“Isn’t there a problem selling snake oil as vitamin tonic?”
— Jon Stewart to Jim Cramer, March 12, 2009
Despite misgivings on whether dividend growth will be as rosy as recently experienced, there was nothing fundamentally dangerous in Derek “Canada’s-Youngest-Retiree” Foster’s first two books (review of Stop Working and The Lazy Investor). With his new book though, the author is treading on dangerous ground with options and leverage, the risks of which the author seems to underestimate and which could land even experienced investors in a heap of trouble. It is disconcerting to think that relatively novice investors might be buying into this snake oil.
A large portion of the book is devoted to explaining how writing puts can earn “free” money. I’ve already posted why a strategy of writing puts isn’t without any risks. But Derek doesn’t stop there. Another “money for nothing” strategy suggested is leveraging to invest in income-producing securities. The distributions should cover the interest payments on the loan and after some years of rosy distribution increases, the income trust can be owned free and clear. If only investing were so easy! The book does carry warnings about the risks of leverage but claims that the risks can be reduced:
With my strategy, I focus on the highest quality companies that have been in business for decades — or even over a century in many cases. I further reduce risk by focusing on companies that offer recession-proof products or services. To add diversification and reduce risk even more, I invest in a number of companies from a variety of different industries.
The interesting parts of the book (at least for me) are the ones in which Derek talks about his own investments. It turns out his early retirement was achieved through a generous dose of leverage. And we’re not just talking about his all-or-nothing bet on Philip Morris:
In 1999, I borrowed money at 8.5% and invested it into Riocan. I paid $9 per unit and the distribution at that time was $1.04 per share. So the before-tax income from this investment was:
($1.04 dividend by $9) = 11.55%
So by borrowing at 8.5% and earning 11.5%, I was making free money using other people’s money (the bank’s money–which is how they usually make money).
It makes me wonder: how much of the Derek Foster story was achieved through unrepeatable, high-risk gambles and not through the sensible strategies advocated in the first two books?