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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.
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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.
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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.
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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.
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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.
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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.
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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.
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I also have a very small smattering of options <5% of portfolio.
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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.
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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.
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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.
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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?
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If you use margin to leverage please share your game plan, I would like to hear how others approach this.
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Take it easy,
Jason
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