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Suppose I have an investment account with $10,000 in it. I have a margin rate of 10% per year. For a total of $2.7 interest per day, or $1,000 per year.

I can invest in a high risk ETF with returns of 25% per year, or safer investments that are from 10-15% per year.

I know that if I don't use margin, my investments are a straightforward calculation. If I leverage my portfolio and use margin, then potential profit calculations become more complex.

Question

  • Given a margin interest rate of X, and Y dollars on margin, what must my % return be in order to beat the straight non margined investment?

My intent is to prove that buying treasury bonds on margin is probably a bad idea, and figure out how much of my portfolio I should put into an ETF that is likely to beat 15% YOY return

This is not a homework question. The specific funds I'm looking at are EZU, IWC, SCHC, SCHX, SCHA, XLF, and XSD.

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    Is this a homework question? I ask because the numbers are textbook, not reality. The word "safer"doesn't belong with the numbers 10-15%, although I suppose in comparison to 25%, it might apply. There is no ETF likely to exceed 15%. Not in US$, anyway. – JoeTaxpayer Nov 22 '13 at 19:25
  • No, I'm not in school.. (done with college 12 years ago). I'm just trying to wrap my head around this concept and how to not be dumb. The numbers are simplified for discussion purposes, but I can put exact numbers if needed. @JoeTaxpayer – goodguys_activate Nov 22 '13 at 19:49
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Margin interest is deductible on Sch A. So my first warning is that if you don't itemize, the deduction is lost.

Assuming you already itemize, it adds to your itemized deductions. If your gains are short term, they are taxed at your regular rate, i.e. your marginal rate same as earned income. If your return is higher than the margin rate, you are in the black. If bounced off long term gains, the numbers change slightly, as the gain may be taxed 15%, but your margin interest is offset 25%, for example.

My comment question was to try to understand the intent. A 10% margin rate is certainly a deal killer. I have a 2.5% equity line, and am not considering using it to buy stocks despite the 10% long term gains in the market. In your case, a 20% drop would cost you 40% of your equity. Buying on margin is not recommended for most investors, let alone those just learning.

  • At Schwab the effective rate for borrowing less than $25k is 8.5%. The next tier is 8%. How did you achieve a 2.5% equity line? – goodguys_activate Nov 22 '13 at 20:36
  • Using the equity line puts my house at risk. HELOCs tend to run below Margin Loan Interest. And when I got my loan it was Prime-1.5% with a min of 2.5. (So prime can go up to 4% and I still have this rate. Unused, except for small family loan, but that's another story) – JoeTaxpayer Nov 22 '13 at 20:45

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