If a margin loan charges 6.7% interest and National Australia Bank Ltd. (ASX: NAB) shares pay dividends of 6.7%, you're getting the shares for free, right?
NAB shares
National Australia Bank shares have paid great dividends to shareholders for many years. And thanks to a recent sell-off in the NAB share price, investors can pick up the company's shares at a forecast dividend yield of 6.7% fully franked.
However, while NAB's dividend has proven to be consistent and it looks very tempting, it's not guaranteed. The last time NAB lowered its dividend was during the global financial crisis (GFC) of 2008. But, there's nothing to say that it will not cut its dividend payment next year or the year after that.
Margin loan
You can get a margin loan with NAB on a variable rate of around 6.7% for amounts between $250,000 and $1 million.
That might sound tempting. But, once again, ask yourself: If it was such a good deal, why are they offering it to you?
Why wouldn't they just buy the shares and collect the dividends for themselves?
The answer: it's risky.
Using debt to buy shares is similar to using a mortgage to buy a property. But a key difference is the frequency at which share prices change. Some experts call this volatility.
For example, over the past year, NAB shares have risen 18%. But in that time they have risen from $24.50 to over $34 (a 39% increase) and fallen back to $29.75.
House prices also rise and fall, but not nearly as quickly as share prices. What's more, rental contracts are usually in place.
The worst part of it all is that you could be forced to sell your shares if your investment falls below a certain value (read: margin call), making you a 'forced seller'. That is, making you sell at the worst possible time.
Foolish Takeaway
Of course, it's unlikely you would buy just one ASX share using a margin loan. And the interest on the loan is likely tax deductible, which might be enough incentive for some investors.
However, there are two ways I like to think about debt and investing:
1. It's compound interest in reverse
2. It's like a guitarist's amplifier — if you are a terrible guitarist (investor), the worst thing you could do is plug it into an amplifier (debt)
If you want to buy ASX shares, like NAB, I recommend starting off with small amounts in good companies, adding money regularly, reinvesting dividends and leaving it alone.
That's my recipe for a wealthy future and retirement.
