4 ms·

I’ve been torn about his comments of not using leverage to buy stocks. Berkshire uses insurance float which has risk. I guess they feel that this risk is small

by kayhi 9y ago

I’ve been torn about his comments of not using leverage to buy stocks. Berkshire uses insurance float which has risk. I guess they feel that this risk is small and supported by the 400 billion reserved to pay out. Is attaining debt at a 4% rate mortgage riskier than utilizing their float?

deleted 9y ago
[deleted]
ThrustVectoring 9y ago
A 30-year amortized non-callable loan is much less risky than insurance float. It's also much less risky than a margin loan (which is at a correspondingly lower interest rate - best margin loan rates for small balances is roughly 2.6% at InteractiveBrokers, last I checked). "Don't use leverage" is good advice for people who do not have the skills and experience to properly manage risk (which is to say, over 90% of the population). The proper answer is something like a long explanation of the Kelly Criterion, risk of ruin, how to evaluate the very fuzzy notion of your own career's job security and social safety net, and a ton of other factors. Circling back to your question about a mortgage, though - just don't become "house poor". You want to have free cash flow above monthly expenses. Outside of that, on a 30-year fixed-rate mortgage basis, feel free to borrow and invest literally every dollar the bank approves you for. Especially if the loan is single-action or your investments get funneled into creditor-protected retirement accounts.
- sedachv 9y ago
  > Especially if the loan is single-action or your investments get funneled into creditor-protected retirement accounts. That is a very interesting strategy. Do you have any recommendations for books or other resources that discuss this?
  - ThrustVectoring 9y ago
    I don't really, it's just a matter of risk avoidance, paying attention to what happened post-2008 housing crisis, and understanding the consequences of strategic default. If you don't pay your mortgage, it's generally either impossible or not worth suing you for the outstanding balance. Usually what happens is the bank spends a few months going through the foreclosure process, trashes your credit score, takes your house, and evicts you. This is bad, but if you owe $400k on a house that's worth $300k, it's less bad than continuing to pay your mortgage and dump an extra $100k down the drain. You save up first + last + security + moving costs for an apartment or renting a house out of the freed up cash flow, deal with the fact that getting credit is going to be difficult for a while, and move on with your life.
    - chrisweekly 9y ago
      This description of (individual / personal) "strategic default" is interesting, maybe because it strikes me as a theoretical approach that is extremely rarely employed in real life. Corporations can and do consider bankruptcy a rational option under various circumstances, but -- maybe for a mix of cultural and legal reasons -- for individuals, there's a stigma, a sense of shame and failure, and it's viewed as a desperate measure of last resort. I know, citation needed...
      - deleted 9y ago
        [deleted]
vajrabum 9y ago
Using the float shares the solvency risk with borrowing, but they aren't paying 4% on the money.
- kayhi 9y ago
  Correct, they are paying essentially 0% interest in exchange for the policy risk. My interest is that the policy risk according to Berkshire actions is less than 4% debt they could likely attain (or better). In other words - they are recommending investors not to use leverage, but in a sense they do use it against policy risk. The trade off between debt and policy risk is interesting as both greatly increase returns by leverage.
kgwgk 9y ago
The risk is not on the debt you take, but on the stocks you buy. If the stock market halves next month (it could happen), will you be ok? Edit: I guess a secondary concern is the risk of interest rates going up, will you be ok if the cost of servicing the debt doubles?
- icelancer 9y ago
  >> Edit: I guess a secondary concern is the risk of interest rates going up, will you be ok if the cost of servicing the debt doubles? Are people seriously considering borrowing against adjustable-rate instruments to buy equities?
Matt_Mickiewicz 9y ago
His historical leverage has been 1.6: http://docs.lhpedersen.com/BuffettsAlpha.pdf http://docs.lhpedersen.com/BuffettsAlpha.pdf

by kayhi 9y ago

deleted 9y ago

[deleted]

ThrustVectoring 9y ago

A 30-year amortized non-callable loan is much less risky than insurance float. It's also much less risky than a margin loan (which is at a correspondingly lower interest rate - best margin loan rates for small balances is roughly 2.6% at InteractiveBrokers, last I checked). "Don't use leverage" is good advice for people who do not have the skills and experience to properly manage risk (which is to say, over 90% of the population). The proper answer is something like a long explanation of the Kelly Criterion, risk of ruin, how to evaluate the very fuzzy notion of your own career's job security and social safety net, and a ton of other factors. Circling back to your question about a mortgage, though - just don't become "house poor". You want to have free cash flow above monthly expenses. Outside of that, on a 30-year fixed-rate mortgage basis, feel free to borrow and invest literally every dollar the bank approves you for. Especially if the loan is single-action or your investments get funneled into creditor-protected retirement accounts.

sedachv 9y ago
> Especially if the loan is single-action or your investments get funneled into creditor-protected retirement accounts. That is a very interesting strategy. Do you have any recommendations for books or other resources that discuss this?
- ThrustVectoring 9y ago
  I don't really, it's just a matter of risk avoidance, paying attention to what happened post-2008 housing crisis, and understanding the consequences of strategic default. If you don't pay your mortgage, it's generally either impossible or not worth suing you for the outstanding balance. Usually what happens is the bank spends a few months going through the foreclosure process, trashes your credit score, takes your house, and evicts you. This is bad, but if you owe $400k on a house that's worth $300k, it's less bad than continuing to pay your mortgage and dump an extra $100k down the drain. You save up first + last + security + moving costs for an apartment or renting a house out of the freed up cash flow, deal with the fact that getting credit is going to be difficult for a while, and move on with your life.
  - chrisweekly 9y ago
    This description of (individual / personal) "strategic default" is interesting, maybe because it strikes me as a theoretical approach that is extremely rarely employed in real life. Corporations can and do consider bankruptcy a rational option under various circumstances, but -- maybe for a mix of cultural and legal reasons -- for individuals, there's a stigma, a sense of shame and failure, and it's viewed as a desperate measure of last resort. I know, citation needed...
    - deleted 9y ago
      [deleted]

vajrabum 9y ago

Using the float shares the solvency risk with borrowing, but they aren't paying 4% on the money.

kayhi 9y ago
Correct, they are paying essentially 0% interest in exchange for the policy risk. My interest is that the policy risk according to Berkshire actions is less than 4% debt they could likely attain (or better). In other words - they are recommending investors not to use leverage, but in a sense they do use it against policy risk. The trade off between debt and policy risk is interesting as both greatly increase returns by leverage.

kgwgk 9y ago

The risk is not on the debt you take, but on the stocks you buy. If the stock market halves next month (it could happen), will you be ok? Edit: I guess a secondary concern is the risk of interest rates going up, will you be ok if the cost of servicing the debt doubles?

icelancer 9y ago
>> Edit: I guess a secondary concern is the risk of interest rates going up, will you be ok if the cost of servicing the debt doubles? Are people seriously considering borrowing against adjustable-rate instruments to buy equities?

Matt_Mickiewicz 9y ago

His historical leverage has been 1.6: http://docs.lhpedersen.com/BuffettsAlpha.pdf http://docs.lhpedersen.com/BuffettsAlpha.pdf