Letters of the Week

Gearing promoters the real winners

Your recent article on gearing was a timely article for the issue at hand, but perhaps the most important information to be garnered from this piece lies in the responses of your contributors. Gearing is a seriously misunderstood strategy. Even elementary mathematics (inclusive of costs, fees and taxes) reveals that the probability of success for retail gearing strategies is rather low, and more often than not the increased return potential does not compensate for the additional downside risks.

What investors need to understand is that gearing promoters share a far higher success rate than their investors. If I sound a little critical, consider this: four out of the five of those quoted sang the praises of gearing and margin loans, with but a passing glance at the additional risks. All four represent organisations that profit from the selling of such products. The only one who recommended caution represents a private family office with no vested interest in selling such strategies/products. Coincidence? I think not.

– B Bevan

There are always options

Today’s article on gearing makes no mention of options. Buying options seems to me a very cost-effective way of increasing exposure to the rise and fall of a particular stock without borrowing money from a bank. Is this a subject Eureka could cover with some recommendations on the best options?

– Name and address withheld

Editor’s response: Thanks for writing in. You raise a good point that options are also a way to maximise returns in an equity portfolio. To read more on this topic in Eureka Report have a look at Is a buy-write for you?, Investment Road Test: Citi Turbo Warrants, Westpac self-funding instalments, and Investment Road Test: UBS self-funding instalments.

It's all in the timing

I recently read James Frost’s article What Buffett didn’t say and thought it made some useful points. While I agree that not everything Mr Buffett says should be taken as gospel, I think it’s not a matter of what he doesn't say '” but what laymen don't understand. Every "Buffett watcher" will know that Buffett has been horrible in the sense of timing, or picking bottoms '” be it in stocks, currency or even commodities.

Take, for example, his investment in the Washington Post in the 70s, whereby he estimated the entire company was selling for 1/5th of its true worth. The result? Buffett lost more than 20% of his investment in just the first year alone as a result of enormous selling pressures. So what did Buffett do? He simply bought more! Ignoring "momentum" actually paid off, as a few years later the stock would deliver an annualised 32% return. Lesson: there are always going to be things that are unknowable or unimportant. So long as you have a long enough time horizon, these things are irrelevant.

– P Ravi

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