Wednesday, 9 September 2020

Why Borrowing at Current Low Interest Rate Works (just be Smart)

 Recently, Singapore's favorite oppa, Jamus Lim, has been receiving flaks for his suggestion of the government employing leverage during this recession time. While it may be true, it is not ideal for government; for us ordinary people, in the realm of personal finance it makes sense.

Its just that we have to be wise about it.

Low Interest Rates and Strong Dividends 

Many Singaporeans have been using the low interest rate environment to make their bucket of gold in Singapore's property market. Borrowing at 2.0% interest and below, they have purchased apartments and rented them out to foreigners, expats and even to our own countryman at rental yields of 2-3% on the condo price.

They have earned the differential between rental yields and interest yields as well as having earned their pot of gold from the appreciation of Singapore property prices through the decade.

In my view, it is definitely wise and even prudent to borrow at low interest rates works.... BUT only borrow a small amount. This is because of the loan-to-value ratio.

Leveraging on Stocks (aka Borrowing)

Right now, in the stock market, margin rates are going at low interest rate of 3-4%. On the contrary, many stocks are providing 3-5% dividends yields despite having reducing their dividends. So perhaps when the good times returns, they can be 6-8% dividend yielders. Borrowing at 3% interest helps a lot. 

The reduced dividends now will cover partially some, if not all your interest expense for leveraging; and when the good times return, you will earn from the differential of increased dividends or be able to keep up with the increase in margin rates. 

The best part is that during such a good economic period, stock prices tend to rise because it is not dependent on factors such as having more foreigners to maintain the property demand.

Do it Safely

But we need to focus on the margin (leverage) level you take. In my opinion, leveraging on blue chips at a 10% leverage ratio (10% debt, 90% cash) works. This is because you will only get margin called if your stock portfolio falls by 85% (in today's context, this means DBS stock has to fall to below $4).

Secondly, do note, I mentioned the words "leveraging on blue chips". These are stocks who have been stood the test of many crisis or are the "Temasek stalwarts" that Temasek owns substantially (heck even Temasek is leveraged at about 20% ratio based on its financial filings).

So yes, I do feel borrowing on our low interest rate environment now is good- but do it in small amounts (10% borrowing, 90% cash), invest in blue chips and diversify across them. It might be wise to employ a little leverage now during this Covid times.


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