[Shawn Allen]

For centuries banks made money by paying low rates on depoists (affectively they borrow the depositors money) and then they lend it out at higher rates.

With 20 times leverage for example a 1% profit on a loan turns into a sweet20% Return on Equity for the Bank.

Now you can be the Bank!

Interest rates are incredibaly low. Banks will lend on a varaible mortage at 3.3% (lates posted rates) or lock in for five years at 4.1%. My line of credit secured indicates I can borrow at 2.5% (insane!)

Now take that money and invest in a few Bank preferrred shares that pay more than 6% and are eligible for dividend tax credit.

Or find other safe preferred paying higher than that.

Have you just found a money machine? Could be quite worthwhile if you have say 100,000 or better, 300,000 of equity in your house.

Normally the rule is don't borrow to invest. But is this a normal time?

 

[mfd]

Normally the rule is don't borrow to invest. But is this a normal time?

Aye. I have a LOC invested right now and yes this isn't a normal time. I can also say is that its taken a certain amount of testicular fortitude to see it all the way through. I'm hoping march has marked the end of the market lows.

My biggest concern isn't losing a certain amount of money its losing the ability to invest. My fiance has no risk appetite at all and if I don't come out on top it will savings accounts from now on.

 

[lb71]

A lot of companies have some juicy yields right now, and banks are at the top of the list. A lot of people are convinced that their dividends will be cut, so there is a small risk of the yield falling below your loan rate.

Another option might be preferreds, again especially those of the banks. A lot of them are paying high fixed yields for the next five years, with the rate re-resetting to something along the lines of the 5-year government bond plus 4-5%. You can expect these to be recalled at that point.

 

[moneygardener]

My biggest concern isn't losing a certain amount of money its losing the ability to invest. My fiance has no risk appetite at all and if I don't come out on top it will savings accounts from now on.

That is interesting. Do you mean becoming insolvent before the market becomes rational? To be fair, your fiance should wait years to judge your leveraged investments.

 

[mfd]

My biggest concern isn't losing a certain amount of money its losing the ability to invest. My fiance has no risk appetite at all and if I don't come out on top it will savings accounts from now on.

That is interesting. Do you mean becoming insolvent before the market becomes rational? To be fair, your fiance should wait years to judge your leveraged investments.

I wouldn't say insolvent but at least come out with a lost. Now I don't think that will happen but anything is possible. I've always told her that this has a 10 year horizon and I have no intention of paying the loan until then.

 

[The Financial Blogger]

This is definitely the best timing ever to borrow money and invest in the market. Working for a bank myself, I borrowed as much as I could to invest in index funds. The question is the following:
Do you think that the market will make a better return than 2,5%? (this is what you have as an interest rate if you played wisely last year and applied for a line of credit secured by your property).
if you think so, than borrow and invest ;-)

 

[Kool-aid]

LOC Prime +1%

This is definitely the best timing ever to borrow money and invest in the market.
Do you think that the market will make a better return than 2,5%? (this is what you have as an interest rate if you played wisely last year and applied for a line of credit secured by your property).
if you think so, than borrow and invest ;-)

I believe now is a great time to invest especially with your LOC. I have one at prime, but yesterday when I was at the bank I was told if I want more money on my LOC I will have to open a seperate one at Prime +1%. This seems to be coming down through all the banks, might want to see if yours will be affected too!

 

[canbyte]

Seems a bit crazy to me but then again, youth is the time to do crazy things. You can lose 100% and not care a whittle.

I notice the blue suede shoe types (the folks with financial blogs) are egging you on, even to suggest borrowing hundreds of thousands of dollars of your equity to advance this strategy. Well, if you have that much equity you probably aren't young. What you have to think of as you try to get the spread you imagine is 1) what will those dollars be worth after they print all those zillions in bailout fees 2) in a depression, cash is king, debt is a dog 3) banks, having initiated & orchestrated the mess we are in are still being hailed as the saviour!! and 4) if this strategy is so obvious, why wouldn't the banks themselves do the same thing?

 

[CanadianCapitalist]

I notice the blue suede shoe types (the folks with financial blogs) are egging you on, even to suggest borrowing hundreds of thousands of dollars of your equity to advance this strategy.

I'll put in my 2 cents of dissenting opinion.

Personally, after a steep decline in prices, I believe stocks now have much better valuation and hence have higher expected returns. That said, I'm, as always, wary of leverage.

Look back to 2003 when stocks had experienced another steep decline. You are thinking that it is a great time to leverage and invest and that's what you do: you pull $100K equity out of your home and you invest it in stocks. Now, 6 years and 72 loan interest payments later, stocks are pretty much where they were in 2003 and even counting dividend payments, you are deep in the hole because you've made 6 years worth of interest payments. Not to mention, the sleepless nights when stocks were really low as recently as March, when you were looking at significant capital losses. I'm skeptical that the vast majority of average leveraged investors will have the fortitude to stick with stocks in the face of such declines.

 

[Shawn Allen]

Canbyte, good points there are no gurantees.

Stocks TSX are up 7% from where they were at start 2000 (TSX )
But since the low at the sart of 2003 are up 37% not counting dividends

S&P 500 is down 43% since start of 2000 but down only 3% since start of 2003 (not counting dividends)

The unique thing today is you can borrow on home equity at extraordinary low rates. You can even find Bank preferrred shares that will give you about 3% spread over the borrowing cost. High grade corporate bonds too. So you spread it around a bit and it can look very safe. Not huge returns though only $3000 or so profit on a $100k. But imagine a senior with lots of equity in the house, you could generate an extra $500 in cash flow per month with a $200k mortage.

Not without risks though, but a high probability it would work.

You can lock in five years at 4.1% mortage and then look for 5-year rese prefs that pay around 7%. Some good quality corporate prefs pay a lot more than that.

 

[CJB]

I'll put in my 2 cents of dissenting opinion.

Personally, after a steep decline in prices, I believe stocks now have much better valuation and hence have higher expected returns. That said, I'm, as always, wary of leverage.

Look back to 2003 when stocks had experienced another steep decline. You are thinking that it is a great time to leverage and invest and that's what you do: you pull $100K equity out of your home and you invest it in stocks. Now, 6 years and 72 loan interest payments later, stocks are pretty much where they were in 2003 and even counting dividend payments, you are deep in the hole because you've made 6 years worth of interest payments. Not to mention, the sleepless nights when stocks were really low as recently as March, when you were looking at significant capital losses. I'm skeptical that the vast majority of average leveraged investors will have the fortitude to stick with stocks in the face of such declines.

True, but keep in mind that the one thing that is different, is the spread between interest and yields. In 2003 you could not pick up 10% yields from blue chip companies on a regular basis. That said, being wary of leverage is always a good idea.

 

[DrStan]

Beating the bank is precisely what I'm doing right now. Leveraged $20K from home equity (a relatively small part of my net worth, so not crippling if the investment goes down) to purchase XDV (iShares dividend ETF) at 5.5% yield, with a 3.5% interest rate at the time (now down to 2.5%). This provides a nice 3% spread, with room for eventual capital gains and capacity to absorb interest rate hikes up to 3% if they should occur. I plan on repaying this loan over the next couple of years, and that $20K will provide about $1,000 per year in dividend income. It certainly seems to be working for me, but then again at 31 I have more risk tolerance than many. If I had more intestinal fortitude, I would leverage all the way up to my $150K HELOC, but let's not get crazy. There will be more pullbacks to pounce on.

 

[Ben]

I am skeptical of leverage, for the average investor, or even the investor who figures himself to be an above-average investor - it's unlikely to be a tool I ever use.

Dr Stan: Remember that you are paying interest on the loan in after-tax dollars, so you need to adjust either the loan interest rate upward or dividend return downward. I can't be sure of how your dividend interest will be taxed, but it seems the spread is not truly 3%, on a tax-adjusted basis.

 

[DrStan]

Ben, you're correct. I have oversimplified. The 3 % spread is not exact because I need to factor in taxes paid on the dividends and the effect of the interest deduction. This, however, is a tax-efficient dividend solution, so the taxation rate is fairly low. There is some "gambling" element to leverage. I believe that this investment is comprised of solid dividend payers that will gradually increase them over a long period; I have simply picked my entry point and taken advantage of low borrowing rates to get in. There is room for leveraging, but one has to be on a very solid financial footing to do it. Thanks for pointing this out!

 

[archanfel]

What if the market crashes, wouldn't the ETF be worth less? What if the housing market also crashes, wouldn't you get called on the HELOC?

 

[DrStan]

What if the market crashes, wouldn't the ETF be worth less? What if the housing market also crashes, wouldn't you get called on the HELOC?

Archanfel, the "value" of the ETF is not a huge concern. It could crash, of course, but these companies have intrinsic value; they will continue to generate cash and dividends. Like I mentioned, I picked my entry point and that's that. I think you have to look long term and evaluate your risk tolerance honestly (mine is high). Ironically, I think leverage is probably a good idea only for people who have some financial leeway and are able to absorb fluctuations; ie. those that probably don't need it as much as others.

One other thing I want to mention: my simplistic interest calculation is conservative and does not provide for any eventual capital gain. Well, if Nat Bank, CIBC, TD, RY, BMO, etc. don't increase their stock prices over the next 10 years, I think we'll have huge problems... the value of this investment will be the least of them!

Finally, the investment HELOC is only about $20K, and is the only encumbrance on the house (no mortgage). The bank won't come knocking for their money anytime soon.

 

[Sampson]

"Well, if Nat Bank, CIBC, TD, RY, BMO, etc. don't increase their stock prices over the next 10 years, I think we'll have huge problems"

I'm not sure I fully agree with this statement. It seems many people think we either need to get out of this funk by re-attaining the growth rate experience before or the economy will sink further.

But Japan can be our working example - they've been encouraging growth for a decade with near 0% interest rates - and stocks on the Nikkei have been going sideways for 10 years. So there is a 3rd scenario.

 

[DrStan]

"Well, if Nat Bank, CIBC, TD, RY, BMO, etc. don't increase their stock prices over the next 10 years, I think we'll have huge problems"

I'm not sure I fully agree with this statement. It seems many people think we either need to get out of this funk by re-attaining the growth rate experience before or the economy will sink further.

But Japan can be our working example - they've been encouraging growth for a decade with near 0% interest rates - and stocks on the Nikkei have been going sideways for 10 years. So there is a 3rd scenario.

If the stocks go sideways (and I agree they could), the dividends still keep rolling in; that's the point. I can also absorb dividend cuts if they should occur. I'm not looking for huge growth, just a reasonable return in the long run. If the stocks increase in price over the next decade or two, there will be some capital gains to reap. But I see this price appreciation as an "if", which is why I didn't use it in my example. All of my financial calculations are based on a 5% return rate before inflation, which is conservative.

As for the Japan example, the Nikkei was close to 40,000 in 1989 and is now in the 9,000 range. Devastating... But people who were buying 20 years ago were facing unbelievably high P/E ratios, investing in a bubble. I think that today's stock prices are far more reasonable, and constitute a good entry point. Others will disagree.

 

[ethos1]

What if the market crashes, wouldn't the ETF be worth less? What if the housing market also crashes, wouldn't you get called on the HELOC?

exactly "what if"

I suppose having that level of exposure you would need to offset the risk & cover yourself, possibly buying PUTS just in case everything tanks to zero

Archanfel, what would you do?

 

[DrStan]

exactly "what if"

I suppose having that level of exposure you would need to offset the risk & cover yourself, possibly buying PUTS just in case everything tanks to zero

Archanfel, what would you do?

These companies have intrinsic value, assets and income. They won't "tank to zero". If they did, we'd have to move to caves because that would mean our economic system had completely failed and money would be worthless. That seems like a fairly remote possibility. Let's stick to reality...