PSSST. Want to earn big money fast?

Try leverage. Put down $100 to own $1,000 worth of shares.

If prices rise 10 per cent, you make 0.10 x $1,000 = $100. The best part is your $100 investment makes $100/$100 = 100 per cent. Leverage boosted your return from 10 to 100 per cent.

Of course, it can go the other way too and you would lose 100 per cent.

Here are the three most popular leveraged investments. The first two have problems. The third works well.

The worst

Structured warrants and options. You pay only a little for the right to buy shares at a certain price by a certain date. The advantage is, you won't lose more than the price of the warrant.

The drawback is, the chances of losing it are high. First, the warrant's value deteriorates as it nears the expiration date in six to nine months.

Second, in order to win, you must accurately forecast short-run stock price movements. Studies show even the experts cannot do it.

Third, it is a negative-sum game. Like gambling, money continuously bet will eventually be lost unless you have special or insider information.

Fourth, costs are unknown but probably high. Six foreign banks issue 90 per cent of the 430 structured warrants traded here.

Their fees are so well-hidden that most investors don't know they are paying them.

Exchange-traded options are a cheaper alternative and offer nearly the same thing without the charges by issuing banks.

These options are traded on US and European exchanges. Singaporeans can trade them.

The not-so-bad

Contracts for Difference (CFD) and broker loans. Unlike warrants and options, these require borrowing to get leverage.

Say you put down $100 to buy $1,000 of shares. Then you must borrow the other $900 at around 6 per cent interest.

If the market moves against you, you will have to put up more money or be sold out. The only way to avoid it is to accurately predict short-term stock prices. As mentioned earlier, this is difficult if not impossible.

On the plus side, the charges are transparent and rather low. Best of all, you can often carry your position into the long-run, paying only interest costs.

The best

Can you guess what this investment is: You put down only 10 per cent of the cost and borrow the other 90 per cent at low annual interest rates of 2 to 4 per cent. There are no hidden costs.

If the investment declines in value, your 10 per cent downpayment may be wiped out, but it's not a problem. You can simply hold until the market recovers. You won't be required to put up more cash or be sold out.

You can hold for the long-run and earn returns on invested capital of about 9 per cent per year. You can even live in the investment, which raises your returns much higher.

On top of that, it is the only leveraged investment you can purchase with your CPF money.

Have you guessed? It is a home. It is the best leveraged investment on the planet. Go for it.

COMPARISON OF LEVERAGED INVESTMENTS

RANK (Worst to best) : (Investment, Long-run returns, Typical holding period)

5: (Structured warrant, Negative, Under 6 months)

4: (Option, Negative, Under 6 months)

3: (Contract for difference, Uncertain, Under 1 year)

2: (Broker loan, Uncertain, Under 1 year)

1: (Your home, Positive, Over 10 years)  Back to Columnists