WHY I AM TAKING OUT 401K LOAN TO MAXIMIZE MY PORTFOLIO RETURN: Part 2 – some Q&As

I posted my previous version in reddit, and there were some very helpful feedback. Just to be sure, you need to make sure that your current financial profile fits the criteria of mine and be aware that this could be a very risky financial decision. I took this approach because I see clear cash saving opportunities that would improve my cash flow. I laid out a few questions / comments below:

COMMENTS ON CONCERNS ABOUT INTRODUCING HIGHER LEVERAGE

Stock prices can go down and there is a lot of survivor bias in the market that is bringing in many beginner investors. I agree with their comments that it is risky suggestion. I suggested this as a way to finance existing portfolio if you already have margin account or want to add some leverage with essentially no cost due to government regulation. This was fascinating for me and I was bummed out that I didn’t know about this. I now know and wanted to make people know about this option.

I also received a great question – this sounds like someone who is familiar with financial engineering to juice up return – his or her question is immediately below and my response follows (not indicating the user, but I am happy to disclose if the user wants to be disclosed):

Question: “Great post – how does this differ from getting a better brokerage account that lets you borrow at 1% interest and doing the carry trade where you borrow at 1-2% and buy dividend stocks that yield 4%? Of course a correction like March would tap you you out and is thought to be the reason why the market corrected so hard because the carry trade is so crowded…” <End>

Response: Big plus here is that you are paying interest to yourself, so interest expense is effectively zero and the capital getting pulled out is not carrying 1-2% of management fee (essentially negative carry) for mutual funds that I was forced to buy under my company’s plan.

Lets just say high growth companies compound at 12% OVER LONG TERM (emphasis on long-term and illustratively added 2% spread over S&P’s 10% annual return) – if I can fund it with 0% interest rate (as interest I pay) is going back to my 401K account), I am capturing excess return (alpha) above what I would have gotten with S&P or most of the mutual funds that essentially return S&P less management fees over long period and the long-term leverage on the PORTFOLIO juices up the spread even further LONG TERM.

I saw interactive broker has very very competitive margin rate and considered moving, but I am sticking with Fidelity for much better execution (has not gone down for me – which can cost massively if I can’t enter or exit positions) and customer service. However, Fidelity comes with very high margin interest rate (8% for me), which I am looking to pay off with my loan from 401K loan.

Hope this is helpful as you navigate your portfolio construction!” <End>

ANOTHER REMINDER

Adding leverage intrinsically adds more volatility to your portfolio and volatility is one measure of your portfolio risk. Is the volatility tolerable to you psychologically? Do you have enough liquidity to weather through drawdowns so that your positions are unwound at the exact worst time?

If you don’t have confident answer to above, PLEASE do think hard again about how you are financing your investments / portfolio. Happy investing!

*not investment advice.