I have been toying with this idea for the past 6 months. The reason why I haven’t made a move yet is that I was too busy managing debts and moving into my new house. Now that I am settled, I am again looking at the low borrowing rates and the high dividend yields paid by good companies and am asking myself; “Is it too good to be true?”.
I live in Canada and I currently have the possibility to borrow money below the prime rate (I enjoy a discount since I work for a bank). Therefore, my borrowing cost to invest would be 1.50%. About 2 years ago, I was using my Home Equity Line of Credit (HELOC) to invest in the market. I had stopped my strategy, ill-timed in (May 2009) but it wasn’t related to what was going on in the stock markets. In fact, I stopped leveraging since my wife quit her job and was staying home to take care of our two children. With only one income in our household, I thought of reducing our investment risk. But now that we are financially stable and that interest rates are very low, I am thinking of leveraging on the investment opportunities that I see.
As of now, I really like the US market in terms of dividend investing. I have recently reviewed a US DIvidend Portfolio and the average rate of this portfolio was 3.74%. So if I borrow money at 1.50% (tax deductible), I could earn a 3.74% yield + potential capital gains. Even if the interest rate rises, I will still be in a comfortable position for quite a while. This makes the investment strategy very attractive.
Cons of borrowing money to invest
There are a couple of things that make me think twice before going ahead with a leveraged dividend portfolio:
#1 The bank may call my line of credit at anytime. While it hasn’t been done in Canada, I have been aware that US banks limited their clients credit facilities back in 2008. This would force me to sell my stocks to pay back my line of credit.
#2 Lack of liquidity. The problem while investing with a loan is that you are stuck with your stocks for a while when the market drops. If you need money for something else, you don’t have many options since cashing your investments will not even fully pay back the loan.
#3 Less dividends to reinvest. One of the keys to a strong dividend strategy is to use dividend reinvesting. The problem when you combine it with a leveraging strategy is that you can’t reinvest the full 3.74% in your portfolio as you have to allocate a part of the earnings to pay interest costs. This will definitely slow down the growth of my portfolio.
Considering borrowing to invest anyways
After giving some it serious consideration, I still think that buying dividend paying stocks would be the best strategy if I was going to take a loan to invest. The steady dividend payout would pay the interest and the investment strategy would become “free cash flow”. Since I am not planning on using this money for a long time, I think this will be a great avenue.
Do you leverage?
Have you ever borrowed to invest in the stock market? What do you think of this strategy? Do you think it’s foolish to invest with other’s people money?