Take the 2-minute tour ×
Personal Finance & Money Stack Exchange is a question and answer site for people who want to be financially literate. It's 100% free, no registration required.

I am getting ready to invest some of my savings in a stock brokerage account. The well-known brokerages, e.g. ETrade, Ameritrade, etc, have relatively high margin interest rates for the level I am looking to invest. They typically charge between 6 - 9%. I have found a few less-known discount brokerages that have 3 - 4% margin interest rates.

Is it safe to invest in a portfolio of dividend stocks yielding 7 - 9%, with the money used to buy the stocks borrowed at 3 - 4% from one of these brokerages? What are the advantages, disadvantages, and risks?

Thanks.

share|improve this question
    
Is it extremely important to you that the investment must be made using money borrowed at high interest rates from a margin account, or would it be possible for you to make the same investments in high-yielding stocks since you are going to "invest some of my savings in a stock brokerage account"? If the latter alternative is unworkable for you, where are you planning to invest your own savings (as opposed to the money that you will borrow from your margin account: you have already told us where that money is going to be invested) –  Dilip Sarwate Sep 12 '12 at 3:43
add comment

5 Answers

My gut is to say that any time there seems to be easy money to be made, the opportunity would fade as everyone jumped on it.

Let me ask you - why do you think these stocks are priced to yield 7-9%? The DVY yields 3.41% as of Aug 30,'12.

The high yielding stocks you discovered may very well be hidden gems. Or they may need to reduce their dividends and subsequently drop in price.

No, it's not 'safe.' If the stocks you choose drop by 20%, you'd lose 40% of your money, if you made the purchase on 50% margin. There's risk with any stock purchase, one can claim no stock is safe. Either way, your proposal juices the effect to creating twice the risk.

Edit - After the conversation with Victor, let me add these thoughts. The "Risk-Free" rate is generally defined to be the 1yr tbill (and of course the risk of Gov default is not zero). There's the S&P 500 index which has a beta of 1 and is generally viewed as a decent index for comparison. You propose to use margin, so your risk, if done with an S&P index is twice that of the 1X S&P investor. However, you won't buy S&P but stocks with such a high yield I question their safety. You don't mention the stocks, so I can't quantify my answer, but it's tbill, S&P, 2X S&P, then you.

share|improve this answer
add comment

"Is it safe to invest in a portfolio of dividend stocks yielding 7-9% with the money borrowed at 3-4% from one of these brokerages?" Yes and no.

It depends on your risk profile! Any investment has its risks of losing your capital, but not investing is a guaranteed risk, as you will be guaranteed to fall behind the rate of inflation. Regarding investing on margin, this can increase your gains but can also increase your loses.

Regarding the stock market - when investing in stocks you should not only look at the dividend rate but also the capital gain or loss potential. Remember in regards to investing on margin, if the share price drop too much you can get a margin call no matter how much dividend you are getting. It is no use gaining 9% in dividend yield per year if you are losing 15% or more in capital each year. Also, what is the risk of the dividend rate being cut back or dividends not being paid at all in the future? These are some of the risks you should consider before investing and derive a risk management plan as part of your investment plan before you invest.

No investment is totally safe or risk free, but it is less risky than not investing at all, as long as you understand the risks involved and have a risk management plan in place as part of your overall investment plan.

share|improve this answer
1  
Victor, is "safe" not an absolute, but actually different for each individual? An interesting view but tough for me to embrace. –  JoeTaxpayer Sep 12 '12 at 2:05
    
@JoeTaxpayer, what someone may consider safe may be different from what someone else considers safe. Some may consider flying in a plan safer than driving a car (when looking at the statistics), however, others who may be terrified of flying would not consider flying safe at all. AME is asking for people's opinions whether they consider an investment safe or not. The answer will depend greatly on the views and risk profile of the person answering the question. –  Victor Sep 12 '12 at 6:09
1  
we can agree to disagree, or until enough folk offer consensus. I understand each person has her own risk tolerance, but I believe the risk for a given scenario is quantifiable, and it's the person's reaction that's different. If this isn't so, we'd just have a series of opinions not facts. –  JoeTaxpayer Sep 12 '12 at 12:56
    
@JoeTaxpayer, the actual risk can change depending on one's risk management strategy. If someone goes into an investment with no risk management strategy then their risk in that same investment will be higher than someone who has got a risk management strategy in place. As I said AME has asked for people's opinions if they consider an investment safe or not. The answer will depend on the person answering and their views, experience and knowledge based on similar type of investments. In the end there are many variables which can change the risk profile of an investment. –  Victor Sep 12 '12 at 23:51
1  
you made your point very eloquently. And in fact, I may be splitting hairs on this one. I can be wrong (of course) but believed the word risk was well defined, i.e. a black and white result at a given moment. I see the OP used the word "safe," in which case, we may agree 100%, if you agree with me that risk can be defined, but each person's situation interprets that level of risk and their view of safe is actually different, I'm ok with that. –  JoeTaxpayer Sep 13 '12 at 12:50
show 3 more comments

I wouldn't recommend leveraged dividend fishing. Dividend stocks with such high dividends are highly volatile, you will run out of collateral to cover your trades very quickly

share|improve this answer
    
That depends on where you look CQM. In Australia there is a telco called Telstra, it is a defensive stock, so whilst the market has become very volatile and dropping sharply, Telstra usually is very stable and may either go down slightly or go up slightly. It's dividend yeild is over 7% fully franked (over 10% grossed up, ie before tax). –  Victor Sep 29 '12 at 2:00
    
@victor, I'm not too familiar with charting resources for australian stocks, but good luck with that –  CQM Sep 29 '12 at 4:41
    
I am just saying that you can't class all high dividend stocks as highly volatile, as many stocks that don't pay any dividends can be quite volatile and others that do pay dividends can be less volatile. –  Victor Oct 1 '12 at 1:01
add comment

You can use long-term options called LEAPS to increase dividend yield. Here's how it works:

Let's say you buy a dividend-yielding stock for $38 that pays an annual dividend of $2 for a 5.3% yield. Next, you SELL a deep-in-the-money LEAPS options. In this hypothetical we'll sell the $25 call option for $13. That now reduces our cost basis from $38 to $25. Since the dividend remains @ $2, our yield is now $2/$25 = 8%. Now there are issues that may need to be dealt with like early assignment of the option where rolling the option may be necessary.

More details of this strategy can be found on my website.

share|improve this answer
2  
Thanks for stopping by! Good articles are appreciated. The community generally agrees that we should excerpt relevant portions of the article in addition to the link. We like knowledgeable authoritative sources, but we dislike pure link backs –  MrChrister Jul 5 '13 at 18:19
    
Thanks for the edits! I think we can agree linking to your blog is acceptable, we just need the answer to be able to stand on its own. Linking to a citation is okay. –  MrChrister Jul 12 '13 at 16:25
add comment

In addition to the other answers, here's a proper strategy that implements your idea:

  1. (Mentally) buy the shares
    • Either buy (mentally) put options matching the quantity of the shares bought at a strike price either close to the price to open your position or close to the opening price ex (your predicted) dividend, both of which should mature shortly after the dividend payment
    • or (mentally) sell futures contracts (SSF) that mature after the dividend payment, matching the quantity of the shares bought. There's usually two kinds of futures dividend-protected and unprotected (see below)

If the options are priced properly they should account for future dividend payments, so all other things aside, a put option that is currently at the money should be in the money after the dividend, and hence more expensive than a put option that is out of the money today but at the money after the dividend has been paid.

The unprotected futures (if priced correctly) should account for dividend payments based on the dividend history and, since maturing after the payment, should earn you (you sell them) less money because you deliver the physical after the dividend has been paid.

The protected ones should reflect the expected total return value of the stock at the time of maturity (i.e. the dividend is mentally calculated into the price), and any dividend payments that happen on the way will be debited from your cash (and credited to the counterparty).

Now that's the strategy that leaves you with nearly no risk (the only risk you bear is that the dividend isn't as high as you expected). But for that comfort you have to pay premiums. So to see if you're smarter than the market, subtract all the costs for the hedging instruments from your envisaged dividend yield and see if your still better than the lending rate. If so, do the trade.

share|improve this answer
add comment

protected by littleadv Feb 17 at 10:23

Thank you for your interest in this question. Because it has attracted low-quality answers, posting an answer now requires 10 reputation on this site.

Would you like to answer one of these unanswered questions instead?

Not the answer you're looking for? Browse other questions tagged or ask your own question.