Borrowing money to make an investment is a common strategy. The concept is to enhance the investor’s equity by borrowing to invest and increase the investor’s profit over what it would normally be without the additional borrowed funds.
Borrowing to contribute to a registered retirement savings plan (RRSP)
One strategy for peoples who do not have the cash is to borrow a portion, or all the funds necessary to make that contribution and partially repay the loan using the tax refund stemming from the contribution and the remainder from income over the rest of the year.
Interest on money borrowed to contribute to an RRSP is not deductible for income tax purposes.
Borrowing to buy a non-registered investment
Interest on money borrowed to earn income is deductible from income for tax purposes. This can be done with non-registered investments.
Relatively common strategies used by individuals include opening what are called margin
accounts with investment dealers. These allow investors to borrow against the equity in their
accounts within defined limits. The interest on the money borrowed is deductible, provided the money borrowed is used to buy additional investments.
The ratio of debt to equity must stay within defined limits, which may change over time. If the value of the equity in the account declines, the borrowers will be required to put up additional capital. If they cannot, the dealer will sell enough assets to maintain the required ratio.
While money can be made using leverage in periods of rising market, there are risks that should not be overlooked. Leverage programs should generally be considered long-term. Markets move in cycles and declines can be significant.
Those investors who do use leverage strategies should have income available to pay the interest or a possible margin call. While some people redeem units from their investments to pay interest, this strategy will reduce equity in periods of market decline and should be considered speculative and unsuitable for investors for reasons of age, income, and ability to withstand risk.