Ten Commandments for Investors (Part 8)

Commandment 8, the prohibition against stealing, seems obvious. Investors deal with money, and money is the object of most theft. But the investment lessons can go further.

Stealing has been called the most basic human failure. In The Kite Runner, a bestselling novel and movie, Baba, one of the main characters, maintains that there is no more basic transgression in life than stealing. “When you kill a man, you steal a life, when you lie, you steal someone’s right to the truth. Every other sin is a variation of theft,” he says.

While of course we condemn the outright theft of Bernie Madoff’s Ponzi scheme or the lawyer Marc Dreier’s fraudulent promissory notes–frauds that amounted to billions–there are smaller thefts that tempt investors every day. Expanding on Baba’s definition, dealing in inside information is a theft of the market’s integrity; breaking confidentiality is a theft of a person’s right to privacy; and so on. Such an expansive view of theft is illuminating.

There’s another, more controversial view of theft, however, and that’s using borrowing to lever returns out of a portfolio. If a portfolio grows by 8% and you can borrow at 4%, borrowing 50% of the portfolio’s value and putting those borrowings into the same assets could lever the portfolio 1.5 to one, and potentially increases the net return from 8% to 10% after interest. Is this better living through leverage?

There’s no free lunch, though, and that increased return comes at the cost of increased volatility. The returns will swing more wildly, and in a severe downturn a levered portfolio can run short of collateral and be forced to liquidate, leading to a permanent loss of capital.

You can’t borrow your way to performance, and you can’t steal return from the market. It’s a reason why the Eighth Commandment is so instructive.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2017-07-17T12:34:53+00:00 July 3rd, 2012|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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