Investment Club

Purpose of the investment club

Unless you are the less than 0.01% of people that are good at stock picking, it’s impossible for most of us to beat the market with our own funds over the long term. However, with careful use of margin and the Dollar Cost Averaging technique to invest in a low cost market index fund that is certain to go up over time, we can all beat the market relatively safely. To be able to invest with margin safely, we need higher margin ratio than the normal 1x that is allowed. Interactive Brokers allows up to 5x margin, it also has low margin rate and low commission fees, therefore it is the best choice for the purpose. It’s not by chance that it is named the best broker by Barron for many years. The benefit of large margin buffer will become obvious when your portfolio value cross the $1 million mark, as you can WITHDRAW FUNDS FROM MARGIN WITHOUT LIQUIDATING YOUR POSITIONS to supplement your living expenses if the dividends income is not sufficient.

Benefit of the investment club

The Dollar Cost Averaging technique works better with more frequent trades of smaller amount in order to capture more low price points, but this strategy is cost prohibitive due to the minimum commission charged by most brokers. Another advantage of Interactive Brokers is that they allow this minimum commission, usually $0.70, to be shared across multiple accounts. The trade is ordered through a central Friend and Family account, then the shares and the fees are allocated proportionally according to the net worth of each account. The individual account holders of the investment club have full control of their account and funding options. By trading together, all members of the investment club will enjoy reduced risks to market fluctuations.

Fees of Interactive Brokers that are relevant

Successful investment returns relies on low fees, with Interactive Brokers:

  • You need to maintain $100,000 and above to avoid the monthly account fee of $10
  • With limit orders of 300 shares, fees are around 70c, for SCHX it works out to be around 0.0045%
  • Margin interest rate is currently 1.6% for amounts under $100,000, and 1.1% over that.

Investment strategy

The dollar cost averaging with margin technique works with any investment that moves up or sideways over time. With single stocks or single sectors, it may take decades for the market to recover, which will be detrimental to a margin portfolio. Therefore, we will only trade broad market ETFs, the major one will be SCHX, the pricing of around $50 is perfect for easier allocation to individual accounts, and the expense ratio of the fund is only 0.04%, the lowest in the industry.

100% of cash funds will be invested in a lump sum. Weekly, or sometimes daily DCA when portfolio value allows, will then be carried out with margin. Margin positions will be closed out whenever market reach new highs, then new rounds of DCA will be carried out. This will make sure margins don’t accumulate at high prices. All of your own funds will be fully invested to take advantage of market run ups, supplemented with small to moderate gains with margin funds. When I feel the market is too high, small short position may be placed on leveraged ETFs to hedge the risk.

As you can see from the the excel file in the DCA post, even if your lump sum money was invested right at the top of the market, you still gained more than 45% when market returned to the previous high. Furthermore, since you are always fully invested, even if you didn’t DCA any more after this, you still would rake in all the 30% gain in the 1.5 year that followed. The total return over the 7 years would be about 10% annually, while if you didn’t DCA at all the return will be only less than 4% per year. With fine tuning of the DCA amount and frequency, it’s possible to bump the return up another 1% or more. Compare this to the long term return of the US stock market of 7-8%, the difference will be enormous after decades have passed.

This investment strategy is fool proof, you don’t have to predict the market, you can download any historical data to replace the SPY data, and the end result will always beat the market. The only requirements of the strategy are that the market index that the ETF tracks will return to previous highs, which has been proved for over 400 years; and that it do so within 6-7 years. Only the Great Depression in 1929 and the Nikkei crash in 1989 lasted longer, and that’s because the central banks didn’t react correctly, as reasoned in the DCA post, this probably will never happen again on the US stock market.

Requirement and fees

As shown in the DCA post, equity amount can drop more than 70% using margin in a severe down market. With the portfolio margin option of Interactive Brokers, you need to keep more than $100,000 to be able to carry out trades. I will do my best to limit the drop to below 60% even in a bear market comparable to the Great Recession, but it still require a minimum net account value of $300,000 to join the investment club. I will charge a portfolio fee of 0.03% ($90/year on a $300k account) to maintain the investment club, and I’m certain that the small tweaks that I will apply to the DCA technique will more than compensate for this small fee.

Tax Considerations

The trading strategy is very tax friendly, the bulk of the funds are invested long term and therefore will only be subject to long term capital gains tax. The small short term gains that results from the frequent margin DCAs will mostly be offset by margin interests, while the dividends will all be taxed as qualified ones, even those that result from margin purchases.

However, although the strategy is good for low taxes, the tax reporting will be hideous due to the many small transactions. It’s highly advisable to use your retirement account to join the investment club if you have enough funds (401k and roth accounts may be combined). Details of how to set up your retirement accounts for margin trading can be found in the EBook.

How to join

If you are interested, please shoot me an email or call me at 301-326-9409 to discuss.