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Author: StockNewb One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76421  
Subject: Leveraged investing Date: 2/26/2011 6:04 PM
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What are the opinions here on leveraged investing? I've been looking at Margin accounts and seeing how they can accelerate my investing.

I just want to know how you guys use your margin accounts. I was thinking of trading funds in the account, due to it being slightly safer, cause funds go to $0 less often then stocks lol.

The biggest thing for me is I get to trade twice as much money and keep the gains minus the borrowed capital.

Anywho anyone have any advice or tips?
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Author: DrTarr Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68554 of 76421
Subject: Re: Leveraged investing Date: 2/26/2011 7:46 PM
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I've been looking at Margin accounts and seeing how they can accelerate my investing.

Yes, and they can just as easily accelerate you LOSSES!

IMO leveraged investing is OK for those who can take the risk: both financially as well as emotionally. Once you lever up, it would be my advice that you monitor the account frequently due to the additional exposure. OF course watching it more frequently means even on the down days, which can be painful.... painful.... On the other side the good days are very enjoyable.

If you are doing this in a "margin" account you need to worry about the downside risk and the liquidity issues associated with capital calls. Which to me is like a knife in the back of some one who just got stabbed in the somach. If be some chance your stocks/funds do go to zero - remember that you will still owe the borrowed capital.

My advice would be to first try out some of the leveraged ETF's that are available. You were alluding to funds being safer than stocks because of the diversification. You can get the same diversification in an ETF as well as the additional leverage and it is at reduced costs to you. Both in the fees to the funds which are usually more than for an ETF (some leveraged ETF's have hefty fees too)as well as the borrowing costs that you are paying because the fund gets a much better rate than you probably will.

Draw out in your mind what you beleive is the realistic market crash scenario (how low will you go before you exit or do you have the stomach to ride it out) and then design your portfolio so that if it happens you have at least set some expectation of what will happen and that you can decide if you want to accept the risk. And put it in dollar terms - not just percentage. Example on a 1MM portfolio - It is easy to say "oh ya I can lose 60% of my portfolio" but if you say "I can lose $600,000" just seems to put on a little different flavor.

d(leveraged)/dT

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68555 of 76421
Subject: Re: Leveraged investing Date: 2/26/2011 10:49 PM
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I've been looking at Margin accounts and seeing how they can accelerate my investing.

Anywho anyone have any advice or tips?


Um, an analogy to what you asked is somebody who wanders into a saloon and asks if they will teach him to play poker.

The fact that you asked this question at all, not to mention the way you asked it, tells me that you are soon going to be losing all your money.

Don't use margin.

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Author: billjam Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68556 of 76421
Subject: Re: Leveraged investing Date: 2/26/2011 11:59 PM
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Margin accounts are not for the inexperienced or casual investor. Heck, even the big boys get burned trading on margin sometimes.

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68557 of 76421
Subject: Re: Leveraged investing Date: 2/27/2011 12:32 AM
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Learn to invest without using margin. You are going to make mistakes as you learn. With margin, those mistakes are larger.

Once you've learned, then you can use margin to your advantage.

How long does it take to learn investing? That depends on the person. Some learn enough to be safe with margin in just a year or two. Some take closer to a decade. And some people never really learn how to invest well enough to be let loose with margin.

Margin is a very sharp tool. You wouldn't let your 5 year old kid use a chain saw without any training. Same thing with margin.

--Peter

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Author: Donna405 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68558 of 76421
Subject: Re: Leveraged investing Date: 2/27/2011 1:33 AM
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I want to point out that there were wide-spreading margin calls during 2008 and 2009. Many people lost all of their money during this period of time.

Like the other posters, I strongly recommend that you not use margin to invest.

Donna

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Author: StockNewb One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68559 of 76421
Subject: Re: Leveraged investing Date: 2/27/2011 3:17 AM
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Thanks for the input guys :)

I know I have the stomach for the risk and I am working in Concert with two experienced investors, if I do decide to go with Margin it wont be for about another year. I want to up my original nest egg before leveraging it, if I do.

But thanks for the very strong warnings against leveraging. Knowing me and how I just like to do things once I make up my mind, I will probably leverage my portfolio. But I will very strongly consider leveraging a smaller portion then the entire thing... that way if I only leverage say 15% and I consider that my "risk" capital and I take a serious hit there... it isnt as bad as 100% of my capital...

Also it doesnt help that I think the markets are going up and we will be having a nice run up for a bit.. but anywho thanks for the input and warnings guy :)

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Author: CheersSRX One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68560 of 76421
Subject: Re: Leveraged investing Date: 2/27/2011 6:34 AM
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StockNewb -- Given what you've said here, and your thinking that the market is headed upward, perhaps options would be a better strategy for you. You could use that 15% of your nest egg to purchase long-dated (January 2012? January 2013?) call options on (say) SPY. They won't cost you very much, and if you get the run-up you expect, you can do very nicely.

Cheers!

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Author: 0x6a74 Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68561 of 76421
Subject: Re: Leveraged investing Date: 2/27/2011 4:20 PM
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StockNewb -- Given what you've said here, and your thinking that the market is headed upward, perhaps options would be a better strategy for you. You could use that 15% of your nest egg to purchase long-dated (January 2012? January 2013?) call options on (say) SPY. They won't cost you very much, and if you get the run-up you expect, you can do very nicely.



good idea...

( when i was young and wild, i used option -- fed the Gambler and with limited down-side /where margin has larger down-side

and it worked GREAT ..until it didn't work. )

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Author: SirTas Big gold star, 5000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68562 of 76421
Subject: Re: Leveraged investing Date: 2/27/2011 6:23 PM
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What are the opinions here on leveraged investing? I've been looking at Margin accounts and seeing how they can accelerate my investing.

I believe that the linked post is the most recommemnded post ever on the Fool. If you're attracted to margin trading, it may be of interest. http://boards.fool.com/the-real-real-risks-of-margin-1225137...

--SirTas

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Author: StockNewb One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68563 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 1:22 AM
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Thanks SirTas!
Biggest lesson in that post for me is Margin is evil when it is run by greed. So keep it simple, diversify and check yourself.

Very crappy story, thanks for linking it :)

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Author: 0x6a74 Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68564 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 1:26 AM
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Thanks SirTas!
Biggest lesson in that post for me is Margin is evil when it is run by greed.



LOL



(>:

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Author: madbrain Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68565 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 2:18 AM
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Stocknewb,

If you really must, there are some ways to use leverage for investing that do not involve using margin. You can use other, separately available, credit lines, and thus never get a margin call. Unsecured loans can be expensive sometimes.
Sometimes your choice might be to prepay high debt (eg. a mortgage or home equity line of credit) vs invest the money. That is using leverage, too. Of course your home loan can go underwater too, but at least you will not get a margin call.

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Author: CheersSRX One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68566 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 5:59 AM
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Just thinking out loud... how different is "greed" from "stubbornness"?
You've received excellent advice from multiple sources. And your conclusion is that if you just keep it simple and diversify and check yourself, you can avoid a fate that so many other folks succumbed to.

Good luck, Newbie! Let us know how it works out down the road.

Cheers!

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68567 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 9:23 AM
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Just thinking out loud... how different is "greed" from "stubbornness"?
You've received excellent advice from multiple sources. And your conclusion is that if you just keep it simple and diversify and check yourself, you can avoid a fate that so many other folks succumbed to.

Good luck, Newbie! Let us know how it works out down the road.


Well, we all know how this movie ends. http://www.youtube.com/watch?v=tHbFOt9n_cc&feature=relat...

This is the age of the internet, y'know. All anyone nees to do is read 2 books and 5 on-line magazine articles and you are an instant expert. ;-)

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Author: StockNewb One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68568 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 1:59 PM
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Ok Guys, I really did get your points. The general consensus here is Margin is a really sharp knife that if you dont know what your doing you WILL get cut and even if you do you may get cut anyways.

Now yes, I want to play around with Margin and see if it fits me.
But what I see you guys missing is;
Im using funds not stocks. Funds are less volatile then stocks.
I have decided to leverage only about 15-20% of my portfolio. Two reasons the remaining portfolio should act as a gaurantee against margin calls and leveraging 100% is really risky.
I'll be holding a couple funds in the leveraged position instead of just one as I had planned. Due to volatility factors and it is harder to make two funds tank then it is to make one tank.

Right now I want to pick a couple funds that are consistent in there returns i.e large cap funds or very respectable manager's i.e Ned Goodman or both. I dont need to hit a home run, I just want small consistent gains. If I start going for the home run hits thats were I get greedy and potentially lose it all. Right now you guys THINK I'm being stubborn, which I may be, it is a failing of mine. But I am trying to learn and adapt and Margin just seems like an extremely usefull tool.

as per using option's, I like how you can hedge risk with them and it is sorta like leveraging but not quite. I think I may start using them in some positions too. and what I mean by check myself is do my due diligence and have controls in place to where I Can not go against my trading method.

I have no doubts I will get cut by margin either now or later, but I also have no doubts ill get cut by investing period. Everything has a place and time, I figure i'm 25 I dont mind the risk, if i was 40-50 years old it might be another story. I'd rather experiment now and find were my true risk tolerances are then experimenting when im 40 or 50.

anywho I just wanted to make sure my position was clearly defined. I have gotten the general feeling that this board hates margin, thats fine. I intend on using some of it, so now I am on to the advice stage. if you have used margin in the past, tell me what led to your downfall or your stopping of its use. If you do use it tell me how you use it. Vanishing point reference's are great, I loved the movie, I get the point, but I got the point a while back. Now it is time as an investment community to ante up and help the Newb who is I.

I really do appreciate the strong opinion's on Leveraging, but now I feel I should move forward from that. Mayhap in the detailed planning on how I will trade I may decide I don't like it after all. Or maybe I might just use option's instead of leveraging or what not. But I cant know that until I have a plan and looked at the feasibility of it. If I cant make a feasible plan, then it kinda shoots my theories in the foot.

gtg
SN

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Author: Crosenfield Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68569 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 3:34 PM
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Instead of fading into the woodwork, in 6 months let us know what your experience has been.

Yes, I have used margin in the past. No, I don't use it now, other than maybe for a couple of days while moving some money around to cover. Why did I stop? Didn't need it. As my accounts have grown, I have positions with dividends and interest that pay my living expenses without risking my retirement accounts.

Do let us kknow of your experience after you have some.

Best wishes, Chris

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Author: madbrain Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68570 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 6:03 PM
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Stocknewb,

Im using funds not stocks. Funds are less volatile then stocks.

I suggest you check out the prices of equity mutual funds in 2008 and reconsider. Many lost in the range of 40%. Some more. My 401k was all in highly-rated mutual funds and lost over 40% that year. That was $93k of market losses.

But of course it wasn't margined (not possible in a 401k). I didn't sell any of it, and it recovered .

If it had been margined, I would probably have lost it all - 12 years of savings. It's an expensive lesson. You say you are 25 now. Do you want this to happen when you turn 37 and start over ? It would be a very expensive lesson to learn.

Options are very much leverage. But unless you use naked options, you cannot lose more than you invest. Options are not for newbies either.

Margin cannot just break you, it can make you go broke. Just don't go there.

As far as "hitting a home run", just forget about it. No one can consistently beat the market. Everyone has good and bad years. Many managers who "beat the market" still had huge losses in 2008. You don't want to be leveraged during those times, and you can never tell when it's going to happen.

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68571 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 6:12 PM
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I have decided to leverage only about 15-20% of my portfolio.
That should be reasonably safe. Ya gotta be real careful though--buying on margin is sorta like eating ONE potato chip. There is a stong temptation to eat just one more.


But what I see you guys missing is;
Im using funds not stocks. Funds are less volatile then stocks....Due to volatility factors and it is harder to make two funds tank then it is to make one tank.


You wish. In fact, we all wish. Not true though. Not true at all. Worse yet, when the market tanks, the correlations go to 1.

Take a look at this: Vanguard Large Cap & Small Cap, VV & VB. Take special note of what happened in October 2008. I well remember Oct'08. We were on a 3 week cruise and the market lost 20% while we were gone.

http://finance.yahoo.com/echarts?s=VV+Interactive#chart1:sym...

Hope it shows up okay, Yahoo is screwing around with links again. Anyway, it's the 5 year chart of VV compared with VB. Add SPY or DJIA or whatever to the comparison and you'll see that everything tanks at once.

That said, a small amount of margin is pretty safe. So then you've got to factor in the 2nd-order killer---margin rates. If you are paying 8% interest on your margin it's damned hard to get ahead. FWIW, etrade is 8.14% on margin balance less than $25,000.
The cheapest rate I know of is IB, who charges about 1.6%. However, I would NOT recommend IB to a newbie. They are totally geared toward highly experienced active traders.

small consistant gains Yeah, that's what everybody is looking for. Only place I knew where you could get that was with Bernie Madoff.

S&P500 long-term average is about 10.5%. That's about the best average you can reasonably plan to achieve. Paying 8% interest to get a 10% gain is of questionable benefit. You net only 2% but the 10% gain is lumpy while the 8% cost is steady.

Here's a suggestion. When you decide on a stock/fund/etf, download the historical monthly quotes for the last 10-20 years into a spreadsheet and then see what the month-by-month gains/losses would have been, both without leverage, and with 15%-20% leverage. Pick a reasonable starting value, maybe $10,000, or whatever amount works for you, and compute your month-by-month account balance. Don't forget to subtract the margin interest you'd have paid each month.
(When I do this for myself, I generally ignore taxes & dividends, figuring that they roughly cancel out each other.)

Then look at the monthly figures and the final total and see what you see. Did the margin help? What's the closest you'd have come to a margin call? How much total interest did you pay the broker? Did you wind up giving the broker the bulk of your extra gains?

Truthfully, I don't know what this spreadsheet would show, so I'm kinda looking forward to you doing it and then posting the results.

---------------
Oh, the reason that so many people are telling you not to use margin is that many many many of us got burned with margin. My wife still reminds me of the dinnertime phone call I got from my broker telling me to wire them $7000 by the next day, to meet the margin call. Not fun!

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Author: joelcorley Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68572 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 6:56 PM
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StockNewb,

You wrote, But what I see you guys missing is;
Im using funds not stocks. Funds are less volatile then stocks.


A patently false statement, if I ever heard one.

Some funds are more volatile than some stocks. Do a stock screen for a beta < 1.0; the result are stocks that are less volatile than the market as a whole. The Yahoo Stock Screener lists 3478 securities that fit this selection criteria. This includes the S&P500 index ETF SPY, which has a beta of 0.99. Most of those 3478 issues are less volatile than the S&P 500.

Also, I'll be holding a couple funds in the leveraged position instead of just one as I had planned. Due to volatility factors and it is harder to make two funds tank then it is to make one tank.

Another patently false statement. Or did you completely miss the 2008 credit crisis? Pretty much everything tanked - even bonds. Only the gold buffs and holders of cash or Treasuries were sitting pretty.

Also stock fund performance tends to be highly correlated. Just pull up any two stock funds and show them on a comparison graph for the past 10 years. You'll be surprised by how most of their movements look very similar and they only diverge over time. In fact many stock funds have many of the same holdings. But in any case, diversification can only save you a certain amount here. Ultimately there are common systemic risks built into most investment categories.

Finally, as per using option's, I like how you can hedge risk with them and it is sorta like leveraging but not quite. ...

Actually options [and insurance] are exactly like using margin. There is no practical difference. Options like insurance can be used to hedge [limit] your risk; they can also be used to lever-up your risk. A hedge is simply an option bet in the opposite direction of an existing position; a bet in the same direction produces leverage. With margin you can do much the same. If you bet with a position, you buy more than you could have purchased with cash on-hand. Betting against a position with margin is called shorting.

- Joel

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Author: StockNewb One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68573 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 8:57 PM
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Rayvt- I will work on that spreadsheet, but don't expect it overnight. I still have yet to choose which funds I am going to use and with this tidbit of info about some stocks being less volatile I have a lot of work to do. Also that one potato chip analogy does worry me, but I will make rules and play the rules. I;m decent at following my own rules.

As per the options, the broker I use doesnt do option's so for right now that is out of the question.

Interest I am paying is 4% I believe on the margin and I have no intention's of starting to use Margin until I have about $5,000 saved which should take about a month. I was using the time it would take me to accumulate the funds as a "cool off" and "planning" stage.

Thanks for the reply's guys. I will build that spreadsheet when I have time and pick funds for one and stocks for another. See which one is the least volatile, decent CAGR etc. I bet you the mechanical investing boys will be usefull for this... they have tools for this, I may have to head over there.

Anywho, I;m off for now.
SN

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Author: DrTarr Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68574 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 9:55 PM
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I well remember Oct'08. We were on a 3 week cruise and the market lost 20% while we were gone.


Leverage:

You saw my position in the earlier post, in moderation use it. I read that other sad story post and not for nothing - he got greedy! Like the old saying goes Bulls make money, bears make money - pigs get slaughtered!!! Sold all his other stocks - put them in one company which was selling for over 100 P/E and then levered up???

SET THE RULES:
Limit the allocation amount in your portfolio! Set the limit and do not go over it! Rebalance out if you exceed either the percent or dollar amount. That takes determination. And is really easy to say - oh ya, I can do that - and then just let it ride one more day!!

I encourage it on a diverse basis. Others have pointed out that funds may have the same volatility as individual equities. Easy to find funds that have more volatility than say a boring utility, but in the case of funds - and to your point, The one stock going down so dramatically - not even to zero just down, down, down did that other guy in and will do us in too. But if that one stock was part of an index it may not have even be that noticable in the index (yes 2008 was a highly correlated pile of doggie dodo) but you get the point. Don't set yourself up with a chance for single point of failure.

Understand - with leverage you go up faster, and you go down faster. What most folks forget or don't realize is that volatility punishes sideways markets: Meaning this:

http://finance.yahoo.com/echarts?s=xle#chart5:symbol=xle;ran...

If the chart did not work - it is a graph of ERX vs XLE Novemr 20, 2008 through July 6, 2010

ERX is a three times leveraged Energy Sector ETF and XLE is an index - so you expect three times the performance. Note that after a year and a half the XLE is up 20% while the ERX is down about 20%. Point being - depending on how you leverage if you are going up and down, down has a bigger influence. and mean reverting volatility is not your friend.


Roll forward in time:
http://finance.yahoo.com/echarts?s=xle#chart8:symbol=xle;ran...

This is the same two instruments but from a bull market view: Notice how ERX is returning more than the three times - infact almost four times, this is the compounding effect.


Again depending on how you lever up. Understand what happens in both the up and down cycles - as well as sideways!! 4% is a pretty big drag!


Don't go on a cruise: Leverage - yes it cuts, faster and deeper than regular. So if you are going to lever up be prepared to monitor a little more frequently. Imagine if you had been on the cruise and instead of 20% it had been 60%. Enough to give you a margin call, that you would not have received cause you are on the cruise and then your broker would have cashed you out! At the low price and when you got back...... after you have done this for a while maybe a short cruise.

Take a cookie every time they pass the plate: If you get into a position and have good hit, take some profits. Example: the average market return is 10.5% a year. And lets say you levered up 2X. What amount would make you happy. If you hit say 20% maybe take a little off the table and find another place. You can get pretty elaborate here - such as watching the underlying index and some stats on that benchmark like P/E or 1 yr forecast and then lever based on those numbers. But take some when they pass it and dont lever based on past performance. Both hard to do!!


Monitor the reason you picked that position - Say you picked Technology cause of its currently low P/E, or Financials because you think there is good growth potential. Montior those items. If technology earnings start to go down do you still want to play with leverage. IF banks start upping the provision for loan losses maybe the growth ain't coming soon - get out.

Decide how you are going to "lever" Straight up borrow the money, use option, or leveraged ETF's. You can do any combo of the above but each has its own benefits and traps. Look at all options (pun intended) both long and short calls and puts...

Enough for now:
1 Limit Allocation
2 Limit Concentration
3 Understand how it works
4 Monitor your position
5 Take a cookie / cut your losses
6 Monitor the fundamentals

And after every exit - honestly tell yourself what went right and what went wrong.

d(lever)/dT
Who would like to see the spreadsheet too! I have one that does simulation on the S&P using 2X leveraged for SWR stuff and that comes out favorable-- most of the time!!! <:g:>

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Author: DrTarr Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68575 of 76421
Subject: Re: Leveraged investing Date: 2/28/2011 10:06 PM
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Doesn't look like the charts worked out - sorry!

Parameters are there XLE vs ERX and differing times.

- And another way to "lever" is shorting the short. So for example shorting SH and buying SPY. Don't just think about borrow- explore!!!

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Author: StockNewb One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68576 of 76421
Subject: Re: Leveraged investing Date: 3/1/2011 1:22 AM
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Dr.Tarr and guys, wow, just wow.

I will be working on picking funds over the next little while, very interesting with the leveraged funds. Using leveraged funds in a levered account could be interesting. Or hmm use the Levered funds in the non-levered portfolio (My TFSA) due to margin calls, then use the slow and steady funds/stocks in the levered account and have an ultra safe haven for my gains.

Ok I have a lot to pore over for the next couple weeks even before I pick funds. I will be using backtest.org to cheat on making those spreadsheets if I can. I am not sure how high I should shoot for, for my gains. but I will keep it conservative. low p/e valuation's makes sense to me, but I may need to look at the support behind the funds too i.e how many people are buying/selling it and any news that can show why...

ok im just rambling and thinking out loud. Trying to figure out my diversification will be hard, since I dont have any real handle on it and I have such a small portfolio. I will probably just poke around here and slowly grow into an aggressive portfolio that suits me i.e when i start margin trading around $5,000 in capital, I will only have enough capital for 4 or 5 positions and as i gain more capital ill keep diversifying. I should probably map out how I want to expand and as I get gains ill siphon them off into those classes...

ok gotta go I write these things down in a book to help me think, so i better go do that. I will try to get another handle on how to pull this and come back at you guys in a bit. maybe with some fund picks.

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Author: BordLyron Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68710 of 76421
Subject: Re: Leveraged investing Date: 3/25/2011 7:19 PM
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SNB,

In an earlier post you mentioned that you had another year of learning/research before you started using margin/leverage. No need to rush your picks. I advise that you concentrate more on the process, potential gains & losses first.

Byron

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Author: hachmujt Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68975 of 76421
Subject: Re: Leveraged investing Date: 5/6/2011 2:57 PM
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StockNewb,
Good question and thread. I see that others have explained the risk of margin; I think you have a grasp of that and will skip it. I have a few comments to add and questions of my own.
~
The most important decision you make with your portfolio is your stock/bond split. One response pointed out that in a tanking market most indexes have a correlation of 1. This is a powerful point. In my opinion you must hold a portion of your portfolio on bonds. I start with my age and then adjust for risk and factors such as fixed income etc… no need to go into detail you can find it all on the fool or bogleheads. Holding a target percentage of bonds and rebalancing will bring your volatility down and reduce your risk with the margin.
~
The second most important decision is tax efficiency, use tax efficient accounts first then work on your cash account. Think about tax implications of your strategy, it is a must.
~
I assume that you have read up on the fool or elsewhere on personal finance. For example if you have any high interest consumer debt I would pay that off before your experiment begins.
~
Mortgage Your Retirement--A Commentary by Ian Ayres and Barry Nalebuff http://www.law.yale.edu/news/1826.htm The authors here make an interesting argument for diversifying across time. If you have not read it I think it is the argument you make. Their comments are not backed by real money portfolio testing. Another major problem is that you can not leverage in tax advantaged accounts.
~
Street credit: I had a $5k portfolio in the late 90’s. I had no idea what I was doing. I built it to $15k fully margined and quickly lost it all. Even the $5k loss is devastating if you look at what it means over 40 years. I was in my early 20’s at the time. Now I am a boring index investor with my age in bonds as a % of portfolio. This works extremely well.
~
I do have a fun money cash brokerage account which is about 5% of my entire portfolio. I hold 10% bonds in the account, 20% foreign ETF, 5% REIT ETF. My bond allocation will start mechanically increasing this summer after QE2 ends. The rest is a real money index of all Stock Advisor picks. I never buy a position up to more than 2% of net liquidation value. Most positions are bought up to 1% of portfolio. I leverage is account using broker margin. Currently I have a set rule for normal buying of no more than 10% margin or levered ratio of 1.10. My top end max is that if there is a market correction I may increase this to 20% or 1.2 levered ratio. This would be to have ammo to buy low.
~
I also have a very small smattering of options <5% of portfolio.
~
I use Interactive Brokers. One poster commented that this platform is not for new investors. I agree, it is very busy and can be confusing. Customer service is geared toward experienced investors. They are currently charging 1.59% interest which makes it a good place for margin. They also only charge $1 per trade, this is how I can own so many small positions and create diversity.
~
On my trading dashboard I have important margin information posted: Cushion, Special Memorandum Account and Current Excess liquidity. IB also has a margin stress test you can run on your account to see potentially how your portfolio will react to worst case scenarios.
~
I am an extremely conservative investor and have a textbook personal finance plan. I think that there can be a place to use margin. I would suggest setting strict rules on how you want to use it in your overall plan. You must write these rules down and post them up on your wall. If you have a partner you must get on the same page. What is your thesis and how are you going to deploy it? A previous poster gave the potato chip analogy, this is a great point.
~
I would like to increase my margin limit rules. I will not do this until I can come up with a good academic thesis. Can any readers please post with articles, links, threads or books on the subject?
~
If you use margin to leverage please share your game plan, I would like to hear how others approach this.
~
Take it easy,
Jason

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68976 of 76421
Subject: Re: Leveraged investing Date: 5/6/2011 3:58 PM
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[responding at invitation]

The biggest problem (read: risk) with leverage is that you can get a margin call at any time. ANY TIME, not just if you hit the Reg T limits. Read the disclosures----your broker can give you a margin call at their whim.

(This is why people who say "investing in the market while you have a house mortgage is just like buying your house on margin--and everybody knows how risky margin is." are just plain ignorant. Your house mortgage can't get called. </editorial comment> )

I actually like the stance that IB takes. They don't issue margin calls. They just immediately sell you out. In real time.

If you are going to use margin, stay safe. Don't go more than maybe 15%-20% initial margin, not the 50% that Reg T allows.
Be very clear in your mind that with margin at most brokers you are dragging a huge anchor. Typically margin rates are around 8%. That essentially means the the first 8% of your gain goes straight to the broker. Stock goes up 10%---you get 2%, broker gets 8%. Worse yet, suppose the stock goes down 10%. You lose 10% on the stock PLUS you pay another 8% to the broker.

================================
FWIW, I don't particularly like the rule-of-thumb that says your bond allocation should increase each year. And we are retired.
Instead, I use the 5 asset class mix, where each class is 20% of your portfolio. The "fixed income" class is what people thing of as bonds. We don't have any bonds (except incidently). Most of our fixed income class is in preferred stocks and other steady dividend-paying stocks. But mostly preferreds. 'course, preferreds are essentially bonds that trade like a stock.
We have a nominal position in bonds in the form of BND. That's a small but fixed percentage of our 20% income-asset-class.

My broker for BND is Interactive Brokers, mainly because I can take advantage of their low 1.65% margin rate and juice up my returns in BND. That won't last forever. When the rate differetial disappears I will sell enough BND to zero out the margin balance.

====================
The best (read: worst) margin story I heard was during the dot-com boom & bust.
This lady had been trading using maximum margin and made a fortune (over $1 million) all short-term capital gains. End of tax year, so she owed something like $300,000 in Federal income tax. Between Jan1 and April 15 the marker went down, she got matgin calls, and lost all of the profits she'd made plus she got sold out due to the margin calls and locked in her losses.
But the IRS says, If you make $1M in one year and lose $1M the next year, too bad. You owe taxes on the $1M and must pay by April 15th.
So she owed $300K but had lost all her money, so she couldn't pay the IRS.

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Author: hachmujt Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68977 of 76421
Subject: Re: Leveraged investing Date: 5/6/2011 4:23 PM
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@ Rayvt,

Thanks, I am here to find opinions different than mine, that is why I asked you to comment.

I realize after reading you post I have to have a strategy for when interest rates rise. I assume that IB will raise rates on borrowed money.

Am I thinking correctly on this? If I have 2k in debt on a 20k liquidation value portfolio that is 1.1 leverage. If I take a beating from Mr. Market and I loose 30% now my NLV is 14000 and my leverage is 1.143. This seems reasonable.

If I started at 20% margin that would be 4k debt on 20k. 1.2 leverage. Drop 30% brings it to 1.286. 29% margin seems like it would be pushing it. This wold force a buy and hold forever investor to possible sell low instead of buying low. This seems unreasonable.

I see why 20% is at the high end of the recommendation. It sounds conservative but I have to think about what it turns into when the market drops.

Thoughts?

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Author: DrTarr Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68979 of 76421
Subject: Re: Leveraged investing Date: 5/6/2011 9:45 PM
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FWIW, I don't particularly like the rule-of-thumb that says your bond allocation should increase each year

FWIW - I agree!
**********************************************

Other factors such as your current position, investing goals, and the market primarily dictate asset allocation.

Examples:
Current Position Investing Goals Market
Retired - $10MM net, $50,000/yr Exps, 7.5% UST 10 yr
(conservative type)

or

Working - $10 net, to retire one day*, 3% UST 10 yr
(*exps in some horizon, can fully fund 401(k), non conservative type)


Both the same age...and you can pick the age but then justify the same bond allocation for both! Does taht work for all ages?

Age can play a factor in risk tolerance but really is a small driver for asset allocation. And there are more than two asset classes which did not all correlate to one when the SHTF!


My bond allocation will start mechanically increasing this summer after QE2 ends.

Does it matter what rates are doing - have done etc.?

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68983 of 76421
Subject: Re: Leveraged investing Date: 5/8/2011 9:58 AM
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I see why 20% is at the high end of the recommendation. It sounds conservative but I have to think about what it turns into when the market drops.

Yah, that's the thing about margin that so many beginning (and short-time) investors don't see. Until you've lived through a couple of market cycles---boom, crash, boom, crash---you don't have a good feel for what can happen when the SHTF. Not to mention the breathtaking speed at which crashes happen.

I'm looking at one of our accounts that had these values for "growth of $1000 invested", at year-end from 2006 to 2010:
1000
1180 (wow! 18% gain in one year--load up the boat!)
684 (Oops, 42% loss in one year.)
934
987


============================================
My bond allocation will start mechanically increasing this summer after QE2 ends.

[DrTarr:]Does it matter what rates are doing - have done etc.?


This is a variation of the sunk cost fallacy. Very common error and damned hard to avoid making this error, even when you are aware of it.

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Author: hachmujt Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68991 of 76421
Subject: Re: Leveraged investing Date: 5/9/2011 1:48 PM
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@ Rayvt,
~
If you are going to use margin, stay safe. Don't go more than maybe 15%-20% initial margin, not the 50% that Reg T allows. I think this is where I am going to land, especially in a bull market. If there is some obvious bear market and my portfolio has not naturally gone to 20% I will keep that the high end I am allowed to buy into. New money does come into the account every month.
~
Be very clear in your mind that with margin at most brokers you are dragging a huge anchor. Typically margin rates are around 8%. Currently IB is charging 1/59%. As I said I need a game plan for when interest rates rise.
~
FWIW, I don't particularly like the rule-of-thumb that says your bond allocation should increase each year. And we are retired.
Instead, I use the 5 asset class mix, where each class is 20% of your portfolio. So not to confuse a new investor, I think we agree that it is important to use some sort of fixed income? We both have different methods of choosing this part of our portfolio. My point is that this decision has a very large impact on how a portfolio will perform. Interestingly I was holding PGF for years which is a preferred share ETF. Also we are at a similar % allocation for fixed we just got there a different way.
~
Your best/worst example is an excellent illustration.
~
@ DrTarr, Thanks for joining in. Other factors such as your current position, investing goals, and the market primarily dictate asset allocation…
…Both the same age...and you can pick the age but then justify the same bond allocation for both! Does taht work for all ages? I do not disagree with you that there are more things to think about there. I was throwing out a rule of thumb for a new guy. In general I do not think people hold enough fixed. You also need to consider other sources of fixed income such as a pension or Social Security… I wrote: “In my opinion you must hold a portion of your portfolio on bonds. I start with my age and then adjust for risk and factors such as fixed income etc… no need to go into detail you can find it all on the fool or bogleheads.” Emphasis mine.
~
My bond allocation will start mechanically increasing this summer after QE2 ends.

Does it matter what rates are doing - have done etc.? Just to clarify I am only talking about 5% of my portfolio in this fun money account. Everything else is allocated the way I want it and has been for years. In this specific account I do not hold as much bonds as I would like to because I wanted to buy SA recommendations instead.
~
To answer your good question it is no, it does not matter. I am well aware that the yield and price of a bond move inversely. So if I have the correct duration it will not matter. Rates go up and price goes down. I lose some principle but it recovers with a higher yield over the duration of the bonds. I set this date as kind of a mental date to start adding around 2% per year until I get to where I want to be. You are correct that it is a mistake to not just start averaging into the position if that is the allocation I have set. I must wait for new money, already at 10% margin. ?
~
Back @ Rayvt, I like the real life example:
~
I'm looking at one of our accounts that had these values for "growth of $1000 invested", at year-end from 2006 to 2010:
1000
1180 (wow! 18% gain in one year--load up the boat!)
684 (Oops, 42% loss in one year.)
934
987
~
If you held 20% margin at the 1180 level that would be 236 borrowed. Then when it dropped to 684 your borrowed amount would now be 34.5%. If one started with 25% margin you would be at 43% at the bottom, which is pushing it. This helps me wrap my mind around it.
~
This is a variation of the sunk cost fallacy. Very common error and damned hard to avoid making this error, even when you are aware of it. I agree that it is very hard to avoid. I see that my aversion to a price drop is affecting a totally rational decision here. This is why I am such a mechanical investor. I try to avoid it every day by having my rules and following them, f.u. Mr. emotions. ? Thanks again DrTarr for pointing this out first.
~
Good stuff, I do want to bring the discussion back to the leverage using margin question. Does anyone else have any good resources on the subject? Message boards, articles, books etc…
~
Thanks again,
~
Jason
PS Not getting much action here, is there a better place for the question?

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Author: hachmujt Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 68992 of 76421
Subject: Re: Leveraged investing Date: 5/9/2011 2:11 PM
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Ug, forgot to style properly. This should be more readable.

@ Rayvt,
~
If you are going to use margin, stay safe. Don't go more than maybe 15%-20% initial margin, not the 50% that Reg T allows. I think this is where I am going to land, especially in a bull market. If there is some obvious bear market and my portfolio has not naturally gone to 20% I will keep that the high end I am allowed to buy into. New money does come into the account every month.
~
Be very clear in your mind that with margin at most brokers you are dragging a huge anchor. Typically margin rates are around 8%. Currently IB is charging 1.59%. As I said I need a game plan for when interest rates rise.
~
FWIW, I don't particularly like the rule-of-thumb that says your bond allocation should increase each year. And we are retired.
Instead, I use the 5 asset class mix, where each class is 20% of your portfolio.
So not to confuse a new investor, I think we agree that it is important to use some sort of fixed income? We both have different methods of choosing this part of our portfolio. My point is that this decision has a very large impact on how a portfolio will perform. Interestingly I was holding PGF for years which is a preferred share ETF. Also we are at a similar % allocation for fixed we just got there a different way.
~
Your best/worst example is an excellent illustration.
~
@ DrTarr, Thanks for joining in. Other factors such as your current position, investing goals, and the market primarily dictate asset allocation…
…Both the same age...and you can pick the age but then justify the same bond allocation for both! Does taht work for all ages?
I do not disagree with you that there are more things to think about there. I was throwing out a rule of thumb for a new guy. In general I do not think people hold enough fixed. You also need to consider other sources of fixed income such as a pension or Social Security… I wrote: “In my opinion you must hold a portion of your portfolio on bonds. I start with my age and then adjust for risk and factors such as fixed income etc… no need to go into detail you can find it all on the fool or bogleheads.” Emphasis mine.
~
My bond allocation will start mechanically increasing this summer after QE2 ends.

Does it matter what rates are doing - have done etc.?
Just to clarify I am only talking about 5% of my portfolio in this fun money account. Everything else is allocated the way I want it and has been for years. In this specific account I do not hold as much bonds as I would like to because I wanted to buy SA recommendations instead.
~
To answer your good question it is no, it does not matter. I am well aware that the yield and price of a bond move inversely. So if I have the correct duration it will not matter. Rates go up and price goes down. I lose some principle but it recovers with a higher yield over the duration of the bonds. I set this date as kind of a mental date to start adding around 2% per year until I get to where I want to be. You are correct that it is a mistake to not just start averaging into the position if that is the allocation I have set. I must wait for new money, already at 10% margin. ?
~
Back @ Rayvt, I like the real life example:
~
I'm looking at one of our accounts that had these values for "growth of $1000 invested", at year-end from 2006 to 2010:
1000
1180 (wow! 18% gain in one year--load up the boat!)
684 (Oops, 42% loss in one year.)
934
987

~
If you held 20% margin at the 1180 level that would be 236 borrowed. Then when it dropped to 684 your borrowed amount would now be 34.5%. If one started with 25% margin you would be at 43% at the bottom, which is pushing it. This helps me wrap my mind around it.
~
This is a variation of the sunk cost fallacy. Very common error and damned hard to avoid making this error, even when you are aware of it. I agree that it is very hard to avoid. I see that my aversion to a price drop is affecting a totally rational decision here. This is why I am such a mechanical investor. I try to avoid it every day by having my rules and following them, f.u. Mr. emotions. ? Thanks again DrTarr for pointing this out first.
~
Good stuff, I do want to bring the discussion back to the leverage using margin question. Does anyone else have any good resources on the subject? Message boards, articles, books etc…
~
Thanks again,
~
Jason

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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 69014 of 76421
Subject: Re: Leveraged investing Date: 5/11/2011 3:00 PM
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I think we agree that it is important to use some sort of fixed income?

Not at all.
For most people, unless they are nearing retirement age (and hence losing their paycheck), they should not have ANYTHING in fixed income.

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