They are rolling 10-year periods ending at the end of each year – not rolling decades. That is why there are 129 periods since 1871.

Ed

It is not 129 of 10 year periods. It is 12.9 periods.

His ‘large portfolio’ is half the value but the loan (equivalent to mortgage) is large as ever. And to add insult to injury Mr. Smith has no taxable income so no tax benefits currently. Welcome to real world, Mr. Smith

Most people think the markets are far more risky than they actuallly are. This is why the benefits of seg funds are emotional – not financial.

Let’s quantify this risk/return. We have the S&P500 total return by calendar year since 1871. It is the most broad-based index for which we have a long history.

In that period, there have been 3 times when the S&P500 was down over a 10-year period. That is out of 129 10-year periods. Therefore, the S&P500 has only been down 2.4% of 10-year periods.

Two of those 3 were during the Great Depression (1929-38 and 1930-39) and the other one was 1999-2008.

The worst ever 10-year period was a loss of 1.47% comounded. This is a loss of 13.8% in total.

If the seg fund has a higher MER of .5%, then the total cost over 10 years is 5.1%. If the index is down 13.8% and the cost of the guarantee is 5.1%, then the net gain from having the seg fund in the very worst 10-year period ever was a saving of 8.7%.

So, with an investment of $100,000, in 3 of 129 cases (2.4% of the time), you would save money with a seg fund with the highest possible saving being $8,700. However, in 126 of 129 cases (97.6% of the time), the fund is up so you just lost the $5,100 cost.

I realize this is over-simplified, since this is only calendar years, other indexes are less consistent, specific funds can be worse, and being able to switch between seg funds significantly increases the chance that you will be down over 10 years.

However, many seg funds are balanced funds or even bond funds, which are laughable. Who would ever pay a seg fund guarantee fee for a balanced or bond fund?

My point is that the risk is far lower than most people think and the cost/benefit vs. the amount you would save/lose is highly against you.

Why do you think insurance companies offer them? They are taking on the risk but have a very high chance of making a nice profit.

We think seg funds are okay if it means you would invest more in equities in your portfolio then you would otherwise or if market risk really keeps you up at night.

The bottom line, however, is that the benefits of seg funds are emotional – not financial.

Ed

As usual, I beg to differ about the attractions of segfunds. In my opinion they are ideal for the purpose of SM, precisely because of their guarantees, by virtue of reducing the risk inherent in investing.
Contrary to Ed’s assertion, the cost associated with those guarantees are not really too high. The ones I am using are charging 0.3%. This, added to the basic MER, would amount to 2.3-2.7% all told, well within the range that most mutual funds of comparable profile would charge, but with full exposure to market risk.
I also disagree with the claim that most markets would customarily rise over ten years, therefore the guarantee is worthless. Although it is true that the markets do rise over the long term, but if they crash only once in that ten years, (a traditional occurrence), and the crash happens exactly at the time when you wish to liquidate, at the end of the period, then it really doesn’t matter how they had risen in the years before: you can still suffer a loss.
The guarantee especially welcome in case there should be more than one contraction in the market: the periodic resets of your capital in its effect protects you from the volatility: in fact you can insure your gains, while reducing the risk of losses.
The segfunds I am using refund the extra MER at the tenth year anniversary. It is true, that this is less money than the future value of the same amount would be, but the difference is the cost of protection.
So, for example, if you insure $100,000 with the guarantee, it will cost you (0.3%) $300 yearly, or $3,000 over ten years. Had the same amount been invested at a 7% return, it would have earned $2,025. This is the opportunity cost of the guarantee. But if there were losses over the period, then this amount also would have been subject to those losses, so, this would be less too, while your capital would be safeguarded against those losses.
It is also mistaken that you have to keep the fund for ten years in order to qualify for the guarantee. The only restriction is that you must remain within the same group of funds, i.e. stick with your investment company. Within the group of funds you can freely move your money from one fund to the other without any restriction. This enables you to balance and rebalance your portfolio according to your needs.
The specific guarantees were introduced only 4-5 years ago, so in fact, so far nobody really has benefited from them yet. But suppose, they were in effect for ten years already, those trying to take advantage this last February, for instance, would have faced the 30-40% losses without it, or no losses at all with it.

Seg funds can work fine with the SM, but the cost over time can add up. At .5-1%/year, if you calculate how much this reduces your returns in the long term, you may be surprised how much this can add up. If you make 7.5% instead of 8%, you lose 11.3% of your gain over 20 years.

This is especially true because the benefit of the principal guarantee is questionable. The guarantee is only after 10 years and the major stock markets are very rarely down over a 10-year period. You would also need to keep the fund for the full 10 years.

The odds are very high that your investment will be up after 10 years, so the only difference is the lower return.

Investing for capital gains is fine. Your interest is still tax deductible. CRA is very clear in IT-533 that investments in mutual funds and stocks are fine.

It does say that you need to have an expectation of income excluding capital gains, but then goes on to say that mutual funds and stocks are fine as long as their prospectus does not specifically disallow ever paying a dividend. We have never seen any mutual fund or stock with this clause.

As FT said, the interest is not deductible if you invest in a TFSA.

Ed

Borrowed money put into a TFSA is not tax deductible.

I have been considering a Smith Maneuver for some time now and we will probably buy a house in the next 6 months and I’m still refining my strategy.

Would a SEG fund offered by an insurance company be an investment qualifying my interest on the LOC to be deductible?

SEG funds offers guarantees ranging from 75 to 100% of the capital at maturity for a relatively small deduction on your return. This can be part of a healty investement strategy.

I will consult a CFP before implementing this but I am still confused by the information I get. Some will say that investments returning capital gains are NOT deductible, this would leave dividend paying funds? I am still not sure either if a TFSA account would qualify.

Thanks to anyone who could enlighten me!

You would benefit from reviewing one of the articles at MDJ’s site where it reviews the various SM friendly mortgages. Some allow for multiple sub accounts so you can more easily separate an investment LOC from a car loan vs. a mortgage, etc., etc.

Technically, I should be able to put the whole remaining mortgage balance to the credit line. One thing that is still not clear to me is how to use the same credit line for both mortgage (i.e. non tax-deductible loan) and a tax-deductible one. The calculations are relatively easy to do, my only concern here is how to correctly report it to CRA (i.e. to make sure they accept my calculations). Currently when using HELOC only for the investments it is pretty simple.

Thanks for the comments!

First of all, I am a newcomer to Canada (<6 years) and ~4 years ago my financial knowledge was limited to the interest paid on the bank account and term deposits :) We have a house for about 4,5 years and we have a fixed mortgage for 5 year term, the term expires next spring.

In general my view on the family finances is quite simple. As long as we live within our means, we invest the rest for the future. The future is divided in two major parts: retirement and "something within approximately 4-5 years from now". We have no debt except the mortgage and the car loan, but the car loan is at 0%, I consider it a good loan for a good car. Thus, the only tax-inefficient debt was the mortgage.Even before I have learned about SM, I was trying to prepay as much as possible towards the principal of the mortgage as early as possible. I believed that what really counts is how much interest do you pay over the life span of your mortgage, I was not very concerned about the cash flow today. In other words, pay as little interest as possible and as little taxes as possible without going too crazy about chasing the last dollar :)

About 3 years ago I have started do my own investments. I did work with an adviser at the beginning and he was a nice guy, but the conflict of interests (his commissions vs. the performance of the portfolios) was more and more evident so we have decided that our relationships has come to an end. Still, I am grateful to this guy because his lack of attention has stimulated my curiosity :)

Once I have learned about SM idea I have decided that it is the way to go. Unfortunately, when I was buying the house I did not have any extra funds available, we barely had enough for the modest 10% down payment and for the initial expenses. I have started implementing the partial SM as follows:

- within my mortgage contract I have right to prepay up to 15% of the initial amount of mortgage. With all extra payments we have made before 2008, effectively this amount is equal to ~25% of the remaining balance.
- I have arranged a HELOC with the interest rate significantly lower than my fixed rate. The limit on the HELOC is set to the market price of the house, which is approximately 50% higher than the original mortgage balance. Not all the funds are immediately available, but when the mortgage balance goes down, the limit goes up.
- I have started selling some securities back in May, using the proceeds to prepay the principal of the mortgage and borrowing similar amounts of money to purchase the investments
- I purchased good dividend-paying stocks (no, I did not have MFC before Aug 6 but now I do ;) ) and ETFs. Some of them are the same I owned before. My transactions are very clear, I make a purchase and then transfer exactly the same amount from HELOC to the brokerage account. Thus it is very easy to track the money. Should I decide to sell one of these investments, I will put the entire amount of proceeds back to the credit line and then borrow again the new amount. All these transfers are electronic and instant, it costs me nothing but a couple of mouse clicks.
- I do not use HELOC for anything else but the investments. Should I need a credit for something else, I have a non-secured credit line for that. Never used it so far.
- By doing all this I have rotated about the quarter of the remaining mortgage balance to the tax efficient investment loan. My total amount of debt has not increased. The remaining mortgage balance is now less than 50% of the original amount.
- As of January 1st 2009 I will be able to rotate another ~25%. And when the mortgage matures in a couple of months from there – I will be able to do more, but I am not sure I will have enough cash for that by that time. Depending on the situation I may prefer to fund our TFSAs in the beginning of 2010.
- If I sign another 4 or 5-year fixed term with the same bank (I do not mind – they are as nice as bankers can be :) ), I will keep the ability to prepay 15% of the original amount every year, not counting the double payments. Thus, in 3 years I will be able to turn the entire mortgage in a tax-efficient loan. And I will be doing it in chunks so I preserve the flexibility. But I have not decided yet on the next mortgage term.
- I try to make sure that the combined investment portfolios of my family (including RRSPs) are significantly more than enough to cover the entire amount we owe. Knowing this makes me comfortable.

I am sure one could do better than that but I prefer the mechanisms that I fully understand and that are 100% under my control (except the market conditions, of course). I hope my strategy will prove to be successful long term, however, we never know. I invest with the hope to earn decent income while understanding the possibility of losing significant amount of principal on some positions. I believe if the market crashes completely so a well-diversified portfolio goes bust we will have more important things to worry about :)

Uff, what a long post….Probably not very consistent but I tried to answer your question as clearly as possible.

Nikolai is right: there is nothing in the SM that you could not do (and screw up!) yourself.
Indeed nobody can guarantee results for you, but the difference is that the advisor is bound to do due diligence. Make every effort to help you succeed and find different ways and strategies to that end. None of which is available to you.
That is the difference.
If not for the lack of performance, then everything else the advisor can be sued for and they are sued often and successfully. But if you are looking for guarantees you won’t have that left to your own devices either.
Your choices are simple: pay someone to do it for you, or do it yourself.
I would like to know which of the two, Nikolai or you, would expect to have the better prospects of success.
Hi Nikolai!
Please, tell us how many SM did you do lately, is your mortgage tax-deductible and if so, tell us how you did it.

Personally I would say that $2000 + $75/month (+ probably commissions and trailer fees that would account for other 1-2K/year) is not reasonable. In fact, there is nothing about the SM you cannot do yourself. The only questionable part is how to invest the money. If you cannot make your choice of investments yourself, then you may want to talk to a specialist. But please note: there is no specialist that will guarantee you anything!

“when an advisor undertakes a project for you he is taking on a lot of work and a great deal of responsibility on your behalf” – this is not true. What responsibility they are talking about? The worst that can happen is that they will stop receiving their commissions and they will get an unhappy customer. Suing an adviser for inadequate performance of the investment portfolio is difficult, especially in Canada.

You are asking: “I have read the book, aware of the risks. What I want to know is should it cost me the fees I talked about to find a FP/Accountant to help set it up and make sure everything is above board?”

Well, I am an advisor and I have done about seventy of them last year.
Your dilemma is that if you do it alone, you take a high risk of failure, but at the same time you would not like to pay for the professional service, in your estimation the price is too high.
A pressing dilemma indeed.
However, I must remind you what is important: it is not how much you have to pay alone that matters, but also what is it you are getting in return.
I personally find the $2000 setup fee reasonable, because you will earn that back in 3-4 months by doing the SM and from then on you will have profit. Provided the setup is good. On the other hand I find the monthly fee of $75 too much and unreasonable. Also, if you consider the future value of that $75 it is in fact nearly $20,000 assuming an 8% return on investment, in ten years.
But your position, namely that you would not pay for a service that is doing a great good for you, is simply untenable. You just have to make up your mind: do you want the SM and its benefits, or would you rather keep the fee for yourself and either take the risk of messing up the SM and loose money, or do nothing and pay the Bank and taxes, as you are doing now.
You should consider and understand that when an advisor undertakes a project for you he is taking on a lot of work and a great deal of responsibility on your behalf. In exchange for that fee he is making sure that the risk you would take alone will not occur and deploys his knowledge and experience on your behalf, providing you with a lot of money over the long term. Begrudging pay for work is not reasonable and if you go the cheap way you will have cheap results.
If accountants were so good at this, they would have already converted everybody’s mortgage. In fact, accountants have the tendency never to look beyond their own specialities, they often have no idea of the possibilities, never mind the lack of experience. If you ask your accountant whether his mortgage is tax-deductible, likelihood is that it won’t be. Would you trust then your SM on the accountant who couldn’t even get himself rid of the onerous mortgage?
My suggestion is that you should pay the fee as long as you are convinced, by figures, that you are getting value for your money.

Best bet would be to contact a FP/mortgage broker who has experience with the SM. I can give you a couple of names, contact me via email by clicking on the “contact” button in the Nav bar.

I have read the book, aware of the risks. What I want to know is should it cost me the fees I talked about to find a FP/Accountant to help set it up and make sure everything is above board?

Thanks for the help.

I would recommend that you pick up the book to get a good understanding of the concept and risks involved.

I have found one person but there costs seem high. $2000 for the intial setup and then $75 / month to maintain the process and help us through i for the duration of the manouevre.

I am nervous about being Auditted and making sure we get a good setup in terms of HELOC/Mortgage and making the process automatic, but should it really cost me this much to do it?

Please advise, this person seemed leggit and well informed but once the cost was laid out I became concerned. As the person who is also handling the investment side of our SM wouldn’t they also get a cut of that with the management fee? Are the right to be asking this much money or is it a scam. Please remember I am not financially savy in terms of investing and tax laws.