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Leveraged Dividend Investing for the Cash Flow

After reading "The Brainwashing of an American Investor", my mind has been on the subject of investing for cash flow.  As the author states, a big fat portfolio is nice, but having a portfolio that pays for steaks is better.  I'm also a believer in cash flow.  As I've stated many times before, the day that your passive/alternative income meets your expenses, you are financially free.  Imagine the day that you don't depend on your 9-5 job to pay the bills!  For those of you who "love" your jobs and never want to leave, you are more of the exception than the rule, sad fact, but true.

What are some methods of passive/alternative income?  The ones that come to mind are investing for dividends, starting a side business and investing in cash flow/rental real estate.

This article will focus on investing in strong dividend stocks that increase their dividends on an annual basis.  How does this strategy stack up? 

As I'm currently looking to leverage my investment portfolio, this is what the cash flow would look like based on:

  • Province of NL
  • Prime Rate: 6%
  • Marginal Tax Rate: 40%
  • Dividend Tax Rate: 19.78% (find your tax info here)
  • Market Cap Growth (after inflation): 4%
  • Dividend Growth (after inflation): 2% (conservative)
  • Dividend Rate: 3.5%
Year Portfolio Dividend Div after Tax Annual Interest Interest after Tax Cash Flow/Yr
1 $100,000.00 $3,500.00 $2,807.70 $6,000.00 $3,600.00 -$792.30
2 $106,807.70 $3,813.03 $3,058.82 $6,000.00 $3,600.00 -$541.18
3 $114,138.82 $4,074.76 $3,268.77 $6,000.00 $3,600.00 -$331.23
4 $121,973.15 $4,354.44 $3,493.13 $6,000.00 $3,600.00 -$106.87
5 $130,345.21 $4,653.32 $3,732.90 $6,000.00 $3,600.00 $132.90
6 $139,291.91 $4,972.72 $3,989.12 $6,000.00 $3,600.00 $389.12
7 $148,852.70 $5,314.04 $4,262.92 $6,000.00 $3,600.00 $662.92
8 $159,069.74 $5,678.79 $4,555.52 $6,000.00 $3,600.00 $955.52
9 $169,988.05 $6,068.57 $4,868.21 $6,000.00 $3,600.00 $1,268.21
10 $181,655.78 $6,485.11 $5,202.36 $6,000.00 $3,600.00 $1,602.36
11 $194,124.37 $6,930.24 $5,559.44 $6,000.00 $3,600.00 $1,959.44
12 $207,448.78 $7,405.92 $5,941.03 $6,000.00 $3,600.00 $2,341.03
13 $221,687.76 $7,914.25 $6,348.81 $6,000.00 $3,600.00 $2,748.81
14 $236,904.09 $8,457.48 $6,784.59 $6,000.00 $3,600.00 $3,184.59
15 $253,164.84 $9,037.98 $7,250.27 $6,000.00 $3,600.00 $3,650.27
16 $270,541.70 $9,658.34 $7,747.92 $6,000.00 $3,600.00 $4,147.92
17 $289,111.29 $10,321.27 $8,279.73 $6,000.00 $3,600.00 $4,679.73
18 $308,955.47 $11,029.71 $8,848.03 $6,000.00 $3,600.00 $5,248.03
19 $330,161.72 $11,786.77 $9,455.35 $6,000.00 $3,600.00 $5,855.35
20 $352,823.54 $12,595.80 $10,104.35 $6,000.00 $3,600.00 $6,504.35
21 $366,936.48 $13,099.63 $10,508.53 $6,000.00 $3,600.00 $6,908.53
22 $381,613.94 $13,623.62 $10,928.87 $6,000.00 $3,600.00 $7,328.87
23 $396,878.50 $14,168.56 $11,366.02 $6,000.00 $3,600.00 $7,766.02
24 $412,753.64 $14,735.30 $11,820.66 $6,000.00 $3,600.00 $8,220.66
25 $429,263.78 $15,324.72 $12,293.49 $6,000.00 $3,600.00 $8,693.49
26 $446,434.34 $15,937.71 $12,785.23 $6,000.00 $3,600.00 $9,185.23
27 $464,291.71 $16,575.21 $13,296.64 $6,000.00 $3,600.00 $9,696.64
28 $482,863.38 $17,238.22 $13,828.50 $6,000.00 $3,600.00 $10,228.50
29 $502,177.91 $17,927.75 $14,381.64 $6,000.00 $3,600.00 $10,781.64
30 $522,265.03 $18,644.86 $14,956.91 $6,000.00 $3,600.00 $11,356.91
31 $543,155.63 $19,390.66 $15,555.18 $6,000.00 $3,600.00 $11,955.18
32 $564,881.85 $20,166.28 $16,177.39 $6,000.00 $3,600.00 $12,577.39
33 $587,477.13 $20,972.93 $16,824.49 $6,000.00 $3,600.00 $13,224.49
34 $610,976.21 $21,811.85 $17,497.47 $6,000.00 $3,600.00 $13,897.47
35 $635,415.26 $22,684.32 $18,197.37 $6,000.00 $3,600.00 $14,597.37
36 $660,831.87 $23,591.70 $18,925.26 $6,000.00 $3,600.00 $15,325.26
37 $687,265.15 $24,535.37 $19,682.27 $6,000.00 $3,600.00 $16,082.27
38 $714,755.75 $25,516.78 $20,469.56 $6,000.00 $3,600.00 $16,869.56
39 $743,345.98 $26,537.45 $21,288.34 $6,000.00 $3,600.00 $17,688.34
40 $773,079.82 $27,598.95 $22,139.88 $6,000.00 $3,600.00 $18,539.88

As you can see, based on todays rates and my conservative assumptions, the leveraged dividend strategy would be cash flow positive in year 5.  Also note that Newfoundland has the highest dividend tax around, so if you are living in BC or other dividend favorable province, you'll most likely turn cash flow positive sooner.

Again, leveraged investing is not for everyone, the gains AND the losses are amplified.  From my experience, losses hurt a lot more than the highs of winning.  However, I can justify leveraged investing for the long term as the markets have historically returned positive.

If you would like to read more articles like this, you can sign up for my free newsletter service below (we will not spam you).

FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 46 comments… add one }
  • The Financial Blogger January 15, 2008, 9:15 am

    It’s funny that we always say that leveraging is not for everybody but that we write that we could make big money after a certain period!

    You obviously need more than 15 years in order to leverage properly but over time, I think it is one of the best thing one can ever do for his personal finance!

  • FrugalTrader January 15, 2008, 9:21 am

    Guys, I apologize for the erratic posts, it seems that the wordpress scheduling has screwed up my future posting schedule. I hope to get this fixed up soon.

  • Four Pillars January 15, 2008, 9:54 am

    I have the identical spreadsheet. One thing I added was a “present day value” of all the cash flows so that I could see in today’s dollars what they add up to.

    Mike

  • FrugalTrader January 15, 2008, 10:39 am

    Mike, when you say present day value, do you mean that you accounted for inflation?

  • MoneyMusing January 15, 2008, 10:48 am

    I heard rumours that interest on investment loans is only deductible when pre-tax profit is made on the investment.
    This sounded wrong to me, since businesses lose money all the time and still can claim tax deductions.
    Is there any base to such a claim?

    • FrugalTrader January 15, 2008, 10:56 am

      MoneyMusing, where did you hear this? Are you from Quebec? They have different tax laws there than the rest of Canada.

  • MoneyMusing January 15, 2008, 12:14 pm

    I just heard it on a PF forum. I’m sitting in cold & snowy PEI so we fall under the same general tax climate as you.
    I do know that you will be investigated if you’re claiming interest as an expense on a company that has not intention of making profit but I believe it’s all about intent.
    As long as your investment strategy has the reasonable expectation of profit then this isn’t an issue.

  • Warren January 15, 2008, 12:57 pm

    CRA seems to be a little fuzzy on what “reasonable expectation of profit” is, but I’m told they won’t bug you for at least 2 years. Beyond that, they have been slapped down a few times by the Supreme Court when going after taxpayers. That being said, play within the rules and you’ll be fine. :)

  • PhilC January 15, 2008, 2:57 pm

    I have had the same Excel sheet in my head for a few months. I think if we hit a nice recession and the market loses another 20-30% it will be a good time to schedule a meeting with the banker and get this going. I’m aiming roughly at early 2009. I certainly wouldn’t want to initiate this strategy on the day Citibank cuts it’s dividend. More will certainly follow.

    MoneyMusing: Investment loans is deductible when reasonable expectation of profit can be shown. Investing in dividend paying stocks is eligible.

    Frugal: I like the “Are you from Quebec?” Nice one! We use “Are you from Newfoundland?” out here… Just kidding ;-)

  • WhereDoesAllMyMoneyGo.com January 15, 2008, 3:20 pm

    Just a side note to one of your points in the post FT: Behavioural finance researchers found that given a gain or loss equal in magnitude, an investor has roughly twice the physiological/emotional reaction to a loss than a gain.

    Also note that this market (TSX) is only down 8.8% from it’s all time high in the summer. Markets can get much worse than this. (S&P500 is down 11.4% from peak).

  • FourPillars January 15, 2008, 3:25 pm

    FT – yes, I assume 3% inflation and basically discount all future flows to the present. I did it more for personal interest than anything else since I’m not sure what it means other than to verify that your model shows an overall positive return.

    The sheet is called “Div Sheet” and is at the bottom of this post:

    http://www.four-pillars.ca/2007/06/12/leveraged-investments-%e2%80%93-my-grand-plan/

    “Net profit” is the annual cash flow and “annual pv” is the present day value of each future annual flow. Cell I3 adds up the present day value of the cash flows.

    • FrugalTrader January 15, 2008, 3:51 pm

      FP, I must have forgotten that you posted about this, I even have comments in the article. :) Great to see my thoughts confirmed though. How is your leveraged investing going thus far? Are you currently invested in dividend paying stocks?

  • Dom January 15, 2008, 3:59 pm

    I wonder how you calculated your dividends (column 2). I tried 3.5% yield of current-year portfolio value and 2% dividend growth yoy, both don’t work. Along the same line how do you calculate your portfolio value?

    Do you assume a specific inflation rate?

  • Paolo January 15, 2008, 4:04 pm

    I replicated you calculations in a spreadsheet and have the following comments:
    1. Your portfolio is growing at 4% plus after tax dividends. Why include the dividend payouts in the portfolio growth if your intent for this exercise is to have cash flow for other things (like steak). If you include the dividends, you should also include the interest costs. Removal of the reinvestment of dividends results in negative cash flow until year 7. Also reduces your positive cash flow to about a third growing to 50% at year 40.
    2. You inclusion of dividends in the portfolio growth stops in year 21. Any reason?
    3. Your dividend growth rate is only applied in year two, at which your dividend payout stays at 3.57%. Not sure why you bothered with a dividend growth assumption since it would naturally grow with the portfolio (although your portfolio growth is conservative at 4% after inflation) and you don’t use it after the first year.
    4. Tweaking the model slightly, you can demonstrate other uses for this leveraging, such as retirement savings. Use the cash flow to pay off the debt (or increase it the first few years). By year 35 (with my adjustments from #1) you are debt free with annual cash flow starting at 11K and growing (plus all those unrealized capital gains). Who needs an RSP? :)

  • FourPillars January 15, 2008, 4:08 pm

    FT – Yes, basically I take each annual cash flow and discount back to present day using 3% inflation – this gives an idea of what the future cash flows really mean.

    The spreadsheet is the “Div Sheet” link at the bottom of this post:

    http://www.four-pillars.ca/2007/06/12/leveraged-investments-%e2%80%93-my-grand-plan/

    “net profit” is the annual cash flow
    “annual pv” is the present day value of the “net profit”
    cell I3 adds up all the present day cash flows

  • FrugalTrader January 15, 2008, 4:27 pm

    Have you guys been noticing that your comments are showing up right away? I’m in the process of experimenting with a caching blog software that might have some negative side effects.

    Paolo: Yes, I should have said “future” steaks. I like dividends because there is the “option” of withdrawing them to pay for stuff if need be, or, they can be reinvested. I would personally reinvest the dividends until I would need them for retirement around 20 years down the road, which is when I would start withdrawing for cash. Sorry, I should have been more clear in the post.

  • Ben January 15, 2008, 7:42 pm

    Check out the IA Clarington Cdn Dividend fund. I use this for this strategy. I have a no margin call loan at around 6% and this fund distributes monthly at $0.08 per unit (its currently about $7.20 so it works out to 11%). So you’re getting about 5% positive cash flow a month. Plus the distributions are return on capital not dividends so for the first 10 years or so you’re not getting taxed on the returns. Worth a look….

    • FrugalTrader January 15, 2008, 7:50 pm

      Hey Ben, as i’ve mentioned on the blog before, do not withdraw your ROC distributions. It will reduce the tax deductibility of the investment loan.

  • Paolo January 15, 2008, 8:32 pm

    Ben: Morningstar is critical of that dividend fund. They do not believe the payout is sustainable.

  • Four Pillars January 15, 2008, 10:11 pm

    FT – the leveraged investing is going fine from a cash flow perspective. I’ll probably post exact results soon. From a capital gain point of view it’s not so good but short term gains/losses are not what the strategy is all about.

    I do invest in dividend stocks. So far I have BMO & BNS. I’m not convinced that div stocks will outperform necessarily although they should be less volatile than the market but for a leverage strategy they fit the bill perfectly because you can control how much dividend yield you get in order to pay the interest – of course the favourable taxation is another reason.

    Mike

  • Ben January 15, 2008, 11:23 pm

    Paulo: I am aware of the morning star rating and I was made aware of the pros and cons of the fund by my advisor. We believe that the fund will continue to perform in the long run but if it doesn’t and the distribution rate changes we could adjust our strategy accordingly.

    FT: I did a quick search for the ROC rule but I don’t see where it explains how the ROC withdrawals can affect the debt deduction. Can you elaborate or point me to where I can find the tax rule? thanks

    • FrugalTrader January 15, 2008, 11:42 pm

      Ben, I first read the ROC rule in one of Tim Cestnick’s books and it’s confirmed by Ed Rempel. As a general rule of thumb, capital gains and ROC distributions should not be withdrawn from an investment loan or else the tax deductibility of the loan will be reduced. You should double check this with an accountant.

  • Four Pillars January 16, 2008, 1:52 am

    For what it’s worth – my explanation for the ROC issue:

    Getting ROC in a dividend is equivalent to selling shares which means the loan covering the amount that you have “sold” is no longer eligible for interest deductibility.

    Mike

  • Konstantin January 16, 2008, 3:26 am

    FP/ Guys,

    am I getting this right?
    If you are in low (<15%) marginal tax rate (tax-efficient income sources) and/or lower tax bracket this strategy is net PV negative (losing)because the effect of the loan interest tax deductibility is pretty minimal and therefore the tax benefits cannot offset the interest burden over the final net PV result?

    Thank you for your clarifications/explanations.

    • FrugalTrader January 16, 2008, 11:04 am

      Konstantin, Yes you are correct. If you are in a lower tax bracket, leveraged investing has less benefit as a smaller amount of interest is tax deductible. Same with an RRSP. If you are in a lower tax bracket, it’s generally advised to keep most of your investments outside of an RRSP.

  • Dividendgrowth January 20, 2008, 11:39 pm

    If I were doing this strategy, I would be choosing a basket of stocks which do tend pay at least 1-2% above the market yield of the S&P500, but not more than 6%. I think that most companies which show excessive yield ( at least on the US market) are actually paying excessive dividends, which the market says are noit justifiable by the company’s current financial position. ( example: Citigroup and a plethora of financial stocks that recently cut their dividends). If you buy stocks in lists like high-yield dividend achievers, or high-growth dividend achievers you will have a peace of mind about specific stock risk (http://dividendgrowth.blogspot.com/2008/01/my-strategy.html). However, you should run different scenarios assuming worst case scenarios as well. I had data about S&P 500 returns from 1871-2005 and I tried researching a similar strategy. However I assumed a 6% interest rate on my loan, buying S&P 500 ( or a similar basket of US )stocks in 1929. My sample strategy resulted in a complete wipe-out several years later.(http://www.econ.yale.edu/%7Eshiller/data/ie_data.htm) I know that bear markets are not as common as bull markets and that stocks tend to rise over time. However, I would use this sort of leverage/borrowed capital ($100,000) only if I already have $100,000 invested in dividend stocks. That way you will be safer on average in case stocks tumble or dividend payment decrease.

  • Wpg dividends February 2, 2008, 5:57 pm

    Nothing sexier than a spreadsheet about dividends. I am a little surprised at the low rate of growth in the dividend. If like Tom Connolly you chose major canadian financials the annual growth would be in the teens. Leveraging aside have you considered a sheet using those numbers? Even a company like Reitmans has a good yield right now and great annual growth in the dividend. Thanks.

  • Dividendgrowth February 7, 2008, 3:16 pm

    With US interest rates in free fall, I think that this leveraged strategy makes much more sense. I was checking Fidelity’s margin rates, and boy, if you borrow more than $500k you are only paying a 4.25%, which is a steal..
    http://personal.fidelity.com/products/fixedincome/pocd.shtml.cvsr?refhp=cp

  • Jared March 10, 2008, 10:39 am

    Hey,

    I may be mistaken but looking at your numbers it appears you only apply the dividend growth of 2% in the very first year instead for each year after that. Or was it your intention to use 3.57% as the divdend rate for each year after the first? If it was, why that number?

  • Jared March 10, 2008, 12:13 pm

    FT,

    Have you taken a look at doing this leveraged strategy under the current conditions? With the interest Rate Cut, and the current high yield on all of the big banks it could be cash flow positive almost immediately.

    Actually using the following numbers:

    Prime Rate 5.50%
    Marginal Tax Rate 43%
    Div Tax Rate 19.61%
    Market Cap Growth 4%
    Div Growth 0%
    Div Rate 4.00%
    Loan Size $100,000.00

    It is cash flow positive in year one.

    Obviously, I am ignoring the risks that the big banks could cut their dividend (did set Div growth to 0%) or that they could continue to lose value. But if you can accept those risks (or diversify more, and keep the Div Rate) this could creat a positive cash flow very quickly.

    • FrugalTrader March 10, 2008, 12:20 pm

      Jared, yes, I will be implementing my leveraged portfolio soon under current market conditions. Only time will tell whether or not i’m making a good move. :)

  • Jared March 10, 2008, 11:33 pm

    FT – One last question about the sheet you displayed here. I noticed that you seem to be using the dividend to both pay the interest and to re-invest. Obviously, this isn’t possible so are you assuming that you pay the interest from another souce of income so that you could actually put the dividends back into the portfolio?

    If that is the case, then each year you actually have a cash flow of -$3600 to pay the interest.

    Or the other option is to use the dividends to pay the interest, in which case you are not cash flow positive until year 9 (using 0% div growth rate).

  • FrugalTrader March 11, 2008, 9:20 am

    Jared, the spreadsheet simply shows the power of dividend growth. The taxes are paid out of pocket and dividends are reinvested until year 20.

  • Chewbacca May 7, 2008, 4:44 pm

    Not sure why you have assumed annual dividend growth rate of only 2%. Here are some of the growth rates I have calculated and even if you take inflation into account, these numbers are much higher than 2%.

    BNS.TO – Since 1995, 16.87%.
    CM.TO – Since 1995, 12.31%.
    BMO.TO – Since 1995, 12.01%
    SLF.TO – Since 2001, 18.72%.
    CNR.TO – Since 1996, 17.40%

  • telefantastik August 8, 2008, 12:19 am

    Hi FT and readers,

    If you’re aware of any resources (books/articles) on leveraged investing, could you recommend any? It would be interesting to see some more analysis on both optimistic and pessimistic sides of things.

    The market conditions and especially low interest rates make the strategy seem very attractive for the mid-long term, but I wouldn’t want to jump in without doing some due diligence.

    Thanks

  • annbanan December 12, 2008, 11:47 am

    I read recently that with a leverage, it is best to use the dividends to pay out the loan meaning you never use you own money but eventually get the loan paid off. I always thought it was better to reinvest those dividends? Could someone give the pros and cons of each?

    thanks

  • Slack Investor February 11, 2009, 10:07 pm

    This post is an oldy, but goody. I forgot that I read this last year, but something must have stuck because when I met with my financial advisor in January, I talked about now being the time to leverage and invest in dividend paying stocks.

    We came up with a mix of ETFs with solid dividend paying companies (the ETFs are yielding 6.5% to 7.5%). We borrowed money from our HELOC, which is still at prime (3%) since we got it in 2007 before the credit markets got messed up. This means that we’re averaging about 4% return on the investment, so we’ve got significant positive cash flow by using other people’s money. I haven’t decided if I’m going to take the extra cash flow to pay down the HELOC or continue to reinvest. Any thoughts?

    Granted there is risk that companies will start cutting or lowering their dividends as their profits suffer in the year ahead, but we would have to see the payouts drop significantly (more than half) before we need to worry about not being able to cover our interest costs. Another risk is that interest rates start to climb again, but if you believe the media hype, this shouldn’t happen until the economy starts seeing significant improvement.

    I personally think that now is a great time to leverage and buy stocks while they’re on sale. (With the caveat that you have a long term investing time horizon). I’m interested to see some updated comments on this thread since the market has changed a lot in the last year since it was posted.

  • Tired Khan July 9, 2010, 6:23 am

    This is a very interesting discussion.

    Would it be possible for anybody who has borrowed to buy shares to give feedback on their experiences, good or bad? (Now that we’re more than a year on since last post)

  • FT FrugalTrader July 9, 2010, 6:54 am

    @Tired, you can take a peek at my leveraged portfolio here. I started pretty close to the peak market in 2008, back to break even now, but have collected a few thousand in dividends since then.

  • Tired Khan July 9, 2010, 11:35 pm

    Thanks FrugalTrader

    I’ve looked through the messages in the link that you gave.
    So even though it was just about the worst time to start, you’re happy that you took the plunge, and expect that at some time it will pay off very well?

    It would be comforting to know that, because I’m planning to do something similar. I’ve organized a 300K loan using our house as collateral.

    That’s Australian dollars (similar to Canadian). I plan to take 100K at first and invest in exchange traded funds tracking the Austr top 200 companies. Not particularly looking for high dividends.

    If the market continues to move downwards I would take the rest of the loan in 50K chunks and invest. If it moves up strongly then I might not take any more of the loan.

    If the market crashes after doing this, then I will be in a similar situation to you were a year and a bit ago.

    I’m very confident that I will always be able to pay interest costs whatever the interest rates could reasonably move up to. So I would plan to just wait and wait until the approach finally paid off.

    At the moment it all seems like a reasonable thing to do, but I’ve been struck by the horror shown by so many people when I talk about borrowing to invest in the sharemarket. It’s made me wonder whether I’m doing something very wrong! (I’ve never borrowed to invest in shares before)

    (I wonder whether it’s because we’ve just gone through the GFC so any sort of leverage is out of fashion at the moment – maybe opinions were different pre GFC.)

    That’s why I’m keen to get as many opinions as possible, so I’m looking around message boards and blogs etc to educate myself and get opinions wherever people are kind enough to give them.

    I really appreciate the information you’ve made available on your web pages as it helps people like me to consider these sorts of things!

  • FT FrugalTrader July 11, 2010, 7:48 pm

    @ khan, does Australia have the same tax rules regarding the tax deductibility of investment loan interest?

  • JG January 9, 2011, 2:25 pm

    Recent history, past 2-3 years, has shown us that this can be quite nerve wracking and time consuming to monitor

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