Entering text into the input field will update the search result below

Now Is A Terrible Time To Buy On Margin

Jan. 22, 2014 11:15 AM ETSPY15 Comments
Peter Larson profile picture
Peter Larson

Buying stocks on margin is always a risky proposition. You can pick the wrong stocks and you end up with a leveraged loss, or you can overextend yourself during a downturn and receive a margin call. But for the last several years at least, you could say that there was a profitable spread. Long-term expected returns for an S&P 500 index fund (SPY), were higher than the margin interest rates being charged by most brokers.

Well, not anymore.

By my calculations, the implied market discount rate has fallen to 7.0%, lower than the margin interest rates available to all but the most wealthy account holders. Almost everyone borrowing to buy long term will see their profits eaten up by interest payments, even if they pick solid stocks and are able to hold them through any dips or crashes. And yet NYSE data is showing margin debt reaching record high levels.

Normally I try to shy away from saying anything that could be construed as direct investment advice in Seeking Alpha articles. But, if you are carrying significant margin in your account, and you are paying interest rates above 7%, PLEASE take this opportunity to pay it down.

These high margin, low yield conditions could precipitate a market crash, but even if that doesn't happen, it's just common sense.

Explaining the implied market discount rate

Every week for the past year I have performed a discounted cash flow analysis on thousands of stocks. This began as a project on my Seeking Alpha instablog, and has now grown into the DCFHub website. The implied market discount rate is a byproduct of this process that happens to be equal to the expected return for the stock market as a whole.

A discounted cash flow analysis requires two things; a projection of future cash flows

This article was written by

Peter Larson profile picture
A humble engineer and family man. Never been to Wall Street. Not psychic or anything. The idea behind DCFHub: I realized one day that it is possible to automatically calculate and track a net present value for just about every stock by simply plugging the analyst consensus growth estimates into a discounted cash flow analysis. So I am doing it.

Recommended For You

Comments (19)

Kyle Fishman profile picture
How about this strategy:
buy $2,000 worth of an index fund on margin......
if it drops in value, then buy another $2,000 on margin (at a lower price than before).....
and repeat the process until it goes back up.
and as it goes higher, sell some of your position.

We do know that it will go back up..........just not when and how long it will take, and how large the dip will be.

just borrowing 100k outright to buy stock on margin may not work.......
but take it slow; borrow 2k......
if it goes higher, you make a slight gain.
if it goes lower, you buy more and make a bigger gain.
As long as Japan 1990-present, or the USA 1970-1980 doesn't repeat itself, sure.
Peter Larson profile picture

Buying on margin means you pay interest on the investment.

While it is a good bet that the market will "go up" at some point in your future, it is NOT likely to appreciate faster from today's levels than interest will accrue on your margin.

Additionally, the strategy you are advocating is what gamblers call a "Martingale bet". These strategies do not work and they often leave the practitioner bankrupt.

If you want to size a bet/ risky investment properly, use the Kelly criterion.
Kyle Fishman profile picture
Well the theory I was getting at is: It's more likely to go up if the market is lower, on a dip. The more it corrects, the more likely it is to go up fast.

I'm just saying; if the Dow gets a 10% correction, it will be an excellent time to buy on margin. History proves it pays to buy on dips.
jz30 profile picture
I don't understand how these other brokers compete with IB, seems like a ripoff
24 Jan. 2014
About two years ago I started to move my margin account to IB from TDAmeritrade. But TDA called me and offered to lower their margin rate. I ended up paying 2.0% at TDA on a balance over $500,000.

Doyle3000 profile picture
Great article. One clarifying point is that you should cull your long positions that are on margin. What I do with most of my margin is hold short positions on a few high-flyers who are so far out over their skis it feels like 1999. This way, when the next correction (or gasp, crash) comes I'll have a heavy keel beneath me to offset the storm.

But your point is well taken. And thanks everyone for enlightening me about Scottrade and IB!
i repeat what other commenters have said. u can get a loan with Interactive Brokers at 1 %. It doesn't make any sense using as a baseline something as expensive as Scottrade
Peter Larson profile picture
Interactive Brokers does appear to be a great deal, so thank you everyone for pointing that out.

But let me put it this way: the point of this analysis is to figure out at what point in time we should expect to see broad de-leveraging.

Last year, when the market was trading at an 8% discount rate, I felt that it was expensive but there was still a little meat on the bone because most investors could still easily borrow for less than that.

I don't think the market will get to a 1.58% future discount rate.
SmokyFever profile picture
I have been using Interactive Brokers for years and manage my own account of 50-100 stocks that are rebalanced quarterly. Although I have used IB for trading on Margin (mainly for shorting SPY on occasion), I use them mainly for the savings on commissions. At $1 a trade on most of my trades (US stocks), it sure helps with the rebalancing costs.
edexter profile picture
The real story here is that most brokers cannot compete with interactive brokers margin interest rates and they are low world wide and they said they are expanding into other markets.. borrowing at 1.57 and then buying a bdc that pays 11 and raises it's dividend every month pays a little bit... I suspect the dollar could go up in part because margin shifts to other countries with low rates when the interest rate goes up..
Even the 1% at IB may be too much if returns are negative. The US market faces huge headwinds of higher long term interest rates, and declining earnings. Paying published Scottrade margin rates for a fully collateralized margin loan is basically asking to be robbed.
Margin interest is tax deductible, you need to redo the math on the breakeven point.
Peter Larson profile picture
My understanding- and feel free to correct me if I'm wrong- is that the interest is only deductible against investment income, which does not include long-term capital gains.

So if someone wished to count the gain as a long-term capital gain, they would still have to pay full taxes on it.

In practice, they would most likely just elect to have a portion of the capital gains counted as investment income. But that's getting pretty far away from the concept of the article. I'm assuming noone reading this would even be considering a loan that large in the first place.

I'd be happy to submit a correction if I can figure out a clearer way to state this.
Interactive Brokers' margin rates are but a fraction of those charged by Scottrade.

Currency Tier Rate Charged
USD 0 - 100,000 1.57% (BM + 1.5%)
100,001 - 1,000,000 1.07% (BM + 1%)
1,000,001 - 3,000,000 0.57% (BM + 0.5%)
3,000,001 - 200,000,000 Greater of 0.5% or (BM + 0.25%)
200,000,001 + Greater of 0.5% or (BM + 0.25%) 1

Or you simply switch to Interactive Brokers and pay... 1.57% up to $100.000, declining thereafter.

But I agree with the author on one point : now, at market peak, is when you want to owe money to no one...
Christopher Mahoney profile picture
How many of you guys were bullish in March of 2009?
Peter Larson profile picture
I was borrowing money hand-over-fist to get in March of 2009. Also 2010.

And to be fair, also 2008 and the later part of 2007.
Or you can use futures contracts to 'borrow' at 0.5%
Disagree with this article? Submit your own. To report a factual error in this article, . Your feedback matters to us!

Related Stocks

SymbolLast Price% Chg
SPDR® S&P 500 ETF Trust

Related Analysis

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.