What would you do with a 1% interest rate?
Buy a property?
Build a new one?
Start a business?
With interest rates through the roof these days, this isn't an option most people have.
Unless you're investing in Japan.
Lately I've been buying stocks on leverage for the first time in my life.
This is surprising even for me, as I've always been strictly a zero leverage guy.
But after running the numbers on this one, it made too much sense to ignore.
Why Japanese Stocks?
Full disclosure: This wasn't my idea.
I stole it from none other than ... Warren Buffett.
Buffett made headlines during Covid for buying stakes in the top five Japanese trading houses - Itochu, Mitsubishi, Marubeni, Mitsui and Sumitomo.
Most people don't know what a "trading house" is - think of it as a general term for an importer-exporter-distributor. Since Japan is such a tiny country, heavily populated, and scarce on natural resources, they get a lot of their goods through import-export. These five trading houses are responsible for getting much of the goods you see in Japan in and out of the country.
As I always like to investigate Buffett's moves, I looked deeper into this to figure out what he was doing.
Firstly - yes, the trading houses were trading for very low multiples - several of them around 5x earnings.
But even then - 5x earnings isn't that unique - and there are many companies in the US trading at those levels.
Not to mention, Japan's stock market has been a notorious dud, not providing any growth for investors in decades.
Then I learned that Buffett bought these stocks on leverage, and it started to make more sense.
Japan interest rates are practically zero.
So he's buying five of the biggest and most established companies in Japan, with someone else's money, and is paying nothing for the privilege.
How Can I Get 1% Interest Too?
If interest rates on Japanese yen are so low, how can I get them too?
That's when I learned that my broker, Interactive Brokers, allows you to buy Japan stocks on margin.
Here are the rates:
So if you borrow between zero and 11 million yen ($125k NZD), you'll pay 1.5% interest.
And anything over that, you'll only pay 1% or less.
Meaning as long as you're confident your investment can return at least 1.5% per year, your investment will pay for itself.
What Japanese Stocks Should I Buy?
So I can get Japanese yen at 1.5%, with no minimum, what should I buy?
- A Japan-listed investment
- Confident it will return more than 1.5% per year
- Confident I won't lose money.
The obvious answer - ETFs.
Over the long term, broad-based index ETFs historically have had a 100% chance of making money.
And an index like the S&P 500 has returned ~10% on average over 20 years.
In fact, the dividend yield on the S&P 500 is around 2%, meaning just the dividends alone will cover the interest.
But can you buy an S&P500 ETF on the Tokyo Stock Exchange?
You'll see you can buy many major indices here - FTSE, Nikkei, Dow, S&P500.
Buying Japanese Stocks On Leverage Safely: The Gameplan
One of the biggest lessons I've learned from stock gurus is with every investment, always focus on how much money you could lose, rather than how much you could gain.
Protecting your downside is always the first consideration.
The good news is - if we play our cards right here, we can buy stocks on leverage, while still keeping cash in the bank, and still actually earn more interest than we pay.
Meaning even though I'm leveraged, I'm not actually in leveraged position, because I still have more cash than debt.
Sound too good to be true?
Let's work through it.
Step 1: Buy A Broad-Based ETF On Margin With Interactive Brokers
The first step is to borrow Japanese yen and buy our assets.
There are four ETFs I have opened positions in:
- ISHARES S&P 500 ETF (1655)
- ISHARES JPX NIKKEI 400 ETF (1364)
- ISHARES MSCI JPN HIGH DIVIDEND (1478)
- GX S&P 500 DIVIDEND ARISTOCRATS (2236)
All of these are broad-based ETFs with strong dividend yields above 1.5%.
As an example, let's say you open a $10k NZD position in each of them, for a total of $40,000 NZD exposure.
This will mean you should be paying around $600 in interest per year (1.5% of 40k).
Step 2: Keep enough cash to cover your positions in a savings account
The next step would be to keep $40k in cash in a bank account to make sure you're never actually in debt.
You might think - that's weird - why not just use the $40k to buy the stocks, instead of borrowing?
Because we can earn more interest on our cash!
Right now, my cash is being held in a Heartland call account, earning 4.6%:
This means you're paying $600 interest per year on your borrowed yen, but earning $1,840 interest per year on your $40k in the bank.
So just with interest, your leveraged ETFs are paying for themselves.
But the main reason you keep this $40k in the bank is to de-risk your leveraged position.
You'll never be in a position where you cannot pay back your margin loan, because you have that cash in the bank ready to go at all times.
So the two scenarios here are:
- Your ETF positions grow in value. This means you can just let your dividends pay off your margin loan over time. Essentially you will get these assets for free, eventually. Your cash position will grow as well.
- Your ETF positions fall in value. As long as they do not fall too much, your dividends will still pay off the loan over time. You can also use the interest from your savings to pay it off faster. If they fall to the point you get margin called, simply transfer the cash from your savings account to pay off the margin loan. Remember - you won't ever lose money here - the assets are still yours. This outcome will be no different than if you had simply bought the ETFs with cash to begin with.
It's important to keep in mind that it doesn't actually matter which happens in the long run.
Of course you would prefer them to go up immediately, but even if they go down you shouldn't lose any money.
As long as I can cover the margin loan in the short term, I would be confident that the S&P 500 and the Nikkei will go up over the long term, so over a long enough time frame the position will be profitable.
Step 3: You should have some equity to borrow against
The caveat for this strategy to work is you must have some existing assets to borrow against.
Otherwise your risk of liquidation is too high.
Generally how it works is you will borrow against your existing portfolio.
Because I have existing assets in Interactive Brokers (my entire US stock portfolio), it means I can borrow a decent amount of Japanese yen against it.
The only way my position will get liquidated is if my US stock portfolio tanks along with my Japan ETF positions, to the point where my entire portfolio falls below the value of the loan (unlikely).
I believe you can also buy on margin without existing collateral if you want, but in my opinion that is far too risky.
This strategy works best when you have an existing portfolio to leverage against.
This allows you to beef up your exposure to stocks through ETFs and leverage, which over the long run has high potential to give you outsized returns and grow your asset base.
If you're still scratching your head at the logic, just think of it like this:
When you buy an investment property, you borrow money from the bank against your home. This allows you to increase your property assets from one to two, by leveraging the bank's money.
In this scenario we're doing exactly the same thing, except I'm borrowing money against my current stock portfolio, to buy more stocks, using my broker's money (and paying a much lower interest rate than at a bank). I also think stocks will outperform property (and are easier to manage!)
As this is a long-term position, the key risk here is currency risk.
If the NZD falls heavily against the yen, AND the ETF positions fall in value considerably, I could find myself needing to buy a lot of strong Japanese yen with weak New Zealand dollars to cover the margin loan.
And of course, the secondary risk is the S&P500 isn't guaranteed to go up. There's always a chance the S&P500 could perform terribly over the next 10 years.
However, as long as you keep a strong cash position, you should never be in a position where you get liquidated.
Want To Get Started With Interactive Brokers?
If you would like to open an Interactive Brokers account, you can get up to $1,000 in free stocks using this link (referral link).
If you have any existing US stocks, you can also transfer them in by making a simple request to your existing broker.
When I opened my Interactive account, I transferred all my positions in from Hatch which was reasonably easy to do.
This allowed me to start leveraging my existing portfolio, such as using their "stock lending" feature, where your stocks get lended to short sellers and you earn interest, and also using it as collateral to buy on margin like we've talked about in the example above.
You can open an Interactive Brokers account by clicking the yellow button below.
Disclosure: Long 1655.T, 1364.T, 1478.T, 2236.T