Oh man, Oh man Oh man. I will start this post with a big disclaimer note: I am not telling (influencing, forcing, giving you a hint on the market) you to do what is written in the following post. This is my humble opinion and my financial thoughts are as good as yours. So please don’t blame me if you do anything with your money

However, I still believe that this is the perfect timing to leverage in order to benefit from the low stock market. Why?, here’s why:

Very low interest rates

This probably once in a lifetime as interest rate across the world is at its lowest. You can basically borrow money for free . In Canada, if you have been fast enough when I was telling you to get the biggest line of credit possible while the rates were low, it is possible to borrow for 3%. This is what you can get from a Home Equity Line of Credit. While HELOC’s are seen as the product of greed, I can tell that people paying 3% right now are laughing

Unfortunately, if you just wake up and run to the nearest banks, they will more likely offer you a P+1 HELOC. This is still not bad since you will borrow at only 4%.

The stock market is filled with opportunities

Yeah, you have been hearing the same old track over and over again by financial advisor. Hey, you know what? You hear it because it’s true! Peter Lynch beat the market for 13 years and 50% of the investors that purchased his mutual fund lost money. How come? They sold during rough times and bought more during good year on the market

Well stop listening to your instinct, humans have not been made to trade the market This is the job of your money only You don’t believe in mutual fund managers? Can’t blame you as 7 out of 10 don’t beat their index However, there are index funds and ETF’s which are pretty cheap and guarantee you to be very closed to the index.

Do you really think you can’t create more wealth than 4% on your investment?

You don’t want to invest in the stock market? That’s fair. But it doesn’t mean that you can’t create more wealth by borrowing money. If you have liquidity, you may be able to purchase a rental property and build a strong equity in it since mortgage rates are pretty low. Buying foreclosure properties could be a great alternative to the stock market.

On the other side, you can also start a small sideline and as long as your efforts translate into a return of 4% per year, you are in a good position to create more wealth and improve your net worth.

I personally setup my personal finance so I can access a huge line of credit at a very low rate. I do a smith manoeuvre and increasing my number of shares every month through a systematic investment plan. Then, I took 7K to invest in my own company.

Since the latest has been growing steadily since its creation back in March 2008, I am already covering my interest cost from all my leveraging strategies. When the market will come back, I guess that people will tell me that I am lucky

So you can sit on the bench or pull your helmet and go on the field!

Leverage is a CFD advantage

CFDs offer traders four main advantages. Leverage allows traders to use a fraction of the cost to trade stock. Shorting allows traders to profit from declining prices. CFDs commissions are generally competitive. And a well placed stop loss can limit a trader’s risk.

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In fact, it is a line that is quite important for someone who is interested in leveraging. For example, the legibility of the Smith Manoeuvre depends on this tax rule.

I will refer you to the full description of the line 221 here. However, here are the key points you need to remember:

You are allowed to claim the following charges and interest you paid to earn income from investments:

- Management fees (not MER’s since they are included in your net return but fees related to Private Wealth Management would be a good example).

- Safe-keeping related charges (such as safety deposit box to hold your 1806 Bank of Holland Share Certificates ).

- Fees for certain investment advice (fees paid to a person who’s principal activity is to give advice about buying or selling stocks).

- Most interest you pay on money you borrow for investments purposes, as long as you use it to earn investment income such as dividend and interest income. The last part of this rule is the most important: if the only earnings your investment can produce are capital gains, you CANNOT claim the interest you paid.

When you first read it, you may think: what is the purpose of borrowing to invest if it’s only to get me GIC returns? Well, this is where the interpretation goes: since they don’t mention that most or the majority of your investment income has to come from dividend or interest sources, you still can invest a part of the money to make capital gains without getting questioned by the CRA. It’s only a matter of playing by the rules (and by their weakness).

I think that the Government didn’t want investors to speculate with borrowed money. However, if you are able to increase your level of income with a good leverage strategy, this is simply good financial planning.

On the other side, having interest and dividend income means that you have less volatile assets in your portfolio which might not be a bad thing when markets are dropping.

The best advice as to know if you can deduct or not your interest and other charges paid to get investment income is definitely to hire an accountant to fill up your tax report correctly and according to the proper rules from the CRA. The last thing you want is to get caught for $5,000 of unpaid taxes because you misinterpret a rule!

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I am not going to do a review of their service (since I didn’t get paid for it ) but I will use the example of Chris, one of the two readers, to illustrate which kind of question you should ask a financial advisor when they approach you with such leverage strategy.

What is the strategy?

Chris and his partner make 150K and have a free mortgage property worth 400K. They have been approached by TDMP in order to leverage over their property. This sounds a lot like a Smith Manoeuvre strategy but it is called that tax deductible mortgage plan. The projection was based on a “income fund” providing 8% return per year. So if you have bad debts (i.e. non tax deductible debt); you pay them with your investment returns and you re-borrow the money to invest again. Therefore, you are switching bad debts into good debts.

Hum… let’s say you pay 4.75% (prime rate) on a loan where the interest are tax deductible (therefore a net charge of 3%) and you make 8% per year with your portfolio. This sound very interesting isn’t? Well I don’t think that things can be that easy!

What are the fees and why should I pay them?

According to both readers, TDMP charges $39 a month for the administration fee of the whole setup. While this sounds to me like another hidden / other fee that company charges to improve their profit margin, they may do extra stuff for their client too. Even thought $40 a month seems a lot (since you are still paying interest on the loan and MER’s for your investment), I told Chris to ask them what were they doing for so much a month. An added value would be to keep track of the client’s investment record and interests charged along the year in order to facilitate the completion of their tax report.

In which kind of investment portfolio the leveraged money will go into?

I think this part is a big must as it will determine if you will end-up as the king of the leveraging or another poor victim from “evil” advisor bringing their clients blindly into the abyss of madness.

In Chris’ case, the broker didn’t give much information the first time besides the fact that it will (will? Never use this word as a financial advisor) give a 8% return according to past performance. I must admit that this is kind of odd. The first thing would be to determine the client’s investment profile instead of offering a one fits all fund. Anyway, there is no such thing… regardless the past performance of the fund. Based on that premise, we should all sell Sprott Canadian Equity Fund that has an astonishing record. However, the fund also went down badly a few times since its inception as well!

I guess the main point I am trying to make with this post is do not sign leverage proposal on the first meeting and come back with a lot of questions for the second meeting. My conversation with Chris was obviously lengthier but in the end, it will lead to a second or maybe a third meeting where fundamental questions must be answered. Good luck to you my friend!

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Unfortunately for them, those who decided to stop eating because the ice cream was not as great as usual are the one you will miss the delicious chocolate sauce sitting at the bottom of the cup (man, I feel I’m in the middle of a Dairy Queen’s commercial!).

If you don’t have much debt, I would strongly suggest using your extra cash flow in order to setup a systematic investment strategy. This will boost your investment portfolio as you will have the possibility to buy more shares for the same price. Once it is set, you will simply have to let the power of compounding interest do its magic.

Another great thing about systematic investments is that you don’t feel market fluctuation that much. The reason is fairly simple. If you invest $500 per month and your portfolio lost $1000 last trimester, you will see your global investment increasing by $500 when you receive your statement.

Of course it is not real growth; it’s the money that you put in during 3 months! However, even though you still loss a $1000, you are not feeling it that much as the global overview seems positive. This will only help you out managing your emotion in times of high market fluctuation.

This is a right timing for leveraging strategies

If you didn’t have stroke recently, you may want to dive into the banana split cup like it’s your last meal by borrowing to invest. The next year might be a bit rough as nobody knows when the madness will stop. However, one thing is for sure; the madness will come to an end. I saw people who leverage at the beginning of 2003. A year before, we had Enron, Worldcom, Tyco and friends that were forging their financial statements. Investors were totally depressed and still, some people leveraged in 2003. Guess what, they are laughing today as they are +80%, +100%

So the bottom line is that we are in a perfect moment for investing and even better for leveraging!

image source: estb.msn.com

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Option #1: Full RRSP contribution

If Peter would to invest $300 a month over a period of 30 years, he would end up with $450,088. Over that period, we would also receive the sum of $1440 in tax return every year. If he would to invest this sum in a non-registered account, he would create an additional $176,178. However, Peter must keep in mind that he will have to pay taxes on the 450K in RRSP at the time of withdrawal. The marginal tax rate will be much lower on his non-registered investment.

Option #2: RRSP contribution plus an investment loan

At a borrowing rate of 7%, Peter would be able to borrow 30K to invest and his monthly payment (interest only) would be of $175 per month. Therefore, he would still get $125 to invest into his RRSP each year. This strategy would bring $301,879 in non-registered investments (including the 30K loan) and $187,536 in RRSP. This brings us to a total of $459,416 once we pay the investment loan. In Canada, the interest paid on an investment loan is tax deductible, therefore, Peter would receive again the same $1,440 that could be invested the same way as option #1. You may think that the whole strategy doesn’t really worth it as it creates only an additional 9K. However, you have to take into consideration that you have $301K sitting into a non-registered account.

Option #3: Registered and non-registered contribution

If Peter doesn’t believe in leverage strategies and still wants non-registered investment, he could invest $175 per month into a non-registered account and $125 into his RRSP. This would give him $450,088 but with much less tax return per year ($600 instead of $1440).

I would like to get back to option #1 and #2 one last time. Imagine that Peter’s marginal tax rate on his RRSP withdrawal his still 40% and 25% (capital gains, dividend, interest income mixed together) on his non-registered investment. If he would to cash in all his investment in one shot, the option #1 would give him $402,186 (450K*60% + 176K*75%) while option #2 would give him $448,565 ((301K-30K)*75% + 176K*75% + 187K*60%). Therefore, a small 30K investment loan would increase your net investment by 45K. This is the magic behind all the different ways of using your cash flow!

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