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What is everyones' attitude on Margin?
Old 02-08-2011, 11:10 PM   #1
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What is everyones' attitude on Margin?

I searched through the archives and was surprised to find that the topic of Margin is rarely discussed.

How does everyone on this board feel about it? Investrade and Interactive Brokers are two discount brokers that are lending as low as 1.0%. Not much of a hurdle, but good argument to be made for the extra risk. Don't know if rates have ever been this low, but doesn't seem popular around here and I thought I'd ask why.
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Old 02-08-2011, 11:18 PM   #2
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I feel the same way about spending. If I can't pay cash I don't need it.
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Old 02-08-2011, 11:28 PM   #3
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Doesn't fit my approach to long term, buy & hold investing.
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Old 02-08-2011, 11:30 PM   #4
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I do not trade stocks on margin - sooner or later the volatility would result in a margin call, possibly at a time when it is inconvenient for me to make the payment.

However, if it's 1% pa, I might be tempted to take on a small amount of debt against a portfolio of very good quality stocks paying reasonable dividends. "Small" being small enough to avoid a margin call if the market drops 50% and to repay it from other investments should the broker withdraw the facility.

You may also want to check out if there is a recharging risk in the US - in some markets, brokers who provide margin finance to their clients do so by recharging all the securities of all their clients to third party lenders. If the broker defaults, the third party lender can and will enforce against any or all of the the recharged securities. The result is that a failure by the broker can result in investors losing their securities even if the investors are not themselves in default.
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Old 02-08-2011, 11:51 PM   #5
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A guess a more specific question is this:

Margin call being the primary risk, can that be mitigated appropriately? Borrowing $1 for every $1 in cash principal is bad (I think we all agree). What about the diminished risk of borrowing $1 for every $10? The effectiveness disappears, but early in someones investing career, those potential gains could compound well in time.

From what I understand, there are some additional complications with a margin and short account. The account could be subject to normal dividend treatment instead of qualified if the securities are lent out of the account. I do not think the deep discount brokers pay the difference, but I am aware the bigger houses DO pay the (tax) difference.
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Old 02-09-2011, 12:44 AM   #6
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A guess a more specific question is this:

Margin call being the primary risk, can that be mitigated appropriately? Borrowing $1 for every $1 in cash principal is bad (I think we all agree). What about the diminished risk of borrowing $1 for every $10? The effectiveness disappears, but early in someones investing career, those potential gains could compound well in time.

From what I understand, there are some additional complications with a margin and short account. The account could be subject to normal dividend treatment instead of qualified if the securities are lent out of the account. I do not think the deep discount brokers pay the difference, but I am aware the bigger houses DO pay the (tax) difference.
I am too risk averse and too close to retirement even to consider investing on margin. You might be interested in reading Lifecycle Investing. Written by two economics professors from Yale, the book advocates leverage for young investors, and at 29 you fit that description. OTOH since you have already have a large portfolio, you have no need to take more than minimal risk. Why would you want to use margin when you don't need to? Or are you just curious?
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Old 02-09-2011, 01:04 AM   #7
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Yes - I am just curious.

Thank you very much for the book recommendation, I've ordered it.

The reason I brought the topic up here was that it doesn't get much attention in the books I've read. In the few books that do address it, they usually refer to the substantial interest charged as a key factor for not recommending its use. I agree, for those looking at paying upwards of 3 or 4 percent.

There have been other books that recommend leveraged index funds. One that comes to mind is the Neatest Little Guide to Stock Market Investing 2010 ed. There is an entire chapter dedicated to praising double leveraged DOW funds, especially for young people. I don't follow the logic though. The author says it is "less risky" than margin because you can only lose what you have invested, and no more. I understand that concept somewhat, but I think its a dumb way of looking at it. The only thing I would say about the leveraged ETFs is that for someone heart set on leveraged trading (margin vs a levered fund), go with the fund if you have to borrow margin upwards of 3%. The fund has expense of around 1.5 or 2.0%, so they are borrowing more effectively. Anyway, thats all just a tangent, I have no interest at all in using a 2X levered index fund.

I'm very curious to see what the book you recommended has to say.

As for my long term picture, being only in my late 20s, I just want to make the best investment decisions that I can to manage risk appropriately. I am obviously risk averse, but I do have my human capital (earning power) to fall back on if necessary. I don't want to rule out the value of having growing assets. There could be a time in the future where that money could go towards something and really make a difference in the world.
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Old 02-09-2011, 03:02 AM   #8
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Yes - I am just curious.


As for my long term picture, being only in my late 20s, I just want to make the best investment decisions that I can to manage risk appropriately. I am obviously risk averse, but I do have my human capital (earning power) to fall back on if necessary. I don't want to rule out the value of having growing assets. There could be a time in the future where that money could go towards something and really make a difference in the world.

I have use margin on occasion when I was in the accumulation phase in my late 20s. I used it briefly as bridge loan when buying a house. I can't imagine a use for it as a retiree except under extraordinary situations.

It seems to me that inquiries about the use of margin and statements about being risk averse are pretty much a non sequitur. As Buffett has said leverage is the only way a rich man can become poor. Or Nord has said, you already won the game why are you trying to run up the score?
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Old 02-09-2011, 06:22 AM   #9
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I've had margin account for about 16 years. It's no big deal. I think I've paid about $12.51 in that time of margin interest. A margin account was needed to conduct certain options trades.

I've also use it to buy EEM on margin in the morning and sell it in the afternoon.

It is also useful for some tax-loss harvesting moves. Suppose I want to sell VWO at a loss and replace it with EEM. In some cases, I prefer to double-up on emerging markets for a few hours (even if I have no cash) by buying my EEM replacement shares before I sell my VWO shares at a loss.

So a margin account is just another useful tool.
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Old 02-09-2011, 06:28 AM   #10
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I think margin is great - it makes a nice border around written documents. Otherwise I have no use for it.
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Old 02-09-2011, 07:18 AM   #11
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I am obviously risk averse . . . I'm considering using margin
The first word that comes to mind when I read this is "non sequitur", as in "does not logically follow."

Margin always increases risk. There is no way to mitigate that. It's really only a question of how much incremental risk we're taking; a little, or a lot.

Certainly margin can be used successfully to boost returns, but it is an aggressive investing strategy. And aggressive investing strategies are not appropriate for people who consider themselves "obviously risk averse", IMHO.
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Old 02-09-2011, 07:26 AM   #12
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I use margin now and then, mostly to buy round lots but can see how it could burn people.
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Old 02-09-2011, 07:47 AM   #13
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One more thought. The risk of a margin call isn't the only risk. Leverage magnifies returns, both positive and negative. And stocks don't always go up. Some stocks go down and stay down, forever. Even indexes go down and stay down for a long time (see Nasdaq, or SPX 1968, or 2000). 50% margin amplifies a 20% decline to 40%. A bad stock or index pick could mean magnified losses even if you never have to worry about getting forced out of positions because of margin calls.

Not something for the risk averse.
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Old 02-09-2011, 07:54 AM   #14
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I put use of margin (for me it was with trading currency futures) in the "been there done that, delayed FI" category. That said I know a number of folks from my investing group which use it successfully..... apparently.

good luck!
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Old 02-09-2011, 09:19 AM   #15
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I try to spend as little of my hard earned retirement time worrying about my investments. At this stage, the primary goal is to have them last my lifetime while supporting my current lifestyle. Maximizing return is not the primary objective. I believe that my current asset allocation & periodic re-balancing & budget tweaking will be enough.

Using a margin account will just add more complexity.

You may find better responses in an investing forum - perhaps even bogleheads.org.
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Old 02-09-2011, 10:27 AM   #16
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So a margin account is just another useful tool.
+1. Like any tool, it can be used for good or bad.

I've used it occasionally. Maybe you are fully invested, see a buying opportunity, but you don't want to liquidate another position (maybe you want to hold for another month to capture LT gains, for example). Or maybe you just want to try a short term 'testosterone' trade (fully realizing you may win/lose that amount) w/o liquidating anything else, regardless the reason.

And while it is fair to say it "increases risk", that has to be put in perspective. Does someone with a 50-50 account who decides to put an additional 5% into a stock really taking more "risk" than someone who is 75-25 with no margin?

Many people see the word "margin" or "options" and blindly say "risky!". My advice though, is always think about what it means to your portfolio if your margin trade went to zero - could you handle that?

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Old 02-09-2011, 10:36 AM   #17
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If used prudently, margin can be a tax-efficient way to access a portion of the capital gains in one's account. One avoids the taxes associated with selling the securities and is able to deduct the interest on the loan against other taxable investment income.
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Old 02-09-2011, 10:54 AM   #18
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How does everyone on this board feel about it? Investrade and Interactive Brokers are two discount brokers that are lending as low as 1.0%. Not much of a hurdle, but good argument to be made for the extra risk. Don't know if rates have ever been this low, but doesn't seem popular around here and I thought I'd ask why.
I think I'd assess the issue by first asking why the brokerages are so eager to lend us little retail investors such cheap money.

Margin, options, and shorting can all provide market liquidity, which is a good thing, but I've always struggled with their undesirable constraints on market timing. It's a lot easier to be early with one's prescient omniscient predictions, and in the meantime it's way too easy to go broke waiting for the market to be rational.

Another problem with margin is the brokerage changing the rules. There's nothing worse than seeing your favorite undiscovered stock (purchased on margin) pop up on the wrong side of the breaking news, followed by the brokerage deciding that they need to tighten up the margin requirements on what's just become a highly-speculative & volatile security, followed shortly afterward by a margin call. You end up spending way more time drumming up extra cash for the call managing limited margin resources than you do on analyzing stocks.

I don't recall reading any analysis of margin vs options, but I'd suspect that it's cheaper to buy call options than to buy the stock on margin and pay the interest. The penalty for being wrong is a lot less painful, too.

Another reason not to invest on margin would be access to cheaper sources of capital or easier ways to make money. For example I'd be happier buying call options with the money obtained by writing a check on a home equity line of credit. I'd be paying 2.75% interest instead of 1% but it'd be on a much smaller balance and I wouldn't be worrying about margin calls. I'm also happier to use a 30-year mortgage at 3.625% fixed rather than having to cope with variable margin interest rates.

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Or Nord has said, you already won the game why are you trying to run up the score?
Every time I sit around with the rest of our investor's group I ponder the wisdom of that issue... maybe I should ask Ed that same question during this Friday's pre-meeting.
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Old 02-09-2011, 02:43 PM   #19
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[QUOTE=ERD50;1035113And while it is fair to say it "increases risk", that has to be put in perspective. Does someone with a 50-50 account who decides to put an additional 5% into a stock really taking more "risk" than someone who is 75-25 with no margin?
-ERD50[/QUOTE]

people often conflate leverage with margin. There are many ways to get leverage- like taking out a mortgage and investing the money in stocks. Brokerage account margin has a particularly bad feature- an intra-day airpocket could led to you being sold out. Not common, but not impossible either. This of course is not very meaningful with very low amounts of leverage- but as soon as the leverage gets worthwhile, the margin gets risky.

As a blanket statement I would say if you have to ask about this on the internet, you do not know enough about it to even consider it.

But again, evolution, like God, loves all her children.

Ha
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Old 02-09-2011, 03:07 PM   #20
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Doesn't fit my approach to long term, buy & hold investing.
Ditto, plus I do not understand anything about margin trading.

Some things are better left untouched (for me at least).
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