Responsible leveraging. A wealth creation strategy

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1 Responsible leveraging A wealth creation strategy

2 What is leveraging? Borrowing to invest is a wealth-building strategy that has been used for thousands of years. The financial term for borrowing to invest is leveraging. An investment strategy that is often used by high-income investors, leveraging has also become popular with middle-income Canadians. 1 Are you interested in accelerating the growth of your assets? Would you like to benefit from tax-efficient investing? Do you need a disciplined way to save? A responsible leveraging strategy may help you reach your financial goals. Investment leveraging is simply borrowing to invest. It s similar in approach to taking out a mortgage or a registered retirement savings plan (RRSP) loan. When managed correctly, borrowing to invest has the potential to accelerate the growth of your savings. Done inappropriately, it can have negative effects and present undue risks. Responsible leveraging typically means borrowing an amount that results in payments you can easily afford. It works best using fundamental risk management techniques like proper diversification and asset allocation. 1 Excerpted from Dispelling the Myths of Borrowing to Invest, by Talbot Stevens. Published by Financial Success Strategies Inc., London, Ontario, Used with permission.

3 How does borrowing to invest work? In a traditional investing strategy, you save an amount each month to purchase investments that have the potential to grow over time. Leveraged investing allows you to invest a larger lump sum today. Using the same amount you would save each month, you make the payments on the loan. There are two main components that make borrowing to invest an effective strategy: 1 Compound growth A larger initial investment can potentially enjoy the benefits of compounding. 2 Tax efficiency The interest charged on an investment loan may be tax deductible 2. Benefits of borrowing to invest 1 Tax savings Interest on the loan may be tax deductible when used exclusively to generate income. 2 More money invested sooner This can mean greater potential growth as your money starts compounding. 3 Disciplined savings Having a loan payment can actually help ensure you dedicate funds to your wealth accumulation plans. A loan can be easier for some to manage than a voluntary contribution that can be started and stopped. Generally there are two major categories: good debt, which has tax-deductible interest, and bad debt, which does not. 2 At this time, the Canada Revenue Agency (CRA) indicates that investments such as mutual fund trusts, mutual fund corporations and segregated funds policies are eligible investments for interest deductibility purposes. All tax laws can change at any time, so interest deductibility cannot be guaranteed. For Quebec income tax purposes, investment expenses (that include interest on loans that were used to purchase non-registered investments) are only deductible up to the actual amount of taxable investment income earned during a particular year. Investment expenses in excess of the taxable investment income in a year may be carried back three years or carried forward indefinitely to offset taxable investment income.

4 Ways to manage risks of borrowing to invest Market declines and portfolio loses value Ensure you have 10 or more years to hold your leveraged portfolio. While equity returns fluctuate, especially in the near term, experience suggests investors may enjoy more consistently positive average annual returns when held for periods of a decade or more. A well-diversified portfolio can help decrease market volatility risk. Hold an appropriate mix of investments suited your own needs and preferences about risk and return. Avoid overweighting your portfolio in particular sectors or specific investments. Starting the strategy at the wrong time Again, invest for the long term. Given an appropriate time frame, the risks of getting in and out of the market at inopportune times tend to be reduced. Those looking for additional risk management may wish to consider a dollar-cost averaging strategy that allocates funds from a money-market fund to a longer-term portfolio slowly over the course of a few months. Personal stress associated with market returns Start leveraging with a small amount you can dedicate to long-term investing without constant attention to help avoid undue concern. Consider using segregated fund policies with guarantees that offer protection in case of death, or that provide predictable maturity values. Use an investment loan with no margin calls to avoid concerns with providing additional collateral during weak markets. Payment increases as a result of higher interest rates Borrow less than you can afford to give yourself a reasonable cushion to accommodate fluctuating interest rates. Be sure the investment loan program you choose provides flexibility and liquidity. 3 3 Subject to National Bank underwriting and credit approvals

5 Case study Use disciplined savings to accelerate wealth Bill and Sandra At age 45, both Sandra and Bill are maximizing their RRSP contributions and want to grow their non-registered portfolios. They both have about $1,000 to invest on a monthly basis. After discussions with their advisors *, they determine their individual approaches. Leveraged loan Sandra borrows $200,000 through the Canada Life investment loan program. Monthly payments of $917 cover the interest-only costs throughout the term of the loan 4. We assume Sandra will receive a deduction on her income tax return for all the interest on the loan. We also assume she immediately invests the additional tax refunds in a non-registered account with the same rate of return. Monthly deposit plan Bill chooses a standard monthly deposit of $917 in a non-registered investment account. There is no debt to pay or interest to deduct. Scenario one Six per cent rate of return Looking ahead to retirement in 20 years Sandra would have a 38 per cent larger fund from which to draw income, once the loan has been repaid. This is due to two main reasons: The tax savings that come from the tax deductibility of investment loan interest The effect of compound growth on a larger investment with a loan 4 The Canada Life investment loan program has interest-only and principal and interest payment options. To qualify for interest-only payments, additional collateral is required. Sandra - Uses an interest only leveraged loan with payments of $917 per month Bill - Invests $917 in a monthly deposit plan Fund value $800, , , , , , , ,000 0 Assumptions Leverage loan Results 20 years later Age 65 Investment compound annual growth rate is six per cent Investment loan borrowing rate is 5.5 per cent Loan payments are interest only Deposit plan Sandra has 38 per cent more. Non-registered fund at age 65 Sandra $748,558 Bill $542,322 Fund value includes all extra tax refunds and is after tax and net of loan All growth is taxed as capital gain (50 per cent inclusion rate) or eligible dividends Marginal tax rate of 45 per cent All loan interest is deductible and payments remain constant and are comprised of interest only The examples in this brochure are for illustration purposes only and use constant returns and interest rates, which are not attainable in real-life situations. Returns and interest rates will fluctuate with market conditions and can create even more positive outcomes or negative outcomes than what is presented here. While the use of leveraging can magnify returns, it will also magnify losses and is a strategy that should only be employed by knowledgeable investors with a relatively high risk tolerance. The information in these examples is current as of June 2009.

6 While leveraging can provide a way to accelerate investing success, it is possible for it to provide less favourable outcomes when markets do not fair well. Consider the following alternative example. Scenario two Three per cent rate of return Looking ahead to retirement in 20 years Sandra would have 11 per cent less funds from which to draw income, once the loan has been repaid. This is due to two main reasons: Low rate of return Tax liability has greater impact on the annual growth compared to policies that experience higher rates of return Things to consider Before borrowing money, ensure you have the cash flow to pay the interest and repay the loan. Borrow less than you can afford to give yourself a reasonable cushion to accommodate fluctuating interest rates. Borrowing to invest magnifies gains if investments increase in value, but also magnifies losses if investments decrease in value. Invest conservatively to minimize the effect of negative market volatility on your investment portfolio. Fund value $ 290, , , , , , ,000 0 Results 20 years later Age 65 Leverage loan Deposit plan An investment loan allows you to repay principal and interest or in some cases, interest only. The cost of borrowing for an investment loan may be tax deductible. The CRA can change its position at any time, so interest deductibility cannot be guaranteed. Any tax refund could be applied to the balance of the loan to significantly reduce the amortization period. (The case study assumes no repayment of the loan and that tax refunds are similarly invested for maximum growth.) It is always best to re-invest the tax benefits to achieve the best long term results. Non-registered fund at age 65 Assumptions Investment compound annual growth rate is three per cent Investment loan borrowing rate is 5.5 per cent Loan payments are interest only Sandra $250,304 Bill $281,703 Fund value includes all extra tax refunds and is after tax and net of loan All growth is taxed as capital gain (50 per cent inclusion rate) or eligible dividends Marginal tax rate of 45 per cent All loan interest is deductible and payments remain constant and are comprised of interest only Borrowing to invest can be an effective alternative to a regular investment program Magnify your returns with your investment objective with an investment loan. You have one-stop investment financing at competitive rates. Canada Life offers a wide range of segregated fund policies to meet your investment needs. Explore how an investment loan may suit your situation and discuss a solution with your advisor.

7 A description of the key features of segregated fund policy is contained in the information folder. Any amount that is allocated to a segregated fund is invested at the risk of the policyowner and may increase or decrease in value. While borrowing to invest can be a powerful means to build wealth, the risks involved make it a strategy that is not suitable for everyone. Your financial security advisor can help you determine if borrowing to invest is a strategy that is right for you. All information is subject to change. Loans provided solely by National Bank of Canada. The Canada Life Assurance Company does not act as a lender nor does it intend to. The program is a means by which a client may transfer loan proceeds approved and funded by National Bank to a new or existing Canada Life product in a client s name. Canada Life does not process client investment transactions until loan proceeds are received from National Bank and sufficient client authorization to do so is provided. Canada Life accepts no responsibility for loan approval delays or delays to transfers of approved loan proceeds to Canada Life. For information purposes only. Individual circumstances may differ. Please seek independent financial advice. An investment in a Canada Life Generations contract may be made on a registered or non-registered basis. Some of the contractual benefits may be modified under the terms of a registered contract. All aspects of registration should be discussed with your advisor before selection of a product and before the purchase of a contract. Helping people achieve more TM FSC/FPO Canada Life and design and Helping people achieve more are trademarks of The Canada Life Assurance Company. * In Quebec, advisor refers to a financial security advisor for individual insurance and segregated fund policies; and to an advisor in group insurance/annuity plans for group products /08

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