“Borrow for growth, not Consumption” –Rule quoted by Financial Planner
“Blow it out your ear” -Big Cajun Man
No, I am not saying you should borrow for consumption either, you should not borrow. Buying a house is the only thing I can see as a good reason to borrow money, borrowing money to invest just strikes me as asking for a swift kick in the lower abdomen.
Simple Rules to Follow
It’s interesting that I tripped across this in my archive of articles that I started and then stopped, as Robb E. over at Boomer and Echo went and asked a whole bunch of folks about this, and got some interesting answers to the Question, Should You Borrow to Invest. Lots of interesting ideas in that article (no I am not condoning the advice, simply saying that it is an interesting read).
Borrowing money to buy a single stock can be viewed as buying on margin (in a simple understanding), the advantage is that you can buy lots more of the stock with your borrowed funds, and enjoy the huge profits, however, the best way to do this is to find a sure thing that will deliver profits that out-strip your borrowing rate, and that stock is? Anyone? In the 90’s it was Nortel, Enron or WorldCom, not sure what they are now. The con of this are you could have borrowed money and end up with a less valuable (or worse worthless) asset at the end of things.
Selling Short is another way to borrow, where you find someone who is willing to sell their stock and you guarantee that you will buy it back for them in a prescribed time period (or when the person who loaned you the shares says they want their shares back). The exciting part on this one is you can lose infinite money with this one (if you believe infinite growth is possible in the market), let me explain:
- I convince Michael James to sell his International Buggy Whip at $10 a share
- The world decides that buggy whips are making a big comeback and the share price sky rockets to $100 a share
- I decide not to buy back yet, because the market will drop out, but it keeps going up, and up….
This will never happen! Don’t know, but I bet there are folks that Short Sold Apple in the 90’s that might disagree with that statement.
Put no money into the Stock Market that you are not willing to lose
Surprisingly when I started looking at the markets in 1981 that was one of the rules, wonder what happened to it? Anyone hear anyone espouses this “Debbie Downer” point of view of the markets (aside from the sky is falling bloggers like me)?
As usual, different strokes for different folks.
So you are not comfortable “borrowing” to invest. Many good reasons for that, among others, can you afford to lose the money?
But scale does matter at times. I can use my hard earned cash to purchase one stock at $10 and paying 5% per year ($0.50) which is a lot better than what a GIC or CSB will pay. Now it cost me $10 brokerage to buy it and it will cost me $10 to sell it for a total of $20 transaction fees. At $0.50 dividends per year it will take me twenty years to cover the transaction fees alone. Plus if it is in a non-registered account I get to pay taxes on my $0.50 every year. Yes, I know. I would be probably have “0” tax on fifty cents but this is just for illustration.
Now if I have a HELOC @ 3% (which I do) and borrow $10K to purchase 1000 stock, this will pay me $500 per year less my 3% interest charge on the HELOC, which is tax deductible. This leaves me with $200 to pay taxes on at a reduced rate as the money is from dividends. The dividends “pay” my interest charges and, if you are wise pay down the principal owed on the HELOC. So every year there is less interest to pay as the principal pay down accelerates.
A few caveats. If you let the dividends pay down the principal then obviously you are “contributing” every year as you are paying the taxes on the dividends as well. So you are investing (lowering) in the HELOC by paying the taxes due on the dividends you paid.
So what is my situation. Fast approaching retirement at 24hrs per day. HMM! I think every one is in this situation.
Max the RRSP & TFSA every year.
No debts other than the credit card (paid in full every month) and the HELOC
House paid for.
Still working. Have to if I max the RRSP but probably retired mid 2015 at latest.
The HELOC: Have margin of $160K of which $133K is presently invested in equities.
Any equity MUST pay more than 3% to pay the interest charges.
All dividend paying stocks.
I pay the interest charges every month so this is an investment on my part.
I may also contribute any extra monies to the HELOC as, in theory, it pays me 3% to pay down the principal rather than leave it in a low paying bank account. Reminder, I have already maxed the RRSP & TFSA
This also allows more wiggle room if I buy a stock at some time. Recently HSE
Using this payment scheme I have built the non-registered account to over $260K (less the $133K owed to the HELOC)
Interest charges for 2014 will approximate $3K. Again tax deductible.
I do buy and sell in this account so the HELOC principal varies through the year
Will receive aprox $14K in dividends so, again, I support the HELOC by also paying the taxes on $11K. But as they are dividends, at a reduced rate.
So, to recap. If you pick the right stocks (doesn’t everyone?) and they pan out for you then you will receive increasing dividends as well as, hopefully, increasing stock value. IPL just increased their dividend 14%. But you have to be prepared to accept that stocks can just as easily go down as go up and hopefully your picks will rise from the occasional trough. I have stocks below my purchase value as well as stocks that have appreciated but they ALL pay me something.
Where have I really lost money in the past? Non-dividend paying stocks. Being a good Canadian, think NT. As I read somewhere, if you get dividends then you can not lose everything. I have sold at a lose as well as gains. In a non-registered account at least the lose can be applied against any gains.
So that is it for me gentlemen. It has worked so far. I may change this once I am retired.