Borrowing on margin

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Borrowing on margin

Post by pqpq »

I'm hoping I would get some feedback on what seems like a bright idea, but something that I haven't heard much about before.

I currently have an outstanding mortgage of 375k @ 2.35%, fixed for another 4 years. I have a portfolio of 500k invested at 85/15. Roughly 250k is sitting in tax advantaged accounts and 250k in non registered.

Does it not make more sense to leverage through margin rather than a mortgage? I'm locked in for 4years but upon renewal I should have close to $1million in liquid investments. IB offers a rate of 1.9% and since the interest rate is tax deductible it's more comparable to a rate of 1.24%.

I can keep all my bonds in non-registered to minimize portfolio volatility and further reduce the risk of a margin call.

What's the catch here? Is this a free lunch? Why isn't everyone (With the means)doing this? Or are they...
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Re: Borrowing on margin

Post by nisser »

While you may earn 2-3% per year on dividends, there's also a chance to lose a massive amount if investments themselves go down. I borrowed up to 110k at one point on margin and it has done me well.
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Re: Borrowing on margin

Post by pqpq »

I guess the point is I'm already leveraged with the mortgage. In theory it doesn't make a difference whether I have 1 million in investments + 375k mortgage versus fully paid off house, 1 million in investments and 375k of it is a margin loan.
My asset allocation isn't changing. The amount of leverage isn't changing. Only how the loan is structured, and the rate at which I can borrow.

Is there a flaw in this thinking somehow?
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Re: Borrowing on margin

Post by OptsyEagle »

Since you will be taking out $375K from your margin account to pay off your mortgage (if I understand your strategy correctly) you will have two issues to deal with.

1) Interest deductibility is offered when the money borrowed is used to buy investments that earn taxable income. Debt in a margin account does not qualify for deductibility just because it is owed to a margin account. Since paying off your mortgage does not meet the deductibility test above, you would be required to do a little money laundering to get to the position you so desire. You would need to sell some investments (a lot of investments), pay off your mortgage and then borrow the money from the margin account and buy back the investments. You would also need to avoid superficial losses while this process is going on.

2) Not all money with your broker will be marginable. One cannot margin money held within RRSPs/RRIFs since they have a level of creditor proofing and therefore it is simply not allowed. The issue here then is what "level of margin" will you be sitting on when this process is completed. Will your non-registered investments allow for a $375,000 loan, when no more investments are generated from that loan, since you used the money to pay off your mortgage. Even if you did have enough non-registered money; what will your "level of margin" be after a 30% stock market decline. After you are done with that, check out a 50% decline and think about how well you will sleep at night. A margin call has nothing to do with a person being wiped out. It is simply rules put in place that will rapidly change a good investment strategy to a losing investment strategy from nothing more then volatility.

So with that said, although you are correct in that your strategy does not change the leverage level of your personal situation, it does however, change the risk level quite substantially, and that is assuming you could pull it off at all. From the numbers you have posted I would recommend a combination of some ridiculously low level of margin and the rest a regular non-deductible mortgage. No sense taking a very large and unnecessary loss so that you can pocket the few thousands of dollars of tax savings, your strategy will produce ... and nothing more. If you save $3,000 per year in tax savings your rate of return on your $1,000,000 just increased by 0.30%. Is that really worth all the risk and hassle?
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Re: Borrowing on margin

Post by deaddog »

I used a similar strategy when I was in the accumulation stage;

Rather than put money in an RRSP I used a Line of credit to borrow a lump sum then invested the whole amount plus use some margin to buy stocks.
I deducted the interest paid which worked out to about the same amount I would have contributed to my RRSP. Tax refund was added to my brokerage account.

I deducted both LOC and Margin interest. Kept a good paper trail so I could show that any money borrowed was invested in dividend paying stocks.
The loan was paid off when I retired. The end result was a portfolio with a small registered portion and a large unregistered portion giving me the flexibility in my retirement to take advantage of dividend tax credit and capital gains tax treatment, plus I control when I withdraw my money.

PS google Smith Maneuver
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Re: Borrowing on margin

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deaddog wrote: 08 Nov 2017 12:23Kept a good paper trail so I could show that any money borrowed was invested in dividend paying stocks.
Yes make sure that any interest payments were to fund dividend-paying investments.
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Re: Borrowing on margin

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Yep I understand the need for the $ to go directly to investments for it to be tax deductible.
We would pay down the mortgage with new moneys, and borrow from margin to invest at the same time, keeping the same leverage and also reasonable leverage %. HELOC will always be there as a backup.

$3000 a year sounds pretty significant to me! I'm only 27 so I'm in the accumulation phase. $3000 over 40 years, compounded... Maybe I can buy a free Ferrari one day :beer: I borrowed 20k from credit card because it was at 1% compared to my mortgages 2.35%, so ya :rofl:
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Re: Borrowing on margin

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Even if you did have enough non-registered money; what will your "level of margin" be after a 30% stock market decline. After you are done with that, check out a 50% decline and think about how well you will sleep at night.
Be the same as a 3 or 50% decline in Real estate values.
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Re: Borrowing on margin

Post by OptsyEagle »

BRIAN5000 wrote: 09 Nov 2017 19:43
Even if you did have enough non-registered money; what will your "level of margin" be after a 30% stock market decline. After you are done with that, check out a 50% decline and think about how well you will sleep at night.
Be the same as a 30 or 50% decline in Real estate values.
No it won't. You won't get a margin call if your house declines in value...stock market brokerages are not quite so understanding, however.
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Re: Borrowing on margin

Post by OptsyEagle »

pqpq wrote: 09 Nov 2017 19:13 $3000 a year sounds pretty significant to me! I'm only 27 so I'm in the accumulation phase. $3000 over 40 years, compounded... Maybe I can buy a free Ferrari one day :beer: I borrowed 20k from credit card because it was at 1% compared to my mortgages 2.35%, so ya :rofl:
Your thinking like a 27 year old kid here and not like a millionaire investor. It is 0.30% annually and that is all it is. Contrast that to the leverage level you will be sitting on with respect to your NON-REGISTERED investments and I think the downside way outweighs the upside, if you ask me.

Now if you really want to do this, my suggestion would be first to pay off the house and go get a HELOC. Now take the money from the HELOC and deposit it into the margin account. Now borrow some more on the margin account and use both those loans as your leverage. This way the leverage from the HELOC actually goes towards more security in the margin account, allowing you to maintain a little less debt in the margin account.

It's the outstanding debt in the margin account compared to the ever changing asset value of the margin account, where all the risk I speak off comes from. This suggestion would reduce that risk significantly, but the risk can never be completely eliminated. If you are 27 and have close to a million dollars, I wouldn't bother with any of it. It is simple greed if you ask me since I would have no problem meeting my life goals without the leverage, if I was in that situation, at that age. But I am not greedy and have very few wants and less people to look after and/or impress.
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Re: Borrowing on margin

Post by florch »

pqpq - I think you have a good idea here, and I've been mulling something similar. You have some well considered responses here and I think they each reflect the individuals investment style and risk tolerance. As mentioned there is a book called "The Smith Maneuver" by Fraser Smith which speaks to your idea of making your mortgage tax deductible. You clearly have the jist of it already, but it may reinforce your resolve.

My mentors (a couple) told me long ago that it was their goal to have $1M in debt one day, and they did it over the course of just a few years - in the 80's when $1M was a lot more money, and they came from modest roots. That debt was of course of the tax deductible and income producing variety, rental real estate in this case, and they worked incredibly hard to make that investment work by doing as much of the on site work as they could themselves until it became more efficient to hire other people and direct their energies on other aspects of the business. It was stressful and hard work but it paid off for them.

I don't quite have this risk tolerance, nor the desire to be as hands on with an investment, and so I've been considering something similar to your idea. I do have a small amount of leveraged rental RE, and I've been considering my next investment. I don't like the real estate metrics in my area, and I have a good paying career I'd rather invest my time in anyway. I'm on a second marriage, and this time around we went into the house 50/50 and don't want to encumber each other with the our personal debt, and so the HELOC is off limits except in an emergency, which could include a margin call.


I developed a spread sheet to prove the idea to myself. I had to make some assumptions, and here are the results:

50% margin (ie 100k of my money, 100k borrowed for easier math)

4.5% margin interest (TD's rate. I'd also set up with IB @~2%) In my tax bracket, it would cost me 2.25% at TD or 1% at IB. Interest expense: $2250

2% dividend rate (XIC is at 2.82 and would increase relatively with a stock price drop) taxed at 40% (thanks Justin): $2400. $2400-2250= $150 cash flow per year - which is skinny, but cash flow is not the point. After 5 years with no additional investment cash flow = $882.

Average ROI on the broad index is 10%. 10%-2% dividend - 2% inflation = 6% ROI on 200k, or 12% real ROI on your own money.

At 50% margin you could withstand an almost 30% stock market correction before you'd need to buy stocks at a MASSIVE DISCOUNT using money from your HELOC to meet your margin call. I see this as no riskier than real estate, far less work, infinitely scalable, or you could use only the initial margin amount and have a decreasing risk profile over time as your investments appreciate.

I am a couch potato investor, and so I'd leave my other investments inside my RRSP and TFSA, and use this for the Canadian portion for tax efficiency, although Justin and Morneau have sucked a lot of the fun out of this by increasing dividend tax rates.

FYI, if you had 2% interest (like IB) and a 3% dividend rate, you'd cash flow $2350 in year one and $3448 after year 5. I assume your ROI would be approximately the same with increasing dividends coming out of capital gains, therefore I only really want dividends sufficient to pay the interest.

Risks include cash flow and margin calls, job loss, loss of HELOC for some reason, stock market complete crash, collapse of western society. You'd need the perfect storm, or really bad management to mess this up.

And here I open myself to criticism and ideas, please!
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Re: Borrowing on margin

Post by SQRT »

Your plan would probably work fine. I did something similar while I was working. But rather than buy a broad etf, I bought my employer (big bank) stock. At the peak my margin loan was mid seven figures. Over time the divs increased quite a bit higher than the interest cost on the margin loan and helped to reduce the balance. Everything was great until fall 2008, two years after I retired. Got a little scary but didn’t get a margin call. Market would have had to reduce by half again for that. Many sleepless nights though. I also had couple million in heloc backstop which I didn’t need. In the end everything worked out splendidly. Repaid margin loans out of employee option proceeds once the market recovered. Lucky. It could have been much different. This experience cured me of the desire to use margin loans.

Iwould not recommend this plan. But if you have the nerve to hold steady when your portfolio declines by say 75% you could try it. Most people wouldn’t be able to.
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Re: Borrowing on margin

Post by florch »

Thanks SQRT for sharing your experience. I will re-run the numbers at this level of collapse to see how much of a margin call I'd have to make. I will assume that it will eventually recover but that I'd need to have cash available to weather the storm and how much it would cost in terms of cash flow from my HELOC assuming a much higher interest rate environment.
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Re: Borrowing on margin

Post by AltaRed »

I'd assume a 50% haircut (market loss) as a reasonable t case. 2008/2009 was over 50% but that is from the 2007 peak
The Dow hit its pre-recession high on October 9, 2007, closing at 14,164.43. Less than 18 months later, it had dropped more than 50 percent to 6,594.44 on March 5, 2009.
Read this article for a good Coles notes version of the 18 month debacle.
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Re: Borrowing on margin

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florch wrote: 13 Nov 2017 10:52 Thanks SQRT for sharing your experience. I will re-run the numbers at this level of collapse to see how much of a margin call I'd have to make. I will assume that it will eventually recover but that I'd need to have cash available to weather the storm and how much it would cost in terms of cash flow from my HELOC assuming a much higher interest rate environment.
Good idea. Plan for the worst case. As long as you can weather the storm both financially and emotionally, it’s a “reasonable” plan.
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Re: Borrowing on margin

Post by florch »

Thanks Alta. I remember the pain :cry: I held on, right to the bottom and somewhere near 9 or 10k I used all my spare cash to bargain hunt. It wasn't much, but it was minor mitigation. Today I'd like to think I'd continue to buy.

I don't generally try to time the market, other than to buy on dips or balance my portfolio. In this case I'm setting up my IB account, and there it will sit until there's a major correction. I'm sitting tight on my remaining holdings and will weather that storm - who knows how much gain I'd miss out on by pulling out too early, but before I back up the truck, there will have to be a significant correction.
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Re: Borrowing on margin

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SQRT wrote: 13 Nov 2017 11:23
florch wrote: 13 Nov 2017 10:52 Thanks SQRT for sharing your experience. I will re-run the numbers at this level of collapse to see how much of a margin call I'd have to make. I will assume that it will eventually recover but that I'd need to have cash available to weather the storm and how much it would cost in terms of cash flow from my HELOC assuming a much higher interest rate environment.
Good idea. Plan for the worst case. As long as you can weather the storm both financially and emotionally, it’s a “reasonable” plan.
It would be tough, but my HELOC could handle it, as could my income. As dividends increase and portfolio value rises vs. margin, the margin call gets further away and the cash flow is stronger. Maybe fine tuning the plan is in order to optimize the risk/reward level.
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Re: Borrowing on margin

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florch wrote: 13 Nov 2017 11:37Today I'd like to think I'd continue to buy.
If you're worried about a margin call, you're more likely to be selling at the bottom than buying.
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Re: Borrowing on margin

Post by BRIAN5000 »

OptsyEagle wrote: 10 Nov 2017 08:56
BRIAN5000 wrote: 09 Nov 2017 19:43
Even if you did have enough non-registered money; what will your "level of margin" be after a 30% stock market decline. After you are done with that, check out a 50% decline and think about how well you will sleep at night.
Be the same as a 30 or 50% decline in Real estate values.
No it won't. You won't get a margin call if your house declines in value...stock market brokerages are not quite so understanding, however.
You would only get a margin call if you used all available margin not sure why you would do that instead of use only some available margin to protect from downside market risk. I would never want to be scrambling to find funds or something to sell if I got a margin call. Just like paying your mortgage you need to have some sort of back up if you lose your job etc..

Sounds like you can in a few years arrange your affairs so all interest on borrowed money is tax deductible with or without increasing leverage. If you leave yourself some "outs" to cover worst case scenarios not sure what's wrong with this?
My mentors (a couple) told me long ago that it was their goal to have $1M in debt one day
Hmmm not sure why anyone would want a million in debt think I'd rather have the ability to borrow a million but not need to.
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Re: Borrowing on margin

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DenisD wrote: 13 Nov 2017 15:27
florch wrote: 13 Nov 2017 11:37Today I'd like to think I'd continue to buy.
If you're worried about a margin call, you're more likely to be selling at the bottom than buying.
That's a dark day, selling for pennies on the dollar. If the market never rebounds after a crash, God help us all and it will be the least of our worries.

The idea is to leave enough margin for a crash and have a HELOC to boot. If you have to add funds, stocks are cheap. I think you need to plan it as an eventuality and have the means and mentality to do it.
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Re: Borrowing on margin

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BRIAN5000 wrote: 13 Nov 2017 16:33
OptsyEagle wrote: 10 Nov 2017 08:56
BRIAN5000 wrote: 09 Nov 2017 19:43

Be the same as a 30 or 50% decline in Real estate values.
No it won't. You won't get a margin call if your house declines in value...stock market brokerages are not quite so understanding, however.
You would only get a margin call if you used all available margin not sure why you would do that instead of use only some available margin to protect from downside market risk. I would never want to be scrambling to find funds or something to sell if I got a margin call. Just like paying your mortgage you need to have some sort of back up if you lose your job etc..

Sounds like you can in a few years arrange your affairs so all interest on borrowed money is tax deductible with or without increasing leverage. If you leave yourself some "outs" to cover worst case scenarios not sure what's wrong with this?
My mentors (a couple) told me long ago that it was their goal to have $1M in debt one day
Hmmm not sure why anyone would want a million in debt think I'd rather have the ability to borrow a million but not need to.
Yeah it was just a counter intuitive statement. What it meant is that they owned a great deal of income producing property and it cash flowed.
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Re: Borrowing on margin

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BRIAN5000 wrote: 13 Nov 2017 16:33 Hmmm not sure why anyone would want a million in debt think I'd rather have the ability to borrow a million but not need to.
Isn't that the cut off point where we change who's problem it is?
If you owe the bank less than a million and can't pay, it is your problem.
If you owe the bank more than a million and can't pay it becomes the banks problem. :D :D
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Re: Borrowing on margin

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Yeah it was just a counter intuitive statement. What it meant is that they owned a great deal of income producing property and it cash flowed.
Yeah I get what was meant still wouldn't be something I'd aspire to. Maybe having revenue property generating a positive cash flow of a few $100,000 a year 8)

I have the means to leverage up immediately being retired and 60 ish and not requiring any more money it ain't happening. Considering giving daughter a sizable down payment to get her into the real estate market when market and her timing sync she how she handles that for maybe five years and then pay off her mortgage if she wants us to.
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Re: Borrowing on margin

Post by SQRT »

deaddog wrote: 13 Nov 2017 18:47
BRIAN5000 wrote: 13 Nov 2017 16:33 Hmmm not sure why anyone would want a million in debt think I'd rather have the ability to borrow a million but not need to.
Isn't that the cut off point where we change who's problem it is?
If you owe the bank less than a million and can't pay, it is your problem.
If you owe the bank more than a million and can't pay it becomes the banks problem. :D :D
Yes, that’s the old saying. Probably a lot more than a million today though. Also, margin loans are very low risk for banks and are almost always repaid through margin calls and forced stock liquidation. So it’s not really the banks problem.
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Re: Borrowing on margin

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BRIAN5000 wrote: 14 Nov 2017 16:37

Yeah I get what was meant still wouldn't be something I'd aspire to. Maybe having revenue property generating a positive cash flow of a few $100,000 a year 8)

I have the means to leverage up immediately being retired and 60 ish and not requiring any more money it ain't happening. Considering giving daughter a sizable down payment to get her into the real estate market when market and her timing sync she how she handles that for maybe five years and then pay off her mortgage if she wants us to.
This is why I come here. I like to hear you perspectives, and what people who have had success value. I think the $1m in debt is only a start if you want a few 100k in cash flow if you are a young person starting without assets :D
That much debt isn't for me, my goals and situation is somewhat different. I just liked to think how they thought for a minute and learn from their perspective. I don't think they would do it now because they are older and set, but I think if they had to do it again in the 80's they might have went even harder - with the hindsight of how the world works and biased by the success they had. Survivor bias maybe, we don't hear the tales of those who failed in the same game.
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