Newsletter April 25, 2009

InvestorsFriend Inc. Newsletter April 25, 2009

Avoid Borrowing to Invest?

The usual advice is for individuals to avoid borrowing to invest. If you save to invest then a stock market loss may hurt but it is almost always something you can overcome.

Losing borrowed money however could be financially devastating. You could be forced to sell investments at the bottom in order to make loan payments.

But for some people right now may be a time to make an exception to this rule.

Borrowing rates on secured lines of credit and mortgages are at HISTORIC lows. They have NEVER been lower.

You (assuming you have reasonable credit and income) can get a 5-year fixed rate mortgage at 3.89% from ING Canada. Or you can get 3.0% floating.

There are lots of investment ideas where you could EXPECT to earn far more than 3.89% in the next five years. But the actual return earned in many cases would be uncertain and could turn out to be negative.

But you can also find reasonably certain investments that will earn about 2% higher than your borrowing costs.

Now 2% is not a lot to earn on YOUR money. But if you borrow at 3.89% you may be able to earn a 2.0% spread or more on the BANK’s money. In effect, you become like a bank borrowing at a low rate and investing /lending at a higher rate.

You can borrow at a given rate and then turn around and buy something like  Bank preferred stock that is actually earning you more than loan interest. It’s bizarre and it won’t last. Now is the time when you could take advantage of this unusual opportunity.

Some people may be mortgage free and may be in the position where they could take out, say a $300,000 mortgage and earn a spread of say $6000 per year or $500 per month. That might work out to say $400 after taxes. That is not  a huge amount of money, but if you can make $400 per month using the bank’s money that is worth considering for some people. However, you may not be able to make the spread in cash. The mortgage will require principal payments as well and so you may not realize the profit in cash until you ultimately sell the investment(s) and pay off the mortgage in say five years.

Here are some investment ideas to apply this too. (None are risk-free)

Canadian Western Preferred Shares (CWB.PR.A) are yielding 7.2% and are eligible for the dividend tax credit. Pre-tax spread on money borrowed at 3.9% is 3.3% or $3300 per year per $100,000 borrowed.

On a more risky note, Boston Pizza Income Royalties Trust is yielding 16.0%. This is fully taxable like interest. This yield may drop to closer to 12% (or lower) when the Trust becomes taxable in 2011. Also the distribution could be cut if the restaurant sales slow with the recession. But due to the fact that this Royalty is based on sales and not profits it should be relatively stable. One salivates at the thought of the apparent 12% spread or $12,000 per $100,000 borrowed! But be aware of the risks here.

There may be 5-year investment-grade corporate bonds available that pay in excess of 6%. TD Waterhouse has only a small selection including Wells Fargo yielding 5.34% and maturing June 30, 2015. and Bell Canada yielding 5.29% and maturing June 15, 2014.

I suspect there are some higher-yielding but still investment grade bonds available but you would have to check with the bond desk at your broker. Even discount brokers can offer these.

Obviously on a $300,000 mortgage one could spread the investment across three to six different bonds or shares to limit (though not eliminate) the risks.


Our investment performance over the years is summarized on our home page. This year to date our best picks have been:

The TMX Group or Toronto Stock Exchange up 47%. (Ya gotta love a near-monopoly like that)

Home Capital Group – up 46% (specializing in higher interest mortgages for customers the banks won’t take)

Canadian Oil Sands Trust – up 31%

In fairness, I will tell you that those are our BEST performers and our AVERAGE Pick was only up 4.8%. (Our average stock also pays a dividend of roughly 4% per year). My own portfolio was boosted by concentrating on some of the Stock Picks I liked best and by some trading in and out to take advantage of highs and lows and is up 10.6% so far in 2009 (after all costs and dividends) which does beat the market.

If you are looking for stocks to invest in then why not subscribenow? For a limited time the cost is just CAN $14 per month or $109 per year. When you think about the potential returns from just one well-researched Stock Pick, you can see that this is an excellent value.

Free Report on Global / International Exchange Traded Funds

If you want to invest in Japan or China or Brazil, you are not likely going to try to pick individual stocks. Exchange Traded Funds are an excellent way to diversify into other countries. These funds have low management expense ratios compared to international mutual funds.

We have just updated our reference article on International Exchange Traded Funds. This is a valuable report which we could easily charge for if we wished. It’s yours free.

Housing Wealth Has Vaporized. (Or has it?)

There is much complaining and gnashing of teeth regarding the huge amount of wealth lost as house prices have fallen, especially in the U.S.  This is often described as an alarming vaporization of wealth. There are cries to do something about it.

To some degree I certainly agree that wealth has been lost. Consider a homeowner who had a house that previously could, if needed, have been “cashed in” for say $500,000 cash which could be used to purchase that amount worth of goods and services such as rent, groceries, cloths, trips, cars, etc. Now, it may be that the same house would only be able to be cashed in for $350,000. The homeowner feels less wealthy even if he had absolutely no intention of actually selling the house.

The unfortunate people who bought houses at the top of the market, with little or no money down, are faced with continuing to pay for a house that is no longer worth what they owe on it. These people are certainly bitter that a good chunk of the former value of their house has somehow vanished into thin air.

But it is interesting to note that when house prices were leaping upwards, few people stopped to consider that the associated increase in wealth was simply being created out of thin air.

Did we really think that we could all become rich or at least richer by selling our houses to each other at ever increasing prices?

Isn’t the “real” wealth of a house the fact that it provides shelter and warmth, our “nests” as it were? Would birds somehow create wealth if they started trading nests with each other for higher and higher quantities of worms? The birds are probably smart enough to realize that what really counts is having a sufficient number and quality of nests and a sufficient total supply of worms or other food. Creating a system whereby nests were worth more and more in terms of worms would not add to the stock of nests or worms nor to the “wealth” of birds.

Did we really think that the system we had whereby one could buy a house or cottage and live in it or use it for ten years and then sell it at a price that was far greater than we paid really made sense? Did it make sense that you could effectively live for free in a house or get the use of a cottage for free, given that the gain in value of the house was often greater than the sum total of all the interest you had paid to own the house? And this assumes the place was close to fully financed.

When we buy cloths we expect that to cost money. We expect to eventually discard those cloths as worthless after they are worn out. We don’t expect our cars to appreciate in value. Why then did we ever expect houses to appreciate at a great rate? Why did we think the house we live in would be an investment rather than an expense? Rental houses can be expected to be investments, but by what logic did we expect a house to effectively pay us to live in it?

Yes, I know houses have appreciated throughout history as land became more expensive to develop and as the costs of replacing a house rose. But believe me the long-run average gain in housing prices was historically fairly small and nothing like the huge increases we saw in the tens years or so prior to 2007. In 2007 most of the houses in Alberta “made” more than their owners did! How could that possibly have been thought to be rational?

If the real wealth and real value of a house is in its ability to provide shelter then, as a whole has North America really lost any wealth due to the fall in housing prices?

Obviously first-time buyers have benefited greatly by the fall in house prices, especially when combined with the lower mortgage rates.

Lower house prices has been a psychological blow to many homeowners. But if they were not planning to sell it does not affect their lifestyle in most cases.

Overall some people have lost money due to the fall in house prices and others have benefited.

A lot of wealth that people THOUGHT they had in their house has indeed disappeared into the same thin air from whence it came. Given that this house wealth also came from thin air, we should not be so surprised that it has disappeared.

It Costs a Lot of Money to Be Poor!

In June of 2008, I wrote that It Costs a Lot of Money to be Rich. You know, what with the high taxes to be paid, the cost of upkeep and insurance on the McMansion, the costs of private schools etc. Well, that’s probably not a situation that is going to garner much sympathy.

But consider the poor and the lower middle class. Generally the poor including the working poor are forced to spend less on various goods and services than the middle class and the rich. However, in some cases it costs the poor more instead of less!

Note that the following comments contain some generalizations about poorer people. I believe these things to be true on average though they most certainly do not describe every person with a lower income. Some people can manage very well on a low income. Others manage to be poor even while making a huge income. The following is not meant to offend anyone.

Consider how much the rich and the higher middle class pay in credit card interest rate fees. Usually the amount is Zero. These people pay their credit card bills in full and enjoy an average of over 30 days of interest-free loans. And if the credit card bill is too large to pay all at once, they can usually access a low-interest rate line of credit which minimizes the interest paid.

But what of the lower middle class and the poor? Maybe they should not be using credit cards. But the reality is if you need food or gasoline or the kids need shoes, and you don’t have money, but you have a credit card, you ARE going to use it. And pretty soon you are stuck paying 18% interest month after month with no ability to eliminate the balance.

Of course according to finance theory, the 18% interest rate is needed in order to make up for the people who default on their credit cards and don’t pay. There is some truth to that. Credit card companies typically have bad-debts of about 5% per year.

What is ironic though is that the entire cost of the bad-debts is effectively covered by those poorer people who manage to keep up with at least their minimum payments. A particular person who always pays the minimum amount incurs interest and effectively pays not only an amount that the credit card company would consider to be a reasonable net interest but also the costs (interest and principle) of those who default and never pay. Meanwhile, the rich don’t contribute to the costs of the bad debts, since they avoid paying interest altogether by paying on time.

The same thing is happening with mortgages. As of today the lowest rate for a five year mortgage listed in the Financial Post is a record-low 3.9%. But poor people with spotty credit ratings and incomes that make it tough to cover the payments, can’t access that juicy 3.9% rate. Instead they can run on over to (for example) Home Trust where the five -year rate is 5.45%. And I have knowledge of a friend who was forced to go to Home Trust and who was charged an additional 1.35% due to his credit record. So the total interest rate for a poorer person is 6.8% while a well-off person gets to pay 3.9%. That’s fully 74% higher interest for the poorer person!!

Again the people paying high interest rates at Home Trust, those who manage to make the payments and not default,  effectively have to subsidize those customers who end up defaulting. Rich people don’t help with the subsidy. They are over at the big banks paying the lowest possible interest rates.

There are many other examples. Many Poorer people can’t get a Costco membership. Many Poorer people can’t qualify for a line of credit. So they turn to Pay-day loan companies and pay large fees for small loans. Poorer people don’t have jobs that give them medical plans for drugs. So they pay for that themselves or go without. Many Poorer people don’t typically have over-draft protection. They end up paying bouncing cheques at least occasionally and getting hit with high fees for that. They are often late with bills and end up paying late fees here there and everywhere.

In desperation, many poorer people more often turn to lottery tickets and casinos. Richer people, like politicians then congratulate themselves on all the money they are making on lotteries and casinos.

Clearly poorer people are forced to spend a higher proportion of their income on the basics. By definition, little or nothing is typically left over for luxuries.

At the end of the day, it truly does cost a lot of EXTRA money to be poor. And the result can easily be a vicious circle where it becomes impossible to break out and pay off things like credit card bills.

I don’t have a solution for this. Overall it is just the way our society works. It does create a strong incentive to become educated and to earn enough money to be able to escape some of the costs of being poor. I do sympathize with people caught in this situation. I truly hope they can work their way out of it and one day become investors themselves.


Shawn Allen, President
InvestorsFriend Inc.

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