In singapore, it is widely accepted that to leverage to buy property is a good move as it is an asset. However when i introduce this concept to buy stocks it is usually being label as dangerous or risky.
Well, personally i think there is no right or wrong answer to the question. one must know which phase in life one is in. One must also consider the phases of the credit cycle at the point of leverage.
Usually in a rising interest rate environment - it is good to deleverage. During easing time it is logical to leverage within your own limit.
Things to consider during leveraging in any assets classes.
1) Cost of funds or interest expense
2) where are we in a credit cycle. (starring of easing or starting of tightening)
3) Forecasted ROI of the assets that will be vested.
1) the appreciation of assets would come in 2 forms Capital appreciation and cash flow return.
The 2 components would form a total return in a given time frame. Below an example of one of my past allocation on the stocks listed in UK, and ADR in US to calculate total return.
For non financial assets - eg properties.
Gross yield is top line, net yield is bottom line.
Example to purchase a 1 million condo inclusive of stamp duty and legal expenses
cash flow out (-1m)
Rental income +3k per month.
gross yields is 36k/1m or 3.6 percent per month. (gross yield)
Net yield is to minus the maintenance fee, depreciation if the property is not freehold or 999, agent fee, property tax, income tax on rental income and transition period to find new tenants and replacement of furniture etc...
So the net yield would be lower than the gross yield... usually 1-1.5% (Use higher figure if you are kiasee type like me. If the deal is no good just walk away.....)
Wait, we can leverage assuming with the new ruling - you only need to put a down payment of 25%
Finance 75% .. (ideally the logic make sense, however, the hurdle rate is around 2+% currently so if you manages to get a net rental yield of say 3.5% and your COF is 2.5% multiply that by 3 you will get a total yield of 3% higher.
when we used leverage to finance our stocks or housing or cars etc.... it would be good to calculate the interest servicing ratio or interest coverage ratio.
If one were to borrow money to speed up the process of acquiring something. Always remember there will always be a cost to it. It is hard to justify right or wrong or which formula is best for you. But throughout my life, my debt to equity level has never been more than 100%. ideally one should be working towards the 30% debt to equity ratio.
Debt to equity of 100% means that - for every 1 dollar you have in capital you should only borrow max 1 dollar. The borrowing includes your car loan housing loan and any loan outstanding. you can borrow more if the interest expenses are cheap. During the QE period, interest rates are very low when your hurdle rates are low, everyone seems to be very smart. you just need to make 2% annual return on a 1% interest expenses to be above water.
I think we are entering a period of interest rate normalization period it is harder to invest as the COF is higher.
Warren Buffett mention before "Interest rates are to asset prices what gravity is to the apple. When there are low-interest rates, there is a very low gravitational pull on asset prices."
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