May 31, 2007, 2:30 am

Compound Interest VS Interest Risk

by: The Financial Blogger    Category: Leveraging Strategies

I read a post on milliondollarjourney.com about Myths about leveraging into Equities. I decided to add more details regarding the interest risk.

Either we are talking about the Smith Manoeuvre or the RIF Meltdown Strategy; there are always individuals to outline the leveraging strategies’ risks. For example, they claim you have a huge interest risk as your loan is linked to a variable rate. The interest rate can fluctuate over time and cause surprises. Nonetheless, the power of compounding interest can eliminate this risk over time.

Let’s take a 100K investment loan at prime for example. With an expected return of 7,2%, your investment will double after 10 years. Therefore, you will still be paying $6,000 of interest but you will make $14,400 in investment income. Compounding interest make your investment grow over time while you will always pay the interest on 100K.

Would you imagine the interest rate goes more than 14% in 10 years? It is possible. However, you need to remember that the interest paid on an investment loan is 100% tax deductible. Therefore, if your marginal tax rate is 40%, you end up paying 8,4% in real cost of borrowing.

On the other hand, the earned income from your investment will be derived from capital gains, dividends and interest. If you select your investment properly, you should not be paying more than 15% to 20% on your investment income. Then, you would earn $11,520 if you are taxed at 20% while you are paying a net interest of $8,400 if the rate goes up at 14%. The interest rate would need to reach 19,2% in order to offset completely your investment income after taxes.

Let me tell you something, if prime rate goes up to 19% in ten years, you will have better concern than your possible investment loss. Economy would be in such a bad shape that nothing you could have done in the past could save you from the present situation.

It is obvious that you will not always make positive return years after years. However, if you have a well balanced portfolio, you could reach an average of 7%-8% without taking too much investment risk. In regards to the interest risk, I think I made it clear for everybody that it becomes a minor effect after ten years of investment.

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May 30, 2007, 4:02 am

Is Your Mortgage a Bad Debt?

by: The Financial Blogger    Category: Assets and Net Worth

Oh boy, I’ve had this conversation over and over with my parents about their house being an asset. But before going on that route and walk on pins and needles, I would like to talk about the mortgage related to your main residence. Is it a good or a bad debt?

 

A mortgage can be a bad debt for several reasons. In fact, on top of paying your mortgage payment and interest, your property will require additional monthly payments. You will have to cover the electricity bills, heating fees, municipal and school taxes and so on. In addition to all that, you will have to invest in your property in order to make some renovations and maintenance repairs.

 

The property linked to your mortgage doesn’t produce revenue as well. Unless you are renting your basement as a bachelor, there is no source of income from your house. Therefore, you can expect a positive return on a long term basis.

 

Finally, no interest on your mortgage is tax deductible for Canadian residents. You are paying this debt with after tax dollar. You have then a huge amount of interest paid year after year and you can’t do anything about it.

 

You might be discouraged at looking at all the reasons why your mortgage is a bad debt. However, I got good news for you. Unfortunately, you’ll have to wait for the next post to find out. See ya!

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May 29, 2007, 1:29 am

Winning Stock Trading 101 contest but not getting the reward

by: The Financial Blogger    Category: Miscellaneous

3 points, actually 3,24 to more precise. This how I was close to make $200 in a single week. That would have been great, isn’t? I participate to The Stock Trading VI hostes by Stock Trading 101 last week. The winners were disclosed this Monday. Out of three categories, I finished 1st, 2nd and 3rd.

 

Like every morning, I was surfing on milliondollarjourney.com and reading posts and comments. MDJ announced that contest where you can win $200 by guessing where the NASDAQ will stand in a week. I guessed wrong but not bad. 3,24 points missing…

 

The two other categories was best buy for one week and best short for the same period. I had such good results because Good Luck Lady was sitting next to me when I picked my stock. A little bit of technical analysis on some pre-picked stock and I was in business.

 

All that to say you can’t predict what’s going to happen on the stock market. Sometimes you win, sometimes you lose. Real investing is over the long run but not necessarily easier. At least, by picking companies that are well established with a strong growth history, you may make some good bucks.

 

However, it is always fun to participate in contest such as this one. You look-up the internet, make research, and follow your picks for a week.

 

There was another contestant who finished first for the best stock to buy for a week with a return over 37%. The stock ticker doesn’t matter anymore as the big jump already occurred but I hope for him that he bought the stock last week. He is probably dancing right now if it’s the case. It certainly worth more than $200!

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May 28, 2007, 2:25 am

Creating Assets

by: The Financial Blogger    Category: Assets and Net Worth

A single question is always on my mind: How can I make money differently than receiving my regular pay check? Although the answer seems pretty simple, it is not always the case. After reading a few books, they all come to the same thing: create your own asset. Good knows I’d love to do so, but I know nothing about magic!

 

Fortunately for me, no black magic is required to get rich. Instead of a bloody heart and a snake, all you need is your brain and a passion. Human beings are capable of the greatest when they are driven and passionate about something. Get that special thing that makes you smile and start working on it.

 

I do have several passions. I love my wife, Josée and my son, William, I do golfing, I love cars as well but I decided to work my passion for personal finance. I think it’s a great thing because it is already about money. I’m already working on the field and trying several side lines on the side. This is how I got into writing about personal finance.

 

I want to make money by another mean than just working for a company, get a pension plan and retire at the age of 60. I think that we all deserve better than this. The real question is; “Are you willing to pay the price?”. If you are really passionate about something, you’ll make the effort and you’ll find you way through this.

 

People will tell you that you are stupid. That you are double working for nothing. That you should put more effort on your day job and get a promotion than working on something that is not profitable. Remember, an asset creates wealth and positive cash flow on a long term basis. Maybe I’m an outcast. If it means to make more money, I don’t’ care!

 

Look at most rich people such as Bill Gates, Donald Trump, Robert Kiyosaki. They all have something in common; they do what they love for a living. Get yourself started on something. Worst comes to worst, you’ll develop a passion and make new friends.

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May 25, 2007, 2:29 am

RIF Meltdown Strategy: A complete example

by: The Financial Blogger    Category: Leveraging Strategies

First things first, I would like to thank Canadian Capitalist for hosting The Canadian Tour of Personal Financial Blog #3 earlier this week. This was definitely a great experience. For the tour, I posted an article about The RIF Meltdown Strategy explaining how to withdraw money from your RRSP without getting whipped by the taxes at the end of the year.

I received comments and emails about how profitable this technique could be for senior citizens who are not planning on investing their money in high risk portfolios. I then decided to create an example with real figures.

Here are the key points: You have 100K in RRSP and you would like to withdraw 7K for every year. You invested this money in a more conservative portfolio and your expected return is 5%. Your marginal tax rate is 35%. Therefore, you would pay $2,450 in taxes on a $7,000 withdrawal (7K*35%). After 10 years, you would have withdrew $70,000 and pay $24,500 in taxes. So your net income after taxes would be $45,500. Not bad.

I received comments and emails about how profitable this technique could be for senior citizens who are not planning on investing their money in high risk portfolios. I then decided to create an example with real figures.

Here are the key points: You have 100K in RRSP and you would like to withdraw 7K for every year. You invested this money in a more conservative portfolio and your expected return is 5%. Your marginal tax rate is 35%. Therefore, you would pay $2,450 in taxes on a $7,000 withdrawal (7K*35%). After 10 years, you would have withdrew $70,000 and pay $24,500 in taxes. So your net income after taxes would be $45,500. Not bad.

Now, take a 100K investment loan with an interest rate of 7% (right now, you can get 6% with most institutions) and pay interest only. Your 100K RRSP is still invested at 5% and you are withdrawing $7,000 again. At the end of the year, you will offset your 7K withdrawal with the 7K paid in interest on your investment loan. Then, what’s the point?

Year1

2

3

4

5

6

7

8

9

10

Invested Amount

$105,000

$110,250

$115,763

$121,551

$127,628

$134,010

$140,710

$147,746

$155,133

$162,889

Tax

$650

$683

$717

$752

$790

$830

$871

$915

$960

$ 1,008

RIF

$98,000

$95,900

$93,695

$91,380

$88,949

$86,396

$83,716

$80,902

$77,947

$74,844

Let’s suppose that you are investing at 5% as well. However, your return should be composed by dividend and capital gain instead of interest income. The main reason why is because dividend is taxed around 8% (please see your provincial laws as it vary from 4% to 17%) and your capital gain should be half of your marginal tax rate, so 17,5%. In order to produce the chart above, I calculated a 13% average marginal tax rate at the end of each year. I also took in consideration that you would sell all you investment and reinvest every year to crystallize gains and calibrate your portfolio. I know it would not happen in the real life, but it makes tax calculation much easier for this example.

As you can see, after 10 years, you would get more than 62K and pay a total of $8,176 in taxes for a net amount of $54,173 after taxes. Therefore, after 10 years, even with a very conservative portfolio, you would still make almost 10K out of this strategy.

If you are wealthy enough, or do not have an aversion to risk, you can invest at 8% without jeopardizing your retirement. If you keep your RIF at 5% but you change your investment loan return at 8%, here’s what you will get after 10 years.

 

Year

1

2

3

4

5

6

7

8

9

10

Invested Amount

$108,000

$116,640

$125,971

$136,049

$146,933

$158,687

$171,382

$185,093

$199,900

$215,892

Tax

$1,040

$1,123

$1,213

$1,310

$1,415

$1,528

$1,650

$1,782

$1,925

$2,079

RIF

$98,000

$95,900

$93,695

$91,380
$88,949

$86,396

$83,716

$80,902

$77,947

$74,844

 

You would then get 215K worth of investment with a 100K debt and you would have paid a total of 15K in taxes. After taxes, you would get 100K in your pocket so more than twice if you would just have withdrawn your investment.

 

I think the numbers speak for themselves. The real question is not really if the technique works or not but more if you are comfortable with leveraging strategies because there is always the risk of negative return. No pain, no gain!

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