A margin carry trade is a strategy where you borrow money at a low interest rate through a margin account, then invest it in higher-yielding assets. Those are typically dividend-paying stocks or exchange-traded funds (ETFs) whose returns exceed your borrowing cost.
The goal is to earn more from your investments than you pay to borrow, and to collect the difference.
In Canada, there's also a tax angle. The interest you pay on money borrowed to earn investment income is tax-deductible, which makes the strategy more attractive on paper.
Below, we explain how a margin carry trade works, why some investors use it, and the risks to understand before you consider it.
How it works
Borrow on margin. Your brokerage extends a margin loan based on the value of your existing holdings. The interest rate on that loan is your cost of carry — what it costs you to borrow.
Invest in higher-yielding assets. You put the borrowed money into dividend-paying stocks or ETFs with a yield that exceeds your borrowing rate. The bigger the gap between what you earn and what you owe, the better.
Collect the spread. Each quarter (or month, depending on the investment), you receive dividend income that's higher than the interest you're paying, creating positive cash flow.
Deduct margin interest at tax time. The Canada Revenue Agency (CRA) allows you to deduct interest paid on money borrowed to earn investment income. This lowers your effective borrowing cost and widens your spread further.
A hypothetical example
Let's say you have a $50,000 debit balance in a margin account, an annual income of $150,000, and you're investing in Ontario. Here's what the math might look like.
Input | Value |
|---|---|
| Margin debit balance | $50,000 |
| Margin interest rate | 3.95%* |
| Portfolio dividend yield | 5.50% |
| Marginal tax rate (Ontario, ~$150k income) | ~43.41%** |
Gross income and costs
Dividend income earned: $50,000 × 5.50% = $2,750
Margin interest paid: $50,000 × 3.95% = $1,975
Net cash flow before tax: $775
Tax treatment on dividends
Canadian eligible dividends are taxed more favourably than employment income, thanks to the gross-up and dividend tax credit mechanism.
Step | Amount |
|---|---|
| Actual dividends received | $2,750 |
| Grossed-up amount (×1.38) | $3,795 |
| Federal tax @ 26%** marginal tax rate on grossed-up amount | $986.70 |
| Federal dividend tax credit @ 15.02%** on grossed-up amount | ($570.01) |
| Ontario tax @ 11.16%** marginal tax rate on grossed-up amount | $423.52 |
| Ontario surtax @ 6.25%** on grossed-up amount | $237.18 |
| Ontario dividend tax credit @ 10% on grossed-up amount | ($379.50) |
| Total tax on dividend income | $697.90 |
| Effective tax rate on dividends | ~25.38% |
That's significantly lower than the ~43.41% marginal rate on employment income, which is a big part of why this strategy appeals to higher-income investors.
Tax savings on margin interest
Step | Amount |
|---|---|
| Margin interest paid | $1,975 |
| Tax savings from interest deduction (at 43.41%) | $857.35 |
| After-tax cost of borrowing | $1,117.65 |
| Effective interest rate | ~2.24% |
Net result
Metric | Amount |
|---|---|
| Dividend income | $2,750.00 |
| Tax on dividends | ($697.90) |
| After-tax dividend income | $2,052.10 |
| After-tax cost of borrowing | ($1,117.65) |
| Net after-tax profit | $934.45 |
| After-tax return on borrowed capital | ~1.87% |
Why it works
There are three distinct advantages when the strategy works as intended:
A positive spread. A 5.50% yield against a 3.95% borrowing cost gives you a 1.55% gross spread before tax — that's the foundation of the whole trade.
Preferential dividend tax treatment. Eligible Canadian dividends are taxed at ~25.38% in this example, compared to ~43.4% on employment income. You keep more of what you earn.
Deductible interest. The CRA's interest deductibility rule cuts your effective borrowing rate from 3.95% to ~2.24%.
