What to do with Extra Cash?

williammartin said:

My advice begins with a question: what's your current tax bracket? If you're in the top-end, consider that over time, your yearly tax liability will dominate the Expense side of your ledger, particularly given you've already paid your mortgage and your RRSP is maxed out.

With the usual tax saving tactics exhausted, how are you attacking the growing tax liability?

As others have called out, consider borrowing to invest, using the interest paid on the loan to create a durable tax credit machine, that provides a certain amount of tax savings today and into the future provided you don't pay off the loan completely.

Indeed, assuming you can get the standard Investment Loan Rate (namely P+1%) the 1600 monthly cashflow funds a ~350K investment loan (assuming interest-only payments).

You could really add rocket fuel to this by re-borrowing against your mortgage and use the "found" money to drop more into the market.

Food for thought!

Wills.

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Definitely do not do the leveraged investment at prime+1%. If you want high beta, just go for the ETF that does it for you and can borrow at a lower rate. But IMO just stay with beta =1 and do not leverage

Muchadoaboutnothing said:

Top up Tfas and rrsp. Have half a year of expenses put aside for an emergency fund (you never know).
healthcare always seems to take my money living with chronic pain. I like to give to Charity otherwise. Going on a vacation always had a good effect on yourself and those around you as you come back with a fresh look on life.

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TFSA - yes (always), RRSP - only if your income now is more than what you expect to earn when you retire. Given that you can save only $1600 per month even after paying off your mortgage means your current income (and, thus, marginal tax rate) is very low, so, contribute to RRSP only if you do not see any future improvement in your career.

fall said:

Definitely do not do the leveraged investment at prime+1%. If you want high beta, just go for the ETF that does it for you and can borrow at a lower rate. But IMO just stay with beta =1 and do not leverage

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@fall - appreciate your POV. What's your rationale for not using direct leverage, given the interest on the loan provides a durable source of tax deduction, for high income earners?

Is your concern rooted in margin trading / getting margin called?


Wills.

williammartin said:

@fall - appreciate your POV. What's your rationale for not using direct leverage, given the interest on the loan provides a durable source of tax deduction, for high income earners?

Is your concern rooted in margin trading / getting margin called?


Wills.

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No matter who does the leverage: you directly or a mutual fund on your behalf, the interest is tax deductible (e.g., you earn $10, pay $2 interest, you pay taxes on $8, or the mutual fund earns $10, pays $2 interest, report $8 profit and you still pay taxes on that $8 profit). The difference is that you pay Prime+1 interest while the mutual fund pays Prime+0. So, you end up earning 1% less pretax. Assuming you are in the highest tax brackets, it will be 0.5% less earning after tax (even worse if you are in lower tax brackets). This has nothing to do with the decision to leverage - both cases you leverage the same way, it is just cheaper to let the mutual fund do it for you.

fall said:

No matter who does the leverage: you directly or a mutual fund on your behalf, the interest is tax deductible (e.g., you earn $10, pay $2 interest, you pay taxes on $8, or the mutual fund earns $10, pays $2 interest, report $8 profit and you still pay taxes on that $8 profit). ... it is just cheaper to let the mutual fund do it for you.

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I don't agree with this line of reasoning, as it is material who does the borrowing. Only the entity that bears the borrowing cost (aka the carrying cost) of the investment can deduct that expense on their taxes.

So if the mutual fund "does the borrowing" , they get the tax deduction, not you, the mutual fund investor.

So, while your example assumes that both scenarios pay tax on an $8 profit, you're negating the impact of $2 interest expense, which is deductible by the investor if he borrows / leverages, but not if the mutual fund does.

Also, consider that your example falls down if there is a loss in a given year. In both instances, the loss can be carried forward, or carried back to offset gains from previous years, but the interest cost reduces the investor's tax burden regardless of the performance of the underlying investment.

Finally, consider that for high-income earners--say 1%ers (i.e. earning $293K+ in Canada)--who have typically already exhausted their RRSPs and TFSAs, and the associated tax benefits of those registered accounts, leveraging in their non-reg account creates a much needed tax deduction, while increasing their overall asset base.

Now, I'm definitely not saying that leveraging is for everyone, but IMO it has considerable benefit if you skew towards the top end of the income game and are fine with holding / using leverage through the market drops.


Wills.

williammartin said:

I don't agree with this line of reasoning, as it is material who does the borrowing. Only the entity that bears the borrowing cost (aka the carrying cost) of the investment can deduct that expense on their taxes.

So if the mutual fund "does the borrowing" , they get the tax deduction, not you, the mutual fund investor.

So, while your example assumes that both scenarios pay tax on an $8 profit, you're negating the impact of $2 interest expense, which is deductible by the investor if he borrows / leverages, but not if the mutual fund does.

Also, consider that your example falls down if there is a loss in a given year. In both instances, the loss can be carried forward, or carried back to offset gains from previous years, but the interest cost reduces the investor's tax burden regardless of the performance of the underlying investment.

Finally, consider that for high-income earners--say 1%ers (i.e. earning $293K+ in Canada)--who have typically already exhausted their RRSPs and TFSAs, and the associated tax benefits of those registered accounts, leveraging in their non-reg account creates a much needed tax deduction, while increasing their overall asset base.

Now, I'm definitely not saying that leveraging is for everyone, but IMO it has considerable benefit if you skew towards the top end of the income game and are fine with holding / using leverage through the market drops.


Wills.

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I am not sure you understand how it works. For simplicity, assume stock (call it "market index") costs $100, generates 5% return, and borrowing costs is 2%, you have $100 of your own money to invest and there are two mutual funds. Fund 1 invests all money into that "stock". Fund 2 for each $1 it gets from investors borrow $1 and invest these $2 into that stock, You have two possible leveraged investment strategies:

Strategy 1: Borrow $100, invest $200 into fund #1, generate $200*5%=$10 return, pay $100*2% interest, have $8 pre-tax profit and $8 taxable income
Strategy 2: Invest $100 into fund #2, fund #3 borrow $100 an invest into the stock, the stock generates $200*5%=$10 return to the fund, the fund pays $2 interest and distribute the remaining $8 profit to you. You get pay $8 pre-tax profit and $8 taxable income.

Both strategies result in the same after-tax profit of 8*(1-tax rate)

Now, if you pay 3% interest while the funds can borrow at 2%, the first option will lead to $10 return, $100*3% interest, $7 pre-tax profit, $7 taxable income, and 7*(1-tax rate) after-tax income.

Assuming the stock return is a random variable, the above is for expected values (in case of a loss, both you and the mutual fund can carry losses forward the same way) and the beta of your investment is also the same (=2) in both scenarios (in fact, not just beta but the realized return in any possible scenarios)

So, the only difference is the borrowing costs

Spend it all on hookers

"Spend it all on hookers" No, no no, Skiierelite

Spend half on hookers the other half on booze!

fall said:

Strategy 1: Borrow $100, invest $200 into fund #1, generate $200*5%=$10 return, pay $100*2% interest, have $8 pre-tax profit and $8 taxable income
Strategy 2: Invest $100 into fund #2, fund #3 borrow $100 an invest into the stock, the stock generates $200*5%=$10 return to the fund, the fund pays $2 interest and distribute the remaining $8 profit to you. You get pay $8 pre-tax profit and $8 taxable income.

Both strategies result in the same after-tax profit of 8*(1-tax rate)

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Uh - Why couldn't he put his $100 + $100 borrowed into fund #2 then, and generate $16 ($14 taxable)?