# Should I do a smith maneuver?



## ireflect

I have a mortgage for $290k on a condo that I purchased 6 months ago for $350k. It's fixed at 3.65% for another 4.5 years. I earn about $100k/year before tax, have no dependents, am single, and 27. I keep an emergency fund that can float me for about 3 months, and a non-registered basket of ETFs and government bonds that could be sold to keep me going for another 6 or so. My job security is moderate.

Is the smith maneuver right for me? I think I understand how it works, but I'm not confident in my ability to assess whether it's a good thing to do right now, and in my situation.

I was thinking of getting a HELOC and dedicated chequing account with TD (they also have my mortgage), using that to fund my existing Questrade RRSP account, and buy ETFs as necessary to satisfy my asset allocation strategy. When my tax refund comes, I'll pay down the mortgage. I'll pay the HELOC interest for now, but might have to eventually start capitalizing it as it grows. Next year, I'll get to deduct the HELOC interest from my income tax.

Is this sane? Comments please!


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## FrugalTrader

Ireflect, you should have at least 20% equity in your home before even starting the SM. I would focus on paying down your mortgage first.


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## ireflect

Many thanks, FG.

I have about $8k to make a last-minute RRSP contribution for 2009. Am I better off using that money to pay down my mortgage instead? Should I split it half/half?


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## Dana

ireflect said:


> I have about $8k to make a last-minute RRSP contribution for 2009. Am I better off using that money to pay down my mortgage instead? Should I split it half/half?


You could also consider making an RRSP contribution for the full $8k and using the resulting tax refund to paydown your mortgage. Assuming there is going to be a tax refund - I am unfamiliar with your tax situation.


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## FrugalTrader

ireflect, most would just say to pay down the mortgage. However, as you have higher income, an RRSP contribution would work well here as well. Dana's suggestion is a good one, hit two birds with one stone.


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## houska

I'm intrigued by the fact that you have a mortgage and you also have nonregistered investments. One can debate whether that's a good idea, but you are effectively already a leveraged investor, and are presumably comfortable with where you stand.

If you choose to continue in this vein, you could probably get a tax benefit from a simplified Smith Manoeuvre-type set-up. In theory it looks like this:

1. Liquidate your nonregistered investments (note will expose you to taxable gains/losses on your 2010 taxes)

2. Pay down your mortgage with the value of the investments.

3. Turn around and take out the same amount from a HELOC or separate 2nd mortgage

4. Directly use this reborrowed cash to purchase very similar (but not exactly the same) investments

You can now document that the money in #3 is being used as an investment loan, and so going forward the interest on it will be tax deductible. (This is true for as long as you use the money for investment purposes - you would lose this if you actually liquidated the investments and used the proceeds to fund living expenses at some point in the future.)

This is one of the underlying principles of the SM, the other being the gradual conversion of principal payments on your mortgage into a bigger and bigger investment loan by maximizing the leverage at all times. That's the part that is controversial, since it is exposing you to more risk.

Now there are all sorts of practical complications, especially since you would be trying to do this once you have already signed a mortgage rather than when you are setting up financing for your purchase. Therefore there is a real question whether you can repay in #2 without penalty and reborrow in #3 at the same rate. (You should also do your research and/or consult an advisor on the little wrinkles about what is deductible, what paper trail you need to have, and what happens with distributions).


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## OptsyEagle

_"I have a mortgage for $290k on a condo that I purchased 6 months ago for $350k. It's fixed at 3.65% for another 4.5 years. I earn about $100k/year before tax, "_

You owe 3 times your annual salary on a mortgage and you want to borrow more. What do I think of it? Perhaps you should move to the United States where you have more company in people that think this is OK and think that they have nothing to worry about. 

Sorry about the sarcasm, but pay down your debts a little more would be my advice.


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## ireflect

Thank you for these great comments. Seriously.

@houska:
My rationale for continuing to own a portfolio of non-registered ETFs is to maintain an asset allocation that isn't too heavily weighted on real estate. I suppose I should really be selling off some of that non-registered portfolio and re-buying those assets in my RRSP account to max out my contribution room. I'm unsure how to do this in a tax-efficient way (more research required here on my part... any blog post suggestions?)

@OptsyEagle:
I appreciate the sarcasm  and agree that I shouldn't be looking to go further in debt. I see the SM as a way of converting debt from a mortgage into a tax-deductable HELOC. From the other comments in this thread, I am beginning to see that that's an overly simplistic view, and that I should pay down a significant portion (and do a lot more research) before I attempt any sort of financial gymnastics like a SM.

@Dana & FrugalTrader:
I do expect a substantial tax refund for 2009, so I think I will put my $8k into RRSP, and use my entire refund to pay down my mortgage.


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## Four Pillars

OptsyEagle said:


> _"I have a mortgage for $290k on a condo that I purchased 6 months ago for $350k. It's fixed at 3.65% for another 4.5 years. I earn about $100k/year before tax, "_
> 
> You owe 3 times your annual salary on a mortgage and you want to borrow more. What do I think of it? Perhaps you should move to the United States where you have more company in people that think this is OK and think that they have nothing to worry about.
> 
> Sorry about the sarcasm, but pay down your debts a little more would be my advice.


I agree (minus the sarcasm). You owe a heck of a lot of dough - just work on paying it down. That might end up being your best investment.


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## Spidey

I also agree with most of the above posters. When you have a mortgage, particularly a large mortgage, you've got more than enough strategies at your disposal without getting into leveraging: you can max out your RRSP, your TFSA, RESP (if applicable) and then if you have any spare cash available throw it towards the mortgage. Only after the mortgage and other consumer debt was wiped out would I consider using a manageable-sized HELOC to buy investments and even then only in certain economic environments (like last winter -I don't think we're currently in a good environment for leveraging).


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## OptsyEagle

What me? Sarcastic.

It does sometimes get the point across. I mean no disrespect.

The SM is a concept that sounds great when you have a big non-deductible mortgage and someones says they can show you how to make it tax deductible. The problem that gets lost in the strategy is that they never actually make it tax deductible. You actually have to borrow more money, and that amount becomes deductible. The original mortgage is still a non-deductible loan and that never changes. Although most figure this out, it gets lost in all the wonderful benefits that are shown on paper. Sometimes those benefits materialize and sometimes they don't, but the debt is always material.

Good luck to you.


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## bean438

Optsy i see your point, but you are not borrowing more. As you pay down the mortgage you reborrow the same amount.
It should really be called a "shift your debt from non deductible to deductible over the long term, and as a side benefit you pay your mortgage down a wee bit faster".
I think anyone thinking about doing this should get a 2nd or 3rd opinion from people who do not stand to make a generous commission, and nice trailer fees . You also need to ask yourself if you have the temperament to stick with it through the long haul. Easy to say, but very difficult to do.
My TFSA stocks were purchased in March of 09, ALMOST at the absolute market bottom. It was pure luck, and not at all involved with skill.
I was greedy when others were fearful, BUT I admit I was fearfull to. Emotions are very hard to harness, and my mind started thinking about the end of the world, etc.
The warning about leverage are that it magnifies your losses as well as your gains, BUT I would also like to add that leverage also magnifies your emotions too.


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## HaroldCrump

bean438 said:


> Optsy i see your point, but you are not borrowing more. As you pay down the mortgage you reborrow the same amount.
> It should really be called a "shift your debt from non deductible to deductible over the long term, and as a side benefit you pay your mortgage down a wee bit faster".


OptsyEagle is correct - you are not shifting your mortgage debt from non-deductible to deductible.
You are converting your latent equity into deductible debt.
The argument for SM is that latent RE equity is not getting you any returns, so leverage that to buy investments and get a tax deduction in the process.


> I think anyone thinking about doing this should get a 2nd or 3rd opinion from people who do not stand to make a generous commission, and nice trailer fees . You also need to ask yourself if you have the temperament to stick with it through the long haul. Easy to say, but very difficult to do.


Very true.
A lot of financial advisors and mortgage brokers got their customers into SM in the few years leading up to 2008.
Most of them would have ended up buying stocks/mutual funds at the peak of the largest bull market since 2000.
It would be interesting to evaluate how much money those folks lost since Oct 2008, how many had their rates jacked up by the banks, and how many are still in the game
When you see your investments lose 30% or more in value, bank jacks up your LOC rate by 1% or more, it is not easy to keep borrowing more every month and re-investing.


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## bean438

Not sure what you mean by latent, but you ARE shifting the debt. As you pay down, you re borrow the same amount.
You are shifting when comparing the SM to not doing the SM. Potatoe/potato.

I have also read that many leverage based advisors use DSC funds. (not sure if this is true) so if there was a panic after a 30-40% drop, PLUS a 5-7% redemtion charge.........ouch!

Advisor still eats his cake.


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## HaroldCrump

bean438 said:


> I have also read that many leverage based advisors use DSC funds. (not sure if this is true)


Was true in my case.
My mortgage broker (who also doubled up as a "financial advisor") was pushing me for a SM.
I asked him for a sample portfolio where all the leveraged investments would go.
The list of funds he provided me were all high MER (some as high as 2.5%) and DSC load funds.
There were lots of duplication in holdings and the risk level was through the roof (emerging markets, high yield bond fund, etc.)
My take-away from that recent experience is that anyone contemplating a SM should first learn how to invest on their own and build their sample portfolio *before* initiating the SM.
And use the broker/advisor only to set up the accounts, loan, etc. but manage the investment decision on his/her own.


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## steve_jay33

Do I have this simple sm calculated right?

Suppose you have %20 equity in your home.
You have 50K in a non registered account
Suppose you can get a 3.5% HELOC
If you implement the SM, 50K * 3.5% = 1750 you pay in interest

Now you deduct 1750 on your tax return and suppose a 47% marginal tax rate.
(I believe that is the highest marginal tax rate)

So your return is 822.50.


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## Racer

bean438 said:


> Not sure what you mean by latent, but you ARE shifting the debt. As you pay down, you re borrow the same amount.
> You are shifting when comparing the SM to not doing the SM. Potatoe/potato.


I think you are mistaken here Bean. Another way of putting it is that you are borrowing against your future cash flow. With the SM, it takes you twice as long to kill your debt. I made a comment on this in the other SM thread.



steve_jay33 said:


> Do I have this simple sm calculated right?
> 
> Suppose you have %20 equity in your home.
> You have 50K in a non registered account
> Suppose you can get a 3.5% HELOC
> If you implement the SM, 50K * 3.5% = 1750 you pay in interest
> 
> Now you deduct 1750 on your tax return and suppose a 47% marginal tax rate.
> (I believe that is the highest marginal tax rate)
> 
> So your return is 822.50.


This is how I understand it, steve_jay33. It effectively means you can invest at half the interest rate -- 1.75% instead of 3.5%. Plus regular transaction fee drag and any account fees.

*Edited to add:* Bean438, have you ever read Ender's Game? I always think of that book when I read your name here.


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## HaroldCrump

Racer said:


> With the SM, it takes you twice as long to kill your debt. I made a comment on this in the other SM thread.


Actually the point of the true SM is to _never_ kill your debt.
Once the mortgage is paid off, your debt will be 80% of your home equity.
The idea is to keep that debt forever for getting the tax deduction.
Between the tax deduction and the income generated from the portfolio, the interest payments _should_ be covered without you having to divert any of your regular household cash-flow to it.
At least that's what I understand.

Of course, you may collapse the SM once the mortgage is paid off, but then the "benefits" cease as well.


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## CanadianCapitalist

HaroldCrump said:


> Was true in my case.
> My mortgage broker (who also doubled up as a "financial advisor") was pushing me for a SM.
> I asked him for a sample portfolio where all the leveraged investments would go.
> The list of funds he provided me were all high MER (some as high as 2.5%) and DSC load funds.
> There were lots of duplication in holdings and the risk level was through the roof (emerging markets, high yield bond fund, etc.)
> My take-away from that recent experience is that anyone contemplating a SM should first learn how to invest on their own and build their sample portfolio *before* initiating the SM.
> And use the broker/advisor only to set up the accounts, loan, etc. but manage the investment decision on his/her own.


It's hard for me to understand how these financial advisors can even claim that a SM will be profitable for their clients.

Stocks return about 3% to 4% over the risk-free rate.

Banks charge 2% over the risk-rate for a secured line of credit (provided you can get one at Prime these days).

The mutual fund charges 2.5% in MERs alone to manage your money. Add in another 0.5% for trading expenses.

Implementing a SM through your advisor will cost you 5% over the risk-free rate. How exactly would an investor profit with a SM?


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## bean438

CC, the best I could do was prime +.5 for my HELOC, making your point even more valid.
Personally I can see the SM working if you either:
1. DCA into a couch potato portfolio
2. Purchase CDN dividend growth stocks at a reasonable price. Initial income should cover interest (non capitalized/pay interest out of pocket), and at the very least keep up with inflation, but hopefully grow at a nice clip over 20+ years. Tax efficient in terms of no capital gains as long as you hold the stock, but dividends are taxed preferentially.

I do believe there are Buffets out there to manage funds, but the trick is to find them. Not very good odds. Since leverage entails more risk i would want to stack things in my favour by keeping fees low.


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## houska

CanadianCapitalist said:


> It's hard for me to understand how these financial advisors can even claim that a SM will be profitable for their clients.
> 
> Stocks return about 3% to 4% over the risk-free rate.
> 
> Banks charge 2% over the risk-rate for a secured line of credit (provided you can get one at Prime these days).
> 
> The mutual fund charges 2.5% in MERs alone to manage your money. Add in another 0.5% for trading expenses.
> 
> Implementing a SM through your advisor will cost you 5% over the risk-free rate. How exactly would an investor profit with a SM?


A point I've made elsewhere is that making leveraged home equity investing (whether you do the readvancing part that makes it the Smith Manoeuvre or just have a leveraged investment loan secured against home quity) is a game of penny pinching others' take.

If you achieve something like the following, it's a great way to avoid having all your eggs in one basket (house rich, investment poor):

(Investment return of RFR+ 4-5%) - (MER 0.5%) - (P-0.75% open variable mortgage rate, i.e. RFR+1.25%) + (50% tax benefit on the loan interest = 0.75-1.25%) = about 4% effective return

But if you're not careful and trust advisors not working in your best interest, you'll get

(Investment return RFR+ 3-4%) - (MER 2.5%) - (P HELOC rate i.e. RFR+2%) + (tax benefit on loan interest) = about 0% effective return, not worth the risk

That doesn't mean a good advisor who sets it up for you well (saving you time and effort) isn't worth say a 1% cut if it would otherwise be a good strategy for you. But it does mean that if you don't watch each 0.25-0.5% at each step of the process, you may be shorn of all the benefits.

I'm happily leveraged invested now (very slightly under breakeven for the past 2.5 years due to the crisis, but I went into it accepting the risks) but unless I can renew my open variable "investment loan" at P-0.75 when it's term is up in a few years, I may well collapse it.


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## CanadianCapitalist

houska said:


> If you achieve something like the following, it's a great way to avoid having all your eggs in one basket (house rich, investment poor):
> 
> (Investment return of RFR+ 4-5%) - (MER 0.5%) - (P-0.75% open variable mortgage rate, i.e. RFR+1.25%) + (50% tax benefit on the loan interest = 0.75-1.25%) = about 4% effective return


Fair enough. But I do have a bone to pick with the tax differential between the deduction on interest and the tax on capital gains being 50%.

Capital gains tax is a tax on your nominal gains. If you get periods of high inflation, the tax differential will be much much less than 50%. 

Here's a simple example: assume you purchase a stock at $20. You sell it at $50 after 10 years. You are left with $44 after taxes. However, at a 2% inflation rate, you are actually investing $24 in future dollars. 

Your profit is not ($44 - $20) = $24. It is ($44 - $24) = $20. Your capital gains tax rate is not 20%; in real-terms (which is all that counts), it is 23%.

It gets worse when inflation is higher. At 3% it is 25%. At 4% it is 29%.


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## bean438

CC if you stick with CDn dividend growth stocks, the income should keep up with and surpass inflation.
Even with inflation, were you to sell and pay tax you would still have something left over, as opposed to nothing had you not done a SM.

I think the SM has merit but you must look at the whole picture, not just focus on the tax deductions.


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## houska

CanadianCapitalist said:


> Fair enough. But I do have a bone to pick with the tax differential between the deduction on interest and the tax on capital gains being 50%.


Good point. Another 2nd order effect is as follows. If inflation (and also hopefully the risk free rate) goes up, the nominal interest rate on your loan goes up and so your tax deduction (which is still a higher marginal rate than your cap gain tax rate) goes up too.

I'd hazard a guess (confess I haven't thought this through - rushing to the airport) that an environment of moderately high inflation is the one which is comparatively most supportive for leveraged investing. As long as the economy continues chugging along, with the risk free rate being higher you benefit more from the interest-cap.gains. tax arbitrage element and you are more likely to get a VRM at a higher discount below prime (assuming the prime - RFR differential stays the same).

Bottom line is that I started leveraged investing at P-0.75 and slightly overoptimistic investment return expectations. I'm happy to continue but would not start it myself now if I had to do it at today's P+0.5, especially if I wasn't investing in low-MER vehicles. And even at P-0.75, I haven't been maxing out my leverage space. But that's more a risk appetite issue than cost differential.


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## Sampson

We are in an environment now where interest rates may possibly rise - however, the reverse also happens.

One benefit I've always seen with the SM or any HELOC investing is that you are hedging your interest rate risk if you hold a fixed rate mortgage and are exposed to the fluctuating rates in your line of credit.

It takes the 'guessing' when to lock in out of the equation.

However, many lenders are offering more complex mortgage products (half locked-in, half variable interest) so its a little unnecessary to use the SM to do this.

While I don't do the SM currently, it certainly is on the radar, but I've got a very healthy amount of equity in my home. I'll keep this option in mind for the next crisis/crash


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## financeguru

I think the Smith Manoeuvre makes a lot of sense provided one is not over leveraging oneself. 
Some posters mentioned here that SM never eliminates your non deductible debt. I don't believe thats exactly true. You can choose to aggresively pay off your non deductible mortgage through dividends etc. You can also choose to pay off a portion of your mortgage if you have enough capital gains to pay off your loan with some left over. Other techniques like cash damming may also apply.

The key principle to remember is to think of this as a long term strategy and apply it through good times and bad....preferrably more aggressively during the bad times. The compounding effect of even a 2-3% gain year over year over the rate you are borrowing (which is knocked down because it becomes tax deductible) will create a significant cushion if allowed the time to grow. Also i would never put my money with the SM into high MER funds...just go for index funds, if you don't want to pick stocks - a fund like XIU can do you no harm in the long run.


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## Jungle

financeguru said:


> Also i would never put my money with the SM into high MER funds...just go for index funds, if you don't want to pick stocks - *a fund like XIU can do you no harm in the long run*.


My gosh, that fund is up one dollar from 10 years ago. The dividend's it's paying is 2%. I wount touch this for the SM. 


http://www.google.ca/finance?q=xiu


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## CuriousReader

OptsyEagle said:


> _"I have a mortgage for $290k on a condo that I purchased 6 months ago for $350k. It's fixed at 3.65% for another 4.5 years. I earn about $100k/year before tax, "_
> 
> You owe 3 times your annual salary on a mortgage and you want to borrow more. What do I think of it? Perhaps you should move to the United States where you have more company in people that think this is OK and think that they have nothing to worry about.
> 
> Sorry about the sarcasm, but pay down your debts a little more would be my advice.


OptsyEagle ... op earning $100k salary which I think is a very good position to be being under 30 and esp with no dependents.

Now, if a mortgage bigger than 3x salary is met by such sarcasm, how would one go about to buy one's home esp in a market like Toronto? I am not saying everyone should be taking big mortages that they cant afford ... but surely the line cant be drawn by "3x annual salary" calculation.


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## houska

Jungle said:


> My gosh, that fund [XIU] is up one dollar from 10 years ago. The dividend's it's paying is 2%. I wount touch this for the SM.


Hmm. XIU, a low-cost stock index fund, is exactly what I would make a part of an SM plan. You are making a long-term bet that stock total returns will exceed your cost of debt (at least after tax). If you don't believe that, you shouldn't be doing SM. I'm not saying high dividend paying stocks don't have a place too, just nothing against making the bet on growth.

By the way, my understanding is that (at least outside Quebec) for tax deductibility of the interest you don't actually need to have the HELOC interest exceed interest and dividend income - there just needs to be reasonable expectation that such income will be generated. Can someone confirm?


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## MoneyGal

Ah, the REOP ("reasonable expectation of profit") test. CRA will never define it. However, what I've heard is that you can expect red flags to start popping up on your tax returns after 5 to 7 years with no profit (5 years if you have other or previous flags; 7 years if you are clean as a whistle).


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## Racer

MoneyGal, I believe the REOP test was overturned by the Supreme Court in 2002. Instead, they adopted a broader test for activities that are not clearly commercial. 

The new test is: "did the taxpayer have an intention to profit?" Only where the taxpayer can show that their main intention was to profit, and the activity has been carried out using objective standards of businesslike behavior, will the claim be allowed. 

The test was recently used in the _Landriault _judgment, where a couple tried to rent a property to their disabled son at a loss. Their claim for the losses were denied. http://www.canlii.org/en/ca/tcc/doc/2009/2009tcc378/2009tcc378.html

The only difference this really makes (which is slight, imho) is that CRA can't second-guess whether it was a good business ide aor not. The taxpayers just have to show that they weren't doing it for non-commercial reasons and their actions back that up.


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## bean438

IT533 says you must borrow to earn income, It specifies that it doesnt have to be net income, but the bulletin also says it does not have the force of law.
CRA never really clearly defines anything. Is this to guarentee jobs for them or is it so they can randomly pick people to deny deductions, and hope they cave in and submit?


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## Racer

bean438 said:


> IT533 says you must borrow to earn income, It specifies that it doesnt have to be net income, but the bulletin also says it does not have the force of law.
> CRA never really clearly defines anything. Is this to guarentee jobs for them or is it so they can randomly pick people to deny deductions, and hope they cave in and submit?


Bean, that made me laugh because I have said the same thing myself. I remember hearing my tax professor explain that even if a taxpayer wins a case against the CRA, they don't know if they have really won the fight for anyone but themselves...after all, the next year, the new Income Tax Act could just be changed so as not to be struck down by the courts. After the taxpayer and its supporters have spent countless hours and hundreds of thousands in legal fees. 

_Smith_ and _Singleton_ were so inspiring -- what a battle, to go all the way to the top court and win. _Lipson_, on the other hand, created a mess by unnecessarily giving huge power to the GAAR, despite the fact that a specific attribution rule was available to be used. Poor Justice Rothstein, who got it right in his dissent. 

Now the rest of us have to shake in our boots when we think of the newly-empowered GAAR. What little certainty we have was significantly eroded...and government funding to various organizations who may have lent support to future challenges has been cut. These cuts may or may not be a bad thing in general, but will specifically play a large role in reducing regular taxpayers' access to the justice system (while increasing financial profits and professional challenges for tax practitioners).

Sigh. 

Sorry for the hijack.


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## MoneyGal

Gah! it should be reasonable INTENTION to profit, then. Whatever the wording, you must prove you had some intention of turning a profit. Not, for example, renovating a basement suite and then renting it to a relative at or below market levels while claiming deductions.

Editing to say: not that that example has anything to do with the original question. A better example would be something like borrowing and then putting the borrowed funds in a money market account over long periods.


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## OptsyEagle

CuriousReader said:


> OptsyEagle ... op earning $100k salary which I think is a very good position to be being under 30 and esp with no dependents.
> 
> Now, if a mortgage bigger than 3x salary is met by such sarcasm, how would one go about to buy one's home esp in a market like Toronto? I* am not saying everyone should be taking big mortages that they cant afford *... but surely the line cant be drawn by "3x annual salary" calculation.


In my opinion, that is exactly what you are saying. If you don't make enough money, you shouldn't buy an expensive house. Now I am sure, many people have bought a house with a mortgage higher than 3x their income and lived happily ever after. But I am sure way too many have faltered under such scenerios. 

I am just getting a little tired of paying for it. Please live within your means. I can't afford to pay for people who are reckless with their money, anymore.


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## houska

OptsyEagle said:


> If you don't make enough money, you shouldn't buy an expensive house. Now I am sure, many people have bought a house with a mortgage higher than 3x their income and lived happily ever after. But I am sure way too many have faltered under such scenerios.
> 
> I am just getting a little tired of paying for it. Please live within your means. I can't afford to pay for people who are reckless with their money, anymore.


OptsyEagle, what do you think is "within your means"? I think we're all (at least on this board!) concerned about the situations in TO and Vancouver where some (many?) purchasers are financing at 5x+ income. However, the interest and principal payments on a mortgage at 3x household income, amortized over 25 years with a 6% interest rate (I'm deliberately not saying 35 year amort at 2%) are 23% of gross pre-tax income. You could even amortize it over 12 years and be at 35% gross pre-tax income for the payments. Neither seems out of line, though maybe we've all drunk the cool-aid.

Now given the risk of a housing market deflation, if I were taking such a mortgage with too small a downpayment, I might indeed be worried - but the reason would be the degree of leveraged housing market exposure I would be taking on, not the size of the mortgage and its liquidity implications on my budget.


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## Berubeland

OptsyEagle said:


> I am just getting a little tired of paying for it. Please live within your means. I can't afford to pay for people who are reckless with their money, anymore.


Please explain how you pay for it? 

With that income he could have bought a much more expensive house. This is not where ever you are from guy. Even my crappy house with two bedrooms in Scarborough is $300K these days. It's either that or live under a bridge. The rental rates for a place with no cockroaches is about the same as a house. Sorry but the OP is not living in some kind of mansion... for $350,000 it's ok with not too much space, ensuite laundry, maybe two baths. Probably around 850 square feet but newer finishings.


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## OptsyEagle

Berubeland said:


> Please explain how you pay for it?


We all pay for it when someone defaults on a debt. We pay for it in higher interest payments, we pay it in our bank shares going down, we pay for it by our economy faultering and its wonderful effects.



Berubeland said:


> Please explain how you pay for it?
> 
> With that income he could have bought a much more expensive house. This is not where ever you are from guy. Even my crappy house with two bedrooms in Scarborough is $300K these days. It's either that or live under a bridge. The rental rates for a place with no cockroaches is about the same as a house. Sorry but the OP is not living in some kind of mansion... for $350,000 it's ok with not too much space, ensuite laundry, maybe two baths. Probably around 850 square feet but newer finishings.


Has anyone ever stopped and thought that maybe, just maybe, our houses are overvalued? It's just the thought that borrowing $300,000 with a single income of $100,000 is OK, that made those house prices go so high. This though has its limits and its costs. Re-run his scenerio with a 10% interest rate living on unemployment insurance for 9 months.


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## bean438

Racer said:


> Bean, that made me laugh because I have said the same thing myself. I remember hearing my tax professor explain that even if a taxpayer wins a case against the CRA, they don't know if they have really won the fight for anyone but themselves...after all, the next year, the new Income Tax Act could just be changed so as not to be struck down by the courts. After the taxpayer and its supporters have spent countless hours and hundreds of thousands in legal fees.
> 
> _Smith_ and _Singleton_ were so inspiring -- what a battle, to go all the way to the top court and win. _Lipson_, on the other hand, created a mess by unnecessarily giving huge power to the GAAR, despite the fact that a specific attribution rule was available to be used. Poor Justice Rothstein, who got it right in his dissent.
> 
> Now the rest of us have to shake in our boots when we think of the newly-empowered GAAR. What little certainty we have was significantly eroded...and government funding to various organizations who may have lent support to future challenges has been cut. These cuts may or may not be a bad thing in general, but will specifically play a large role in reducing regular taxpayers' access to the justice system (while increasing financial profits and professional challenges for tax practitioners).
> 
> Sigh.
> 
> Sorry for the hijack.




Case in point:

http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/wthdrwls/spsl-eng.html


Key words are MAY have to pay....... ALL, or PART of......... etc.

So what is it? Do I have to pay or not? If I do, do I pay all of it, or is it part of? Lol.

Then under exceptions:

"At the time of payment, or when we consider the payment to have been received, you and your spouse or common-law partner were living separate and apart because of the breakdown of your relationship."

Again is it the actual time of payment? Or is it when CRA determines? If so, who determines? How do you determine? Is it based on time of day, CRA employee's discretion? Or is it simply a coin flip, or perhaps determined by planetary alignment of solar moons, and the gravitational pull the moons shadows cast upon the sun, unless CRA determines, that the sun is actually a star, BUT, it COULD be a sun, which MAY mean that CRA MIGHT determine the shadows have no bearing, unless they don't.


----------



## CuriousReader

OptsyEagle said:


> In my opinion, that is exactly what you are saying. If you don't make enough money, you shouldn't buy an expensive house. Now I am sure, many people have bought a house with a mortgage higher than 3x their income and lived happily ever after. But I am sure way too many have faltered under such scenerios.
> 
> I am just getting a little tired of paying for it. Please live within your means. I can't afford to pay for people who are reckless with their money, anymore.


How do you propose that one to buy a house in Toronto then?
You cant simply say "dont buy" or "move out of Toronto" - there are many reasons people need to stay in Toronto and that buying come up as a better option than renting.

And then you said the possibility of housing being overvalued - that may be true, may be not - but then again, it's irrelevant because if that's the way the market is, when one want to get into the real estate game, then one have to follow the market (despite still trying to get the best deal possible).

So then again, with the average household income being less than 70k, how do you propose a family can buy a house? Save up over 30+ years to get enough down payment such that they dont borrow more than 3x their income? I dont think that's reasonable.

Yes, some people might fail, but isnt that part of the game? Banks make lots of money out of interest from lots of people, lots of which manage to pay their debt off. People who may fail is just part of the risk of the business, is it not?

As Berubeland and houska have pointed out, I think OP is well within his means. $100k income annually with just below $300k mortgage left, sounds pretty good to me. I've been thinking to buy a house in Toronto myself and $350k is around the minimum price of a decent house I would go with.

Again, if you could answer my question: How, in your opinion, one can buy a house in Toronto?


----------



## OptsyEagle

CuriousReader said:


> How do you propose that one to buy a house in Toronto then?
> You cant simply say "dont buy" or "move out of Toronto" - there are many reasons people need to stay in Toronto and that buying come up as a better option than renting.
> 
> 
> 
> Again, if you could answer my question: How, in your opinion, one can buy a house in Toronto?


So what are you people saying? If Toronto house prices rise to $1Million on average, he should take his $100,000 per year and buy the house anyways. Perhaps, some innovative financing might help him along. Is that it?

My point is, if everyone and I mean everyone, was a little more reserved in how much debt they take on, house prices would be a heck of a lot more affordable. That is all I am saying. I am not telling this guy to sell his house because he'll be bankrupt tommorrow. I am actually telling him he had borrowed enough for now. More people need to be told that ... and they need to listen, including our governments.

That is all I am saying. Every borrowing has some justification to it, but it doesn't make it sound. Listen to yourself. I can't afford a home in Malibu either, but that doesn't give me the right to borrow beyond my means to acquire it. Thousands of families in Toronto cannot afford to buy a home, but they all don't go out and risk their family's future and their neighbours job and wellfare and buy one anyways. Just because they believe it is their right to have a 3 bedroom, 2 1/2 bath home for their family. It is this thinking and this thinking alone that makes the prices so unaffordable.


----------



## houska

OptsyEagle said:


> My point is, if everyone and I mean everyone, was a little more reserved in how much debt they take on, house prices would be a heck of a lot more affordable [....] Thousands of families in Toronto cannot afford to buy a home, but they all don't go out and risk their family's future and their neighbours job and wellfare and buy one anyways. Just because they believe it is their right to have a 3 bedroom, 2 1/2 bath home for their family. It is this thinking and this thinking alone that makes the prices so unaffordable.


OptsyEagle, we're not trying to gang up on you.  I think we all agree that an unreasonable sense of lifestyle entitlement and careless levels of borrowing to match have contributed immensely to the excessive growth of the real estate market.



OptsyEagle said:


> I am not telling this guy to sell his house because he'll be bankrupt tommorrow. I am actually telling him he had borrowed enough for now. More people need to be told that ... and they need to listen, including our governments.


I think this is where you've surprised many of us. I think a lot of us are feeling that at 3x income (in absence of other information) he's probably quite OK. We wouldn't say "go out and borrow more" but if the OP's feeling he'd like to stay at that level (i.e., readvance his principal repayments for an investment loan) and prioritize building an investment portfolio over paying off his debt - and is aware of the risks of leveraged investing in doing so - we're not nearly as concerned as you are. 

We may all be conditioned by market excesses and maybe you're the only sane one here. But would love to know about where you draw the line. I'll go out on a limb and say if someone told me "I'm borrowing 6x my income to buy a house", I'd be getting worried and wonder if he is completely overreaching. If someone says 4x or 5x I would say "good luck and hope you pay it down quickly"*. At 3x someone saying "I'd like to stay at that level" doesn't raise red flags to me. What are your threshholds, approximately? Maybe we all need a sanity check.

* All of this depends on downpayment and location, stable job situation, etc. In Ottawa or Montreal with a 10-20% downpayment, sure. In Vancouver, sit out and wait. In Toronto, don't know what to think.


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## Berubeland

Yeah I totally agree all houses should be the same price as they are in my parents small town. There no one has built a house in years because a house is immediately worth less than the aggregate cost of materials. 

And your idea that you have to pay for everyone who defaults on their debt is a little nonsensical as well. I guess you resent my breathing too because i'm breathing your air.....


----------



## CuriousReader

OptsyEagle said:


> My point is, if everyone and I mean everyone, was a little more reserved in how much debt they take on, house prices would be a heck of a lot more affordable.


Unfortunately, that's not the reality, and as much as you hope, such thing wont happen.

You havent answered my quesiton yet: Considering the current reality that house prices in Toronto are they way they are right now (around $300k-$350k for a decent start) and household income of less than $70k - what do you think one should do to buy a house in Toronto?


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## HaroldCrump

Jungle said:


> My gosh, that fund is up one dollar from 10 years ago. The dividend's it's paying is 2%. I wount touch this for the SM.
> http://www.google.ca/finance?q=xiu


You are looking only at the unit price.
The returns should include dividends.
XIU annualized returns are close to 7% over a 10 year period.
http://ca.ishares.com/product_info/fund_returns.do?ticker=XIU

Of course, past performance doesn't equal future performance, but that's true for any investment.


----------



## OptsyEagle

Berubeland said:


> And your idea that you have to pay for everyone who defaults on their debt is a little nonsensical as well. I guess you resent my breathing too because i'm breathing your air.....


Well my retirement portfolio is down about 30% because some idiots in the US thought it OK to borrow multiples of their income in debt to buy a house. I am sure yours is down as well as well as pension plans, education plans you name it. 10% of the continent is out of work for the same reason. Lastly, if 1% of people default on a loan the others who don't, need to pay exactly 1% more. Does that make sense to you or should I go over the math again.

I know it seams like it should be and is, their problem, but as we have seen it soon becomes ours, when it gets out of hand.


----------



## OptsyEagle

CuriousReader said:


> Unfortunately, that's not the reality, and as much as you hope, such thing wont happen.
> 
> You havent answered my quesiton yet: Considering the current reality that house prices in Toronto are they way they are right now (around $300k-$350k for a decent start) and household income of less than $70k - what do you think one should do to buy a house in Toronto?


I answered your question. Don't buy a house.


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## Berubeland

OptsyEagle said:


> Well my retirement portfolio is down about 30% because some idiots in the US thought it OK to borrow multiples of their income in debt to buy a house. I am sure yours is down as well as well as pension plans, education plans you name it. 10% of the continent is out of work for the same reason. Lastly, if 1% of people default on a loan the others who don't, need to pay exactly 1% more. Does that make sense to you or should I go over the math again.
> 
> I know it seams like it should be and is, their problem, but as we have seen it soon becomes ours, when it gets out of hand.


I'm sorry I entirely disagree with you - the reason that the real estate market and money market funds collapsed is not because some guy didn't pay his bills. It is entirely because of unregulated lenders and their predatory lending practices. Then they sold these predatory mortgages onto Wall Street. 

The idea of ever increasing corporate profits only works if your market is increasing. In a closed system there is a limit to market. 

Then there is a continuing problem of the decreasing house prices as we speak because all these houses now are worth less than it cost to build them. Why because the same lenders that caused the problem are dumping houses on the RE market. The entire fiasco is disgusting. 

Basically the people who invested were not the same people who wrote the mortgages so the people who wrote the mortgages didn't care because if it goes into default they don't pay. 

As for just choosing not to buy a house I guess your answer is not to buy one.... So I guess I should be happy to pay more than a mortgage in rent just so you can have your way. The house I live in would rent for about $1600 per month.


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## HaroldCrump

Berubeland said:


> I'm sorry I entirely disagree with you - the reason that the real estate market and money market funds collapsed is not because some guy didn't pay his bills. It is entirely because of unregulated lenders and their predatory lending practices. Then they sold these predatory mortgages onto Wall Street.


Berubeland, OptsyEagle has a valid point.
While it is true that the bankers and mortgage lenders were greedy and were over-zealous in selling such loands, in the end, it is the homeowners that applied for those loans and were more than happy to take the loans and live beyond their means.
There has to be individual responsibility and accountability.
We can't blame it all on "those awful bankers, that corrupt government, them nasty brokers", etc.

As far as selling mortgages, that is not a new practice.
Packaging mortgages as investment instruments has been around for decades and were always considered the safest investments and were the darlings of pension plans, smaller levels of govt. etc.

Having said what I did about individual accountability, at the same time, I also believe that US, Canadian and European governments should not have bailed out the large banks, pension funds and investment banks.
Debt rating agencies also need a slap on the wrist (to put it politely) for fudging the ratings and misleading the entire world as to the true nature of these instruments.


----------



## OptsyEagle

Berubeland said:


> I'm sorry I entirely disagree with you - the reason that the real estate market and money market funds collapsed is not because some guy didn't pay his bills. It is entirely because of unregulated lenders and their predatory lending practices. Then they sold these predatory mortgages onto Wall Street.
> 
> 
> As for just choosing not to buy a house I guess your answer is not to buy one.... So I guess I should be happy to pay more than a mortgage in rent just so you can have your way. The house I live in would rent for about $1600 per month.


If you can't see the total cause of the callamity, we are bound to repeat it. 

My issue surrounds the fact that these people who agreed to pay back their mortgage money and then didn't, all seem to feel that they are blameless. That they didn't do anything wrong. That it was someone else's fault. That they had to acquire a home for their family. That a 4 bedroom, 2 1/2 bath home with a swimming pool, was a minimum necessity that a family was entitled to have.

I dissagree. I doubt I will change the world with this thread. If I had a family, living in Toronto, would I push the envelope a little for them. Sure. Would I push the envelope to then borrow more to invest in a portfolio. No, and they shouldn't either. But we live in a world that seems to think this is acceptable behavior. I would have hoped that we could have learned from the financial crisis, but it would appear that we haven't.

Just because rent is high, it does not mean they should buy. If you rent a 2 bedroom appartment in a rougher neighbourhood of Toronto, it will be cheaper than the house I describe above, in almost all cases. People use the rent analogy to justify buying spralling houses everyday, and that analogy does not give them the right to put other peoples money in jeapardy.

We may need to agree to disagree on this one. I don't have an exact figure that proves some amount of debt is too much. It obviously will vary with everyone. The OP asked if he should borrow more givin his situation and I believed he should not, since I would not. I have not been convinced that my opinion is wrong, nor have I convinced you to change yours.

Good luck to you all.


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## cardhu

Berubeland said:


> the reason that the real estate market and money market funds collapsed is not because some guy didn't pay his bills. It is entirely because of unregulated lenders and their predatory lending practices.


Seasonal fruit-picking labourers should never have been buying $500k homes in upscale communities with adjustable rate mortgages. It was inevitable that once the initial low-promo-interest terms ended, and rates reverted to the real world, they would be unable to carry the home. They should have known this. It is true that the lenders must take SOME of the blame, for having approved the loans in the first place, but certainly not all of it. 

If the notion of "personal responsibility" has any meaning, then the fringe borrowers cannot fob off onto others the responsibility for their own stupid decisions.


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## CuriousReader

Shouldnt the one that give permission to allow such loan to happen would be the one that shoulder most if not all of the blame?

If asking can be so wrong - that means one should never ask for anything and only accept what's given?

eg. If you have a 10 year old kid that keep asking you to drive your car. And you allow it. And then there's accident happen - who is to blame?
- does the 10 year old who asked is to blame?
- or is it the parent that ALLOW the kid to do the driving should be blamed?

The fact that some people live beyond their means is definitely a problem, and something that's so rooted in human nature because lots have the "need" to have the latest and greatest .... but the fact that such problem become everyone else's problem should be the fault of whoever allow such people to keep borrowing so much.


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## HaroldCrump

But we are not talking about 10 year olds here.
We are (supposedly) talking about mature, responsible adults who are old enough to make decisions that not only affect them, but their families and the rest of society.
These are people old enough to drink, drive (hopefully not at the same time), get married, vote, etc.
Or maybe we _are_ talking about 10 year olds - since taking our such irresponsible loans, living beyond their means and general fiscal wastage is no better than 10 year olds asking for candy and chocolates all day.

I'm not saying that the banks and financial system are not to be blamed - of course they are.
But there has to be individual responsibility and accountability.


----------



## cardhu

The politicians who encouraged the necessary policy-changes so that the law would allow lenders to consider such fringe borrowers, and anyone who encouraged Americans to think of home-ownership as a right, rather than a privilege, are also partly to blame ... but I absolutely disagree with the suggestion that the poor schmucks on the borrowing end were just innocent victims.


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## bean438

Everybody was responsible. Banks, made bad loans, credit rating companies gave bad ratings (I do not trust ratings agencies anymore), wall street was greedy, and the gov't didnt really regulate anything, but the home buyer certainly should shoulder some blame.
I remember watching 20/20 and seeing a "victim" complaining she was losing her house and blamed everyone involved for it.
I think she made 40K per year and got a mortgage of around 500K, which was some weird kind of "negative reverse amortization" structure. It sounded complicated, and borderline illegal, or at least just plain wrong.
Bottom line is greed. Sounds to good to be true that you can afford a half a million house then it probably is. Dont blame everyone else.
I think it is wrong that some of these people walked away from their homes.
I hope there are lengthy prison terms handed out over the whole sub prime deal in the US.
Thankfully Canada wasnt as screwy.


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## CuriousReader

HaroldCrump said:


> But we are not talking about 10 year olds here.
> We are (supposedly) talking about mature, responsible adults who are old enough to make decisions that not only affect them, but their families and the rest of society.


Sure, adults are supposed to be better than 10 year olds.
But at the end of the day, they put _their_ interest first, ahead of the interest of the rest of society - and pretty much everybody will do that.

If they think (however wrongly) buying that big house in upscale neighborhood is in their and their family best interest (for whatever reason), then they will do it. Why would they care about its potential effect on the rest of the society? It's _their_ interest first.

Hence, there comes the politicians/lawmakers and bankers who _supposed_ to control those individual interests. But then again, bankers will prefer _their own_ interest too in turning big profits, ... politicians / lawmakers are supposed to be the one who make the regulations to make sure the interest of the rest of society is taken care off.

I am not saying the people who ask those loans are totally innocent - yes, they supposed to know better, if nothing else it's for their own sake too - but the regulators / people who allow such loans should be the ones who put the stops on those people.

If you are talking about individual accountability - then may be we should put those people that make bad decisions (either knowingly or through misjudgement or just unfortunate) to court and convict them of a crime? Arent those people already lost their house, and surely their credit rating?


----------



## Jungle

houska said:


> Hmm. XIU, a low-cost stock index fund, is exactly what I would make a part of an SM plan. You are making a long-term bet that stock total returns will exceed your cost of debt (at least after tax). If you don't believe that, you shouldn't be doing SM. I'm not saying high dividend paying stocks don't have a place too, just nothing against making the bet on growth.
> 
> By the way, my understanding is that (at least outside Quebec) for tax deductibility of the interest you don't actually need to have the HELOC interest exceed interest and dividend income - there just needs to be reasonable expectation that such income will be generated. Can someone confirm?


You need to do the math. You will lose with that ETF XIU. If HELOC interest rates are 3.25% and the dividend is paying 2%, what do you think will happen? This fund is not suited for SM, use it for something else. 

Betting on stocks is not investing, it's gambeling. You can go to the casino and do that more easily. 

The SM is not about betting an index fund will grow so big, you can pay off the HELOC with cash, when you sell it. Good luck with that and don't forget about capital gains, when you sell. 

I would advise you to stay far, far away from the SM until you know what your talking about.


----------



## houska

Jungle said:


> You need to do the math. You will lose with that ETF XIU. If HELOC interest rates are 3.25% and the dividend is paying 2%, what do you think will happen? This fund is not suited for SM, use it for something else.
> 
> [...]
> 
> The SM is not about betting an index fund will grow so big, you can pay off the HELOC with cash, when you sell it. Good luck with that and don't forget about capital gains, when you sell.


Leveraged investing, SM or not, is a bet that your investment return over the long term will exceed your cost of borrowing (after tax, as you point out). This can come from (a) overall market growth, (b) stock picking prowess, and (c) dividends. You point out that dividends on XIU are 2%; assuming that's right, my bet is that this 2% plus long term market growth (a) will exceed cost of borrowing. I have no faith in my abilities as a stock picker, so I stay away from (b).

Now I think you're saying you prefer to bet on (c), plus a bit of (b), because you have little faith in (a). You may or may not be right. I think your strategy is more risky, you think mine is. 

At the moment, my interest costs are 1.5%. With the tax deduction on the interest, that's 0.75% so taking your dividend yield number of 2% (1.5% after tax) it's still positive. Any cap gains are icing on the cake. However, as I pointed out in another post, I'd be more leery of starting leveraged investing now. A P+1 HELOC is at 3.25% now costs 1.5 to 1.75% after tax, so in that case you really need to believe in market growth (a) to make the math work - never mind the market and interest rate risk.



Jungle said:


> Betting on stocks is not investing, it's gambeling. You can go to the casino and do that more easily.


Betting on individual stocks is gambling. Betting on a broad market index is, like all investing, a bit of a gamble too (and more so if you are doing it with borrowed money!), but the odds are a lot better than at the casino.


----------



## cardhu

CuriousReader said:


> If you are talking about individual accountability - then may be we should put those people that make bad decisions (either knowingly or through misjudgement or just unfortunate) to court and convict them of a crime?


As far as the buyers go, being stupid isn’t a crime. But that stupidity was definitely a contributing factor in the trainwreck ... 



> If they think (however wrongly) .... is in their best interest (for whatever reason), then they will do it.


Getting tossed out into the street for failing to make mortgage payments is in their family’s best interest??


----------



## Jungle

houska said:


> Leveraged investing, SM or not, is a bet that your investment return over the long term will exceed your cost of borrowing (after tax, as you point out). This can come from (a) overall market growth, (b) stock picking prowess, and (c) dividends. You point out that dividends on XIU are 2%; assuming that's right, my bet is that this 2% plus long term market growth (a) will exceed cost of borrowing. I have no faith in my abilities as a stock picker, so I stay away from (b).
> 
> Now I think you're saying you prefer to bet on (c), plus a bit of (b), because you have little faith in (a). You may or may not be right. I think your strategy is more risky, you think mine is.
> 
> At the moment, my interest costs are 1.5%. With the tax deduction on the interest, that's 0.75% so taking your dividend yield number of 2% (1.5% after tax) it's still positive. Any cap gains are icing on the cake. However, as I pointed out in another post, I'd be more leery of starting leveraged investing now. A P+1 HELOC is at 3.25% now costs 1.5 to 1.75% after tax, so in that case you really need to believe in market growth (a) to make the math work - never mind the market and interest rate risk.
> 
> 
> 
> Betting on individual stocks is gambling. Betting on a broad market index is, like all investing, a bit of a gamble too (and more so if you are doing it with borrowed money!), but the odds are a lot better than at the casino.


The point was, that you recommended XIU as a good choice to others, in this SM thread. Now you are saying it's best for you. I disagree with it being good for others. 

For the average person and as written in the book, the SM is about having the oppertunity to use your house's equity to build a non registered portfolio. The borrowing vehicle for this would be the HELOC or re-advanceable mortgage. 

Now with that said, YOU may be better suited (not others), as you claim having 1.5% interest rates. That's a pretty good rate. Not everyone has access to these preferred rates. Most have access to HELOC, being 3.25% right now. This is why I don't agree with it being suggested as a great investment for the average. 

Now there are other costs:


XIU is Canada's biggest 60 companies, with a MER of 0.17%. That will eat at your cost as well. Equity investments can grow in the long run, but in the mean time, you need to service your loan with payments and have a profit left over to pay down your mortgage. 

If you are going to do a true SM, you will reinvest your growing available borrowing credit back into more stocks, for every payment you make on your mortgage. You have to now add brokerage fees to this. 

With your strategy using XIU it's border line do or die on producing income profit. If interest rates rise (which is coming this summer) your small room for profit shrinks fast. 

I would like to know how you are getting a 0.75% discount on the borrowing costs. I don't believe you are calculating it correctly and including dividend tax. 

I think with all said, XIU is better suited for something else. 

PS, as I said before, XIU has not grown one doller in the last 10 years. Please don't tell other's to bet on this growing huge to save your bacon later on.


----------



## HaroldCrump

Jungle said:


> PS, as I said before, XIU has not grown one doller in the last 10 years. Please don't tell other's to bet on this growing huge to save your bacon later on.


You are repeating the mistake/misconception again.
I clarified above that it is not correct to judge the return of XIU purely by the unit price.
See my post# 45 above.
http://www.canadianmoneyforum.com/showpost.php?p=18240&postcount=45
Whether XIU is suited for SM or not is another matter, but your calculation of its return is incorrect.


----------



## houska

Jungle said:


> The point was, that you recommended XIU as a good choice to others, in this SM thread. Now you are saying it's best for you. I disagree with it being good for others.
> 
> For the average person and as written in the book, the SM is about having the oppertunity to use your house's equity to build a non registered portfolio. The borrowing vehicle for this would be the HELOC or re-advanceable mortgage. Now with that said, YOU may be better suited (not others), as you claim having 1.5% interest rates. That's a pretty good rate. Not everyone has access to these preferred rates.
> 
> With your strategy using XIU it's border line do or die on producing income profit. If interest rates rise (which is coming this summer) your small room for profit shrinks fast.
> 
> I would like to know how you are getting a 0.75% discount on the borrowing costs. I don't believe you are calculating it correctly and including dividend tax.
> 
> I think with all said, XIU is better suited for something else.
> PS, as I said before, XIU has not grown one doller in the last 10 years. Please don't tell other's to bet on this growing huge to save your bacon later on.


Any investment strategy is based on some sort of belief. My belief - and I would hazard the belief of most leveraged stock market investors - is that equity market growth, plus a bit of dividends, will over the long term exceed borrowing costs (+ other expenses). I hope for long term stock market returns in the 5-8% range per year, including both capital appreciation and dividends. I consider both the pre-2007 runups, as well as the 2008 crash, and the 2009 super-recovery to all be aberrations. Whatever the number is for total market returns over the past 10 years is a randomly weighted average of these 3 aberrations and, in my opinion, not very meaningful.

If I did not believe in a reasonably level of long term market growth, I would not be leveraged investing at all. And I think if others don't believe in it, they shouldn't be leveraged investing either. Since it is inherently risky, you need to believe in something which doesn't merely break even, but compensates you with expected returns for the extra risk.

If I understand your approach, you don't believe in market growth, but think a leveraged investment strategy can be made to work based on dividend yields alone. I haven't investigated it in detail, but I think your strategy is too risky for me (doubtless you feel the same about mine). 

I agree with you that *if* you want a leveraged investment strategy based on dividend yields alone, XIU is not a good choice. Hopefully you can also agree that *if* you wanted one based largely (but not exclusively) on capital growth, XIU or another vehicle that gives you broad market exposure can be a good part of the portfolio. You are right that it's not easy to make an "income profit" in this situation; you depend on the capital appreciation.

I think we both also agree that cost control is key to success. In my (which I believe is the conventional) approach, you want to keep broad market exposure, so either very low cost no load mutual funds or low cost ETFs purchased through a discount brokerage are probably the way to go. Which one is better is a tradeoff between the higher MER and the trading commissions.

My own leveraged investing is through a P-0.75 open variable mortgage. This was an important part of the cost equation for me, and if I had to borrow at P+1 I would not start a leveraged strategy now (though I would wish I had done so at the beginning of 2009  ). If someone is considering an SM or other leveraged approach, they had better be comfortable (i.e. optimistic enough long term) for their math to still work at this higher rate. I think that means they need to be relatively optimistic on the market; I can't see it working otherwise. Then XIU as part of their portfolio can make sense. The important part is to a) be clear on what bet you are making and be comfortable with it, and b) really control those costs.


----------



## FrugalTrader

Houska, you stated that your mortgage is p-0.75%, which is fine as mine is in the same range. However, are you sure that your HELOC (investment loan) is under prime?


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## cardhu

Jungle said:


> XIU has not grown one doller in the last 10 years


XIU has produced a 5.37% average annual compounded rate of total return over the past 10 years, (to 31Dec09) ... not spectacular, but certainly respectable ... a far cry from $1.

[segment retracted]


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## houska

FrugalTrader said:


> Houska, you stated that your mortgage is p-0.75%, which is fine as mine is in the same range. However, are you sure that your HELOC (investment loan) is under prime?


We are leveraged investors but not quite doing a conventional "creeping" SM. We have two mortgages (within a total equity plan) which are both P-0.75 open variable. One is our "pay for the house" normal mortgage, the other is an investment loan (we liquidated investments when buying the house, paid cash, and immediately took the equity out and rebought similar investments). 

We have periodically paid down a chunk of the "pay for the house mortgage" and then readvanced it on the investment loan mortgage, thus effectively mimicing a SM with less regularity but profiting from the better rate. This is subject to bank approval, and we have not tried to do it since HELOC rates were hiked from P to P+1, P-minus mortgages vanished, etc. and so don't know if they would let us do it now. We feel our level of leverage is appropriate now.

Note that the loans are 40 year amortization mortgages, so there is principal repayment involved too. We don't need that, but don't object to it in return for the rate discount. It's important that the mortgage terms are open - we could have gone for P-0.85 closed with repayment restrictions but wanted the flexibility.


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## bean438

cardhu said:


> XIU has produced a 5.37% average annual compounded rate of total return over the past 10 years, (to 31Dec09) ... not spectacular, but certainly respectable ... a far cry from $1.
> 
> 
> You’re asking for a headache if you do this with assets purchased under a SM ... in order to maintain interest deductibility in your SM debt column, ALL of the proceeds of any such sale would have to be either (1) reinvested in some eligible use, or (2) used to pay down DEDUCTIBLE debt ... paying down non-deductible debt is not an eligible use ... if the proceeds of sale were used to pay down the non-deductible mortgage, you’d end up on the SM side with a commingled debt – partially deductible and partially not --- and tracking that will produce the aforementioned headache.



Cardu I believe capital gains can be used to pay non deductible debt. Ed Rempel has said that anything that is taxable can pay down non deductible debt and still be onside with CRA. You would have to pay the investment credit line or re invest with the original investment amount.


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## cardhu

> Cardu I believe capital gains can be used to pay non deductible debt.


Oops .... Yup, you're right ... I was thinking about something else when I wrote that ... shouldn't post while distracted ... my bad [comment retracted upthread]

What I was thinking about was that a leveraged stock portfolio (SM or otherwise) is not a single entity from CRA's point of view ... it is a basket of separate properties, each with its own separate leverage trail ... and that can get to be a record-keeping headache, if you draw frequently ... particularly if you're only making partial sales instead of totally liquidating any particular security. But that's a separate topic, for another day.


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## bean438

Good way to explain it. When you look at it533 simply substitute "property A" for " common stock A" and so forth. 
Much is written about setting up a SM but very little is written about the draw down phase. Actually I can't find anything about the draw down.


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## Jungle

HaroldCrump said:


> You are repeating the mistake/misconception again.
> I clarified above that it is not correct to judge the return of XIU purely by the unit price.
> See my post# 45 above.
> http://www.canadianmoneyforum.com/showpost.php?p=18240&postcount=45
> Whether XIU is suited for SM or not is another matter, but your calculation of its return is incorrect.


What you posted shows a growth of 7.42% over 10 years, or a grand total 0.742% per year. (correct me if I'm wrong)

Either way you calculate it, once you pay the SM expenses with the dividends, you are left with the same share price, as 10 years ago. (or probably a loss all together)

With that said, and houska recommending this :



houska said:


> Hmm. XIU, a low-cost stock index fund, is exactly what I would make a part of an SM plan. *You are making a long-term bet that stock total returns will exceed your cost of debt* (at least after tax). _If you don't believe that, you shouldn't be doing SM._ I'm not saying high dividend paying stocks don't have a place too, just nothing against making the bet on growth.


the "long term bet" will borderline with little profit or a loss. 

XIU mainly consist of large cap stocks, with each stock typically holding between 5-25 billion in equity. These companies are already huge, inflated if you will. _Typically,_ they will not see a lot of growth. These shares, funds or indexes are like dead fish, for the SM. 

If you're looking for faster growth, go with well managed, small-mid cap companies; but this is more suited for your RRSP, not SM, since capital gains are sheltered.


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## Jungle

houska said:


> At the moment, my interest costs are 1.5%. *With the tax deduction on the interest, that's 0.75%*


I am very curious how you are getting 0.75% after tax deduction. This seems incorrect. 

I believe you subtract your marginal tax rate from the interest rate. Take this cost and add your dividend tax.

(Not including MERS, FEES, other costs)


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## HaroldCrump

Jungle said:


> What you posted shows a growth of 7.42% over 10 years, or a grand total 0.742% per year. (correct me if I'm wrong)


Since you ask, I believe you are wrong 
Those returns are annualized, not cumulative.
So if XIU were a GIC instead of an ETF, the 7.42% would have been the compound interest return.


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## houska

Jungle said:


> I am very curious how you are getting 0.75% after tax deduction. This seems incorrect.
> 
> I believe you subtract your marginal tax rate from the interest rate. Take this cost and add your dividend tax.
> 
> (Not including MERS, FEES, other costs)


Jungle, I think you're mixing apples and oranges here. 

As to the calculation: My interest rate is currently 2.25% (prime) - 0.75% = 1.5%. However, since this interest is an investment expense (leverage), it can be deducted from taxable income. At a marginal tax rate of close to 50%, this tax benefit is 0.75% of the loan value, so the net post-tax interest cost of borrowing is 0.75%.

(If someone else's interest rate is 3.25% and - for the sake of the argument - their marginal tax rate is 30%, their net post-tax cost of borrowing is 3.25%-30%(3.25%) = approx 2.25%. They of course need to be more optimistic on their investment strategy to make it pay off.)

After you calculate the cost of borrowing, to get your expected net return, you add whatever return you expect to get on the investment you're making with the borrowed money, adjusted for the taxes you will pay for it and fees. In your case, all or a lot of that return you expect to come from dividends, so that's where the dividend tax comes in.

I wish you all the best in your strategy, but just as you worry that stock markets will show no growth going forward, I worry that dividend yields have spiked and may be unsustainably high for the long term. (Actually, I shouldn't say I worry - I don't know too much about dividend focused strategies so I merely read Rob Carrick's column in the G & M a few weeks back). So if you're right about lack of future stock market growth, I fear relying on dividend income to make the numbers work for an SM may be risky. Time will tell.


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## bean438

How did you ever get P-.75? I know P- was common but when P went down many banks changed their rates on people. Many complained, so how did you avoid that?

Why do you fear dividends in a SM?
Back in 08/09 when "it" all began, I watched my stock values plummet. However my dividend income went up 9%, even after 2 dividend cuts. 
It wasn't leveraged BUT had I not had the rising dividend stream it would have been tougher to stay the course.


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## cardhu

bean438 said:


> I know P- was common but when P went down many banks changed their rates on people. Many complained, so how did you avoid that?


Lenders cannot change the rate in the middle of a term. I still have P-0.75 as well, which is really P-0.8 in HELOC-speak, because of the way mortgage interest is calculated. 



bean438 said:


> I watched my stock values plummet. However my dividend income went up 9%, even after 2 dividend cuts.


dividend income went up?? ... or dividend yield?? ... I'd be interested to see the math on how dividend cuts lead to a rise in income.


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## cardhu

Jungle said:


> ...a growth of 7.42% over 10 years, or a grand total 0.742% per year. (correct me if I'm wrong)


XIU has produced a 5.37% average annual compounded rate of total return over the past 10 years, (to 31Dec09) ... not spectacular, but certainly respectable ... a far cry from 0.742%.


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## houska

bean438 said:


> How did you ever get P-.75? I know P- was common but when P went down many banks changed their rates on people. Many complained, so how did you avoid that?


http://www.canadianmoneyforum.com/showthread.php?t=1945



bean438 said:


> Why do you fear dividends in a SM?


I'm all for earning dividends anytime anyone wants to give me any. But I think you need to invest at least partially for growth (and be comfortable with the volatility) to make the risk-return balance work out for leveraged investing. I may be wrong.

Most of my skepticism is theoretical. For mere mortals, it makes no sense to borrow money to invest in bonds or other income bearing securities. If you do that, you're effectively arbitraging along the yield curve. You need to add either some elbow grease to be compensated for (the investment property approach), or take on a different risk, like equity growth. Dividend-paying stocks behave like a hybrid between equity and income, so I can't help but think that it's not an efficient leveraged portfolio. But I haven't taken the time to think it through properly.

(BTW I will now vanish from this thread at least for few days - travel)


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## bean438

So P-.75 is your mortgage portion, but what is your HELOC?

If you invest for dividend growth, over the long haul you "should" get capital growth, almost lock step with the dividend increases.
As the income increases, so does the price of the income producing asset.


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## Jungle

houska said:


> Jungle, I think you're mixing apples and oranges here.
> 
> As to the calculation: My interest rate is currently 2.25% (prime) - 0.75% = 1.5%. However, since this interest is an investment expense (leverage), it can be deducted from taxable income. At a marginal tax rate of close to 50%, this tax benefit is 0.75% of the loan value, so the net post-tax interest cost of borrowing is 0.75%.


The only province to have that Marginal tax rate near that, is Quebec and it's actually 48%, if you make over $127,000. 




houska said:


> If someone else's interest rate is 3.25% and - for the sake of the argument - their marginal tax rate is 30%, their net post-tax cost of borrowing is 3.25%-30%(3.25%) = approx 2.25%. They of course need to be more optimistic on their investment strategy to make it pay off.)


^^I don't think this is right. 2.95% would be the final number. How did you get 2.25%? 



houska said:


> I wish you all the best in your strategy, but just as you worry that stock markets will show no growth going forward,


Just for the record, I never said the stock markets will show no growth. I said the fund _you_ recommended (XIU) _will _perform poorly, for the SM. 



houska said:


> I worry that dividend yields have spiked and may be unsustainably high for the long term. (Actually, I shouldn't say I worry - I don't know too much about dividend focused strategies so I merely read Rob Carrick's column in the G & M a few weeks back). So if you're right about lack of future stock market growth, I fear relying on dividend income to make the numbers work for an SM may be risky. Time will tell.


Calculating some factors, such as the companies' abilities to pay dividends, (and reviewing every quarter) will allow you to select some stong, healthy shares, suited for the SM.


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## Jungle

bean438 said:


> So P-.75 is your mortgage portion, but what is your HELOC?


I beleive it's a re-financed mortgage. This is not a true SM, since he must be serving the loan with other income (emnployment?)


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## Jungle

I was reading into this fund (XIU) it has:


other income, 
foreign income, and
return of capital

paid out in its distributions. 

You can not claim the dividend tax credit on these portions, making it less efficient for SM. This also gives more work for the calculations and tax records.


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## financeguru

Jungle, 5.37% compunded over the last ten years, which includes two bear markets is nothing to sneeze at. Specially given the havoc that was played out in the stock markets for the last 2 years. 

For the sake of discussion lets do some roughcut analysis using fairly conservative numbers:
Suppose you are borowing at the rate of prime and say the average prime rate you have borrowed at is 5%. Suppose your marginal tax rate is 30%. So the effective rate of interest you are borrowing is 5%-5%(.3) = 3%, lets throw in an extra .5% to cover your trading costs or whatever you want to factor in, . So thats 3.5%. So you are making an effective return of 5.37%-3.5% = 1.87%. If you had dumped 100K, 10 years ago in this fund, you would have currently be sitting on 120K (Granted that in real terms, most of these gains have been eaten away by inflation). 
In the above , i have used 5% borrowing costs which i think is very high, if you decrease these, you will be easily beating inflation (specially in these times of uber low lending costs). Secondly, as i mentioned that if the fund has given a 5.37% compounded over the last ten year horizon,even when you factor the 'great recession', the performance presents a lower range boundary in my mind at least, so you should expect it to go up from here. If i remember correctly that the last 10 years (probably ending Feb, 2009) represent the worst performance of the stock market over any ten year horizon other than the great depression.
Is XIU the best fund to invest? i don't know, but if you are looking for broad exposure to the market and want to choose solid blue chip companies, its not the worst either. It is very well diversified and is one of the most actively traded funds.
If you want something more aggressive, then yeah there are other funds out there that may perform better. However if XIU represents a good proxy of the market, then there are not too many active fund managers who beat the market over the longer periods of time. Many people think they can do better, but not too many actually do.


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## houska

The rate arithmetic is right as I wrote it (within rounding error - I went to the nearest 0.25%). You are correct that I assumed top marginal tax rates: in Ontario I think the top rate is approx. 46.5%. Also confirming that in order to achieve the P-0.75 rate I have myself been readvancing (less frequently than monthly due to the hassle) on a separate open variable mortgage rather than using the more typical but also more expensive HELOC.

I think this discussion highlights how a leveraged strategy - SM or other - is heavily dependent on situation. To me the niche segment for these strategies are people whose financial situation is stable, income likely fairly high, but whose home would otherwise comprise the bulk of their net worth. They have a mortgage they are paying down, but don't want to stay out of the market until they pay everything off. Those people can benefit from the SM as a vehicle to gradually pay down their mortgage while converting their growing home equity into an investment portfolio, with the tax benefit helping to speed things along. In general, I think a diversified portfolio biased towards growth over income probably makes most sense for them. If that is the case, XIU makes sense as part of their portfolio. They will likely need to capitalize the interest, but would likely want to do that anyway.

If I understand right, some of you are saying you prefer your leveraged investment portfolio to be focused on dividend income, in part due to less risk (?? not completely sure, I assume that' s why), in part due to the significantly reduced dividend tax rate (a difference more pronounced in lower tax rates), and perhaps since the income generated allows you to capitalize less (or maybe none) of the interest expense on your investment loan. Thinking it over some more, I agree this makes sense - provided :

a) I think a substantial part of the ultimate benefit still needs to come from some capital gains on your dividend-paying stocks for the strategy to make sense (someone said this above), and 

b) you're careful about concentration risk. I personally don't have the time to pick and track stocks and so limit myself to low-cost diversified ETFs, and the concentration of XDV and CDZ in the financial sector scares me a bit for the long term. But if you can replicate a less-concentrated version still with good dividend yield as well as good growth prospects, and keep the trading fees down, that now makes sense to me.


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## Jungle

financeguru said:


> Jungle, 5.37% compunded over the last ten years, which includes two bear markets is nothing to sneeze at. Specially given the havoc that was played out in the stock markets for the last 2 years.


For just an ETF large cap "return rate" alone and markets history, much agreed. 

However, in terms of using it with SM, here are my thoughts: While this fund is sitting, compounding for 10 years, *so is the mortgage*. You are loosing out, because the investment does not produce _enough_ income ( after interest expenses are deducted), to apply _extra_ payments on the mortgage. (Using higher dividends). 

Unless:

You cash out every year, pay capital gains tax and make your lump sum payment from the profit. Then re-purchase, rinse and repeat. With this you loose:

1. Effective 10 compound interest; (lost by more brokerage fees)
2. Risk of cashing out when share is at lower price or re-purchase the share at a higher price;
3 and as Derek Foster pointed out in his book, _Stop working, here's how you can, _ someone who cashes every year will loose substantially more, then someone who cashes out once every 10 years. This is because you are paying capital gains tax every year, which can lose a lot on compound interest, if left for 10 years. 

So with that said, you are back at letting the mortgage sit and compound for 10 years also. 

The more frequently you make extra payments, the faster the mortgage is paid off. Higher dividend paying stocks will do this more effectively. 



financeguru said:


> For the sake of discussion lets do some roughcut analysis using fairly conservative numbers:
> Suppose you are borowing at the rate of prime and say the average prime rate you have borrowed at is 5%. Suppose your marginal tax rate is 30%. So the effective rate of interest you are borrowing is 5%-5%(.3) = 3%, lets throw in an extra .5% to cover your trading costs or whatever you want to factor in, . So thats 3.5%.


I'll use your numbers; I don't think the math is right:

The rate of borrowing is:
1. $100,000 x 5% interest = $5000

2. Interest cost ($5000) X marginal tax rate (30%) = $1500 tax refund

3. Interest cost ($5000) - ($1500 refund) = $3500

4. Adjusted borrowing cost is actually 3.5% 

5. Add your 0.5% costs for "other" fees= 4%



financeguru said:


> So you are making an effective return of 5.37%-3.5% = 1.87%. If you had dumped 100K, 10 years ago in this fund, you would have currently be sitting on 120K (Granted that in real terms, most of these gains have been eaten away by inflation).


The effective return rate would be 1.37%. After 10 years, you would be at $114,576.


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## financeguru

Jungle, yeah you are right, i make a mistake in my original calculation 5%-5%(.3) =3.5% not 3% as i had indicated. 

Anyways, whether you choose to use Smith Manouevre to invest in dividend producing stocks to accelerate payment of the mortgage or if you invest it for capital gains, its a moot point. It really depends on one's preference. 

To me, accelerating the mortgage payment is not a _prime_ objective of the SM - to the degree where i'm taking out dividends, capital gains etc to pay down th mortgage. I might decide at some point in the future to cash out some portion of my investments, if i think interest rates are starting to climb and its time to take some profits off the table. However if i'm paying 1.5% in mortgage carrying costs as i am currently, I really am not incented to pay down my mortgage more quickly. I'd rather take that money and see how i can do by investing in stocks. For the most part it has worked out well for me, though market timing has been a big driver, i've got %50K in capital gains over the last year when i started the SM, which has increased my appetite for risk at this point.


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## Jungle

houska said:


> The rate arithmetic is right as I wrote it (within rounding error - I went to the nearest 0.25%). You are correct that I assumed top marginal tax rates: in Ontario I think the top rate is approx. 46.5%. Also confirming that in order to achieve the P-0.75 rate I have myself been readvancing (less frequently than monthly due to the hassle) on a separate open variable mortgage rather than using the more typical but also more expensive HELOC.


Examples below do not include dividend or capital gains tax. With your income, dividends tax is more expensive than capital gains. 

Your borrowing rate is 1.5%
Let's say you borrow $100,000
Cost of borrowing is $100,000 X 1.5% = $1500
Tax deduction is $1500 interest X 46.5% =$697.50
$1500 borrowing cost - $697. tax refund =$802.50
Your effective borrowing cost is 0.8025% (cheap!!) 

Another example 
$150,000 borrowed X 1.5% = $2250 interest cost
$2250 interest X 46.5% =$1046.25 tax refund
$2250 interest cost - $1046.25 tax refund=$1203.75
Effective borrowing cost is 0.8025% (cheap!)

. 




houska said:


> I think this discussion highlights how a leveraged strategy - SM or other - is heavily dependent on situation. To me the niche segment for these strategies are people whose financial situation is stable, income likely fairly high, but whose home would otherwise comprise the bulk of their net worth. They have a mortgage they are paying down, but don't want to stay out of the market until they pay everything off. Those people can benefit from the SM as a vehicle to gradually pay down their mortgage while converting their growing home equity into an investment portfolio, with the tax benefit helping to speed things along. In general, I think a diversified portfolio biased towards growth over income probably makes most sense for them. If that is the case, XIU makes sense as part of their portfolio. They will likely need to capitalize the interest, but would likely want to do that anyway.
> 
> If I understand right, some of you are saying you prefer your leveraged investment portfolio to be focused on dividend income, in part due to less risk (?? not completely sure, I assume that' s why), in part due to the significantly reduced dividend tax rate (a difference more pronounced in lower tax rates), and perhaps since the income generated allows you to capitalize less (or maybe none) of the interest expense on your investment loan. Thinking it over some more, I agree this makes sense - provided :
> 
> a) I think a substantial part of the ultimate benefit still needs to come from some capital gains on your dividend-paying stocks for the strategy to make sense (someone said this above), and
> 
> b) you're careful about concentration risk. I personally don't have the time to pick and track stocks and so limit myself to low-cost diversified ETFs, and the concentration of XDV and CDZ in the financial sector scares me a bit for the long term. But if you can replicate a less-concentrated version still with good dividend yield as well as good growth prospects, and keep the trading fees down, that now makes sense to me.


Well said. If you read my post above I believe it answers your questions. However I think we can conclude to this: 
1. A true SM strategy is not the same as regular leveraged investing 
2. A true SM strategy is more effective


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