This is where your finance takes place

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 are going down and I expect everybody with a brain to invest their available liquidity in the following months. I know, this is not the first time you hear that, but people just do not listen! If you are a bit gutsy, the best time for leveraging might come pretty soon. Yeah, I think we should all borrow money to invest if things continue to go down this way. Why is that? Here are a few reasons:

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.

I often seefinancial strategies as recipes. The main reason being you need the right ingredients, the right utensils and a good cook to make a feast. The problem is that most people have some knives and spoons here and there, get a few things at the grocery store because they have been told to and have no clue how to cook their meal at perfection. Enough with the analogy and let’s get going with some calculation!

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.