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Kevin Stone plans to borrow $20K this year to invest in various stocks

By Aleksandra Sagan, Posted: Aug 04, 2015 5:00 AM ET Last Updated: Aug 04, 2015 5:00 AM ET

Kevin Stone is 28 years old and already has over half a million dollars of debt, including a mortgage and a loan to purchase farmland. But he’s not concerned, because that apparent burden is actually helping fuel his roughly $400,000 net worth.

He’s one of a number of Canadians taking a gamble and borrowing money at historically low rates not to fuel an excessive lifestyle, but to invest in the stock market. It’s a strategy one financial planner warns isn’t for everyone, and even seasoned investors can see things go wrong.

The Bank of Canada recently lowered its benchmark lending rate by 25 basis points for the second time this year. Canada’s major banks partially followed suit and lowered their prime lending rates to 2.7 per cent.

These changes caused the rates for already low variable-rate mortgages, as well as home equity and personal lines of credit, to fall.

The low rates prompted Harry, an Albertan in his 40s who requested his last name not be used for privacy reasons, to look at his $100,000 home equity line of credit, or HELOC, a different way.

He plans to use that money over the next several years to maximize his unused RRSP contribution room. He’s withdrawn funds from his HELOC before to pay for a few vacations, but this will be his first time borrowing the money for investments.

Harry plans to use his annual tax returns as large, lump-sum payments against the loan, while paying down the remaining balance at a low 2.2 per cent interest rate.

“I think the bigger risk is not using other people’s money to invest,” says Stone, who blogs about his money maneuvers at Freedom Thirty Five, where he doesn’t shy away from aiming to join Canada’s one per cent. “By taking on these debts today, I can have a longer time to build up my assets.”

Plans to borrow $20K this year

Last year, he made $75,000 — or more than his graphic designer salary, which pays $25 an hour — from his investments.

He’s shouldered tens of thousands of dollars of debt to help fund his stock market activity. Stone’s already racked up $60,000 in margin loans — they offer people money to invest using their shares as security — as well as pulled several thousand from his HELOC.

Stone plans to expand his HELOC limit by $9,000 and mine some other loan avenues to secure another $20,000 for investing this year.

Low lending interest rates are “absolutely” helping fuel his interest in this, he says.

“I’m continuing to make money that’s enough — more than enough — to cover the interest that I’m paying,” he says of the 3.2 per cent interest charge on his HELOC. For comparison, credit card companies typically charge around 20 per cent, but some rates edge as high as 30 per cent.

If interest rates climb above the return his investments yield, Stone says he’ll cash out some of his investment funds to repay his HELOC and other loans.

‘It can be a disaster’

While the strategy looks appealing on paper, it’s certainly not a good fit for everyone, says Jason Abbott, the principal financial planner at WEALTHdesigns.ca and a member of the Financial Advisors Association of Canada.

He’s borrowed money in this way before and his first attempt wasn’t too successful. He chalks it up to bad timing. Abbott invested the money in late 2008 “when the market had dropped substantially, but before it still had more to fall.”

Novices to investing are better off focusing on growing their net worth through more traditional methods, he says, because they don’t have the experience to handle this strategy.

A simple market correction can make the investment worth less than the loan, he says. Usually, a newbie will panic, sell and try to pay back the loan in another way.

Things can also go south if the person’s cash flow hits a setback and they can’t make their monthly loan payments.

“It can be a disaster,” says Abbott, who hears from investors who attempted this four or five years ago and are still “under water” trying to recover.

Stone hardly considers this a risky business for a seasoned investor like himself, but concedes this type of strategy may not be for everyone.

He compares investing risk levels for different people to those of driving. Consider the risk to everyone on a busy road, he says, if a car has someone without a driver’s licence behind the wheel versus a Formula One competitor.

The Lewis Hamiltons of investing don’t have much to worry about, he feels.

For some seasoned investors with a higher risk threshold who can weather a market’s ups and downs over an extended period this alternative strategy can work, Abbott says.

He would still urge them not to throw their entire available HELOC funds into the stock market, but rather start small with a diversified portfolio to gauge their comfort levels. He only invested “a small amount” back in 2008, which made his initial loss easier to handle.

Even when properly implemented, this shouldn’t make up the core of an investment plan, he says. There’s always the chance things will not turn out as planned.

A more conservative gamble

Tim Stobbs, an engineer and personal finance blogger who has a $100,000 HELOC and $12,000 personal line of credit available to him, takes this more conservative approach.

Tim Stobbs uses his HELOC to free up cash for help purchase investments, but he always pays it back within about three months. (Tim Stobbs)

“It did occur to me with these dirt cheap interest rates that I could go ahead and just pre-save a full year worth of investment in one fell swoop,” he says. But, he doesn’t want to go down the “slippery slope” of borrowing from his HELOC too much.

The most he’s ever withdrawn from his six-figure HELOC is about $5,500 — the former contribution limit for a tax free savings account.

It happens occasionally when a stock he’s watching becomes more affordable. He’s always paid back the borrowed money within a few months.

He’s not comfortable borrowing from a line of credit for any longer and recognizes people who make this system work to their advantage need to be in it for the long haul.

“I don’t ever want to be in the situation where I’m forced to sell something to pay off part of a line of credit.”

KIRA VERMOND
Special to The Globe and Mail

Last updated Friday, Feb. 13 2015, 5:15 AM EST

Not long ago, a potential client walked through Jason Abbott’s door with a conundrum. What should she do about a sizable overcontribution to her registered retirement savings plan?

Mr. Abbott didn’t have to think hard to give her an immediate answer: Fix it.

“It’s expensive not to. If people really got their heads around how excessive the penalty actually is, they’d be amazed,” says Mr. Abbott, a Toronto-based certified financial planner and president of WEALTHdesigns.ca Inc.

Maybe overcontributors are not keeping track of numerous RRSP accounts, or they forget they belong to their employer’s defined benefit plan, a defined contribution plan or a deferred profit sharing plan, which diminishes RRSP contribution room.

Now let’s say some of these overachieving savers know the 2014 maximum – $24,270 – but don’t read their tax assessment, which lists their actual (read: lower) personalized amount. They could wind up exceeding their RRSP deduction limit.

“They just don’t track their numbers and see where they stand,” Mr. Abbott says.

In other cases, new Canadians or those working in the country for less than a year get caught overcontributing since RRSP contribution room is based on the prior year’s income. If you didn’t work in Canada in 2013, you can’t contribute in 2014.

Luckily, there’s a $2,000 cushion. In other words, there’s no tax penalty on the first $2,000 of excess contributions no matter why the deposits happened. That’s welcome news if someone has made a math mistake, got a little overaggressive with savings or forgot about their employer plan.

Anything above the $2,000 amount? You pay one per cent tax on the excess amount each month, and there could be other interest and penalties too.

One per cent might not seem like much, but over time, the tax can take a big bite out of investment growth. Just consider what would happen if you overcontributed $12,000 to your RRSP. The first $2,000 gets a free pass on the penalty, but the other $10,000 would cost $100 the first month and every month. One year later, you’re looking at a $1,200 tax bill.

“That’s still 12 per cent over the year. You’d have to do really well investment-wise to overcome that penalty,” says Bruce Ball, a chartered professional accountant and national tax partner for BDO Canada LLP, in Toronto.

The problem, he explains, is that if an investor doesn’t realize his or her error, the Canada Revenue Agency isn’t necessarily going to spot it either. At least, not right away. In the meantime, the penalties continue to mount.

There are, however, mechanisms to get the tax waived. Basically, the CRA wants to know that the excess contribution was an inadvertent error and that you’re doing what you can to fix it. So pull the money out as soon as you notice the problem. If you do it in the same year or the following year, the CRA will be more likely to conclude that you simply made a mistake.

In another scenario, you’re less likely to be charged the penalty if the contributions were part of your qualifying group plan amount.

Think you need to pay the tax? File a T1-OVP Individual Tax Return for RRSP Excess Contributions to calculate the amount of the overcontribution and penalty tax. Just be sure to do that no later than 90 days after the end of the year in which you made the excess contributions.

Although there are ways to have the tax waived in some cases, don’t even bother pleading ignorance of the tax law. Judges have already thrown out such cases saying that ignorance can’t be considered the same thing as reasonable error. If tax forms confound and RRSP rules confuse, seek advice from someone who can explain them, judges have said.

Despite the penalties, RRSP overcontribution doesn’t keep Darren Coleman awake at night. The senior vice-president and portfolio manager for Raymond James in Toronto is far more concerned with excess contributions to tax-free savings accounts. Not only do they offer no wiggle room, so every extra dollar gets dinged with a 1-per-cent penalty tax, most people don’t understand how TFSA contributions work. That means it’s much too easy to go over the $5,500 maximum yearly limit.

For instance, if someone contributes $5,500 in June and then withdraws it in August, they must wait until the next calendar year before they can replace that money. But say they made another payment of $2,000 in September; they would have an $80 tax bill at the end of the year. (Four months at $20 a month.) What’s more, that extra $2,000 would eat into the following year’s contribution room. It’s a double whammy.

“Most people don’t understand the hokey-pokey of this thing. It causes all kinds of problems,” Mr. Coleman says. “At least with the RRSP the first $2,000 of overcontribution isn’t taxed. A TFSA? No. They get you on the first dollar.”

DARAH HANSEN
Special to The Globe and Mail
Published Tuesday, Sep. 09 2014, 5:00 AM EDT
Last updated Monday, Sep. 08 2014, 1:34 PM EDT

It was more accident than intention that led Anni Jansson to buy her first investment property in the growing Calgary suburb of Airdrie, Alta., in 2006.

Ms. Jansson, 39, had planned to live in the three-bedroom townhouse herself, but fate intervened when she met WestJet pilot Jason Hyland. The couple, now married, moved into his Calgary home and decided to put hers up for rent rather than incur the penalty of breaking the mortgage.

It proved to be a good financial move. People were lining up for rentals at the time and Ms. Jansson, who works in sales with a local residential development firm, quickly calculated that she could ask enough in rent to cover all her property expenses and still pocket a couple of hundred dollars every month.

It wasn’t long before Ms. Jansson decided to jump into the market again. She now owns and manages three income properties in Airdrie, and is in the process of closing on a fourth. Her long-term plan is to own up to 10 properties and use the revenue generated to supplement her retirement.

“I don’t have a pension plan,” she adds.

Ms. Jansson is in good company. Thousands of Canadians rely on residential income properties, whether close to home or abroad, to help them feather their financial nests.

Done right, investors stand to reap big rewards over the long haul, industry experts say. But property investment can also come at a heavy price to those who aren’t prepared to learn the market and do the less-than glamorous work of a landlord.

If talk about housing bubbles gives you ulcers, or you aren’t willing to answer the phone at 2 a.m. when the tenants call to tell you the pipes have burst, then investing in real estate might not be right for you.

“It’s like any business that you want to enter. It’s all about time, money and expertise. If you don’t have the time, you at least have to have the expertise and you have to have the money to make it fly,” says Phil McDowell, a mortgage broker in Calgary.

For those who are considering investing in a rental property, there are a few basic rules to keep in mind in order to mitigate the risk of the deal turning sour, says Melanie Reuter, director of research for the Canadian branch of the Real Estate Investment Network (REIN), an investor advisory organization based in British Columbia.

The key is to look for a community or region that shows clear signs of growth and economic sustainability. Avoid one-horse towns whose existence are tied to a single company, no matter how tempting the sale price.

“Ask yourself: Are there jobs? Are there people moving in for jobs? Because if they are moving in, they’ll need a place to stay and often that means they’ll need a place to rent,” Ms. Reuter says.

Ms. Reuter says Alberta continues to be one of the best bets for income investors in Canada. The provincial average price for homes sold in June was a record $407,166, an increase of about 6 per cent from June of 2013, according to the Alberta Real Estate Association. The national average price, by comparison, rose 7 per cent on a year-over-year basis to $413,215.

At the same time, Alberta’s rental vacancy rates are consistently among the lowest in the country. With a vacancy rate of about 1.3 per cent, Calgary rents average about $1,300 a month for a one-bedroom apartment, according to rentboard.ca. In Fort McMurray, renters can expect to pay upward of $1,900 for a one-bedroom.

REIN has also identified Hamilton and Surrey, B.C., as promising investment markets.

Ms. Reuter says it is equally important for investors to have a clear idea of the true monthly costs, including mortgage, interest and property tax, as well as potential extras, such as garbage pick-up, water usage or strata fees.

She recommends those considering property investment should also set aside an emergency fund to cover repairs and maintenance, or unexpected vacancies.

Investors purchasing across the border or in holiday destinations away from home can expect to tack on another 10 per cent of total costs to pay for a property manager.

Many investors choose to save money by doing the management work themselves, but that comes with its own costs. Landlords should expect to put effort into finding good tenants, avoiding bad ones and fielding the overnight phone calls when something goes wrong.

“We’ve all heard stories of someone who had the tenant from hell,” says Jason Abbott, a financial planner and president of Wealthdesigns.ca Inc. in Toronto.

A real-estate investment fund may be a better option for someone who wants to be involved in real estate without having to manage a property or assume all of the risk, Mr. Abbott says. The one downside is that it can be a lot harder than more traditional funds to access your money should you need it.

“If the fund doesn’t hold enough cash, it has to sell something off … but that is going to be the same if I go out and buy a rental property myself,” says William Britton, a financial planner in Kingston with Marlin Financial Services Inc.

Mr. Britton recommends his clients treat property investment as they would any business. That includes hiring a tax professional to help them report an income property, including expenses, revenues and asset appreciation. Not reporting an income property can land an investor in hot water with Canada Revenue Agency.

“If you choose not to report, you are taking the chance you won’t be found out. If you are, it is not going to be pretty,” Mr. Britton says.

Securing a mortgage for an income property can also be complicated, says Mr. McDowell, who is also a director with the Alberta Mortgage Brokers Association. Mortgage rules require investors to have a minimum down payment of 20 per cent and to have proof through tax returns of the their income and assets. In most cases, it is important to have secure employment to prove you can cover a portion of the mortgage at any time.

“You should be able to demonstrate that you’ve got a reserve fund available to you should you have a major repair or if the tenant skips,” Mr. McDowell says.

Homeowners who are interested in an income-generating property, but don’t have 20 per cent to put down, may want to consider a basement or suite within their own home, he adds. A primary residence with a rental suite requires a 5-per-cent down payment.

A mortgage helper in the house can also increase the chances of getting a better return on your own property when it comes time to sell, and you won’t have to pay capital gains, Ms. Reuter says.

Ms. Jansson, meanwhile, says she is always on the lookout for a modern three-bedroom home near a school and transit. “That’s the sweet spot,” she says.

She does worry about the economy softening, but says her business plan is based on a worst-case scenario. The income generated by all three rental properties significantly outstrips expenses. The regional economy would have to suffer seriously before she would even break even.

“The rent would have to decrease by 40 per cent. It is not going to happen,” Ms. Jansson says.