Author Topic: Did I miss something in the newest MMM margin loan blog post?  (Read 3656 times)

fizzgig

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Did I miss something in the newest MMM margin loan blog post?
« on: February 08, 2021, 10:15:41 AM »
Where does it talk about paying off the principal of the loan and how does that factor into everything?

RWD

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #1 on: February 08, 2021, 10:33:39 AM »
I think in this specific case his plan is for the friend to buy the place (with an actual mortgage) so he can pay back the margin loan:

Quote
Then my friend would take her time to get a mortgage, and buy the place from me at a more leisurely pace Ė effectively just leasing it from me in the meantime.

secondcor521

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #2 on: February 08, 2021, 01:03:05 PM »
It also factors in because MMM is probably not holding the margin loan for very long.  There was another thread here (which I think gets referenced back to in the comments on MMM's article) where a poster basically asked "Why not use a margin loan instead of a mortgage?"

I personally think it's generally riskier because of the fact that a margin loan is at a variable rate and the possibility of a margin call at an unfortunate time;  these two risks are reduced if you only hold the loan for a short while or only margin a "low" percentage of your portfolio or both.

IIRC the other poster was wanting to hold the margin loan for longer and at a higher percentage than what MMM describes in his blog post.

Nick_Miller

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #3 on: February 08, 2021, 01:18:51 PM »
Uh yeah, I was taken aback by the article.

I was like, "you're taking out a margin loan of that size for a friend?" And MMM went out of his way to make it clear he doesn't want the house, so if the deal falls through with the friend, he's incurring transaction costs to sell to a third party, or else he's renting out a house right next to where he lives, or else he's holding and betting on a continuing rise in home values to set off the inevitable transaction costs.

It just seemed unnecessarily risky to me. And a little weird.

ericrugiero

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #4 on: February 08, 2021, 01:31:40 PM »
Yeah, the whole thing surprised me.  MMM makes enough blog income that the risk is a non-issue for him.  For the rest of us, it seems highly risky.  If you do a margin loan and borrow 30% (the limit is 50%) and the market drops 50% would you be able to sleep at night?  Knowing that the market dropping a little more would result in me automatically selling at the bottom would terrify me.  If everything goes well, it's fantastic.  Borrowing at 1% interest is a great deal.  Yes, things have to get really bad for it to not work out.  But, if things DO get that bad, it's a HORRIBLE time to sell. 

In the case of MMM, buying this particular home seems like a great deal.  If his "friend" can't get a mortgage, he can probably sell for a profit.


SwordGuy

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #5 on: February 08, 2021, 05:49:51 PM »
We bought a distressed house for cash for a family friend because the house wouldn't qualify for a mortgage as is.   A mentally ill person had lived there and messed up the interior, mostly cosmetic stuff, but enough was messed up any bank paying attention wouldn't issue a normal mortgage.

She spent the next 10 months renovating it at her expense, then she got a mortgage and repaid us.

Saved her over $20k -- after accounting for the out-of-pocket repair costs -- compared to buying a house that was in good condition.

No real risk on our part.   We could have renovated the property and resold it for a profit or just rented it out and any repairs she did would save us money.

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Once you have enough plus a goodly buffer, these things are no big deal.

swashbucklinstache

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #6 on: February 08, 2021, 06:23:55 PM »
I posted a number of important caveats, or at least considerations before acting, on the first page of comments on the post itself several response deep to someone gleefully talking about using a HELOC in conjunction with the margin loan without much discussion of risk.

Relatedly, one should be careful about the case of buying houses for others. You need to take care to not run afoul of the IRS regarding gift taxes if you're "letting them pay you back" and/or living there for free while doing so. Similarly, if you're "gifting" down payment money that someone will eventually pay you back for you're committing mortgage fraud. I don't think MMM violated any of these. There can be concerns with buying cash then selling to a friend who is getting a mortgage, along the lines of local fair housing laws, but those are more likely to come into play if you do this repeatedly. Most people are fine, but please do talk things through with a professional.

From the IRS, emphasis mine:
Quote
The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not.

The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.

The gift tax is not the end of the world, given the currently very high limit (relative to the past and expected future limits). But please don't ignore it, and if limits drop this could have impacts on your estate.

Travis

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #7 on: February 08, 2021, 07:57:39 PM »
I posted a number of important caveats, or at least considerations before acting, on the first page of comments on the post itself several response deep to someone gleefully talking about using a HELOC in conjunction with the margin loan without much discussion of risk.

Relatedly, one should be careful about the case of buying houses for others. You need to take care to not run afoul of the IRS regarding gift taxes if you're "letting them pay you back" and/or living there for free while doing so. Similarly, if you're "gifting" down payment money that someone will eventually pay you back for you're committing mortgage fraud. I don't think MMM violated any of these. There can be concerns with buying cash then selling to a friend who is getting a mortgage, along the lines of local fair housing laws, but those are more likely to come into play if you do this repeatedly. Most people are fine, but please do talk things through with a professional.

From the IRS, emphasis mine:
Quote
The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not.

The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.

The gift tax is not the end of the world, given the currently very high limit (relative to the past and expected future limits). But please don't ignore it, and if limits drop this could have impacts on your estate.

There was a guest on ChooseFI a couple years ago who described in detail how he and his family pooled money in some kind of shared account where they would give interest-free or low-interest loans to each other for mortgages, cars, and investments. The majority of the comments section afterwards was "Yeah, the IRS would like to have a word with you."

Trudie

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #8 on: February 12, 2021, 05:35:28 AM »
Specific commenters above have made many good technical points, but I was pretty taken aback by this blog post.  Maybe MMM has run out of things to write about, but I found this move (doing business, on impulse, for ďfriendsĒ) pretty ill-advised. 

Papa bear

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #9 on: February 12, 2021, 06:26:25 AM »
I thought this was one of his best articles in a long time.  It challenged my thinking behind margin loans completely.  Without knowing the details, I had that they were only used for stock purchases. 

Anyway, the dude knows real estate.  And when you know real estate or invest in real estate, buying a house really just isnít a big deal anymore. 

I seriously considered purchasing a house on my own street to remodel and the control who the neighbors could be.  This really isnít different at all. MMM isnít going to lose anything on this deal unless the housing bubble finally pops.

Assisting a buyer that may have issues with obtaining a mortgage is also something that is completely normal in the investing world.  This happens a lot.  Itís a big nothing burger. 

So to summarize.

1) holy crap I didnít know I could do that with margin loans maybe I need to completely rethink my strategy
2)he bought an investment property and will control who he sells to.  Nothing to look at here


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Syonyk

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #10 on: February 12, 2021, 10:43:11 PM »
My main takeaway was, "Oh, this sort of creative financing again?  Well, obviously we've forgotten any lessons learned in the 2005-2007 era..."

Also, he clearly has lost all interest in any of his earlier concepts, and is now "loaded and doesn't care."  Which he's certainly welcome to be!

SwordGuy

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #11 on: February 13, 2021, 06:24:33 PM »
My main takeaway was, "Oh, this sort of creative financing again?  Well, obviously we've forgotten any lessons learned in the 2005-2007 era..."

Also, he clearly has lost all interest in any of his earlier concepts, and is now "loaded and doesn't care."  Which he's certainly welcome to be!

The nice thing about being loaded is it allows you to look for ways to help out your friends with money you don't need.
I recommend it highly.   It's good for the soul. 

And since you get paid back, you get to recycle that money to help someone else.

I thought MMM made an intelligent discussion of the risks involved and demonstrated how they aren't all that big to someone in his situation.   It's aspirational inspiration just like his posts about being FI were to people who were still stuck in consumer-spending traps.

yachi

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #12 on: February 19, 2021, 08:48:57 AM »
Yeah, the whole thing surprised me.  MMM makes enough blog income that the risk is a non-issue for him.  For the rest of us, it seems highly risky.  If you do a margin loan and borrow 30% (the limit is 50%) and the market drops 50% would you be able to sleep at night?  Knowing that the market dropping a little more would result in me automatically selling at the bottom would terrify me.  If everything goes well, it's fantastic.  Borrowing at 1% interest is a great deal.  Yes, things have to get really bad for it to not work out.  But, if things DO get that bad, it's a HORRIBLE time to sell. 

In the case of MMM, buying this particular home seems like a great deal.  If his "friend" can't get a mortgage, he can probably sell for a profit.

Here is some math for this scenario:
Initial Value of Stock: $1,000,000
Borrow (30% of initial value): $300,000
Allowed to borrow: $500,000
After the market drops:
Value of Stock: $500,000
Borrowed: $300,000
Allowed to borrow: $250,000
Need to sell: $50,000 of stock at market bottom


The $50,000 is stock that had been valued at $100,000 pre-drop when the decision was made to borrow on margin.  Being forced to sell in this case results in a $50,000 loss.

Because of the above, I would say you want to limit this technique to real estate deals you can get because you're able to move quickly, or you're able to purchase something does not qualify for conventional financing.  You should also limit this technique to cases where the real estate deal is priced at least ($50,000/$300,000) = 17% below market value due to just the financing.  eg.: If the house doesn't qualify for typical financing because it's missing a kitchen, and a kitchen costs $25,000 in your area, you'll want the house to sell for at least:
$300,000 (your purchase price)+$25,000 (cost of kitchen)+$50,000 (possible cost of financing should SHTF)+1%*300,000 (if it's going to take a year to flip, adjust accordingly)
 to make sure you're covered in the case of a market meltdown.


ericrugiero

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #13 on: February 22, 2021, 11:29:58 AM »
Yeah, the whole thing surprised me.  MMM makes enough blog income that the risk is a non-issue for him.  For the rest of us, it seems highly risky.  If you do a margin loan and borrow 30% (the limit is 50%) and the market drops 50% would you be able to sleep at night?  Knowing that the market dropping a little more would result in me automatically selling at the bottom would terrify me.  If everything goes well, it's fantastic.  Borrowing at 1% interest is a great deal.  Yes, things have to get really bad for it to not work out.  But, if things DO get that bad, it's a HORRIBLE time to sell. 

In the case of MMM, buying this particular home seems like a great deal.  If his "friend" can't get a mortgage, he can probably sell for a profit.

Here is some math for this scenario:
Initial Value of Stock: $1,000,000
Borrow (30% of initial value): $300,000
Allowed to borrow: $500,000
After the market drops:
Value of Stock: $500,000
Borrowed: $300,000
Allowed to borrow: $250,000
Need to sell: $50,000 of stock at market bottom


The $50,000 is stock that had been valued at $100,000 pre-drop when the decision was made to borrow on margin.  Being forced to sell in this case results in a $50,000 loss.

Because of the above, I would say you want to limit this technique to real estate deals you can get because you're able to move quickly, or you're able to purchase something does not qualify for conventional financing.  You should also limit this technique to cases where the real estate deal is priced at least ($50,000/$300,000) = 17% below market value due to just the financing.  eg.: If the house doesn't qualify for typical financing because it's missing a kitchen, and a kitchen costs $25,000 in your area, you'll want the house to sell for at least:
$300,000 (your purchase price)+$25,000 (cost of kitchen)+$50,000 (possible cost of financing should SHTF)+1%*300,000 (if it's going to take a year to flip, adjust accordingly)
 to make sure you're covered in the case of a market meltdown.

Yes, that's good math and locking in a $50,000 loss doesn't actually seem that bad on a million dollar investment.  But, I will point out that the losses will go up exponentially as the market drop gets worse.  If the market dropped 75% (unlikely but possible) the numbers look like this: 

Value of Stock: $250,000
Borrowed: $300,000
Allowed to borrow: $125,000
Need to sell: $175,000 of stock at market bottom

The $175,000 is stock that had been valued at $700,000 pre-drop when the decision was made to borrow on margin.  When the market comes back to where it was before the drop you have lost $575,000 ($700,000-$125,000). 


Note:  These numbers are if you are forced to sell all the stock at the 75% drop.  That wouldn't happen unless the drop was sudden.  If it went down more gradually you would sell some at a slightly higher price (starting when the amount borrowed drops below the amount you are allowed to borrow based on current stock value).  As the market continues down, you would have to sell at worse and worse times.



hgjjgkj

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #14 on: February 25, 2021, 04:42:11 PM »

I have been looking for this topic on the forum because while I consider myself halfway decent at finance I did not totally grasp his article, but was intrigued by it. I agree it was one of the most interesting MMM articles.

  • In Reply 4, Ericrugiero wrote that "if the market dropped 50% would you sleep at night because a margin call was near", but then yachi showed some math demonstrating that if a 50% drop happened you would have a margin call. Which is correct?
  • In my reading, I saw that Reg T overnight margin requirement is 50% so I assume MMM is subject to this rate during his holding period is that right?
  • I did not quite understand how he was able to use his whole portfolio as a borrowing limit (the $1M example he gave) when he specifically said he did not use the complex "portfolio margin option" with IBKR.
I had an hypothesis that this strategy is better for a performing RE asset, as you are then able to pay down the margin loan with rent over time.

1) For example assume a $1M portfolio with 500K in SPY and $500k in Speculative Stocks (Apple, TSLA, whatever).

2) You could borrow $300K, but reallocate the corresponding amount you borrowed out of Speculative Stocks and into BND, which dipped only 10% in 2009 and was resilient in corona. It also yields 2.5% or so.

3) You then have a portfolio of $500K SPY $300k BND and $200K Speculative stocks. Then with a 50% drop in SPY and a 10% drop in BND you have this

Post Drop Portfolio: $620k ($250k SPY+ $270K BND + $100K Speculative Stocks)
Originally Borrowed: $300K
Allowed to Borrow: $310
No Margin Call.

For a 75% drop this does not quite work though. In the 75% case:
  • I was thinking in a 75% drop scenario you could sell BND to repay most of the loan. Essentially you made a bet you could pay back the margin loan before a crash happened but you lost. So you must sell BND but you for the most part are not forced to realize stock losses.
  • You would still own the real estate asset and could sell the property or conventionally finance to buy back into the market.
  • One other thing I was also wondering is if you could move your 6 month emergency fund to sit in cash in your broker account to further insulate you from a margin call. If it was a 50K emergency fund that would cover the $50K of the $52K margin call in the 75% drop scenario with my suggested portfolio.


I know this is long but the other thing I was considering is that "when it rains, it pours." A 50% or 75% stock drop could threaten your job, your tenants job, and property values which complicate this strategy. I do think a 75% drop in BND might result in a return of hunting and gathering though.

I hope its ok but at the bottom of my post I wanted to tag some folks from the other thread who are much smarter than me and might want to weigh in on my thinking.

@SwordGuy @Financial.Velociraptor @ChpBstrd

sailinlight

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #15 on: February 25, 2021, 06:20:16 PM »
I think the more risky part is that IB can do a forced margin call any time they want. That's why their rates are so low.

Financial.Velociraptor

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #16 on: February 26, 2021, 07:48:38 AM »
Normal margin is what the SEC calls "Regulation T" margin.  It has the standard 50% requirement.  Interactive Brokers has a proprietary product known as "Portfolio Margin" that allows 5:1 leverage.  It requires a net liquidation value of 110,000 at application time and has a 100,000 minimum balance thereafter.  You can totally borrow your entire balance at IB if you have at least 110,000 in liquidation value.

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Dicey

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #17 on: February 26, 2021, 09:27:31 AM »
Pete can afford this, and it's something new to write about. He also has the time and will to complete the project fairly quickly, seriously reducing the likelihood of any of the precipitous drops some of you are projecting. Sure it's a possibility, but it's not very likely.

He has plenty of other resources that he isn't particularly transparent about. In the event of an actual downturn, he has plenty of $$$ to cover his ass This article is just about new way (for him) to think about money. Learning about something doesn't pose any particular risk, unless someone inadvisedly chooses to take a risk they can't afford. It felt like the article and comments included plenty of caveats, except perhaps the potential tax complications.

I'm a red panda

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #18 on: March 18, 2021, 09:31:46 AM »
My biggest problem with the article is I felt it didn't do a good enough job of "margin is a very very dangerous game to play".
MMM is a very rich guy, but is branded as "just like you".  I'm scared people will take this as being a good idea for them, when they are in very very different situations.

Doing anything on Margin is just like going to Vegas and rolling dice. People need to understand that this is gambling, pure and simple.

Dee_

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Re: Did I miss something in the newest MMM margin loan blog post?
« Reply #19 on: April 16, 2021, 04:49:19 PM »
I appreciated the article. I wasn't even aware the margin loan existed as a product to the public.

I think it would be very useful in a specific scenario- you have tons of capital gains, you need an amount that's more than pretty cash pretty quickly, and you have more than 2x the value available in stocks. (though some folks have been saying that IB can call whenever they want?) Also if you have individual stocks but not mutual funds, which makes this useless to us now.

It almost feels like a HELOC, though ofc a margin call is easier to execute than a foreclosure.