Understanding margin: buying high and selling low

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MetaPhysician
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Understanding margin: buying high and selling low

Post by MetaPhysician »

Hello,

For margin investing, I've been told that it forces one to 'buy high and sell low' in order to keep the desired leverage amount.

Of course, this is the opposite of the golden mantra of 'buy low and sell high.'

I have three questions

1) Therefore, is buying or selling to return to the desired leverage amount merely for risk management?

2) What is the 'ideal' scenario for margin? I imagine taking the most amount of leverage on a lump sum and then seeing it go up. I know that for standard non-margin investing it is 'best' if the market tanks when one is young so they may acquire more assets along the way and then pray that at the end near retirement the asset increases dramatically in value.

3) (The real question) When using margin and if the underlying asset goes down the amount leveraged goes UP, of course. So one could either sell (sell when low) or purchase new assets to lower the leveraged amount. Does the latter replicate the ideal scenario in #2 wherein a young person loads up on assets when they are cheaper?

Thank you, Bogleheads for sharing your wisdom. :sharebeer

PS Happy Fathers Day
PPS This is for theory. With all due respect I am not interested in a comment along the lines of "if you don't understand this you shouldn't be using margin" or "this marks peak irrational exuberance"
hithere
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Re: Understanding margin: buying high and selling low

Post by hithere »

My approach to margin is leveraging so little that I don't get margin called during a decline. A leverage ratio of 1.05x at the ATH is what I aim for. As the market declines, the leverage ratio increases on its own, but not so much that I have to take action. And I don't, I leave it do its thing. I only interfere once a year if the market goes higher than the current ATH and hence my leverage ratio dips below 1.05x - in that case I just buy more equity on margin to rebalance the leverage.

1.05x is quite conservative, and for a reason. I'm taking into account possible margin requirement and interest rate increases, as well as a possible bad sequence of returns over the next decades. And I can't afford to lose all of my money. With that being said, I might decide to increase my leverage if the market continues dipping.

I don't sell low, but you could argue that I buy high. That isn't an issue though, I still get the leverage effect that I strive for.
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firebirdparts
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Re: Understanding margin: buying high and selling low

Post by firebirdparts »

MetaPhysician wrote: Sat Jun 18, 2022 5:22 pm Hello,

For margin investing, I've been told that it forces one to 'buy high and sell low' in order to keep the desired leverage amount.

Of course, this is the opposite of the golden mantra of 'buy low and sell high.'

I have three questions

1) Therefore, is buying or selling to return to the desired leverage amount merely for risk management?

2) What is the 'ideal' scenario for margin? I imagine taking the most amount of leverage on a lump sum and then seeing it go up. I know that for standard non-margin investing it is 'best' if the market tanks when one is young so they may acquire more assets along the way and then pray that at the end near retirement the asset increases dramatically in value.

3) (The real question) When using margin and if the underlying asset goes down the amount leveraged goes UP, of course. So one could either sell (sell when low) or purchase new assets to lower the leveraged amount. Does the latter replicate the ideal scenario in #2 wherein a young person loads up on assets when they are cheaper?

Thank you, Bogleheads for sharing your wisdom. :sharebeer

PS Happy Fathers Day
PPS This is for theory. With all due respect I am not interested in a comment along the lines of "if you don't understand this you shouldn't be using margin" or "this marks peak irrational exuberance"
These are great fundamental questions.
1. I say absolutely yes. However, you're not forced to increase risk. You can, but you're not forced to. You're forced to decrease it.
2. To me, the ideal scenario is that you have some way to deal with this other than it has to work. That is tough. If you have some money to bail yourself out, then you weren't actually leveraged. In "lifetime portfolio leveraging" (I forget what they call that) the alternative is you are young and you can start over. That may be reasonable, but it's not going to feel good. As you know, the 3x ETF's and some similar derivatives don't require any risk management at all, so they can also be a version of "ideal". Leveraged stocks + bonds makes some sense, but not much right now. With short term bonds, you don't earn anything, so the temptation is 20X leverage instead of 3. With long term bonds, well, you know rates are going up already. FWIW.
3. I don't get it. If you have the ability to purchase new assets, then you weren't actually leveraged. See #2. You could decide to decrease risk in the portfolio by taking out a mortgage, risking up your personal life. I'm not sure what you had in mind.
A fool and your money are soon partners
Statistical
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Re: Understanding margin: buying high and selling low

Post by Statistical »

MetaPhysician wrote: Sat Jun 18, 2022 5:22 pm Hello,

For margin investing, I've been told that it forces one to 'buy high and sell low' in order to keep the desired leverage amount.

Of course, this is the opposite of the golden mantra of 'buy low and sell high.'

I have three questions

1) Therefore, is buying or selling to return to the desired leverage amount merely for risk management?

2) What is the 'ideal' scenario for margin? I imagine taking the most amount of leverage on a lump sum and then seeing it go up. I know that for standard non-margin investing it is 'best' if the market tanks when one is young so they may acquire more assets along the way and then pray that at the end near retirement the asset increases dramatically in value.

3) (The real question) When using margin and if the underlying asset goes down the amount leveraged goes UP, of course. So one could either sell (sell when low) or purchase new assets to lower the leveraged amount. Does the latter replicate the ideal scenario in #2 wherein a young person loads up on assets when they are cheaper?

Thank you, Bogleheads for sharing your wisdom. :sharebeer

PS Happy Fathers Day
PPS This is for theory. With all due respect I am not interested in a comment along the lines of "if you don't understand this you shouldn't be using margin" or "this marks peak irrational exuberance"
I think you misunderstood what someone was saying. The danger of margin is it may lead you to buying high and selling low in other words being forced into losses that wouldn't occur without leverage. Nobody uses margin to intentionally buy high and sell low.

Now how low is "low". If you open a margin position at 5% of account value you would need a market decline of 90% before you faced a margin call. If you are periodically contributing to this account that would pay down the margin over time. Is it more risky than unleveraged position? Of course because assuming you can handle the volatility you could remain invested without leverage even if the market declines 99.9% before recovering. Still 5% leverage isn't a serious concern.

One other risk of leverage is what is happening right now. Margin rates are always floating. The rates rise with interest rates however if the market is down you can't exit without a loss so you are stuck between realizing a loss and paying higher rates over time.

Neither aspect make margin "bad" but certainly something to consider.

On a related note access to margin is part of our emergency "fund". We have less funds in cash because we have cheap access to funds via margin. This is only really true if you are using a broker with low margin rates and you have a large taxable account balance relative to annual expenses.
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LTCM
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Re: Understanding margin: buying high and selling low

Post by LTCM »

"Buy low and sell high" is nonsense. If we knew which prices were high and which were low we wouldn't be messing around on bogleheads.

It's where the price is going not where it came from that determines high/low and you can't know that unless you're a genius.
60% VUG - 20% VEA - 10% EDV - 10% I-Bonds
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MetaPhysician
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Re: Understanding margin: buying high and selling low

Post by MetaPhysician »

hithere wrote: Mon Jun 20, 2022 2:10 am My approach to margin is leveraging so little that I don't get margin called during a decline. A leverage ratio of 1.05x at the ATH is what I aim for. As the market declines, the leverage ratio increases on its own, but not so much that I have to take action. And I don't, I leave it do its thing. I only interfere once a year if the market goes higher than the current ATH and hence my leverage ratio dips below 1.05x - in that case I just buy more equity on margin to rebalance the leverage.
@HiThere

What happens if it does decline so much that you have to take action
a) what is your action?
b) what is the reasoning behind your action (risk management vs maximizing returns vs other)
firebirdparts wrote: Mon Jun 20, 2022 10:15 am 3. I don't get it. If you have the ability to purchase new assets, then you weren't actually leveraged. See #2. You could decide to decrease risk in the portfolio by taking out a mortgage, risking up your personal life. I'm not sure what you had in mind.
@FIreBirdParts

My apologies for being unclear. And you are correct that if there is money on the sideline then one is not leveraged. What I had in mind was the following:
January 1: fully leveraged to the desired amount
June 1: bonus from work or windfall or additional monies saved from astute budgeting

What do you do in June then provided the market has gone down - sell low in order to bring the leveraged amount down OR put more money in? And why?
Statistical wrote: Mon Jun 20, 2022 10:29 am I think you misunderstood what someone was saying. The danger of margin is it may lead you to buying high and selling low in other words being forced into losses that wouldn't occur without leverage. Nobody uses margin to intentionally buy high and sell low.

Now how low is "low". If you open a margin position at 5% of account value you would need a market decline of 90% before you faced a margin call. If you are periodically contributing to this account that would pay down the margin over time. Is it more risky than unleveraged position? Of course because assuming you can handle the volatility you could remain invested without leverage even if the market declines 99.9% before recovering. Still 5% leverage isn't a serious concern.

One other risk of leverage is what is happening right now. Margin rates are always floating. The rates rise with interest rates however if the market is down you can't exit without a loss so you are stuck between realizing a loss and paying higher rates over time.

Neither aspect make margin "bad" but certainly something to consider.

On a related note access to margin is part of our emergency "fund". We have less funds in cash because we have cheap access to funds via margin. This is only really true if you are using a broker with low margin rates and you have a large taxable account balance relative to annual expenses.
I could very well be mistaken. Am I correct in understanding that 'buying high and selling low' occurs during forced margin calls but NOT when more monies is added voluntarily?

What if one did NOT want to pay down the margin over time and instead keep it fixed for a certain amount of time?
LTCM wrote: Mon Jun 20, 2022 5:23 pm "Buy low and sell high" is nonsense. If we knew which prices were high and which were low we wouldn't be messing around on bogleheads.

It's where the price is going not where it came from that determines high/low and you can't know that unless you're a genius.
I've been called many things...a genius is not one of them!

I would respectfully suggest that in margin when one is fixated on a certain amount of leverage then there may be some buying high and selling low in order to get back to the desired amount of leverage...unless there is another way around this.
Statistical
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Re: Understanding margin: buying high and selling low

Post by Statistical »

Fixating on a specific amount of leverage is a dubious idea. By definition any market decline would force a sale. So yes in that case if the market ever declined to below your entry point you would sell at a loss (buy high and sell low).

That isn't what anyone I have ever known who used margin has done. That isn't some inherent requirement to margin usage. If it were I would say margin is idiotic.

I mean you buy VTI on some level of margin. The price declines one cent. You are forced to sell (by this artificial constraint). The only time it would make sense to use margin is when you "know" the market can only rise.
hithere
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Re: Understanding margin: buying high and selling low

Post by hithere »

MetaPhysician wrote: Mon Jun 20, 2022 5:51 pm
hithere wrote: Mon Jun 20, 2022 2:10 am My approach to margin is leveraging so little that I don't get margin called during a decline. A leverage ratio of 1.05x at the ATH is what I aim for. As the market declines, the leverage ratio increases on its own, but not so much that I have to take action. And I don't, I leave it do its thing. I only interfere once a year if the market goes higher than the current ATH and hence my leverage ratio dips below 1.05x - in that case I just buy more equity on margin to rebalance the leverage.
@HiThere

What happens if it does decline so much that you have to take action
a) what is your action?
b) what is the reasoning behind your action (risk management vs maximizing returns vs other)
The risk of ruin is very, very low, but I still have other high-risk investments that admittedly I may or may not be able to liquidate during a black swan event, as well as a line of credit as a last resort.

I'm not really trying to squeeze every bit of return I could get via margin investing. Rather, I see it as a way to get a little bonus in addition to the market returns. That little bonus still amounts to a good chunk of money at the end of my investment horizon though. I came up with the 1.05x figure by doing Monte Carlo simulations that take into account what I think are pessimistic changes in circumstances (margin requirements, interest rates, volatility, market returns). My 1.05x leveraged strategy has over 95% success rate over 30 years even in those unrealistically bad circumstances. If I take into account my ability to deposit money into my investment account during the worst outcomes, then the success rate is even higher.
Statistical
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Re: Understanding margin: buying high and selling low

Post by Statistical »

hithere wrote: Tue Jun 21, 2022 3:40 am
MetaPhysician wrote: Mon Jun 20, 2022 5:51 pm
hithere wrote: Mon Jun 20, 2022 2:10 am My approach to margin is leveraging so little that I don't get margin called during a decline. A leverage ratio of 1.05x at the ATH is what I aim for. As the market declines, the leverage ratio increases on its own, but not so much that I have to take action. And I don't, I leave it do its thing. I only interfere once a year if the market goes higher than the current ATH and hence my leverage ratio dips below 1.05x - in that case I just buy more equity on margin to rebalance the leverage.
@HiThere

What happens if it does decline so much that you have to take action
a) what is your action?
b) what is the reasoning behind your action (risk management vs maximizing returns vs other)
The risk of ruin is very, very low, but I still have other high-risk investments that admittedly I may or may not be able to liquidate during a black swan event, as well as a line of credit as a last resort.

I'm not really trying to squeeze every bit of return I could get via margin investing. Rather, I see it as a way to get a little bonus in addition to the market returns. That little bonus still amounts to a good chunk of money at the end of my investment horizon though. I came up with the 1.05x figure by doing Monte Carlo simulations that take into account what I think are pessimistic changes in circumstances (margin requirements, interest rates, volatility, market returns). My 1.05x leveraged strategy has over 95% success rate over 30 years even in those unrealistically bad circumstances. If I take into account my ability to deposit money into my investment account during the worst outcomes, then the success rate is even higher.
That last part is important. Margin works best if you are regularly contributing to the taxable account. Even if the market did decline 90% historically it has never declined 90%+ in a single month giving one time to bring down the ltv by monthly contribution (that were going to the taxable account anyways).

The worst scenario for margin would be someone who gets a one time windfall and puts it into a taxable brokerage account. Their budget doesn't support adding funds regularly to the account. If they margin heavily they will unlikely be able to pay it down significantly via outside funds leading themselves to watching the value tick lower until a margin call and liquidation happens.
Valuethinker
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Re: Understanding margin: buying high and selling low

Post by Valuethinker »

hithere wrote: Tue Jun 21, 2022 3:40 am
MetaPhysician wrote: Mon Jun 20, 2022 5:51 pm
hithere wrote: Mon Jun 20, 2022 2:10 am My approach to margin is leveraging so little that I don't get margin called during a decline. A leverage ratio of 1.05x at the ATH is what I aim for. As the market declines, the leverage ratio increases on its own, but not so much that I have to take action. And I don't, I leave it do its thing. I only interfere once a year if the market goes higher than the current ATH and hence my leverage ratio dips below 1.05x - in that case I just buy more equity on margin to rebalance the leverage.
@HiThere

What happens if it does decline so much that you have to take action
a) what is your action?
b) what is the reasoning behind your action (risk management vs maximizing returns vs other)
The risk of ruin is very, very low, but I still have other high-risk investments that admittedly I may or may not be able to liquidate during a black swan event, as well as a line of credit as a last resort.

I'm not really trying to squeeze every bit of return I could get via margin investing. Rather, I see it as a way to get a little bonus in addition to the market returns. That little bonus still amounts to a good chunk of money at the end of my investment horizon though. I came up with the 1.05x figure by doing Monte Carlo simulations that take into account what I think are pessimistic changes in circumstances (margin requirements, interest rates, volatility, market returns). My 1.05x leveraged strategy has over 95% success rate over 30 years even in those unrealistically bad circumstances. If I take into account my ability to deposit money into my investment account during the worst outcomes, then the success rate is even higher.
If I had $1 for every Hedge Fund Manager who talked about "6 sigma events" in the summer-autumn of 2008 ... your language is almost exactly like theirs. (N+1 Magazine published a book about an anonymous HF manager "Diary of a Bad Year" - that was quite educational). Also read what Donald Mackenzie has written and in particular "The End of the World Trade" - which was in the London Review of Books. A rare academic who writes very well.

(Nouriel Roubini's history of the Crash is good. So too, Alan Blinder's)

Monte Carlo is Garbage In-Garbage Out -- if the historic data has different distributions than the future data, it's not a good guide to prediction. Read Benoit Mandelbrot "The Misbehavior of Markets" - eye opening re market volatility.

Scott Patterson The Quants - for that exact "once in 10 million years" quote by a Goldman Sachs fund manager.

Read half a dozen books of Financial History. Especially re Market Panics and Crashes. Edward Chancellor's book is a good place to start.

An example. I never considered that I could lose 100% of my investments of a country in less than 2 weeks.

In the case of Russia, I did just that (as part of a larger fund which was about 20% tilted towards Russia).

someone in another thread is citing Morgan Housel. An excellent investor writer:
But it opened my eyes to the idea that there are three distinct sides of risk:

The odds you will get hit.

The average consequences of getting hit.

The tail-end consequences of getting hit.

The first two are easy to grasp. It’s the third that’s hardest to learn, and can often only be learned through experience.

We knew we were taking risks...

Never, not once, did we think we’d pay the ultimate price.

But once you go through something like that, you realize that the tail-end consequences – the low-probability, high-impact events – are all that matter.

In investing, the average consequences of risk make up most of the daily news headlines. But the tail-end consequences of risk – like pandemics, and depressions – are what make the pages of history books. They’re all that matter. They’re all you should focus on. We spent the last decade debating whether economic risk meant the Federal Reserve set interest rates at 0.25% or 0.5%. Then 36 million people lost their jobs in two months because of a virus. It’s absurd.

Tail-end events are all that matter.

Once you experience it, you’ll never think otherwise.
https://www.collaborativefund.com/blog/ ... s-of-risk/
hithere
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Re: Understanding margin: buying high and selling low

Post by hithere »

Valuethinker wrote: Tue Jun 21, 2022 9:55 am
hithere wrote: Tue Jun 21, 2022 3:40 am
MetaPhysician wrote: Mon Jun 20, 2022 5:51 pm
hithere wrote: Mon Jun 20, 2022 2:10 am My approach to margin is leveraging so little that I don't get margin called during a decline. A leverage ratio of 1.05x at the ATH is what I aim for. As the market declines, the leverage ratio increases on its own, but not so much that I have to take action. And I don't, I leave it do its thing. I only interfere once a year if the market goes higher than the current ATH and hence my leverage ratio dips below 1.05x - in that case I just buy more equity on margin to rebalance the leverage.
@HiThere

What happens if it does decline so much that you have to take action
a) what is your action?
b) what is the reasoning behind your action (risk management vs maximizing returns vs other)
The risk of ruin is very, very low, but I still have other high-risk investments that admittedly I may or may not be able to liquidate during a black swan event, as well as a line of credit as a last resort.

I'm not really trying to squeeze every bit of return I could get via margin investing. Rather, I see it as a way to get a little bonus in addition to the market returns. That little bonus still amounts to a good chunk of money at the end of my investment horizon though. I came up with the 1.05x figure by doing Monte Carlo simulations that take into account what I think are pessimistic changes in circumstances (margin requirements, interest rates, volatility, market returns). My 1.05x leveraged strategy has over 95% success rate over 30 years even in those unrealistically bad circumstances. If I take into account my ability to deposit money into my investment account during the worst outcomes, then the success rate is even higher.
If I had $1 for every Hedge Fund Manager who talked about "6 sigma events" in the summer-autumn of 2008 ... your language is almost exactly like theirs. (N+1 Magazine published a book about an anonymous HF manager "Diary of a Bad Year" - that was quite educational). Also read what Donald Mackenzie has written and in particular "The End of the World Trade" - which was in the London Review of Books. A rare academic who writes very well.

(Nouriel Roubini's history of the Crash is good. So too, Alan Blinder's)

Monte Carlo is Garbage In-Garbage Out -- if the historic data has different distributions than the future data, it's not a good guide to prediction. Read Benoit Mandelbrot "The Misbehavior of Markets" - eye opening re market volatility.

Scott Patterson The Quants - for that exact "once in 10 million years" quote by a Goldman Sachs fund manager.

Read half a dozen books of Financial History. Especially re Market Panics and Crashes. Edward Chancellor's book is a good place to start.

An example. I never considered that I could lose 100% of my investments of a country in less than 2 weeks.

In the case of Russia, I did just that (as part of a larger fund which was about 20% tilted towards Russia).

someone in another thread is citing Morgan Housel. An excellent investor writer:
But it opened my eyes to the idea that there are three distinct sides of risk:

The odds you will get hit.

The average consequences of getting hit.

The tail-end consequences of getting hit.

The first two are easy to grasp. It’s the third that’s hardest to learn, and can often only be learned through experience.

We knew we were taking risks...

Never, not once, did we think we’d pay the ultimate price.

But once you go through something like that, you realize that the tail-end consequences – the low-probability, high-impact events – are all that matter.

In investing, the average consequences of risk make up most of the daily news headlines. But the tail-end consequences of risk – like pandemics, and depressions – are what make the pages of history books. They’re all that matter. They’re all you should focus on. We spent the last decade debating whether economic risk meant the Federal Reserve set interest rates at 0.25% or 0.5%. Then 36 million people lost their jobs in two months because of a virus. It’s absurd.

Tail-end events are all that matter.

Once you experience it, you’ll never think otherwise.
https://www.collaborativefund.com/blog/ ... s-of-risk/
Well, it's not just my simulations, but investing in general also relies on historic data, so your idea that the future might be completely different than the past applies to not just margin investing.

Observing the tail ends is what Monte Carlo simulations are for. The worst scenarios that my simulations come up with are akin to a financial apocalypse that has never been seen before, so I'd say that they're able to account for the tail ends fairly well. The input values that I use are more pessimistic than those of your typical Bogleheads model, so in a sense, my input is a little bit less of a garbage than that of a widely praised investing model. Granted, margin investing introduces variables such as margin requirements that are not present in a vanilla Bogleheads model, but those can be properly accounted for as well.
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MetaPhysician
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Re: Understanding margin: buying high and selling low

Post by MetaPhysician »

Statistical wrote: Mon Jun 20, 2022 5:59 pm Fixating on a specific amount of leverage is a dubious idea. By definition any market decline would force a sale. So yes in that case if the market ever declined to below your entry point you would sell at a loss (buy high and sell low).

That isn't what anyone I have ever known who used margin has done. That isn't some inherent requirement to margin usage. If it were I would say margin is idiotic.

I mean you buy VTI on some level of margin. The price declines one cent. You are forced to sell (by this artificial constraint). The only time it would make sense to use margin is when you "know" the market can only rise.
I agree with you Statistical in the sense that fixating on a specific amount of leverage is arbitrary. I'd like to suggest that instead of an absolutely fixed amount of 2x that the goal range is more flexible like 1.75 to 2.25. With that being said I'd still argue that there *is* some arbitrary line.
Statistical wrote: Tue Jun 21, 2022 8:32 am That last part is important. Margin works best if you are regularly contributing to the taxable account. Even if the market did decline 90% historically it has never declined 90%+ in a single month giving one time to bring down the ltv by monthly contribution (that were going to the taxable account anyways).

The worst scenario for margin would be someone who gets a one time windfall and puts it into a taxable brokerage account. Their budget doesn't support adding funds regularly to the account. If they margin heavily they will unlikely be able to pay it down significantly via outside funds leading themselves to watching the value tick lower until a margin call and liquidation happens.
Very well said. This helps me understand the worst-case scenario better.

Would you say adding money from every paycheck like you described is the optimal way to minimize risk and maximize return?
Statistical
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Re: Understanding margin: buying high and selling low

Post by Statistical »

MetaPhysician wrote: Thu Jun 23, 2022 9:45 am Very well said. This helps me understand the worst-case scenario better.

Would you say adding money from every paycheck like you described is the optimal way to minimize risk and maximize return?
Technically it isn't necessary. A static portfolio with no contribution (or withdrawals) could be margined. However since we don't know how long or deep a correction could be I like the assurance of paying down the margin balance from outside funds. For me it isn't so much as oh I have a margin balance I should pay it down I always contribute each month to our taxable brokerage account. If it is margined (like it is now) that goes partially to paying down the margin balance.
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