This is part 3 of a multi-part series that examines leveraged investing and how it works. See the other parts here.
Let’s assume you have chatted with an investment professional and you have determined that a leveraged strategy fits within your plan/risk tolerance, how do you do it?
-
Doing a lump sum investment purchase by borrowing against a secure asset (typically a home).
-
Example: say you have $200,000 in equity available on your home equity line of credit (HELOC). Borrow a portion of that and put it into the market at once or in a couple of bunches. Do this in a non-registered account. Once a pre-determined rate of return is hit or a period of time has passed. Sell the investment and pay back the loan.
-
Advantages: it is the easiest way to leverage, it can amplify your returns, interest payable is tax deductible.
-
Disadvantages: what if you do it at the wrong time (it can amplify your losses), you need to be able to pay the monthly interest payments (although if this were an issue you likely wouldn’t have been a potential candidate).
-
Investing on margin – this is borrowing against non-registered investments. The amount you can borrow is a percentage of what you currently own. The available amount is based on the assets you have.
-
Example: you can borrow more if you are lending against a big company (think like Bell Canada or RBC) vs. a penny stock where you may not able to borrow anything against it (think marijuana stock or any other high risk name).
-
Advantages: same as the lump sum, generally faster to get into the market.
-
Disadvantages: same as the lump sum, can run into margin calls (i.e. the make you sell names to pay interest), you need non-registered assets to borrow against (you can’t do it against a RRSP or TFSA), interest rates are generally higher vs. a HELOC.
-
Smith Manouevre: This strategy is a variation of option 1. It involves slowly using your home equity to invest in the market. You would need both a mortgage and home equity line of credit to do this.
-
Example: Say you have a mortgage payment of $1000 each month, of which $600 is interest and $400 is principal payment. This split between interest and principal is pretty consistent over time (principal % slowly grows but not materially over a 5 year fixed mortgage).
-
With each mortgage payment, you are gaining $400 of HELOC room
-
Each month/week that they occur, set up an automatic contribution for the $400. What this does is keeps your debt the same but slowly moves it from a non-deductible mortgage payment to a tax deductible investment loan.
-
Advantages – same as option 1, generally less volatile as you’re dollar cost averaging into an investment
-
Disadvantages – monthly payments, you aren’t paying down your debt, interest rates can go up, although it is deductible you do pay extra interest on the HELOC vs. the mortgage
Which one is right for you?
Each option has its pros and cons. One may be better or worse depending on your personal situation. Discuss everything first with an investment advisor before implementing any of the strategies above.
All the best,
Gary
This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ®Registered trademarks of Royal Bank of Canada. Used under license. © 2018 RBC Dominion Securities Inc. All rights reserved.
-
Doing a lump sum investment purchase by borrowing against a secure asset (typically a home).
-
Example: say you have $200,000 in equity available on your home equity line of credit (HELOC). Borrow a portion of that and put it into the market at once or in a couple of bunches. Do this in a non-registered account. Once a pre-determined rate of return is hit or a period of time has passed. Sell the investment and pay back the loan.
-
Advantages: it is the easiest way to leverage, it can amplify your returns, interest payable is tax deductible.
-
Disadvantages: what if you do it at the wrong time (it can amplify your losses), you need to be able to pay the monthly interest payments (although if this were an issue you likely wouldn’t have been a potential candidate).
-
-
Investing on margin – this is borrowing against non-registered investments. The amount you can borrow is a percentage of what you currently own. The available amount is based on the assets you have.
-
Example: you can borrow more if you are lending against a big company (think like Bell Canada or RBC) vs. a penny stock where you may not able to borrow anything against it (think marijuana stock or any other high risk name).
-
Advantages: same as the lump sum, generally faster to get into the market.
-
Disadvantages: same as the lump sum, can run into margin calls (i.e. the make you sell names to pay interest), you need non-registered assets to borrow against (you can’t do it against a RRSP or TFSA), interest rates are generally higher vs. a HELOC.
-
-
Smith Manouevre: This strategy is a variation of option 1. It involves slowly using your home equity to invest in the market. You would need both a mortgage and home equity line of credit to do this.
-
Example: Say you have a mortgage payment of $1000 each month, of which $600 is interest and $400 is principal payment. This split between interest and principal is pretty consistent over time (principal % slowly grows but not materially over a 5 year fixed mortgage).
-
With each mortgage payment, you are gaining $400 of HELOC room
-
Each month/week that they occur, set up an automatic contribution for the $400. What this does is keeps your debt the same but slowly moves it from a non-deductible mortgage payment to a tax deductible investment loan.
-
Advantages – same as option 1, generally less volatile as you’re dollar cost averaging into an investment
-
Disadvantages – monthly payments, you aren’t paying down your debt, interest rates can go up, although it is deductible you do pay extra interest on the HELOC vs. the mortgage
-
Which one is right for you?
Each option has its pros and cons. One may be better or worse depending on your personal situation. Discuss everything first with an investment advisor before implementing any of the strategies above.
All the best,
Gary
This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ®Registered trademarks of Royal Bank of Canada. Used under license. © 2018 RBC Dominion Securities Inc. All rights reserved.