Should You Borrow Money to Buy Dividends?

It is one of the oldest temptations in finance: using other people's money to get rich.

The logic is simple. Borrow money from a broker or bank at 4%, buy dividend stocks that pay 5-6% dividends, pocket the ~2% difference for "free". 

When something looks like a free lunch, it's usually a trap.

Picking Pennies In Front of a Steamroller

When we buy stocks with cash, the worst thing that can happen is the price drops. You wait. You collect dividends. You go on with life.

When you buy with leverage, you introduce new risks that can kill your portfolio overnight.

Margin Calls can happen when the value of your shares dropped to the extent of breaching the agreed Loan-to-Value (LTV) or security ratio. This forces you to deposit more cash or sell assets to cover the shortfall. You face a wipeout on your investments, locking in losses permanently.

Stock returns and dividends are never guaranteed. The "spread" between your loan interest and dividends can easily disappear in the event of dividend cuts. In the case of recessions, which can come fast and unexpectedly, both stock prices and dividends will tend to drop. The profitable spread is now a monthly expense, and you face margin pressure on top of that.

The Math Must Be Perfect

While we are already looking at razor thin margins between your effective interest rate (EIR) and your dividends received, there are often other costs involved in investing.

At the very minimum, you would pay brokerage commissions if you are investing into shares individually. Leveraging into complex investment products offered to you may incur even more fees and essentially make you lose money immediately when taking on the loan. 

Is risking your entire portfolio really worth an extra 2% return?

The Investor's Verdict

Leverage is like a chainsaw. It is a powerful tool for a professional, but it can also cut your leg off if you are careless. 

I sleep better knowing that my stocks belong to me, not the bank. I can earn dividends free and clear. It's boring and slow, but I never have to check my phone in a worry about the market dropping. As a new investor especially, I believe it is good to focus on saving cash and building your portfolio from the ground up.

For an experienced investor, using leverage is a personal choice that can elevate returns. If I must use leverage, I would keep it to a certain % of my portfolio, and I must ensure that any yield I have well exceeds the cost of debt by >2%. This setup is very hard to find currently in Singapore blue chips. 

"Protect the downside and the upside will take care of itself"
- Donald J. Trump
Disclaimer: This article represents my personal views and portfolio actions. It is not financial advice. Please do your own due diligence before investing. 
 

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