I just noticed your post. We are not really fans of ETF’s or other index products. We work with what we call “All-star fund managers” that have all beaten their indexes by wide margins (3-5%/year) over long periods of time (15-30 years). There are fund managers that know how to take advantage of systematic inefficiencies in markets. They are often less risky than indexes as well.

With ETF’s, you still need to decide which ones to own, which means that your portfolio would still be an amateur portfolio. If you want professional advice with investing ETF’s, you would likely pay at least 1%, which would mean lower than index returns. We would prefer to have the best professionals manage our clients investments.

We think amateur ETF investors will generally make less than amateur index investors, since ETF’s have a huge temptation to switch them and buy at the wrong times.

Most ETF investors will buy whichever ETF is “doing well”, which means they will consistently buy high. Studies also show that 80-90% of all trades by all investors are stupid, so almost any strategy involving fewer trades beats almost any strategy with more trades. ETF investors tend to trade more often than index investors.

In short, we are not fans of ETF’s either as an amateur portfolio or as part of a professional portfolio.

Ed

You’re still the customer in the transaction and I could understand your advisor concerned with the risks involved in leveraged investing, but at the end of the day its your decision. My father did leveraged investing for 20 years with a full service broker – without issues.

I’d guess he’s reluctant because your proposed move from mutual funds to ETFs means a potential reduction in commissions (or trailer fees) to the advisor.

Thanks for the confirmation.

I am trying to learn how to invest efficiently via learning from you, FT and everyone here. My advisor is not interested in the SM and he doesn’t care about what we can achieve through the SM.

Yes. I am thinking of reinvest LOC to ETF after it grows up. What is your suggestion?

Thanks again,
Julie

As long as 100% of the ROC distribution is paid down onto one of the investment loans and you can trace it, you should be able to deduct all the interest from both loans.

The other option that is usually better is to just have all distributions reinvested.

What are you trying to accomplish, though, Julie? It sounds like you are trying to get out of the leverage or invest differently – is that right? Why do you want to take money out of the invetments to pay down on the loan (as opposed to trying to maximizing the investment nest egg long term)?

Ed

Could Ed confirm it? I don’t know any accountants.

Have a nice weekend!

Julie

I have some questions to bring up.

I am doing a sort of SM. I have two portions of investment loan invested through a financial advisor. I don’t think he is knowledgeable as Ed. Thanks Ed for sharing such important investment knowlege with us).

One investment loan is borrowed from B2B and invested in two CI funds with monthly distribution. After checking T3 form, I know the distribution of one fund is consisted of ROC and interest . I also have another investment loan borrowed from LOC which also pays both loans interest. If I want to cash out ROC, can I return ROC to LOC loan to avoid of reducing loan tax deductibility? The reason is that B2B will not take back a small portion of return – monthly ROC, and I don’t want to reinvest the ROC which will go to back end of the fund.

Thanks a lot!
Julie

[...] Is 100% Tax Efficient Investing Possible? (30 comments) [...]

Yes, I’m sure. The difference comes down to procedure. Tim Cestnick is right that you can’t just withdraw capital gains. However, you can if you cash in everything and then reinvest.

For example, let’s say you invest $100,000 and it grows to $200,000. If you withdraw the amount of gain – $100,000, then 1/2 of it is your principal and half is your growth. You cannot just withdraw the $100,000 gain. Any withdrawal is considered to be 1/2 your capital and 1/2 the growth.

However, if you sell the entire investment, then you can withdraw the $100,000 gain and then immediately reinvest the original $100,000. This way, the entire $100,000 gain is taxable as a capital gain, but this allows you to withdraw the amount of the gain and then reinvest your capital again.

Ed

You caught me – when I implement the SM I will actually take on more debt than I did with the original mortgage and will not be based on current investment streams or other calculations akin to “Rempel Maximum”.

I’m comfortable with borrowing (when the time is right) for investing in solid companies keeping a long term (>15 years) view. I’m not looking to get rich quickly, just get more comfortable, more quickly.

I will heed your advice in investigating any pitfalls to setting up a structure which would allow the investments to ’self fund’, i.e. after tax cost of borrowing = after tax revenue in dividend income.

It is possible to withdraw capital gains without affecting your loan interest deductibility. If you sell an investment and pay the amount borrowed down on your credit line, then you can use the capital gain any way you want. Then reborrow the same amount and invest it again.

It is all a matter of traceability. You can’t just withdraw the gain, but if you follow the procedure above, then you are fine.

Mutual funds allow you to get around this by paying capital gains distributions. You can have them paid in cash without affecting your interest deductibility.

The general rule is that any income paid to you that you pay tax on (dividends, capital gains distributions or interest), you can withdraw (or spend or pay down on your mortgage). Any amount paid to you tax-free (ROC distribution from a mutual fund or an income trust) reduces your loan deductibility on that amount.

Ed

If you get the chance, please read this article:
Key Considerations to an Investment Loan

Ed, you said:
>I would recommend against paying any distributions onto your >mortgage, unless you know what you are doing and how to do the >“Snyder tax calculation” to figure out how much of your credit line >interest is still deductible.

“Do 100% tax efficient mutual funds have the same performance as a 75% tax efficient fund? Seems a little silly to focus on paying less tax if the consequence would be lower returns.”

In general, more tax-efficient funds tend to have somewhat higher returns. This is an interesting point and possibly the topic of a future article.

In comparing any 2 investing styles, almost always the one with lower turnover (fewer transactions) out-performs. This explians why:

1. Every study shows that women are much better investors than men.
2. Studies show market timing strategies reduce returns.
3. Technical anaylsis (charting) usually does not work.
4. Day traders usually lose money in the long run.
5. The average mutual fund makes less than their index.
6. The world’s top investors and fund managers are usually buy-and-hold investors.

Any study I’ve ever seen comparing 2 investing styles almost always shows that the one with fewer transactions wins.

This is not just because of trading costs or taxes. Most investing strategies still end up with buying and selling at the wrong times (buying high and selling low).

One huge study done over 10 years of all transactions done in a number of discount brokerage firms showed that most of the time, the investment any investor sold out-performed the next one they bought. Think about that every time you are considering a transaction.

This same reason means that tax-efficient funds in general have higher long term returns than less tax-efficient funds.

Ed

We use some 100% tax-efficient funds, but also some that are less tax-efficient because of the risk/return and quality of manager.

CC, by comparison, the equity index funds that have been around for 10 years are mostly between 85-95% tax efficient. Indexes normally have a turnover of 10-15% of their holdings each year. This is quite a bit lower than most funds, but many buy-and-hold funds can have far lower turnover. One of our fund managers has an average turnover of only 4%/year – less than 1/3 of the turnover of his index. Warren Buffett’s turnover is similarly low.

Ed

The issue with fees and MER’s is to get value for your money – not just cheap. If you want to have the world’s best fund managers working for you, you can’t expect them to be cheap.

If you want to find Tiger Woods, don’t look among the low-priced golfers!

The difference with Universal Life insurance policies is that you are usually not getting anything for your extra fee. The higher cost is for insurance for life and is a waste of money unless you actually need insurance for life. And you can almost always get the same investment outside of your policy for less money.

Have you looked at this AIC fund, Sam? It has beaten the TSX Composite by 2.3%/year compounded since inception 21 years ago. This is AFTER the 2.47% MER. And it has had zero distributions of any kind. I think this is good value for the MER.

While we don’t use this particular fund, all the fund managers we use have similar profiles – they have normal to slightly high MER’s, but despite that, they have all beaten their index by a significant margin for a minimum of 15 years.

Ed