Some people will think that I’m crazy but I did it again! I took out another loan. But don’t worry, I’m not taking a real loan and it’s not to finance my lifestyle. I’m taking a $10,000 RRSP loan (loan used to contribute to my retirement plan) to benefit from the dip in the markets. I was a bit slow to get it so I only started investing on August 12^th. However, there was some damage done on the market and since I was going to invest $10K from my bonus in January for my RRSP contribution, I’m just doing it 5 months in advance as I think it’s good timing!

Since maximizing my RRSP is one of my financial priorities, the first thing I always do with my year-end bonus is to maximize my retirement account. Since I’m allowed, I know that my first 10K of bonus will go towards my investment account. The only difference is that, right now, I have a great chance of making a better return. I’ll be detailing my trading moves on The Dividend Guy Blog but I wanted to discuss the leverage strategy here. Why? Because leveraging is one of the most powerful tools used to reach financial independence.

I recently discussed how Uncle Sam is helping us make money. This is why I have decided to put my money where my mouth is and to benefit from the situation. The stock market has gone down on government debt concerns. This is why successful companies with strong balance sheets are declining in price for no sound reason. This looks like the perfect time to jump into some dividend investing!

How to know when to borrow?

I’m a big fan of leveraging, you know that. However, there is always a good time to borrow. And this is quite easy to know when you should make the move:

a)      Interest rates must be low with a reasonable perspective that it will stay low

b)      There must be an opportunity in a market that you understand

c)       You must have a repayment plan before borrowing

If you can combine these 3 factors, you have a winning situation to borrow. As the interest rates in both Canada and United States will likely remain at a low level for a year or two, you already have the first factor as a given.

Then, you must find opportunities in something that you understand. If you have no clue how the stock market works, it might not be a good idea to jump in blindfolded… it may hurt! However, you can also check out the real estate side. The fact that interest rates are low makes investing in real estate easier. The key here is to know what you are talking about so you can really determine if there is an opportunity or not!

Finally, you must know how you will reimburse your leverage. Many people borrow money expecting their investments to repay the loan. This is always a poor strategy. Why? Because even if you know what you are talking about, there is always a chance that you could be wrong. For example, right now, I think we are in the middle of a small dip in the market. However, I could be wrong and the market could continue to go down for several months. If I was expecting to make a quick buck from the market and payback my loan in 6 months, I would be in trouble. Yet in my actual situation, I know that I will have a bonus of around $30-40K. Therefore, borrowing 10K upfront is not such a big deal.

Don’t look back

Once you have planned your leveraging strategy, don’t look at your debt and investments all the time. Stop doing the match up of what you owe with what you have made. Most opportunities come with fluctuation and volatility. You don’t want to second guess your moves. Just wait a few months before you take any actions. In fact, once your leverage strategy is in place, you should be able to hold onto it for several years. If you invest aiming to make a quick buck, think again; leverage is not for you!

Are you going to borrow to invest in the market?

What do you think of this strategy? Are you looking to leverage the market?

image credit

Unless you have been living under a rock since 2008, you already know that: The USA has a debt problem. Okay, so far, nothing very shocking here as half of the planet has a debt problem! However, the USA debt addiction reached critical mass last week with the need to increase their debt limit. On top of this, Standard & Poors dropped their credit rating from the historic and prestigious AAA to AA+ (which is one grade lower). What the hell does the USA credit rating change have to do with anything in your life? I guess you are asking yourselves the question even more if you are Canadian. Well, regardless if you are American or Canadian, the USA is helping you become richer by fooling around with its credit rating. Here’s how:

The Case of Interest Rates

Since the end of 2008, borrowing rates have been at their lowest since I was born (1981 for the most curious of you!). The interest rate has been cut down to the minimum in order to let both consumers and companies breathe and avoid a bigger financial collapse. Having such low interest rates is good for most consumers as;

a)      It lowers their mortgage payments (and enables the smartest, who kept their original payment amount, to pay more capital at the same time)

b)      It creates huge opportunities for those who want to leverage.

As European countries are struggling with their debts and the Americans can’t restart their huge capitalist engine, interest rates should stay at low levels for another year. This means that it gives you the opportunity to use these low interest rates to your advantage. If you look at my net worth statement, I have personally decided to not pay my debts and focus my cash flow on asset creation. I didn’t borrow more money to leverage per se, but I am voluntarily ignoring my debts to focus on adding more assets. Once the interest rates rise again, I’ll probably change my strategy as I will be making more money (from my assets) and be in a better position to clear my debts.

Opportunity on the stock market

I don’t know if you have followed the market for the past 2 months but it is going down week after week. The main concern (for the past 18 months) is again the debt level of many countries, especially the US of A. On the other hand, there are plenty of great companies that have published strong financial results over the same period.

This is what tells me that investing right now is a great idea. If you have missed the gigantic 2009 stock market rebound, you can certainly make a few bucks from the next rebound. When will it happen? I don’t know. All I know is that when you can buy successful companies with strong balance sheets paying high yield dividends, it’s like Christmas during summer time!

Opportunity with real estate

Then again, if both interest rates are low and the stock market is down, chances are that you can also find great deals in real estate. I wouldn’t look North of the Border for this one as the Canadian housing market is not in a bubble according to me. However, many people can’t afford to pay for their homes in the States (since 2007!). So buying a piece of land or a vacation property might be the good timing at the moment.

Opportunity to create a business

If you can create a business and survive the present economic times, your business will skyrocket once the economy gets back on its feet! Tough times are always the best time to start a new business since you will be up and running when the lights come back on.

You can benefit from low interest rates and the fact that people want to get rid of their house/land/condo. Why don’t you become their savior? Many people got rich during the last real estate crisis.

Seizing the opportunity is like surfing:

Are you too afraid to jump at any of these opportunities? You would rather wait until things calm down a little and “wait for the better timing”. Remember this: seizing the opportunity is like grabbing the perfect wave when surfing: if you are sitting on the beach waiting for the perfect wave, chances are that you will see it happen in front of you but you will be 200 feet away and won’t be able to jump on it. On the other hand, the surfer dude who is already in the water, battling with small waves and being crushed once in a while will have a much better shot for the perfect wave.
  image credit

I am pretty convinced that the “easy money” has been made in 2009. However, there are several great investment opportunities in the upcoming years. Remember back in 2008, the TSX was at 15,000 points before it melted faster than a GI Joe in the microwave. We are now around 12,000 points and there is still a lot of room to reach our previous peak.

In addition to that, the Canadian economy is strong, the most productive country on earth (USA) will benefit from a weak dollar to boost its internal production and the emerging markets are as thirsty as vampires for resources to support their growth.

What about Canadian interest rate forecasts?

Sure variable rates will start going up. We hear 50 to 100 basis points this year. This is also why our Canadian Loonie is so strong. However, it’s not 1% that will make a big difference when you can find amazing companies (such as Canadian banks, Telus, BCE and oil companies) yielding dividends over 4%.

What about the loan from my parents?

Funny enough, I am not really concerned about the investment market or the interest rate forecasts. I am most concerned about reimbursing my parents! As of today, I still owe them about $21,0000 payable in full in a few months (November 2010). The good news is that with the sale of my house, I’ll be able to give them a good lump sum payment in June and probably end it up this summer (as I am expecting a nice tax return and a part of my job bonus in June as well).

Changing my investment strategy

I’ve been thinking about leveraging for a few months already. I didn’t want to move my stuff around too much as I really wanted to pay back my parents and sell my house first. Now that I know more numbers in my situation, I’ll be able to start thinking about my leveraging strategy.

I am not quite sure which route I will take first. I’m very tempted to build my own stock portfolio but I don’t have enough money to start this. My investment strategy will remain to invest about $400 to $500 in the market on a monthly basis. Therefore, buying ETFs or stock is impossible.

I think I will go with a mix of Altamira index mutual funds (Cdn and US) with an emerging market fund to complete my investment strategy. I might take a dividend fund in order to have distribution to pay off my interest… I am still wondering about this part.

One thing is for sure is that I will give more weight to the Canadian market at first. We have one of the strongest banking system and there is not much chance of having a surprise blow up in our face (I don’t believe there is a housing bubble in Canada).

So my first thought would be to invest (on a monthly basis):

$200 in the Altamira Canadian Index Fund

$100 in the Altamira US Index Fund (currency neutral)

$100 in the National Bank Omega Emerging Market Fund

$100 in the National Bank Omega Dividend fund (100% dividend stocks)

It might change as I won’t implement my investing strategy until July or August. I really want to make sure that I have enough money to pay for everything first, then, I’ll start having some fun investing again

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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Markets will not go down forever

Right now, markets are being influenced by the subprime lender crisis (Keep in mind that I called this one back in April!). As we are living in a bull market for several years, most stocks are at their highest peak, everybody thinks this is the end of the party and the bear will not take time to show up. I could not disagree more on this statement.

First, Sub-prime lender crisis is mainly affecting the US market. The impact is being reflected across the world but mostly because people are in panic mode. Do you see any major sub-prime lender in financial difficulties in Canada right now? We presently show the best economic stats since the pas 30 years. Our economy is driven by the prices of resources but the world is craving for it!

Second, the BRIC should not slow down their economic progression. It is especially the case for India and China. Buildings are being built faster than I type my posts! I recently saw some stats about India and it is ridiculous to see the amount of engineers and doctors they are producing years after years. I do not think they will stop buying our resources any time soon.

Third, technical analysis shows that the bull market is not over yet. We are just living another market correction. This is exactly the time for a buy and hold strategy.

What if I am wrong? (after all, if I knew everything, I would be writing this blog from my Condo in Panama City!)

If we are really entering into a bear market and the price of stocks will continue falling, it is still the best time to leverage. Why is that? It is simply because you need to test your mental capacity of supporting potential losses. Leveraging strategies were doing pretty good for the past 5 years as the market was always going up. The tough part about leverage is when things turn sour.

If you borrow a small amount to invest right now, you will have a great chance to practice your mental toughness against the market. Most people lose money on the street as they buy and sell at the wrong time. They buy high and sell low.

Then, if you borrow to invest now, two things could happen. The first one will produce immediate profit as markets were going into a small correction. The second possibility is a bear market. You will then have the opportunity to practice your tolerance against losing stocks.

The key here is to invest an amount that will not kill your monthly cash flow so you can keep up with the investment loan payments and that you do not expect to need this money anytime soon. Then, you can leave your investments in the market and wait until you make good profit. A small amount such as 10K-25K should be considered a good starting point. Another possibility is to start a Smith Manoeuvre. Please make sure to validate your strategy with a professional before you go ahead with.

The following assumptions will be used to show the effect of a double dip over 10 years. You
marginal tax bracket is 40%, interest rate on investment loan is 6,5% (so my
post can be accurate next year as well!), amount of the loan is 100K, expected
return on investment is 7,2%. The chart below shows the result of the double
dipping technique.

As you can
see, I’ve had a lot of fun calculation the tax return, RRSP contribution, RRSP
growth and total cost of this strategy. It is true that too often we think about
the benefit of leveraging strategies but we tend to forget that they
include fees. In this example, total fees (including full interest cost as we
are reinvesting the tax return plus the tax on the invested amount) are equal to
$190,339 over 20 years. I used a marginal tax rate of 20% for the investment as
it combines capital gains, dividends and interest rate. In order to simplify the
calculations, I took for granted that we are paying tax on capital gains at the
end of each year even if they can be differed until the asset is sold.

After 20
years, you will end up with a net after tax profit of $278,236. That includes
your total investment plus your RRSP contribution minus all interests paid and
the tax on your investments. Keep in mind that you will also have to calculate
taxes upon withdrawals of your RRSP. So for as little as $793 a months, you can
build an half of million dollar portfolio (in today’s dollar). Inflation was not
taken in consideration as you will have 567K in your portfolio and your payment
will remain what it is as well. 567K is equal to 315K with an inflation rate of
3% a year.

I also
discover something funny while playing with my Excel spreadsheet. The benefit of
contribution to your RRSP (tax return + growth of your investment) is bigger
than the cost of interest. This means that if interest goes up, you will end up
with a bigger net after tax profit. However, the success of this strategy is
directly related to the yield earned on your investments. I think I was
conservative with my assumptions. Any comments, suggestions or questions are
welcome!