Leverage for equities– good or bad?

In continuation of my previous post on the topic whether it made sense to take on a 30 years loan for HDB, (http://singaporemanofleisure.blogspot.com/2011/05/are-hdb-flats-public-housing-affordable.html ) I would like extend it to the realm of investing/trading in equities/futures.

What I am sharing is what I am doing in practice right now. But please be aware from “My story” that I have lost an arm using margin to speculate on stocks previously.

Why still play with “fire” when I’ve been burnt before? Eh… Since I’ve paid my school fees, I might as well finish the whole course?

To make things easier to explain, let me use a hypothetical example if I have SGD 50,000 (once upon a time it was a true reflection of my savings).

No leverage camp

If you belong to this school of thought, then if you are fully invested, that would mean you would have max SGD 50,000 worth of equities.

When the stock market corrects, you have more “holding power”; and be less prone to sell in “panic”. Plus you don’t incur margin interest costs.

Judicious use of leverage camp (me!)

What if I say I put SGD 40,000 into a fixed deposit or money market fund, and put SGD 10,000 into a CFD or futures account?

This SGD 40,000 can be called an opportunity or emergency fund. It’s equivalent to 12 months of salary for someone earning 3333.3333 per month or 6 months of salary if you are earning 6666.6666 per month (And you think I plucked this 50,000 from thin air! Don’t the numbers look nice?).

I will only use max 5 to 1 leverage for my CFD or futures account. This way, I have my peace of mind that the “borrowed” SGD 40,000 is backed-up by my opportunity or emergency fund.

Why pay margin interests when you can pay in full?

Nothing is free! For those who value cash flow over accounting profits when analyzing companies may understand me better:

Emergency fund

Imagine if you are fully invested in a dividend stock and 1 week before the ex-dividend cut-off, you have a pressing emergency need for SGD 40,000? It’s painful to sell at the wrong time right?

Even more painful if you don’t believe in cut-loss and after months of waiting/hoping, the moment you have to sell due to an emergency need, the price starts to recover!? Blistering barnacles!!! I know! Been there; done it myself. Sigh…..

By the way, you may also want to visit this “Will you use your emergency fund to invest” discussion/poll from Derek’s blog: http://thefinance.sg/2011/05/11/will-you-use-your-emergency-fund-to-invest   No prizes on how I voted!

Opportunity fund

Have it happened to you when you are fully invested, spot an opportunity but just don’t have the funds and have to watch this opportunity slip away?

Here I am talking about a real risk/reward opportunity that is in our favour – not a “Hail Mary pass” kind of speculation.

Let’s use an inspiration from a recent blogger who bought a 2^nd hand iPad: http://fivecentstencents.com/blog/2011/05/16/rewarding-yourself-within-your-means-my-2nd-hand-ipad

Imagine this iPad is a SGD 40,000 stock ;)

If you spot someone selling a 2^nd hand first generation iPad for SGD 200, and you are technologically savvy to know that it’s a genuine product, would you grab it?

Of course it’s a “safe” arbitrage trade if you know the iPad product and market. You can easily flip it and sell it as SGD 400 or more!

You can say you apply for loan or borrow from friends. I am talking about first mover advantage here. By the time you have raised the money, it may have already been sold to someone with the ready cash on hand.... They don't say cash is king for nothing ;)

Make your quick profit and deposit the capital back to your money market fund. The profits you can decide to put it to the money market fund or add this to your margin account (Hey! It’s your money, you decide!).

Don’t listen to me!

I am merely sharing my first hand practical experiences. Hypothetical examples are used merely as props to make it easier for me to put it in words.

What works for me may not work for you. I belong to a generation where I value the advice from seniors who “ate more salt than rice” compared to me. I would recommend you to one such “senior”: http://createwealth8888.blogspot.com/2011/05/following-someone-investing-idea.html

I don’t learn how to swim by reading or watching. Learn by doing?

Then we can swap war stories all we want!