$2000 in Dividend Income

by Mr. Cheap

A while ago I hit a bit of a milestone with my stock portfolio, and collected my 2000th dividend dollar, which has made me somewhat retrospective. I’ve gotten more used to having the dividends roll in, but I still feel a happy rush whenever they show up in my E*Trade account. Because I’m leveraging my account (buying on margin), most of the dividend payments have gone to pay the interest on what I’ve borrowed, so I certainly haven’t made $2000.

My (horribly non-diversified) portfolio consists of BMO, ROC, NA, RUS, and BAC. I bought WM without really understanding the company. I thought they were a conservative, long-term dividend payer, but instead they’re a growth bank (which is why they got hit so hard by the sub-prime fallout – they were in a VERY aggressive growth mode). There was a temporary rally with WM, which let me sell for a little more than a bought it for, which is when I moved into BAC.

Similarly, I didn’t really understand that RUS was cyclical (and hence the dividend isn’t as safe as I expected when I bought it). They haven’t cut their dividend, but they certainly could if we enter a prolonged recession. I’ve been planning to sell it when it goes above what I paid for it (I know, I know this is a fallacy – I should either keep it or sell it and ignore the current price vs what I paid).

So I’ve massively misunderstood 33% of the stocks I’ve bought so far – not too shabby, eh? 🙂

Other then those two, I’ve been happy with the stocks I own, even though they’ve lost about $4k of their value. My plan was alway to hold them long term, and collect the dividends (ala Derek Foster & Tom Connolly). The only two events that would make me consider selling are 1) they cut their dividend (like WM) or 2) the price goes so high without a corresponding increase in the dividend that the yield drops dramatically (at which point I *might* consider selling it and using the proceeds to buy another stock with a much higher dividend yield). Currently the securities are worth $58,632.04, I owe $33,922.79 (for a net value of $24,709.25). This puts my portfolio at 58% on margin. Margin calls occur at 70% (which I’ve had 2 small ones). With hindsight being 20/20, I clearly bought too early during the sub-prime meltdown.

Originally my plan was to maintain a large debt in the account, and to use the preferred taxation of dividends, along with the deductibility of investment debt, for tax planning. If you go to the Morningstar marginal tax rate calculator and put in an income of $80k, you see that the marginal taxation of public dividends is 20.24%. Since the marginal tax rate is 43.41%, if you bought a dividend paying stock on margin, and the interest rate was equal to the dividend yield (as it was recently for BMO), it will act as a 23.17% “tax sink” (after the dividend pays the interest, you get a 23.17% tax credit). This is only for Canadian dividends, this wouldn’t apply to BAC or WM dividends.

Now that I’m back at school, and not earning anywhere close to $80k (plus, given that grad students don’t have to pay taxes on most of their funding), this doesn’t make as much sense anymore. I’ve shifted gears and am now working on paying down the margin debt rather than expanding the portfolio (as I was planning to do when I was working – I was going to target keeping the portfolio at about 50% on margin). I’m somewhat sad as I think I’ve missed an incredible buying opportunity in the recent months.

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{ 10 comments… read them below or add one }

1 Four Pillars

I think paying it down is the best strategy – without the tax rebate your cost of borrowing is too high.

I wouldn’t worry about the missed opportunity – they’ll be others down the road.

2 telly

I agree with Mike, pay it down in part at least. A margin call with a temporary lower income could be scary.

Looks like our unregistered portfolios are pretty similar. I own BMO, ROC and NA as well (and a few others) but don’t have as much invested. Hopefully I’ll catch those other opportunities FP eluded to…

3 Kyle

Wow, you’ve got balls.

4 Canadian Capitalist

Ouch. What are you thinking Mr. C? A 58% margin is far too high. Even if your have researched your picks thoroughly, a margin call might come at the worst possible time and force you to lock in your losses. It’s simply not a game worth playing, IMO.

5 Wealth Manager

I also maintain an unregistered portfolio for medium-long term purchases but never have I invested using margin. Personally, I just don’t get the lure vs. a standard investment loan which I’ve done in the past and feel much more secure about doing.

As far as investment choices, mine have not been derived specifically with dividend income in mind but rather growth opportunities and if there happened to be a dividend associated then it was seen as a bonus.

So far, I haven’t lost anything in 5 years – but that’s for another thread ;->

6 Mr. Cheap

CC: I was going to put a side comment in the post that “the Canadian Capitalist would NOT approve” ;-). I have reserves in case of a margin call to avoid a forced sale (my $20K LOC), and can easily, even on a grad student stipend, afford the month interest payments (a little under $200 / month).

I definitely agree this is an aggressive strategy, but its aggressive on a small scale (in comparison to my income). If I inherited a million dollars and bought 58% on margin, I’d agree that you should declare power of attorney on me and take control of my portfolio ;-).

Plus, as I wrote, I’m backing off on it now 🙂

7 Lise

I’m not so sure a 58% margin is all that bad. When all this settles down, banks will prove to be a good buy. Their fundamentals are solid. I probably wouldn’t buy mining stocks (I can’t tell if RUS in on the Canadian or americn exchange, but as the only one that pays dividends in the Canadian one…) on margin.. too volatile, but that’s me.

I’m curious about your strategy:

a) You sound pretty young. Why the focus on income vs. growth?
b) With your focus on dividends, why did yu pick the lowest dividend paying banks (in Canada, anyway) ?
c) why do you like banks so much?

Just curious… I always like to see how other people think.

8 White Eagle

With some good timing, going 58% Margin would have made you look like a genius but with the recent downturn and your recent change in tax categories, I think 4P is right in saying paying it down would be the right thing to do.

That being said, hindsight’s 20/20 and it’s better to learn from the small mistakes than the really expensive ones.

9 Mr. Cheap

Hi Lise, great questions! RUS is a Canadian company listed on the tsx (their head quarters in just south of the 401 on Don Mills in Toronto). Technically they are a metal distributer rather than a mining stock (that’s my understanding at least), but they’re still more affected by economic cycles than what I’m really looking for.

a) I’m hoping to “retire” soon (currently looks like 6 months years might be doable). I’ll probably actually keep doing something that makes money, but I want to get to the point where I don’t have to. To my mind, a basket of reliable, solid dividend payers seems like great part of the foundation to be confident that my financial need will be met regardless of what happens.

b) I think they’re actually the highest yielding banks. As of today:
BMO – 5.6%
NA – 4.7%
CM – 4.6%
TD – 3.4%
RY – 4%
BNS – 3.8%

They were the highest yields when I bought too.

c) Because that’s where the money lives 😉

Seriously, I’m a contrarian, so when things are getting tons of bad press, I start wondering if its a good time to buy. When I read an article talking about how you can’t lose investing in banks and everyone I know starts putting money in them, that’s when I’ll sell :-).

I like their business, I don’t think technology will make them obsolete.

Mostly they’ve got good, stable, reliable dividends (which I like).

For full disclosure, I think Mike and CC are right, 58% is pretty high. If I didn’t have the cash & income to back it up, I’d be somewhat nervous borrowing at that level.

10 Canadian Capitalist

If you are able to handle your margin calls that definitely gives you some leeway. You are planning on paying it down anyway, so I guess you’ll do ok.

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