Investing

Leveraging comes in different forms

Leveraging is getting a lot more attention these days. In the last couple of weeks, we spent some time talking about the benefits and risks of leveraging. If you are looking to put some leveraging strategies in place, I will share with you some of the different forms of leveraging.

  1. Buying Real Estate – This is the most common form of leveraging. The difference between the purchase price and your down payment is the leveraged amount. For example, if you buy a property worth $100,000 and you put down $25,000, then you are leveraging $75,000. In real estate, you can put down as low as 5%. However, if you invest less than 25%, you will face a CMHC fee. In most circumstances the financial institution will require that the property be used as collateral on the loan. From a tax perspective, it is important to note that if you are buying your personal residence, the interest on the loan is not tax deductible.
  2. Leveraging paid off homes – In some places, real estate can be a great investment. However, in other places, real estate has appreciated at modest rates. If you feel real estate has a modest future, you might consider using the equity in your home more productively. For example, if my home is worth $200,000 and it is paid off, I can generally get a line of credit for about 75% of the value of the home. If I think the markets will appreciate at a faster rate than my home, I might choose to get that line of credit, borrow the money and invest it into mutual funds.
  3. Matching programs – Matching programs work like this. Say you have $10,000 to invest. What you can do is get a financial institution to match your investment with borrowed funds. A 2 to 1 matching program means the financial institution will lend you $20,000 on your $10,000. A 3 to 1 program means you will get $30,000 of borrowed funds for $10,000. One of the major concerns over matching programs is the dreaded margin call. If the investment drops in value to a point below the borrowed amount, the institution can call the loan. There are some institutions that have programs now where there is no margin call.
  4. Borrow off lines of credit – Any line of credit can be used for investment purposes. One of the most important tips I can give you is to make sure that you can track the use of the funds for interest write-off purposes. In fact, you are better off getting 2 separate lines of credit – one for investment purposes and one for personal purposes. For tax purposes, it is your responsibility to prove that the borrowed money was used for investment purposes.
  5. Replace mortgage with leverage – Sometimes I run across individuals with a mortgage and also investments outside the RRSP. For these people conversion of debt from non-deductible to deductible makes a lot of sense. For example, let’s say you have a $50,000 mortgage and you also have $50,000 in mutual funds. If we ignore tax and fees, lets assume you sell your $50,000 in mutual funds so that you can pay off the mortgage. Now, you have a clear title home. What you then do is go to the bank and get a $50,000 line of credit secured by the home and borrow the $50,000 to re-invest into mutual funds. In the end you are in the exact same situation as you were at the start. The difference is you have more flexibility on the repayments and more importantly, the interest on the $50,000 is now tax deductible.
  6. RRIF meltdown – I often get the question “Is there a way to get the money out of the RRSP without paying the tax?” The RRIF meltdown is one possible strategy. For example, say you are 69 and you must start taking income out of your RRSP. Let’s say you have a $100,000 in a RRIF and for simplicity sake you must withdrawal $4500 in income. To avoid paying the tax, you must create an offsetting deduction of $4500. To do this, you can borrow $65,000 and invest it into mutual funds. The interest on the loan at 7% is $4500. This interest is tax deductible if you borrow to invest the funds.

Leveraging can be very complicated because there are so many variables involved. The descriptions here are oversimplified due to space constraints. Before you decide to leverage, you should consult with a financial professional like an advisor and/or and accountant to see if it makes sense for you.

Comments

  1. Claude Mayrand

    Leveraging Comes In Different Forms.

    A variety of leveraging strategies are mentioned, explained in this article.

    Missing is the simple, easy to control, highly effective Margin Discount Brokerage Account for a un-registered portfolio. A Margin Loan can easily and simply be obtained when you open a discount brokerage account, or an existing brokerage account can be modified to accommodate Margins. The Loan collateral is the net portfolio itself.

    I’m retired. Without developing my investment portfolio in 2002 to initially generate a minimum wage income from investments, I would be broke, living with one of my children – hopefully, in their basement, without a car, disposable cash. Today disposable cash is not an issue.

    I started using a Margin Account around 2005. The rationale was simple: earn more tax-advantaged income and write-off 100% of the tax deductible loan expense. Every rich individual has borrowed money in a variety of ways to increase income or portfolio value.

    My portfolio pays me monthly cash. I’ve been collecting 14%+ since 2009-2010. At present my Margin Loan costs me 3.20%. When I started in 2005, my Margin Loan cost about 6.50% and it was a profitable decision then.

    Today? My gross investment income is about 14% (income tax-advantaged), my loan costs 3.20% (100% deductible from my income). My cost should have been 3% after the January and July 2015 Bank Of Canada rate cuts, but… we all know that banks and greed are synonymous and Canadian banks are an oligopoly.

    The downside of my strategy? I have to pay income tax (2.34% in 2014), health care premiums, prescriptions, dentist, etc. I didn’t pay any of those things when I started actively investing in 2002.

    The CRA says an investment loan is a legitimate tax deduction if it generates income. My tax reporting data – income and expenses – come from one source on the same document from my discount broker. Simple, easy.

    Since I can look up my portfolio with a web browser, I can simply and easily monitor my Margin Loan anywhere 24/7 at home or on a trip. It takes 5 minutes, maybe 10 if I get curious about something.

    Risk? Even in 2009 when values crashed but not my income, managing my Margin was easy, simple, quick. Also unpleasant, as I had to sell some holdings to reduce my Margin Loan. But is was easy, simple, quick to execute. My income was reduced when I sold a holding but so were my Margin costs.

    Effective? Banks love to loan money; that is the essence of their business. Margin Loans are a zero loss loan provision for the banks, as they can sell some of the portfolio to cover excessive Margin. I can quickly, easy and simply determine how much Margin I want to use. I can be very aggressive in my strategy – 100% Margin – or conservative – 50% Margin or less. This percentage is the Loan amount compared to the portfolio value: a $5,000 portfolio might generate a $5,000 Margin – aggressive – or a $2,500 Margin – conservative. Cash-flow is simply not an issue: the Margin Loan charges are applied by my Discount Broker directly on my Marginaccount and the monthly 14%+ income easily pays for the monthly Margin 3.20% interest.

    Why a Discount Brokerage Margin Account? It’s simple, quick and effective. I can earn more monthly income averaging 14%+ at a cost of 3.20%.

    A sidebar: the value of my portfolio fluctuates, but my income is very stable and may also fluctuates a bit. If you own Mutual Funds in a RRIF, your income and portfolio values also fluctuate.

    This Investing for Cash strategy has one basic principle: get paid monthly cash to invest in stocks, ETFs, Closed End Funds. I’ve excluded Mutual Funds because they can’t be traded immediately on the TSX.

Leave a reply

Your email address will not be published. Required fields are marked*