Back in December, 2014, a bunch of Canadian finance bloggers started to rag on the concept of borrowing to invest. Investing was already risky, they argued. Why add more risk to the equation?
I took a different stance. As long as an investor wasn’t stupid about the whole exercise, borrowing to invest could end up being a profitable endeavor. So I set up a simple portfolio that invested $75,000 into a bunch of dividend-paying stocks. Half of the amount came from hypothetical savings; the other half was borrowed at Prime.
When we last left the portfolio, it was handily beating the TSX Composite. How’s it doing today?
Not bad, kids. Not bad.
A couple of notes about the spreadsheet before I talk about the performance. The total dividends at the end there are off by a few bucks because I originally had Bombardier in the portfolio. I replaced it with Manitoba Telecom, which will now be replaced again since it was acquired by BCE.
You’ll also notice that the amount invested has gone down to $69,826. This is because I’ve had to replace three companies that cut their dividends (Bombardier, Cenovus, and TransAlta) which all went down in value. This explains the lower cost base on the spreadsheet, but in reality the portfolio is still based on $75,000 invested.
Remember, the portfolio was $37,500 of our own money and $37,500 in borrowed cash. Interest costs so far come to $2,318.49, which assume the person borrowing didn’t pay down a nickel of debt. Logic would dictate someone doing this would be using their dividends to pay off the debt.
Remember, any interest charged would be tax deductible. If you were in the 25% tax bracket, borrowing to invest would only have costed you $1,738.86. Plus the tax on the dividends, naturally.
So, did I beat the market?
We’ll use the iShares TSX Composite ETF (TSX:XIC) as a market proxy. It’s not perfect, especially considering a good 20% of my portfolio is invested in U.S. stocks. But it’s a reasonable substitution.
In total, our borrow to invest portfolio is worth $94208.42. We’ll ignore interest costs for this part. That’s a total return of 25.6% in just under 2.5 years.
On December 5th, 2014, XIC shares traded at $22.97 each. They currently trade hands at $24.81. Investors received total dividends of $1.9665 per share in that time. We’ll round that up to $1.97 per share because I’m feeling generous. That’s a total return of 16.59%.
To look at it another way, our portfolio made $19,208.42 in total profits, before taxes. We only invested $35,000 of our own money. That’s a return on equity of 54.88% in just 2.5 years.
This portfolio is on the right track. Excellent.
We only have to punt one stock this time around, which is Manitoba Telecom. Unlike the last three changes, this one came with a happy ending. It was bought for just over $24 per share. It was then acquired by BCE for $40 a share. That gives us $4,800 to invest in something new.
I’m going to stick with the utility theme and pick up Altagas Ltd. (TSX:ALA). Shares trade at a very reasonable price-to-FFO ratio and investors aren’t entirely in love with its decision to acquire Washington-based WGL Holdings. It’s not quite at a 52-week low, but it’s close. It seems like a decent time to buy.
Oh, and shares yield 6.81%. Which will add $327.60 to our annual income total.
The transaction will be to spend $4,809 of the fund’s cash on 156 Altagas shares which trade for $30.83 each.
Note: if you’re interested in Altagas, the subscription receipts trade at a discount to the common shares. They’re essentially common shares in disguise, as this post explains.
Let’s wrap it up
Borrowing to invest gets a bad rap because some people are really bad at it. I’ve gotten emails from people who are so confident about some undervalued stock they’re willing to borrow money just to put into it. That’s dumb.
You have a much better chance of doing well if you stick to stocks that pay generous dividends, are a little boring, and only use a reasonable amount of leverage. If I had this portfolio personally, I would feel confident to continue holding. Even if stocks go down some, I don’t have much risk here. Meanwhile, it’s going to spin out about $3,000 a year in pretty damn dependable income.