Does Anyone use Margin in Their Personal Portfolio

[ERICOPOLY]

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

 

I think if you are sitting on a gain, then buying a put at-the-money or in-the-money falls under the restrictions of shorting "against the box".  I think it restarts the holding period as you suggest when the put is closed out (or expires).  I think the IRS uses the term "constructive sale" -- if you search under that term you'll find the rule.

 

Exercising a call option also resets the holding period.  You might have been holding that call option for 6 months, but if you exercise it you'll have to hold the shares for an additional 12 months to get into long term hold tax status.

 

So my suggestion works best for situations where long-term calls are not available.  When long-term calls are available you have the opportunity to book your gains long-term by selling the call near expiration.

 

[twacowfca]

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

 

I think if you are sitting on a gain, then buying a put at-the-money or in-the-money falls under the restrictions of shorting "against the box".  I think it restarts the holding period as you suggest when the put is closed out (or expires).  I think the IRS uses the term "constructive sale" -- if you search under that term you'll find the rule.

 

Exercising a call option also resets the holding period.  You might have been holding that call option for 6 months, but if you exercise it you'll have to hold the shares for an additional 12 months to get into long term hold tax status.

 

So my suggestion works best for situations where long-term calls are not available.  When long-term calls are available you have the opportunity to book your gains long-term by selling the call near expiration.

 

 

 

Also, buying a leap put on the market index may be a good choice to lock in a gain that will be long term in the future.  This is appropriate for a stock that has a beta close to that of the index.  If the stock goes down with the index, a certain portion of the gain on the put can be treated as long term, even though you have held the put for less than 12 months.  :)

[Myth465]

I want to thank everyone for taking the time to respond. I have learned alot from this thread.

 

I have even moved another oversized position to options to raise cash based on this thread and others. Based on the replies I think I will avoid callable margin. I may use leverage, but will focus on finding it in ways which give me control over when the asset is sold. I will also limit it to situation in which the yield covers the interest paid. The leverage will probably be via a 401k loan, margin backed by a line of credit (depending on which has the lower interest rate), or additional options / leaps.

 

Thanks again everyone for the responses.

[jtvalue]

I would like to start this topic up again.  I've been thinking about using a small amount of margin and would be interested in hearing the experiences of others.  I'm fully aware that market valuations including the Shiller PE are at historically high levels.  However:

 

1)I would use the margin interest for tax purposes to offset dividend income that I reinvest anyway

 

2) I have no debt otherwise (I rent my apartment)

 

3) The pre-tax cost of funds is only 1.5-2%

 

I also began thinking about this more after reading the "Buffett's Alpha" paper (link below). It stated that a big source of his returns was leverage of 1.6x assets to equity. 

 

http://www.econ.yale.edu/~af227/pdf/Buffett's%20Alpha%20-%20Frazzini,%20Kabiller%20and%20Pedersen.pdf

 

I also remember a quote from Munger along the lines of "Berkshire's success can be attributed to borrowing at 3% and investing at 13%?" 

 

I realize margin is different than insurance float, but if used intelligently at a low cost it seems to me it could enhance after-tax returns on a long-term basis? Thoughts?

[frommi]

I use 3 accounts and use margin debt in one of them up to around 30% of its value. Thats comes out to an overall leverage of 10%. I can see nothing wrong with that, when it cost me 1.6% to buy equities yielding a lot more. Options are a good alternative, but you have to understand the cost involved. (Bid-ask spreads, volatility going down when the stock goes up, raising dividends that are not priced into the option, forced timeframe, etc.). When you are not disciplined you can overleverage yourself a lot faster with options. (That is especially true for people buying far OTM calls or warrants)

[dpetrescu]

This has been mentioned before in a previous post....How about using a home equity line of credit. Except, use a very stringent limit of use: 1. Set it up  2. Do NOT use it, forget you have it  3. Wait for a recession and keep researching while waiting    4 when a recession is officially announced (usually a few months after it starts) use it in increments

 

This seems interesting because a HELOC will have a variable rate so if used midway into a recession, the interest rate will be low at the time it is used

[james22]

My employer will loan me up to a year's base salary at ~3.5%.

 

I'll take it if the market crashes.

[Rainforesthiker]

I have had very good success using margin in my personal portfolio.  A couple of important points:

1) I have a good stable job with a good salary

2) I own some income producing real estate that can generally pay my expenses

3)  I have other somewhat illiquid assets that I can tap for cash if truly needed

 

I have generally tended to constantly use margin that is at or less than 20% of my portfolio and is typically less than my yearly income.  I go somewhat heavier on margin when I see certain circumstances present, i.e., the trifecta of: 

1) companies that are greatly undervalued based on my valuation estimates ;

2) a psychological story for why these companies are undervalued, such as a market panic that indicates people are selling irrationally (and for the respective company I am convinced the business franchise is intact and will both survive and return to a more normal earnings position); and

3) other noted value investors have jumped into these undervalued stocks, and the prices have gone lower still.

 

I used a good bit of margin in March 2009 and was very glad I did.  In 2011 I went somewhat all in with BAC, AIG and BRK using a good bit of margin, and again was glad I did.  Berkshire selling at book value was a great reason for margin IMO (esp with hindsight in view of the 1.1x and now 1.2x buyback statement).  In 2011 I actually took out a new mortgage on my paid off house to use for investing, as I thought it was such a great opportunity.  Some time back I paid off my margin, but I tapped it again for some recent opportunities, such as C, EZPW, BP, FTP.TO (under $3) and GM B warrants which declined in view of the recalls.  I have realized that I have a weakness for bargains that I need to temper, something that my partner Racemize constantly admonishes me about.  Unless I see anything compelling going forward, I plan to work my margin down a bit this year.  I will probably plan to use on average about 10 - 20% of my portfolio value in terms of margin.  But of course if I cannot find anything compelling I will pay it off over time. 

 

Like one of the other posters, I view my personal portfolio somewhat as a business, and borrowing 20% or so of my equity at 2 - 3% for great opportunities just seems to make sense to me.  I would probably cut my margin use to 10% or less if I did not have other income streams.

[Lance]

Enjoyed the posts, but my initial reaction is to add more $120 strike 2016 IWM puts.

 

Thanks,

Lance

[dpetrescu]

My problem with margin is that your line of credit is variable. The ideal time when leverage is needed is during a crash. With margin, available credit will shrink during a crash. It seems that a HELOC or bond investment started during the good times become more beneficial because interest rates will decrease during a crash.

 

I have had very good success using margin in my personal portfolio.  A couple of important points:

1) I have a good stable job with a good salary

2) I own some income producing real estate that can generally pay my expenses

3)  I have other somewhat illiquid assets that I can tap for cash if truly needed

 

I have generally tended to constantly use margin that is at or less than 20% of my portfolio and is typically less than my yearly income.  I go somewhat heavier on margin when I see certain circumstances present, i.e., the trifecta of: 

1) companies that are greatly undervalued based on my valuation estimates ;

2) a psychological story for why these companies are undervalued, such as a market panic that indicates people are selling irrationally (and for the respective company I am convinced the business franchise is intact and will both survive and return to a more normal earnings position); and

3) other noted value investors have jumped into these undervalued stocks, and the prices have gone lower still.

 

I used a good bit of margin in March 2009 and was very glad I did.  In 2011 I went somewhat all in with BAC, AIG and BRK using a good bit of margin, and again was glad I did.  Berkshire selling at book value was a great reason for margin IMO (esp with hindsight in view of the 1.1x and now 1.2x buyback statement).  In 2011 I actually took out a new mortgage on my paid off house to use for investing, as I thought it was such a great opportunity.  Some time back I paid off my margin, but I tapped it again for some recent opportunities, such as C, EZPW, BP, FTP.TO (under $3) and GM B warrants which declined in view of the recalls.  I have realized that I have a weakness for bargains that I need to temper, something that my partner Racemize constantly admonishes me about.  Unless I see anything compelling going forward, I plan to work my margin down a bit this year.  I will probably plan to use on average about 10 - 20% of my portfolio value in terms of margin.  But of course if I cannot find anything compelling I will pay it off over time. 

 

Like one of the other posters, I view my personal portfolio somewhat as a business, and borrowing 20% or so of my equity at 2 - 3% for great opportunities just seems to make sense to me.  I would probably cut my margin use to 10% or less if I did not have other income streams.

[ourkid8]

My portfolio is about 12-15% leveraged (during the recession it was significantly higher) as i borrowed against my HELOC during the crisis.  I am paying this down aggressively as I am also trying to avoid excessive leverage.  On top of that leverage, I currently have a significant position of BAC warrants / options so those have inherent leverage built in.  To sum it up, I have too much leverage which I have to reduce especially as the market is making new highs! 

 

Thanks,

S

[bz1516]

I don't see a reason why there should be a hard and fast rule on using margin?  It depends what other non securities assets you have.  Lets say two people each have $2mm in securities, but one has $400,000 equity in his residence, and the other has $3mm in several properties.  Their margin should be different, the same if one expects a fairly large inheritance vs the other who will not inherit anything.

 

Another issue with margin is investing style.  The investor with more volatile investments shouldn't have a much margin as the one with less volatile holdings. 

 

I'm more inclined to let my individual securities selection determine what proportion of my nav is invested.  I think its a good idea to limit your margin outright or relatively if you feel a need to, i just don't think its a correct to say its good for everyone in all circumstances..

[Castanza]

Not to bring this back from the dead, but I'm curious what everyone's appetite for margin is in the current environment? Personally, I don't use it, but I have seen a lot of discussion (inner circles) regarding it.

[Gregmal]

Yup, almost always. If you can manage the risks involved in what you are investing in, its silly not to if you can borrow at 5% or less. Especially with real estate investments.

[Castanza]

Yup, almost always. If you can manage the risks involved in what you are investing in, its silly not to if you can borrow at 5% or less. Especially with real estate investments.

 

Do you have general rules of thumb that you follow? Most people who I see use margin seem to limit their exposure to say 10% of their portfolio.

[Gregmal]

Nothing solid. Its simple but do what you're comfortable with. Some people cant stomach any margin. So it would be silly for them to use it because that fear would weigh on your decision making process.

 

One thing I like to pay attention to are look through leverage/debt ratios, and also types of debt. You also need to look at valuations(duh). I mean Berkshire has virtually zero debt and a massive cash pile with a reasonable, REAL EARNINGS supported valuation. I think one would be just fine with it levered at lets say 1.5x. Personally could probably sleep at 2-3x. BRK at 2x leverage is still probably safer than having 10% of your portfolio in GM or Ford, or something like that. So it all varies.

[LC]

I have used margin off and on for years. My living situation is probably most similar to Al's post in this thread.

 

My uses have traditionally been "bridge" financing if called on written options. Also when pursuing corporate actions or one-time events with discrete outcomes. In these cases I'll be on margin for a few weeks but ultimately try to pare it down.

 

I have sometimes done the spread play with dividend paying stocks. I think in all cases I have never exceeded 1.2x leverage. As Greg mentioned valuation is important but so is asset quality. Some assets are more suitable to leveraging. Sanjeev made a warning earlier in this thread that with margin, one mistake can blow you up. It's important to take heed of that, probably moreso in the current environment.

 

Mortgage I presume isn't what you're interested in but I have that as well.

 

Thanks for reviving this thread, good to see some long forgotten names.

[Castanza]

I have used margin off and on for years. My living situation is probably most similar to Al's post in this thread.

 

My uses have traditionally been "bridge" financing if called on written options. Also when pursuing corporate actions or one-time events with discrete outcomes. In these cases I'll be on margin for a few weeks but ultimately try to pare it down.

 

I have sometimes done the spread play with dividend paying stocks. I think in all cases I have never exceeded 1.2x leverage. As Greg mentioned valuation is important but so is asset quality. Some assets are more suitable to leveraging. Sanjeev made a warning earlier in this thread that with margin, one mistake can blow you up. It's important to take heed of that, probably moreso in the current environment.

 

Mortgage I presume isn't what you're interested in but I have that as well.

 

Thanks for reviving this thread, good to see some long forgotten names.

 

Absolutely agree. I’ll still most likely refrain from leverage. I avoid most types of debt in my life and choose to live with the loss of potential gains.

 

I guess I mostly wanted to revive it to see what the mentality was alongside this ever increasing frothy market.

 

Thanks

[LC]

I'll give another example of "bridge" loan behavior. I was harvesting tax losses a few years ago in December. And was planning to repurchase the securities in a month. So, during that month I had cash laying around, and sure enough some other opportunity presented itself.

 

And so in mid-January I was now fully invested but also still interested in repurchasing the shares I had "harvested" in December. Margin here is useful because I was able to repurchase the shares in Feb. on margin, and then after a few weeks with more contributions to the account and other sales, was then able to reduce the leverage back to near-zero.

[thepupil]

I used to use more margin than I do.

 

Instead I borrowed a lot of money at a blended 3.5% for 5 years - 10 years.

 

80% LTV 1st mortgage at 3.125% (10 year fixed period, 30 year amort, floating thereafter, cannot go higher than 8.125%, cannot go up by more than 2% / year)

80-98% LTV 2nd mortgage at 5.25% (5 year balloon, 15 year amortization)

 

because the proceeds of the 2nd lien were used to buy stocks, this is "investment interest" and the bulk of the 1st mortgage is also tax deductible. in order to take the investment interest deduction, you have to classify all your realized gains/interest/dividend as short term so it may not make sense every year to do so, but in some years the after tax cost of that debt will be very low.

 

so in other words, I'm partying like its 2005 with my 98% combined LTV with a 2nd lien balloon!

 

what a time to be alive.

 

 

 

 

[Spekulatius]

I use margin very sparingly for extraordinary opportunities. I would also limit myself to perhaps no more than 20% of my portfolio and reduce it as quickly as possible.

 

Berkshire May have a lot of cash, but it has had several 50% drops during  its trading history, so a 2:1 margin could definitely wipe you out, regardless of the fact that Berkshire ultimately was fine.

[fareastwarriors]

I used margin as downpayment for my last investment property.

 

Margin is a powerful tool but can be dangerous if used improperly.

[SharperDingaan]

Margin is just a tool. The result depends on how good/bad the workman is.

When we use it, we're typically doing something similar to LC. Temporarily mortgaging in pounds sterling and reinvesting in CAD, in anticipation of a pound sterling devaluation. Temporarily stumping up to cover a short sale, prior to covering the short with a convertible debenture.

 

SD

 

 

[wabuffo]

Berkshire May have a lot of cash, but it has had several 50% drops during  its trading history, so a 2:1 margin could definitely wipe you out, regardless of the fact that Berkshire ultimately was fine.

 

Spek - that is a great watch-out.

 

The only nit is that the two times in the last twenty-five years that BRK dropped by 50%, it did so from a starting point of trading at 2X book value per share:

1) Q4, 98 to Q4, 99 - BRK-B fell from $  54.26 to $27.02  (BV was ~$25 per B-Share)

2) Q3, 07 to Q4, 08 - BRK-B fell from $101.18 to $44.82  (BV was ~$51 per B-Share)

 

Both of these occurred in the absence of any announced BRK buyback policy (though the first instance caused Buffett to write an open offer to buy shares in his March, 2000 Chairman's letter).  The second instance caused Charlie Munger to "sell" a ton of BRK shares to his heirs on margin (via a note - so, like 95% margin) in a shrewd-tax planning move in Nov. 2008.  One could say a bell was wrung in both cases near the top and bottom.  Since then, BRK has communicated various forms of buyback policies starting in 2011.

 

Short-hand rule used to be - buy at book, sell at 2x book, rinse and repeat.

 

wabuffo

(who sometimes uses a bit of margin against his BRK position to buy market-neutral positions like liquidations  ;)).

[muscleman]

If you are good enough, you should not need margin. David Tepper is doing 30% a year without margin.

If you are not good enough.... hmm..... Why use margin to kill yourself faster?

 

With that said, if you want to use margin, you ABSOLUTELY need to have a plan that includes a stop loss mechanism purely based on price alone, no questions asked. Otherwise, no matter how many times you compound, if you multiply it with a 0, it is a 0.