Given that Canadians’ debt loads and the volume of official warnings about the perils of rising debt are both soaring ever higher, the title of a new book by Talbot Stevens, The Smart Debt Coach: Secrets of the Rich to Increase Your Wealth and Security, is timely.
While the title may be fashionable, the London, Ont.-based financial speaker and author’s book offers a unique take on a lot more than just the question of debt. In short, the book covers the difference between good and bad debt as well as promising how to increase savings and investment returns.
The book is written in the conversational style pioneered by David Chilton’s The Wealthy Barber, a format that might not appeal to all readers. It also features some concepts and strategies that are somewhat controversial.
Chief among those is Mr. Stevens’s advice that people should borrow to invest, which seems odd given his acknowledgment that a sizable percentage of Canadians carry debt “up to or past their eyeballs.”
His call for people to take on investment debt boils down to his definition of what constitutes “good” and “bad” debt. Much household debt is of the bad kind: double-digit interest paid to stubborn credit card balances, excess vehicles in the driveway, expensive home renovations paid for on a line of credit.
His definition of bad debt is simple: “Anything that doesn’t increase your net worth by increasing your income or some asset’s value in the future.”
Though the bad debt side of the equation is fairly conventional, his call to “invest like the rich do” is not. Mr. Stevens’s underlying premise is that the rich are different than the rest of us, and yes, they invest differently, too. They are not afraid of debt and use it to increase their wealth through investments rather than as a way to supplement their income and lifestyle like the majority of people.
He gives the example of someone presented with a $20,000 windfall from a bonus or inheritance. “You could use that, of course, to pay down your debt,” he said.
The wealthy, however, might take that money, pay down a debt and then turn around and borrow the same amount to invest outside their RRSP or TFSA to make interest on the loan tax deductible. “The government is essentially assisting you in the creation of your future investments which, of course, they are going to tax you on.” He says this “debt swap” manoeuvre is more effective than simply paying down a debt.
The financial adviser does not overlook RRSPs. In fact, he believes that most people grossly undercontribute to the federal tax deferral program, an issue he refers to in his book as putting “dry pasta in your RRSP.”
He gives the example of a person making a $3,000 contribution to their RRSP, a figure that is pretty close to the national average, by the way. That’s dry, uncooked pasta in his analogy, versus the plumped-up cooked stuff.
People need to rethink RRSP contributions altogether, he says, and dramatically increase them. The $3,000 average contribution, he notes, is made with after-tax dollars and a person would have to earn $5,000 in the first place to make that $3,000 contribution. And because that $3,000 will be taxed again whenever you pull it out, say at a rate as high as 40 per cent, you should account for that. The industry, he adds, has not cottoned on to the idea of accounting for the withdrawal, he said, but at least has begun arguing that people should invest any tax rebate in their RRSP.
While people can either save or borrow to contribute more to their RRSP, he is more definitive on the subject of investments outside the RRSP: leverage is the way to go, although it is viewed as a dirty word by many.
“How can you outperform the market? Again it goes back to the mindset of the wealthy. They don’t borrow to buy when the market is high. They borrow to buy more businesses, competitors, real estate, stock market investments …when the market is down.”
Mr. Stevens, a self-admitted statistics geek, has charted TSX market data back to 1957 and has found the annual return to be about 10 per cent. What he has found is that the market typically does well after an off year: an 18-per-cent annual return for an investment made after a year of negative returns for the exchange and a 25-per-cent return following a 12-month period when the market has been down at least 15 per cent.
On top of using leverage, the author has just introduced two more dirty words: market timing. “My response to that is I can completely agree, trying to be more effective with market timing with your own cash flow is not going to work,” he said. “But what I am trying to be clear in differentiating is that when you borrow to invest lots, market timing isn’t just neutral it is critical.” That’s because there is an explicit cost, namely the cost of borrowing to buy investments.
“If you ever wanted to use your full capacity [to borrow to invest] it should be one of those very rare times when the market is down, say, 50 per cent.”