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March 17, 2005
The turbocharged RRSP
As a Certified Financial Planner, I am asked a common question facing many Canadians wanting to increase their wealth. Do I pay off my mortgage, invest in my RRSP, or invest outside my RRSP?
Lately I have witnessed a rising popularity of the Reverse Mortgage. It seems that following a strategy of only paying off a mortgage and not taking advantage of tax assisted investments such as RRSPs and leveraged investments causes one to become house rich and cash poor.
An alternative strategy is to make your debt tax-deductible and use your assets as a springboard for acquiring additional investments.
This is what the rich do. They follow Rule #2 of The Turbocharged RRSP Strategy which is to “use other people’s money” or investment leverage.
For those who are unfamiliar with this strategy, investment leverage is simply borrowing money to invest. While it may seem counter intuitive to introduce interest-payments into your investment strategy, leverage can work for two reasons.
1. Compounding — With a traditional investment strategy such as dollar-cost-averaging, a small contribution is made regularly, for example every month. Assuming a 10-year investment horizon, only the first contribution grows for the full 10 years. The contribution you make one year from now only has nine years to grow, and so on. With leverage, the full amount of your investment has the entire ten years to grow.
2. Interest Deductibility — Interest payments made on a leverage loan are generally taxdeductible. This lowers your cost of borrowing and reduces the return you need to achieve for leverage to make sense.
Together, the power of compounding and interest deductibility can help a leveraged portfolio outperform a traditional portfolio.
As with any financial planning strategy, rules must be followed.
To make investment leverage successful you must focus on the long term, have your investments professionally allocated and rebalanced.
And most importantly, use the services of a competent professional with the required qualifications.
John Niekraszewicz, B.Math, FCSI, CFP, is a certified financial planner and president of JVK Life & Wealth Advisory Group.
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