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Putting My IB Margin Account To Work

February 26th, 2013 Leave a comment Go to comments

I wrote a couple of articles previously that talked about how to borrow cheap money from the Federal Reserve to buy stocks on margin. These articles were just talk and theory, today I will talk about a portfolio that I setup that puts this into action. It’s been active for about 3 months and has a return of 9.4% so far. This return was earned taking far less risk than a pure equity portfolio since it partially invests in corporate debt. Also, the equity investments have relatively high, but sustainable yields from quality companies.

You can do this, too, but likely not at the broker you currently use because their margin rates are too high.

To get very low margin rates, you need to switch to a broker that charges a small spread over Fed short term interest rates. Interactive Brokers (IB) is one such broker that offers margin rates of 1%. IB is a professional level broker that offers very sophisticated investing tools that enable you to buy any kind of security from all over the world. Overall, I’ve been happy with my experience with my Interactive Brokers account, though I’ve just used it to execute regular types of transactions. The account setup went smoothly and it took a few days to get approved and the account funded.

If you didn’t read the original articles here are links:

Get In The Wagon! Use The Fed’s Free Money To Make Money, Part I
Get In The Wagon! Use The Fed’s Free Money To Make Money, Part II

Position Strategy Recap

The goal of this portfolio is to earn a spread between the margin rate (1.7%) and the dividend yield of each investment. Every individual investment will earn a spread. So, I won’t be buying investments that don’t pay dividends. In this market it is relatively easy to find investments that pay sustainable dividends of 3, 4 or even 5% yields. To emphasize the income aspect even more and provide stability to the portfolio, I’ve also added a few high yield below investment grade preferred stocks.

It is possible (even in today’s interest environment) to earn 10%/year using this strategy if you focused on the high yield debt instruments. I won’t do this because I want some part of the portfolio to offer the possibility to earn capital gains. Sacrificing a few percent of interest to get a much larger capital gain is worth it in my view.

After setting up the portfolio, the dividends received will reduce the margin. Over time, interest costs will decrease and I will own a larger percentage of the margin-ed securities. Any capital gains from the equities on top of the dividends will be earned for free.

Portfolio

The portfolio has (2) positions that were bought with cash. The other (2) positions were bought on margin. The table below summarizes.

Position Shares Dividend/Yield On Cost Value (When Bought) Method
Realty Income Preferred Series E (O-E) 1000 1.69 (6.75%) $25,000 Cash
Lorillard (LO) 200 2.2 (5.3%) $7,900 Cash
Philip Morris (PM) 100 3.4 (4.1%) $8,325 Margin
Bank Of America Preferred Series I (BML-I) 300 1.6 (6.3%) $7,449 Margin

The yields for the entire portfolio are summarized below:

Nominal Yield: 9.0%
Effective Yield: 8.2%
Nominal Yield, Tax Adjusted: 9.5%
Effective Yield, Tax Adjusted: 8.7%

Nominal Yield: This is the yield of the portfolio based upon dividends received.
Effective Yield: This is the yield of the portfolio after subtracting margin costs.
Nominal Yield, Tax Adjusted: This is the yield adjusted to account for the lower taxes of the qualified investments.
Effective Yield, Tax Adjusted: This is the yield adjusted to account for the lower taxes of the qualified investments after subtracting margin costs.

Portfolio Performance

The positions over time have increased in value and margin has decreased as dividends were paid. The time frame here is about 3 months in total (the November and February months were partial). The performance over this time frame is about 9.4%

Performance So Far, as of February 2013.

margin interest dividends portfolio value
November 15,774 0 0 $32,900
February 15,131 89 732 36,004

If each position maintains its current value, the estimated return (based on cash alone, ignoring tax considerations) is about 16%. This would occur because dividends would be collected which would cause the margin balance (and interest) to decline over time.

Performance For 2013 Total (estimated)

margin interest dividends portfolio value
November 15,774 0 0 $32,900
February 13,092 251 2950 38,043

Conclusion

So far, I have been happy with the new account and how the portfolio has worked out. Over time, I may add more positions and take on more margin if opportunities come up. I have good hope for this portfolio, since I started it Lorillard has increased its dividend almost 7%, and it wouldn’t be unexpected to get a similarly sized gain from Philip Morris (PM) later this year.

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