Buying Dividend Stocks on Margin

Buying on margin is a fairly straightforward, but somewhat dangerous way to buy stocks. Basically the idea is that you buy stock using money that you borrow from your broker. The broker has your stock as collatoral to force you to pay your debt, and will use the value of your account to determine your credit limit.

Usually the interest they charge you on what you borrow is based on how much you have invested and prime (for example, in my E*Trade account right now I’m paying prime + 1%, or 7% interest). If you can earn more then this amount through your investment, borrowing is good. If you can’t it’s bad.

Every book and article on investing that mentions buying on margin says how dangerous it is. Basically it magnifies your returns. If you make money, you make more, if you lose money, you lose more (because you’ve bought more stock and because you have to pay the interest).

If you’re buying very volatile stocks, your “credit” will fluctuate wildly (when the stock is high, your broker will loan you a lot, when the stock is low, he won’t). This can lead to a “margin call” when your debt becomes higher then your limit. At this point, if you can’t “top up” your account to deal with the loses, your broker will sell your stock to cover it. Since the stock is down at this point, you probably won’t be happy with the sell decision.

In Canada you can deduct expenses for investment, including interest, which can make trading on margin more attractive. Instead of paying 7%, I’m actually paying 7% * (1-marginal tax rate). Say my marginal tax rate was 25%, I’m actually only paying 5.25% after I get my tax deduction. With the Bank of Montreal stock I bought recently, I’m anticipating a 4% dividend-yield, which should be 3.5% after I’ve paid taxes (since dividends are taxed at 1/2 the income rate). Therefore if the long term appreciation of this stock is greater than 1.75% buying it on margin makes sense (which is what I did).

The additional benefit is that I won’t always have the opportunity to buy Bank of Montreal stock when its at 4% yield. By the time I’ve saved up more money to buy more of the stock, its price may have gone up and it might not be as attractive. By buying on margin, I can buy when the stock is attractive, then use my savings to “pay off” my broker.

Obviously buying more speculative stocks on margin is far more dangerous than buying “blue chips”. Additionally, anything I owed to my broker, I’d want to feel confident I could pay it off in the near future, whatever happened to the stock.


Dividend Growth

I used to wonder why anyone would buy Disney or Coca-Cola or any of the big name companies. Sure they were leaders in their fields and great companies and all that, but there stock price seemed pretty stead (with modest gains year-after-year) and it just seemed like GICs and more conservative investments could match them with zero risk (instead of the slight risk these companies seem to offer).

Even when I started getting into dividend stocks, I looked at the dividend-yield on these companies, and just couldn’t figure out why anyone would buy them (at 1% dividend-yield it still seemed like a savings account was a better bet).

What I was missing was the rate of the growth of the dividend. Sure Coca-Cola’s dividend might be 2.58% today, but given there 5 year dividend growth of 11.49%, means the dividend should be 4.4% in 5 years and 7.6% in 10 years, 13.2% in 15. Along with that dramatically increase dividend-yield (relative to our original purchase price) will be the new dramatically higher price for the stock to support the higher yield. Rob Carrick and Tom Connolley make a very convincing case that over the long term these high-growth dividend stock prices will keep shooting up, supported by the ever increasing dividends. A retirement income that increases by 11.49% per year is exciting both from a “easily fend off inflation” perspective as well as a “no worries about running out of money” perspective.

Consider instead a stock that pays a high yield, but which doesn’t increase. You’d be happy receiving the higher amounts in the first years, but when a growth stock overtaxes the yield and keeps going you then might become a little less happy.

I’m convinced there’s some way to factor in the current yield and the growth yield to figure out which is a better buy, but am somewhat at a loss how to calculate this. One idea I had is to get a “short list” of companies I like, which are all blue chip, long term increasing dividend payers. Sort the list in order of the 5 year dividend growth and throw away the bottom half. Then rank the remainders in terms of dividend-yield and examine the first few companies as potential “buys”. Repeat when funds allow.

Alternatively, you could only look at the top half of the current yield, then examine the first few when you order for growth. I’m not sure how much weight should be given to each element of a stocks history if you wanted to order them taking both ratios into account (naively I’d guess 50/50). Define “dividend strength” as yield x growth and rank. Start at the top and look for good buys.

There’s probably a mistake in this overly-simplistic approach, if any readers know better than I do (and have been good enough to read this far), I’d love to have my error pointed out in the comments!

Real Estate

Getting Started With Investment Real Estate – Part 3

To start at the beginning – please see part 1 of this series.

My agent was actually very useful in targetting areas of town to look in. After repeatedly telling her my criteria (very affordable, near a subway, possible to rent) she focused on two areas of town. One wasn’t on the subway and so we quickly stopped looking there. I got her to show me two other areas that I didn’t believe her when she said they wouldn’t be the best locations to target, but after seeing some units and becoming more familiar with the area in the end I agreed with her.

If you want to be a total jerk, at this point you could dump your agent and put in offers yourself (which would be quite a bit more attractive without the buying agents 2.5% cut). I did NOT do this and view it as a pretty scummy trick to pull (and this is the main reason buyers’ agents get the signed contract, to prevent people from doing this). My agent had very real knowledge of the city and was able to help me quickly cut through the enormous number of listings and find the right area for me to target, this was VERY valuable, and for it she definitely deserved to be compensated. I’m a believer in “statistical karma”, and if you behave badly towards people enough, eventually you’re going to do it to the wrong person and get majorly burned.

With the area targetted (there were three buildings that were very similar in the area I liked), it is then worthwhile to view EVERY unit available that meets your criteria (a 2 bedroom condo or a very cheap 1 bedroom was mine). The advantage you have as an investor is that you aren’t going to fall in love with any unit. When a buyer loves something, the seller can get top dollar out of them. Conversely, when a buyer is willing to accept multiple properties, it becomes like an auction where the seller who’ll agree to the lowest price gets to sell first. Don’t fall in love. You can’t afford to as an investor. Its expensive, but permissable as a home-owner, but not if you’re looking to make money.

One thing I didn’t do which I should have is factor in the quality differences in the unit. They aren’t interchangeable, so viewing them all as acceptable/unacceptable then putting in equal bids on each in order of desirability (which is what I did) is a mistake. Instead you want to come up with a very low offer price, consider that the price for a unit in good repair, and discount this price by what you think it would cost to bring each unit up “good repair condition”.

E.g. I bought my condo (sorry to skip ahead to the end of the story 🙂 ) for $126K. I had to put $6K of repairs into it (supplies and labour) and it took 2 months before I was able to rent it out (at $500 / month in condo fees, +100 / month in property taxes + interest on the mortage). So basically, I should have offered $134K to a similar unit that didn’t need repairs and they would have been equal offers (instead I offered $126K to the units in better repair, and unsurprisingly the roughest unit was the first to accept). Live and learn.

Your agent is going to hate you (mine got to the point where if the offer that was accepted hadn’t been she was going to cut me loose), but you put in offers on ALL the properties, with the repair adjusted prices. Let your agent tell the selling agents that you’re looking to buy one of X units, and that you’ll be back with another offer if all of the others say no. This will scare the heck out of the selling agents (all it takes is one of the others to say yes and you’re gone) and they’ll champion you to the seller (I’ll discuss motivations and incentives as it relates to real estate agents in a future post).

If one of your first round of offers is accepted, you probably paid too much. Tough luck, try to be cheaper in the future. My first offer on the place I bought was $122K which was rejected. Clearly the minimum price the seller would have accepted was somewhere between $122-126K, which I’m very happy with as a small range (I’d be depressed if I paid $126K to a seller who would have accepted $110K).

Your agent will try to get you to let them handle the negotiations or will provide advice. Don’t take it. Unfortuately your objectives at this point in the process are not in line, so you have to set the offer price yourself.

Each round when everyone rejects your offer (which should happen at least once so all of the sellers had a chance to give you a low price), you up your offer and go through them again. Agents will try to scare you with the idea that you’ll “offend” the sellers and they won’t listen to future offers. Malarkey! An offer is just that, an offer. Which is an option the seller didn’t have before. They can say no, in which case they’re no worse off then before they heard the it. If their time is so valuable that spending 30 seconds hearing the offer is a huge inconvience they have some sort of mental illness. If someone is such a child that they won’t listen to future offers because I don’t worship their property the way they do, I’ll happily buy from one of the other 11 people I’m offering to.

Even if someone SAYS they’re offended and won’t listen to future offers, they still will.

The only time I wouldn’t follow this advice is if I found my dream house and fell in love with it (again, this is the high price of falling in love with a property). In that case, you’ll want to keep the lines of communication open and stay on good terms with the sellers, in which case low-balling isn’t in your best interest. If someone has just listed a property at a good price in a hot area, you’re wasting everyones time with low-ball offers. HOWEVER, if there are multiple property in the area that have been available for an extended period (the condo I bought had been vacant for 7 months), you should get a good deal.

(continue to part 4)

Real Estate

Getting Started With Investment Real Estate – Part 2

To start at the beginning – please see part 1 of this series.

My strategy was to find a condo that I felt I could afford and be happy living in (this basically meant quite economical and on the Toronto subway line as I don’t own a car and don’t want to have to buy one). I intended to try and rent it out, and if I couldn’t find a tenant, decided I didn’t want to be a landlord, or couldn’t charge enough rent to make it worthwhile, I’d move in myself (I was hedging my bets).

I met with a Real Estate Agent, and early in the relationship caught her in a few lies. I debated whether it was better to stay “with the devil I knew” or find one I didn’t. In the end I figured I didn’t think I was going to find any saints working as Real Estate Agents and stayed with her.

I met with her and she kept pushing me to get pre-approved for a mortgage and to buy a pricier condo in a “hot” area of Toronto. I kept repeating that I wanted to buy something for a low price near a subway line, and that I wasn’t looking for appreciation (since my intention was to hold the unit for a long time). I think RE Agents are used to selling speculation to clients and it took a while for her to get that my interests were in a different direction, but eventually she got it.

Once she realized that I wasn’t going to stretch my budget, a pre-approval wasn’t necessary any more (I had 25% down for the price range I was targeting). She tried to get me to sign a “buyers agreement”, which would have locked me in with her for a set period of time (if I bought property without her I would have had to pay her commission). I was willing to sign for short periods, but in the end once we’d talked a bit she didn’t bring up the agreement again and neither did I. It kind of bugged me that she tried to tell me the “buyers agreement” was for my benefit (it was clearly for her’s). I’m a pretty straightforward guy, and it bothers me when people try to deceive me.

With an agent to work with, we were ready to start seeing units!

(continue to part 3)


Getting Started With Blue Chip Dividends

About a year ago I got really excited after reading Stop Working by Derek Foster. His basic idea is that you buy stable, well established companies that are leaders in their industries which have paid a regular increasing dividend for a long time when they’re on sale. You determine this by looking at the Dividend-Yield (which is basically the last quarterly dividend, multiplied by 4, divided by the share price). The Dividend-yield tells you how much of your purchase price you’ll get back annually (so a $100 stock with a 4% dividend yield would pay you $4 per year, $1 each quarter).

His idea is that these companies aren’t going anywhere, their share price should increase over time, and since the dividends increase you can basically live off of the dividends and use the increases to compensate for inflation. Apparently Derek very aggressively built his portfolio, and he is now retired in his early 30’s with a family of 4.

After reading his book and looking at some stocks I was excited to buy Merck and General Motors. The problem with this strategy is that these companies will only have a decent dividend-yield after there is bad news, so everyone will tell you you’re crazy to buy (which could be considered another good reason to by – they call this contrarian investing). At the time, the bad news scared me off (GM was losing money every quarter, and Merck has a lot of its patents expiring soon with no other popular drugs in the pipeline to replace them).

I never gave up on the strategy, and have recently begun mulling it over again. With the new Canadian tax laws giving very favourable tax rates for dividend income combined with the abysmally low interest rates currently (great news for mortgages, not so great news for GICs), I finally bit the bullet this week and put $6773.77 into the account and have bought 242 shares of Rothmans (a tobacco company) for $5349.87 (including a $20 trading fee, which gives a dividend-yield of 5.45%) and today I bought 65 shares of Bank of Montreal at $68.88 (which would give me a dividend yield of 3.95%) for $4477.20.

For the mathematically astute, yes 4477.20 + 5349.87 > 6883.77. I’ll discuss buying on margin in a future posting.

So far since buying the Rothmans its gone up 5% (so I’ve made a cool $270). Share prices for dividend stocks are somewhat unimportant if your following a buy-and-hold dividend strategy (as you only really care how much you’re getting per quarter – if you’re not planning to sell, the current price doesn’t matter).

One modification on the general strategy that I’m considering is to sell any stock that drops to a dividend yield of 3% or less. This would mean that either they’ve cut the dividend (which would suck if you’re counting on the dividend payments for your retirement) or the price has gone really high (which it might make sense to sell at that point and buy stocks with higher yields). Most people who write about this strategy seem to favour a hold-forever outlook, so I’m not totally committed to this approach yet.




DIYers, You never had it so good!

Do you lose sleep trying to calculate if you should convert your index fund holdings to ETFs now or wait another month? Was it a tough decision to go with the brokerage with the $8 trades vs. the one with the $5 trades? If so then you might want to consider the fact that as investment DIYers, things have never been better.

Here are some of the reasons why:

Stock trading commissions – In the past you could only buy and sell stocks through full service brokerages which would charge in excess of $100 for a trade that you can do now for $5. A frequent trader would go bankrupt pretty quick with those commissions and even for a buy and hold strategy, lower commissions represent a big saving.  Read a BMO Investorline review here.

Mutual fund costs – Prior to the advent of the dreaded DSC (or back end) option in 1987, front end commissions were as high as 9%. The DSC option was actually an improvement over the front-end option because all of your investment dollars would be invested instead of being lopped off for commission. Now you can get most funds with front end option and no commissions. You still have to shop around for lower MERs however.

Information – The number one improvement in this area is the internet. Financial blogs, forums, websites, company sites, investment book reviews, learning pages, online research reports all help DIYers not only learn more about investments but allow them to carry out the execution via online brokerages. Television is also another area where there is much more information on dedicated business channels than in the past.

Index Funds – These first appeared in the US in the mid-70s although they were slow to catch on. According to there are only 6 Canadian index funds that have 15 year returns with the oldest being established in 1985. These passive investment funds provide a low cost alternative to actively managed mutual funds.

ETFs – The first Canadian Exchange Traded Fund established in 1990 was called TIPS and was the first ETF in Canada or the US. The last several years has seen a huge increase in the number of ETFs traded on the TSE and the US markets. ETFs are valuable building blocks for a low cost diversified portfolio.

If you can think of any other reasons why DIYers have it much better now than in the past then feel free to leave a comment!

Real Estate

Getting Started with Investment Real Estate

In Fall 2006 I was flipping through “The Automatic Millionaire Homeowner” by David Bach and it forced me to re-think my perspective on real estate as an investment vehicle.

Previously I’d always viewed real estate as intensely speculative. You hear about the areas where properties go up in value 36% in a year, but when you view it as a whole, I was very unimpressed with the returns (I don’t buy 11% average returns, I suspect 3-4% is more realistic). Bach gives a list of the 5 ways you get income from real estate, and taken as a whole it seemed a lot more appealing. The one that really convinced me was the idea of leverage. If you can get a property that’s cash-flow positive (makes money every month after all expenses are paid), the apprication is basically increased the lower your downpayment.

E.g.: You buy a house that’s worth $100,000. You make a downpayment of $10,000 and the income equals the expenses. After a year if it goes up in value by 3% and you sell it (for $103,000), you now have $3000 more then you started with, a 30% return.

Obviously this is an overly simplistic example (in real life the transaction fees to buy and sell would cost far more than the $3,000). This concept is the core of “other people’s money” that the get-rich-quick low-lifes love to chant about. Leverage is a very powerful concept, and although it can be dangerous, real estate is one of the easiest ways for normal people to use it (trading on margin would be the other I guess).

My plan was to start small. Instead of getting a 93 unit building, I decided to get a condo near the Subway line. I would get the cheapest place I could find, rent it out if I could, and live there myself if I couldn’t. It seemed like the best way to “hedge my bets” if landlording didn’t work out for me (be willing to live there myself so I wouldn’t have to turn around and start trying to sell a couple of months after buying. I realized from a strictly dollars-and-cents perspective, condos aren’t the best investment, but they have a lower price tag, and it seemed like a good way to learn (with training wheels firmly attached).

Luckily I had a friend who owned multiple buildings (from Condo townhouses up to a recently aquired 8-Plex) and he was a great source of information. I also spent tons of time in Chapters/Indigo reading the Real Estate Investing books (for free).

By chance, my girlfriend got a notice under her door for a free seminar for first time buyers (clearly a sales presentation for a Real Estate Agent). I went to that, connected with an agent, and started my house hunt…

(continue to part 2)

Personal Finance

A week in the life of…

I got into real-estate (as a first time buyer and invester) last year, and had intended to blog my way through the process. I’ve now reached the point where I’ve competed the process (I own a condo with a tenant in place), so its probably time to start the blog .

Since the first real estate adventure is complete, I think I’m going to try and take a wider perspective and actually blog about all my money adventures (not just landlording).

Money is interesting in that it means such different things to different people. I hate being forced to do boring tasks and having to grin and take it when idiot bosses throw their weight around. For me, money is freedom and security, being able to do what you want, without having to worry about ending up eating dog food on the street.

This this end, like many other, my ulimate goal would be to have passive income that equals my living expenses and then have complete control over how I spend whatever time I have remaining on this planet however I want (probably reading and drinking coffee would take up a large part of it).

I consider passive income as money that comes in that doesn’t require very much ongoing effort. I like to think of my condo as a passive investment, even though I had to replace the dryer duct recently, simply because once I’ve done maintenance work on the condo, I hope that there will be a long period of time where I just cash rent checks and pay the bills (every property owner’s dream).

To give some numbers, I do computer contract work and charge $40 / hour for full-time, longer-term (3+ months) work. This works out to about $80K / year income before taxes (and being self-employed I can deduct a few work related things).

For the last week, I’ve been carrying a notebook with me everywhere I go and jotting down what I spend. This morning I plugged the numbers into a spreadsheet and have hopefully determined a rough cost-of-living estimate for myself.

For my fixed monthy costs:
Rent – $440 (1/2 of $880 rent paid by gf on 1 bedroom apt)
Cable – $40
VOIP – $22.45
locker – $12.50
phone+internet – $40.25
transit pass – $99.25
Cleaning – $45
Total: $699.45

Over a week, my variable spending was $396.26, which works out to a total monthly “cost of living” of about $2,348.26. I think this was actually a fairly representative week as I sent my mother some flowers for mother’s day, ate out at a pricier restaurant and had a night on the town, bought a book, etc. Hopefully if anything most weeks should be cheaper (which I’m hoping to keep tracking and determine).

The thing that blew my mind was that I’m spending $195.21 weekly on food (groceries, lunches at subway, dinner out once in the week). That seemed reasonable to me, until I did some hunting and apparently the average Canadian HOUSEHOLD spends $150 / week on food! I found some US numbers, and apparently single men spend the most on food weekly, and they spend on average $60 / week.

I was always convinced that it would be tough to eat much cheaper than I do, but apparently some people are doing it in a major way. I’ve always felt $7 is a reasonable value for a Sub (try buying deli meats, bread and veggies at the grocery store and your total will hit $7 in a hurry!) and friends always tell me you can eat way cheaper than that at home – I guess they’re right.

I lost a ton of weight (about 70 pounds), so I’m not too eager to start eating cheap and badly, but I definitely want to figure out a healthy way to spend around $60 / week on food (ideally if it was easy too that would be even better :-).

Any ideas?