- Money Morning Australia

Three Steps to Wealth: Leverage, Volatility and Risk


Written on 06 September 2011 by Kris Sayce

Three Steps to Wealth: Leverage, Volatility and Risk

In yesterday’s Money Morning we signed off with this thought:

“Think about it this way: the long-term average annual gain for stocks is about 11% per year – give or take a few per cent. But if you play smart, you can make roughly half of that by sticking a wad of your money in cash or a term deposit.

“The trick, of course, is how to make up the extra 5-6% you need to mirror the long-term performance of stocks?

“That’s where you use stock market leverage, volatility and risk to your advantage.”

But before we get stuck into that, a quick note on this year’s Gold Symposium. This is an event our colleague, Australian Wealth Gameplan editor, Dan Denning has spoken at for the past few years. He’s speaking at this year’s event too.

As an added bonus for attendees [wink], your editor is set to chair day two of the Gold Symposium.

Keynote speakers that day include Eric Sprott of Sprott Asset Management, based out of Toronto. And Ben Davies of Hinde Capital, based in London.

If you’d like to check out the programme, click here. And if you’d like to register for the two-day event in Sydney at a cost of just $199, click here.

Oh, by the way, we don’t get a kickback or anything if you register. We just mention it because it’s something we think you may be interested in…

And as you know, gold is one of our must-have components in an investment portfolio. And we don’t just mean the 3-5% rubbish some of the mainstream advisors now recommend. They’ve just jumped on the bandwagon so they can say, “Yeah sure, we recommend gold…”

But even those guys are in the minority. 98% of financial advisors wouldn’t have a clue about gold, let alone recommend it.

Anyway, you know our position on the shiny metal. So we won’t labour the point. There are other things to discuss…

The glum 10-year record of stocks

Back to yesterday’s cliff-hanger: just how do you make up the extra 5-6% you need to match the long-term performance of stocks?

The first answer I can give you is: don’t invest in an index. For the past 10 years, the S&P/ASX 200 has gained a whopping… 26.4%.

That’s an average non-compounded gain of 2.64% per year. That’s terrible.

Of course, if you add dividends, the result is better… From June 2001 to June 2011 you would have doubled your money, assuming you were able to reinvest all dividends.

But here’s the thing. Most of the return has come from income, not capital growth.

That tells you, for growth investors, betting on the index and blue-chip stocks won’t get you anywhere fast.

Most of the return – three-quarters of it – has come from income. But in order to get the income, investors have had to sit through an extraordinary period of gut-wrenching market volatility. To sit back and keep cashing the dividends while stock prices fall takes nerves of steel.

But let’s be honest, most folks don’t have nerves of steel. Most aren’t hardened investors… they’re just people who want to make a decent living.

People who want enough saved for retirement so they don’t have to live off tinned hotdogs, wear op-shop clothes or rely on the crappy public health system.

What we’re getting at is this: why have sleepless nights with all your cash in the stock market if the stocks you’ve invested in are only giving you income rather than capital gains?

Why wouldn’t you relax by having most of your cash tucked away in the bank? (We’re no fan of the banks. That’s why you should hedge your cash position by holding a decent position in gold.)

But, that doesn’t mean you should put all your cash in the bank. Not while there’s the opportunity to use leverage, risk and volatility to your advantage.

The key is not to play along with the crowd. Because the crowd is rigged by vested interests. It’s a game they’re playing, using their rules… and your money!

If you can’t get the same deal, get a better deal

A perfect example is Warren Buffett’s deal to buy part of Bank of America [NYSE: BAC]. When the news was announced, investors loved it. They bought Bank of America shares on the news. The share price rallied 20%… “Well, if Warren’s buying, it must be good.”

But it isn’t. Warren’s getting his own deal. In fact, under the structure, it’s actually bad news for other Bank of America investors because he gets an almost guaranteed 6% dividend yield while ordinary shareholders get an unguaranteed 0.55% yield.

Warren is playing for the other side. He’s not playing on the same team as you. That means you shouldn’t do what he does, you should do the opposite to what he does!

For a start, it means buying gold, holding cash for a 5% or 6% compounded return and then using just 10-20% of your savings on strategic investments.

How so? Let us explain…

We’re not saying shares are a bad investment – that would be strange for a publisher of financial newsletters. But you’ve got to be smart with investing. You’ve got to understand how the market is rigged against you, and what you can do about it.

The best way to handle it is to through Risk, Volatility and Leverage:

  1. Leverage: This is where you try to bet pennies to make pounds. Stick a few small-cap stocks in your portfolio that are leveraged to market events. My old pal, Diggers & Drillers editor, Dr. Alex Cowie has done this with a bunch of gold and silver stocks. Don’t invest your life savings in these stocks. They’re risky. But with gold edging higher, small-cap gold plays should out-gain physical gold at some point. And that makes them worth it. But small-caps aren’t just about growth. If you’re conservative, there are a number of profitable small-cap stocks that offer growth and better-than-the-bank dividends. Again, you can make a small investment in them and get a good yield, plus growth.
  2. Volatility: Trade stocks. It sounds hard, but it doesn’t have to be. You can start off small and these days with the market volatility you can even make good returns trading blue-chip stocks. Just ask our Slipstream Trader, Murray Dawes. This morning he sent out a take-profit alert on two stocks he short-sold last Friday. Of course, be careful. Trading isn’t for everyone. And if you don’t have the time to do your own research, you either need to make time or pay someone to do it for you. You can check out Murray’s latest free video update here
  3. Risk: Buy no more than a handful of reliable blue-chip stocks that pay a regular dividend. These should be “bottom drawer” stocks. That means, stocks you’re prepared to hold on to through thick and thin… simply because you’ve only got a small part of your wealth invested in them. If the blue-chip stocks you’ve picked are really good you should think about taking part in the dividend reinvestment plans so you can compound your returns. But you should only do this if you don’t need the cash income from dividends.

Now. Don’t ask us how much you should invest in each area. That’s up to you. The most important thing is to do what’s comfortable. If you’re not comfortable trading, then don’t do it – it’s not the end of the world if you don’t.

But it may mean increasing your exposure to small-cap stocks, or putting a bit more into stocks that pay a dividend – or any other way of giving your returns a little boost.

But whatever you do just remember that when central bankers, politicians and mainstream advisors tell you something has to be done to save the economy, what they’re really saying is, “This is what needs to be done to save our own necks, and you – the taxpayer – have to pay for it.”

Don’t fall for it.

Cheers.
Kris



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Kris Sayce
Kris is never one to pull punches when discussing market developments and economic events that can affect your wealth. He’ll take anyone to task — banks, governments, big business — if he thinks they’re trying to pull a fast one with your money. Kris is also the investment director for Australian Small-Cap Investigator, Diggers and Drillers and Revolutionary Tech Investor. If you’d like to more about Kris’ financial world view and investing philosophy then join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays. Read more about Publisher and Investment Director Kris Sayce.

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If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au


3 Comments For This Post

  1. susan Says:

    Leverage

  2. SG Says:

    Hong Kong………the most ‘different here’ real estate bubble there every was (this decade)

    So breath in that fresh different air, put a big different smile on your face and some difference in your step………and get out there and feel better about that different you………….(realities sold separately)
    “We would love to spend some money in Hong Kong,” he said. “But I just think the cycle timing is completely wrong right now. My concern is we’re headed towards another 1994.”
    Low interest rates sent Hong Kong office values to record highs in early 1994. Prices of offices in landmark buildings fell as much as 30 percent by February 1995, then Morgan Stanley Asia Managing Director Peter Churchouse estimated. The decline came after Hong Kong followed the U.S. to raise interest rates, suppressing demand for housing and offices, and as China ordered its banks to tighten credit.

    http://www.bloomberg.com/news/2011-09-06/hong-kong-sells-the-tseung-kwan-o-site-for-400-million-missing-estimates.html
    “Property prices will start to decline soon and we are likely to see that in the rest of the year,” said Yu Kam-hung, a Hong Kong-based senior managing director for valuation and advisory services in Greater China at CB Richard Ellis Group Inc. “Prices will trend down by about 10 percent in the next two years and I don’t rule out the chance that they may fall as much as 20 percent in the worst case scenario.”

  3. Chris Chalkley Says:

    Another excellent article! Well done!



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