Planning Your Retirement
RRSP VS Investment Loan:
Canadians often wonder as is it a good idea to borrow the money and invest. The answer is Yes or No. Borrowing to invest comes with a significant amount of risk and one should be very careful when it comes to borrowing. Very few people understand that even buying a house is a risky investment as you have borrowed the money and if the house losses its value by 10% and if you did 10% downpayment you lost all your capital. That being said, real estate has been one of the sectors which has generated most returns in last 20 years.
Why should I even consider borrowing to invest?
As mentioned earlier borrowing comes with a lot of risk but on a positive side it can generate amplified returns. To give you an example consider buying a house with 10% down payment and the value of house $500K. In case the house appreciates 10% you have doubled your capital investment (Because you had invested only $50K as a down payment and the market value of the house is $550K). The only downside of real estate investment it is not tax efficient.
Who should consider getting an investment loan?
Individuals who can handle volatility and have a high-risk taking profile might consider taking an investment loan. Due to the tax effectiveness of investment loan, it makes sense for individuals who are in high marginal tax rate.
How do you compare RRSP and Investment Loan?
If you want to compare RRSP VS Investment loan, we can consider the following example.
Individual A choose to contribute $500 per month into RRSP and he/she is in 53% marginal tax rate. Also, he/she decides to contribute for next 10 years. If we assume the rate of return as 8% and reinvest the tax refund, we have the following scenario.
1st year Contribution $6000
Tax Refund $3000 (approx.)
Value after 10 Years $19,430
If we add up all the contribution, growth, tax refunds reinvested after 10 years. The total value of the portfolio is $140,708.
Assuming the individual retires at 65 and at redemption his/her Marginal Tax rate is 33% the individual will net out at $74,525.24.
In the investment loan scenario $500 per month will fund an investment loan of $100K interest only 6% rate of interest. Let us assume that we put their $100K in the investment funds and generate same rate of the return that is 8%. Also, we are investing the additional tax refund at the end of the year that we are getting from CRA (Interest paid on investment loan is tax deductible).
Interest paid every year $6000. Additional tax refund generated every year is $3000.
Total value of portfolio after 10 years (reinvesting $3000 tax refund) = $256,352.
Amount in the portfolio after the loan payout = $156,352.
If we are in 33% MTR, we are taxed at 50% of the capital gain. In this case,
Capital Gain = $156,352
50% of Capital Gain = 78,175
33% of 78,175 = $ 25,797
Total Pay out after taxes = $130,395
This shows that by simply changing the strategy we can have at 30 to 40% gain in the outcome of the portfolio.
What are the disadvantages of the Investment Loan?
Investment loan is suitable only for individuals who can handle significant volatility inside the portfolio. Also, this strategy is only for a long-term horizon and does not suit for individuals who have a short investment horizon (less than 5 years).
Whom do I contact if I want to do an investment loan?
You can contact your financial advisor to arrange investment loan also you can call us for more information at 416-839-4561.
Am I taking a lot of risk if I am doing an investment Loan.
Yes and No. Yes, in the sense that if your financial situation changes and your monthly cashflow is challenged than for sure it might create stressful situation for you. No, in the sense you are not taking any additional risk in changing the investment vehicle.
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