Last week we looked at the differences between “good” and “bad” debt. Now I want to introduce you to the three main strategies used by advisors to build wealth from debt.
Remember that debt should only be considered for the acquisition of appreciable assets, such as real estate or securities, with a clear and concise plan for eliminating it during the life of the asset or retired. Many of you may think this is a great time to consider borrowing for the purpose of accumulating wealth, but I have to warn you: it will never be without risk. Debt strategies should only be considered as part of a well-thought-out financial plan with a professional. Let’s look at some options.
Strategy 1 – Borrowing leverage to buy securities: It is a strategy used by many investors. Remember that investment gains and losses are always magnified when you borrow money to buy securities in the stock market. Some advisers will tell you that you only have to pay interest on the investment loan. Please, do not do that. It is best to reduce the risk by making mixed payments of principal and interest. Make sure you follow a disciplined investment strategy rather than following market trends. Never consider using this method with advisers who think they can make tactical moves in the market. I’ve seen this in the past, and it never works well for anyone. It is a much better idea to consider investing over a longer period to reduce risk.
Strategy 2 – Reversal of the RRIF: This strategy is used to reduce the taxation of RRIF withdrawals. The investment loans are set up in non-registered accounts and the interest is used as a tax deduction to match the amount withdrawn from his RRIF each year. The tax is offset by the deduction for interest charges, which allows taxpayers to have no net tax consequences of their RRIF withdrawals. In this method, taxes are simply replaced by interest payments on a larger portfolio of assets.
Strategy 3 – Debt Reversal: This strategy is based on the premise of turning the equity in your home into deductible debt to purchase an investment.
The Canada Revenue Agency can be a challenge for investors under general anti-avoidance rules, so it’s a good idea to seek the advice of a good lender and financial planner when considering this decision.
For the most part, you need to remember that you cannot merge equity investments in your personal debt or mortgage. If you have a mortgage on your home and have the flexibility to borrow more, you should make sure that this new debt is kept separate in order to meet the CRA guidelines for interest tax deductions.
The best loan product to choose for this strategy is a collateral charge offered by all major banks and most financial institutions. A collateral charge is usually put in place to give you 80-100% of the value of your primary residence, can be split into multiple loan segments (usually 10 or more), has no renewal or term. In my opinion, this is the best product to use when purchasing investment property or securities. It can even be used to inject money into a business while complying with CRA tax guidelines.
Borrowing to invest has long been a habit for many in trying to build wealth, and it can be very lucrative; however, it can also have its pitfalls when you stretch out too much. Only you will know what is right for you.
Be ruthless when looking for information to jumpstart your wealth building strategy. Create a team of people to help you (accountant, lawyer, financial planner). Find other professionals who will help you achieve your personal goals to build a bigger, stronger financial future.