A debt recycling strategy is a useful financial strategy that enables a homeowner to take years off from paying the mortgage. The strategy involves taking out a line of credit or restructuring your debt where your primary residence is used as collateral to invest in a portfolio of shares or an investment property, the benefit of doing so is that the interest charged for investment purposes can be claimed as a tax deduction. This strategy isn’t a silver bullet for financial freedom as it warrants consideration. Here’s 7 tips that every 40-year-old should know about paying off their debt faster and using leverage to get ahead in life:
1.Debt can be used wisely
Conventional wisdom teaches us that all debt is bad and that we should aspire to be debt free as soon as possible. The financial reality is that access to credit and used responsibly allows us the opportunity to invest in companies or real assets that produce income. This additional income can be reinvested and compounded where we as the investor accumulates more capital (investments i.e. portfolio of shares). Debt recycling doesn’t equate to being debt free in a shorter period, it entails that you transfer non-deductible debt to debt that can be used as a tax deduction – learn more about the strategy here –
[If you’re looking for a how-to guide on paying off your mortgage faster – you can download our strategy booklet here]
2.Leverage Amplifies Gains (And, Losses)
Leverage magnifies both gains and losses by using borrowed funds to increase investment exposure. While it can amplify returns when asset prices rise, it equally increases losses if prices fall. This heightened risk makes leverage a powerful but risky tool, requiring careful management to avoid significant capital erosion.
3.Understand Your Relationship with investing
Money can bring out a spectrum of emotions. Every individual has a complex relationship with their finances and how money can affect their welfare and living standards. There’s been an increasing focus in the world on finance on investor psychology, and how our personal biases affect our ability to make decisions on investing. It’s important to consider your risk tolerance and whether using debt is palpable.
Partnering with a financial advisor can help unlock any of these emotions and put the fears, uncertainties and doubts into perspective. They also put together a portfolio of securities that give you a greater control over the strategy.
4.Make sure you’re protected on the downside
It’s wise to plan for the worst-case scenario – what if things didn’t go according to plan?!
Some of these worst-case scenarios include:
- Market downturn (correction)
- Getting sick and not being able to work
- Emergency fund (job security)
It’s always pertinent to keep cash at hand in the event of a rainy day. Not to mention personal insurances if you couldn’t work due to sickness. An advisor can put a get out clause to mitigate a worst-case scenario. In respect of market downturn or a black swan; nobody has control of what the market does particularly in the short term. A means of protecting yourself against systematic risk may include protective puts in your portfolio or keeping a cash/equity reserve to buy the dip. In the long-term markets are more predictable as the law of averages take over.
[Download our insurance booklet here]
5.Ability to dollar cost average into investments
Dollar cost averaging involves investing a fixed amount regularly, regardless of market conditions. This strategy mitigates market volatility by purchasing more shares when prices are low and fewer when prices are high, resulting in a lower average cost per share over time and reducing the impact of market fluctuations on investments.
6.What’s your cash flow and tax rate
Gearing and leverage benefits people on high tax brackets; as a general rule of thumb a debt recycling strategy benefits people on a marginal tax bracket above 34%. It’s also important to consider rising interest rates and the sensitivity of interest rates on your cash flow.
7.Double the risk, double the time horizon
Time in the market generally leads to better returns due to compounding and market growth over the long term. Using leverage can effectively double an investor’s time horizon, helping to smooth out short-term volatility and mitigate risk, as longer-term investments tend to recover from temporary market downturns.
In summary, debt used in a prudent fashion can be structured in a way that can pay off our mortgage sooner. It involves restructuring the debt from non-deductible to deductible and accumulate a portfolio of securities. Partnering with a financial advisor can help you put together a strategic plan, structure and discipline to get ahead of the curve in achieving your financial and lifestyle goals.
