Value averaging and MYR -A safer approach to margin?

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Value averaging and MYR -A safer approach to margin?

Postby jcw » Sat May 15, 2010 9:24 pm

Hello,

I have been investing for 8 years and am about to start a taxable account
since I have maxed out my 401k and IRAs and have enough disposable
income to do so.

I am thinking about using a margin account (leverage) and applying a value averaging concept. My plan is to always have
a constant percent of leverage and to invest more or less based on how the market moves.
So, if I invest $1000 bi-weekly + $500 on margin for a total
of $1500, I would be at 50% leverage.
If the investment were to drop by $100, then my total investment would be $1400 with
$500 on leverage (~55% leverage 500/900).
So in my next bi-weekly investment, I would add the $1000 but only use $450 on margin, brining my leverage back to 50%.
You continue doing this until you have an absolute dollar value on margin, like 100k, or whatever you are comfortable with.
At that point, you start reducing the leverage by continuing to make the principal investment but not using additional leverage.

I choose 50% leverage, because I could withstand a 50% market drop with no margin call.
In the worst case scenario (ie: a > 50% drop in a week), I could borrow against my 401k or Roth IRA to completely
pay off the margin account. In this case, I would have just transferred my investments from my retirement accounts,
to my taxable accounts and would be fine. I would then divert all future payments to pay off the 401k
loan until everything is even again.

Does this sound like a viable approach?
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Postby livesoft » Sat May 15, 2010 9:30 pm

How much is the interest that you pay on money you borrow on margin?
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Postby dodonnell » Sat May 15, 2010 9:47 pm

Depending on how large your IRA is ... you may be able to implement your strategy totally in the IRA.

For example. An IRA account with lets say greater than $200k could buy possibly buy futures contracts in lieu of index etfs, freeing up 95% of the cash.

SP500, Midcap 400, Russell 2000, EAFE and Emerging Markets are all available as E-minis. The cost of carry on these contracts is Libor ... much much cheaper than Broker margin rates.
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Postby jcw » Sat May 15, 2010 10:13 pm

Livesoft - I just started an IB account. So 1.66% interest which is tax deductible, so effectively ~.9%.

dodonnell - I have around 80k in Roth and 401k + 25 in high yield
accounts (emergency). I'll continue maxing out the 401k but I'm no longer eligible to contribute to Roth.
I would use the Roth and IRA as an "exit" strategy in case things go south.
That is, I would only margin up to an absolute value of 40k (half my 401k+ IRA) so that I could cover all my loses against the 401k/IRA in case of market crash (assuming 50% losses in 401/IRA). The absolute value increases over the years as I continue contributing to the retirement accounts. My emergency fund remains untouched.

I would only invest in tax efficient index ETFs like VTI or a total international ETF. I don't want to use futures or e-minis cause I want to keep it simple.

Also, I am only 28 with a pretty high income (and higher future potential).
I think I could reasonably make it to 100k on margin by 35, and then
start reducing leverage.
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Postby Abbas Danesh » Sat May 15, 2010 10:36 pm

Please don’t take this the wrong way,

How was your track record on your IRA investment? Since you want to invest on margin now.

You have many years to retirement, by taking money out of your Roth IRA to pay your margin account; you’ll miss a great deal on compounded tax free money down the road.

Also to pay off the 401K loan, you’ll pay with after tax dollars and your distributions in retirement will be taxed again.

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Postby market timer » Sat May 15, 2010 10:48 pm

jcw wrote:I have around 80k in Roth and 401k + 25 in high yield
accounts (emergency). I'll continue maxing out the 401k but I'm no longer eligible to contribute to Roth.


Why not just leverage your Roth with futures or LEAPS?
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Postby market timer » Sat May 15, 2010 10:51 pm

Abbas Danesh wrote:Also to pay off the 401K loan, you’ll pay with after tax dollars and your distributions in retirement will be taxed again.


This is not such a big deal, actually. For example, instead of the cash balance growing by 2% in a MMF, the 401k loan may grow at 4%. The incremental cost is 4% - 2% times the tax rate in retirement. Assuming 25% tax rate in retirement, we're talking about a 50bp expense for the loan.
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Postby jcw » Sun May 16, 2010 12:51 am

Abbas: I have mainly invested in Vanguard retirement 2045 since around 2004. I haven't really kept track of year over year returns but I think
I have around 23000 contributed and the fair market value is currently
27,889 all in VTIVX (target retirement 2045).

I don't plan to borrow from my 401k. That is only in the event of
a market crash so I can pay off the margin account.

Market Timer: I don't use LEAPS or futures because I don't really have
a solid understanding of those products. I will stick to a simple
3 fund portfolio (total stock market, total international, total bond) and
keep the stocks in the taxable.
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Re: Value averaging and MYR -A safer approach to margin?

Postby grabiner » Sun May 16, 2010 11:01 am

jcw wrote:Hello,

I have been investing for 8 years and am about to start a taxable account
since I have maxed out my 401k and IRAs and have enough disposable
income to do so.

I am thinking about using a margin account (leverage) and applying a value averaging concept. My plan is to always have
a constant percent of leverage and to invest more or less based on how the market moves.
So, if I invest $1000 bi-weekly + $500 on margin for a total
of $1500, I would be at 50% leverage.


Essentially, you are trying to maintain an allocation of more than 100% stock, with all the associated volatility. Consider what would happen in a major market decline such as the one in 2008, noting that recovering will be harder because you won't be able to increase your leverage on the way up.

I have mainly invested in Vanguard retirement 2045 since around 2004

I will stick to a simple
3 fund portfolio (total stock market, total international, total bond)


In that case, investing on margin makes no sense. You should not be both borrowing and lending money in your investments, as it costs less for you to increase your stock allocation by selling bonds to buy stock than by borrowing money. If you have a low margin rate, that is because the rate is short-term, and your broker gets a higher interest rate by lending you the money than by lending it to a lower-risk borrower such as the US Treasury.

If you do want to take the extra risk, first move your investments to 100% stock, then make sure you can sleep through a bear market like the one in 2008 when you lose more than half your portfolio, and then decide whether you are willing to risk losing 75% of it.
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Postby SP-diceman » Sun May 16, 2010 11:17 am

I thought the biggest problem with value averaging was
running out of money.
(at some point you are asked to buy what you dont have funds for)
So it sounds like mixing it with margin wouldnt be a good idea.

If you have an oversized income then just save what isnt nailed down.
Your only enemy would be a bad market.
(and that would probably blow the VA idea out of the water)


Thanks
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Re: Value averaging and MYR -A safer approach to margin?

Postby market timer » Sun May 16, 2010 11:34 am

grabiner wrote:If you do want to take the extra risk, first move your investments to 100% stock, then make sure you can sleep through a bear market like the one in 2008 when you lose more than half your portfolio, and then decide whether you are willing to risk losing 75% of it.


This is good advice.

BTW, jcw's idea is MYR with 1.5:1 instead of 2:1 leverage. I don't see the value averaging element. Why not read the Lifecycle Investing book for more info?
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Re: Value averaging and MYR -A safer approach to margin?

Postby xerty24 » Sun May 16, 2010 4:33 pm

grabiner wrote:Essentially, you are trying to maintain an allocation of more than 100% stock, with all the associated volatility...

You should not be both borrowing and lending money in your investments, as it costs less for you to increase your stock allocation by selling bonds to buy stock than by borrowing money. If you have a low margin rate, that is because the rate is short-term, and your broker gets a higher interest rate by lending you the money than by lending it to a lower-risk borrower such as the US Treasury.

If you do want to take the extra risk, first move your investments to 100% stock, then make sure you can sleep through a bear market like the one in 2008 when you lose more than half your portfolio, and then decide whether you are willing to risk losing 75% of it.

It's not quite as simple as that. For example, you can take extra stock risk in the obvious way (margin to buy more stock), but you can also take extra interest rate, credit, and inflation risks by borrowing short and lending long in fixed income. Since OP's paying around 1% in borrow costs and 5 year treasuries are paying 2.5%, he is getting paid 1.5%/year to take those extra interest rate risks. Total bond is paying more I'm sure. It's sensible to not invest in fixed income (or not borrow) when those rates are higher than your borrowing costs, but that's not strictly the case here.

Oh, and OP should know the max 401k loan you can get is the lesser of 50% or $50K, so you can't count too much of that as an emergency reserve. I would also point out that as a matter of practice, the market falls pretty fast when it falls (like last Thursday), and it seems unlikely to me that you'd be able to get cash distributed from an IRA or 401k in time to meet a margin call (due to all the process and paperwork). Something else to keep in mind.
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Re: Value averaging and MYR -A safer approach to margin?

Postby lub » Tue Feb 07, 2012 12:04 am

I am not sure if anyone is following this thread still...... The question I have a hard time with is why is it such a good idea to employ large amounts of leverage to by a primary residence, yet such a lousy idea to use any leverage at all to purchase and index fund. Especially, if the borrowing rates are so low (if one looks). Clearly, I am restating the arguments of the book Lifecycle Investing which is definitely worth a serious read.
Reading the book Value Averaging, by Edleson, one would think the buying would be primarily at market dips and one would be reducing leverage as the market rises. If JCW is employing leverage, after fully funding retirement accounts, this may be an appropriate strategy. I have employed this strategy for 18 months (a short time, I know), but by saving 30-40% of my income provides a substantial safety net. My theory being that a 100% stock allocation for Warren Buffett is appropriate even though he is in his 80's.
If anyone knows of a forum for exploring this concept, or, would like to continue this discussion of this idea in this venue, please let me know. There are some really interesting investing implications and ideas that could be employed.
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Re: Value averaging and MYR -A safer approach to margin?

Postby yobria » Tue Feb 07, 2012 1:00 am

Keep you investing life very simple, and point your energy in other directions.
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Re: Value averaging and MYR -A safer approach to margin?

Postby tpm871 » Tue Feb 07, 2012 2:11 am

lub wrote: Reading the book Value Averaging, by Edleson, one would think the buying would be primarily at market dips and one would be reducing leverage as the market rises. If JCW is employing leverage, after fully funding retirement accounts, this may be an appropriate strategy.


I've been doing value averaging for almost five years. In the past, I've thought about doing something like what you're suggesting: only using leverage when you've "run out of money" to cover buying to your target value during dips; immediately paying off leverage as money becomes available (e.g., selling some shares when above your target).

I think you could describe it as a "safer approach to margin", since it means that you use leverage when it is "safer" to do so (i.e., during dips, when valuations are low) and you eliminate leverage when it is "riskier" (i.e., during run ups, when valuations are high). However, the feeling of "safe" and "risk" is the opposite for people actually in the moment. It feels very risky to buy a lot after a sharp drop; it feels very safe to let it ride during a run up. I would think that adding leverage to the equation would probably make these "opposite feelings" even more intense, encouraging wrong decisions. For me, I chose not to use leverage because I like being debt free and I think that using leverage during dips would make me worry.

Also, in practice I haven't really had many times that leverage would have helped since I tend to build up large cash reserves when the market is doing well. The only time that I "ran out of money" to buy on dips was the end of Jan 2009 (near the bottom of the great stock market crash) -- at that time I became fully invested according to my AA, but couldn't quite cover all of my value averaging targets. I kept investing new money as I got paid, to keep up with my value averaging plan as closely as I could. Luckily, a little over a month later, the market started a bull run and I had bought lots of shares near the bottom. Yes, I would have done quite well using leverage in that case. But it was painful enough at the time to stick with it using my own money. I don't know if I would have had the nerve to use leverage in Feb 2009. At the time it felt as if the market would never stop falling.

But perhaps you have much greater risk tolerance than I...
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Re: Value averaging and MYR -A safer approach to margin?

Postby FinanceFun » Tue Feb 07, 2012 8:03 am

You own 100% of the risk. So if your investment pool is 200% then you effectively double your standard deviation:

Stock's would have: 40% Standard Deviation, ~20% return
Bonds would have: 6% Standard Deviation, ~8% return

Since margin acts multiplicably to risk, I will assume an 80/20 AA.

AA: 36.25% Standard Deviation, ~17.5% return minus margin costs

Wow! Just.... WOW! All you need is two years in a row of negative returns WITHIN a single standard deviation to get to a margin call. Words of wisdom: "The market can stay irrational longer then you can stay solvent"
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Re:

Postby FinanceFun » Tue Feb 07, 2012 8:30 am

jcw wrote:Abbas: I have mainly invested in Vanguard retirement 2045 since around 2004. I haven't really kept track of year over year returns but I think
I have around 23000 contributed and the fair market value is currently
27,889 all in VTIVX (target retirement 2045).

I don't plan to borrow from my 401k. That is only in the event of
a market crash so I can pay off the margin account.

Market Timer: I don't use LEAPS or futures because I don't really have
a solid understanding of those products. I will stick to a simple
3 fund portfolio (total stock market, total international, total bond) and
keep the stocks in the taxable.


You aren't anywhere CLOSE to maxing your tax deferred accounts. You should not be doing a taxable account. $17,500 per year into 401k, $5k into IRA, and $10k in IBonds - THEN open a taxable account.
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Re: Re:

Postby FinanceFun » Tue Feb 07, 2012 8:30 am

FinanceFun wrote:
jcw wrote:Abbas: I have mainly invested in Vanguard retirement 2045 since around 2004. I haven't really kept track of year over year returns but I think
I have around 23000 contributed and the fair market value is currently
27,889 all in VTIVX (target retirement 2045).

I don't plan to borrow from my 401k. That is only in the event of
a market crash so I can pay off the margin account.

Market Timer: I don't use LEAPS or futures because I don't really have
a solid understanding of those products. I will stick to a simple
3 fund portfolio (total stock market, total international, total bond) and
keep the stocks in the taxable.


You aren't anywhere CLOSE to maxing your tax deferred accounts. You should not be doing a taxable account. $17,500 per year into 401k, $5k into IRA, and $10k in IBonds (optional) - THEN open a taxable account.
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Re: Value averaging and MYR -A safer approach to margin?

Postby xerty24 » Tue Feb 07, 2012 8:41 am

FinanceFun wrote:Bonds would have: 6% Standard Deviation, ~8% return

That 4% return seems pretty optimistic these days.

FinanceFun wrote:AA: 36.25% Standard Deviation, ~17.5% return minus margin costs

Wow! Just.... WOW! All you need is two years in a row of negative returns WITHIN a single standard deviation to get to a margin call.

With futures you won't have a margin problem til you get down to ~10% equity, or an 80% loss at 2:1 initial leverage. Double the return on the last couple years would have worked out quite well I imagine, the 2007-2008 period not so well. It's just double the risk, good and bad.
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Re: Value averaging and MYR -A safer approach to margin?

Postby market timer » Tue Feb 07, 2012 9:18 am

Hmm, another thread on lifecycle investing / margin. Are we nearing a top in equities?
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Re: Value averaging and MYR -A safer approach to margin?

Postby nisiprius » Tue Feb 07, 2012 10:52 am

jcw apparently expects us all to understand the initialism MYR, which nobody in this thread has yet bothered to explain. I've never encountered it outside of Market Timer's postings in this forum. Is it a widely understood abbreviation?

I assume it stands for Mortgage Your Retirement, an early presentation of the strategy elaborated by Ayres and Nalebuff in Lifecycle Investing. Lifecycle Investing's Amazon sales rank is currently within the top million, and the hardbound on Amazon has been marked down to $7.37--weirdly, the regular hardbound is cheaper than "bargain book" version, which is $8.03. Buying opportunity?

"A safer approach to margin" sounds to me like "There's no guard on the circular saw, but I'm going to be really careful." But I assume that if jcw picked up the initialism MYR from Market Timer's thread, that he's read the whole thread. I also assume that jcw didn't tell any fibs when he signed the agreement that brokerages require for opening margin accounts.
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Re: Value averaging and MYR -A safer approach to margin?

Postby yobria » Tue Feb 07, 2012 11:31 am

market timer wrote:Hmm, another thread on lifecycle investing / margin. Are we nearing a top in equities?


Good point. Weren't any posts on buying on margin when stocks were cheap a couple of years ago. Buy low, sell high.
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Re: Value averaging and MYR -A safer approach to margin?

Postby AndroAsc » Wed Feb 08, 2012 10:46 am

I am not too familiar with Margin and stuff like that cause I always assumed it was a speculator's tool. I too practice VA, and I ran out of money during the recent dip (about half a year back). I started only 1.5 years ago, so obviously I did not have the time to build up cash.

How exactly would this margin strategy be implemented? Is margin like taking a short-term loan from the broker? For example, if I invest $1000 per month, and I need $2000 to top up my VA path, then I would "margin" an additional $1000 from the broker and return it to the broker the next month?

Using margin to cover VA shortfall during a crash sounds like an interesting idea, but I'm thinking it could be risky because during an economic downturn the probability of losing one's job would increase. What happen after this margin, you lose your job and cannot pony up the money?

Also, there seems to be interest charge for this margin (I'm guessing it's not an interest free loan?)

For example, if the stock price $10/lot, I can buy 100 lots now. If the margin interest is 6% per month, that means I spent $1060 on 100 lots for $10.60/lot.
1) If next month the market recovers by 6% to $10.6/lot. and I had not employed margin and just used next month's contribution, I would get the same price.
2) If next month the market recovers by 3% to $10.3/lot, and I had not employed margin and just used next month's contribution, I would get a better price
3) If next month the market recovers by 9% to $10.9/lot, and I had not employed margin and just used next month's contribution, I would get a worse price

So that means you are betting that in the next month, the market will increase by that interest charge or more. Is this a bet we should be making?
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Re: Value averaging and MYR -A safer approach to margin?

Postby xerty24 » Wed Feb 08, 2012 12:14 pm

AndroAsc wrote:I am not too familiar with Margin... If the margin interest is 6% per month

Margin interest is more like 6% per year, not per month. If you use futures, it's more like 0.5% since that's around the current 1 year fair interest rate.
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Re: Value averaging and MYR -A safer approach to margin?

Postby Snowjob » Thu Feb 09, 2012 4:21 pm

Margin rates are around 2% per year.
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Re: Value averaging and MYR -A safer approach to margin?

Postby nisiprius » Thu Feb 09, 2012 5:01 pm

Is that 2% rate locked in at all? Or does it trace the prevailing rate short-term rate, or what? If you have a substantial leveraged portfolio, what's the exit strategy if interest rates increase?
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Re: Value averaging and MYR -A safer approach to margin?

Postby market timer » Thu Feb 09, 2012 8:25 pm

nisiprius wrote:Is that 2% rate locked in at all? Or does it trace the prevailing rate short-term rate, or what? If you have a substantial leveraged portfolio, what's the exit strategy if interest rates increase?


It is possible to lock in a fixed rate by shorting long term bonds. This introduces more volatility, of course.
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Re: Value averaging and MYR -A safer approach to margin?

Postby xerty24 » Fri Feb 10, 2012 10:11 am

Snowjob wrote:Margin rates are around 2% per year.

Where are you seeing that? I checked several major retail brokerages and they offered 8-9% margin rates for moderate sized margin balances. On the other hand, Interactive Brokers offers 1.6% as its highest rate and larger balances will qualify for around 1%.

Nisiprius - margin rates are floating rates, expressed as a spread to short term rates (either Fed Funds or overnight LIBOR, both of which are around 0.1% right now). The Fed will only let rates rise if the economy recovers (right?), so if that happens you'll make lots of your leveraged stock bets. Can't lose, right? ;)
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Re: Value averaging and MYR -A safer approach to margin?

Postby AndroAsc » Sat Feb 11, 2012 12:44 am

The entire margin thing is confusing and complicated to me. It increases the expenses of your investment via the margin interest, and you are betting that the market will recover by the next time you invest. If the market continues to tank, then you would have wasted money buying at a higher price with interest.

Instead of margin, why not tap your emergency fund? I am assuming that most people have at least 1-year's worth of emergency fund. If your job is stable and you want to pump more cash to keep up with your VA path, then perhaps it makes more sense to "borrow" from your emergency fund at NO interest.

And honestly, I don't see how brokers would be willing to loan you money for 1%. How do they make money off that? What's the repayment period? What happens if you can't pay back next month? What's the catch? There is always a catch, and I think something is being left out here.

Even mortgages and car loans are like 3-4%. If the margin interest is so cheap and there is really no strings attached, why isn't everyone borrowing this margin money to pay off their CC debts? Or why not just take a margin loan for your car loan or when you are laid off (assuming no emergency fund available)?
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Re: Value averaging and MYR -A safer approach to margin?

Postby Liquid » Sat Feb 11, 2012 2:52 pm

AndroAsc wrote:The entire margin thing is confusing and complicated to me. It increases the expenses of your investment via the margin interest, and you are betting that the market will recover by the next time you invest. If the market continues to tank, then you would have wasted money buying at a higher price with interest.

Instead of margin, why not tap your emergency fund? I am assuming that most people have at least 1-year's worth of emergency fund. If your job is stable and you want to pump more cash to keep up with your VA path, then perhaps it makes more sense to "borrow" from your emergency fund at NO interest.

And honestly, I don't see how brokers would be willing to loan you money for 1%. How do they make money off that? What's the repayment period? What happens if you can't pay back next month? What's the catch? There is always a catch, and I think something is being left out here.

Even mortgages and car loans are like 3-4%. If the margin interest is so cheap and there is really no strings attached, why isn't everyone borrowing this margin money to pay off their CC debts? Or why not just take a margin loan for your car loan or when you are laid off (assuming no emergency fund available)?



Individual investors should never expect to pull a fast one on professional investors, there are no free rides. My understanding is that margin is very low risk for brokerage houses. Your equity is colateral and will be liquidated long before the bank will suffer a loss on its loan.
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Re: Value averaging and MYR -A safer approach to margin?

Postby xerty24 » Sun Feb 12, 2012 6:19 am

AndroAsc wrote:And honestly, I don't see how brokers would be willing to loan you money for 1%. How do they make money off that? What's the repayment period? What happens if you can't pay back next month? What's the catch? There is always a catch, and I think something is being left out here.

No catch. The big boys can probably get paid to take money from the Fed, or at least they're paying much less than 1%.

mortgages and car loans are like 3-4%. If the margin interest is so cheap and there is really no strings attached, why isn't everyone borrowing this margin money to pay off their CC debts? Or why not just take a margin loan for your car loan or when you are laid off (assuming no emergency fund available)?

Most people have a broker that will charge them 8% and not 1% for margin. If you've got the good rate, you should either take the margin loan or sell the stocks altogether to pay off these higher rate debts.
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Re: Value averaging and MYR -A safer approach to margin?

Postby market timer » Sun Feb 12, 2012 11:00 am

xerty24 wrote:
mortgages and car loans are like 3-4%. If the margin interest is so cheap and there is really no strings attached, why isn't everyone borrowing this margin money to pay off their CC debts? Or why not just take a margin loan for your car loan or when you are laid off (assuming no emergency fund available)?

Most people have a broker that will charge them 8% and not 1% for margin. If you've got the good rate, you should either take the margin loan or sell the stocks altogether to pay off these higher rate debts.


There is also the issue of the upward sloping yield curve and prepayment optionality. A 30-year fixed rate with the option to prepay at any time is a very different animal from a floating rate loan secured by a volatile asset. One should be willing to pay a higher rate for the former.
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Re: Value averaging and MYR -A safer approach to margin?

Postby jcw » Sat Dec 22, 2012 9:50 pm

Hello,

I am the original poster and have not been in here in a long time as I quit work, traveled around the world, and now attend a top 3 business school in the US.

A little update. I did use the margin account for about $20-30k in margin ($50-60k total invested) at about 1.66% interest (< 1% after tax deductions). With the benefit of hind sight, you can see that I made a decent amount of money investing in the S&P index on margin. I never got a margin call and nothing bad happened. I was probably lucky but I always had a backup plan to cover a margin call by borrowing against retirement account, which are currently around $130k (across IRA and 401k), in the worst case scenario.

Anyhow, I closed my margin account a while back and cashed out the earnings to pay for the MBA, which is very expensive.

Given the same opportunities in the future, I might consider doing this again based on my income levels after business school. I would probably take a slightly different approach to limit my downside risk though. There are actually arbitrate opportunities where you can borrow at a low rate and invest in something safe like BND or vanguard total bond market. Since that is beyond the discussion of this thread, I won't go into that.

thanks for reading.
jcw
 
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Re: Value averaging and MYR -A safer approach to margin?

Postby dodonnell » Sun Dec 23, 2012 12:57 pm

Welcome back.

Yes, your margin account rate was good for your small portfolio size.
It is not as effective as the effective rate achieved using equity index futures:
http://indexarb.com/yieldCurve.html

Your "arbitrage" idea regarding investing excess margin cash (~90% futures) in BND is not arbitrage. You are significantly increasing the risk in your portfolio if you don't use duration matched Treasuries (or 3 month Eurodollar deposits to be more precise). Even then, there are other additional risks you are assuming.

Remember, in fall of 2008, credit risk exploded. The effective borrow rates on futures exploded over 5% from a low around 1% essentially overnight. At the same time, clearing houses raised margin requirements across many futures instruments.

Before you take action on your idea, please go back to 2008/9 and see how different your draw downs would have been from a Bogleheads buy/hold/re-balance portfolio.
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Re: Value averaging and MYR -A safer approach to margin?

Postby jcw » Thu Dec 27, 2012 2:38 am

I do use a core boggle head portfolio (s&p index, total international and total bond). In 2008, I started shifting all my bonds to stocks until I had almost no bonds. I am back at 80% stock to 20% bond now. I have a higher risk tolerance because I don't plan to use that money for 35 years and I am entering the prime earning years of my life (150-250k or more).

Looking back to 2008, I see that BND's largest drop was 10% (from $77 to about $69) and recovered within 3 months. That is not enough to trigger a margin call, even if one were to margin all the way up. BND also continued to pay 3.5% yields. Is there absolutely no interest rate in which you would borrow money to do this? Even at < 1% borrowed?

The way I think about it is to consider best/worst case scenario. The best case scenario, you borrow at about 1.5% and BND returns only 5.5% (instead of the >6% it has been). You pocked 4% on your money borrowed money. Worst case scenario is a 2008 situation. BND drops 10% yields drop to 1.5%. Remember that BND is composed of 30% corporate bonds and 70% treasuries, so it will still have a > 0% yield due to the corporate bond yield. Ok, so the worst case scenario is one in which you get no margin call, and you are breaking even on interest paid vs owed. You can hold on indefinitely until it returns. You would also just start dollar cost averaging your yearly bond portion into the margin account until you are made whole ( you will be slightly tax inefficient until things settle). Base case scenario is probably somewhere in between these two, but you will come out making money. So why is this crazy?
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Re: Value averaging and MYR -A safer approach to margin?

Postby Wolkenspiel » Thu Dec 27, 2012 8:37 am

jcw wrote: The way I think about it is to consider best/worst case scenario. The best case scenario, you borrow at about 1.5% and BND returns only 5.5% (instead of the >6% it has been). You pocked 4% on your money borrowed money. Worst case scenario is a 2008 situation. BND drops 10% yields drop to 1.5%. Remember that BND is composed of 30% corporate bonds and 70% treasuries, so it will still have a > 0% yield due to the corporate bond yield. Ok, so the worst case scenario is one in which you get no margin call, and you are breaking even on interest paid vs owed. You can hold on indefinitely until it returns. You would also just start dollar cost averaging your yearly bond portion into the margin account until you are made whole ( you will be slightly tax inefficient until things settle). Base case scenario is probably somewhere in between these two, but you will come out making money. So why is this crazy?


What would be your exit strategy in a rising interest rate scenario, which could come in many shaped and forms? The BND price would possibly take a prolonged significant hit, while at the same time your borrowing costs would rise significantly. Do you then eat the loss and get out or wait for a turn-around that may not come for years? Surviving a "2008 situation" stress test is a necessary condition for any reasonable strategy, but this is by no means a "worst-case" scenario.
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Re: Value averaging and MYR -A safer approach to margin?

Postby jcw » Fri Dec 28, 2012 1:04 am

My exit strategy would be to fold it into my overall portfolio. BND is just the total bond market and I already hold vanguard total bond in my 401k, so I'd be over weight bonds for a while. I invest about $50k per year across retirement accounts and outside. 20% bonds would give me about $10k. So the bond portion of that investment would just be used to pay back the margin account. Or, I could just borrow $50k out of my 401k (the bond portion) to pay down the margin account. I would then pay myself back the interest into my 401k.

Also, you can lock in a 1.99% fixed rate for 5 years so no risk of rate increase. The margin rates might go up very quickly though, in which case I could pay it back by borrowing against 401k as specified. This would basically be a transfer of my bond allocation from my 401k to the margin account for a period, so very little has really changed except being tax inefficient for a little while. Worst case scenario, I transfer bonds from my 401k to margin account or pay down the account with my yearly investment. Best case scenario, my normal portfolio stays the same and I'm making thousands of dollars off borrowed money and very little work.
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Re: Value averaging and MYR -A safer approach to margin?

Postby jcw » Fri Dec 28, 2012 1:11 am

Also, please give me what you think a "worst" case scenario would be. I am definitely a young investor and I could benefit a lot from the wisdom of this forum. I am humble enough to acknowledge that there is a ton I don't know. After having seen what happened to "market timer" (and he definitely knows much more than I do) with his MYR portfolio, I would never try to be on margin with equities and in a position where I had no exit strategy.

However, unless you think total bond market is going to plummet >50%, I don't see how this is THAT risky. If you do believe that total bond market is going to go down > 50%, then maybe we should be worrying about buying bullets and moving out of the US, because that way lies certain doom for this country.
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Re: Value averaging and MYR -A safer approach to margin?

Postby Wolkenspiel » Fri Dec 28, 2012 6:17 am

jcw wrote:However, unless you think total bond market is going to plummet >50%, I don't see how this is THAT risky. If you do believe that total bond market is going to go down > 50%, then maybe we should be worrying about buying bullets and moving out of the US, because that way lies certain doom for this country.


I was referring to "you will come out making money", not "why is this crazy". I don't think it is crazy, but there are risks you are assuming when trying to exploit the rate differences. Using a fixed rate loan reduces some of them but limits your strategy in time and magnitude (unless you find someone to give you an unsecured, low rate, long term loan - in which case they should just pay you directly). 401k loans are nasty if one runs into repayment problems.
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Re: Value averaging and MYR -A safer approach to margin?

Postby Bongleur » Sat Dec 29, 2012 12:18 am

>401k loans are nasty if one runs into repayment problems.

OTOH, those who don't HAVE a 401k cannot even contemplate this arbitrage. Something is fundamentally wrong with that...
Seeking Iso-Elasticity. | Tax Loss Harvesting is an Asset Class. | A well-planned presentation creates a sense of urgency. If the prospect fails to act now, he will risk a loss of some sort.
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