Thoughts on leverage & margin loans

As a novice investor, I'd like to know peoples opinion on using margin loans and leverage in the stockmarket.

Essentially, can leverage be used successfully in the long term with minimum risk?

The reason I ask is this:

1. I haven't heard many stories about making a lot of money from using margin loans, except the examples that margin loan marketing provides. However, I've heard a lot of stories about people losing a lot of money from using margin loans.

2. I saw a Warren Buffett interview the other day. He said something along the lines of “Stay away from leverage. Nobody ever goes broke that doesn’t owe money.” and "If you’re smart you don’t need it, and if you’re dumb, you got no business using it."

3. I'm thinking if you only gear conservatively, lets say for interest sake approx 25-35% LVR you're pretty safe right? But you still need to outperform interest to make it all worthwhile. So is the trouble worth it?

Just interested in peoples thoughts

NB: just to clarify i'm only talking about leverage into the stockmarket and equities, not property.

dumadiscount said:

As a novice investor, I'd like to know peoples opinion on using margin loans and leverage in the stockmarket.

Essentially, can leverage be used successfully in the long term with minimum risk?

The reason I ask is this:

1. I haven't heard many stories about making a lot of money from using margin loans, except the examples that margin loan marketing provides. However, I've heard a lot of stories about people losing a lot of money from using margin loans.

2. I saw a Warren Buffett interview the other day. He said something along the lines of “Stay away from leverage. Nobody ever goes broke that doesn’t owe money.” and "If you’re smart you don’t need it, and if you’re dumb, you got no business using it."

3. I'm thinking if you only gear conservatively, lets say for interest sake approx 25-35% LVR you're pretty safe right? But you still need to outperform interest to make it all worthwhile. So is the trouble worth it?

Just interested in peoples thoughts

NB: just to clarify i'm only talking about leverage into the stockmarket and equities, not property.

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Simply put, if you invest your own $10,000 and earn 10% you make $1,000,

If you use your own $10,000 as a deposit and loan $90,000, and earn 10% on your total investment of $100,000 you make $10,000. So by using you leverage you have turned a 10% investment profit into a 100% return on your invested cash.

However, you have to understand that it things went just 10% the opposite way, you will have suffered a 100% loss on your invested cash, plus the cost of interest.

Leverage is not for begineers, and it shouldn't be over used. Thousands of smart people have gone bust using leverage.

Agree, just like to add that Warren Buffett has used massive leverage, so don't believe everything he says.

dumadiscount said:

As a novice investor, I'd like to know peoples opinion on using margin loans and leverage in the stockmarket.

Essentially, can leverage be used successfully in the long term with minimum risk?

The reason I ask is this:

1. I haven't heard many stories about making a lot of money from using margin loans, except the examples that margin loan marketing provides. However, I've heard a lot of stories about people losing a lot of money from using margin loans.

2. I saw a Warren Buffett interview the other day. He said something along the lines of “Stay away from leverage. Nobody ever goes broke that doesn’t owe money.” and "If you’re smart you don’t need it, and if you’re dumb, you got no business using it."

3. I'm thinking if you only gear conservatively, lets say for interest sake approx 25-35% LVR you're pretty safe right? But you still need to outperform interest to make it all worthwhile. So is the trouble worth it?

Just interested in peoples thoughts

NB: just to clarify i'm only talking about leverage into the stockmarket and equities, not property.

Click to expand...

If you have made money from your own money, then leverage used sensibly can be rewarding. If you haven't made money from your own money, how can you expect to make money using someone elses?

Tysonboss1 said:

Thousands of people who thought they were smart have gone bust using leverage.

Click to expand...

Just a slight correction.

wayneL said:

Just a slight correction.

Click to expand...

Yeah you can say that, But look at the longterm capital story. Those guys were very, very intelligent but they just missed somthing from left field and because of the leverage they went down hard, with out the leverage they would have been fine.

Interesting video here.

wayneL said:

Just a slight correction.

Click to expand...

Perhaps a double entendre there too .

Tysonboss1 said:

Yeah you can say that, But look at the longterm capital story. Those guys were very, very intelligent but they just missed somthing from left field and because of the leverage they went down hard, with out the leverage they would have been fine.

Click to expand...

Without the leverage they wouldn't have existed . All quant funds use leverage, since they rely on repetitively profiting from small price actions.
Good vid, btw .

Imagine having a Margin Loan and getting the CALL on Friday (13 Feb) that the buffer had been breached, and not having the cash. Likely down 30%, positions sold out, then a 10% rebound by close!!

(I have a ML, and just looked up my LVR; even after the big falls, it's at 11%. I haven't touched the shares held in it, but will comment that during the GFC, it was useful when companies had calls on capital, it was handy to draw on the line of credit)

i used to use margin tactically in options trading. most of the time my cash balance would sit above zero, but i'd use the margin facility to collateralise short put positions and dip into it for short periods of time if and when i got assigned on some of those.

my bread and butter strategy is selling puts at a strike and IV i'm comfortable with, ideally if the underlying has a dividend coming up, then if it gets assigned, take delivery and keep selling covered calls until it gets called away, even if i have to take a small capital loss doing so, as the time decay is what i'm after and that was more than enough to fund the interest on the margin at rates far higher than what they are now.

the margin came in handy as it let me put on more of these positions because i knew i had it available to take delivery if i had to, rather than closing out or rolling before expiry if something looked like it was going to get assigned. this makes a small, but over the course of many trades, significant difference as closing out or rolling means crossing an additional spread (which tend to be nasty on expiry day), paying more brokerage, and missing out on that final hour/final day decay, when the theta is really high.

i don't use margin now because IB stopped offering it to Aust customers following the migration from IB LLC to IB Aust. probably just as well in light of the current crisis. but it was nice to have had it in years gone by during less volatile times. i don't think margin is an inherently bad thing, just don't overdo it, and get yourself familiar with what rules your broker uses to calculate it, what rules they use to trigger margin calls, and what process they follow in the event of a margin call.