Author Topic: Borrowing to Invest  (Read 2497 times)

pumpkinlantern

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Borrowing to Invest
« on: August 08, 2017, 10:18:11 AM »
Before you look at the subject line and jump to conclusions, please read my specific situation.

I am Canadian for tax purposes.

I have a significant amount of student loans (from medical school).  I didn't want to hold off investing for years while I paid off my debt (especially given low interest rates), so I have adopted a strategy of using part of my excess money to pay off my student loans and part of it for investing.  At this point, I have a line of credit at 2.70% (prime minus 0.25%), which is a private bank loan, so it's not tax deductible.  I also have a non-registered investment account.  The value of this investment account is currently greater than the line of credit.

I am thinking of selling some of my investments and "paying off" my line of credit and then re-borrowing that money and re-buying the investments.  I can do this without any significant capital gains/losses.  The interest on my loan will then become tax-deductible since borrowing to invest is tax deductible in Canada.  The tax deduction will be at my marginal tax rate (currently ~40%, soon to be 54% as my income will rise within a couple years).  My effective interest rate would then be 1.2-1.6% at the current prime rate.

Technically, I am "borrowing to invest", which I know has all sorts of negative connotations of high risk, but as far as I can tell my risk profile hasn't really changed except that I can now deduct the interest.

My risks as I understand them are:
- I continue to have debt, which is currently very low cost (although interest rates are likely to rise).
- There's always the risk of market corrections/crashes (and the current market isn't particularly cheap).

Can anyone see any other major problems with this that I am missing?

Proud Foot

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Re: Borrowing to Invest
« Reply #1 on: August 08, 2017, 11:14:39 AM »
Not familiar with Canada things so I could be off. You are correct that your risk profile really hasn't changed any.

When you draw from your LOC is the interest fixed until that draw is paid off or does it reset based upon movement of prime? How often do you need to renew your LOC and is that when the interest rate changes based upon prime or does the rate change whenever prime changes?

pumpkinlantern

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Re: Borrowing to Invest
« Reply #2 on: August 08, 2017, 01:47:36 PM »
The interest rate is variable based on the prime rate, so if the bank prime rate changes then so does my interest rate.  There shouldn't be any issue renewing although technically they reserve the right to change the rules on me at anytime.

Indexer

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Re: Borrowing to Invest
« Reply #3 on: August 08, 2017, 07:19:38 PM »
The way I see it you are borrowing to invest right now. You have a loan in the right hand and investments in the left and you could use the investments to pay off the loan. You are leveraged, it just isn't in the same account.

I'm in the same boat, but my loan is a mortgage with an insanely low interest rate. I could pay it off tomorrow, but I could earn more than the interest rate just by investing in treasury bonds.

Sure, use the investments to pay off the loan, and if the interest rate is that low turn around and invest.

The only downside I see to this you have already pointed out, the market isn't exactly cheap. Since it is just about impossible to market time there isn't much you can do about that.

One thing to check, does Canada's tax agency treat transactions that are close together in time as 1 transaction or multiple? It sounds like a stupid question, but here in the US we have wash sale rules if the transactions are too close together. Something to check before you submit the trades.

arcyallen2

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Re: Borrowing to Invest
« Reply #4 on: August 09, 2017, 06:37:48 PM »
I am Canadian for tax purposes.

Is this how you introduce yourself at parties? :)

bigchrisb

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Re: Borrowing to Invest
« Reply #5 on: August 09, 2017, 10:13:24 PM »
Your risk profile is unchanged, but your real cost of debt has dropped.  Seems logical to me from what you have posted.  I've done much the same in the Australian market, paying off my home loan (not deductible), and then re-drawing it to re-finance margin loans (tax deductible in our system).  Converted the debt to a lower interest rate, made it tax deductible (49% marginal tax rate), and made the loan less callable by the lender if there is financial strife.

Are there any capital gains tax issues or other transaction costs to consider?  Is there any risk of the money not being re-loaned to you to make the re-purchase, if availability of credit has tightened?

pumpkinlantern

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Re: Borrowing to Invest
« Reply #6 on: August 10, 2017, 07:35:50 AM »
Are there any capital gains tax issues or other transaction costs to consider?  Is there any risk of the money not being re-loaned to you to make the re-purchase, if availability of credit has tightened?

Thanks for the response.  Credit is starting to tighten in Canada as interest rates rise and there's growing concern about our ridiculous housing bubble (sounds like you are having the same problem in Australia).  That's partially why I want to set this up now.  I shouldn't have problem getting the money now, but it could be a problem later as the credit tightening gets worse.



I am Canadian for tax purposes.

Is this how you introduce yourself at parties? :)

LOL.  I'm Canadian for other purposes too, just not for the bad beer.

Mr. Rich Moose

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Re: Borrowing to Invest
« Reply #7 on: August 10, 2017, 10:07:11 AM »
Before you look at the subject line and jump to conclusions, please read my specific situation.

I am Canadian for tax purposes.

I have a significant amount of student loans (from medical school).  I didn't want to hold off investing for years while I paid off my debt (especially given low interest rates), so I have adopted a strategy of using part of my excess money to pay off my student loans and part of it for investing.  At this point, I have a line of credit at 2.70% (prime minus 0.25%), which is a private bank loan, so it's not tax deductible.  I also have a non-registered investment account.  The value of this investment account is currently greater than the line of credit.

I am thinking of selling some of my investments and "paying off" my line of credit and then re-borrowing that money and re-buying the investments.  I can do this without any significant capital gains/losses.  The interest on my loan will then become tax-deductible since borrowing to invest is tax deductible in Canada.  The tax deduction will be at my marginal tax rate (currently ~40%, soon to be 54% as my income will rise within a couple years).  My effective interest rate would then be 1.2-1.6% at the current prime rate.

Technically, I am "borrowing to invest", which I know has all sorts of negative connotations of high risk, but as far as I can tell my risk profile hasn't really changed except that I can now deduct the interest.

My risks as I understand them are:
- I continue to have debt, which is currently very low cost (although interest rates are likely to rise).
- There's always the risk of market corrections/crashes (and the current market isn't particularly cheap).

Can anyone see any other major problems with this that I am missing?

What is your LOC secured against? Will you be able to use the same structure for "borrowing to invest"?

Personally I think you have the right idea. It's basically a swap of your debt and it's 100% legal and very smart considering your income level.

It's pretty clear at this point that interest rates will be going up from where they are at. I wouldn't be surprised if bank prime hits 4% in the not to distant future.

Don't forget if you are borrowing to invest you have to be careful of your investment holdings and how they impact your tax situation and the deductibility of your loan. I would not be diving into dividend stocks or any of that sort.
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Le Barbu

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Re: Borrowing to Invest
« Reply #8 on: August 11, 2017, 07:11:24 AM »
Your strategy may work even better in a high interest rates environement, go ahead!
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pumpkinlantern

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Re: Borrowing to Invest
« Reply #9 on: August 11, 2017, 11:49:44 AM »

What is your LOC secured against? Will you be able to use the same structure for "borrowing to invest"?

Personally I think you have the right idea. It's basically a swap of your debt and it's 100% legal and very smart considering your income level.

It's pretty clear at this point that interest rates will be going up from where they are at. I wouldn't be surprised if bank prime hits 4% in the not to distant future.

Don't forget if you are borrowing to invest you have to be careful of your investment holdings and how they impact your tax situation and the deductibility of your loan. I would not be diving into dividend stocks or any of that sort.

Unsecured LOC.

I have mixed feelings about what to do with increasing interest rates.  My tax deduction is actually higher at higher interest rates (eg. if it's 6%, then my effective post-tax rate is 3%, an absolute difference of 3%), but at some point it just makes more sense to sell your investments and pay off the debt - not entirely sure what that point is, but I feel like it's probably not now at an effective interest rate of 1.2-1.6%.

Yes, I need to spend a bit of time looking carefully into the tax implications of my investments.  Good point - thanks!

Mr. Rich Moose

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Re: Borrowing to Invest
« Reply #10 on: August 11, 2017, 12:35:00 PM »
I think it really depends on your overall risk tolerance. If your only savings are in this account, then you theoretically have an approximately worth of $0. (With lots of earning power of course.)

If your risk tolerance is really really high, borrowing makes sense. But I think it can be very damaging to your investing confidence to see your net worth sink to negatives because of your leveraged strategy. It can cause psychological panic.

In many ways, and for the vast majority of people, it is better to invest from a firm foot forward (no debt). I firmly believe for myself that I would never have leverage in excess of 50% of my total net worth. It limits the downside and change of being wiped out.

Just don't let tax strategies govern your investment decisions. Good investing comes first, tax efficiency is second.
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Le Barbu

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Re: Borrowing to Invest
« Reply #11 on: August 11, 2017, 05:05:11 PM »
I was once (20 years ago) 75% leveraged (mortagaged house, no investments)

Today, I am <20% leveraged and house is less than 25% of NW
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Retire-Canada

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Re: Borrowing to Invest
« Reply #12 on: August 11, 2017, 08:36:04 PM »
Are you planning on using the same LOC you have now to invest? If so I don't see any reason to sell investments and rebuy them. Since you could sell investments and rebuy them with the same LOC it's meaningless to go through the unnecessary transactions. You maintaining the LOC vs. paying it off is due to the desire to invest therefore the interest from the LOC is tax deductible now.

If this is the case I would just document the facts as they stand and pick a date from which you'll start deducting interest.

FWIW I used my LOC to deal with some unexpected [poorly calculated] taxes. I will be deducting the interest I paid on the LOC since I could have instead sold investments or invested less to avoid using the LOC. Therefore my LOC is supporting my investments.


See my post below for a correction.
« Last Edit: August 12, 2017, 09:14:05 AM by Retire-Canada »

Mr. Rich Moose

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Re: Borrowing to Invest
« Reply #13 on: August 12, 2017, 08:05:29 AM »
Are you planning on using the same LOC you have now to invest? If so I don't see any reason to sell investments and rebuy them. Since you could sell investments and rebuy them with the same LOC it's meaningless to go through the unnecessary transactions. You maintaining the LOC vs. paying it off is due to the desire to invest therefore the interest from the LOC is tax deductible now.

If this is the case I would just document the facts as they stand and pick a date from which you'll start deducting interest.

Sorry R-C, but this is exactly how to get wacked by the tax man. Always make the transaction so it's properly documented with the paper trail to prove it.
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Retire-Canada

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Re: Borrowing to Invest
« Reply #14 on: August 12, 2017, 08:52:22 AM »
Sorry R-C, but this is exactly how to get wacked by the tax man. Always make the transaction so it's properly documented with the paper trail to prove it.

I dug around in CRA documents and found this: https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-3-property-investments-savings-plans/series-3-property-investments-savings-plan-folio-6-interest/income-tax-folio-s3-f6-c1-interest-deductibility.html

See sections 1.29 - 1.33. I agree that you need to buy the securities directly. My error. I have corrected my post above.

https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-221-carrying-charges-interest-expenses.html

BTW - in reviewing CRA requirements around deducting interest charges for use in investments a few things came up of interest:

- cannot be used with TFSA and RRSP
- can only be used with securities that pay dividends or interest
- if a investment only generates capital gains you cannot deduct borrowing cost interest
« Last Edit: August 12, 2017, 09:13:33 AM by Retire-Canada »

pumpkinlantern

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Re: Borrowing to Invest
« Reply #15 on: August 14, 2017, 07:54:06 AM »
Thanks for the info and advice!  I think I will be going ahead with the plan.  Aside from some account changes, my overall savings/investing plan won't really change that much except that I'll swap my debt to make it tax deductible.

ChpBstrd

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Re: Borrowing to Invest
« Reply #16 on: August 14, 2017, 09:47:17 PM »
If it's leverage you're after, options can accomplish the same task without so much shuffling. E.g. buy or sell a spread.

talltexan

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Re: Borrowing to Invest
« Reply #17 on: August 15, 2017, 11:56:57 AM »
How old are you? Your age should affect your willingness to take on leverage.

bigchrisb

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Re: Borrowing to Invest
« Reply #18 on: August 15, 2017, 09:44:58 PM »
I'd think more about how long you are accumulating, rather than how old you are.  Leverage, while you can support it with a fat income is good - provided the expected value of your earnings is greater than your interest cost, AND you can avoid blowing up, such as your stream of savings from work.

I'm young-ish (35), but 2 months away from pulling the employment pin.  I'm much less happy about holding leverage if I don't have a savings stream from my job.

I've brought down my total investment debt from about $1.2m to $500k in the last couple of years, and intend to drop it further to about $300k (on a ~3M net worth) soon into FIRE.   I would have done so already, however I pre-paid  some interest in my last earnings tax year to move around some tax deductions, so have a fixed pre-paid loan the next 10 months.

Le Barbu

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Re: Borrowing to Invest
« Reply #19 on: August 16, 2017, 11:33:08 AM »
I'd think more about how long you are accumulating, rather than how old you are.  Leverage, while you can support it with a fat income is good - provided the expected value of your earnings is greater than your interest cost, AND you can avoid blowing up, such as your stream of savings from work.

I'm young-ish (35), but 2 months away from pulling the employment pin.  I'm much less happy about holding leverage if I don't have a savings stream from my job.

I've brought down my total investment debt from about $1.2m to $500k in the last couple of years, and intend to drop it further to about $300k (on a ~3M net worth) soon into FIRE.   I would have done so already, however I pre-paid  some interest in my last earnings tax year to move around some tax deductions, so have a fixed pre-paid loan the next 10 months.

In Canada, investing debt is deductible against income for taxable investments. Deleveraging after retirement is logic. My leverage is 20% now and will sligthly decrease to 10% when retiring.
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Re: Borrowing to Invest
« Reply #20 on: August 16, 2017, 11:49:11 AM »
I'm no expert on being Canadian but:

Personally I think you have the right idea. It's basically a swap of your debt and it's 100% legal and very smart considering your income level.
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Re: Borrowing to Invest
« Reply #21 on: August 17, 2017, 01:30:38 PM »
PTF