Leverage Success Stories

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
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whodidntante
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Leverage Success Stories

Post by whodidntante » Sun Aug 28, 2016 11:24 am

Many of us make decisions to direct free cash flow to the purchase of index funds instead of loan paydowns. We also think it's fine to borrow money to buy and hold real estate even though it's a risk asset. Local or national real estate markets can plummet, and there are situations where your real estate becomes less desirable and the value plummets even if there is no shock in the market. But explicit leverage on index funds is often treated as scandalous here. Discussion of leverage is usually met with a chorus of "don't do it" and a mention of market timer's thread.

It occurs to me that I don't know anyone who has or had a leveraged portfolio with meaningful success. It is possible that the same impulse that leads to leveraged investing often leads to highly leveraged investing, and that a lot of these stories end with a crash and burn when the market moves against the investor. But that is a behavioral problem, not a fundamental issue with leverage. How did you implement your leveraged portfolio, and what benefits did you realize? If you stopped, why did you stop? Post your success stories so we can learn from them.

randomguy
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Re: Leverage Success Stories

Post by randomguy » Sun Aug 28, 2016 12:02 pm

I think the time frame for using leverage in an index fund has been pretty short. When you have to pay 8%+ to borrow money, it is hard to make things work out as a long term investor who expects to return say 10% from stocks. Compare that to today where you can borrow at say 1.2% and expect to earn maybe 5-6%. But as you say, you have to use low leverage. 10x+ like markettimer will make you go broke 100% of the time. 25% isn't going to have you go broke very often but you are also only goin got have slightly bigger gains. Over 10+ years that might add up but it will take a while

On the housing front, I made something like 800k by taking out a mortgage over the past 6 years. I would count that as big leverage success story.:)

Dimitri
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Re: Leverage Success Stories

Post by Dimitri » Sun Aug 28, 2016 12:08 pm

I wouldn't say it has necessarily been a great success but I've owned shared in the Aberdeen Asia-Pacific Income Fund (FAX) for quite a few years and reinvested the dividends. It is a closed end fund that is levered 28%.
More info on fund - http://www.funddata.com/abpdf/1253.pdf

I believe there are quite a few levered closed end funds. How they have done on average I'm not sure. Actually, I'm thinking this may not even be the direction you are addressing - it may be those who have invested on the margin in their accounts. If I'm off track please accept my apologies.
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whodidntante
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Re: Leverage Success Stories

Post by whodidntante » Sun Aug 28, 2016 12:28 pm

Dimitri wrote: I believe there are quite a few levered closed end funds. How they have done on average I'm not sure. Actually, I'm thinking this may not even be the direction you are addressing - it may be those who have invested on the margin in their accounts. If I'm off track please accept my apologies.
It qualifies. Any approach where you have more exposure or more capital under your control than the capital you put up is "leverage" in my mind. There are many ways to do that. Futures, margin, loans that are not tied to your investment portfolio, options, leveraged funds, etc.

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packer16
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Re: Leverage Success Stories

Post by packer16 » Sun Aug 28, 2016 12:29 pm

I do have a levered bet on my assets just in a tax and cost efficient manner via a home mortgage. One of the larger differences between a margin loan and a mortgage is the tax deductability of mortgage interest against your ordinary income. This is a tax benefit which can be substantial. Also,if you live in place like I do owning a home is cheaper than renting. So not only save on the rent I get the tax benefit to and I doubt I can the same level of benefits owning my home with no debt and borrowing in a margin account.

I have BTW borrowed against equity mutual funds in the past which has worked out. I have always had low levels against my portfolio (Less than 30%) because I never wanted a margin call I could not make. I stopped when I had a family to support.

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Tamarind
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Re: Leverage Success Stories

Post by Tamarind » Sun Aug 28, 2016 12:32 pm

I suspect the primary difference between the kind of leverage Bogleheads approve of and the kind we warn against is simply the terms of the loan one can get.

A 30-year non-callable mortgage at 3% or 4% is a different proposition than a callable 8% margin loan. If mortgages were callable (as many were before the Great Depression) we would consider them much riskier.

Also, Bogleheads usually do advise against considering primary residence real estate an investment, or even including home equity in net worth calculations, precisely because it is so illiquid.

None of this applies to leveraged funds, where one's own risk is at least limited to going to zero.

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Watty
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Re: Leverage Success Stories

Post by Watty » Sun Aug 28, 2016 12:48 pm

One of the reasons you don't see much mention of using moderate leverage is that is not really necessary unless you want to be overly aggressive.

For example if you have $100K and your desired asset allocation is 20% bonds and 80% stocks you might decide to use 10% leverage and buy another $8K in stocks on margin. That would give you $88K in stocks.

Over all that would give you an asset allocation of

88% stocks
20% bonds
-8% margin loan.

Instead of using the leverage with the margin loan it makes more sense to just change your target asset allocation to 12% bonds and 88% stocks.

There really isn't a good reason to use leverage unless you want to be above 100% stocks but that would way too aggressive for most(all?) situations.

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Toons
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Re: Leverage Success Stories

Post by Toons » Sun Aug 28, 2016 1:00 pm

Borrow money to invest?
Why not just save enough to invest.
That way you don't have to anyone interest on your money.
Why make it more complicated than it needs to be.
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Daryl
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Re: Leverage Success Stories

Post by Daryl » Sun Aug 28, 2016 1:18 pm

I've replaced most of my equity index (mutual fund) holdings with S&P 500 emini futures contracts. The implied financing rate is better than I could get elsewhere (less than 1%). It is a little more work in that I need to roll the contract quarterly and monitor my margin balance.

Swelfie
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Re: Leverage Success Stories

Post by Swelfie » Sun Aug 28, 2016 1:32 pm

I use a great deal of leverage (currently 5.3x).

I also have a portfolio with a 2.08% std dev skewed to the upside and use contributions and dividends to delever on a number of negative economic indicators. Not a fire and forget strategy by any means.

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whodidntante
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Re: Leverage Success Stories

Post by whodidntante » Sun Aug 28, 2016 2:31 pm

Tamarind wrote: A 30-year non-callable mortgage at 3% or 4% is a different proposition than a callable 8% margin loan.
If I had an 8% loan, I would pay that down rather than invest in index funds. There are less expensive methods available. A low cost option is futures contracts, which Daryl said he uses in his post. The risk of a callable loan bringing your house down can be mitigated to some extent by limiting the amount of leverage.

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tfb
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Re: Leverage Success Stories

Post by tfb » Sun Aug 28, 2016 2:40 pm

whodidntante wrote:It occurs to me that I don't know anyone who has or had a leveraged portfolio with meaningful success.
We have this thread in this forum: Should I use margin to buy a balanced fund?

It looks like reasonably successful.
Harry Sit, taking a break from the forums.

Spirit Rider
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Re: Leverage Success Stories

Post by Spirit Rider » Sun Aug 28, 2016 3:28 pm

First, was a case of arbitrage and time shifting of taxable redemptions. In late '99, and early '00 I bought 3.4% I-Bonds using credit cards and then balance transferring them to other cards with 0% promotions. In those days it was easy to find offers with $0 or $75 balance transfer fees. I originally planned on flipping the I-Bonds , but then decided in spring 2000 to keep them and deleverage by selling taxable equities.

Second, I was one of the founders of a startup in 01/2002. Little did we know that Angel and VC money would evaporate following the dot com bust. The founders deferred compensation to only receive approximately minimum wage for 2002 - 2004. Combined with taking advantage of converting to Roth at zero and low tax rates, I was in serious need of cash flow.

Instead of selling equities at market lows, I used a HEL, a HELOC (prime - 1%) , and 0% for life balance transfer offers from Discover, Citibank and Chase for living expenses and Roth Conversion taxes. Paid minimum payment for many years to take advantage of the 0% for life, except for Chase who reneged circa '09/'10. I received a portion of the deferred compensation in 2005/2006, paid off the HELOC and paid off a portion of the HEL. This year I received an even smaller portion of the deferred compensation, but I am unlikely to ever see the remaining 40%.

I view the I-Bonds purchase as an arbitrage play and the loans for living expenses and taxes as just that. However. I realize that money is fungible and I could have sold taxable equiities instead in both cases. So I might be deluding myself because I didn't use margin and invest in more marketable securities.

Random Walker
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Re: Leverage Success Stories

Post by Random Walker » Sun Aug 28, 2016 3:29 pm

This intrigues me. As is probably mentioned in the above referenced thread, when looking at different stock/bond combinations, it is at least theoretically more efficient to lever the combination with the highest sharpe ratio than to increase the % equity in an effort to increase expected returns. Guess this is finance 101, but I never took that so it intrigues me. Of course the borrowing expense means everything.

Dave

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JoMoney
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Re: Leverage Success Stories

Post by JoMoney » Sun Aug 28, 2016 3:39 pm

Watty wrote:One of the reasons you don't see much mention of using moderate leverage is that is not really necessary unless you want to be overly aggressive.

For example if you have $100K and your desired asset allocation is 20% bonds and 80% stocks you might decide to use 10% leverage and buy another $8K in stocks on margin. That would give you $88K in stocks.

Over all that would give you an asset allocation of

88% stocks
20% bonds
-8% margin loan.

Instead of using the leverage with the margin loan it makes more sense to just change your target asset allocation to 12% bonds and 88% stocks.

There really isn't a good reason to use leverage unless you want to be above 100% stocks but that would way too aggressive for most(all?) situations.
I think this probably hits the nail on the head. Even for people with larger equity allocations, rather than lever up to say 117% , if they believe the finance theory, they might just as soon 'tilt' to a more volatile small-cap portfolio that doesn't have the interest or time decay expenses and margin call risks.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

TMCD75
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Re: Leverage Success Stories

Post by TMCD75 » Sun Aug 28, 2016 3:53 pm

Leverage is simply using other people's money to try and make yourself money. It's HUGE in the real estate business, in particular buying rental properties.

I've got a cousin in law, he bought 1.2 million dollars worth of apartments on leverage. He and his partner gave 200k down and then borrowed a cool million to finance the deal. He also is leveraged to the tune of probably another 300k-500k with this partner on other similar projects.

A while back he came to my house and we were talking about this leverage concept. He knew I had some mobey to invest and wanted me to play the leverage game. After drinking a 6 pack of beer together, I told him I'd rather not owe anyone hundreds of thousands of dollars.

I told him I was going to buy two rental houses straight out with cash. He did not like that at all. His point was I could buy 10 houses with the money I had at that time, but it would require lots of risk. What if we have another 2008, or just a recession about half that bad??? Folks with leverage are in dire straits at that point.

qwertyjazz
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Re: Leverage Success Stories

Post by qwertyjazz » Sun Aug 28, 2016 6:35 pm

Swelfie wrote:I use a great deal of leverage (currently 5.3x).

I also have a portfolio with a 2.08% std dev skewed to the upside and use contributions and dividends to delever on a number of negative economic indicators. Not a fire and forget strategy by any means.
Swelfie
I have read your posts with great interest in multiple threads and have pieced together some of the method you have used. But I was wondering if you were willing to write a longer post where you more explicitly lay out your investments and decision making process.

Thank you
QJ
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Stormbringer
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Re: Leverage Success Stories

Post by Stormbringer » Sun Aug 28, 2016 7:22 pm

whodidntante wrote:We also think it's fine to borrow money to buy and hold real estate even though it's a risk asset.
There are substantial differences between leverage on real estate and leverage on a stock portfolio:
  • Real estate values generally aren't volatile in the way that stock market valuations are.
  • There are no margin calls on real estate.
  • Interest on real estate is tax advantaged.
  • Lenders perform due diligence on mortgages (i.e. an appraisal). Your stock broker doesn't care if you buy General Electric or Pets.com.
  • Mortgages on investment properties must be matched with income (rent) that can service the debt.
  • In many states, mortgages are "no recourse" meaning your liability in the event of default is limited to the property itself.
Also, many corporations have substantial debt on their balance sheets, which itself a form of built-in leverage to the shareholders.
"Compound interest is the most powerful force in the universe." - Albert Einstein

randomguy
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Re: Leverage Success Stories

Post by randomguy » Sun Aug 28, 2016 8:39 pm

TMCD75 wrote:Leverage is simply using other people's money to try and make yourself money. It's HUGE in the real estate business, in particular buying rental properties.

I've got a cousin in law, he bought 1.2 million dollars worth of apartments on leverage. He and his partner gave 200k down and then borrowed a cool million to finance the deal. He also is leveraged to the tune of probably another 300k-500k with this partner on other similar projects.

A while back he came to my house and we were talking about this leverage concept. He knew I had some mobey to invest and wanted me to play the leverage game. After drinking a 6 pack of beer together, I told him I'd rather not owe anyone hundreds of thousands of dollars.

I told him I was going to buy two rental houses straight out with cash. He did not like that at all. His point was I could buy 10 houses with the money I had at that time, but it would require lots of risk. What if we have another 2008, or just a recession about half that bad??? Folks with leverage are in dire straits at that point.
No folks with leverage were not in dire straits. Folks with TOO MUCH leverage could have been in dire straits. Where that line is is hard to say and will depend a lot on what they are doing with that money. If they can cut rents by say 30% and still be cash flow positive, I wouldn't worry about their leverage situation. If they are declaring bankruptcy if they have a unit sit vacant for 3 months, they are over leveraged:)

gclancer
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Re: Leverage Success Stories

Post by gclancer » Sun Aug 28, 2016 8:50 pm

I took out student loans not to pay for my education, but to max out my and my spouse's Roth space beginning in 2009. I wouldn't have been able to invest much at all at the time without the use of leverage (to quote the famous market timer thread I was "monetizing future earnings before actually earning them"). Needless to say it worked out quite well. Obviously I acknowledge there was a bit of luck involved, but I also knew what I was doing and knew it could have gone the other way at the time I did it. I don't use leverage anymore, because I don't need to in order to hit my investment account funding goals. I could borrow to invest in taxable but don't. I'll probably pay off my mortgage before investing in taxable (which is admittedly sort of ironic - I got a bit lucky with debt and now I'd consider myself quasi debt adverse).

KlangFool
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Re: Leverage Success Stories

Post by KlangFool » Sun Aug 28, 2016 9:53 pm

OP,

1) I have 30 years mortgage at 3.49%.

2) I have enough investment in my taxable account to pay off my mortgage if I want to.

3) My mortgage payment plus other housing costs are lower than renting.

4) My portfolio annual return is around 5% to 6%.

I guess this is a small success?

KlangFool

Swelfie
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Re: Leverage Success Stories

Post by Swelfie » Mon Aug 29, 2016 12:36 am

qwertyjazz wrote:Swelfie
I have read your posts with great interest in multiple threads and have pieced together some of the method you have used. But I was wondering if you were willing to write a longer post where you more explicitly lay out your investments and decision making process.

Thank you
QJ
Having been doing a lot of deep analysis on treasuries lately, I'm starting to trend towards Rob's method and lever up. In a straight up stock/bond split it really looks like your best sharpe ratio lives somewhere around 5/3/92 Equities/TIPS/Short Term Treasuries. The shorter the better it looks like but unfortunately for futures there is a floor at 2 years, and for ETFs (SHV and BIL) the low expense ratios become significant when measured against the returns. If you could lever 3 month treasuries to the max, the sharpe ratio is ridiculously high.

Unlike Rob, I don't use LTT at all. I'm really questioning whether they ever make sense. TIPS on the other hand seem to be a good asset uncorrelated to others. And I've done a lot of analysis and my portfolio is much more complex than Rob's to maximize uncorrelated assets.

Currently targeting:
2.3% S&P 500 (^ES)
2% Developed (^MXEA)
1% Emerging (^MXEF)
0.5% International Small Cap (VSS)
0.52% Momentum Tilt ETF (MTUM)
1.38% Value Tile (^RLV)
0.92% Mid Cap (^EMD)
0.63% Small Cap (^TF)
85% Short Term Treasuries (^ZT + I count my employer's 401k Stable Value fund as part of this)
5% TIPS (SCHP, or TIP in my TD Ameritrade HSA cuz it's no commission)
0.75% Commodities (DJ-AIGCI plus some Bitcoin and Etherium I have lying around the house. Might do some physical junk silver and a gold coin or two in here. Might even start rolling a short VIX contract. I figure if live cattle goes in this bucket, so does any random fun thing not expected to be correlated with the other stuff).

Did factor analysis on these with a huge correlation matrix. Using CAPE for expected equity returns, bond yield for bond returns, etc, etc to calculate a Std. Dev and two expected returns for the portfolio. Then a backtest gives me another pair. Mixing and matching std. dev and returns I get 6 possible sharpe ratios and corresponding kelly criterions. My most trusted for the portfolio are the calculated taking into account factors:

Est CAGR: 2.17%
Std. Dev: 1.57%
Sharpe: 0.989
Kelly Criterion: 63.13
Expected CAGR at Kelly Gearing: 49.5%

My method is to move my minimum leverage upwards monthly towards this 63.13x gearing, ever slower and slower, at a rate inversely proportional to the VIX and proportional to the distance to that number. If I am below my minimum leverage, I'll buy up to it. If I am above it, then my monthly contributions just buy down leverage. If any of the following is true, then I do not move my floor and I do not buy up to my floor:

VIX in backwardation (Market is melting)
VIX or VXV > 20 (Market is Panicking)
VXV:VIX ratio > 1.4 (Market is thinking about panicking)
US Unemployment higher than 12 month moving average (Market should be thinking about panicking)
Any point in the treasury yield curve inverted. (Money is being weird)

My leverage floor will never go above 30x because if it did, I would be at my goal notional value. 4 of my 6 Kelly Criterions are above this, so I'm pretty comfortable inching my way up there.

When I hit my target notional value, I will just buy down leverage with dividends and contributions from then on, slowly moving the portfolio towards a 60/40 one as the falling leverage reduces risk and retiring the futures and moving into ETFs as I can.

This is split between a brokerage account, Roth IRA, HSA, employer traditional and post tax traditional 401k and my own self directed 401k. All the futures are in the self directed 401k and the Roth IRA so I don't have to pay the capital gains. I'll probably self direct the Roth IRA soon because I forsee needing the room for more leverage (Interactive Brokers triples the margin requirements for IRAs but if I self direct I can use standard brokerage account). I might need to self direct the HSA if I can find a way to do that. I don't take on any actual debt in the 401k or IRA because of the unfavorable tax situation for that, but I could in a pinch, and with this much diversification and portfolio margin, I pretty much double my available funds available for margin. With this low of a std. dev. and the fact that my volatility is skewed to the positive, I just can't see maxing that out without going out above 60x leverage or so which I'm just not going to do, plus I'm contributing a great deal to this monthly. No model I can think to run can hurt this thing short of the market literally going to zero, in which case we are all screwed. I'm comfortable slowly ramping it up, and then slowly bringing it down. I'd ramp up to 25x or so faster but I really don't like this treasury environment so I'm camping down in the 5x range and following my slow ramp up plan. At my current leverage my expected returns are the same as a 100% equities portfolio but with more of the risk of a 60/40 portfolio, since really I'm about 50/450 Equities/STT.

Rob should have higher returns at the same gearing because he's got those long term treasuries and I sacrificed more return for more uncorrelated assets. My 5% TIPS are going to weigh me down unless inflation comes out of no where, but they really make this thing bulletproof in backtesting. (And someone needs to offer a TIPS future btw).

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in_reality
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Re: Leverage Success Stories

Post by in_reality » Mon Aug 29, 2016 1:31 am

I have munis in leveraged CEFs. Too early to say how it'll work but they are up about 14% YTD which is about when I started.

If I understand from Rob's thread on balanced funds, the loss of NAV from interest rate rises will scale linearly with leverage, but the time to recovery is still the same (with financing being a possible drag on returns depending on the yield curve).

Anyway, I'm neck deep in very short term duration holdings due to my wife's work which I don't control, so adding this in brings us close to return and duration of total bond (actually that is scaling duration with leverage which Rob suggests isn't the case for time to recovery and so my time to recovery is probably shorter than I expect ...who knows...).
Last edited by in_reality on Mon Aug 29, 2016 4:21 am, edited 1 time in total.

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Portfolio7
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Re: Leverage Success Stories

Post by Portfolio7 » Mon Aug 29, 2016 3:42 am

First post here. To the extent this is relevant, we burned through savings then opened a Heloc to allow us to continue to make 401K contributions and buy into a business, during a period when cash flow was tight for a number of years. We have about $45K in Heloc debt at around 3.5% that's been earning about 7% behind the tax wall the past 3 years, and part of it went into a business that's generating double digit returns, and now a healthy stream of cash flow.

We actually have the Heloc, a business loan, a car loan, and a Mortgage (with a 2nd home we bought for relatives that's paid off), and income of two salaries and disbursements from the business - I can't say we are a success yet, but we're turning the corner. We passed the $1M NW threshold, but still have a lot of debt. Worst case scenario, we could sell the house and pay off every penny, and have enough left over to fund basic living expenses until our tax advantaged funds were available. We saved a lot age 25-35, then from about age 35-45 we incurred debt, but in our minds we were arbitraging it, throwing every penny we could into investments/business. All our debt is 2% to 3.5% except one business loan of 6% that we're targeting now. 22 years of investing, CAGR of 9.6% (my portfolio is something like Bernstein's 'madonna portfolio'), and the business investment IRR projected to exceed 30% over 7 years, not counting our ownership stake when we eventually sell. I think the arbitrage has been pretty successful. Now that cash flow is improving, we will let time do it's job while we pay off debt as aggressively as we can (and help the kids with college) for the next 10 years.
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qwertyjazz
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Re: Leverage Success Stories

Post by qwertyjazz » Tue Aug 30, 2016 10:50 am

Swelfie
Interesting
Thank you
QJ
G.E. Box "All models are wrong, but some are useful."

SouthernCPA
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Re: Leverage Success Stories

Post by SouthernCPA » Tue Aug 30, 2016 12:47 pm

Stormbringer wrote:
whodidntante wrote:We also think it's fine to borrow money to buy and hold real estate even though it's a risk asset.
There are substantial differences between leverage on real estate and leverage on a stock portfolio:
  • Real estate values generally aren't volatile in the way that stock market valuations are.
  • There are no margin calls on real estate.
  • Interest on real estate is tax advantaged.
  • Lenders perform due diligence on mortgages (i.e. an appraisal). Your stock broker doesn't care if you buy General Electric or Pets.com.
  • Mortgages on investment properties must be matched with income (rent) that can service the debt.
  • In many states, mortgages are "no recourse" meaning your liability in the event of default is limited to the property itself.
Also, many corporations have substantial debt on their balance sheets, which itself a form of built-in leverage to the shareholders.

+1. I'd also add that typically when people leverage investment properties, the property can still produce the same income (lease agreements) even with fluctuating market prices and continue to service the debt.

Tanelorn
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Re: Leverage Success Stories

Post by Tanelorn » Tue Aug 30, 2016 12:53 pm

I reached financial independence years earlier than I would have without the additional returns from leverage. Being able to find lower risk investments and cheap financing are both important aspects to this. Not an approach I generally recommend to others.

Beliavsky
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Re: Leverage Success Stories

Post by Beliavsky » Tue Aug 30, 2016 2:48 pm

Swelfie wrote:
qwertyjazz wrote:Swelfie
I have read your posts with great interest in multiple threads and have pieced together some of the method you have used. But I was wondering if you were willing to write a longer post where you more explicitly lay out your investments and decision making process.

Thank you
QJ
Having been doing a lot of deep analysis on treasuries lately, I'm starting to trend towards Rob's method and lever up. In a straight up stock/bond split it really looks like your best sharpe ratio lives somewhere around 5/3/92 Equities/TIPS/Short Term Treasuries. The shorter the better it looks like but unfortunately for futures there is a floor at 2 years, and for ETFs (SHV and BIL) the low expense ratios become significant when measured against the returns. If you could lever 3 month treasuries to the max, the sharpe ratio is ridiculously high.
You can buy Eurodollar futures to access the part of the yield curve shorter than 2 years. When you say 3-month T-bills have a very high Sharpe ratio, what are you assuming the funding rate to be? The yield of 1-month T-bills?

Beliavsky
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Re: Leverage Success Stories

Post by Beliavsky » Tue Aug 30, 2016 2:51 pm

whodidntante wrote:It occurs to me that I don't know anyone who has or had a leveraged portfolio with meaningful success. It is possible that the same impulse that leads to leveraged investing often leads to highly leveraged investing, and that a lot of these stories end with a crash and burn when the market moves against the investor. But that is a behavioral problem, not a fundamental issue with leverage. How did you implement your leveraged portfolio, and what benefits did you realize? If you stopped, why did you stop? Post your success stories so we can learn from them.
Warren Buffett has liked to own insurance companies in part so he could invest the "float". This could be viewed as a form of leveraged investing, and it has worked extremely well for him and his shareholders.

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JoMoney
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Re: Leverage Success Stories

Post by JoMoney » Tue Aug 30, 2016 3:22 pm

Beliavsky wrote:
whodidntante wrote:It occurs to me that I don't know anyone who has or had a leveraged portfolio with meaningful success. It is possible that the same impulse that leads to leveraged investing often leads to highly leveraged investing, and that a lot of these stories end with a crash and burn when the market moves against the investor. But that is a behavioral problem, not a fundamental issue with leverage. How did you implement your leveraged portfolio, and what benefits did you realize? If you stopped, why did you stop? Post your success stories so we can learn from them.
Warren Buffett has liked to own insurance companies in part so he could invest the "float". This could be viewed as a form of leveraged investing, and it has worked extremely well for him and his shareholders.
In a certain light, even Buffett's initial "partnership" was a carefully structured leveraging of his talents in the securities market.
From what I've read, it was initially formed with Buffett putting up a $100 along and the others putting in more than $100,000.
Buffett agreed to pay 4% in interest on the prior years balance, + 50% of the investment returns above the 4%.
Some might call it a fee structure, but I think it can be seen as a clever use of other peoples money to leverage his talents. The money he earned from that arrangement certainly helped seed his 'snowball' of wealth.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

garlandwhizzer
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Re: Leverage Success Stories

Post by garlandwhizzer » Tue Aug 30, 2016 7:23 pm

Leverage success stories certainly exist. So do leverage failure stories. Bankruptcy court is a good place to find leverage failure stories especially with high levels of leverage. I personally know of folks who were once got rich off real estate investing but got over leveraged into bubble real estate in coastal California and were totally wiped out in the collapse of 2008-9. I believe that those who use leverage with net success over long periods of time tend to be knowledgeable, savvy, and experienced. Those who do not have these qualities are in my view unlikely to successfully manage leverage's excess risk on a long term basis. Most of us have difficulty handling the risk of a non-leveraged portfolio. Winning once or twice with leverage may be luck just as a coin can turn up your call of heads twice in a row. Hedge fund managers that were once hot commodities but subsequently went bust know all about that. Winning with leverage over a long run of time well in excess of losses is, I suspect, rare. Most of us on this Forum are in my view well advised to avoid leverage.

Garland Whizzer

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unclescrooge
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Re: Leverage Success Stories

Post by unclescrooge » Tue Aug 30, 2016 7:56 pm

whodidntante wrote:
Dimitri wrote: I believe there are quite a few levered closed end funds. How they have done on average I'm not sure. Actually, I'm thinking this may not even be the direction you are addressing - it may be those who have invested on the margin in their accounts. If I'm off track please accept my apologies.
It qualifies. Any approach where you have more exposure or more capital under your control than the capital you put up is "leverage" in my mind. There are many ways to do that. Futures, margin, loans that are not tied to your investment portfolio, options, leveraged funds, etc.
Another vote for leveraged Closed-End Funds.

I have a portfolio of leveraged investment-grade muni CEFs that have done exceedingly well over the past 3 years. I've been buying them at a discount, selling them when they reach par, and reinvesting the coupons.

But 30% over three years could be due to luck as well. YMMV.

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Re: Leverage Success Stories

Post by unclescrooge » Tue Aug 30, 2016 8:06 pm

garlandwhizzer wrote:Leverage success stories certainly exist. So do leverage failure stories. Bankruptcy court is a good place to find leverage failure stories especially with high levels of leverage. I personally know of folks who were once got rich off real estate investing but got over leveraged into bubble real estate in coastal California and were totally wiped out in the collapse of 2008-9. I believe that those who use leverage with net success over long periods of time tend to be knowledgeable, savvy, and experienced. Those who do not have these qualities are in my view unlikely to successfully manage leverage's excess risk on a long term basis. Most of us have difficulty handling the risk of a non-leveraged portfolio. Winning once or twice with leverage may be luck just as a coin can turn up your call of heads twice in a row. Hedge fund managers that were once hot commodities but subsequently went bust know all about that. Winning with leverage over a long run of time well in excess of losses is, I suspect, rare. Most of us on this Forum are in my view well advised to avoid leverage.

Garland Whizzer
Back in 2006, I knew this couple in their late-40s through a real estate investment club. They had $2 million in equity across several properties and they both worked in real estate.

I had bought over a dozen properties in another state, and they wanted me to hook them up with my agents and property managers. I did, but I told them I was starting to liquidate everything and strongly advised them to do the same, pay the taxes and sit on their thumbs. They ignored that advice and went ahead anyway.

Eventually in 2008 they lost their jobs and all their equity.

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whodidntante
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Re: Leverage Success Stories

Post by whodidntante » Sun Sep 04, 2016 4:42 pm

Thank you for your posts on this topic. I have been considering how to enact leverage for my own investments, i.e., beyond not prepaying my mortgage. Futures seem an attractive instrument, so I will start by learning how to use futures to implement exposure. However, a side benefit is apparent with futures. The low implied financing rate for futures as well as the low requirements for performance bonds means you can earn some money by investing the rest of your exposure elsewhere. Currently, even a bank CD would be profitable after tax.

Since I am completely new to futures, I will start small, by buying a single futures contract, most likely MSCI Emerging (MXEF). Though futures contracts are not granular, so “small” is relative. I will have funds readily available sufficient to cover 100% of my exposure in this learning phase. This is so I can be sure I understand futures, rolling over the contracts, etc.

Are there any things you wish you had known before buying your first futures contract?

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Re: Leverage Success Stories

Post by Daryl » Sun Sep 04, 2016 5:50 pm

whodidntante wrote:Are there any things you wish you had known before buying your first futures contract?
Taxes - Are you getting started with a taxable account, or some type of tax deferred / tax free investment vehicle? Different brokers have different margin requirements.

What is your plan for the inevitable margin call? Are you going to be forced out of your position on a really bad day?

Liquidity - With futures contracts, there is a little more active trading. Most contacts expire quarterly so you may want to stick with contracts with tight bid/ask spreads. The S&P 500 emini is an example of a fairly liquid futures contract.

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Re: Leverage Success Stories

Post by Watty » Sun Sep 04, 2016 7:21 pm

Someone with a user ID of "who didn't ante" and and avatar of cards who wants to use margin to buy futures.


I would guess that you know that you are just making bets and the odds favor the house.

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JoMoney
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Re: Leverage Success Stories

Post by JoMoney » Sun Sep 04, 2016 7:52 pm

What makes you think now is the time to go 'all in' (and then some) into the market? I ask because so many are complaining about high valuations, we've had a bit of a bull run, some even point out that we're 'due' for a cyclical down-turn.
Unless you're planning on maintaining a constant mix balance of a certain percentage of the portfolio, there is a bit of 'market-timing' element implicit with this. If you are planning on rebalancing to maintain a constant amount of leverage, can I ask what % you're looking at, and how you came up with that number? Have you looked at the drag this puts on a portfolio (for example the complaints about the daily re-balanced 2x and 3x levered ETF's ) ?
If you're not planning on keeping the risk 'balanced' do you have a loss amount in mind that you'd be willing to get up to before calling it quits, or would you just wait for a margin call, or keep chasing it adding more money trying to keep your head above water before the margin gets called?

I'm not recommending it, and I know it's not necessarily as 'cheap' as futures, but have you looked at using options? There is a 'time decay' cost but they're more widely available, can be traded in smaller $ amounts, and don't require a margin account - you can buy a deep in the money option on SPY or other ETF's (or some Indexes directly) and also get into a leveraged position with no possibility of a margin call (but maybe potential issues if you get near expiration, are underwater, and cant afford to roll into a new equivalent contract).
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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whodidntante
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Re: Leverage Success Stories

Post by whodidntante » Sun Sep 04, 2016 9:18 pm

Daryl wrote:
whodidntante wrote:Are there any things you wish you had known before buying your first futures contract?
Taxes - Are you getting started with a taxable account, or some type of tax deferred / tax free investment vehicle? Different brokers have different margin requirements.
I will be doing this in a taxable account at IB. I'm aware that performance bond requirements varies among brokers at that brokers will tighten the requirements in periods of volatility.
Daryl wrote: What is your plan for the inevitable margin call? Are you going to be forced out of your position on a really bad day?
The goal right now is to use futures to implement exposure. I will keep cash sufficient to cover my entire exposure now. A margin call is not inevitable and I don't see how it could happen with this approach.

I don't plan to ever use margin to cover the performance bond. In the future, I may eventually take a position that I don't have cash to cover if the market moves against me, and I understand it eventually will, so I'm not going to leverage more than I am comfortable with.
Daryl wrote: Liquidity - With futures contracts, there is a little more active trading. Most contacts expire quarterly so you may want to stick with contracts with tight bid/ask spreads. The S&P 500 emini is an example of a fairly liquid futures contract.
Thanks. I will check the bid/ask spreads before I buy the contract. My preference for EM futures is to maintain my desired asset allocation. To rebalance I would need to sell off TSM and I would owe substantial capital gains. I will have to look at what is best.
Last edited by whodidntante on Sun Sep 04, 2016 9:24 pm, edited 2 times in total.

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Re: Leverage Success Stories

Post by whodidntante » Sun Sep 04, 2016 9:21 pm

Watty wrote:Someone with a user ID of "who didn't ante" and and avatar of cards who wants to use margin to buy futures.


I would guess that you know that you are just making bets and the odds favor the house.
I'm not planning to use margin to buy the futures.

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Re: Leverage Success Stories

Post by whodidntante » Sun Sep 04, 2016 9:22 pm

JoMoney wrote:What makes you think now is the time to go 'all in' (and then some) into the market? I ask because so many are complaining about high valuations, we've had a bit of a bull run, some even point out that we're 'due' for a cyclical down-turn.
I don't plan to go all-in at all. I will write down a specific strategy if I decide to take on more exposure than I have the cash to cover. For now, my goal is to gain exposure through futures.

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Re: Leverage Success Stories

Post by Daryl » Sun Sep 04, 2016 9:32 pm

whodidntante wrote:
Daryl wrote:
whodidntante wrote:Are there any things you wish you had known before buying your first futures contract?
Taxes - Are you getting started with a taxable account, or some type of tax deferred / tax free investment vehicle? Different brokers have different margin requirements.
I will be doing this in a taxable account at IB. I'm aware that performance bond requirements varies among brokers at that brokers will tighten the requirements in periods of volatility.
Daryl wrote: What is your plan for the inevitable margin call? Are you going to be forced out of your position on a really bad day?
The goal right now is to use futures to implement exposure. I will keep cash sufficient to cover my entire exposure now. A margin call is not inevitable and I don't see how it could happen with this approach.

I don't plan to ever use margin to cover the performance bond. In the future, I may eventually take a position that I don't have cash to cover if the market moves against me, and I understand it eventually will, so I'm not going to leverage more than I am comfortable with.
Daryl wrote: Liquidity - With futures contracts, there is a little more active trading. Most contacts expire quarterly so you may want to stick with contracts with tight bid/ask spreads. The S&P 500 emini is an example of a fairly liquid futures contract.
Thanks. I will check the bid/ask spreads before I buy the contract. My preference for EM futures is to maintain my desired asset allocation. To rebalance I would need to sell off TSM and I would owe substantial capital gains. I will have to look at what is best.
I want to make sure I understand what you are saying: You plan to have a taxable account with futures trading privileges with one or more futures contracts and a cash balance equal to or greater than the notional value of those contracts.

This strategy will lag behind the equivalent index fund by approximately the sum of: the bid/ask spread, the implied futures financing rate, trading commissions, short-term capital gains, and maybe a couple other things I'm not considering. You won't have to pay the expense ratio on the mutual fund, but I'm sure we can find you an excellent fund that is much cheaper than the proposed futures strategy.

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Re: Leverage Success Stories

Post by Pajamas » Sun Sep 04, 2016 10:20 pm

I have been successful using leverage in my primary brokerage account for several decades but I don't invest in index funds in that account. The current margin interest rate is 2.75 % and margin interest is deductible, so it is not hard to make the numbers work with investments with a higher return.

To put it in perspective, I do not have any other loans (including no mortgage) and have a fairly high risk tolerance. I prefer not to use too much margin and have been decreasing the amount over the last couple of years as holdings have been sold as my risk tolerance has decreased. Right now the margin is under 20% of the account value and it will be even lower later this year when I sell some more holdings.

Some investments already use leverage in the business, so that has to be taken into account. REITs, for instance, can already be heavily leveraged and there are other industries that use a lot of leverage. Of course any company that issues bonds or preferred stock or has a credit facility is probably leveraged to some degree but I don't know how leveraged the companies in the S&P 500 are as an average. Companies like Apple sitting on so much cash are the exception.

Judicious use of leverage is good practice, both for most businesses and for some individuals. I believe that using margin is in some ways less risky than carrying a mortgage because the underlying assets that secure the loan are very liquid and the loan can be repaid in less than a minute if the markets are open.

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Re: Leverage Success Stories

Post by fleebjuice » Sun Sep 04, 2016 10:22 pm

I have only implemented my leveraged strategy for about 2.5 years, so it's far too early to call it a success, but so far it has performed as expected and thus is at least not (yet) a failure.

I have an IB margin account where, twice a month, I deposit $X and buy $2*X worth of (largely Vanguard) index funds. I reinvest dividends without further levering them up. This is obviously in a taxable account, and includes only retirement funds. The plan is essentially to keep doing this until some tbd number of years before retirement. My current leverage ratio in that account is 1.79:1 (having drifted down due to appreciation), but most of my retirement funds are in tax-advantaged plans/accounts where I do not employ leverage. My overall portfolio is at 1.28:1. All equity index funds.

No surprises in operation thus far, but with at least US indices at their peaks a test might be approaching.
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Re: Leverage Success Stories

Post by Stormbringer » Mon Sep 05, 2016 3:55 am

Warren Buffett wrote:When leverage works, it magnifies your gains. Your spouse thinks you’re clever, and your neighbors get envious. But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade – and some relearned in 2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.
Source: http://www.berkshirehathaway.com/2010ar/2010ar.pdf

I'm not a huge fan of leverage. I saw several close friends get wiped out in 2008-2009, and others teetered on the edge because of debt. I bought two investment properties at the Sheriff's sale this year -- each the wreckage from someone else's failed experiment with leverage. Admittedly I employed more of it in my real estate investments when I was young, poor and had a higher tolerance for risk. Now for the most part I strive to keep the debt on my balance sheet to a minimum.

Just the topic, "Leverage Success Stories" makes me cringe, because it implies that the OP isn't interested in hearing about failures, only anecdotes that reinforce his own biases and conclusions. It is easy to get enthused about the potential upside, but the smart investor devotes far more energy to understanding the risks.
"Compound interest is the most powerful force in the universe." - Albert Einstein

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Re: Leverage Success Stories

Post by Park » Mon Sep 05, 2016 6:39 pm

When I initially used leverage, it was successful.

Later on, it hurt me. To illustrate, I received an email from my brokerage stating that I was close to a margin call. If I hadn't used my backup line of credit, I would have gotten a margin call.

It was more than just the email. The market was down, and I wanted to buy. But I was worried about a possible margin call, and that prevented me from buying low. Also, I sold, once again to prevent a margin call. I didn't lose money on the sale, but the sale would have been much more profitable if I had delayed it for several months.

What happened? Leverage can be addictive, and it was to me.

Do I still believe in leverage? Yes, and I intend to use it in the future.

The lesson I learned, and maybe others reading this thread will also, is to keep leverage moderate. In my case, I use margin, and intend to use no more leverage than will let me ride out a minimum 70% decline in my portfolio.

The problem with leverage is volatility drag. When the market goes up 50%, a portfolio levered 2X goes up 100%. When the market goes down 50%, a portfolio levered 2X is gone. So a moderate amount of leverage helps, but as you increase it, it hurts you.

I'd like to make a few other points. When leverage comes up on this board, someone usually quotes Warren Buffett. He has made critical comments about leverage. But if you surf the net, you'll find a paper which found that he was levered 1.6X.

About levering stock/bond portfolios as opposed to stock only portfolios, it doesn't make sense for me. I use leverage in a taxable account. With stocks and tax deductible margin interest, my pretax return on stocks can be lower than the pretax cost of margin. But on a posttax basis, I can come out ahead. That's not possible with bonds. In a tax advantaged account, a better case can be made for levering stock/bond portfolios. But the only source of leverage, which might work in a tax advantaged account, is futures. I've never traded futures. But the people on this board who do so usually mention American stock market futures. At its present valuation, I don't want to lever the US stock market.

As for futures and margin, futures have a lower rate of interest than margin. In the very unusual situation where you can borrow at Interactive Broker's lowest margin rate, I believe that the margin rate is similar to that of futures.

However, futures may be less tax efficient than margin. First of all, there is little deferral of cap gains with futures. Secondly, the cost of borrowing using margin gives me a 45% tax deduction, but I get no tax deduction with futures. Anyone using leverage has to consider the possibility that interest rates will significantly rise. IB uses the Federal Funds rate of 0.4% as its benchmark. IB's highest margin rate is 1.5% greater than the benchmark. The Federal Funds rate reached a peak of around 19% in 1981. 19 + 1.5 gives a rate of 20.5%. That's higher than 19 + 0.1 or 19.1% on futures (I believe that the implied interest rate in futures is around 0.5% presently). But that 20.5% gives me a tax deduction of 45%, so my aftertax interest rate is 11.3%. The aftertax rate on futures is still 19.1%.

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whodidntante
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Re: Leverage Success Stories

Post by whodidntante » Mon Sep 05, 2016 6:58 pm

Daryl wrote: I want to make sure I understand what you are saying: You plan to have a taxable account with futures trading privileges with one or more futures contracts and a cash balance equal to or greater than the notional value of those contracts.

This strategy will lag behind the equivalent index fund by approximately the sum of: the bid/ask spread, the implied futures financing rate, trading commissions, short-term capital gains, and maybe a couple other things I'm not considering. You won't have to pay the expense ratio on the mutual fund, but I'm sure we can find you an excellent fund that is much cheaper than the proposed futures strategy.
I will buy one futures contract since my primary purpose is to learn to trade and rollover futures contracts. I will keep enough to cover the performance bond + a small buffer at IB, monitor the market, and transfer additional money in to cover losses or an increase in the performance bond requirement. I will have funds available to cover the exposure. Any borrowing will be transitory.

I don't believe your comment about costs is correct in every situation. It is feasible to have marginally lower costs with futures compared to the least expensive ETF. The marginal analysis will depend on what the market does, since futures and ETFs are taxed differently, and also on the return I get from the capital that I keep in reserve to cover my exposure.

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Re: Leverage Success Stories

Post by Daryl » Mon Sep 05, 2016 9:15 pm

I misunderstood you. I thought that cash >= notional value of the contract. I now see that that isn't the case, and that you plan to seek some return with the cash in excess of the margin requirement.

If you are interested in learning about futures and would like to practice trading / rolling, most of the brokers offer "paper money" accounts. You can practice for a quarter or two before committing real money.

I agree that futures can be cheaper than the equivalent ETF, but I'd be very concerned about implementing your strategy in a taxable account. Most of the investment return of an ETF would qualify for long term capital gains tax rates. This is a very strong argument in favor of ETFs!

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Re: Leverage Success Stories

Post by HomerJ » Mon Sep 05, 2016 10:54 pm

whodidntante wrote:Post your success stories so we can learn from them.
I know a few people who got lucky picking individual stocks... Should we post those stories too?

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Re: Leverage Success Stories

Post by HomerJ » Mon Sep 05, 2016 10:57 pm

tfb wrote:
whodidntante wrote:It occurs to me that I don't know anyone who has or had a leveraged portfolio with meaningful success.
We have this thread in this forum: Should I use margin to buy a balanced fund?

It looks like reasonably successful.
Sure, it looks reasonably successful since the market hasn't crashed yet.

I will admit it may even survive a crash, because it's not too crazy... but no leverage strategy can be said to be "successful" until it experiences a crash.

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Re: Leverage Success Stories

Post by HomerJ » Mon Sep 05, 2016 11:02 pm

whodidntante wrote:Since I am completely new to futures, I will start small, by buying a single futures contract, most likely MSCI Emerging (MXEF).
The absolute worst thing will be if you make money on your "small" investments...

You'll probably think it's because you're good, instead of lucky, and you'll start investing "big" in futures.

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