We all want to earn more money.
The Canadian and the US market have been great during the past 11 years. Including 2020 when our society and the economy are falling apart, the stock market continues to roar.
My portfolio is divided into three investments: 1/3 Canada; 1/3 US; and 1/3 International.
The ticker symbol of those ETFs are: VFV, VCN, and VIU.
Here is a graph of their returns (credit: Portfolio Visualizer)
The dividend yield
In a time period when bonds and interest rates are at records low, in some central banks there are negative interest rates, the dividend yield for stocks is very attractive:
| VCN | 2.99 |
| VFV | 1.54% |
| VIU | 2.11% |
| Average | 2.21% |
The interest rate on margin accounts
I haven’t done any research looking for the best interest rate on margin accounts. I am just taking the off-the-shelf amount that I find at my local broker TD Waterhouse. I was told by another blogger that he can get loans for less than 2%.
How to leverage your investment and eliminate the risk
My proposition is to leverage your portfolio 25%.
25% is my level of comfort. For some people it could be 50%, for some others it could be 10%. You have to find your sweet spot.
Let’s imagine this scenario:
- I have $100,000
- I borrow an additional $25,000
- If I borrow at 4%, my cost of capital is $1,000
- If I borrow $25,000 my total capital is $125,000
- If the dividend yield is 2.21% my cash flow is $2,762.5
In year one, I pay the $1,000 of interest and I reduce the $25,000 debt by $1,762.5. In year two I have less debt to pay and bigger cash flow.
In short, the cash flow from the dividend pays the interest expense and some of the principal.
Would you leverage your portfolio?
We all know that leverage increases your risk. But most people use leverage to buy their houses and they don’t hesitate twice to do it.
When people buy a house, they generally put down 20% of the value of the house, and the other 80% is borrowed. Also, when people buy a house, they think long term (5 years or more).
If we leverage our portfolio a small percentage, and we think long term (10 years +) we have the potential to increase our portfolio without significantly increase our risk.
Comments from Alex Chan
If we do simply this and remove any compounding interest or gain out of the question. The borrowing cost is 4% while the yield is 2.21%. There should be a deficit on this borrowing though.
If you’re using the dividend yield including original capital and the new leverage to offset the borrowing cost, it give a false sense of illusion.
To better illustrate this
original capital 100,000 yield 2,210 dividend
Leverage of 25,000 yield 552.5 but cost 1,000.
If you add this all up, the total gain is 1,762.5. Meaning, there’s no actual gain by leveraging.
This is based on what was given. Of course, people leverage because there is a chance that they will yield a higher reward than the cost of borrowing. Typically, that’s the risk people are taking. Hence, its why the bank adjusts the borrowing rate based on the market volatility as well.
I hope that makes sense. Let me know if you have any questions.
Alex
Answer from Alain
Alex is completely right.
The borrowed money ($25,000) cost $1,000 in interests and it pays out 552.5 ($25,000 X 2.21%). So the actual lost from this transaction is -447.5.
If this is all the information we have, then, as Alex suggests, this is NOT a good deal. However, I have to add, that on periods of 10 years or more the stock market has a total return of over 4% (our cost of capital). So yes, there is a bit of speculation going on here. We have to hope that in the long run, Dividends plus capital gains will exceed the cost of 4%. In the sample period of 11 years, the average return was 8.33%.
In regards to interest rates, the interest rates are not adjusted according to market volatility. A clear example is that during the times of COVID-19 we saw the market drop and rebound about 30%, yet interest rates are at all times low. Central bankers have said, numerous times, that interest rates are NOT set in relation to fluctuations of the stock market but as a tool to try to keep inflation at the goldilocks level of 2%.
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