Generating income on margin to avoid paying margin interest

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Generating income on margin to avoid paying margin interest

Postby diddleman » Fri Mar 17, 2017 4:18 am

Hi there,
I've been using this forum on and off over the past couple years and have found it to be a great resource, thank you all for contributing various points of view and pointers to things I didn't even know existed.

A few months ago I bought my first home, an expensive ($1.5m) condo and decided to not pay any cash out of pocket to make the 30% downpayment. I opened a margin account with Interactive Brokers and transferred ~$3m in stocks and borrowed the $450k for my downpayment from there. This helped me avoid realizing capital gains. I'm slowly selling this stock and investing into a diversified ETF-based portfolio, but I'm trying to stay under ~400k AGI in order to avoid being in a high tax bracket and paying 20% capital gain taxes and phasing out deductions too much.

IB charges me $664/mo in interest (1.77% on $450k, even though I guess the rate is going to go up this year, it's still super competitive). My goal is to keep this balance for 2-3 years and then start to pay it off by selling stocks more aggressively. In the mean time, I'm just paying the interest and I've been looking for ways to not actually have to pay it out of pocket either.

Just to be clear, I have not used margin to invest with leverage. So my portfolio would have to tank 80% before I get a margin call ($3m -80% = $600k, minus $450k of loan = $150k of equity left, and $150k is 25% of $600k, and margin requirement is 25%).

I'm not a day trader and don't aspire to become one. My investment strategy is mostly just buy-and-hold. I've been looking into preferred stocks in order to generate some income taxed at 15% that I could use to pay the interest on the margin loan. For example I could borrow another $100k to buy $200k of preferreds on margin (now my portfolio would have to tank 77.08% before I get a margin call) and if the preferreds yield 5-6% after tax, that's enough to pay off my interest on the loan and even shrink the balance a bit each year. I haven't bought any preferreds yet as I was waiting to see how the FOMC was going to increase the interest rates, which will probably drive down the price of preferreds a bit.

I've read a few posts on this forum that cooled me down with respect to preferreds (e.g. this post, which linked to an interesting article; and there's, of course, the wiki), so I'd like to hear about other strategies to avoid having to regularly pay interest on this loan for the next 2-3 years, without generating too much income taxed as regular income.

Thanks in advance.

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Joined: Fri Mar 17, 2017 3:34 am

Re: Generating income on margin to avoid paying margin interest

Postby diddleman » Mon Mar 20, 2017 3:05 am

I spent some more time researching this and I still find the preferred stocks compelling, despite their caveats. I'm planning to stick to preferreds issued by big financials, such as BCS-D, HSEB, DKT, C-P. They trade slightly above par and are non-cumulative but the returns are great and credit ratings solid (for preferreds at least).

Bad idea?

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Re: Generating income on margin to avoid paying margin interest

Postby monsterid » Mon Mar 20, 2017 3:20 am

I don't hate it. It's obviously a "more advanced" funding strategy.

I have access to a $200k personal line with my bank at 75bp over LIBOR at any time. It's super hard to ignore a cost of capital that low when looking at potential investments.

Goes without saying adding leverage to any investment adds financing risk. At 70-80% LVR I'd be ok sleeping at night, others may not.

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Re: Generating income on margin to avoid paying margin interest

Postby Valuethinker » Mon Mar 20, 2017 4:04 am

I honestly didn't realize that there were people who still bought stocks on margin.

I mean, at an intellectual level I knew that, but an emotional one, I just assumed no one would actually do this.

I grew up on tales of people wiped out on margin in 1929. I lived through the 1987 stock market crash (-19% in *one day*). And 2 bear markets of at least 30% since (2000-3; 2008-9).

Plus of course people with negative equity on their houses -- always fun. Or people who had borrowed money against their houses to buy stocks (2000-03; but also mining & energy stocks in the early 1980s).

Preference shares? I've seen so many of these get crushed-- dividend stopped then wiped out in the restructuring. We are not Warren Buffett.

Of course there's spread betting, which is much the same thing. But the people I know who made big money in spread betting *worked* for spread betters, not were clients of spread betters.

If I am not being clear, in the jargon when you trade on margin you are short volatility. And the house (aka your brokerage firm) is long volatility.

Who do you think tends to win on that trade in the long term?

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Re: Generating income on margin to avoid paying margin interest

Postby diddleman » Mon Mar 20, 2017 11:21 am

monsterid, that sounds like a great deal. Can you share a bit more about the terms of this personal line with your bank? I looked at various other alternatives like pledged asset lines, but I haven't found a deal as good as LIBOR+75bp even when pledging $3m.

Valuethinker, you're absolutely right, this can be a dangerous game. I did the math and I'm certain that a crash of -19% in one day or a bear market of 30% or even worse a flash crash of 60% would not put me in the red. As long as my margin requirement remains 25%, that is. This is the biggest unknown to me: the broker could decide at any time for any reason to increase the maintenance margin requirement. Should this happen I can decide how to react based on the circumstances. I could sell some stocks, put in some cash, ACAT more assets if I have at least 3 business days, or any combination thereof. Either way, it could hurt, but I would never borrow enough that they could wipe me out.

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