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July/August 2010

Commentary - Hans H. Mathisen

I'm sorry, but until further notice, my usual commentary will not be available. However, I can still provide you the valuable benefits and financial insight of LIFE LETTER and LIFE LETTER MATURE:

Should I borrow to invest?- LifeLetter for July discusses leverage. We all know that it's wise to make conservative investments and to diversify, but does it pay off to borrow money to invest?

Are you wearing your wealth? - Does what we wear and purchase indicate how wealthy we are? August's LifeLetter investigates this myth and takes a look at the actual cost of some of our lifestyle purchases.

LIFE LETTER MATURE - July's entry looks at what the taxman wants to take out of our children's inheritence, and August's LLM tells us to beware how we help out our children financially.

Hans Mathisen





Should I borrow to invest?

Grace makes regular RRSP deposits and has been using up all her contribution room for several years. She also makes regular deposits to a non-RRSP account to build up her retirement savings. Grace is wondering if there is a better way to build wealth.

Grace's investments can be made with cash or a combination of cash and borrowed money. If only cash is used, her gains or losses on the investment are equal to the percentage increase or decrease in value over time. However, when money is borrowed to invest, the gain or loss on her cash invested is magnified. This effect is called leveraging.

Let's say that Grace has $25,000 of her own money to invest and she borrows $75,000 so that a total of $100,000 is invested. If the value of her investments drops by $10,000 after one year, her return on equity (her original $25,000) is a loss of 40%. However, if her investments increase by $10,000, her return on equity is a gain of 40%.

It is important for investors to be aware of the terms of their investment loan. Some lenders may require additional funds invested, more collateral or investments sold in the event of a drop in value to keep the loan within a certain percentage relationship. This is called a margin call.

Grace must be able to meet the ongoing costs of the loan. She can arrange to pay interest only for a certain number of years and sell her investments to pay off the loan, or principal and interest so that the loan is fully paid off at the end of the chosen term.

The Canada Revenue Agency (CRA) currently allows the deduction of interest expenses incurred to invest in securities or investment funds that have the potential to generate an investment return. Investments that generate capital gains and dividend returns over time are well suited for this type of strategy. Capital gains and dividends also receive preferential tax treatment.

Leveraging to invest is not a good idea on a short term basis. The risk of this strategy is greatly reduced if it is done over at least 8 to 10 years or more. A well balanced portfolio or investment fund may be a good choice for this strategy.

When using leveraging as a wealth building strategy, it is wise to use conservative investments and to diversify. After watching friends get very high returns on high-tech stocks in the late 1990's, Carl decided to borrow and invest. His investments promptly lost over 40% in one year, magnifying his losses because of the leveraging.

Let's say that Grace can save an additional $3,000 per year. Ignoring taxes along the way, she could accumulate about $42,441 in 10 years at 7.50% compounded annually. The same $3,000 per year can support an interest only loan of $60,000 at 5.00%. If the $60,000 is invested for 10 years at 7.50%, it will accumulate to about $123,662. Grace then pays off the loan from the investment and is left with about $66,662, some $21,221 more than making annual deposits. She can also save about $1,200 per year (40% tax bracket) by deducting the loan interest.

Want to know about borrowing to invest?

Call Hans Mathisen today at (306)242-7042.
or email -

Copyright © 2010 Life Letter. All rights reserved

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Are you wearing your wealth?

We are being misled - seriously misled. No matter where you look, we are expected to believe that by buying lots of expensive, luxurious items, it signifies that we are wealthy. Nothing could be further from the truth. It's really just cash flow.

Television and movies portray people that seem to have an endless supply of money. Some shows, in fact, are nothing more than an endless commercial glorifying consumption. Crime scene cop looks at his watch, a $6,000 designer label piece, and we are expected to believe he can afford it on his salary? Yeah, right. And the banks are all too happy to lend.

Calgary bankruptcy trustee, Barry Nykyforuk, says that excessive lifestyle expenses are the cause of almost all personal bankruptcies. Whenever there's a burp or hiccup in the economy, business gets really good for his firm.

Per capita savings in Canada is at an all-time low and, at the same time, per-capita consumer debt is at an all-time high. This should be a very disturbing fact for all of us. More and more people approaching retirement age are finding it necessary to continue working to service their consumer debt load.

Many people fail to realize the actual cost of their lifestyle purchases. Remember that consumer spending must be made with after-tax money. Think about this next time you're about to purchase a status symbol item.

For example:

Kim leases her vehicles and switches them every three years. Her reasoning is it's nice to get a new vehicle that frequently and she can "afford" a higherend car because lease payments are lower. What she didn't factor into her plan is that she will always have a car payment with this strategy. Kim will never have a period of time that is vehicle payment free.

She also needs to consider that, at her income level, she needs to earn about $900 to be able to make her $600 monthly lease payment.

Paul and Linda bought a much larger house than they truly needed for themselves and their two children. They were able to "afford" it by taking out a 40-year mortgage. The lender was quick to point out that they can qualify for a debt payment load of up to forty four percent of their income, so they went the limit so they could buy in the right neighborhood. But what is the real cost?

Let's say they take on a $500,000 mortgage at 5% and take the full 40-years to pay it off. At age 32, Paul and Linda will reach their 70s and still have mortgage payments. The total they will pay for that house is $1,149,129. They will actually have to earn over $1,741,104 to pay for it after taxes. And this does not include property taxes, repairs and upkeep.

If they set their sights just a little bit lower, say a mortgage of $410,000 for 25 years, the payments will be about the same. However, Paul and Linda would have it paid off at age 57 and would only have made payments totaling $715,374. If your outgo exceeds your income, the upkeep will be your downfall.

Want help with your wealth building?

Call Hans Mathisen today at (306)242-7042.
or email -

Copyright 2010 Life Letter. All rights reserved

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