Leverage

[crimsonghost747]

So how many of you are currently using leverage? Where did you take it from and what kind of interest rates are you paying? Whether or not you are currently using leverage, do you think it's smart to use it in the current market? And finally, how do you pay back your leverage? (dividends, selling the shares, from your paycheck etc)

I currently don't have any leverage but I think the concept is great, especially at today's low rates. I think that currently the prices and volatility are so high that I'd rather not use leverage but I'm planning on using it when the situation presents itself. I can get it cheaply from my broker (IB) and then the dividends would be automatically paying back my leverage, so as long as my dividend income > interest expense then the loan would be paying itself back.

[hendi_alex]

Leverage can be you best friend, but when not properly managed can be your worst enemy. I use margin in my cash account, but only as opportunity cash, to snatch up bargains when they appear and available cash is low. I never use more margin than could easily be repaid in one year, only about $20k max, of which $10k is currently in use. I also sparingly use closed end funds when they appear to represent deep value. Many are levered about 30%. I currently hold KMF an infrastructure fund holding mostly MLPs and selling at a deep discount. My only other use of leverage is via buying calls. I buy calls if a company gets heavily punished in what appears to be a temporary over reaction. Some times will buy calls in anticipation of a favorable release of info that doesn't appear to be priced in by the market.

[Be Here Now]

I own the following leveraged ETNs: DVYL, HDLV, MLPL, MORL. This does not involve any borrowing by me, so I can own these in my IRA, and I do.

Margin rates are based on 3 month LIBOR. A fixed margin is added to LIBOR, ranging from 0 (MLPL) to 0.60% (DVYL).

Current markets are a bit scary for any large commitments to these, with the exception of MLPL, in my opinion. MLPL tracks the Alerian MLP Infrastructure Index, which is composed entirely of midstream MLPs. These do not have direct exposure to commodity prices, but they have been sold off along with the upstream MLPs. This in my opinion makes little sense, so I have a bit more in MLPL than the others.

Another way I use leverage is with mortgage REITs. I do not leverage these directly, but they have high leverage built in. My position in MORL is about 0.10% of my portfolio. I keep it as an experiment, not as a meaningful source of income.

I use all of these positions to fund income from my IRAs. I am at the RMD age so I need the income, and the hope is that the income will stay ahead of the ever-rising RMD percentage.

[earthtodan]

I use a form of interest-free leverage. Specifically, I sell margin-secured puts. Normally if you sell a cash-secured put, your broker will tie up enough cash in your account to secure against the strike price. Or with some brokers, if you are fully invested but sell a put in a margin account, they will charge you interest on the amount secured against margin. However at MerrillEdge, since cash is not actually lent in order to secure the strike, no margin interest is charged.

This means I collect the put premium as cash and get to reinvest it (while retaining liability if the option expires in the money). In a bull market, put options sold at-the-money tend to expire worthless, and you keep the premium. If the position moves in my favor quickly (say the stock rallies and the put loses 60% of its value in 20% of the expiration time), I tend to buy it back cheap, take my profit and then find someplace to do it again.

If the underlying stock tanks and I get assigned on margin, I would end up paying margin interest for holding the shares. In this situation I would have to add cash to the account or sell another position in order to de-lever. That is the risk. Since I contribute to my account every month, I see my contributions as slowly mitigating the risk. I sell puts with laddered expirations (Jul '15, Jan '16, Jan '17, etc) in order to distribute the risk over time.

In a way it's like running an insurance company. People buy puts as insurance against loss; I sell that insurance, take on the liability, and like an insurance company I reinvest the float.

[Dividendsrule]

Great stuff. I am pretty comfortable with using between 10-20% of my portfolio in leverage. What I do is pretty straightforward- I borrow money cheap from IB, and I throw it into high yielding stock. So I am pushing the income envelope.
I guess if the Fed Funds rate gets raised aggressively (unlikely in the current "new neutral" environment), then I'd be in a tough spot. But, I could always sell assets that have appreciated nicely, like my AAPL, WBA, or VFC, and I also tend to invest new cash quarterly which pays off my margin. Of course, my dividends pay back my margin as well.
I'd be curious to hear anyone's feedback. To me it kind of seems like a no brainer. I guess if you don't really need to worry about your income for a while, you might sleep better without any margin or debt in your portfolio. But, I tend to use my dividends every once and a while (this is all in my individual account) so having a 6-7% yielding REIT or an RDS/B purchased with margin I am paying 1.64% on to IB seems like a no brainer to me, for now, at least in this low interest rate environment.
I determined with IB customer service that with up to 30% margin, you won't need to worry about a margin call in the event of a 50% market crash with a Reg-T margin account (my account is even safer, it is a "portfolio margin account").

So I'm curious what you decided to you, CrimsonGhost. EarthToDan, I tend to avoid options, but the concept of what you describe sounds very interesting indeed, and relatable (serving as an insurance company of sorts).

[crimsonghost747]

Dividendsrule, you are pretty much exactly in the situation that I would like to be in. About 15-25% margin, as long as the average dividend % is greater than my interest % then that is basically money from thin air.

But like I said in the first post I don't want to start building leverage in the current situation as I still think, that in general, the stock market is priced quite high and there is certainly some room to slide downwards. I think of the margin more as my "extra ammunition" if there is a dip and I can get some good stocks for cheap. Then I won't hesitate to use 15-25% in leverage and quite frankly I'm assuming that once I start using leverage I won't be going back.

[Caversham]

I would consider using limited margin (<15%) if the market entered a serious bear market.

What brokers have good margin rates? The only broker I know of that doesn't charge ridiculous interest is IB.

[Dividendsrule]

Yep...Basically Mr. Peterffy has somehow found a good business model with IB (he is IB's CEO) to keep rates low (they are essentially floating rates- 1.5% plus Fed Funds rate). It is definitely on his whim. I will say that Fed Funds rates reached 5s and 6s as recently as the early 2000s. So it is not always going to be a free lunch.

I know an ultra high net worth individual who negotiated with Fidelity to give him a fixed 2% margin rate. His wife flips houses with it. I don't know how big his account with them is, all I know is he sold a business and has been trading (not investing) in the market for years. I guess if your account is big enough you might be able to negotiate with your brokerage.

[Dividendsrule]

Even though I use some leverage, it is important to be prudent. Here is a great article on Warren Buffett talking about leverage and unnecessary risk that is important for me to keep in mind.

http://blog.alphaarchitect.com/2015/09/0...ary-risks/

[Kerim]

(09-10-2015, 11:06 AM)Dividendsrule Wrote: Even though I use some leverage, it is important to be prudent. Here is a great article on Warren Buffett talking about leverage and unnecessary risk that is important for me to keep in mind.

http://blog.alphaarchitect.com/2015/09/0...ary-risks/

Great read -- nice find. Thanks!

[Dividend Watcher]

(09-10-2015, 01:12 PM)Kerim Wrote:

(09-10-2015, 11:06 AM)Dividendsrule Wrote: Even though I use some leverage, it is important to be prudent. Here is a great article on Warren Buffett talking about leverage and unnecessary risk that is important for me to keep in mind.

http://blog.alphaarchitect.com/2015/09/0...ary-risks/

Great read -- nice find. Thanks!

Agreed, good article. However, that gesture that W.B. and the young woman were doing in the opening picture reminded me of one used many years ago for something else. OMFG! If ole Warren ever knew what was going through my mind. Of course, maybe he was thinking the same thing!