Last Monday, I mentioned the possibility of using a margin account to invest in a TFSA account. To my knowledge, only Questrade offer TFSA margin accounts. It’s kind of counter intuitive when you think about it: why would you borrow money to invest in an account where you can’t deduct the interest?

 

The idea of leveraging in Canada is often linked to the fact we can deduct the interest from your investment income. I’m not a tax expert but the general concept is that you are allowed to deduct the interest from a loan when the money has been used to invest and there is a reasonable expectation of profit. For example, if you borrow 100K at 5% to invest in a bond paying 2%, you can’t really deduct the interest as it is pretty obvious you will lose money.

 

However, this tax rule doesn’t apply when you borrow money to invest in a tax sheltered account (an RRSP or TFSA for example). So what’s the point of borrowing to invest in a TFSA?

 

Because my Expected Return is Bigger

 

If I invest $1,000 in my TFSA margin account and borrow another $2,000, I will have $3,000 to invest. I would pay 6% interest on $2,000, a cost of $120. This represents 4% of my portfolio. By selecting my stocks carefully, I can probably build a portfolio that will pay all interest within 12 months, maybe instantly.

 

There are many Canadian stocks that would fit in this portfolio:

Telus (T) 3.71%,

BCE (BCE) 5.04%

ScotiaBank (BNS) 3.85%,

Corus (CJR.B) 4.39%

Emera (EMA) 4.20%

National Bank (NA) 4.05%

Riocan (REI.UN) 5.21%

Rogers (RCI) 4.19%

 

This is a short list but it’s more than enough for me to build a $3K portfolio. I would probably buy 2 stocks at first and build on that. The idea is to pick stocks that will pay the interest with their dividend.

 

Then, the dividend growth will be “in my pocket” along with the overall growth of the stock value. When I look at my current portfolio, my YTD total return is 7.4%. It is a great combination of dividend payouts and stock growth. This is what I would like to create with this margin account.

 

You Have to be More Aggressive

 

A margin account is not for the faint of heart. If you don’t want to go “all-in”, it’s better off not doing it at all. I was surprised to find over 100 stocks on the Canadian market showing both EPS and positive revenue growth over the past 5 years and paying over 4% in dividend yield. Then, it’s a matter of researching deeper and look carefully at each company. The short list I just pulled for this article is coming from stocks I know well and that were part of my quick stock filter research.

 

Let’s say I wouldn’t have any problem building a “bank & telecom” portfolio with my TFSA. This could be a good idea to maximize both dividend payouts and overall growth of the portfolio. I’m not completely done with the idea of investing on margin but I must admit this is getting serious in my mind right now.

 

Please note that I didn’t mention any US stocks in this article because dividends paid by US companies in a TFSA are subject to withholding taxes (30% if you don’t do anything, 15% if you take care of it). I explain how you can save 15% withholding tax in my book; Dividend Growth Freedom Through Passive Income Canadian Edition.

 

What do you think? Should I go ahead and use the power of leveraging?

 

Disclaimer: I own shares of T, BNS, NA

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7 Comments   |  

7 Comments

Grant
May 7, 2014, 12:53 pm

Again with this borrowing to invest concept…worst idea ever!
I follow you based on your approach for long term financial growth, buy and hold and get paid, steady Eddie type of approach. Why would you go against this strategy with adding super amounts of risk? Makes me shake my head when I see those who get bored with 5-10% yearly returns, why people feel they have to get greedy is beyond me. Just continue what you do, buy hold get paid and retire early, not that you need guidance but think decades not weeks and years. Rant over. Good luck if you choose to have to or want to take on the risk of margin, be prepared for the dreaded threat of margin calls, been there not a fun financial situation.

HD
May 7, 2014, 1:35 pm

6% to borrow seems high tho.

I get %4.25 with BMO.

Best,

Colin
May 7, 2014, 3:50 pm

Just to be clear, with Questrade, you can use the money in your TFSA to qualify for margin in an unregistered account. The margin is not actually within the TFSA. I think it is important to understand what you are getting yourself into. However, you can technically deduct the interest, if expected returns exceed interest since the margin is unregistered.

RICARDO
May 8, 2014, 7:17 pm

I run a HELOC @ 3% for investment purposes only. I have had it as high as $140K, presently @ $90K
Luckily I have been able to build up a significant non-registered portfolio that pays the HELOC interest as well as a sizable amount of the principal. There is more than enough to pay the interest every month.
The interst is deductible as long as you can “have a reasonable expectation to make a profit”. So, in theory you could have a year with a loss as long as you do turn a profit at some time.
If you can pull 6% on your investments and pay one half (3%) to the bank you will be taxed on the remaining 3% at your marginal tax rate. But remember that these are dividends and, if you sell, hopefully capital gains. So there is less due to Mr. Tax Man than straight earned income.
If you are smart the “free” monies generated do not get spent but are re-invested back into lowering your principal and then you can ferreting out a new worthwhile stock to purchase.
The good thing about the margin is that it does let you play the market.
I have got to the point where I opened a second non-registered account and tranferred some stocks into that. This is because the HELOC account is automaticaly debited any dividends directly back to the bank account. Nice to get you going as you do not have any choice but to pay down the interst principal but if luck is with you then it is nice to transfer some stocks in to another account where you can allocate the money as you see fit. But the primary accounts should always be able to pay the interest and some principal.
Just remember, markets usually go down a lot faster than they go up. You have to be prepared to lose what you have borrowed so go slow to start. Some will get burned and some will make it.

DivGuy
May 9, 2014, 12:48 pm

Hello Grant,

I’ll give it some thoughts, but on the other side, I sleep well at night knowing I have a mortgage which is a bigger leverage than a potential 2K on a TFSA.

Hey HD,

You are right, it is high. What is interesting is the fact you can borrow to invest in your TFSA. I’ve seen margin account at 3.50%, but not for TFSA.

Hey Colin,
Hum… interesting, I didn’t go that far in my research, thx for pointing out this fact!

Hey Ricardo,

yes, this is another option, I’m thinking of using my HELOC with a lower % charged!

May 11, 2014, 11:04 pm

I get 4.25% interest via TD webbroker on Cad stocks and 4.5% on US stocks on margin. I have quite a bit margin available but i wouldnt use it. Only if there is a big crash in the market i would use my margin. Till then its a credit line till I need it

May 15, 2014, 8:10 pm

Guess it makes more sense in Canada to use leverage. I have always wanted to open a margin account so I can write puts or do a covered call option strategy but to me it seems a bit too aggressive for my long term dividend buys. I even reluctant to own REITS or MLP’s because of their high payout ratios. Still, it’s an option to consider. Thanks for sharing.

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