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1. 

   George the original one
   

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   US dollar margin interest rates, at least at Interactive Brokers, are extremely low. Even with their $10 monthly fee for not generating enough trades to eliminate the fee, the margin interest rate is effectively 3% on $10,000 borrowed and it gets lower the more you borrow.

   It seems a shame to not take advantage of low rates, so I opened a margin account in December 2010 with $10,000 as an experiment to see how much consistent monthly income could be derived from dividends. The goal is to have at least 2 stocks paying their quarterly dividends each month plus a couple more stocks that pay monthly for a total of 8 stocks.

   You can follow the progress at:
   https://spreadsheets.google.com/ccc?key=0AtHI-DiqotHYdDkyZGN3bHhjRC1lQ3dhQXRySzJhT1E&hl=en&authkey=CMHbguoK

   So far I've targeted dividend growth stocks, trying to maintain at least a 6.5% initial average yield (not counting the leverage). Purchases are in 100 share blocks, shooting for 200 shares minimum. Stock prices shot upward as I was making purchases and haven't come down, so I wasn't able to complete my initial three purchases as planned and I comprimised on filling out my margin limit with half purchases of LTC and UHT.

   Posted 2 years ago #
2. 

   George the original one
   

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   When I initially conceived of this experiment, in addition to the obvious REITs and MLPs, I had intended on buying shares of lower yielding companies that had faster dividend growth (examples: SJR, TRP, LMT). After a couple months of pondering, I realized initial yield is far more important in a leveraged portfolio and those companies would not be appropriate.

   Indeed, I suspect that initial yield is so important in a leveraged portfolio that I'm coming around to believing that BDCs and mortgage REITs, even with their unpredictable dividends, should constitute a chunk of the portfolio.

   The risk that must be managed is that BDCs & mortgage REITS have a lot of volatility and sensitivity to rising interest rates. Solid dividend growth shares should form the foundation and stabilizing influence, but those super-high yielding investments have a proper place here.

   A lack of training material keeps me from leaping in at this point. About the only advice one can find on margin investing is "don't do it". Compounding the scary effect is that investing on margin is, by its nature, sensitive to interest rates and the best yielding instruments are also sensitive to interest rates.

   Posted 2 years ago #
3. 

   jacob
   

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   NLY and similar mortgage REITs get 10-15% yield on equity. That's some numbers to shoot for.

   Posted 2 years ago #
4. 

   m741
   

   Master
   Joined: Jan '11
   Posts: 733

   @jacob - Do you own NLY? 14% yield is awfully attractive, but it seems as if there ought to be a catch. The price of this name has been stable for a while, but there must be some sort of risks...

   Posted 2 years ago #
5. 

   jacob
   

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   I have 200 shares of NLY. Maybe I'll get 200 more but that's it. The catch is that if the interest rate goes up, their income and share price goes way down. The scheme is to borrow money and buy mortgage based debt (agency stuff like Fannie and Freddie) and make their money on the spread. Since it's a REIT, 90% of that money goes back to the NLY shareholders. If the spread narrows, the income goes down and so does the share price.

   The following things should be noted:
   1) The interest rates are almost as low as possible. They can only go up from here.
   2) The economy is in trouble and thus I don't think they're likely to go up.
   3) The housing market may keep tanking.
   4) The government has already demonstrated its willingness to use taxpayer money to prop up the agencies.

   Also NLY is managed by a really smart guy.

   Posted 2 years ago #
6. 

   George the original one
   

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   Like Jacob, I have 200 NLY plus 100 AGNC in my regular account. Other mortgage REITs to consider are CIM, CYS, HTS, IVR, and TWO.

   Another risk with mortgage REITs is that most are rather new and have little track record. NLY has the longest history by far.

   When deciding which ones to invest in, check what their leverage is and whether they're buying agency-backed mortgages (Fannie and Freddie) or if they're running naked or some combination. The agencies may be going away, at least as federally-backed agencies, so that's another risk to consider.

   If people aren't buying homes or refinancing, then mortgage REITs have a declining income. Don't be afraid of secondary offerings as the money raised is used to expand the business... in fact, secondaries usually provide a nice buying opportunity.

   Posted 2 years ago #
7. 

   George the original one
   

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   BDCs seem to be less risky and thus provide a lower yield (8%-10% range). Book value and how well their loan portfolios are performing seem to be the most important metrics.

   I currently own 200 ARCC and 150 PNNT in my regular account. Others that seem to be worthwhile are AINV, MAIN, and TICC. Like mortgage REITs, none of these companies have been around very long, so it's difficult to judge them on a historical basis.

   Like mortgage REITs, secondary offerings provide good buying opportunities.

   Posted 2 years ago #
8. 

   George the original one
   

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   Spreadsheet is updated for March... (I really need to buy more income for March)

   Posted 2 years ago #
9. 

   chilly
   

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   Joined: Dec '10
   Posts: 275

   One thing that I look at for sanity's sake is how far a particular investment was down at the bottom of the collapse in 2009. I find it interesting that those last two you mention (ARCC PNNT) got brutalized - down 75% - but maintained their dividends, yielding 30-50% at those reduced values. Scary and comforting at the same time! Not sure what to make of that, but it's interesting.

   Posted 2 years ago #
10. 

    jacob
    

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    How many extra lines to fill out on the tax return and how many extra forms when using margin?

    Posted 2 years ago #
11. 

    George the original one
    

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    Tax return: no changes, though you can deduct investment interest if you itemize deductions.

    Forms: if you are converting a standard broker account to margin, then you'll need to fill out a very short form. If you're opening a new account, then you probably won't notice any extra paperwork.

    Posted 2 years ago #
12. 

    George the original one
    

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    The thing that gets me nicely frustrated is that I go to the effort of building a portfolio specifically for income and the damn thing goes & produces fantastic capital gains. The silly little $10k portfolio has grown to $12k in a little over 3 months. I could sell it all and sit pretty with the gain... but that's not what the experiment is about.

    Pity that the portfolio didn't start with $100k instead of $10k...

    Posted 2 years ago #
13. 

    George the original one
    

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    My mental trailing stop loss on UHT was hit and I sold it at 40.95 or so. It had been purchased at 36.62. Since dividend growth on UHT is minimal (e.g. it matches inflation), I couldn't justify losing out on the over 11% capital gain.

    After taxes, that's about a 9% net profit in one quarter.

    I strongly suspect I'll be able to repurchase this in the $38 range soon enough. In the meantime, I'll need to find a replacement for the Mar/Jun/Sep/Dec dividends, probably ARCC or TICC, though I want to see if there are any dividend growth candidates and finish building the base of this portfolio.

    Posted 2 years ago #
14. 

    B
    

    Journeyman
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    George, I just wanted to let you know that I find this very interesting. Thank you for sharing. I look forward to the continued success of your experiment.

    Posted 2 years ago #
15. 

    George the original one
    

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    @B - It's my pleasure to share!

    Posted 2 years ago #
16. 

    George the original one
    

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    Looking over David Fish's most recent compilation of dividend growth stocks (U.S. Dividend Champions available at http://dripinvesting.org/tools/tools.asp), I'm not finding anything that meets my parameters for March dividends. Consequently ARCC & TICC are my candidates unless UHT falls drastically.

    Also want to mention Robert Allan Schwartz's dividend growth site where he's tabulated the growth rates & number of years that stocks have increased their dividends: http://www.tessellation.com/dividends/streaks.html

    [Robert Allan Schwartz is familiar to seekingalpha.com readers as NotBob ... he's now no longer NotBob nor even Not NotBob]

    Use Robert's site in conjunction with David Fish's concept of the 10 by 10 (latest article is at http://seekingalpha.com/article/261754-10-by-10-the-interaction-of-dividend-yield-and-growth) to guide you for generating dividend growth income.

    Posted 2 years ago #
17. 

    Dienekes
    

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    George - To echo B, I find your posts very informative and I appreciate your willingness to share your results. Schwartz's site is full of insightful information.

    Posted 2 years ago #
18. 

    Shane Ede
    

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    I'm curious. Obviously, the idea here is to build an income producing dividend portfolio. But, as you said, the common advice on margin trading is that it should be avoided. Of course, the reason for that is that there's a risk (how much is debatable) of the securities you purchase dropping in price drastically and the margin being called. So, if you don't mind telling, do you have money available to pay the margin if it were called? Or what is your strategy for such a situation?

    Posted 2 years ago #
19. 

    George the original one
    

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    I have no intention of meeting a margin call. Meeting a margin call is throwing good money after bad! Ideally, one's stop losses will mean that you're liquidating in advance of a possible margin call.

    If I haven't already done so, then liquidation of the losing positions is the next best strategy... however, unless you're a highly favored customer, you're not going to get a phone call from the broker telling you that you have 2 hours to come up with the money. Instead, the brokerage firm will start liquidating assets automatically for you. Hopefully you've designated which positions should be liquidated first and the brokerage actually follows those orders.

    My current account lets me buy securities until I've borrowed 100% equity (e.g. with $10,000, I can buy $20,000 worth of securities). Now suppose the market price of the securities drops to $18,000... that is, I will still owe $10,000 and completely close out the position so that I owe nothing, yet have $8,000 on my balance. At that level of indebtedness, the brokerage will not issue a margin call.

    It's not until the market value of all the securities fall to $15,000 that the brokerage will issue a margin call. Thus there's decent leeway to get through most market swings.

    Adding more securities decreases the odds that a margin call will happen, which is why my target holding is 8 securities in this account.

    Posted 2 years ago #
20. 

    DVDend
    

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    @George TOO: You have almost inspired me to start my own experiment! But figuring out how to deduct margin interest on taxes seems a bit turn off. Apparently one cannot deduct the interest expense against qualified dividend income. With the low interest rates, this is still ok. But if/when the margin between the interest and dividend yield starts to close, you are in danger of having to pay taxes on full dividends even if the interest expenses eat bulk of the earnings. Am I missing something?

    Posted 2 years ago #
21. 

    George the original one
    

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    @DVDend - Line 14, Schedule A. Form 4952 may or may not be needed. For more details, see publication 550.

    The interest is not treated like a business expense, so you don't get to remove it off the top. Rather it's treated like mortgage interest, where you get back 25%/28%/33%/35% (or whatever your marginal rate is).

    When you think about it, it's rather strange that it's a deductible item at all... why would the government want to encourage people to increase their investment risk?

    [edit] NOTE: If you're thinking about buying tax-free income on margin, that interest is NOT deductible. You'll want to establish a separate non-margin account for such transactions so that your records aren't muddled.

    Posted 2 years ago #
22. 

    DVDend
    

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    George TOO: Thanks for the reply. I was hoping that I could deduct the interest expense from investment income. Something "unofficial" on the web made me think that interest expense could offset at least short term capital gains. I guess this is wrong. Better to go to the source and read the IRS publications.

    Posted 2 years ago #
23. 

    jacob
    

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    "When you think about it, it's rather strange that it's a deductible item at all... why would the government want to encourage people to increase their investment risk?"

    I can answer that one.

    Mortgage => Steady income => More tax income.

    A government would be rational to give incentives to commit to any kind of indentured work that it can simultaneously tax.

    Posted 2 years ago #
24. 

    Chris
    

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    "it's rather strange that it's a deductible item at all... why would the government want to encourage people to increase their investment risk?"

    A possible answer: it's not that the tax code was set to /allow/ it, but hasn't yet /disallowed/ it.

    If you look at old 1040s, you'll find that all personal interest was deductible. Over the years, this has become more restrictive.

    Posted 2 years ago #
25. 

    George the original one
    

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    A perspective on BDCs and mortgage REITs:
    http://seekingalpha.com/article/262972-dividend-investing-and-higher-interest-rates-bdcs-vs-mortgage-reits

    To replace the UHT income, I've bought 200 ARCC and 200 TICC. For regular stocks, I'd purchase later, closer to their dividend declaration date to minimize margin interest expense. However, BDCs and mortgage REITs tend to be substantially cheaper in the few days after they're ex-dividend and gradually rise in price as you get closer to the next dividend time.

    Next week I beleive my deposit will be credited, so I'm planning the next purchase. MAIN is one of the candidates, a BDC that pays monthly dividends.

    Posted 2 years ago #
26. 

    George the original one
    

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    April results are now posted.

    A sale, a deposit, and several purchases meant fees ate into income. The purchases won't add any income until this month, so the net yield on cost for this month is lower due to the deposit.

    Broke my rule of buying only in lots of 100 shares, since there was only enough margin to buy 50 NRGY. My justification is that a bump in the income was more worthwhile.

    OHI delivered some bad news late last week when 4 of their care facilities were closed by the state of Mass. The market punished the REIT's price by 6+%, which is pretty severe considering the properties represent less than 1.5% of their invested capital and the situation was already cited as a potential risk in the annual report.

    Posted 2 years ago #
27. 

    George the original one
    

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    I'm being punished today for the NRGY choice. They posted quarterly results full of one-time charges (they _better_ be one-time charges!) and the market is beating the price down. Looking at the price chart since last week, it's easy to see that some people had a good idea of what would be in the quarterly report.

    Assuming that the charges are one-time, then NRGY is a better deal now. Time to examine the quarterly report more thoroughly and possibly make another deposit to the account so I can finish out the 100 share lot. Or sell, if there are demons in the report.

    Posted 2 years ago #
28. 

    Chris
    

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    NRGY holder here. I haven't yet analyzed the results closely yet, but APU also had a bad quarter, based on warm weather in the South. Basically, winter "ended early" so propane deliveries were down. Looking at NRGY's propane distribution map, the majority of their footprint is in the southeastern US.

    The quarter was bad, but also the div-ex date was last week, so that may be a factor for at least some of the selling.

    Posted 2 years ago #
29. 

    B
    

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    I am still learning about investing, but couldn't you sell covered calls on these positions for some extra income?

    Posted 2 years ago #
30. 

    George the original one
    

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    Yes, covered calls could be sold. However, if the stock is called, the income ends. Plus options are a zero sum game.

    You also have the question of liquidity. If you have the security locked up for the option, then you can't otherwise sell it if the need arises. The options market is significantly smaller than the regular market, thus it can be difficult to find someone who will take the other side of the bet at a price you're comfortable with.

    Arbitraging the difference in interest rates between the margin loan and the security's yield is not zero sum, doesn't force you to sell if you don't want to (unless there's a margin call), and liquidity is maintained.

    Posted 2 years ago #
31. 

    George the original one
    

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    May results are now posted (see link at the top of this thread), a little later than planned because IE9 didn't like Google docs.

    I was also a little late getting a deposit mailed last month, so it will appear on the June statement.

    As you may guess from the downturns in the major indexes, the market value of my experiment is down. Leveraging does indeed make these turns more volatile.

    However, the income, the real purpose of this portfolio, is fattening up nicely.

    Posted 1 year ago #
32. 

    George the original one
    

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    June results are now in the Google docs spreadsheet.
    https://spreadsheets.google.com/ccc?key=0AtHI-DiqotHYdDkyZGN3bHhjRC1lQ3dhQXRySzJhT1E&hl=en&authkey=CMHbguoK#

    $6,000 in deposits allowed me to fill out my desired positions (and subsequently increase income). Forward estimates suggest the average yield-on-cost to be about 13%.

    On the down side, increasing the equity by 40% drops yield-on-cost for June to <5%.

    There's an extra $10 fee in this month's statement. I don't understand why, it's just labeled "U.S. Security and Commodity Exchanges".

    Posted 1 year ago #
33. 

    George the original one
    

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    For the second time this year, Mr. Market granted me excess liquidity, enough that I added another 100 TICC yesterday.

    Average anticipated net income (excluding taxes... different people would have different tax rates) is now $220/mo for $18k invested.

    Posted 1 year ago #
34. 

    George the original one
    

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    Reviewing total return for the past 6 months, the leveraged portfolio has done about the same as my regular portfolio. Not only that, but the ratio of capital gains to dividends is about the same. I suspect this is due to the fact that deposits into the leveraged portfolio are a greater percentage of the portfolio's value and the deposits take some time, up to 3 months, before subsequent dividend income is generated.

    Looking forward, the leveraged portfolio should have significantly more dividends than the regular portfolio.

    Posted 1 year ago #
35. 

    Sojourner7
    

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    George, thanks for posting all this. I've been thinking about doing something like this for almost a year now but chickened out. 10k is a lot for me!

    Keep up the good work!

    Posted 1 year ago #
36. 

    George the original one
    

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    Yippee! OHI has announced their 2nd dividend increase this year (payable Aug 15) -- dividend is now up 8% since the beginning of the year.

    Posted 1 year ago #
37. 

    Sojourner7
    

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    Hey George, that's good news.

    Anyway, I thought of a question for you. In terms of taxes, is it possible to deduct interest paid for margin expense? I was speaking with someone about investments, and I mentioned that being leveraged in real estate is more tax friendly compared to stocks because you can deduct mortgage interest. They responded saying that you can deduct margin interest if you itemize deductions. Do you know if this is true?

    Thanks,
    S7

    Posted 1 year ago #
38. 

    George the original one
    

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    Yes, margin interest is deductible. Line 14 on Schedule A.

    Posted 1 year ago #
39. 

    Sojourner7
    

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    I just realized that had been mentioned already in this thread. I must've been having too much hard apple cider!

    Posted 1 year ago #
40. 

    Hoplite
    

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    NRGY is getting punished again today, I think for a Citi downgrade from hold to sell. I don't own it, but read the last 10Q and didn't see the reasons for the pessimism (not that that means anything). I noticed that you filled in NRGY to 200 shrs--does the price change affect this one way or the other?

    And I add my sincere thanks-this is a great experiment on the income side and much appreciated!

    Posted 1 year ago #

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