Is 6% too high to trade stocks on margin?
Lets assume I understand the risk of trading on margin and that I can lose the money.
My question is if 6% is too high? I do have dividend paying stocks that could almost cover the monthly interest charged although I don't want to spend all my dividends on interest.
How do you feel about trading stocks on margin? Is there a certain percentage you like to spend on margin? Ex. 70% cash, and 30 % on margin?
Let me know.
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6% isn't "too high" in terms of market rates at the moment, however it's a very subjective question whether it's too high for you. The real question to determine is if paying 6%, can you make more than 6% return (to cover the costs plus your profit)?
As for a rule of thumb, there's none I know of, however your best bet is to take the time to model it in Excel (not difficult). It's different for each portfolio or investment. Something with a high standard deviation of returns is already high risk, adding margin to it only makes it worse. So, long story short is that, "it depends".
Yes, 6% is a waste of money, because some other brokers such as IB offer margin rates below 2%. Also, to borrow money for even less than any broker's margin interest rate, one can do an EFP transaction. This involves simultaneously shorting a stock and buying the SSF for the same stock. When the futures contract expires, you take delivery of the underlying stock to automatically close out your short position. Until then, you've effectively borrowed cash for the cost of borrowing the stock, which is typically less than 0.5% interest for widely traded ones. You also pay for the slight difference in price between the stock and the future, which is typically equivalent to another 0.5% interest or less. The total often comes to less than 1% interest. The only risk with this transaction is that the stock could become hard to borrow at some point, so then you would have to pay higher interest on it temporarily or maybe even have to close out your short early. But it is extremely rare for large, high-volume stocks to become hard-to-borrow. The borrowing cost of SPY has spiked above 5% on only a handful of days in the last decade.
Okay so we are assuming that you can sustain 6% or more return on your investments.
Personally I would compare that rate to what lines of credit are going for and do what ever is least expensive.
Either way your risk is the same. Your net worth is the same. Your assets will be the same.
Your liabilities will be the same.
Its just a matter of who you owe it to and what the rate is.
Don't be afraid of having a second mortgage. If the stocks go down either way you have to sell what's left and pay your debt.
Or what I should maybe say is don't be more afraid of a line of credit more than margin in your investment account.
That seems a little high in my experience. I've used a home equity line of credit instead, as the rates are much lower (~3.5%).
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