How Much Leveraged Risk is Too Much?

On January 15th, 2015, the Swiss National Bank eliminated it’s cap on the Swiss Franc in regards to the Euro.  What does that mean?  Well, up until that day, the SNB had said that the value of a Franc would be tied to the value of a Euro.  Under that policy, they had maintained the Franc at a value of 1.20 Francs to 1 Euro.

Disclaimer: This post is being sponsored by ETX Capital.  The content is mine, however, and isn’t influenced by their sponsorship.

Artificial Currency Valuation

In other words, they were artificially changing the value of their currency.  And when they stopped artificially changing the value of their currency?  The market corrected, and the Franc rose to a more reasonable exchange rate. At the same time, the Euro dropped.  The big problem with all of that?  There was no warning that it was going to happen.  And as we all know from the housing crash in 2008, when there’s no warning, bad things can happen.  Banks across Europe immediately felt the pressure.  Within a day, it wasn’t just banks.  It reached all the way down to many small investors around the globe.  Most of those investors were FOREX investors. You see, FOREX investors invest in foreign currency with the expectation that the currency will increase in value.  For years, the Franc was artificially stuck in one place.  And then it wasn’t.

Leveraged RiskSNB Change Cost Many FOREX Traders

Many FOREX traders trade on margin, or leveraged investments.  They’re required to keep a certain percentage of their overall investment in a cash account.  Say $200 on a $10,000 investment.  And when that $10,000 investment tanks and is suddenly worth only say, $1000?  It’s not like they just get to walk away from that.  They still owe the $9,000 they lost to the brokerage.  But, just like in the housing crash, where many of the investing houses were over-leveraged on sub-prime mortgages, many of the investors simply didn’t have the cash to make up the difference.  And many of the FOREX brokerages were left holding the bag, which left many of them in the same situation as the banks in the housing crash.  Suddenly without much in the way of liquid funds and headed for bankruptcy.

Much like the housing crash, there were a few brokerages that had been cautious with their leveraging, and actually managed to escape relatively well from the SNB issue.  One such brokerage was ETX Capital in London. Not only did they come through the fray,  but, according to LeapRate, they’re buying up some of the brokerages that didn’t make it through so cleanly.

Limited Leverage and Risk Aversion Saves the Day

So, how did ETX Capital make it through the SNB fiasco?  According to a LeapRate interview with the CEO of ETX, it’s because they’re a more risk-averse brokerage.  In other words, they put additional limits on the leveraged investing of their users.  That risk-averse, limited leveraging, allowed them to take far smaller hits in the markets and recover much more quickly.

What can we learn from ETX?  Some risk might be good for us, but we have to be really careful about how much risk and leverage we have.

Limiting Leveraged Risk is Good for Personal Finance Too

Let me put it this way.  How many of you reading this have less than $1000 in the bank right now, and over $100,000 in mortgage, student loan, and credit card debt?  That’s leveraging.  Your credit score is a numerical indicator of the likely hood that you will repay a debt.  The higher the credit score, the higher the likely hood that you’ll repay the debt.  When you take on a mortgage, or use a credit card, you are leveraging your credit score (and future income) for that “investment” debt.  (*note: Debt is never really an investment.  Don’t treat it as such, please.)

Why do we leverage our credit and income for debt?  Because very few of us will ever have the patience or will power to save up for years so that we can pay for a house with cash.  Most of us can’t make it a year to save up for a good used car.  So, we leverage ourselves out to buy the things we can’t buy with cash.  The more debt we accumulate, the more leverage, and thus risk, we have.

What happened to people who bought houses with those sub-prime mortgages before the crash?  We all know the answer.  We saw it streaming across our televisions and the headlines of our newspapers for over a year.  They were foreclosed on.  The economy dipped so hard that there was serious discussion about it becoming another “Great Depression”.  And those people lost their homes.

What if we were more like ETX Capital and other brokerages and banks that self-limit their leveraged risk?

What’s Your Financial Weakness?

We all have a financial weakness.  That one area where we struggle to do the right thing.  We might even struggle with deciding what the right thing is.  If we remain unaware of our financial weakness, it can wreak havoc throughout our financial life, as my weakness did mine.

However, knowing your financial weakness, your financial Achilles’ Heel, so to speak, can help you become a better manager of your finances.

My Financial Achilles’ Heel

Me?  I like to squirrel things away for the proverbial rainy day, but when the rainy day comes, I don’t like to dip into my stash.

My husband and I have an emergency fund.  True, it’s smaller than we’d like, but we do have one in place.  Considering 28% of Americans don’t have any emergency fund (CNN Money), we’re glad to have our small one.

Financial WeaknessThere are other ways I squirrel away things.  We buy produce in season at lower cost by doing creative things like renting an apple tree.   Then we store it away for the cold winter months.  (It makes me feel a bit like a pioneer.  A pampered pioneer, but a pioneer, nonetheless.)  Right now we have a deep freezer in our basement that is filled with plums, grapes, blueberries, strawberries, and applesauce.  If we didn’t have money for groceries, we have enough fruit to easily last us for two to three months.

Having an emergency fund as well as a stocked pantry doesn’t sound like a problem, right?

Right.  I’m being financially responsible and preparing for a time when money will be tight.

Here’s the problem.

I don’t like to dig into my stash.

If I have a financially lean month and I’m faced with a large expense like a car repair, I don’t do what would be logical–dip into my emergency fund.  Instead, my first inclination is to put the repair on my credit card and leave the emergency fund intact.

If I have a month where I don’t have as much grocery money, I’m more likely to put groceries on my credit card than make a significant dent in our food stash.

My behavior makes.no.sense.  No sense.

And yet it took me years to figure out that I do this and to realize that I have to fight the natural inclination to go in debt rather than dip into my reserves.  Part of why my family struggled with credit card debt is because of this irrational behavior.  Now the credit card debt is paid off, and I have a chance to start anew, well aware of my weakness.

What’s Your Financial Weakness

So, what’s your financial weakness?  What completely irrational behavior do you exhibit?  Are you even aware of what it may be?

Honestly, finding the chink in your armor, so to speak, may take years.  I think it took me nearly 15 years to figure out mine, and I made a lot of financial mistakes during that time.  I’m not sure why I exhibit this behavior except that perhaps growing up, I always saw my parents struggle with money.  They never had money to create an emergency fund.  Credit cards were their emergency fund, and they had to use them frequently.

I’m guessing for most of us, the experience is the same.  Financial behaviors we saw in childhood and learned as normal become the basis for some of our adult decision making.

What is your financial Achilles’ Heel?

3 Key Factors That Affect Your Home Loan Eligibility

A home loan can put a prospective homebuyer on the fast track to owning their own home by giving them the resources they need to move into a new home, and lenders will commonly offer up to $500,00 in financing to qualified applicants.

However, not everyone is eligible to receive the same amount of funding from lenders based on their individual circumstances. There are a range of considerations that go into the borrowing power of a given applicant when seeking out a home loan such as amount desired and credit score, but there are a few less obvious factors that can make or break a person’s ability to secure funding for the home of their dreams.

Income and Resources

The income and resources of an applicant are perhaps the most important aspect of their eligibility for financing, as they give a good indication of a person’s ability to repay the loan when it comes due. Direct salary as well as investments, inheritances and other income types are all commonly considered, and good ratings in this area can often offset lackluster evaluations in other facets.

Banking History

An established history with a lender can give a prospective home buyer a fighting chance of securing the necessary funding. Banking institutions see each borrower as a risk of lost investment to a certain degree, but an existing banking relationship gives a lender familiarity with an individual and their financial habits, and so it can be a good idea to seek out a home loan at an institution at which there is an active bank account in good standing already in place.

Down Payment

The amount of an applicant’s down payment can give them tremendous flexibility where securing a home loan from a bank is concerned. Lenders will commonly finance up to 95 percent of a home transaction, and so virtually any applicant should have at least 5 percent of the desired loan amount available at the time of application.

Of course, any amount significantly above this figure bolsters the borrower’s leverage, and a larger down payment now can mean smaller monthly payments and a lower interest rate later. The house and land packages in Perth in particular, can be far more manageable, it’s worth doing some research to find the best deal.

While it is possible for prospective homebuyers to obtain a home loan even if these critical factors are not necessarily in their favor, the available options for these individuals are often unattractive, as they can include high interest rates, uncommonly extensive repayment periods, exorbitant penalties and other undesirable terms. The amount a person can borrow from a lender is effectively unlimited in theory, but in practice, the borrower can only receive what the bank is comfortable lending.