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.
Related: How $18,000 invested in Altagas will ensure you’ll never pay another gas bill again
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.
While working on last week’s post on margin, I stumbled upon an old experiment some of you might remember. No, I’m not talking about that those experiments we all did in college. I’m talking about how I made a dividend portfolio to see whether the borrow to invest concept works.
The borrow to invest portfolio was a simple one. It was $75,000 in total, with $37,500 coming from the borrower’s own sources and $37,500 from margin. The interest rate for the margin was set at Prime, which was 3% at the time. That’s gone down since, so hooray for us.
When we last left the portfolio, it was doing pretty well. The TSX Composite Index was down 3.47% since I started, and my portfolio was only down 2.27%. A victory! Of sorts, anyway.
That was back in June, and a lot has happened since then. The TSX Composite crashed pretty hard back in January, bottoming out just below 12,000. It has since recovered, closing May 11th at 13,788. That’s still a return of -5.9% since the last update and is down 6.5% from when the contest began.
Enough small talk. Here’s how the borrow to invest portfolio is doing, as of the close of trading on Wednesday, May 11th.
Hey, that’s not bad. Big winners included Extendicare, Calloway REIT, Saputo, Rogers Sugar, and Manitoba Telecom. Results were dragged down by Cenovus, TransCanada, TransAlta, and Power Financial.
The value of the portfolio has increased ever so slightly, from $75,000 to $76,906.84. If $75,000 would have been invested in the TSX Composite when the exercise began, it would have been worth $70,125. That’s a nice outperformance. Nelson, go ahead and take the rest of the day off.
Here’s where the outperformance really shines. Including dividends, my total is $81,682. A similar amount invested in the TSX Composite (via the XIC.TO ETF) would be worth a little less than what we started with including dividends, coming in at $74,378. Now, admittedly, this isn’t exactly an apples-to-apples comparison, since my portfolio does include some U.S. stocks and the index doesn’t.
Most importantly, the dividend income was easily enough to easily cover the interest. The borrow to invest portfolio generated enough to pay off the interest and $3,300 in additional income that could be put towards paying down the debt.
The best part of these results is it shows how I can swing and miss on a few picks and still have the results end up okay. Both TransAlta and Cenovus have cut their dividend, which means they’re out of the fund. Let’s go ahead and replace them.
Copyright: Nelson’s brain and definitely not stolen from a major Hollywood movie.
The first replacement stock is going to be Artis REIT (TSX:AX.UN). Even though the portfolio already has REIT exposure via Calloway (which has been renamed Smart REIT), I like Artis here for a crapton of reasons.
First of all, it’s cheap. Shares trade for something like 35% under book value. Most of that discount is because of exposure to Calgary, which is apparently in worse shape than Kabul. But the company only trades at some 10 times funds from operations (which is earnings in the world of REITs), and has a payout ratio in the neighborhood of 70%. The yield is 8%, and the share price as I write this is $13.47 each.
If we sell the TransAlta shares, we can use the proceeds to pick up a nice round number of 259 Artis shares. Good thing it’s all computer trading now or some trader would be plotting ways to kill me in my sleep.
The replacement for Cenovus is going to be something loosely energy related, the misleadingly-named Information Services Corporation (TSX:ISV). It operates the land and corporate registry for the province of Saskatchewan, scoring a contract to do so exclusively until 2033.
Like Artis, it’s cheap, trading at just a little over 11 times what I think 2016’s free cash flow will be. It has succulent net margins, the ability to make small bolt-on acquisitions to grow the business, and it’s shown it can handle a year where property sales are a little slow. It also easily earns enough to cover the $0.20 dividend each quarter (a yield of 5%) and has $36.5 million in the bank, which is enough to pay 2.5 years of dividends.
I’m a little upset having to pay $16.07 per share for it, but hey. I don’t want to let this one get away.
The Cenovus stake is currently worth $3,800, which means we can buy 236 shares of ISV. That represents potential income of $189 per year, while Artis is projected to add $279 each year to the portfolio.
Manitoba Telecom should probably be replaced soon, since it looks pretty likely the takeover offer from BCE is going to go through. But it’ll keep paying dividends in the meantime, so we’ll let it stay for now. YOUR DAYS ARE NUMBERED, MANITOBA. I mean, uh, Manitoba Telecom. You people from Manitoba can live. For now.
Ooh, that’s much classier than saying conclusion. FINALLY, FINANCIAL UPROAR DOES THE CLASSY THING.
A lot of people like to crap on borrowing to invest. But as long as you don’t overextend yourself, it can be an effective way to jumpstart the whole building wealth thing. Think of it like driving. As long as you’re smart about it, the chances of somebody getting hurt is pretty slim. Doing dumb stuff like putting the whole portfolio into one stock is the equivalent of getting behind the wheel after a dozen long island iced teas.
Even though I’ve had three stocks cut their dividends so far, my borrow to invest portfolio is still generating enough cash to easily pay the interest while outperforming the market. I guess time will tell whether I can keep up this performance, but it sure looks like the concept can work.
Back in December, after saying some words about borrowing to invest, I decided to put my (figurative) money where my mouth is (was?) and create a portfolio that I would use if I was using the bank’s money to invest in the market.
Here are the ground rules:
- The portfolio would be a 50/50 split between borrowed and original capital, with the opening value of $75,000
- The portfolio would be mostly Canadian stocks, but with a couple of U.S. ones mixed in for fun
- No additional money would be added, because like hell I’m going to figure that out. If I was going to add more cash, I’d probably use it to pay off the debt taken out in the first place
- The assumed interest rate will be 3%
- Once a stock cuts the dividend, it’s out of the portfolio, replaced with something else
When we last looked at the portfolio, it was underperforming the TSX Composite by about 1% after accounting for the dividends. The decrease in the U.S. Dollar helped the American side of the portfolio, and Extendicare was the big winner on the Canadian side. Bombardier cut its dividend, and I replaced it with Manitoba Telecom.
Let’s take a look at the most recent results:
If you exclude dividends, the value of the shares are down about $3,000, and are down $1,300 from the original investment, made back on December 5th, 2014. Once you add the dividends back on, I’m up marginally, to $75,674.47. That’s good enough for a return of 0.90%.
As much as it sounds like a copout, this portfolio isn’t all about the capital gains. The whole point was to use the income generated by dividends to pay off the interest, which the portfolio has easily done. So far the portfolio has generated $1,879.87 in dividends, while we’ve paid interest of $1,220.55.
Since December 5th, the TSX Composite Index is up 1.23%, marginally beating my portfolio. But since the last update on February 20th, the TSX Composite is down 3.47%, compared to the portfolio’s loss of just 2.27% (including dividends). That’s not bad, considering how I’m getting much higher dividends than the index investor would be.
Some individual notes on some of the companies:
- Extendicare continues to do well. Including dividends, it’s the best performing stock on the list. I own it personally and think it’s worth close to $10 per share
- Pizza Pizza is a stock I’ve been buying on the recent pullback. Now that shares are yielding 6% I think I’ll add to my position
- The recent election in Alberta hit both TransAlta and Cenovus. Typical NDP, crushing the dreams of capitalists
- All three U.S. stocks continue to perform pretty well
- Rogers Sugar has paid out the most dividends. I own this one as well
And that’s about it. So far, not a bad performance.
Oh, what a portfolio it was.
When I completed the Financial Uproar borrowing to invest portfolio, it was literally the greatest thing in the history of mankind. Angels sang in the heavens. Republicans and Democrats stopped fighting to collectively praise it. Jim Cramer FELL TO HIS KNEES and praised Allah. He’s Muslim, who knew?
I promised quarterly updates on the thing, so here it is. Yeah, I know it hasn’t been exactly a quarter yet, but I was looking for something to write about today and it seemed like a good idea. Regular readers learned to stop expecting quality a long time ago.
Anyhoo, enough teasing. Here are the results.
- The portfolio is up approximately 3%, excluding dividends. We’re flirting with 4% if you include dividends, which is lagging the TSX a bit. The TSX Composite is up 5.1% over that time.
- U.S. stocks really helped, mostly thanks to the currency conversion back to Canadian Dollars. Hopefully the dollar stays weak so I can collect some sweet virtual dividends.
- Both Extendicare and GM were up more than 10%. I continue to like Extendicare, and I recommended family members buy it as a yield play. I’ll write more about it at Canadian Value Investing in the coming days.
- The Bank of Canada lowering rates helped me too. That gave Calloway and Pizza Pizza a nice boost.
- The big dog was Bombardier. Someone suggested in the comments that I should have gone with the preferred shares, which was the better move in hindsight. Now that the Bomber has cut its dividend to go along with the bad news baked into the stock, I have $2,940 plus $361 I didn’t spend in the first place.
Which will be the new Uproar Borrow (KINDA RHYMES) stock?
There are a few stocks I like in Canada. Extendicare is one, but I don’t really want to buy more. Too many eggs, not enough baskets. I like Dream Office REIT (disclosure: I own it), but there are already enough REIT/interest rate sensitive stocks in the portfolio. I also like Manitoba Telecom, but I think it’s only a matter of time until it cuts the dividend.
But saying all that, I’ve just spent the last 10 minutes thinking about a stock to add that pays a dividend and isn’t a small-cap, and I can’t think of a thing. So Manitoba Telecom it is. I bought 120 shares at $24.52, which is expected to throw off $204 in dividends annually. I think this gets cut soon, but I’m okay with that. It’ll likely yield about 4% going forward, which I’ll gladly take.
And that’s about it. I”m happy with the performance considering how Bombardier blew up. That shouldn’t happen each quarter. And by the time I update this post again, I’ll have earned enough in dividends to easily cover the first year’s interest. That means I can start paying off my imaginary loan, which I’m sure will make my imaginary banker happy.
A couple of weeks ago, I wrote some words about borrowing to invest. And like all my
crap high quality bloggenin’, I’m sure all of you were literally on the edges of your seat in anticipation.
I promised a model portfolio if enough people (>0) were interested, so here we go.
(Note: if you signed up for the Financial Uproar weekly newsletter, you got a special peek at this article a day before everyone else did. That’s kind of a neat feature, right? The sign-up form is on the right if you just can’t wait to get your thrice-weekly serving of bad jokes)
A few things about this model portfolio before we start:
- Unlike the Uproar Fund, this portfolio is much more… conventional. No weird small-caps.
- The stocks chosen for this portfolio will pay dividends. As you’ll remember I’m dividend agnostic, but I think it’s important you get paid to wait when you’re paying interest on a HELOC.
- We’re going to assume the total portfolio is worth $75,000. Like I mentioned in the original post, I’d only recommend a 50/50 split between borrowed and your own assets. So you put up $37,500 and the bank puts up $37,500
- The assumed interest rate will float at Prime, which is currently 3%.
That’s about it. I’m going to go with approximately 15 different positions with a small cash component, because math is hard. First, a list of the companies chosen. These aren’t in any particular order, and we’ll use Friday’s closing prices.
Extendicare — The company operates assisted living facilities, also known as the place where Grandma fills her Depends for 5 years before she kicks it. They’re in the process of getting out of the U.S. business, which is crummy. Think lawsuits and whatnot, probably after everyone laughed at Grandma crapped herself.
Cenovus Energy — One of the largest oil sands operators, where it regularly rapes the environment. This pisses off James Cameron, for… some reason. Go back to making Avatar not suck, you knob. Anyway, Cenovus has some big growth projects planned, but they’re in jeopardy if oil craters any further. The expansion projects, that is. Not the stock. It’s a fine operator.
TransCanada Corporation — One of Canada’s largest pipelines. It got the nod over Enbridge because of the upside potential from Keystone XL, the power assets, and the activist investors looking to break up the company.
Calloway REIT — I like the idea of having retail exposure, but there aren’t many that I’d find appropriate for somebody looking for steady dividends. So let’s go with Calloway, a retail REIT which almost exclusively has Wal-Mart as their anchor tenant.
Wells Fargo — There needs to be some financial exposure, and the U.S. seems to be doing pretty well. So let’s take the advantage of adding some U.S. exposure to the portfolio.
Power Financial — Power Financial has a nice dividend, has exposure to insurance and wealth management, and trades at a discount to the sum of its parts. Plus, I’m pretty sure the CEO is named Max Power.
IBM — It’s hard for me to like technology as an investment, but the stock is still a cash flow machine. Buffett is long the stock, and it’s literally been around forever.
Rogers Communications — I think the whole telco sector is a little overvalued, but hey, it’ll do well if the market goes down. Well, compared to everything else, at least. Plus, you get to own a small slice of the Blue Jays, which will undoubtedly disappoint us all come April.
Pizza Pizza — Everyone likes pizza, right?
TransAlta — TransAlta is probably the cheapest power generator in North America. It’s trading at a decade low, easily has enough free cash flow to cover the bonerific yield, and should benefit from electricity rates going up in Alberta.
Saputo — Because you’ve gotta have at least one growth stock with a low yield. Saputo has good expansion potential since the dairy business across the world is pretty fragmented. Insert your own ‘milk comes from boobs’ joke here.
Rogers Sugar — I am irrationally attracted to the sugar business. What’s not to love? It has steady revenues, government protection from imports, and there’s only two players of scale in the whole country.
Bank of Nova Scotia — I’m not a huge fan of the Canadian banks, but I’ve been known to be wrong about this kind of stuff, so you’ll want to own at least one. I picked BNS because of its large international exposure.
General Motors — The portfolio needs a little industrial action. GM is cheap because of the recalls, and low gas prices should also help. Plus, more U.S. exposure.
Bombardier — This one is a bit of a high-flyer. Get it? High flyer? It makes planes. Its fortunes pretty much rest on the CSeries program, which is scheduled to begin deliveries in 2015. The market, however, is a little skeptical.
And that’s it. Remember, the portfolio is worth $75,000. Let’s see how it looks in table form.
A couple of notes. First of all, I took the U.S. stocks and converted both the amount invested and expected dividends into Canadian Dollars, using an exchange rate of $1.13. But the share price remains in U.S. Dollars. When I update this fund, I’ll convert the amounts again, keeping it consistent with exchange rates. But only to the nearest penny. I’m not a masochist.
There’s a few hundred bucks in cash laying around which isn’t really accounted for. I’ll use it, plus the proceeds from dividends, to reinvest into something new come March 1st, when I’ll update this next.
The IBM outsized position is on purpose. I’m bullish on IBM.
Keep in mind that the portfolio is designed for income first, and capital appreciation second. Yes, I realize the danger of doing this during a zero interest rate world, but leverage 101 says we want to get the loan paid off quickly. Ideally our imaginary borrower is able to service this loan on their own while reinvesting the dividends, but we’ll give them the option of withdrawal.
And that’s about it. Feel free to critique or to tell me how awesome I am in the comments.
*Disclosure: I own Rogers Sugar. Family members own Power Financial preferred shares and Bombardier preferred shares.