Modest Leverage

[brendanb22]

What's everyone's thoughts on using modest leverage in your portfolio? I.e. 20% or less of your total equity value. IB offers <2% rates and it seems a bit too tough to pass up

[BG2008]

Feels like a late bull market syndrome.  Some of the most sophisticated investors that I know of are holding a large amount of cash.  Most of them are doing so not by design but because they feel that opportunity sets are kind of poor at this moment. 

 

Probably okay following massive market selloff.  But then hindsight bias. 

[doughishere]

Feels like a late bull market syndrome.  Some of the most sophisticated investors that I know of are holding a large amount of cash.  Most of them are doing so not by design but because they feel that opportunity sets are kind of poor at this moment. 

 

Probably okay following massive market selloff.  But then hindsight bias.

 

+1

[Graham Osborn]

What's everyone's thoughts on using modest leverage in your portfolio? I.e. 20% or less of your total equity value. IB offers <2% rates and it seems a bit too tough to pass up

 

It depends on your strategy.  For example, if the equities in your portfolio are highly levered, you can tolerate less margin.  Illiquidity can function like leverage in some ways, hence the same is true of small cap/ microcap trading (most brokers already have speed bumps built in for this).  I usually don't exceed 15-20% of equity - that is with low-leverage longs and generally high-leverage shorts roughly 50/50 (currently). 

 

Like credit card debt, it should be considered bad as a general rule.  Lots of people lost 50% in 2008-9 with no margin.

[Travis Wiedower]

Didn't Allan Mecham lever up in 09 to buy as much BRK as he could? Pretty genius move in retrospect.

 

But yeah, +1 to BG.

[racemize]

Ignoring market timing aspects (and who can do that really?), I think the perfect amount of leverage is the amount that doesn't get called.  I imagine 20% wouldn't kill you historically, unless you are more volatile than the market is.  (e.g., Pabrai with leverage doesn't work very well)

[BG2008]

I've been thinking a lot about this.  I think if you're going to use leverage there are better ways than portfolio margin.  If you typically traffic in extremely large caps like BRK, Apple, etc.  You'll probably never get margin called with 10-20% leverage unless you happen to own Valeant and Energy. 

 

It appears that a better source of leverage can be achieved by doing a cash out refi on your investment property.  Assuming it's not your primary residence (well, it's kind of hard to lose your house.  You don't want to lose your equity portfolio and find yourself homeless at the same time), you can do a cash out refi on your investment property, fannie and freddie qualified mortgages are sub 4% interest.  Net of taxes, it's closer to 2.0-2.5% for people in the highest tax bracket in states with income tax.  Your mortgage is a 30 year fixed rate.  The leverage is on your rental property and not your portfolio.  Your rental property doesn't get a market to mark once you take out the loan.  This allows you to have "leverage" not subject to margin call and you can buy illiquid micro caps.  If the market is down a whole bunch and you wind up in an emotional fetal position due to the leverage, then that's a different story.  Frankly, I'm probably okay with this on my highest conviction ideas that I've done a ton of work on. 

[Gregmal]

Depends entirely on the investment.

 

Some large cap low beta names I'll lever up as much as the heart is content via ITM leaps without risking a margin call or even a substantial outlay.

 

If I'm bullish on GM I'd rather control 2,000 shares via a $25 LEAP costing $16,000 and not pay taxes on the dividend vs put down $66,000 using cash or a margin account. Of course this varies depending on ones risk tolerance but if you can get comfortable with the business and grasp which general ballpark we're in relative to the cycle it's not really all the risky.

[TwoCitiesCapital]

I'm levered in my IB account, but the whole account is betting on a downward move in U.S. equities.

 

Clearly, I'm biased, but I wouldn't be levering to the upside 7-8 years into a bull market. I just have holdings I'm not quite ready to sell yet and still want to place bets to the downside to protect myself from what I am convinced is sheer ignorance in the U.S. market today so I have a bunch of direct shorts and long puts that were funded by margin.

 

Levering a small portion of my portfolio up 1.5-2x betting on downside seems alright and the most likely way of me getting margin called is if U.S. equities skyrockets which would likely mean the rest of my portfolio is doing ok as well. Of course, there is the possibility that the U.S. skyrockets while everything I own tanks...but that was 2014 & 2015 and 2016 has been the massive reversion trade so I'm comfortable maintaining the levered position at this point in time.

[longlake95]

great idea, wrong time. I'll lever up during the next recession.

[brendanb22]

thanks for the great comments all!

[rb]

In my opinion 30% of equity is a good leverage ratio. That way if you get a 30% crash you don't get a margin call. You're basically looking to get a long term loan at a low interest rate. When you get it it's up to you.

 

For example right now I have quite a bit of cash because I sold a bunch of names cause they've reached my price target and I don't have a lot of things to buy. If we get a crash I'm looking to deploy the cash plus take out margin. That would enable me to load up on a lot of stuff when it's cheap.

 

Another strategy would be to be fully invested during normal/frothy markets so you don't have cash opportunity costs. Then take out margin when markets crash, then when markets recover and you sell stuff cause it reaches your price targets you use proceeds to pay down margin. That way you have purchasing power when stocks are cheap and you get to stay fully invested throughout the cycle.