Math Analysis: Using a Line of Credit for ETF Trading

I started trading in Exchange-Traded Funds (ETFs) a year and a bit ago. Honestly, it was easier than I thought it would be: I opened a trading account with a branch of my financial institution, put some money into it, and away I went. For those of you wondering “but how?” That is my literal answer. Get a trading account (your bank can probably offer one), add money, and then buy and sell. After making some money (and suffering an equal loss in a bad investment), I refined┬ámy investment strategy.

Tip: If you only have a few thousand dollars, deal in commission-free investments where available, and in the $5 – $30 bracket, in groups of 5 shares.

Lately, I was looking into a new possibility; taking out a portion of my Line of Credit, which is a relatively low-interest loan, and investing it into some ETFs. Two hours of my day was spent working out the numbers and selecting ETFs suited to the task… But it was actually fun, for once!

So the premise is this; I can borrow a sum of money. I pay interest to the bank to borrow this money. The example amount I was using for the calculations was $5,000. Let’s say the annual interest on this amount is 7%, or $350 — so I pay the bank $350 per year to borrow this $5,000. Then, I turn around and buy some dividend-paying shares with that cash. The goal is for the total dividends paid out by the shares to exceed the amount I pay to the bank for the loan every year. So the dividends paid by these shares has to equal AT LEAST $350/year in total for this to be even worth considering.

Now, clearly, the number of shares I can buy with the $5,000 depends on the cost per share. The ones I’ve been looking at specifically are in the $6-$7 range. There were a few in the $12-$22 range that, frankly, would lose me money with this strategy, so I won’t include them here. Breakdown of the main two I’m looking at below:

Share #1: $6.00/unit, pays out $0.04 every month, no matter what.

Share #2: $6.000/unit, pays out $0.048 every month, but I don’t know how stable its return is.

Share #1 I’ve held for quite a while, and I can tell you from experience that it pays that $0.04 like clockwork. The second share has a higher return and is actually a bit cheaper than Share #1, but I’ve set them both to $6.00/unit. This scenario also assumes the interest rate stays at 7%. It could go higher – but it could also dip lower, which would decrease the interest paid and therefore increase net profit.

Calculations:
$5,000 x 0.07 = $350
$5,000/(price of share) = (# of shares I can purchase)
{[(% yield)/100]/12} x (price of share) = (monthly payout of a share)
(# shares I can purchase) x (monthly payout) = (monthly dividend payment)
(monthly dividends) x 12 = (yearly dividend payout)
(yearly dividends) – $350 = (annual net profit or loss)

IN OTHER WORDS:

$5,000/$6 = I can purchase 833 shares. If they pay out $0.04 I make $33.32/month. If they pay out 0.048 I make $39.98/month. Annually that’s either $399.84 or $479.81. Minus the $350 interest on the loan, that’d be $49.84 or $129.81 a year in passive income.

The cool part is – that’s only if I don’t pay any of the debt back, and that also assumes I don’t reinvest the dividends paid into MORE shares.

I’ll be the first to point out there are still risks here – if the ETF goes kaput, that’s a lot of money to lose. It’s also a relatively small amount of passive income, but hey – I’m starting to think that any is better than none, and I’m sure this is the first of many nifty ideas I’ll come across moving forward.