Would you like to invest in a product that pays a 10% dividend yield and is built on banks and other blue chips?

This is what Dividend 15 Split Corp (DFN.TO) offers: a group of 15 companies where you can hold Class A and preferred shares. When I looked at the list of the 15 companies, I understood it was a select group: Bank of Montreal (BMO.TO), National Bank of Canada (NA.TO), Sun Life Financial (SFL.TO), Bank of Nova Scotia (BNS.TO), CI Financial Corp. (CIX.TO), TELUS Corporation (T.TO), CIBC (CM.TO), BCE Inc. (BCE.TO), Thomson Reuters Corporation (TRI.TO), Royal Bank (RY.TO), Manulife Financial (MFC.TO), TransAlta Corporation (TA.TO), Toronto-Dominion Bank (TD.TO), Enbridge Inc. (ENB.TO) and TransCanada Corp (TRP.TO). The list is pretty solid and the yield is even better, so… what could be wrong with split corps?

Never Trust a Broker

If a broker wants to sell you something, it’s probably because it’s really good… for his pocket! This is the case with most structured products. As you have probably figured out by now; an investor holding those 15 companies in his portfolio would not come to a 10% yield. The Dividend 15 Split Corp is able to generate such high yield because it is a structured product; a clever mix of shares and options that produce high returns… for the brokers. These products show lots of smoke to the investors but are built to generate generous commissions to any broker selling them. This is why these products make it on the market anyway.

As the company’s portfolio doesn’t generate enough to pay a 10% yield and cover the firm’s management fees, the remaining cash has to be found elsewhere. Since this portfolio would generate around 5% dividend yield, the mutual fund company (yes, DFN is in fact a mutual fund company) trades the underlying securities and writes call options on them too. These operations also trigger additional costs to the investors as even performance bonuses for traders are included in the “creation of wealth process”.

Okay, this doesn’t look that good… but what about the 10% yield???

When I hear about something that is too good to be true, I always check its return over the past 10 years. So here’s what the DFN.TO graph looks like:

As you can see; lots of fluctuation and a loss of 8.50% in value over 10 years. I guess the good news is the 10% dividend yield remained during the whole period. Still, during the same period, the Canadian market grew by 60% excluding the dividend (if you held Canadian banks for the past 10 years, I don’t have to convince you made a lot more than the Split Corp).

So the structure is not the best thing for an investor and the return is not impressive… are you still going to argue with the 10% yield? All right, check out what happened when things turn sour. Here’s another split share corp that was very popular prior to 2008:

This is the chart of the US Financial 15 split corp (FTU.TO). The stock lost almost everything while US banks took a hit but bounced back. Why FTU wasn’t able to get back on track like the underlying stocks? Because the firm was too busy trading the stocks and writing options that they completely lost the investors’ capital.

So Are Split Corps a Good Investment?

For any type of investments (stocks, ETFs, structured products or funds), I always rely on my 7 investing principles I follow to succeed. The first one is “high yield doesn’t equal high returns” and the third one is “A dividend payment today is good, a dividend guaranteed for the next ten years is better”. Using these two principles; I’d tell you that a split corps would never be part of my portfolio. But if you don’t like my investing principles, you can also argue with the most prolific investor of all time, Warren Buffett who once said:

Never invest in a company you don’t understand.

If you think you understand how traders write their call options and trade those stocks to make money for you (and not for them), good… I don’t! What I understand is only how they make those trades to generate fees for the firm…

A week ago, it was payday. But not just any ordinary payday, the big one! My year-end bonus was deposited in my bank account. The product of a long and hard year where I truly earned each dollar. Why do I do that? I’ll tell you here; it’s my little secret ;-). I’m not the kind of guy who wants to win contests (been there, done that), not the guy who wants to tell all his colleagues he’s the best and not the guy who’s looking for my boss’ appreciation. I’m simply the kind of guy who works hard to earn a big fat check at the end of the year.

I won’t disclose my real bonus, the title is completely phoney and not the point of my article anyways. The point is; what would you do with a lump sum deposited in your account? Tax season is approaching and you might want to ask this question for a smaller amount anyway. I didn’t always spend my money wisely or the way I should have done it. In fact, many of my bonuses were used to treat myself (like going to Hawaii last year with my wife!). But this year, I’ve tried to make sound decisions.

The Eternal Question; Pay Your Debt or Invest?

My first thought was to make a huge contribution to my TFSA and invest this money in the stock market. After all, I could easily create a 4% dividend yield portfolio right now with the recent volatility. On the other hand, I still have a couple of loans that I’ve carried for the past two years. One was used to install a central AC in my house and the second one was for the pool. You can tell, these were priorities back then ;-). The first point to settle when you are wondering if you should pay down your debt or invest is how much interest you pay vs how much return you can expect. Considering this rule, I should have invested the money in my TFSA since my expected return is greater than the loan interest.

However, I’ve decided to pay both loans and clean my balance sheet of consumer debts. The second point is to consider your current financial goals; do you wish to decrease your monthly payments or increase your balance sheet. Right now, I’m in the middle of my 18 month countdown before I retire and go live in an RV for a year. I don’t want to have any loans hanging over my head during that period. This is why I’ve decided to pay off my debts.

I now have three debts; my car loan, my RV loan and my mortgage. My car loan will be paid off by selling my car in 2016 and my mortgage along with my RV loan will also be cleared by selling my house. If I’m lucky, I’ll even have about 50K in cash once I become “debt free”. That’s a pretty solid plan since I expect to spend roughly $2,000 per month in my RV, this means I can easily live 12 months without even trying to make a penny with my websites…

Crazy Idea: Invest in a Margin Account

While I think I’ve made the right and foremost conservative decision, I’ve also looked at the possibility of taking my money in a margin account to almost double my investment. But I’ve made the following calculation to see if it was worth it:

Assume an investment of $10,000 with a margin at 70%. If I want to give myself some room for volatility, I can’t invest more than $30,000 (9K cash + 21K from the margin) and leave 1K in cash to cover for a potential margin call. So what can I do with 30K? Let’s say I do the best case scenario possible and make 20% return on it. This means I make $6,000 in a single year. That’s pretty amazing when you think about it in term of return (that means a 67% return on my initial investment of $9,000). But does it really change my life for a year considering all the risks taken?

I’ve leveraged several times in my life and it almost always paid off. However, with three kids and a financial future that is uncertain, I would rather play it safe this time. I might want to do it when I leave with my RV as I will live from my websites and investments, but for now, I would still rather pay off all my debts. I will keep the idea of leveraging with a margin account for next year, what do you think? Have you ever traded on margin?

I’ve admitted it in the past; I’m not the typical dividend investor. I started investing by trading, buying & selling every two weeks while most dividend investors usually buy and hold completing the sale transaction after several years holding their shares. In my opinion, the dividend investor is the upgraded version of the buy & hold investors. More often than not, the buy & hold and dividend investor is the same guy. I strongly believe in dividend investing, that is why 100% of my portfolio is composed of dividend paying stocks. I even wrote two books and created a whole investing platform around dividend stocks called Dividend Stocks Rock. Still, I’m not convinced a 100% buy & hold strategy is the best way to maximize your investment these days.

The Investment Thesis Behind the Buy & Hold Strategy

Before I present my view of investing, I think it’s important to mention why the buy & hold philosophy is so seductive for many investors. First, several famous investors have used this method in the past. Guys like Warren Buffett have reputations for success to make following their path seem logical. Invest in solid companies that you can understand and buy only if you intend to hold the stock for ten years… or more. This is roughly what you can learn from the buy & hold strategy.

Then, there will be a horde of investors with shocking examples of company success over the years such as Coca-Cola (KO) which shows a total return of over 5,000% since 1978. But my point is not to debate as to whether or not you should buy & hold stocks for several years. This totally makes sense for your core portfolio, but if you want to maximize your return, I think you should add more trading habits to your investing strategy.

The Way I See Things: a Buy & Hold Core + a Growth Segment

I’ve had several reactions about my latest trade: selling a dividend aristocrats (McDonald’s  NYSE:MCD) to buy a speculative company working in the oil industry which is down 35% since January 2014 (Black Diamond Group TSE:BDI). For many, this transaction looks like a trader’s move at best and like a gambler for others.

I told you already: I’m not the typical dividend investor. I have a set of 7 investing principles I follow religiously and I also allow some cash to make “growth additions” to my dividend portfolio. The point is simple: I have most of my portfolio in shares of companies I truly want to hold forever (such as JNJ, KO, Telus(T), ScotiaBank (BNS), DIS, WMT, etc) but I also allow myself to forget about 1 of my investing principles if I think there is a great opportunity on the market. I have done it in the past with STX, INTC and HSE which all reported profits over 25% over a short period of time. I’m currently holding AAPL, HP, Gluskin & Sheff (GS) and Balck Diamond Group (BDI) in my “additional growth” segment. When I sold MCD to buy BDI, I simply sold a part of my core portfolio to transfer it to my “growth” segment. My point is the following, what if MCD is the new KO that did an astronomic 1.82% (plus dividend) over the past 16 years???

You see it right, someone who bought and held Coca-Cola (KO) since June 30^th 1998 until today only made 1.82% in appreciation. Thank god there is a dividend attached to this stock!

BDI’s drop in price is directly linked to the oil sand industry. BDI rents & sells modular equipment for remote areas. Its biggest market is renting modular homes in Northern Alberta for oil sand exploration businesses. However, nothing is stopping BDI from exploring other markets (basically any company with an interest to develop in a remote area) and generate additional revenue. The company shows solid fundamentals and pays over 5% in dividend yield right now. Between a stagnating company like MCD which is probably going to trade around $95-$100 in three years and BDI which can easily trade at $30 (from $19 right now) in 12 months, I’ll take the chance. Keep in mind that I’m not buying a weak company with shaky financials, if you look at BDI’s fundamentals, you will see that the company shows strong basics. Now it’s only a matter of going through the oil barrel storm before we see the light. The 5% dividend is more than enough to keep me waiting in the meantime.

To be honest, in this specific situation, the perfect scenario would have been to keep MCD and use new money to buy BDI. But since I didn’t have more liquidity at the moment and have been following BDI for the past 18 months, I thought it was the right time to make this move.

I’ve been using this strategy for a few years now and it has served me very well. Let’s see if its only luck or a solid investing strategy. I personally think it’s the latter!