October 1995

How to Earn Over 25%
Interest Guaranteed

© Talbot Stevens

Without a doubt, the topic that attracts the most attention at every workshop I give is how people can earn over 25% interest guaranteed.

As an investor, you are only concerned with your after-tax returns, the amount you get to keep. For the majority of Canadians in the middle income bracket, the tax rate on our favourite investments — those that are ‘guaranteed' and pay interest, like CSBs (Canada Savings Bonds) and GICs — is a little over 40%.

So when we buy a 5% GIC, that is the gross or before-tax return. Our after-tax return is 3%, because we pay 40% of the total to the government. If you could get a 25% GIC, you would lose 40% of that to income taxes, for an after-tax return of 15%.

Let's consider personal debts. If you paid down a 15% debt, like a credit card for example, what rate of return would that be?

Since all personal expenses are paid with after-tax dollars, the after-tax return of paying down any personal debt is the interest rate charged. So paying off a 15% debt is an after-tax return of 15%, the same return as we would get from a 25% GIC.

Department stores charge 28.8%, compounded monthly, which means that the real after-tax interest charge is 33%. To relate this to the before-tax equivalent, paying off a 33% debt is the same as getting a 55% GIC.

If banks advertised 55% GICs, you wouldn't be able to drive down the street for people lined up to get inside! Ironically, millions of Canadians buy CSBs and GICs paying less than 8%, while turning down guaranteed returns of 25% to 55%.

Equivalent GIC Rates for Debt Paydown for Someone in the Middle Tax Bracket (40%)
Type of Debt Interest Charged (After-Tax Returns) Equivalent GIC (Before-Tax Returns)
Mortgage 10% 17%
Credit Card 15% 25%
Department Store Card 33% 55%

One of every two credit card owners pays off their cards in full every month. This means that 50% of credit card owners can start to earn guaranteed returns of 25% to 55%, and the other 50% already are.

Even if you do pay off your cards in full every month, most of us still have a mortgage. As shown in the table, paying down a 10% mortgage is the same as getting a 17% GIC, a darn tough investment to beat.

Does all of this mean that debt paydown is your best investment? Not necessarily, as we'll see later.

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