• Decision is Within my Master Plan
  • Principle Protection is Maximized
  • Asset Earns More than the Cost of the Leverage
  • Interest Rate Increase will not Force a Sale


A few weeks ago I used a margin account balance to start inching my way into a long position with IShares CDZ. It occurred to me that I follow some pretty stringent and conservative guidelines whenever I use leverage. I wondered if other investors have a similar set of rules?

I suppose that everyone has their own criteria when investing with borrowed money. I use margin balances under a specific set of circumstances grounded in two basic known-knowns. My presumptions are:

1. Using the balances are not free.

2. There are no ROI guarantees in the market.

My guidelines, on when and if to use my margin, fall out of those two arguments. All the guidelines must be positive before I pull the trigger on margin use. They are:


1. Decision is Within my Master Plan

I treat margin use as a strategic issue for my portfolio. I would have identified 6-18 months previous if my balance should be used based on the amount of new cash I can bring into the account in the short term. That is to say the amount of margin to be used must equal the amount of money I can expect to bring into the account within approximately 12 months to pay down the debt or funds I can realistically generate by rebalancing my portfolio etc. Particular types of positions would also have been prequalified or disqualified for margin use. For example, for me, the average vanilla type bonds would be a very poor, even detrimental, use of margin. CDZ is a blue chip index that the market is punishing along with everything else, essentially an oversold core holding.


2. Principle Protection is Maximized

The risk of loss of my principle, ie: margin balance used, is at a low point. This means that there is more upside potential than downside eg: within market corrections, which also greatly mitigates the risks of a call. Trading costs, as they are also taken from the margin, are also part of the principle to be protected. CDZ was  purchased well off it’s $27.50 high which gives me significant breathing room on the upside.


3. Asset Earns More than the Cost of the Leverage

We’re talking earnings potential here of course.  The cost for the use of my margin balance is any fee for the use of the account balance plus the interest I’ll pay on the balances used. I conservatively project out at least one year, using the proper compounding period, to calculate the total cost for the 12 months use of the balance. That total cost must be below the potential earnings of the investment I’m planning on purchasing. With CDZ there is a big plus. CDZ has a 4.36% dividend, margin of safety.  By itself, the dividend surpasses the overall cost of using my margin balance.


4. Interest Rate Increase will not Force a Sale

Should the interest rate increase and increase my costs, thereby maybe causing a violation of the above guideline, I also need to ensure that I will not be forced to sell positions should prices be unfavourable. My cost calculations include a modest interest rate increase and that mentally positions me to buy and hold the position in the medium to long term. As CDZ is part of my portfolio blue chip core I’m prepared to hold onto it and will probably add to it as conditions allow.


Final Thoughts

I use margin deliberately as part of my greater investment plan. The guidelines I use that prompts the use of margin have worked well.  I don’t like debt but I believe in using leverage intelligently only to increase wealth.

Which criteria do you use to determine whether to use margin?


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