Financial leverage

The Advocate, Wednesday June 16, 1993

What is financial leverage? Think of it as renting money. Borrowing other people's money to make money. The objective is to produce an expected after-tax return exceeding the net cost of borrowing.

This principle is understood by those who own businesses. Do you know of a businessman who has started a business, and kept it going without using O.P.M. (Other People's Money)? Businessmen know the important fact that no one has ever become wealthy without O.P.M.

Creates Wealth

But if borrowing money helps create wealth, how come 90 per cent of we Canadians are afraid to do so? We're afraid to borrow for investment purposes. I guess I'm lucky, because when people ask how to spell my last name, I say B-o-r-r-o-w, like money from the bank. And to be sure, that's what I do.

Remember, never borrow money for things that depreciate in value. Only borrow money for investment purposes. That way you take advantage of all the tax breaks.

Interest is tax-deductible only when the borrowed money is used for investment purposes. Paying interest with after-tax dollars that is not tax deductible can be very expensive.

It's no wonder with the amount of consumer debt around very few seem to get ahead. They are forever trying to pay off their credit card debts (currently at 17 per cent and higher) with after-tax dolars. It's a vicious circle. Before anyone can begin their road to wealth, they have to pay these off. replace non tax-deductible debts with tax deductible ones.

Let's look at the positive side of things. I borrow money at prime, currently 6 per cent and invest it and make in excess of 15 per cent. That's 9 per cent profit in my pocket, correct? Not really. Remember, I said that interest is tax-deductible on borrowed money for investment purposes.

So, in my tax bracket of 45 per cent, $10,000 at 6 per cent equals interest of $600. Ottawa pays 2.7 per cent and I pay the balance.

In reality, my out of pocket cost is only $330 or 3.3 per cent. My profit margin has been increased to 11.7 per cent. And remember this return is comprised mostly of capital gains which comes to you tax free up to $100,000 less C.N.I.L. and dividends which are taxed far less than interest. That's not a bad return, especially when all I did was use O.P.M.

Where do you make 15 per cent today with interest rates so low? Look in the financial newspapers for the Mutual Funds report. Look at the 10 year compound returns. The best example I know of for a long term 15 per cent profit is the Templeton Growth Fund.

Up to November 30, 1992 it averaged a 17.5 per cent compound rate of return for the past 25 years. That's not debatable. It's a published fact.

Sounds easy, doesn't it? Only problem is you need collateral before the banks and trust companies will lend you money. You have to start saving and investing first. My previous columns have covered this.

Yes, I like using O.P.M. (not opium). When you build your assets maybe you will discover the wonderful world of leverage.

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Created: Thu May 16 10:30:50 1996
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