Subject: Strategy - Buying on Margin
Last-Revised: 19 Dec 1996
Contributed-By: Andrew Aiken (aiken at indy.net)
I have used margin debt to leverage my returns several times this year, with successful results. At no time did my margin debt exceed 25% of my net account equity. This is my personal comfort level, but yours may be higher or lower depending on your risk tolerance, your portfolio return vs. the interest rate on your debt, and your degree of bullishness about your investments and general market conditions.
If I am using margin, I have tighter stop-loss limits. How much tighter is determined by the amount of debt, the interest rate on the debt, and the historical volatility of the stock.
Here are a few more suggestions:
- Never use margin unless you follow the market and your investments on a daily basis, and you consider yourself well-informed about the factors that could influence your asset value.
- Do not use margin debt as a long-term investment strategy.
- Have a clear idea of how long you plan to maintain the margin debt.
- Always have cash reserves outside of your brokerage account that exceed your margin debt, so that you could pay off the debt at any time, if necessary.
- If you maintain the debt for more that a few weeks, contribute cash to your account on a monthly basis, so that you are paying off the debt the same way one would pay off a credit card.
- Start with a small amount of debt relative to your account (5 - 10%), and use this as a benchmark for future actions.
- Have a stop-loss limit and a target sell price for all of the investments in your leveraged account. Stick with your targets!
- Do not let the chance of a margin call exceed 5%. The assessment of this probability should be made and adjusted regularly.
- Learn the techniques that the professional hedge fund managers use in maintaining leveraged investments. This information is available for free at the library.
I consider margin debt to be a tactic rather than a strategy. It is not suitable for a long-term, buy-and-hold investor. The tactic has worked for me so far, but I know several bright individuals who have been burned by it.
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