Getting leverage

[wachtwoord]

And add in a buffer for potential market drops. A 1.3x margin ratio can quickly jump to 2x in a recession.

 

I'm at 1.1 now and dont feel comfortable with any higher. In fact I prefer around 1.05 because I hold quite a few illiquid stocks. I'll surely lower it through this year.

[Guest Schwab711]

And add in a buffer for potential market drops. A 1.3x margin ratio can quickly jump to 2x in a recession.

 

I'm at 1.1 now and dont feel comfortable with any higher. In fact I prefer around 1.05 because I hold quite a few illiquid stocks. I'll surely lower it through this year.

 

What is the purpose of 1.05x - 1.10x leverage? What are your expected returns right now that is worth the costs/risks (I'm assuming no margin call)?

[wachtwoord]

And add in a buffer for potential market drops. A 1.3x margin ratio can quickly jump to 2x in a recession.

 

I'm at 1.1 now and dont feel comfortable with any higher. In fact I prefer around 1.05 because I hold quite a few illiquid stocks. I'll surely lower it through this year.

 

What is the purpose of 1.05x - 1.10x leverage? What are your expected returns right now that is worth the costs/risks (I'm assuming no margin call)?

 

Costs are very low with current margin rates and by keeping the leverage low, risk is also very limited in my opinion. I want the risk of being margin called to be almost zero while still taking advantage of the low margin rates.

 

What's your opinion?

[scorpioncapital]

Leverage should be matched with suitable assets when the rate cannot be locked in (most margin investors have a variable rate). So for example, a good use of leverage is a diversified arbitrage portfolio that runs off over a period of 1 year, or some special situations in fixed income maturing or convertible shortly. Slightly less suitable is a solid, very large company with a 25% maintenance requirement - maybe like Berkshire. The least suitable is pretty much every stock that you may have to hold for many years as a long term investment if rates rise or the business does not perform as expected or you misjudge.

[hillfronter83]

Has anyone here used loan from 401k plan as leverage? It seems to be a good strategy to get some leverage. Since my personal portfolio is all stock, I'm pretty conservative in 401k, most of the fund are invested in short term bond/money market type of funds which returns around 3.5% annually. I can loan money for about 4.5% from 401k.

[stahleyp]

I wouldn't bother with a 401k loan for a few reasons. 

 

1) it's not tax deductible (though to be fair most of the loan is paid back to yourself - you'll want to see the fees the plan keeper chargers). 

 

2) loans are usually pretty small (maxes out at the lesser $50,000 or 50% of account value).

 

3) I'm pretty sure you don't keep the investments in the plan. So you're not even getting the money from the bonds in this case.

[Shooter MacGavin]

Has anyone here used loan from 401k plan as leverage? It seems to be a good strategy to get some leverage. Since my personal portfolio is all stock, I'm pretty conservative in 401k, most of the fund are invested in short term bond/money market type of funds which returns around 3.5% annually. I can loan money for about 4.5% from 401k.

 

hillfronter83, out of curiosity, do you keep your 401k in money market type funds because you are close to retirement age?  You don't have to answer this question if you don't want to but to me I'm not sure why anyone not close to retirement age wouldn't want to tax advantage of tax deferral within their 401k, so just wondering...

[thepupil]

Leverage should be matched with suitable assets when the rate cannot be locked in (most margin investors have a variable rate). So for example, a good use of leverage is a diversified arbitrage portfolio that runs off over a period of 1 year, or some special situations in fixed income maturing or convertible shortly. Slightly less suitable is a solid, very large company with a 25% maintenance requirement - maybe like Berkshire. The least suitable is pretty much every stock that you may have to hold for many years as a long term investment if rates rise or the business does not perform as expected or you misjudge.

 

EDIT: I quoted scorpion from May 2016 but meant to quote hillfronters question about using a 401k loan from Feb 2018.

 

Nope, because they come due if/when you leave your employer for voluntary/involuntary reasons. I think the tax bill changed this to delay it a bit, but the point still stands. It can go from a 5 year amoritizing loan to a 0-1 year loan really quickly. This creates a bad scenario where  you can lose your job (which may be correlated to the economy/stock market) AND effectively be forced seller of whatever you are levering to buy.

 

Also some plans prevent new contributions while there is a loan, making the foregone tax savings equal to a very high interest rate for a small loan.

[hillfronter83]

Leverage should be matched with suitable assets when the rate cannot be locked in (most margin investors have a variable rate). So for example, a good use of leverage is a diversified arbitrage portfolio that runs off over a period of 1 year, or some special situations in fixed income maturing or convertible shortly. Slightly less suitable is a solid, very large company with a 25% maintenance requirement - maybe like Berkshire. The least suitable is pretty much every stock that you may have to hold for many years as a long term investment if rates rise or the business does not perform as expected or you misjudge.

 

Nope, because they come due if/when you leave your employer for voluntary/involuntary reasons. I think the tax bill changed this to delay it a bit, but the point still stands. It can go from a 5 year amoritizing loan to a 0-1 year loan really quickly. This creates a bad scenario where  you can lose your job (which may be correlated to the economy/stock market) AND effectively be forced seller of whatever you are levering to buy.

 

Also some plans prevent new contributions while there is a loan, making the foregone tax savings equal to a very high interest rate for a small loan.

 

 

hillfronter83, out of curiosity, do you keep your 401k in money market type funds because you are close to retirement age?  You don't have to answer this question if you don't want to but to me I'm not sure why anyone not close to retirement age wouldn't want to tax advantage of tax deferral within their 401k, so just wondering...

 

Thanks everyone. It's always nice to listen to wisdom of this board! The reason I'm asking is that a recent investment opportunity requires me to come up with a big chunk of cash. The expected return is about 15-30% within a couple of months period. I'm thinking about borrowing against the 401k with the intention of pay back within a couple of months. Then I thought about using this loan for some short term MA arbitrage opportunity, etc.

 

And I'm not close to retirement age yet. The reason I keep 401k in safe investments is that I'm pretty aggressive in personal accounts and IRA. And my 401k doesn't provide many attractive options other than index funds.

[james22]

With direct deposit of my paycheck, a local bank will loan me a year's salary at ~3.5% (they then recover 25% of every paycheck until paid off).

 

I'll probably take advantage of in any significant correction, BRK falls to 1.2 P/B, etc.

[LR1400]

What are thoughts on just buying a levered ETF if you want to use leverage?

 

Disclaimer. I have only seen this recommended I have not researched in depth. Initial research points to them being poor.

 

 

[Shooter MacGavin]

What are thoughts on just buying a levered ETF if you want to use leverage?

 

Disclaimer. I have only seen this recommended I have not researched in depth. Initial research points to them being poor.

 

There is really no reason to do this if you are managing your own money and purchasing securities you like in an IB account.  You can get the same or custom leverage with IB (if you want) and you don't need to buy a basket of securities.  You can even hedge somewhat by buying puts.  The hit to your equity is basically the same.  You stand the same chance of getting impaired. 

 

Levered Funds also have higher expenses and fees and if they're taking their cut once a month or once a quarter, and the assets are down (so down even more due to the leverage), it's going to be a bigger dollar bite out of your principal.

 

I'm all for as much cheap, long-dated, non callable leverage as possible. The same way private equity does it.  Keep all the upside, pass on the downside.  pat themselves on the back for their high IRRs.  But i haven't found a great way to do it (besides owning good companies that know how to issue that kind of debt.) 

[bennycx]

Say I have a very concentrated portfolio of stocks in IB. What are the pros and cons of these 2 options of getting leverage?

1. Portfolio Margin at IB -- i'm not sure what the typical initial and maintenance margin is needed for say a basket of 3 stocks

2. 5 year personal loan i can obtain at low 3% -- i'm pretty sure i can beat 3% p.a. for the next 5 years

[Mondegreen]

The margin loan from IB will be cheaper but margin is a terrible way to borrow money.

 

A longer term loan is a better way to borrow, but make sure you run the maths on it (as you are paying off principle throughout, the potential return wasn't that appealing in my case). You will also likely have to lie about why you want the loan.

 

IMO the best way to borrow cheaply on a relatively small scale is through 0% interest credit cards. If you are intelligent and spread it across multiple cards you can borrow a reasonably significant amount of money for free.

 

Most importantly, make sure any borrowed money is comfortably covered by earnings/equity in your portfolio. It's not worth getting into financial trouble over

[Dynamic]

Margin is something to be cautious about because of the possibility of a margin call at the worst possible moment.

 

I believe Interactive Brokers will lend 25% of your portfolio overnight (and up to 400% temporarily during trading hours).

 

If you borrow 25%, a small decline in prices will cause a margin call.

If you borrow 10% you can presumably withstand a 50% decline in your portfolio market prices without a margin call. Even a flash crash on top caused by algorithmic traders is likely to be OK if they pull the plug and the market recovers before the next trading day.

 

It is possible that a market panic could be compounded by greatly increased long term risk-free interest rates and that stock prices for many firms could drop more than 50% quite rationally taking perhaps 10 years to recover via growth in fundamentals. Try to think about these unlikely scenarios and whether you could avoid a forced sale at the worst time.

 

Personally, I'd be very wary of exceeding 10% margin in normal times for fear of having to make panic decisions to satisfy the lending criteria (and even then I'd like to have other resources available to cover the margin loan). A margin call only has to happen once in a lifetime to wipe out a significant chunk of your portfolio or even put you at zero. Non-callable long-term leverage is far safer.

[scorpioncapital]

You can easily get very high and fixed rate leverage. Buy a highly indebted company on cash:)

The look through leverage can be much higher than you can achieve on your own. However, one should ask if a company has to use vast amounts of leverage, perhaps a utility, or a bank to get a regular return to you of 10-12%, is it a really great business? And would you want to double leverage a company like that? My rule is if the company has high look through leverage I buy it on cash, if it has no leverage, I will use a little bit of leverage on the portfolio end. That's why I think Berkshire is so powerful. It has long term fixed rate leverage via float and on top of that it invests in companies expecting to get a 10% unlevered return. I wouldn't necessarily double leverage a stock like that, but Berkshire is a strong exception.

 

[Shooter MacGavin]

to revisit this topic, has anyone ever traded CFDs?

 

I think they're not allowed on US exchanges but IB will let you trade them (i believe) on non us exchanges. 

 

I'm thinking of maybe partitioning an account and having 1% of my networth in there as a speculative account and buying some CFDs on some deeply undervalued stocks.  You can get seriously high leverage using CFDs (which also means you can blow up easily of course, hence the partition).

[Dynamic]

I tried a demo account with cityindex.co.uk recently - it has just expired. I tried some CFD and DFT trading and more than doubled the notional £10,000 within the 12 week trial using about 15* leverage while keeping the "margin" indicator below 200%. These contacts are interesting to UK traders because they're betting and are exempt from UK Capital Gains Tax.

 

They also accept payment by debit or credit card to fund the account, I read.

 

With a 36 month interest free purchase period on a credit card there's the potential to obtain ridiculous leverage on a limited initial deposit. It's also easy to blow up.

 

The CFD seems to show near real time market prices for the underlying with tight spread that might mirror the bid ask spread. I found it difficult to follow the overnight interest charges there, though I didn't persevere. DFT seems to bake in time value interest until expiry and have a wider spread and represent 100 stocks (at least on some US securities) so perhaps it's based on underlying options prices lasting up to 3-6 months or the stock price plus effective interest to expiry.

 

There seem to be many other similar platforms I see advertised on YouTube too.

 

I might consider opening a real account when I'm very sure about the downside and keep checking of my leverage to reduce the chances of blowing up in the short term.

[Shooter MacGavin]

I tried a demo account with cityindex.co.uk recently - it has just expired. I tried some CFD and DFT trading and more than doubled the notional £10,000 within the 12 week trial using about 15* leverage while keeping the "margin" indicator below 200%. These contacts are interesting to UK traders because they're betting and are exempt from UK Capital Gains Tax.

 

They also accept payment by debit or credit card to fund the account, I read.

 

With a 36 month interest free purchase period on a credit card there's the potential to obtain ridiculous leverage on a limited initial deposit. It's also easy to blow up.

 

The CFD seems to show near real time market prices for the underlying with tight spread that might mirror the bid ask spread. I found it difficult to follow the overnight interest charges there, though I didn't persevere. DFT seems to bake in time value interest until expiry and have a wider spread and represent 100 stocks (at least on some US securities) so perhaps it's based on underlying options prices lasting up to 3-6 months or the stock price plus effective interest to expiry.

 

There seem to be many other similar platforms I see advertised on YouTube too.

 

I might consider opening a real account when I'm very sure about the downside and keep checking of my leverage to reduce the chances of blowing up in the short term.

 

Interesting.  Thank you.  Never heard of DFT before. Never used a virtual account before.  But maybe i’ll Give it a try

[Dynamic]

Ah, I could be wrong and that CFD profits ARE taxable (see this 2011 article).

 

It's Spread Bets (DFTs = Daily Funded Trade) that aren't taxable (see here for the types of trades)

 

This CMC Markets page indicates that Spread Bets are only available to customers in the UK or Ireland, and are exempt from Capital Gains Tax and stamp duty. CFDs are available to customers globally are exempt from stamp duty but subject to CGT. Maybe I'll try a dummy account with them at some point too.

 

Here are some dummy trades I made in Berkshire Hathaway, just because I hold it in real life and follow it closely, during my dummy trial account with CityIndex:

 

1st May: BRK.B DFT, bought 3 at 19,407.0 each (presume currency=GBP). At time BRK.B was about $194.070.

11th May: current price = 20,101.5, P&L = 2083.50 GBP (=3 x 694.50 = 300 x 6.945). At time BRK.B was about $201.080 (within a minute or two). Initial exposure to about 58,221 GBP as currency of P&L seems to be GBP for an underlying in USD.

 

1st May: BRK.B Jun18 Spread, bought 3 at 19,478.0 each (presume currency=GBP). At time BRK.B was about $194.070.

11th May: current price = 20,166.3, P&L = 2064.90 GBP (=3 x 688.30 = 300 x 6.883). At time BRK.B was about $201.080 (within a minute or two). Initial exposure to about 58,221 GBP as currency of P&L seems to be GBP for an underlying in USD.

 

1st May: BRK.B Sep18 Spread, bought 3 at 19,641.6 each (presume currency=GBP). At time BRK.B was about $194.070.

11th May: current price = 20,351.2, P&L = 2,128.80 GBP (=3 x 709.60 = 300 x 7.096). At time BRK.B was about $201.080 (within a minute or two). Initial exposure to about 58,221 GBP as currency of P&L seems to be GBP for an underlying in USD.

 

1st May: BRK.B CFD, bought 150 at 194.070 each (currency=USD). At time BRK.B was about $194.070.

11th May: current price = 201.08. x150 = 30,162, P&L = 1051.50 USD (=150 x 7.01). At time BRK.B was about $201.080 (within a minute or two). Initial exposure to about 29,110.50 USD as in USD as underlying.

 

I had gone into these four trades with a notional 13,010.17 GBP in the dummy account (I'd made 30% gain already) then closed all positions before doing this trial.

From there I took exposure to £175,579.80 GBP Sterling, plus a further $29,110.50 in USD, which was about £197,03.33 of GBP equivalent exposure. That total exposure is 15.14 x £13,010.17 cash. That is some enormous leverage.

 

If I ever use such an account for real, I'll be certain to rely on my own calculations of effective leverage as I simply don't understand their margin calculation.

 

My Margin indicator showed 197%, and the Total Margin shown was £10,204.54 in GBP. Because these seem to be difference bets, the margin seems to bear no relation to the total effective exposure to the underlying security.

 

My total unrealised gain on those 4 positions was £7,048.40 in GBP and I soon realised that sort of gain in the dummy account, to show over £20,000 with some sporadic trading when I felt the price was a little bit low over about a 12 week trial.

 

I was fortunate to miss out on the major decline in BRK.B to around 186-188 which could easily have wiped me out, I imagine, but I was glad to put on a variety of available positions and see what effect they had to really gauge how it works.

 

I hope this helps anyone interested to understand how it works. The help desk and the person who called me a few times to ask how I was getting on, can apparently reset your dummy account if you wipe out during the trial period.

 

BTW, the CFD prices seemed to be very close to live prices for BRK.B and AAPL, probably with a similar spread, though I didn't have a live pricing subscription active to be sure. I did some real buying an selling in my ISA account (which only allows me to hold cash in GBP) and noticed that "At Market" quoted prices I achieved (or was offered and declined), give or take my estimate of GBP:USD exchange rate, seemed to match quite closely the prices I calculated from the CFD pricing. I think the Market Open prices I saw later in the day, were also very close to the CFD price when the market opened.

 

All in all the power of the leverage is quite dramatic, even a little scary. A $7.01 shift in BRK.B's price is only 3.6% on the starting stock price of $194.07, but was about 54% change on £13,010.

 

They mention that losses can exceed your deposits. You are actually required to pay the debt to them if you go seriously negative (especially a problem that can occur out-of-hours), but they can also close your positions as they decline and your live balance is not enough to meet the margin requirements (e.g. 5% of the trade value, meaning 20x leverage).

 

This page on the risks could be a helpful read for anyone considering it. The risks you can take on are enormous.

[Jurgis]

I was fortunate to miss out on the major decline in BRK.B to around 186-188 which could easily have wiped me out, I imagine

 

Kids, don't do this at home.  8)  ;D

[Shooter MacGavin]

I was fortunate to miss out on the major decline in BRK.B to around 186-188 which could easily have wiped me out, I imagine

 

Kids, don't do this at home.  8)  ;D

 

 

Dynamic,

 

Thanks for the trading diary. 

 

Jurgis,

 

Don't worry, he did it with a virtual account!

 

It could be fun for like a tiny percentage of your net worth though to really see how much upside you could get.  The CFDs basically remind me of the bucket shops in Reminiscence of a Stock Operator. Ha.  No economic purpose besides ridiculous speculation.

[Jurgis]

I was fortunate to miss out on the major decline in BRK.B to around 186-188 which could easily have wiped me out, I imagine

 

Kids, don't do this at home.  8)  ;D

.... 

 

Jurgis,

 

Don't worry, he did it with a virtual account!

 

...

 

I know, I know.

 

I just find it extremely funny that you can get wiped out by ... hold it ... hold it ... a major decline of BRK ... which is one of the most stable stocks ... and not in bubble ... and the decline was less than 10%...

 

Sorry I'm just  ;D  ;D  ;D ROFL.

[Dynamic]

When I worked out my effective exposure in the dummy account I was shocked at how easily it was possible to take such risks. A real taste of the day trader's experience too with the flashing prices and the short term charts.

 

If I ever used this type of product when I thought the downside was very well protected and the risk-reward balance heavily in my favour I would be very careful to calculate my effective exposure and perhaps to institute a stop loss to prevent losses in excess of my original deposit.

 

I think I would only use it in a very extreme favourable circumstances and with a lot of careful thought about leverage and downside risk.

[CorpRaider]

Here's something maybe for you guys to check out a 1.5 levered 60/40 portfolio via an etf using laddered treasury futures (seems pretty interesting, but maybe will get gored if bonds crater):

 

https://www.wisdomtree.com/etfs/asset-allocation/ntsx

 

Expense ratio is .20%.  Not sure what the trading costs in the futures would be.  You guys probably know better than I but I think they are pretty small (maybe offset by cash interest on collateral?).  Right?

 

Seems kind of like some of the PIMCO Index plus funds, but the ETF is better for equity holdings in taxable and is 60/40.  And of course the ER is .20%.

 

Disclosure: long a token/stub position in $WETF (and planning to take a look if stupidity from Fido non-announcement continues in asset manager space).