Leverage the portfolio? How much?

[Roger]

Hi,

I have a question on how much leverage in a portfolio you would consider appropriate:
My bank offers me a securities backed credit line with 2% interest. With the 4% rule, we expect an average of at least 4%+inflation return p.a. Therefore, it would make sense to own more stocks/ETFs than capital available to benefit from the spread.
Now obviously, there is the mathematical side, which would take the maximum drawback into account and all that, but there is also the standpoint of being debt-free. I believe investment is about taking controlled risks.

Do you leverage your investments and how much? What is your opinion on this? And does it make a difference whether you are still working or retired?

Looking forward to hearing your opinions!

best regards,
Roger

[YttriumNitrate]

What's the duration of the loan? If you could borrow money at 2% on a 30-year fixed term, I say back up the truck and borrow to the max.

[SeattleCPA]

You can experiment with effect of leverage using cfiresim and firecalc--and should probably do so.

The trick is to enter negative percentage for bond allocation. E.g., if you have $100K to invest and will borrow $100K and then invest $200K in stock market, you enter 200% as stocks percentage and -100% as the bonds percentage.

I've got a blog post that goes into nitty-gritty detail (link below) but you want to understand that not only does this technique boost the expected medium return, it also widens massively the range of outcomes. You could end up extremely wealthy if everything works just right... and you could just get killed.

https://evergreensmallbusiness.com/portfolio-leverage-modeling-with-cfiresim-and-firecalc/

You probably want to read through the markettimer thread at bogleheads about someone doing the leverage thing in real life. It is arguably the best bogleheads thread of all time:

https://www.bogleheads.org/forum/viewtopic.php?t=5934

[maizefolk]

To ask YittrumNitrate's question the other way around, is the loan from your bank callable? (If your stock market portfolio declines enough, can they force you to sell to cover the balance of the loan?)

Even at 2%, callable debt dramatically increases risk.

Uncallable debt over 30 years is only a small uptick in risk, and potentially results in significant increases in average reterns.

[MustacheAndaHalf]

My bank offers me a securities backed credit line with 2% interest.

Do you have to sign a margin agreement to take out this loan?

This sounds like a margin loan, and at the very least you should ask some more questions about how the loan works.  If you take out the maximum loan, and your securities decline in value, you can face the additional insult of being forced to sell at the low point.  And "forced" is the key word - a "magin call" is not optional, and will be part of the agreement you have to sign before you're allowed access to margin loans.

[Financial.Velociraptor]

You can get an even better rate (for now, its variable rate) at Interactive Brokers.  It is my alternative to an emergency fund in FIRE.  I stay fully invested and if the A/C goes out or I need some other major repair, I borrow at 1.65% or so until I can pay it back. 

That said, margin can kill.  You do do margin as a index investor without the margin call risk by buying leveraged ETFs.  These could arguably be good investments if you follow a strict trailing stop loss policy and a strict re-entry rule.  Else, buy a protective put to put a floor on your downside.  This is sort of do as I say and not as I do (did) advice as when I went FIRE in 2012 I was very confident that QE would propel the market further and that there was a mortal lock of the Bernanke put so I levered up 50% on the entire portfolio.  The portfolio was in high dividend yield and high yield bonds at the time and the returns fairly quickly exceeded 50% and extinguished the margin loan.  I wouldn't do it again at this point in time as the yield curve is mighty close to inversion. 

[Roger]

Thanks for the opinions and background info.

Indeed, the conditions are not final for long-term. The interest rate is negotiated every year and I'm sure the fine print makes it callable. The limit is around a third of my actual capital.
A level of leverage I would feel comfortable with is investing around 110 to 120%. Beyond that, the credit line should also be able to cover for expenses during a market downturn.
I guess most people stick to investing max 100%?

[talltexan]

I would caution you to something more like debt = 60% of your capital.