Monday, August 27, 2012

How to Beat the Bankers at Their Own Game

What I’m about to propose may not be for everyone as it does involve a slightly higher level of risk than many of you may be comfortable with. However, if, like me, you’re solvent, creditworthy and prepared to take one step up the risk/reward ladder in order to spice up your investment returns, then you may find what follows of interest.

The urge to get a little bit frisky with my investment approach first surfaced in the summer when I picked up a bit of light holiday reading at St Pancras station for a Eurostar trip. Of course, being slightly obsessed with the world of investment, I can never really take a break from it, so my relaxing holiday read turned out to be the new book by Duncan Bannatyne of Dragon’s Den fame called “How to be smart with your money” (for non-UK readers, Duncan Bannatyne is a self-made multi-millionaire who appears on a popular BBC TV programme called the Dragon’s Den). I was drawn to his book because I’m a great believer in trying to copy the strategies of those who’ve already “made it” in the world. After all, if you want to be successful in a particular walk of life, who better to learn from than from those who’ve already achieved success?

The book is full of inspirational tips on how to become a successful entrepreneur, laced with many of the author’s personal stories on how he overcame adversity to achieve his incredible wealth, which some estimate to be as high as 320 million pounds. A persistent theme of the book, however, and one which I think has particular relevance for us as hands-on investors, was the emphasis that Mr. Bannatyne placed on the imperative of investing your cash in hard assets if you want to really build your wealth. He then takes this idea one stage further by suggesting that, if you want to accelerate this wealth-building process, you should be prepared to borrow to buy those assets.

Now, of course, he did make a few caveats here. First, you must be able to service the loan – so don’t remortgage the house if your job prospects are looking dicey. Second, he made the very sensible distinction between good borrowing and bad borrowing. So just to drill that point home in a way that most people can relate to – borrowing to buy an asset that’s reasonably priced and likely to grow in value – very good. However, borrowing to buy your partner a new Wii fit and your bit on the side a brand new sports car – very bad!

So it was all good advice, but I did part company with Mr. Bannatyne on one particular point; the asset that he proposed investing in was UK property. Regular readers will know that I don’t think that investing in property is a particularly good idea at the moment – certainly not in the UK anyway. It’s still way overpriced on a historical basis and the current mortgage famine is only going to exacerbate the second leg of the property downturn which, in my opinion, has just got underway.

Nevertheless, this wise old dragon got me thinking because the principle of borrowing to invest in solid, sensibly-priced assets is sound enough. In fact, he got me thinking just enough to push me into experimenting with a little bit of leverage on my own account. It just so happened that I still had a dormant offset mortgage facility with my bank. I’d actually paid off the loan quite a few years ago, but had never actually bothered to close the mortgage account, so when I phoned up the bank to make enquiries, it turned out that this mortgage facility was still available to me. What’s more, it was a tracker deal with an interest rate of a paltry 1% above the Bank of England base rate which is currently at 0.5%.

So let’s take a step back here and evaluate this for a minute: The RPI rate of inflation is currently hovering around 5% and my bank is charging me interest of 1.5% for a loan, which means that, in real inflation-adjusted terms, the bank is paying me 3.5% to borrow money. Alternatively, on the savings front, if I keep my savings in a bank or building society, even if it’s in a cash-free fixed-rate ISA with no lock-in or strings attached, the best deal I can hope for is about 2.25%, thus giving me an instant real-terms, inflation-adjusted loss of about 2.75% per year. Yes, that’s the kind of insane topsy-turvy world we’re living in at the moment – borrowers richly rewarded, savers serially shafted. So if you can’t beat ‘em, you gotta join ‘em. Why not consider a re-mortgage to raise some extra investment funds then?

After all, it’s clear that if we want to protect ourselves against this theft of our wealth, we’re going to have to get a bit creative and, yes, take a little more risk in the process. So what are the potential pitfalls of re-mortgaging to invest? Well, for starters, interest rates could suddenly rocket. Somehow I doubt it because the Bank of England seems determined to bail out the gambl…I mean bankers… with low interest rates no matter what the cost to taxpayers, savers and the wider economy. Nevertheless, if I was going to take advantage of my 1.5% tracker deal and not go for a fixed rate, I decided it would be wise to factor in a potential 3 – 4% rise in interest rates, just in case.

The second risk with this sort of ‘leverage’ is that the asset you decide to invest in could plummet in price, thus amplifying your losses – but that’s where a bit of due diligence, research and risk control come into play, more of which later.

Thirdly, as I said before, there is a mortgage famine out there at the moment, so you’re going to need a fair bit of equity in your property to get access to the best deals.

Now I know that the sort of ‘legacy’ mortgage deal I have access to is virtually impossible to find these days, but if you’re able to put down that chunky deposit (at least 30%) and are very confident in your ability to service the loan or have other resources to fall back on in an emergency, then borrowing at current rates to invest in sensibly-priced, tangible assets makes sense. Just to illustrate the point, I did a bit of random research on a popular high street bank’s website to explore their re-mortgage options. At the time of writing, based on a repayment re-mortgage of �50 000 on a house worth �180 000, First Direct are offering a 5 year fixed-rate deal of 3.9% APR with a 65% loan to value. There’s also a modest �99 arrangement fee.

If you can fix at such a low rate for 5 years, and you’ve done the necessary due diligence on the asset you want to invest in, then it’s very unlikely that you won’t do very nicely over the 5 year period. The real beauty of a deal like this, though, is that

You’ll have made this healthy return using the bank’s money, not your own.
You’ll have protected yourself from the ravages of inflation that the Bank of England has just unleashed on us all – and probably have ended up well ahead of the game to boot.

So in the end, what did I decide to do? Well, I took out a very modest offset re-mortgage on my property at the 1.5% tracker rate, I’m confident that I’ll be able to service the loan (I’m actually overpaying to get the balance down quicker), and I have other resources to fall back on in the unlikely event that I come unstuck for whatever unforeseen reason.

So the next question I’m sure you all want to ask is, what sensibly-priced assets did I invest in and how am I doing so far? Well, one thing I didn’t invest in was buy-to-let, that’s for sure. I know some buy-to-letters would question my judgment here. After all, rents are going up, they would say. However, if, like me, you see steadily increasing unemployment just around the corner, my question to the buy-to-letters would be, how are you going to get your return when your tenants lose their jobs?

In the end, I decided to split my investment 3 ways and bought equal amounts of gold, silver and platinum. I didn’t buy through ETFs, I bought the real physical metals through reasonably-priced precious metals vaulting services – a quick Google search should throw up a few reliable names. These are real, tangible assets which have stood the test of time and will always be in demand to some degree. Even if they do fall in the short-term, I feel it’s very unlikely they’ll be down for long – and unlike houses, they can’t go to zero. Just look at what the ravages of unemployment and industrial decline are doing to house prices in growing swathes of British suburbia these days.

As for performance, well, I made these investments back in August and the results to date (priced in pounds sterling and having deducted all costs) are as follows:

Gold – up 7.55%

Silver – up 62.7%

Platinum – up 6.2%

Now I know pride comes before a fall and the markets have this nasty habit of wiping the smile off your face just when you start to get a bit smug, but there is a certain satisfaction in getting that sort of return in 3 or 4 months and knowing that I did it with the bankers’ money, not my own.

The still more delicious irony is that I know how much the bankers hate precious metals and how much they’ve been trying to discredit them in the eyes of the public as alternatives to their own paper money and credit over the last 40 years or so. So it was ever so nice of them to provide me with the means to hoist them on their own petard, as it were.

Now, having had such a great return over the last few months, I’m not necessarily urging you all to go out this minute and take the sort of risk that I’ve just taken. The market may be due for a temporary reversal any day now and only you know how much risk you feel comfortable with. Of course, advice on timing the market is where the free Hands-on portfolio service comes in!

The main point I’m trying to make here is that if you are in a similar position to me, borrowing very modestly to give a small boost to returns on your wisely chosen investments can make sense in the current low interest rate environment – all the more so if you borrow to buy precious metals and thus contribute to handing the bankers their heads on a plate. In this festive season, there’s nothing like contributing to a good cause, is there? Merry Christmas everybody! Now where did I put that stuffing…?

My website at http://handsoninvestor.co.uk/ is designed to help complete newcomers to the world of investing gain the confidence they need to abandon their commission-hungry financial advisors and take charge of their own financial futures. By following the guidelines provided on my site and by copying my own portfolio suggestions, my readers will, in time, gain the expertise required to become successful investors in their own right.

I provide my readers with a clear, easily executable investment strategy and what’s more, I walk the walk by publishing a regularly updated portfolio of stock picks based on this strategy (at the time of writing all ten investment picks are in profit). At some point I’ll be charging for this service, but for now it’s all absolutely free, so why not pop by while you still can and see what you’ve been missing?

Thanks for reading my articles and I hope you’ll become a regular visitor to my site.

Yours, John Mac, The Hands-On Investor

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