Comments on: The Problem with Leverage http://www.canadiancapitalist.com/the-problem-with-leverage/ Helping you invest and prosper Fri, 19 Mar 2010 10:24:01 +0000 http://wordpress.org/?v=2.9.2 hourly 1 By: Weekend Reading - July 19, 2009 | Million Dollar Journey http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193796 Weekend Reading - July 19, 2009 | Million Dollar Journey Fri, 19 Jun 2009 10:31:12 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193796 [...] Canadian Capitalist writes about the problem with leverage. [...] [...] Canadian Capitalist writes about the problem with leverage. [...]

]]> By: Winner Announcement- New Giveaway and Weekly Blog Review http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193790 Winner Announcement- New Giveaway and Weekly Blog Review Fri, 19 Jun 2009 08:24:12 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193790 [...] Canadian Capitalist looks at the problems with leverage [...] [...] Canadian Capitalist looks at the problems with leverage [...]

]]> By: Fred (ETF2X.com) http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193521 Fred (ETF2X.com) Mon, 15 Jun 2009 20:35:08 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193521 I have to agree with Cash Canuck. When you are backtesting, and I have done my share of it, it is preferred to use sliding windows. If you want to be extraordinarily thorough, you would run tests starting on January 02 and extending for ten years. Then you would run tests starting on January 03 and extending for ten years. In other words, test for sliding windows of ten year periods. Of course this analysis is based on buying-and-holding which is a strategy that I don't employ. I have to agree with Cash Canuck. When you are backtesting, and I have done my share of it, it is preferred to use sliding windows. If you want to be extraordinarily thorough, you would run tests starting on January 02 and extending for ten years. Then you would run tests starting on January 03 and extending for ten years. In other words, test for sliding windows of ten year periods.

Of course this analysis is based on buying-and-holding which is a strategy that I don’t employ.

]]> By: Canadian Capitalist http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193497 Canadian Capitalist Mon, 15 Jun 2009 17:06:45 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193497 @Mike: In two out of nine 20-year periods, leverage would have resulted in a loss is certainly a surprise for me. It is especially surprising that the 1980-2000 period turned out to be negative. It is true that only the return for the total holding period counts but investors are likely to be very discouraged if their returns were negative over 20 years. It would be interesting to see the results when the post-2000 horrible period for stocks is included in the analysis. @Mike: In two out of nine 20-year periods, leverage would have resulted in a loss is certainly a surprise for me. It is especially surprising that the 1980-2000 period turned out to be negative. It is true that only the return for the total holding period counts but investors are likely to be very discouraged if their returns were negative over 20 years. It would be interesting to see the results when the post-2000 horrible period for stocks is included in the analysis.

]]> By: Four Pillars http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193494 Four Pillars Mon, 15 Jun 2009 16:20:10 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193494 1) I'm not sure why this is a surprise. Leverage magnifies returns and obviously not all 10 year equity returns are positive - especially after paying interest. I would think 20 years at a minimum is the "long run" - 30 years would be better. 2) Saying that using leverage isn't always profitable is like saying that owning stocks isn't always better than bonds. However true that may be - it's the overall return for the duration of the investment that matters - not whether some periods were profitable/unprofitable. 1) I’m not sure why this is a surprise. Leverage magnifies returns and obviously not all 10 year equity returns are positive – especially after paying interest. I would think 20 years at a minimum is the “long run” – 30 years would be better.

2) Saying that using leverage isn’t always profitable is like saying that owning stocks isn’t always better than bonds. However true that may be – it’s the overall return for the duration of the investment that matters – not whether some periods were profitable/unprofitable.

]]> By: Canadian Capitalist http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193493 Canadian Capitalist Mon, 15 Jun 2009 15:53:48 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193493 @Guy Davis: The results are gross before taxes. Tax effects are not taken into consideration. It is true that interest on the investment loan results in a tax deduction and dividends and capital gains are taxes preferentially. However, it is very hard to do an after-tax analysis because tax rates have been all over the map. Tax on only half the capital gains is (if I recall correctly), a post-2000 phenomenon. And I've lost count of the number of times dividend taxes have been tinkered with in just the past few years. In any case, the capital gains taxation is a tax on nominal gains, not real returns. If I make an $100K investment and inflation runs at 2% and I have $120K at the end of 10 years, I haven't made any real gains. But if I sell, I'll be on hook for capital gains tax on $20K of my "profits". What I'm trying to get at is analyzing after-tax returns isn't very simple. @Guy Davis: The results are gross before taxes. Tax effects are not taken into consideration. It is true that interest on the investment loan results in a tax deduction and dividends and capital gains are taxes preferentially. However, it is very hard to do an after-tax analysis because tax rates have been all over the map. Tax on only half the capital gains is (if I recall correctly), a post-2000 phenomenon. And I’ve lost count of the number of times dividend taxes have been tinkered with in just the past few years.

In any case, the capital gains taxation is a tax on nominal gains, not real returns. If I make an $100K investment and inflation runs at 2% and I have $120K at the end of 10 years, I haven’t made any real gains. But if I sell, I’ll be on hook for capital gains tax on $20K of my “profits”. What I’m trying to get at is analyzing after-tax returns isn’t very simple.

]]> By: Guy Davis http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193492 Guy Davis Mon, 15 Jun 2009 15:35:40 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193492 Did you account for taxation? Ignoring the tax deductions from the investment loan and preferentially treated Canadian dividend stocks when comparing to interest-bearing investments would introduce error in your analysis. Did you account for taxation? Ignoring the tax deductions from the investment loan and preferentially treated Canadian dividend stocks when comparing to interest-bearing investments would introduce error in your analysis.

]]> By: m1234 http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193489 m1234 Mon, 15 Jun 2009 15:19:01 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193489 Interesting study, would like to read it....I would also like to see a comparison to see how leveraging in real estate has paid off in the last 100 years....everyone says borrow to buy a house...I would like to know how profitable this really is (taking out the mental benefits of owning a home and sticking to just the numbers)...and how it would compare to leveraging stocks.... Interesting study, would like to read it….I would also like to see a comparison to see how leveraging in real estate has paid off in the last 100 years….everyone says borrow to buy a house…I would like to know how profitable this really is (taking out the mental benefits of owning a home and sticking to just the numbers)…and how it would compare to leveraging stocks….

]]> By: Canadian Capitalist http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193485 Canadian Capitalist Mon, 15 Jun 2009 14:19:01 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193485 Cash Canuck: I'm assuming the entire portfolio is leveraged, perhaps with home equity as collateral. That is why, only the difference between stock returns and T-bill returns matters. I also agree that the data is fairly sparse -- there are only 10 non-overlapping 10-year periods between 1900 to 2000. Still, there are some surprising results here. For instance, in the 20-year period ending in 2000, leverage would have been unprofitable. Phil: My point isn't that leverage never works. In the return sequence above there are periods when leverage would have provided out-sized returns. Perhaps, this is one of those periods. What surprised me is that leverage doesn't always result in a profit, even over periods as long as 20 years. Cash Canuck: I’m assuming the entire portfolio is leveraged, perhaps with home equity as collateral. That is why, only the difference between stock returns and T-bill returns matters. I also agree that the data is fairly sparse — there are only 10 non-overlapping 10-year periods between 1900 to 2000. Still, there are some surprising results here. For instance, in the 20-year period ending in 2000, leverage would have been unprofitable.

Phil: My point isn’t that leverage never works. In the return sequence above there are periods when leverage would have provided out-sized returns. Perhaps, this is one of those periods. What surprised me is that leverage doesn’t always result in a profit, even over periods as long as 20 years.

]]> By: Phil S http://www.canadiancapitalist.com/the-problem-with-leverage/#comment-193484 Phil S Mon, 15 Jun 2009 13:24:55 +0000 http://www.canadiancapitalist.com/?p=2539#comment-193484 Which stocks were used as measurement? For myself, I usually only leverage to buy stocks that can "carry themselves" for leveraging like REITs, Limited Partnerships and the now-near defunct Income Trusts. In those cases, you can find many stocks yielding over 10% these days, so in my case at Prime +1 (3.25%), the pre-tax spread is 6.75%! And you're making that 6.75% spread every month. In my case, I only worried about the credit quality of the stock to pay cash to cover the interest. One of my stocks doubled in price so I sold it off and paid back all of the leverage and now the OTHER stocks I bought with leverage are essentially "free" to me now even though many of those ones are under water. Despite being under water, they're still distributing and that's all I care about - the free cash every month. Which stocks were used as measurement? For myself, I usually only leverage to buy stocks that can “carry themselves” for leveraging like REITs, Limited Partnerships and the now-near defunct Income Trusts. In those cases, you can find many stocks yielding over 10% these days, so in my case at Prime +1 (3.25%), the pre-tax spread is 6.75%! And you’re making that 6.75% spread every month.

In my case, I only worried about the credit quality of the stock to pay cash to cover the interest. One of my stocks doubled in price so I sold it off and paid back all of the leverage and now the OTHER stocks I bought with leverage are essentially “free” to me now even though many of those ones are under water. Despite being under water, they’re still distributing and that’s all I care about – the free cash every month.

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