Mind Your Margin

Please note the publish date of this blog. Financial information, market conditions, and other data mentioned in this post may no longer be accurate or relevant.

We are now in the longest bull market in history. If you are using margin to borrow against the value of your portfolio, it’s time to take stock of your situation. Excessive portfolio indebtedness could trigger a margin call, the forced selling of assets. Worse, it would occur at or near cyclical market lows. You would be selling at the bottom. OUCH!

Before we dive into what is an acceptable level of portfolio borrowing, I must disclose that our crystal ball is still broken. Until it is fixed, we won’t be able to predict the future. Joking aside, any attempt at timing the market is far, FAR more likely to hurt than to help you. If you want to reliably reap the impressive wealth-building power of markets, stay invested through the bulls and the bears. In short, this is not a coded message. I am in no way signaling an expectation of a bear market. But bear markets are a normal part of the investment experience, happen from time to time, and it has been a while. We could have one tomorrow or years from now.

Also, while Abacus does not recommend using margin borrowing to leverage your portfolio and juice returns, there are legitimate reasons to borrow against one’s portfolio. It can provide short-term liquidity without having to sell assets that would incur taxable gains. It can be used for longer-term financing in certain situations. In short, it can be used responsibly. But you need to mind your margin, always.

The last bear market reached a crescendo of selling in February 2009. It was the worst peak to trough performance since the Great Depression. It represents a pretty good stress test. Using monthly data, a hypothetical Abacus Rainbow Portfolio experienced these levels of loss off of market highs.

Equity/Fixed Income Allocation: Peak to Trough Decline 

100/0: -54%
80/20: -45%
60/40: -35%
40/60: -25%
20/80: -13%

Would those losses trigger a margin call? First, let’s quickly review how margin works. Your custodian (TD Ameritrade, Charles Schwab, etc.) will let you borrow up to 50% of the value of most brokerage (non-retirement) accounts. If you started with an account worth $1,000,000, you could borrow $500,000. Your equity in the account would be 50%. A decline of 50% would wipe out 100% of your account. The custodian does not want that to happen. So, they require account equity at or above 30%.

Math is annoying*. Here are the maximum levels of borrowing that would have avoided a capital call in 2009 (for an Abacus Rainbow portfolio).

Equity/Fixed Income Allocation: Maximum Safe Margin Borrowing to Avoid Margin Calls (% of account value)

100/0: 32%
80/20: 39%
60/40: 46%
40/60: 50% (max allowed)
20/80: 50% (max allowed)

There is another potential surprise in store for margin borrowers. Once your account equity falls below 50%, you can no longer borrow against the portfolio. If you need access to margin borrowing continuously through a 2009 sized bear market, you would want to limit your margin borrowing as follows.

Equity/Fixed Income Allocation: Maximum Safe Margin Borrowing to Maintain Access to Margin (% of account value)

100/0: 23%
80/20: 28%
60/40: 33%
40/60: 38%
20/80: 44%

Mind you, those are the levels at which a 2009 level bear market would drop your account equity to 50% and deplete further borrowing capacity. So, regard these levels as the absolute maximum.

As an FYI, Abacus has negotiated a discounted margin rate for our clients using TD Ameritrade. If you have a household with $1 million or more, or one account with $500,000 or more, your margin rate is 6%. That is a floating rate. If interest rates keep rising, so will the margin interest rate. And we may be able to negotiate lower rates for clients with assets over $10 million.


*JK! Math is not annoying. Math is the best.

Disclosure: Abacus Wealth Partners, LLC (Abacus) is an SEC registered investment adviser with its principal place of business in the State of California. Abacus may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements. This article is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by Abacus with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Abacus, please contact us or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).

This is not an offer to sell any type of security, and there is no investment currently available through Abacus. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell any security. This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Information was based on sources we deem to be reliable, but we make no representations as to its accuracy. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this article will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

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Disclosure

Abacus Wealth Partners, LLC is an SEC registered investment adviser. SEC registration does not constitute an endorsement of Abacus Wealth Partners, LLC by the SEC nor does it indicate that Abacus Wealth Partners, LLC has attained a particular level of skill or ability. This material prepared by Abacus Wealth Partners, LLC is for informational purposes only and is accurate as of the date it was prepared. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product. Advisory services are only offered to clients or prospective clients where Abacus Wealth Partners, LLC and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Abacus Wealth Partners, LLC unless a client service agreement is in place. This material is not intended to serve as personalized tax, legal, and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Abacus Wealth Partners, LLC is not an accounting or legal firm. Please consult with your tax and/or legal professional regarding your specific tax and/or legal situation when determining if any of the mentioned strategies are right for you.

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