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Carlos
Carlos
03/06/2012 10:40 am

Margin works great, until a black swan happens and your account blows up. If you are using such a high leverage as you pictured on this post, you don’t even need a black swan, a good 30-40% correction will be enough to put you in margin call territory, and then you will be at your bank’s mercy (hint: they have none). If you happen to be lucky and catch a bull market (2000 – 2007), you can be made a millionaire on margin. Bad timing (2007 – 2009), will wipe you out in days.

Liquid
Admin
03/06/2012 10:55 am
Reply to  Carlos

Great point about black swan events. Risk is greatly increased when margin is used. Hopefully today’s poor market performance doesn’t turn into a major correction, or else I’d need to put some more money in my margin account :0)

Anthony Thompson
Anthony Thompson
03/06/2012 4:29 pm

Your explanations on margin accounts was very well done. I like the HELOC example that you used to illustrate how they work. Thank you for making it clear for those who are not very familiar with them.

Liquid
Admin
03/06/2012 4:56 pm

Thanks Anthony ヽ(^。^)ノ
Some people take on HELOCs because of low interest rates. I borrow on margin for the same reason right now.

Theo
Theo
03/06/2012 7:15 pm

Great post. I think leverage is a very good idea when your portifolio is smaller, it can boost growth. When your portifolio is bigger (500K+) maybe a good time to start reducing levarage, at least this is my strategy.

Liquid
Admin
03/06/2012 10:38 pm
Reply to  Theo

Hey Theo. I totally agree. I like to call it the adjustable leverage balance, where the debt/equity ratio should be reduced as the stakes get bigger. It applies to other aspects of investing as well. Going all in on a small cap company with a $1K portfolio is plausible if we can risk losing a few hundred dollars, but for a $100K portfolio we wouldn’t go all in on this company anymore because capital preservation now takes priority over growth, so we have to decrease our investment risk.

Vicky
Vicky
03/07/2012 5:57 am

I’m definitely not ready for margins yet, but thanks for the info! Can’t wait for more posts on this topic; maybe it will increase my comfort level with leveraging. I know I am definitely a risk adverse person though.

Do you think trading products such as ETFs or index mutual funds on margin make sense? I’m not sure the dividend yield in that case would result in a sufficient return for the risk.

Liquid
Admin
03/07/2012 5:52 pm
Reply to  Vicky

That’s cool Miss V. Women are generally more risk adverse than men, which is actually very beneficial. Studies show women are better long term investors than men for this very reason (^-^)
Since ETFs trade the same way as stocks, I have no preference either way. If the ETF or index fund pays a dividend that’s at least equal to the margin loan interest (3% in my case) then I would put it in. However I would warn against putting any inverse ETFs based on the financial sector into a margin account.

Ramon
Ramon
03/07/2012 7:12 am

Thanks for this it made better sense of my margin account. So far I’ve only used my own cash my having that money there is very tempting. I will need to read my margin account`fine print and see how much interest it charges me. I’m very new at this and I’m actually thinking of changing my margin account to a TFSA investing account. Again, thanks for the info very easy to read for a newbie like me.

Liquid
Admin
03/07/2012 6:04 pm
Reply to  Ramon

Your welcome Ramon. I know what you mean by tempting, especially when interest rates are so low right now. Have you thought about creating a new TFSA account and keep the margin account you have now?

Julie @ Freedom 48
Julie @ Freedom 48
03/07/2012 4:56 pm

Good informative post! We’ve always turned down the option of margins – probably because we’re not brave enough! I think it’s a great way to take advantage of money the bank is offering to loan you.

Liquid
Admin
03/07/2012 6:22 pm

For sure Julie. I love borrowing the bank’s money, lol. Some people also like to use margin accounts as a back-up for their emergency fund ( ^^)

Steve @ Canadian Personal Finance

I was actually talking about this strategy with a friend today but wouldn’t it make more sense to use this with a stock that has a way higher yield?

Liquid
Admin
03/08/2012 9:38 pm

Good idea. It certainly wouldn’t hurt having a margin account with high yielding equities in it.

RickPsychGuy
RickPsychGuy
03/10/2012 11:30 pm

That’s the strategy that I use in my leverage account: In October 2011 when stock prices were falling I decided to use my HELOC to borrow $50,000 and invest in 10 dividend stocks. The interest I pay on the $50,000 loan is 3.5% annually (or $1750 in interest a year). Keep in mind that interest used to borrow for investing purposes is tax deductible! After tax deduction I pay $1000 in interest per year. The stocks I own produce an average yield of 5.5% (some are higher such as CFX at 10%, and some are lower such as Telus at 4.5%). Total dividends I receive annually is around $2750. Without using any of my own money I’m earning: $2750 (dividends) – $1000 (interest) = $1750. Of course that’s before any capital gains. I’ve been fortunate so far and my stocks are up by an average of 20%. So, if I sold now, I’d have made $10,000 without using a cent of my own money. Of course there are two major risks with this strategy: 1) interest rates rise and I send up paying more in interest than I earn in dividends 2) stock market tanks, and I am left owning… Read more »

Liquid
Admin
03/11/2012 12:49 am
Reply to  RickPsychGuy

Thanks for sharing your strategy Rick. In fact, HELOCs are even better for doing these kinds of things because their borrowing interest rate is usually lower than margin loans.

Matthew
Matthew
03/23/2012 5:44 am

Looking forward to a post on margin calls… how they happen, and what you need to do to cover them.

Liquid
Admin
03/23/2012 8:57 am
Reply to  Matthew

Thanks for the interest Matt. I’ll probably do a post on margin calls early next month.

Youri
Youri
04/27/2012 11:50 am

Great blog man, had very important content that I can relate to 🙂

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[…] money to buy stocks using your existing holdings as collateral. In the past I’ve described how margin accounts work, and walked through how to execute a trade on margin, so I won’t go into that here. This […]