Ask Colin

I am not sure what to do with trading profits when my portfolio is geared.

The detailed question was:

I am not sure what to do with trading profits when my portfolio is geared. I usually reinvest all of the profits along with my own capital in new positions.  I don't pay off any of the debt. This is fine with a rising market, but if the market turns down, paying interest on borrowed money does not seem appealing.

I think this is an easy one. The logic of using borrowed money (sensibly) is that if you can earn 12%pa on your trading and you can borrow money at 8%pa, it makes some sense to trade the borrowed money. However, if the market falls and you can no longer make in excess of 8%pa on your trades, it makes no sense to borrow the money any longer until the market improves.

To understand this another way, suppose you are a toy retailer. Christmas is your big season. You borrow against your overdraft to acquire the stocks for the season. After Christmas you will hopefully have sold most of the additional seasonal stock and you reduce your overdraft until next Christmas. Every business does this to some extent where the business has seasonal or cyclical peaks and troughs.

What I suggest you might do is to make a quarterly assessment of your return versus the costs of borrowing. If you are not making more than the cost of borrowing, maybe you should cut back the borrowed funds until you can find the conditions favourable to trading with results in excess of the borrowing cost.

You said you were a trader, so I have answered in those terms. The time frame for an investor would be much longer. An investor may more sensibly make annual assessments and look at a three or five year average return. However, the principle still remains true. Investing borrowed funds makes no sense unless you make more than the cost of the credit, and the risk of loss is greater if you do not achieve that objective.

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