holding on to that stock if youâd not written a Call (to use Calls as alternative case).
We were comparing writing put options with buying stocks. Writing call options has a completely different risk profile, more like shorting stocks.
Now if you buy a stock you need cash or a collateral, same as with short selling put options. The stock can rise more than the premium, but you only get to keep the premium and you keep it all when owning the stock.
Anyhow, options are not my thing. You bet on volatility and price and you need good timing. And you fight liquidity issues, have big spreads sometimes.
We were comparing selling put options with buying stocks on credit. I think in theory selling put options makes sense if you think volatility will go down and the price will not move much during your holding period. But then there is nothing more volatile than volatility.
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