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Most reading I have done on managed funds isnt too positive. While there are good managers, finding them before they “do good” is the hard part.
I guess you can say the same for stocks as well. Just because a company has done well for decades (think GE cutting the dividend after decades of raising them ) is no guarantee they will do so in the future.
While there are no guarantees there certainly are reasonable assurances.
Will BMO always pay a dividend? Not 100% for sure, BUT the fact that they have been paying them for longer than Canada has been a country leaves me assured they will continue to do so.
Same goes with a managed fund. I am thinking of the Templeton growth fund for example. It has a very long excellent track record, and I would believe that it would continue to do so so long as the same manager/management style is intact.
I think the key is to stick with it for the long term. Actually after reading the Dick Davis Dividend the premise of the book is that everything works, but not everything works all the time, meaning that dont jump on the growth bandwagon when CNBC is happy, and then switch to value when CNBC is sad.
Be it index funds, managed funds, growth stocks, value stocks, dividend growth stocks, just pick a style and stick with it.
ANy how after reading about index funds I think they would be a good way to implement the Sm. This is where I got thinking what do you do when you retire?
How do you pull your money out of the financed account and maintain deductibility?
I agree there is not too much said about this. Sure with dividend growth stocks it is simple. Buy the stock, dont sell and withdraw your dividends each month as you need them.
Mutual funds withdrawn as a pure capital gain would be the same as a ROC (half of the withdrawal anyway) according to FT’s article on keeping your loan deductible.
I am sure I am screwing things up in my head anyway.
I would also encourage Ed to help us understand this issue better.
Cannon have you met Ed in person? I met Ed and his wife Anne this summer in Winnipeg. Very nice people.
I got a very good “vibe” from both of them and liked the fact that i did not get a typical cookie cutter “financial plan” that you seem to get with most CFP’s.
Up until I met them I didnt see myself considering managed funds, but after our meeting I can see myself working with them for the long term.
Anyhow I am going off the rails here. Maybe others can chime in about winding down or harvesting your SM with mutual funds as your investment?
Brendan,
Yes, I did have the pleasure of meeting Ed. In fact, I’ve been a customer of his (he helped me arrange a very good rate on my BMO Readiline mortgage at no cost to me) and he purchased a customized, Excel-based SM calculator from me.
I know Ed is quite busy as he seems to come by here infrequently but then pepper the site with responses to many questions.
If this is not the best source for information about the SM, both in theory and practice, then I don’t know what is. An article on the drawdown phase of a leveraged portfolio would fill in a critical gap in the discussion.
Brendan, selling mutual funds with a capital gain is different than receiving a ROC distribution. If you sell a fund for profit, then providing that you plan to re invest that money, the investment loan should remain deductible. Note that you will have to pay tax on the capital gains though.
FT in this article you use the example of pulling 5K out of your loan to go on a holiday. Original loan is 10K with a 5K capital gain. You said now only 2/3 of your loan remains deductible, even though the original 1oK is still “in there”.
Retirement situation would be the same.
Maybe that is how the draw down works? Sell your fund units, pocket the capital gain and reinvest the balance?
P.S.
Sure if you reinvest ALL the money from the fund sale the loan remains deductible, but at some point you will want to draw money to live off of.
I guess I am wondering how do you do that and keep the investment loan “intact”, as the puure SM wants you do keep the loan forever.
Hi Brendan, Cannon and FT,
The optimal strategy for withdrawing money during retirement after doing the SM varies a lot depending on the situation. If you recall from the article on clawbacks for seniors, the effective marginal tax rates for retirees varies between 21-71%. This tax bracket makes a huge difference in the strategy that will work best.
In short, this part needs to be done custom for each client.
There are a few options with mutual funds:
1. Systematic withdrawal plan – This produces capital gains, depending on how much the portfolio has grown.
2. Smith/Snyder – This produces ROC for 8-12 years and then capital gains.
3. Dividends
A couple of points that will address most of your concern, Brendan:
1. Capital gains withdrawn from a fund leave the investment loan interest tax deductible generally, although you need to be careful of the tracking. So, if you withdraw $10,000 and $5,000 is a capital gain, then your the other $5,000 is your principal. The amount of the loan that remains deductible is reduced by the amount of principal withdrawn. The capital gain portion is fine.
2. The amount withdrawn to pay the loan interest maintains the tax deductibility.
For example, let’s say you borrowed $100,000 at 4%, it grew to $200,000, and then you started withdrawing $10,000/year after you retire. Of this $10,000 of income, $5,000 would be a capital gain and $4,000 can be used to pay the interest on the investment loan. Therefore, only $1,000 of the loan becomes non-deductible.
Many options in retirement require tracking of how much of the loan remains deductible. The Smith/Snyder does have have the side effect of losing the tax deductibility of your loan, but it can be sometimes be the most effective, for the highest tax brackets in the short term, especially for those low-income seniors in a 71% tax bracket (affected by the GIS clawback and income tax).
Dividend strategies work for low income seniors, but usually not for those affected by any of the various clawbacks.
We do have another cool strategy that will probably be in an article soon.
Ed
Thanks for jumping in Ed.
So Tim Cestnick was wrong then? I was under the assumption that any taxable with-drawls , dividends, interest, AND capital gains does not effect deductibility. This appears to be the case.
But, since the SM goal is to keep the loan “forever”, and you have invested for capital gains then really you have to keep half of your gains inside your portfolio to remain deductible.
Does this not cut your return in half then?
I suppose you could use the principle to pay the interest, keeping the loan deductible. Your return would still be cut in half, BUT now you dont have to use your cashflow to service the loan, giving back your 50% “loss”.
By the way where does CRA stipulate you can use principle to service a loan to keep it deductible?
Personally I think if you do a pure SM and DCA via mutual funds it seems almost like an accounting nightmare. (I recall you do tax returns for long term clients? he he !)
I would think the Rempel Maximum would make for a much easier accounting of with-drawls.
Ed, I dont want to come across as doubting any of your strategies.
I certainly do not. I enjoyed meeting you, and Anne, and look forward to a long term partnership.
But at the end of the day cash in the bank every 2 weeks is the name of the game be it SM, TFSA , RSP, or what have you, and I am just trying to wrap my head around the SM harvest time.
I am always reading and learning. I dont need to know how to tear apart an engine, but it is nice to know how it works. Same with my money. I dont just want to earn it, invest it, and spend it. I find having a pretty good working knowledge of it helps me appreciate it more.
Much is said about the SM mechanics, and building the wealth, rates of return etc. Fraser even has a nice software calculator.
Not much is said how to reap the rewards.
I can’t wait until the new cool strategy is revealed.
Any hints?
So here is a possible strategy to draw down the SM:
Figure out your interest costs i.e 100K @ 4% =4K or 333.33 per month.
Double that number to 666.66. This is how much you draw each month. Pay your capital gains tax, and pay 333.33 to the interest, keeping your loan intact.
Mind you this assumes a 100% capital gain, and the use of the Rempel maximum for 100K at the start.
If you were to do this as a
“pure” SM, aka DCA over time then it is a different ball game.
Would a more simple strategy be to just buy 100 shares of a quality Canadian company with borrowed funds, and collect the rising dividends year after year, applying them to the mortgage pre payment?
You could build up your borrowing room over a few months and by a different company a couple of times a year.
After the mortgage is paid off simply collect the dividends and spend as desired.
No complicated accounting. Simplt interest deduction each year, and a T5 slip.
Want to sell those 100 shares? Sell em, and pay down the loan by your ACB.
Stock markets dont scare me, and neither does the gradual shifting of the original non deductible leverage to a deductible leverage.
The accounting nightmare does though.
I like simple.
Ed, just wondering if you have any updates to a couple of Brendan’s comments in post 91 – specifically “where does CRA stipulate you can use principle to service a loan to keep it deductible?” and “I can’t wait until the new cool strategy is revealed”.
Would like to hear about both, cheers.
Kate I have done a bit of digging and I still can’t find where CRA says you can deduct compound interest.
Everyone refers to bulletin IT 533. This bulletin states you can deduct compound interest on a cash basis pursuant to paragraph 20(1)(d).
I cannot find this information. Trying to navigate the actual tax act is difficult.
I did however come across this:
articles/news.asp?article_ID=1907
