Smart Margin Management

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Warren Buffett has long warned investors about the dangers of using borrowed money to buy stocks. In his 2017 letter to Berkshire Hathaway shareholders, he explained the risk as follows:

Therefore, even if a margin call doesn’t wipe you out, Buffett argues the psychological pressure of owning money during a market crash can lead to panic selling and other costly mistakes.

This logic makes sense. After all, why risk everything for a bit of extra leverage when stocks already provide solid long-term returns?

Yet Yuval Taylor offers a different perspective, one that challenges this black-and-white thinking about margin.

Taylor argues that careful margin use in non-retirement accounts can improve returns without excessive risk. The key is calculating exactly how much you can safely borrow based on market volatility and your specific holdings, rather than avoiding margin entirely or using it recklessly.

Taylor recommends five rules to follow when using margin:

Rule #1: Negotiate Your Rate

Interactive Brokers, M1 Finance, and Robinhood offer the lowest margin rates in the industry. Even if you don't switch, you can use their rates as leverage when negotiating with your current broker.

The difference between paying 8% and 6% on margin debt compounds significantly over time.

Rule #2: Know Your Marginable Stocks

Not all stocks qualify for margin. Low capitalization stocks (companies with market values under ~$2B) typically can't be bought on margin or require 100% cash upfront.

Smaller stocks have less trading volume and higher price volatility, making them riskier collateral for brokers.

Buy marginable stocks in your margin accounts and save non-marginable positions for retirement accounts where margin doesn't matter.

Rule #3: Size Positions Based on Margin Requirements

When a stock only requires 25% margin (e.g., a large tech stock), you effectively control four dollars of stock for every dollar of capital.

This leverage makes it more efficient to take larger positions in stocks with lower margin requirements.

Rule #4: Adjust for Market Volatility

Taylor uses the RVX Index, which measures volatility in the Russell 2000, similar to how VIX measures the S&P 500.

When volatility rises, reduce margin usage. When markets calm, you can safely use more leverage.

Higher volatility means wider potential price swings, which increases the risk of hitting margin requirements and facing forced liquidations at the worst possible times.

Rule #5: Maintain a Safety Cushion

Always add 5% to your calculated margin requirements for each individual stock position.

This buffer protects against broker requirement changes during volatile periods and helps you avoid margin calls, those dreaded moments when your broker demands immediate cash deposits or forces you to sell positions at a loss.

Taylor's system starts with three variables that determine how much margin you can safely use. These variables work together to calculate your surplus, which represents your available buying power:

where:

Think of this surplus as your financial cushion. It represents how much more you could theoretically borrow before hitting your broker's limits. But Taylor never uses all of it, because markets can drop suddenly.

Taylor's approach centers on calculating what would happen to your account during a market drawdown.

First, calculate your expected drawdown based on current VIX levels. Taylor uses this formula:

This formula essentially translates market volatility into an estimated portfolio decline.

When the VIX reads 20, your expected drawdown is about 14%. When fear spikes and VIX hits 40, the expected drawdown jumps to 27%.

Second, calculate your surplus after this drawdown occurs. During market stress, brokers typically raise margin requirements by ~5%, making your situation worse.

Taylor accounts for both the portfolio decline and the increased margin requirements in this formula:

The term “(1 - dd)” represents your portfolio’s value after the drawdown. If you expect a 30% decline, your portfolio retains 70% of its value.

The “(0.95 - R)” part accounts for the 5% increase in margin requirements. So if your original requirement was 30%, it rises to 35% during the crisis, but the formula simplifies this by using “(0.95 - 0.30),” which equals 0.65.

Let's walk through Taylor's calculation step-by-step using his original example.

You start with a $750,000 portfolio, a 36% weighted average margin requirement, and $350,000 in margin debt. Your current surplus is:

With the VIX at 20, your expected drawdown is:

After a 14% drawdown (rounded up), your $750,000 portfolio falls to $645,000. With margin requirements rising from 36% to 41% during the crisis, your new surplus becomes:

This $30,550 buffer means you could safely spend $30,000 on buying new stocks with a 100% margin requirement, or significantly more on stocks with lower margin requirements.

By maintaining this buffer at all times, Taylor has avoided margin calls throughout his investing career, including during the COVID-19 crash when many leveraged investors faced forced liquidations.

Taylor's approach succeeds because it acknowledges two realities of trading with margin:

Many investors treat margin as binary, either using maximum leverage or avoiding it completely. Taylor's approach provides a middle path, one that captures margin's benefits while respecting its dangers.

The math might seem complex initially, but running these calculations before each trade should become routine. More importantly, this approach removes emotion from margin decisions, replacing fear and greed with calculated risk management.