Dangers of CFD

I want to thank Juan from the excellent blog [The Intelligent Investor] for pointing out the stupidity of using CFD for making long term investing.

I had bought dividend paying stocks in € and in £ using CFDs. Incorporating the cost of CFD maintenance reduced my dividend by nearly 2.5% ! For a company paying 4-5% dividend it makes no sense to use CFD unless there is a large capital gains one is expecting i.e., a short term incentive.

If you really do want to buy a particular stock you should buy the underlying currency first and then buy the stock. As you see, this brings in the additional aspect of the currency in question. If the currency behaves against the position then you may lose money overall even if you made money on your investment. It might make sense to use CFD if you think the underlying currency is overvalued w.r.t. your base currency. But make sure that you understand the risk.

I sold nearly all my CFD holdings, incurring some commissions (Vodafone, Tesco). I still hold a good amount of Tesco in my $ account and I was not very attached to Vodafone. I don’t like their management but I bought them a few months back when they were selling around there 52wk low. I have since collected the dividend and have sold it at near 20% cap gain. I still feel that Vodafone is undervalued but I don’t like the fact that they might take the Verizon deal and end up paying taxes on it. The management has a track record of overpaying for acquisitions.

I still have E.On CFD. It is quite undervalued in my opinion and I am expecting capital gains on it – around the range of +40%. I will continue to hold it.

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