Margin - Double Edge Sword

Introduction

Investment using margin is also known as leverage. Leverage is always a double edged sword and it can bring you faster to attain your financial goal or it can lead to your financial downfall. Margin is a high risk strategy that can yield huge return if executed well. However, if you do not know how to use margin, it can go against you. Hence, I strongly recommend that margin is meant for the seasonal investor.

Buying stock on margin is to borrow the stock from your broker, it allows you to buy more than your usual limit. However, this requires you to pledge either cash or stocks. Your broker will require you to sign a legal contract to open a margin account. For Lim & Tan, you need to pledge at least $5,000 of cash or $10,000 worth of stocks. It is important to know that you do not need to margin all the way, you can borrow less, say 10% or 25%.

In addition, there is an interest charge on the loan amount. Over time, the interest expenses may become larger than your stock appreciation, this will result in a loss. If your debt increases, the interest charges will increase. When you sell the stock in margin account, the proceeds go to your broker until it is fully paid and redeemed. In addition, there is a maintenance amount which is the minimum amount that you need to have before your broker will force you to top up in cash or force sell your stock. This is known as margin call. Not all the stocks will be qualified for margin, you need to check with your broker and there is a limit to the each individual counter depending on the quality of the company.

An Example

For instance, you deposit $10,000 in your margin account. In Lim & Tan, cash deposit allows up to 3.5 times purchase power and for shares collateral allows up to 2.5 times purchase power. Hence, this allows you to purchase shares up to $35,000. If you buy $5,000 worth of stock, you still have $30,000 in buying power. You have enough cash to cover this transaction and has not tapped into your margin, you start the borrowing process when you purchase more than $10,000.

What is margin call?

The initial margin is the initial amount you can borrow and the maintenance margin is the amount you need to maintain. For Lim & Tan,  the maintenance margin is at 40%. If the equity of your account falls below the maintenance margin, the brokerage firm will issue a "margin call". A margin call forces the investor to either liquidate his position or top up with more cash in the account.

For instance, you purchase $35,000 worth of securities by securities by paying $10,000 of yourself and borrow $25,000. If the market value of securities drops to $30,000, the equity in your account falls to $5,000 ($30,000 - $25,000 = $5,000). Assuming a maintenance margin requirement of 40%, you must top up additional $2,000 to meet $12,000   (40% x 30,000 = $12,000). The brokerage will issue you a margin call. If the brokerage firm sells your stock, you will not have control over which stock is sold to cover the margin call. It is imperative to read the terms and conditions of the margin contract you signed to understand thoroughly the calculation of interest, the collateral of the loan and repayment of the loan.

The advantage of margin

Companies borrow money to invest in projects, people borrow money to buy properties, investor borrow money to buy stocks.  By having more money through margin, you can either trade or hold for long term position. Assume you borrow $20,000 worth to purchase securities of Super Group shares which is trading at $1 and you feel it will rise dramatically. You have only pump in $10,000 of cash and leverage 50%. Normally with $10,000 of cash you can only purchase 10,000 shares (10000 x $1), with margin, you can purchase 20,000 shares. If the company announce strong performance in performance, the share price double to $2, your investment is worth $40,000 (20000 x $2). After paying back $10,000, you still have $30,000 which is equivalent to $20,000 of profit. This example excludes commissions and interest to simplify the illustration. Similarly, the losses will be amplified if the share price drops.

Margin for the young investors

Young investors in their early 20s with just a few thousand dollars in the market will not have very much diversification and they are underinvest in the market for the first 25 years of their working life. The only way for young investors to have more exposure to the market is to deploy a little leverage. You can deploy 2 to 1. When go to 3 to 1 or higher will make leveraging more expensive, the power of diversification will be eroded due to cost of borrowing. The increased market exposure when young allows you to have less exposure later on, market in the long run will recover any short term losses and bull market is always longer than bear market. However, if the young investors have credit-card debt, then they should clear their debts first before moving to margin.

Conclusion

Investors regardless of age need to be educated financially and need to be disciplined when deploying margin to buy stock to reduce and control risk to succeed in purchasing stocks with margin.

Your house is not an asset

Is your house an asset?

People think that owning a house is an asset. As rich dad poor dad author Robert Kiyosaki pointed out in his book Rich Dad Poor Dad a house is a liability until it is fully paid for then it becomes an asset.  Some thinks that the only to save money is to park it in properties. My definition of an asset is when the house produces cash flow for you. Do note that in Singapore, even the resale public housing can cost up to $700,000 for 5 room flat in Clementi. You will get your flat fully paid off when you are old. Who wants to wait until they are old to have money?

A house is a highly leverage tool, with 20% of down payment, you can leverage up to 80% of the property price by loaning from the bank. This is good if the property price is on an upward trend. However, leverage is a double edge sword, if property price is on downward trend, there is a possibility of margin call by the bank if it drops more than your initial 20% down payment.

The house much like an university education is over hyped has been fed to you by parents. However, our parents bought their house when Singapore is developing and the house is cheap. It works for our parents but old ways of doing things are not viable in this generation. It is a middle class myth perpetuated by outdated thinking, politicians and mass media.

Is renting always a waste of money?

Why will you pay rent to the landlord when you can buy? You may argue that the money that you spend on the rental every month can be used to pay the deposit of your house. Firstly, people rent because they can be mobile and nimble. Mobility is a great thing in today's world. A lot of parents rent a place near their desired primary school for their children.

When you are renting, you are renting space that has no future value. When you buy, you are still renting, you are renting money. The money you rent are used to pay mortgage and a house which depreciates for you to live in. However, there is interest based on the principal you loan.

For simple illustration, there are two brothers Zhixiang the owner and Zhixiong the renter. Both have assets of $100,000 each, liabilities of $0 and net worth of $100,000 each at the start. Zhixiang bought a $500,000 house. He paid $100,000 as down payment. He took a loan of $400,000 and incur stamp duties, legal fees, insurance, fees etc for an amount of $30,000. Hence, his current situation is Assets of $500,000, Liabilities of $430,000, new Net Worth is $70,000. Zhixiong found an identical house next door which rent for $2000 per month. His assets and net worth is still the same as before. However, his Net Worth is higher than his brother Zhixiang. Now we look at Zhixiang the owner, say he took a 3% fixed rate mortgage for 30 years, total monthly payment will be $1,686 and the total interest paid will be $207,109. If we add other charges, the monthly fees will probably be close or slightly lesser than $2000. However, Zhixiang will need to continue to pay for the interest of more than $200,000 whereas Zhixiong can use the additional cash flow to invest in shares which gives cash dividend and appreciation over the long run.

The difference at the end of 20 years ultimately depends on whether Zhixiong can save the differences and also house owner needs to be mindful of the impact of transaction costs of buying and selling houses too often. Real world fluctuations can throw your projection out of the window. Hence, it will be wise to project modestly and not take on too much debt. It makes a lot of sense to buy a modest house to live in so that you will have money left over to invest as well.

Ponzi Scheme 101

What is a Ponzi Scheme?

It is a scheme which investors are paid from money collected from new investors. This continues to work as long as there are new investors keep coming in to feed the previous batches. Ponzi schemes are honoured after Charles Ponzi, an Italian who promised investors in the US and Canada that his clients will be paid 50 per cent profit in 45 days through buying postal reply coupons in other countries and redeem at face value in US through arbitrage. Ponzi continued to pay the promised returns to his clients through collection of money from other investors. His scheme caused investors to lose $20 million in 1920.

Modus Operandi

Ponzi scheme is usually promise of exceptionally high returns to investors, often they will get to be paid in installment and first few installments will be paid but investors will not see their principal. Recently, I met someone during a networking event and he shared with me a fix two years campaign promising 15% return each year for 2 years with guarantee principal through insurance. In addition, there is a referral fee of 1-3% if you introduce an investor. In financial terms, this means there is no volatility and higher return than the S&P!

Ponzi schemes are marketed very aggressively and use a network of agents who are offered high commissions. After looking at the video below, you will be surprised of the entire Madoff chronicle and how he cheated the crowd.

The principle of volatility

The guru always says "High Risk High Return", this is linked to the theory of volatility. There are no such thing as "guarantee" high return products and your principal is protected. If an investor is risk adverse and does not want any volatility, it is as good as putting your money below the pillow. This method does not take the eroding effect of inflation into account. Investors requires a higher return value due to the risk premium in order to justify the risk taken. If you wish to be a long term investor, you need to brace yourself for events when your portfolio may drop by more than 30%.

Updates to Ponzi Schemes in Singapore (26th March 2016)

Ponzi companies guarantee the principal and return of 8.5% to 15%. Some companies highlight that the principal will be protected by insurance. The insurance may cover up to say USD 1 m and looking at the above examples, they are above 1m and when the companies fold, who do you get the coverage from? It pays if you are not the last participant and the company has fresh blood. It pays to be financially literate.

Record of My Career Change

14th February 2016

Recently, I signed up with Udemy and subscribed to Prof Chris Haroun's  An Entire MBA in 1 Course. He kept emphasizing that you need to have passion with what you are doing, life is too short to be doing something which you do not enjoy. Personally, I feel that if you are suffering from Sunday evening blues, it is time to call it a day.

Today's Straits Times has a few interesting articles which spurs me to write this blog post.

Anna Vanessa Haotanto was mentioned to have amassed a portfolio of 1.5 million, achieved her financial independence at age 28 through her proficiency in managing assets in equities and properties. Currently, she is focusing her career on entrepreneur path to bring financial literacy to empower people. This is aligned with our vision as well. Peter achieved his financial independence at an age 29 through equities. I have embarked on this journey towards financial freedom. I hope to achieve my goal at an age of 40.

http://www.straitstimes.com/business/companies-markets/it-pays-dividends-and-more-to-know-your-stocks-well

In another article, it is about lawyers who are taking flight mid career and find success in other industries. Despite the fatty pay check, many lawyers change their career path due to long working hours and lack of ownership over their work. There are examples such as Ms Tay who is a lawyer turn entrepreneur who run the now-defunct nightclub Butter Factory, Mr Esmond Yue who used to get $10,000 per month started sushi restaurant Chikuwa Tei on the side for more than 1 1/2 years before running it on a full time basis, Kendra Liew 28 started an organic skincare business after working for more than 2 1/2 years of average 15 hour days, Ms Rebecca Chiu 29 started Soi 55 on sideline while juggling with her former lawyer job.

This is very inspiring. If lawyers who are working long hours can start their business on a sideline, this leaves me with no excuse. If lawyers can leave their high paying jobs for their dream career, this leaves me with no excuse. Recently, my friend who was in his early 40s passed away due to heart attack, leaving behind his family. Last year, my friend who is one year older  than me passed away due to a fatal accident. I feel that life is fragile and our time on this world is limited. If God request me to return to his heavenly kingdom tomorrow and ask me whether I have fully utilised my talent, I may not have the answer. I need to take massive actions, speed to market and execute my plans. I do not want to live life with regrets.

28th February 2016

I just came back from my business trip to Perth to attend the Australian Oil and Gas Convention. How do you know whether the oil and gas industry is adversely affected by the recent drop in oil price? I met two taxi drivers who used to work in the oil and gas industry. They were made redundant during the latest oil turmoil and lack of projects in Australia. One of them has been out of job for more than six months and by driving a taxi helps to pay his bills. It is an enlightening experience for me as I foresee this will happen to Singapore with just a matter of time. I just need to strap tightly and get myself ready.

5th June 2016

Another month passes by and the situation is getting more challenging as we see more subcontractors gone belly up, filing for Chapter 11. I need to take massive actions. Early May, I told myself that I need to seek an alternative path as my original plan may be derailed anytime if they give me the white envelope and escort me out of the building. I started my affiliate marketing business on 1st May 2016. The more I explore, the more I am intrigued by it. I started reading Scott Fox's Click Millionaires, Laptop Millionaire and Millionaire Fastlane. It is possible to create a lifestyle business because of the evolution of Internet. I have a personal good friend who has achieved this. Seeing is believing. This does not change my plan on my investment journey, it will only complement what I want to achieve.

15th April 2017

I was approached by Mr. E to join his company which is into Offshore Renewable Energy Industry. I was told at the start it is going to be a contract role to bid for EPIC work for offshore installation work for Foundations and Cables. I am familiar with offshore cables but not competent with Foundation especially monopiles. 

I have put a stop to affiliate marketing and e-commerce store to fully concentrate on investment. I want to focus on just one and make it a solid income stream before I can do others. There are a lot of possibilities in the realms of investment.

Euphoria and Depression

Shoe Shine Boy

In 1928 in New York City, John D Rockefeller was having his shoes shined. The shoe shine boy does not know who Rockefeller was, he started to give him stock tips. John took his shoe shine boy’s advice but decided that it was time to exit the market. He decided that if a shoe shine boy was giving stock tips then it was time to get out of the market. He did and it was the reason his family was able to survive the Great Depression, and became one of the richest in history.

During euphoria stage, there are many equivalent to the shoe shine boy, he can be the taxi driver or the auntie at the market selling vegetables telling all her friends to buy shares. It is important to improve market sentiments by observing the people around you. When many people are aggressive investing in stocks, it is probably time to get out.

Tulip Mania

In 1636, the tulip bulb became the fourth leading export product of the Netherlands, after gin, herrings and cheese. The price of tulips skyrocketed due to the speculation in tulip futures by people who never saw the bulbs. Through the process, many men made and lost fortunes overnight. Tulip mania reached its peak during the winter of 1636–37, with tulip bulbs changing hands ten times in a day. However, there was no deliveries made to fulfill any of these contracts. In February 1637, tulip bulb contract prices collapsed abruptly and the trade of tulips ground to a halt.

Sir Isaac Newton

One of the most intelligent man - Sir Isaac Newton lost equivalent to today's millions of dollars through the South Sea Company. The company was established in the early 18th Century and was a monopoly on trade in the South Seas in exchange for assuming England’s war debt. Investors loved the idea of this monopoly and the company’s shares rose.

In early 1720, he profited handsomely from his shares and he reinvested all his money on the expectation that the company shares would continue to rise. There was no warning on earth that can save people who are determined to get rich fast.

Newton added, “I can calculate the movement of stars, but not the madness of men.”

Refer to the above chart of the South Sea Company’s stock price, and Newton’s emotional journey from greed to happiness and then more greed and ending in despair.

2015 Shanghai Stock Market Meltdown

The Chinese stock market rallied more than 150% as the Shanghai Composite Index rose from 2,037 at the end of June 2014 to its peak of 5,166 in June 2015. Many naive investors shared the share journey as Sir Isaac were lured into the market near the peak. They suffered large financial losses. The stock market isn’t meant to be a casino. Its primary purpose is to help high-quality businesses to raise capital at a reasonable cost to bring innovative goods and products to the consumers. In efficient stock market, strong businesses and talented entrepreneurs attract capital and thrive. Weak companies which are not able to attract capital will be eliminated.

However, in this bubble and a moment of euphoria, shady firms and dishonest entrepreneurs exploited the market to raise capital. In the recent A-shares bubble, retail investors paid more than 400 times earnings for firms with no actual assets or sales. Perverse entrepreneurs sold a dream to investors and profit from their optimism and trust through offloading their personal shares at all time high prices in exchange for quick profit.

This turns the stock market into a wealth transfer mechanism from the massive poor to the handful rich with no positive benefit to the real economy.

Conclusion

Ken Fisher's book "Market never forgets (but people do)", history is an excellent guide for investor. Remember history and use it to profit and know when the market becomes too depressed, it is the time to become greedy and when the market is in a state of euphoria, it is time to get the money out.

Value Investing is the sure way to Wealth

In this section, we intend to provide a short course to value investment, the first step is to help you understand your present financial situation and your financial goals. We will need you to consider whether you are ready for value investing.

Introduction

They are two friends - Sara and Bo. Sara starts investing at age 25 whereas Bo only start investing at age 35. At the age of 45, Sara will have $251,282 more than Bo. At age of 65, Sara will have $671,824 more than Bo, achieving close to $1.6 m. This story tells us to start investing as early as possible. If you invest at a later age, you still can catch up but will require a larger amount of investment.  This is the beauty of compound interest.

From Investopedia, Compound Interest is interest calculated on the initial investment ("Principal") and also on the accumulated interest of previous periods of investment. Compound interest is "interest on interest", this will grow at a faster rate than simple interest. The rate at which compound interest grows depends on the frequency of compounding, the higher the number of compounding periods, the greater the compound interest. To illustrate how to harness this tool, Sara bought a share A, the share issues a dividend of $1 per share. This $1 ($1/share x 1 share) is re-invested into the share A. Every instances share A issues dividend, Sara will reinvest into the share to grow her holding in the company.

In simplistic terms and ideal world, you just need to buy shares in the right company, be patient and continue to reinvest dividend and money in a systematic approach.

This is the sure way to wealth.

What are shares?

Shares are issued by companies for the purpose of raising capital from investors. When you buy a company’s shares, you own a stake in the company. Shareholders are entitled to be paid a share of declared dividend. There are two classes of shares which are ordinary and preferred shares. Ordinary shareholders have a right to attend and vote at general meetings. A general meeting provides a platform for shareholders to engage the company's board and management to express your views and gather necessary information affecting the company.

There are broadly two classes of shares – ordinary or common shares and preference or preferred shares. In this guide, we use “shares” to refer to ordinary shares.

Ordinary shareholders have a right to attend and vote at general meetings on matters such as a major acquisition/disposal or the appointment of directors. A general meeting provides a forum for you to engage the company’s board/senior management and voice your views on matters affecting the company.

Shares are mostly traded in board lots of 100. If a share is priced at $1, you would pay $100 to invest in one lot of shares (excluding transaction costs).

Understanding the cost of investing in shares 

In Singapore, most of the brokerage firms charged a minimum fees between $18-25, under $50k is approximately 0.28%, between $50-100k is approximately 0.22% and over 100k is 0.18%. For those who intend to trade for quick bucks, there is another hurdle to overcome, you need the stock price to go up enough to cover for the brokerage commission in order to first break even before you can make profit. Therefore, you will be benefiting your broker if you trade very often, making him rich first before you. A highly recommend read is "Where are the customers' yachts?".

Take profit 03032016

Due to recent letter from my big boss to further reduce headcount, I am terrified. I am fully invested and do not have much cash in the bank.

Today, I sold 29,000 of ThaiBev at 0.76, 5000 SingPost 1.53 and 1000 Singtel 3.8. I took back about 33k cash. This should tide me through for a year. Very unfortunate but I need to see my stocks soar and I need to let go some of the shares.

5/2/2017
Till date, thank God I still manage to keep my job and reflecting on my portfolio. Thaibev went up to S$1 before settle back at S$0.8+. 

It was unfortunate to sell ThaiBev.

Lesson learnt, I wish that I never ever need to sell a stock.