As I already mentioned in my post about the origin of my stash, I changed my investment approach at the end of 2015, early 2016.
The catalyst for this change was a new tax the Belgium government had passed. The speculation tax would tax any profits made on stocks you both and sold within a 6 month time frame. The tax did not take losses into account. As a value investor this tax would not have a really big impact on my investments. Although I never said no to a quick win either. There is on occasion a free lunch to be had on the financial markets. But it was the general principal. We already had a stock order tax when buying and selling stocks (0.27% of value when you buy and sell stock) and the dividend tax had gone up from 15% to 27% (30% now). It felt as our government had been gunning for the private stock investor for a few years now and this new tax was the proverbial last drop in the bucket. It pissed me off. It royally pissed me off and when the tax was announced, I started looking for a way around it. Fortunately for me, I found more than just a work around, I found what amounts to the holy trinity for a quirky guy like me.
That holy trinity for me is Contract for Difference (CfD’s), the low interest rate environment + Interactive brokers (or in my case their local re-seller Lynx).
Contract for Difference
CfD’s is a very special product. You see, it behaves exactly as a the underlying stock but it isn’t a stock. It is also a contract between you and your financial institution meaning they’re not actually traded on a stock exchange (but it does behave in the same way). This means the speculation tax was not applicable. The stock order tax is not applicable either. And the cost of buying or selling a CfD is ridiculous low. Especially for CfD’s on US stocks where it is 0.01 cent per CfD. An almost perfect product. There is off course a catch. When buying CfD’s, you actually borrow the money from your financial institution. And that of course has a cost. It is an overnight fee which means that you are only charged interest if you keep your position overnight. Buy and sell (or sell and buy as you can also go short with CfD’s) in the same day and no interest will be charged. This is why CfD’s are mainly used for day trading. It is also the reason why I never looked closer at this financial product before the end of 2015 although I had been aware of its existence before that.
Enter our current low interest rate environment
The low interest rate environment
When rates are high you would be a fool to keep a CfD postion for a long time. Paying a 6% rate to make perhaps 8 or 10% profit is not a very attractive proposition. Better close that position during the day! But interest rates are low now. Close to zero, and for the euro even negative. The interactive broker rates can be found here.
Borrowing at around 2% to make around 8% to 10% profit? Well that’s very attractive. Especially since you have stocks paying a higher dividend than that!! When I came to this realization I was drooling more than that time Alyson Hannigan appeared as lesbian vampire willow in Buffy the vampire slayer.
It was about the become even better (yay , a threesome!).
Collateral at Interactive brokers
You see, brokers are not willing to have just anybody borrow large amounts to buy CfD’s. They need collateral so they are sure you can cover your losses if the trade should not go as you planned and you have a loss. Most brokers will offer leverage on that collateral letting you borrow more than the collateral. But I am not that big a fan of leverage. Collateral is a lot like lesbian vampire Willow: great in small doses and for an occasional fling in the woods but you do not want to take her home to meet the parents or be married to her. Most brokers want you to put up cash as a collateral. But cash does not offer any decent returns. Meaning you have this pile of dead capital just lying there, except if you would take on leverage and buy CfD’s. Not a very appealing proposal! It forces you to be leveraged all of the time or have 0 return on your cash. You do not want to be leveraged all of the time because just like being married to vampire Willow, sooner or later you will wind up dead.
But Interactive brokers also accept stocks as collateral! They especially love A list stocks like Berkshire Hathaway. You see, this right here? This is the moment where you are fooling around with lesbian vampire Willow and normal Willow turns up, gets exited and ask you if she can join the fun!
What this means is that you can plow everything you have in Berkshire Hathaway. Enjoy a better retrun than the index (well, perhaps not at current prices, but I am speaking early 2016 here, the price was right) on this position. And then, when a decent opportunity arises you can use CfD’s and your leverage to get a bit of extra return. Since Berkshire already gives you an average return of 9% a year, this means you only need one nice trade a year to push your return to 12% or higher. It doesn’t need to be Berkshire stock, and index fund is also accepted. Beating the index all of a sudden became easy!
In my next post I’ll explain how I used this holy trinity to achieve a 39% return last year and what I am contemplating at the moment … And now you have to excuse me because there still seems to be a lot of vampire Willow images on the internet …
I look forward to read the rest
Very interesting read, curious about the follow up! (do add some pictures 😉
Ridiculous ROI by the way for last year, well done. Can it do downwards so fast as well?
Leverage works amazing on the upside but terrifying on the downside. So yes, it can do downwards so fast as well. Only use it if you are very sure of what you doing. That is why it is so very, very convenient of interactive brokers to accept shares as collateral as well. You can build up and manage your portfolio as if the CfD – leverage does not exist, and then when an exceptional trade presents itself (like the reverse split of Ahold stock with often creates a temporary arbitrage possibility), only then use the leverage and score a few extra procent return on the overall portfolio.
what nice numbers!
I didn’t know about CfD. I will read more… Thanks!
It is a nice tool to have but you have to know when to use it.