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Tuesday, November 9, 2010

Me and my debt: how about a margin account with TD Waterhouse?

Here it is, the update you were all waiting for… lol… The “debt situation” update for November 2010! I finish work early today and I am glad I did because tomorrow, some construction is being done in the area and they will be cutting the water at 9am… I usually wake up at 9:30-9:45am to take a shower… Just very glad I actually saw the notice. I sometime skip the morning shower, but never more than 2 mornings in the row…But do you really need more details on my personal hygiene?

As I previously said, I am at 45$k in debt, more exactly 45382.49$. Fact is, I don’t update my debt situation on a regular basis. What I prefer to update is, of course, my investment portfolio.

I hold 45 382.49$ in debt, and my investment portfolio is at 116 389.70$:

116 389.70$ - 45 382.49$ = 71 007.21$

My net worth is at 71 007.21$, which I find good. Not to forget also my dividend income, that is now at more than 5 000$. Nothing to compare to the Dividend Lover, but still…

For me, this overall scheme work quite well, in the sense that I can feel a balance between the debt and the investment. The 10 000$ is my latest credit line at RBC Royal Bank at an interest of 7.27%. At this point of the journey, I am looking forward to find a way to decrease, not my debt level, but the interest gain on the debt.

This was a suggestion made by the Dividend Lover himself a little while ago: to use margin money with TD Waterhouse to pay off debt. I keep thinking about this one over and over again and the plan could work. Here’s the deal: set up a margin account, use the margin money to pay off debt. In this case, I would start small. I would like to begin with a 5 000$ (or less, depending the amount available on the margin) to pay off my 5 000$ TD credit line at 8.75%. 8.75% is quite a huge interest rate. In case of a margin call, I would just reverse the money from the TD Canada Trust credit line to the TD Waterhouse margin account… In order words, the margin account would be used to pay off debt, and not to invest. I find this trick quite interesting. So far, what had stop me from opening a margin account is the responsibility of having to access my online broker account every single night in order to verify if I am on margin call terrify me. But now that fear is less because I told myself: I look into my broker account every single night of the week anyway. So looking into my stocks and dividend or checking if I am on a margin call or not – there’s no difference!

Margin borrowing is definitively something I am looking into to decrease the interest rate of some of my debt. So stay tune!


self-taught investor said...

Hi Sunny,

You have to be careful with a margin, because it doesn't work like a credit line. It gives you a full credit up to the maximum allowed with the type of stocks you own. Usually, stocks about $5 are marginalized at 70% and stocks below 5$ are marginalized at 50%, and some stocks that have low volume of trading are at 50% even if they are higher than $5 because they will be harder to sell if your discount broker as to sell them on a margin call (i.e. when your broker calls you about your margin).

For example, you have $10,000 of stocks at $6. You can buy $15,000 of another stock on margin (assuming the price is higher than $5, so that it will be marginalized at 70%). Your margin level would then be 60% (15,000/25,000 or your debt divided the total value of the stocks you own). Now, if the market goes down by 20%, your portfolio would then be worth $20,000 and now your margin level would be 75% (15,000/20,000). Since your stocks are marginalized at 70% max, you would get a margin call to bring it to 70%. You would have to A)come up with $1000 cash to lower the amount you owe so that your marginlevel to 70% (14,000/20,000) or B)sell some stocks to get 70%. You would have to sell about $3,500 worth of stocks that will go to pay the margin (11,500/16,500). Now your portfolio is worth $16,500.

Now what if the market goes down another 20%, your portfolio would be worth $16,000. In the A) situation your margin level would be 87,5% (14,000/16,000) you would have to come up with another $2,800 cash to get back to 70% on your margin call (11,200/16,000). In the B) situation, it gets bad. You have to sell $9,333 worth of stocks to pay back the margin just to get to 70% (4,667/6,667). Notice that your initial $10,000 stocks is now $2,000 (portfolio of $6,667 minus debt of $4,667.

Make sure you have cash to settle your margin calls, because selling stocks IS NOT the way to go.

Hope I was clear enough!

self-taught investor said...

Margin (continue)

In your case, you would like to take money out to pay your debt. So for every $10,000 worth of stocks that can be marginalized at 70%, the maximum cash you can get is $7,000 (7,000/10,000=70%). And being at 70% is really not a good idea. Now you can do it but you should stay in the 40%-50% margin. Let's use 45%, so to pay the whole debt of $45,000 you would need $100,000 of stocks, and I don't think your are there yet.

There is also a fiscal aspect you should consider (and for this you should see an accountant). When you borrow money to invest (outside RRSPs and TFSAs), the interest you pay is deductible. This means that if you make $30,000 at your job, your marginal tax braket in Québec is 28,5%. So for every $1000 of interest paid toward investment, you would get $285 back.
But in your case it would be hard determine which part of your debt went to investment, and which went to pay credit card payment or other miscellaneous stuff. And it can even be tougher to prove to Revenue Canada. That's where an accountant may help you.

My solution would be : next time you want to invest money (real cash, not money from credit), use your cash to pay your credit lines and credit cards then use the same amount in your margin account to invest. For example, you have $5000, use it to pay the highest rate loan (your 7,27% credit line), than buy $5000 worth of stock with your margin. Eventually, all your debt will be transfert to your margin and you will be able to easily deduct the interest since all that money from the margin would have been used for investment.

WARNING: you really have to be careful with the level of margin you use, because it can easily creep on you. Either you borrow and borrow and get closer to 70% or the market goes way down and you get closer to 70%. And if both happen, you're screwed. And you seem to enjoy buying stock TOO MUCH and care about debt TOO LITTLE. That could be a lethal combination. Are you a stockholic???... just kidding ;-)

But just so that you get the point, this is your journey into debt:
Aug 12 2007 15,184
Apr 19 2009 16,628 that's $76/month
Feb 24 2010 31,358 that's $1,473/month
Sep 03 2010 41,712 that's $1,725/month
Nov 09 2010 45,382 that's $1,835/month
Do you see where I'm going, or actually, where you are going???

And tax season is coming, where will you take the money to either pay taxes or put money in RRSP. It's a good thing you didn't have 2different jobs this year since your taxes will almost have been paid with your paychecks, but you'll still owe taxes on your investment income.

Please be CAREFUL and good luck!


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