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Does Anyone use Margin in Their Personal Portfolio


Myth465
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Also where would you all consider using margin? When is it advantageous?

 

I am considering it further down the line for an investment, but had some fairly bad experiences with it prior. So far I have avoided it.

 

What do you guys think?

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I have used.  Overall, added much more volatility to 2007-2009, but also increased total returns as I was able to buy more FFH & options as market was declining.  I would not use any amount of debt that if you faced a total loss, and had to repay the debt from other resources, would put your retirement or your family's financial security in jeopardy.  Basically, if you have extra resources to speculate with.

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Look for leverage that can't be called if you're tempted to use margin.  I drooled over a savory dish we had bought a few years ago, wanting a much larger serving, then figured out a way to lever it up while taking most of our money off the table.  That's nice work if you can get it.  :)

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Depending on what you are buying options may offer less risk.  I would compare an options based alternative as it limits the downside.  I have only used leverage on a portfolio of value mutual funds before I had kids.  It worked out fine but I did not have the need for the cash for awhile.  Now that I have more financial commitments I only use options as they reduce my downside.  In addition, recourse leverage can reduce your margin of safety as the point/price of total loss is increased.

 

Packer

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Thanks for the great and quick responses. I will try to add a bit more color.

 

Say one had options on SSW which worked out amazingly well, but wanted to exercise them. He had more options then he could exercise. Does he 1. Sell and hold what he can, 2. Exercise using margin on the SSW position allowing him to hold 50% more, 3. Margin his portfolio to take as much as he wanted or could hold considering the risks.

 

Lets assume the yield is much better then the margin costs.

 

Would you all do it?

 

I got burned fairly bad with margin in 2008 so I know the dangers of playing with fire. Right now just weighing options for the future.

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In general, it is prudent to avoid margin debt. Even though the current margin rates are low, the brokerages can change the margin requirements in addition to margin rates at any time of their choosing w/o warning the customer. These events tend to happen when there is general distress in the markets (for ex. Q4-2008), so it could come at a particularly inauspicious time for the investor.

 

My suggestion to Myth465 would be to choose option 1.

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Hell yeah!

 

Margin is the way to go when valuations are compelling and when it is used in moderation.  I do not hesitate to margin up to 110% or 120% equities.  Right now I am about 106% equities (ie, margined 6%).  As others have stated, margin interest is tax deductible and is currently stupid-cheap.  There are a few decent large-cap valuations that have earning-yields well over margin interest rates....

 

In Feb-Apr 2009, I margined about 10%.  I should have cranked it to 30-40%. Opportunity missed.

 

I have a very long term time horizon.

 

SJ

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The "Prudent Speculator," Al Frank used margin successfully in his investment plan. You might wish to read his book on the topic.  Intuitively, I believe that this requires discipline and restraint. There are probably successful methodologies other than Frank's. On the other hand, traders who "go for broke," like the legendary Jesse Livermore, learned discipline and restraint the hard way, by losing an entire fortune, perhaps more than once.

 

Good luck,

Tex

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Thanks for the great and quick responses. I will try to add a bit more color.

 

Say one had options on SSW which worked out amazingly well, but wanted to exercise them. He had more options then he could exercise. Does he 1. Sell and hold what he can, 2. Exercise using margin on the SSW position allowing him to hold 50% more, 3. Margin his portfolio to take as much as he wanted or could hold considering the risks.

 

Lets assume the yield is much better then the margin costs.

 

Would you all do it?

 

I got burned fairly bad with margin in 2008 so I know the dangers of playing with fire. Right now just weighing options for the future.

 

 

No. 1 is a good choice.  Or if you really like SSW, you could exercise what you could afford to hold without leverage, sell the rest and put the proceeds half into cash and the remainder into out of the money leaps if they are attractively priced.  :)

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Absolutely, I have used margin for about 12 years.  I have used up to 40% Debt to Equity at times.  The only time I got hit with margin calls was in Oct/nov 2008 and March 2009.  Both times I had written puts.  I think I would have been okay had I not written the puts.  One thing about using margin is that you cannot be loading up on illiquid stocks.  

 

Two things about my personal circumstance that make it easier to contemplate:

1) I have had two good jobs during that time period - relatively secure.

2) I have enough in my RRSPs, where you cannot use margin, to retire on (in 20 years) even if my other accounts go bust.

 

I am also not adverse to selling losing positions and capturing a tax loss and then buying them back after the wash out period should I still want them.

 

Right now I hold enough dividend paying stocks to cover my entire margin interest about 4 times over after tax.

 

Interest rates on the margin account are around 3% and many stocks can be bought that pay 5%.  That to me is adeal.

 

 

 

 

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I had the same situation with Qualcomm calls in 1999. I had 100 strike calls when the stock was 40, and it exploded after a court verdict. I used every bit of margin I could to exercise as much as I could and it worked out great(I think the eventual unsplit top was 1600 or so). That was a unique company with a very unique and secure moat, in a unique time for stocks though. I wouldn't do that today.

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Further to this discussion.  I consider my personal non-rrsp holdings to be a business that I run.  Most businesses borrow money.  I borrow money.  Via my margin accounts I had more available capital than most businesses could borrow (proportionately) during the credit crisis. 

 

I simply dont understand the difference between me borrowing 30% of my businesses equity, and Fbk borrowing 30% of their equity except there are fewer conditions on mine than theirs, and my interest rates are a fraction of theirs.   

 

 

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One of the annoying things (in the US at least) is an arbitrary rule that stocks under $3 cannot be margined.

 

This is ridiculous of course, the price of the stock isn't what determines risk.  Nevertheless, the rule exists.  Buy a stock for $3.02, and potentially get a margin call if it drops 1%.

 

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As long as you understand that you are borrowing short term with a variable "covenant", callable loan secured against a volatile asset that has a history of crashes, I'm cool with margin.

 

But mostly, this thread just made me a lot more nervous than I used to be.

 

Ben

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We do not use margin in our funds, corporate accounts or personal accounts...all cash-only accounts.  We won't ever!  One mistake could cost you a hell of a lot, if not everything.  And if you're shorting stocks on margin...that's a deadly combination. 

 

I know Al very well, and one of our partners also uses margin regularly.  As Al told you guys, he received two margin calls, but he was liquid enough to easily cover.  Our partner who uses margin covered his positions before the credit crunch at my behest...it saved him a fortune!  I cannot in good conscience encourage any investor to use margin.  Plenty do, and plenty lose money over the long-term.

 

I remember this story that Charlie Munger told at one of the Berkshire AGM's.  An investor came up to him and said "Mr. Munger, I'd really like to be like you one day.  What can I do to achieve that...only quicker!"  And there's the rub.  Everyone wants to do it quicker.  Cheers!

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Munger made use of leverage and margin in the early days of his partnership.  One time he borrowed a million dollars from a bank to do a short term arbitrage on BC Power shares - to make a spread of around 10%.

 

As a member of the Pacific Coast Stock exchange he could borrow up to 50%.  (Schroeder, Snowball)

 

I am not arguing whether broker margin is good or bad.  There are valid comments about the safety of brokers.  Anything can happen at any time so one has to draw the line somewhere on the risk they can handle and their particular situation. 

 

Witness the ABCP freezeup in Canada were people thought they were in perfectly safe commercial paper and found in some cases that their life savings was frozen for over a year in total uncertainty.  This was supposed to be a short term liquid investment and no leverage was involved.

 

 

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Munger made use of leverage and margin in the early days of his partnership.  One time he borrowed a million dollars from a bank to do a short term arbitrage on BC Power shares - to make a spread of around 10%.

 

As a member of the Pacific Coast Stock exchange he could borrow up to 50%.  (Schroeder, Snowball)

 

I am not arguing whether broker margin is good or bad.  There are valid comments about the safety of brokers.  Anything can happen at any time so one has to draw the line somewhere on the risk they can handle and their particular situation. 

 

Witness the ABCP freezeup in Canada were people thought they were in perfectly safe commercial paper and found in some cases that their life savings was frozen for over a year in total uncertainty.  This was supposed to be a short term liquid investment and no leverage was involved.

 

 

 

As a member of the stock exchange, he likely would not have been subject to a short term margin call at the whim of Mr. Market.  :)

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Munger made use of leverage and margin in the early days of his partnership.  One time he borrowed a million dollars from a bank to do a short term arbitrage on BC Power shares - to make a spread of around 10%.

 

Munger also lost 70% of his portfolio in 73-74, but I don't think you want to do that Al.   ;D  By the way, Mohnish also used leverage in the early days of the Pabrai Funds, but he too became enlightened and stopped.  One mistake is all it takes...just one...and the knife cuts fast and deep.  Cheers!

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I think if you use margin or leverage, you need to be smart about it.  To exand -

 

1) If you have a $100,000 portfolio and you like to keep 10% of your portfolio in cash, you can write puts (those sexy naked variety) and keep the cash.  If your potential exposure is $10,000 on the puts, you really are not at any kind of risk with the exception of buying stocks at lower prices (which is why you keep cash anyway).

 

2) Assume you have the same $100,000 portfolio and are fully invested.  I see no problem writing puts for about a $10,000 exposure.  Your worst case scenario is you buy on margin, but it won't kill you. 

 

If you are buying on margin in general (something I never have done or hope to do), good luck.  I would recommend keeping the % low as in the case above. 

 

Just my opinion but the most important thing is to always manage your risk, assume a doomsday scenario, read the Black Swan, and go to church (full disclosure, I have been absent on the last one).  I like Myth's strategy mentioned in a different thread of keeping some good dividend paying stocks (I like MO, PEP, JNJ, PG at the right prices) and take your shots with riskier picks on a small portion of your portfolio.  I also like the insurance guys (Berky B's, L, and Fairfax).  For yield, I have been playing Aspen's preferred, Boardwalk, Ford Preferreds, and BBEP.  Thinking about NLY but I get scared off and waiting for something around $15.

 

I also like the following if I can get at the right prices (GPC, DPS, KMB, TEF, STD, ABT, VOD, CLX, BAM).  I like GOOG, but not after the big run.  BAC is intriguing to me.  Would love a thread on AIG - I always thought it was garbage but BB is smarter than me and has more time to analyze.

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Regarding the suggestion to buy calls...

 

Next year some of us will be facing 38.5% tax rate on short-term capital gains.  So as an alternative to buying calls it might make more sense to buy shares on margin and hedge with puts.  You can let the puts expire and it offsets some of your short term capital gains.  Margin rates at Interactive Brokers are very low, so the tax benefit likely exceeds the interest costs.

 

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I'm not sure, but I believe that buying in-the-money (or maybe at-the-money) puts stops the clock with regard to a stock holding going long-term. If this I correct my recollection is that you can get around this by taking some risk and buying a put a strike or two lower than the current stock price. I'll try to check on this

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