One very interesting comment that was posted last week following my post about leverage was a question about using leverage/debt to increase the size of a dividend portfolio. The question surprised me quite a bit. Not because the idea of using debt was so unique but simply because I thought this subject should be discussed much more and I’m surprised to not have read more about it. So not only did I decide to answer with a complete blog post but I also asked Mike to give out his thoughts on The Dividend Guy Blog, which you can also read (after reading here of course, ha ha).
The idea behind this is very simple. If you are able to get access to credit at 1.5% to 2% for example, would it be smart to use that in order to invest in a dividend portfolio that could generate 4% of dividends? In this low interest rate environment, it’s certainly a question worth asking. There are many different points to consider but here are my thoughts on the idea.
–Using “other people’s money” in order to make more money is not a new concept but it never gets old. Why? Because using leverage can significantly accelerate how much passive income you will be able to generate.
–Dividend stocks are very liquid and while it’s not ideal to have to sell them, especially if you can’t control the timing, knowing that you can do it makes a big difference compared to leveraging yourself
–More monthly cash flows: As I discussed in last week’s newsletter (sign up here if you’ve not already done so!), even in this difficult environment, dividends are still increasing at a very healthy pace so it’s fair to say that by investing into a well diversified dividend portfolio, you should get a very accurate idea of the dividends you will be making. From the perspective of cash flows, you will know from the start if you are making more through this leverage.
–Often Fiscally Advantageous: Depending on how you get the money, it is very possible that you could end up paying less taxes by doing this if for example you end up getting deductions on the interest that you pay on that loan (take the case of a tax deductible mortgage).
-Last week I wrote about the dangers of leverage and how it is taking down the whole system these days with some governments or companies having put themselves in critical situations where they
–Net Asset Fluctuations: One downside is that owning assets, even fairly stable dividend stocks will expose you to market fluctuations. While the impact on your dividend payments will be fairly limited, the value of your assets will go up and down. So yes, if you leverage yourself, those fluctuations will be more important.
Are You Already Doing This?
I always find it very interesting when some friends say they would never borrow in order to invest, it is just too risky. Really? If you have some debt and are putting money aside for investments, that is exactly what you are doing. If you did not want to use any leverage for investing, you would not invest a single dollar before paying back that debt. I am simplifying things a bit because there are fiscal impacts involved in both having debt (mortgage for example) and certain types of investments. I do hope you agree on the general concept though. If you taking a portion of your money to invest rather than pay back debts, you are choosing to live with more leverage than you would need.
In my opinion, it’s all about managing your personal finances. How I do it? Let’s imagine that I currently have:
500K of assets
350K of debts
The question becomes, a few months from now, what do I want my situation to look like? Of course ideally, I’d have a few millions of assets and no debt but let’s be real here. Would I prefer having:
600K of assets
350K of debts
500K of assets
250K of debts
Both can work out fine but you will obviously build your assets much more quickly in the first case. It all depends on how comfortable you are with the amount of debt vs. assets that you own. I guess we each have our own zones of comfort but personally I would probably go somewhere near the middle of those 2 scenarios.
Ways To Do It
There are obviously three critical parts to doing this operation:
1-Determine Amount Of Debt: Once you are able to determine that amount, you will be able to see how much of the money that you earn should go into building your assets or if you should even take a new loan.
2-Find The Cheapest Source Of Money: I think it’s important to be creative about this. Taking a loan of 3% might be your cheapest method but if you are paying less than that on your mortgage, student loans or others, simply diminishing the amount that you are paying back to invest in your dividend portfolio might be a more efficient way to pull this off.
3-Invest In A Solid/Diversified Dividend Portfolio: Regular readers will not be surprised to hear that the type of portfolio I would use a portfolio built like the Ultimate Sustainable Dividend Portfolio. One major reason is that I prefer investing in a portfolio that is yielding 2.9% but is increasing that payout very quickly with stable, growing companies rather than using debt to buy some higher paying, less stable dividend stocks. Just think of the idea of borrowing money at 2-3% to buy shares of FTR, which do pay a great yield, but one that is likely to decline in the short to medium term.
Do You Borrow To Invest In Dividend Stocks?
Have you done it? If so, under which circumstances and how is it done? Don’t forget to check out Mike’s take on the subject at TheDividendGuyBlog