At 10%+, Time to Reduce Margin Exposure in Brokerage Accounts

by: Travis Johnson

As short term interest rates have climbed over the past couple of years, brokerage margin rates have climbed with them. In some cases, quite dramatically. This has presented me (and other investors, I'm sure) with a bit of a dilemma.

As a long term investor with some confidence that I should be able to average 10%+ annual returns, I found it reasonable to use a small amount of margin in one of my accounts to boost my compounding ability. Or, at least I found it reasonable when margin rates were around 6%.

But with rates now at 10%+ from many brokers -- I'm paying almost 11% in the account I'm worried about -- I can't justify using much margin anymore, except for extraordinary short term opportunities.

More information on various brokers, including their margin rates, is available in a Business Week article from last month (I looked at the print initially. The online version doesn't have the helpful chart that lists everyone's margin rates). It seems the average margin rate for relatively small margin loans, like the one I use (most of my account isn't on margin) is hovering around 10%.

So what to do if I can't justify borrowing money at 10 or 11%?

Although I generally don't like to sell unless I have strong concerns about an individual company, I let go of several smaller positions in my margined account -- some at a loss, some at a gain, but on the whole I'm taking a profit to significantly reduce my margin exposure.

If the account were not on margin, I likely would have been content to hold these companies for a much longer term. They all have positive things going for them, and I think most probably have bright futures regardless of their current price or valuation. But since it's borrowed money, I have to be a bit more impatient. These are the companies that I either wouldn't put new money into now or I think are getting a bit overvalued in the short term, or that are down and not likely to recover in the very near future.

I'll post a separate note on each of the stocks that I sold on Wednesday to explain my reasoning in some detail, but I sold all of my Rofin-Sinar (NASDAQ:RSTI) and Formfactor (NASDAQ:FORM) and Middleby (NASDAQ:MIDD), and, (because these holdings are split across accounts,) roughly half of my Lionsgate (LGF) and Imax (NYSE:IMAX) holdings.