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September 3, 2018 | The Write-Off

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

“Here’s the mandatory suck up,” writes Rob (everyone is so well trained now). “I bought The Money Road years ago at the Calgary airport, read the book on a flight to London, and have been a daily blog reader ever since, learning a lot and keeping my finger on the economic pulse. Thanks for your great work.

I’d be interested in your view on our situation.

My wife and I, both 48 years old, with a young child, have about $270,000 invested in an ETF portfolio, held in maxed out TFSAs, and RRSPs with about $50k of it unsheltered. My wife has a medium sized pension, I have none. We have a new house on 6 acres on Vancouver Island that has farm income of about $6k / year net, low farm status property taxes, plus all we can eat organic veg and fruit. I built the house myself with a lot of blood and sweat. Not a cornflake throw away.

In the current market, the house and land are apparently worth about $650k. We have a private mortgage of $183k at a fixed rate of 3.70%, payable to my 80 year old parents. Our current combined gross income, excluding the farm income, is $$88,000, split roughly 50:50.

My question is, what are the pros and cons of using part of the portfolio to pay off the mortgage and then taking out a HELOC and borrowing money against the house to replicate the portfolio or even increase it and thereby making the interest tax deductible? Is this a reasonable idea? I’ve owned a sold a small business and so I’m not risk adverse but I’m also not a gambler at this point in life.

Of course you should pay back your elderly parents – that’s job one. The 3.7% they’re getting from you now is above GIC rates, but below what a stable preferred-share ETF could provide. Besides, all the interest you pay is 100% taxable in their hands, whereas dividends gain better tax treatment. In any case, they’re 32 years closer than you to departing this mortal coil so maybe they just want to blow that money on clubbing and a new Mercedes – or oxygen and motorized wheelchairs. Whatever. Pay it back, dude.

As for your strategy, yup, works just fine. The TFSA assets can be sold with no tax consequence, but any RRSP liquidation will be taxable (you’re in a 20% bracket). If you borrow against your property, count on a secured line of credit for 65% of the appraised value – or about $420,000. The payments need be interest-only, which means 100% of them can be deducted from your taxable income. So, why pay this money back?

More in a minute. First, Regi has a similar question. But no suck-up.

My wife and I (in our early 40’s) can be described as a couple of DINK’s making a solid effort at achieving early retirement. We save a substantial portion of our take home income and have loaded up our RRSP’s, TFSA’s, and non-registered funds into low cost index funds.Life is good! We currently have zero debt, our Calgary townhouse is mortgage free, but we have a HELOC of $300k @ prime that is currently begging to be invested.

My question to you is that my wife and I struggle to determine if these HELOC funds would be best invested in the market with the hope of exceeding the current interest rate, thus putting our house to work! We struggle with the risk/reward proposition, but I feel that if we sold the house and simply rented we would have already invested those funds, so the only issue is the premium associated with paying the bank the current 3.45% premium for the privilege to access these funds.

What are your thoughts on investing HELOC funds into the market? If our timeline is 10 years or longer would it make sense to put these funds to work?

We live in a unique time, of course. Cheap rates and racing hormones drove real estate values to historic highs. The tax code and willing bankers let you access that windfall equity through a secured LOC. So long as the money you borrow is used to produce taxable income, the cost of that loan can be completely deducted. So the higher your income, the greater the benefit (like an RRSP). It means the rich – those making over $240,000 – can borrow and reduce the effective rate by 53%. For regular schmucks, the saving is around 30%.

So, Regi, that cheap 3.45% loan rate is more like 2.4%. Even modest portfolio gains would put you in the black. This contrasts with sitting on real estate equity doing nothing, especially if house values plateau or fall. Dead money is made alive again. Hallelujah.

But, of course, there are risks. This is not suited to everyone. You must know the rules.

(a) It’s a long-term strategy. Markets and portfolios ebb and flow from month-to-month and over years, so borrowing to invest means taking the long view. Never do this if the funds are needed in a year or two, when you might be forced to sell in a down cycle.
(b) Invest correctly – in a balanced, diversified, liquid portfolio. Buy ETFs, not stocks (or mutual funds). Have multiple assets classes (equity, REITs, bonds, preferreds etc). Invest globally – not all in maple or Trump. Stick with 60/40. It works.
(c) Get an advisor if the bucks involve warrant it. Less stress. More professionalism. And the fee is tax-deductible, also.
(d) Don’t worry too much that the debt’s not being reduced. Interest is deductible. Principal payments are not. With a liquid portfolio you can repay the loan at any time, should interest rates spike or your spouse looks murderous.
(e) Track the interest charges carefully so they can be claimed when filing the income tax return. If the payments are interest-only (the most sensible) the accounting is simple.
(f) Ignore skeptics who tell you only assets that pay regular income (like bonds or preferreds), and not those which provide capital gains (like equities), are eligible for this kind of interest-deductible portfolio. They’re wrong.
(g) If you worry about borrowing to invest, freaking out with every market gyration, then don’t. It’s not worth it. Odds are you’d sell at a loss if a big drop occurs. Remember that human nature is the enemy of investing. We crave what’s going up and flee when things decline. Smart folks do the opposite.
(h) Be confident. Markets and asset values rise more than 70% of the time. Even during the 2008-10 financial crisis a balanced portfolio returned an average of 5% a year while stock markets cratered 55% and took seven years to recover. Besides, there’s no 2008 coming. Seriously. If wrong, I’ll totally refund the subscription fee to this blog.

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September 3rd, 2018

Posted In: The Greater Fool

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