Saturday, August 11, 2018

My next talk #2 - REITs, Leverage and Financial Independence



First of all, I better apologise in advance for my next talk because of our standard practice of allocating seats in free events. We released 260 free tickets for a venue that has only 160 seats because of the habit of folks applying for seats and then not actually showing up for the talk. While we expect less than 160 attendees to show up based on our experience with free ticket events (Attendance is approximately half of tickets given out), there is always a small risk that more than 160 attendees appearing because of high demand for an event.

In such a case, I can only advise readers of this blog to show up early to ensure that they can get a seat.

Today I will explain the margin ratio which another one of those concepts which I'm not too confident about explaining well for the talk.

Margin ratio = ( Values of shares bought ) / ( Amount of financing )

Suppose you choose to have an equity multiplier of 2. You bought $200,000 of REITs using $100,000 of your own money. The value of shares bought is $200,000. The amount of financing you took from the broker is $100,000.

Your margin ratio is $200,000 / $100,000 is therefore 200%.

Suppose you choose to have an equity multiplier of 1.5 instead. You bought $150,000 of REITS using $100,000 of your money. The value of shares bought is $150,000. The amount of financing taken is $50,000.

Your margin ratio is $150,000 / $50,000 is 300%.

Imagine your margin ratio as hit points that you manage on your margin account. At least for Kim Eng margin account holders, you will not be asked to "heal" your margin account until it dips below 140%.

So let's imagine that your portfolio of REITs loses 30% of it's value.

If you previously employed an equity multiplier of 2. The $200,000 of REITs is now worth only $140,000.

Your margin ratio is $140,000 / $100,000 is 140%. This means that the broker will be calling you with bad news very soon, you have to top up your account or your positions will be liquidated.

However, if you previously employed an equity multiplier of 1.5, the $150,000 of REITs is now worth only $105,000.

Your margin ratio is $105,000 / $50,000 is 210%. You will not suffer a margin call in such a case.

There is some wisdom in adding cash or leaving dividends in your margin account to keep margin accounts above a safe level like 200% or even 300% if you are experimenting with leverage the first time.





2 comments:

Chun Siang (Jacky) said...

Hi Chris,

Attended your recent free talk. May i ask..

The dividends from your REITs holdings, if left in the margin account without using to buy more, that will contribute towards paying off the margin thus increasing the margin ratio?

And how is the financing cost charged? deducted from cash balance mthly or any other ways?

Christopher Ng Wai Chung said...

The dividends will be used to reduce your borrowings, so your margin ratio goes up every time you receive a dividend.

Financing costs is deducted on a daily basis.