With a life insurance policy, you have to pay the insurance premiums. The amount you can invest is based on the size of the policy. Unless you need life insurance and will need it for the rest of your life (not just till you retire), then this method is far too expensive.

Also, you would pay more in MER for the principal guarantee after 10 years. Since the markets are so rarely down after 10 years, this extra MER is probably not worth it.

If you exclude the Great Depression, the last 10 years are the only 10 calendar year period in which the S&P500 was down since 1871. That’s 1 time in 130. To protect against this rare chance of being down, you have to pay a higher MER of .5%/year.

If instead you have high quality investments and have faith enough to stick with them when they are down, you have about a 99% chance of beating the investments you would buy inside the insurnace policy.

This probably becomes 100% once you include the insurance premium, which can be very high for the UL policy you would need to buy.

You can of course use your equity to invest in more real estate. However, growth of real estate has been far less than the stock market. The average house in Toronto in 1977 was $65,000 and was $379,000 in 2008. That’s growth of 5.9%.

The TSX in the same period has grown 10.5%. If you had invested that same $65,000 in the TSX in 1977, you would now have $1,430,000 and could buy 3 1/2 houses.

The rent generally only creates positive cash flow if you have equity tied up in your home.

Virtually every story I’ve ever heard about someone making money in real estate was actually a story about leverage working. Almost always, it is a good return resulting from the leverage effect on a slow-growth investment.

Most people are not aware that you can leverage similar amounts in faster growing investments. This can give you a far higher return than rental real estate over time, without the PITA factor of renting – that is if you are comfortable with the risk level and can stick with your investments long term.

I was heavily into rental real estate decades ago until I realized that I could make a lot more money without all the work.

Ed

Although the very “policy” you describe is not available in Canada, there is a variant of it, with a floor of 7% and no ceiling. I use this myself. All else is the same.

There is no reason why an other property could not be used for investment, except that the real estate values are slow to rise in value, in some markets it is stagnating for many years. The other thing is that it prevents diversity although that would be desirable in any investment strategy. So, I would suggest to have a property, but have also some equity and some dividend investment as well.

2) Isn’t it better to use your equity a second investment property anyway? (rather than invest the equity in the market). Given all the investment steams investment property gives you can have renters paying several properties for you. OPM my bretheren!

I’ll have to admit, I read your first post, then the most recent, skimmed some of Ed’s comments – For some reason I had the impression that there was a distinct possibility of uncertainty regarding your employment, and the possibility of moving also.

Given those assumptions, I thought there was a chance you might have to liquidate in the near-term – of which you obviously understand the risks.

I suppose my point is that instead of deciding to go all in, or not, you can take a balanced approach. Since it sounds like you had not been investing much in equities in the past, you probably have a somewhat limited feeling for the sting of watching your portfolio drop by >40%. My understanding is that you feel you would be able to stomach the volatility – but its impossible to know until you are tested.

So to your example of the 10k, you might have sitting around. Instead of using all of it for SM (i.e. paying into your mortgage and readvancing the HELOC), why not (i) pay $5k into the mortgage and borrow $5k for SM – put the remaining $5k into the RRSP and reinvest the return (either directly, or using the SM).

This ‘partial’ strategy would mitigate some risk – offer exposure to leveraged investing and the potential rewards, give you some time to assess the ability of your advisor, expose you to the stock market, pay down your mortgage, deduct taxes from RRSP contributions and the HELOC.

This does mirror my current approach – First, I do fully contribute to RRSPs. Then I apply the remaining funds (over the year) and the tax rebate to my non-registered portfolio then mortgage at 70% to 30% rate. I have seriously considered the SM (a partial version anyway) – but would like for the World economic situation to settle down and stabilize.

“If you don’t do the SM and invest – if you lose, you can cut your losses there. With the SM – not only is there a possibility of eating those losses, but also getting stuck with a nasty loan.”

If I can make reference to Ed’s advice to me earlier, these are the words of an investor with a shorter term horizon for investing. I will not know if I won or lost for several years. If I invest right now I fully anticipate I will be on the downside for 2 years or so, but the investment certainly doesn’t end in 2-3 years. In fact cashing out in 2 years or so is what I think Ed is cautious of me doing. He’s probably seen tons and tons of people do that. Cutting the paper losses is a short term view. I’m assuming the losses will not continue for 15-20 years (assumption from historical returns on stock exchanges). How would I get stuck with a nasty loan? Yes, if I cashed in early the leveraged investments would greatly amplify a loss. Over the long haul I believe I will be ’stuck’ with a significant gain.

I’m viewing the SM in the same way as a typical couple views their house. If the value of their house dips, they don’t sell, they need a place to live for the rest of their lives. Sure if my portfolio drops in value I won’t sell, I still need a pension for the remainder of my life. The average couple may change houses as their needs change, and yes over time the fund manager/financial adviser, would alter things in my portfolio.

So let me ask you this, in order for you to defend your position: If you had 10K and 10K left of RRSP room to contribute, and No SM in place at the time, would you put it into RSP in Investment A, or would you use the SM and only leverage $10K of your home’s equity and invest the 10K in investment A ? Obviously there are benefits and drawbacks to each.

Earlier, I mentioned how I ask in several places and look for discrepancies, you seem to lean towards RRSPs first, while Fraser Smith leans the other way.

If I were you, I’d be a little careful treading so quickly into the SM. From your posts, it sounds like you don’t have too much experience with investments – so my question is why would you borrow money to buy investments? Instead of making such huge prepayments, invest your earned money.

My view of the SM is that there are two significant risks. One, you mention is of the holdings themselves, if the investment vehicles selected have decent growth and will yield some form of steady and appreciating income (whether interest or dividends or capital gains).

The second risk comes from the leveraging aspect. If the above falls through (i.e. dividends get cut, you suffer capital losses, inflation overtakes and eats away at fixed income returns) – then you are left with a significant loan.

If you don’t do the SM and invest – if you lose, you can cut your losses there. With the SM – not only is there a possibility of eating those losses, but also getting stuck with a nasty loan.

If sounds like you have significant earning potential – so if you can bank $62k to top up your current mortgage, why don’t you just split that in this coming year, start a solid investment portfolio (simply by maximizing your RRSP contribution you have thousands of $ returned/saved every year in taxes) – and if your advisor can prove their ability, then and only then consider the SM.

Good luck!

This used to involve going into the branch for an adjustment each month.

I gather from the opinions on this blog, the Scotiabank STEP is not a well suited product for SM. *It would appear that it has improved.* But that is not necessarily to say it’s a good fit with SM.

I’m using STEP because I’m halfway through a closed term with them already, because I was approved for 80% of my 440K appraised house 2 years ago, (vs 65% of the current value of 400K) and because my LOC is at prime (instead of prime +1, which appears to be the going rate).

Ed, Thanks for your feedback. I do wonder if you’ve arrived at your suspicion of non suitability for SM without sufficient evidence. In the past few days I have researched a great deal on leveraged borrowing. Here’s more.

First, regarding point about my knowledge, I believe I’m much more knowledgeable around investments than you suspect (Bachelor of Commerce degree – book knowledge granted), and yes I’d agree that I was not using terms dividend & equity properly. ‘Income’ 25% & ‘Growth’ 75% would have better terms. I do admit I’m not nearly knowledgeable or experienced enough to put together a proper portfolio, nor do I wish to.

The financial planner’s job is to select suitable investments/funds, develop a plan etc. My job is to determine the proper financial planner, and to follow his plan.

As you pointed out, I do carry risk by the very nature of being single, and with a variable income. For this reason, I’m very careful with my finances, I make substantial prepayments on my mortgage when I can (62K last year) and take comfort in knowing that I can ’skip’ multiple mortgage payments if I’ve made doublepayments or prepayments in the same calendar year. Also, I have secondary income, that pays 75% of my mortgage. I do anticipate that a financial plan suited to me would address variable income issues, and likely I’d end up sacrificing some long term growth to mitigate the this risk. I’ve been self employed in oil & gas consulting for 8 years, and I think I put in safeguards to address variation in income.

I’m somewhat caught. I wish to establish distance between myself and the activities of my yet to be determined financial planner. Yet, I feel a little knowledge goes a long long ways. I’ve averted huge mistakes by asking around and informing myself. I do not have the experience to know when I’m being ’sold’ a financial fund/policy/product that I’m not suited for, so I do ask more than one source, searching for discrepancies. So no, I’m not deciding what to do with the information I gather from multiple sources, I’m determining (as best I can) whose opinion is suitable and sound, and whose is suspect.

I disagree with your inclination that I may be one of the people who don’t stick it out over the long haul. Here’s why: Unfortunately, I did witness someone leverage their house who was very risk adverse, she was in her 60s, her time horizon was intended to be long, but she bolted, and liquidated her assets with a small loss. If I go into the SM, I do so with evidence that those who react/invest/divest based on natural market fluctuations are have a high likelyhood of being hurt. I’m a believer in DCA, and long term, buy and hold strategy. I feel that I’m extra likely to tough it out when the markets are bearish, due to what I witnessed.

Ed I feel the SM is not where the risk lies. The risk lies in the investments themselves. I’m cautious about talking myself into something that I should steer clear of. I’m also aware that I need to start to establish a pension plan, as I won’t have an adequate one on my own. If I go ahead with SM, I do so to establish a pension. I do take stock in your comments about my suitability. If you truly think that SM would be a bad decision, I admit it would weigh heavily on my decision. This is why I’ve given you extra details.

Downsizing your home in the future should not be a problem, since you presumably would be buying a new home for less money. You can take the difference and pay your mortgage/HELOC down to the point you need or can finance on the new home.

The issue with moving is mainly if you move to a more expensive home, since you need to be able to make the down payment.

From all your comments, the SM might not be right for you. You seem quite concerned about the markets, which makes me wonder if you would be able to stay invested the next time your markets go down.

You seem to be trying to get info from a bunch of places and then decide yourself what to do, but you do not sound very knowledgeable about investments. Dividends would also come from equities, so being 75% equities and 25% dividends would be the 100% equities.

If a prolonged period of no income with a career change is possible for you and since you are single, this is also an issue. You need to be able to maintain the SM as a long term strategy to be confident it will work for you, which means it is best if you are confident that you will always be able to make your mortgage payment.

This can be dealt with, however, if you have an adequate emergency fund and protecting your income.

This may make sense as a calculated risk, however, since all you need to do to maintain the SM is to maintain your mortgage payment. Even in a worst case scenario if you cannot make your mortgage payment, you could always draw on the investments to help make your mortgage payment. This would affect the tax-deductibility of your investment credit line, but is still an option in an emergency situation.

Ed

2) Although applying for credit does lowers your credit rating in general, once you have your LOC, you qualified for it, the only thing that matters is your payment habits. Pay your monthlies on time and your rating will be fine.
That in turn will help you when you buy a second house.
If you just change your house for an other one, as long as LTV and credit rating is ok, you will have no difficulty to carry with you your SM Plan. Nor would it be necessary to liquidate any investments.

I do note that there are side effects to this manoeuvre.

1) Should a couple start SM with a larger house, then find their house has become an empty nest and decide to downsize, they may need to liquidate a portion of their portfolio earlier than they had expected, thus the timing of their house sale will also be when some of their portfolio may need to be sold. For me, single, younger, with a larger house appraised at 440K – Heloc based on 80%, a mortgage of 250K, and 100K LOC, (350K Global limit) if I moved I would probably have to take a new mortgage on a smaller house, (using Stated Income as I’m self Employed) and therefore the institution would lend only 65% of appraised value. I would have to liquidate much earlier.

2) Credit Rating, This one is a bit of a mystery for me as I’m uncertain how much this is affected by a maxed out LOC. Some people may not utilize the entire LOC, only using 75% or so, but since the LOC can’t be used for much else except investing (due to the CRA necessity of interest tracibility) , you give up a lot to preserve the credit score.

Still working on a solid investment portfolio. Looking at 25% of portfolio in dividends. Remainder in Equities. In the immediate near term I’ll leave the equity side alone. I need more help in this investment side. The advisors that I’ve met so far seem to more skilled at tax, than at well researched mutual fund setups.

thoughts?

There are too many uncertain ruminations and too few actual calculations in your reply.
Indeed you must decide what you want to be when you grow up. The question is, how long are you planning to delay that decision. If you like, you can send me your phone number in private, I call you and we can sort out the philosophy problems. The rest you can do yourself easily.

Sandor

Also, nobody on this forum has a personal interest if I invest or walkaway. That is, your opinions are not paying your bills. This morning, I have had 2 opposite opinions from advisers as to the suitability of the SM for me, strangely each advisor worked for the same company, and each had different ideas of what investments work best. Yesterday, I had a mortgage broker tell me the Only way the SM would work is if I got a firstline mortgage and dumped my Scotia STEP mortgage, incurring the $2300 penalty. If it were not for the online information I would believe her ludicrous statements.

Although I know you are biased, based on your earlier posts, thank you for admitting it.

You are partially right.
I have decided.
I have decided that paying down a mortgage as fast as possible, sacrificing investing, not even holding a single investment, is not the best plan for our population.

But is it right for a self employed single individual, who may need to change his course of action in the next few years – examples, move to a different residence(causing a refinance on primary residence), prolonged unemployment/career change, the strong possibility that the prime rate will rise in the next 5 years (I suppose this applies to everyone), narrowing the necessary margin.

But as I see it, and even the book coincides, the tax deduction’s effect is not nearly as great as the investment appreciation. The question I need to figure out is do I want to become an investor, and if so do I wish to become a leveraged investor? (yes I know the book says it’s not leverage, debt transfer instead, but I call it as I see it). I suppose when I really look at it, I’m scared. The Interest deductability portion of the SM makes sense, but has a negligible effect. You mentioned, I’d be taking advantage of a turn around in the market, and this comment is what scares me. I’m not especially risk adverse, but when the dollars are sizable like they are, things change.

If there is one single thing that makes a great amount of sense in investing at this volatile time in the world is that the time for the market to recover has a long time span, whereas investing after I’ve paid my house off will provide a much shorter time span.

At its root SM is more of an investment plan than a tax avoidance plan. And I need to choose if I’m to be an investor.

You are definitely decided.
If you do not trust anybody else, why turn for unknown people for advice?
But, be that as it may, your misgivings are not well founded.
I am proudly biased and can submit to you that this difficult time is ideal for investing (in the right instrument!) and the market is not volatile now but rather clearly sinking.
If your house is loosing value then you should take advantage as long as it is worth its present value.
You do not need an advisor to think about the long term prospects you are facing:
If you pay off your house first, all you will have at the end is a paid-off house whose value has diminished in comparison to what you paid for it. At the same time you shall miss out on the market.
If you do the SM, you will have taken advantage of the turn around in the market, having bought investments at a huge discount, and will have accumulated value that will far outstrip the value of your house.
In other words your present strategy and the SM are moving into opposite directions. The latter having a definite advantage.
See what each would do for you in 10-12 years!

Sandor

Self Employed for 10 years, with highly variable income. Very aware of my finances. Single, 37, . Earn between 50K – 100K per year. My home is my only investment. I’ve never used an RRSP or the savings plan. I already have the STEP product from Scotiabank, with 110K unused Line of Credit at Prime. I live in Calgary, and my house is worth around 400K, and likely depreciating. I have 250K remaining on my 5.35% 5 year fixed closed conventional mortgage,. The original principle was 327K. 2years remain on the term. I frequently make double mortgage payments and have made the maximum 15% (50K) prepayment against my mortgage last year and am thinking of doing the same this year. Any investments I had went into my downpayment, 3 years ago.

My credit is quite strong. I have no pension plan. I mistrust financial professionals, and their motives, but admit good ones have a place.

Although I’m not much of an investor, actually not an investor at all right now – except into my house, I am quite aware of financial matters and products. Although, my mortgage is amortized for 40 years, I disregard the payment plan, through prepayments and double payments. Remaining Amortization is scheduled for 15 years.

Given the Prime on my 110K LOC at 3%, the extreme market volatility (I don’t know of a solid investment that would even break 3%, my highly variable income, and the crappy housing market, I’m torn if SM is for me, or if doing what I’m doing is the best route.

I suspect that with the accelerated mortgage plan I’m on (I used the calculator, constructed for this SM comparison) the tax deductible interest payments will have a very small effect for me. Leaving SM as a leverage tool for borrowing during a less than ideal time to make a Large first lumpsum payment.

Thanks for any unbiased opinions! (Yes I know that’s what a financial planner is for, but their opinions are the ones I trust the least, I trust my limited knowledge over the biased actions of a planner).

cl.

“The SM is effective as a long term strategy for those that can tolerate the higher risk. Many tests have consistently shown that trying to time the market reduces your returns a lot. This is especially true near market bottoms. In generally, we would strongly recommend against trying to time the market while doing the SM.”

That being said, would you not concurr that with the market conditions the way they are right now, it may be an optimum time to start an SM implementation? Alas, I suppose this is nullified by the fact that LOC borrowing in the early goings of an SM would be small, due to the high-interest/low-principal condition of the mortgage payment.

About your situation, Royal usually will allow you to convert your regular mortgage to the Homeline with no cost (or at least our contact does). So, you can start the SM without paying a penalty.

It would not be worth the cost of the penalty for a mortgage coming due this year, but in your case, you can avoid the penalty. In November, you can shop around for the best SM mortgage.

There are 7 mortgages that work in varying degrees for the SM. Only 3 are available through mortgage brokers. Generally the best ones are with the major banks and are not available from mortgage brokers. Royal is quite good, but has some restrictions.

There are a couple of articles on MDJ about what to look for in the best SM mortgage, but in short, you would want to have the credit line limit automatically increase with each mortgage payment and to be able to invest directly from the credit line. Banks are almost always wrong for some reason about whether or not you can invest directly from their credit line, so don’t take their word for this.

If you want a referral in November, we have a free SM mortgage referral service if you answer 10 questions on an article on MDJ.

You may not necessarily be right for the SM, though. The risk of leverage is higher than investing your own money. You state your risk level as “moderate”, you seem concerned about making a profit every year, and you seem to want to time the market by waiting until it hits bottom. All 3 of these imply the SM may not be right for you.

The SM is effective as a long term strategy for those that can tolerate the higher risk. Many tests have consistently shown that trying to time the market reduces your returns a lot. This is especially true near market bottoms. In generally, we would strongly recommend against trying to time the market while doing the SM.

Ed

There seems to be a misconception from many people on this site that receiving income is required for interest to be deductible. Let me quote directly from IT-533. To be deductible, you need to have “borrowed money used for the PURPOSE of earning income”. The key is the word “purpose”, which is also bolded in IT-533.

“Normally, however, the CCRA considers interest costs in respect of funds
borrowed to purchase common shares to be deductible on the basis that there is a reasonable expectation, at the time the shares are acquired, that the common shareholder will receive dividends. Nonetheless, each situation must be dealt with on the basis of the particular facts involved. These comments are also generally applicable to investments in mutual fund trusts and mutual fund corporations.”

Then it gives 2 examples. Interest is not deductible for R Corp. that has a specific restriction of not paying dividends, but interest is deductible for S Corp. that always reinvests all of its cash flow and never pays a dividend. This is because it COULD pay a dividend sometime in the future.

It also spcifically says: “courts should not be concerned with the sufficiency of the income expected or received.” Whether your investment ever pays enough dividends to cover interest is not relevant. As long as you invest for the PURPOSE of earning income and it COULD one day pay income.

In short, almost any mutual fund or stock is fine. We generally focus on very tax-efficient investments that may pay little or nothing in taxable income for many years. Any tax you pay along the way generally reduces the long run return of the SM.

The best advice is to invest based on the risk/return of the investment. Buying investments that pay dividends is generally a sound and somewhat defensive strategy, but it does usually leave you with very little diversification – and the payment of a dividend is NOT relevant to the intest deduction.

Ed

I found both arguments sound, I am 39 and my risk tolerance is medium (3 in a scale 1 to 5). I think I can afford a bit of downside.

I have not gone that far yet as for the details for the mitigation strategy, I have considered the TFSA as one measure but any suggestions are welcome.

As for the investment strategy, in the first years I am expecting a return that will not jeopardize my tax deduction claim, there might be one or two years where there return may not match the interest from the HELOC, would the CRA ding me then?

Thank you

JG,

I wouldn’t wait.
Although Brian is correct in setting conditions for breaking the mortgage, If you calculate how much cash would be liberated for the purpose of investing by converting your mortgage to a LOC, you will find that the cost of penalty would be recovered in about 5-6 months. (In the absence of concrete numbers it is hard to be accurate.)
On the other hand the success of your investment strategy is a temporary factor. The requirement of tax-deductibility is not success, but a “reasonable expectation of making an income.” If your investments don’t pan out iin one year, they will in the next. What you must take into account is your age and income: can you afford to have some losses and do you have enough time to wait for the recovery.
I personally consider the SM a better alternative to the RRSP and as to the TFSA, that is for people who have maxed out their RRSP.
Brian is also correct calling your attention to risk mitigation. That is even more important if you do the SM.

Sandor