It's interesting to compare how a Storm client who invested at the market peak in late 2007 would have fared if the market had gone up 15% in 2008, rather than dropping 45%:
Assume: Retiree/investor borrows 50% ($500,000) against mortgage-free home valued at $1,000,000, interest 8% ($40,000 pa interest)
Pays Storm 7% up-front fee on funds invested (ie. leaves $465,000 "capital" to invest after $35,000 in fees up front)
Invests in a stock portfolio using max 70% gearing, interest 10% (capitalised)
Dividend rate 3%
Margin loan amount = $1,085,000 (total invested in market = $1.55m)
If market had gone up 15%, at end of 2008 situation would be:
Debt: $500,000 (home loan) + $1.085m (margin loan) + $108,500 (interest) = $1.6935m
Int paid: $40,000 (home loan int only payments)
Income: $46,500 (dividends)
Cash flow: $6,500 "tax free" income (due to tax deduction for capitalised margin loan interest)
Portfolio value: $1.7825m (15% rise)
Unrealised capital gain: $89,000
I doubt that any of Storm Financial clients would have been complaining in that situation!
In reality, a 45% market plunge occurred, with losses only being realised in late 2008 when portfolios were liquidated to meet margin calls (where clients tapped into their remaining home equity to borrow to meet earlier margin calls - say up to the maximum 80% LVR for owner occupied home loans):
Debt: $800,000 (home loan) + $1.085m (margin loan) +$108,500 (interest) = $1.9935m
Int paid: $52,000 (home loan int only payments, assuming extra $300,000 borrowed during 2008)
Income: $46,500 (dividends)
Cash flow: -$5,500
Portfolio value: $852,500 (45% drop)
Debt remaining after portfolio liquidated: $1.9935m - $0.8525m = $1.141m
Since this is slightly more than the family home is worth, bankruptcy results!
The worst part of the advice provided by Storm (aside from the investment strategy not matching the clients real risk tolerance or level of understanding) appears to have been to continue borrowing against other assets (the family home or other real estate) in order to meet margin calls while the market dropped during 2008. If the investors had simply liquidated their stock portfolio to meet margin calls as they arose, they would have ended up taking a big loss, but not being bankrupted and losing the family home. However, it was all too easy in March 2008 to imagine that the market had bottomed out after a "normal" 20%-30% correction, and try to hang in there, rather than turn paper losses into real ones.
I wonder if there are any Storm clients who started investing in 2003 and liquidated their portfolios in late 2007 when Storm began their IPO process? They're probably sitting on their yachts sipping champagne.
Meanwhile, it will be interesting to see how the court cases against Storm Financial and the banks turn out. (Not to mention ASIC's role in all this)
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