I hope this will help some of you out. It's a summary of the most important Canadian Personal Finance lessons from my research for all of 2017. Most of these are key posts from The Greater Fool Blog, which I highly recommend as a daily read. Investing Strategy and Advice Random Advice
· Everybody should strive to maximize their TFSAs, then ensure the money stays in there, invested in diversified growth assets like equity ETFs. Remember – a hundred bucks a week invested here for 30 years making 7% will end up being $532,000. That should yield an annual income of $32,000 without depleting the principal and without reducing your CPP or OAS payments by a single penny. So this is job one.
· After that, shovel cash into an RRSP, using the refund to contribute to the TFSA. Unless you have a defined-benefit pension (guaranteed, stable employer-funded payments), this is an excellent way to reduce tax, invest for tax-free growth then support you efficiently when some dingdong CEO destroys your employer.
· Obviously having a cash reserve for an event like this would be a great idea, but establishing a personal line of credit in advance is almost as good. It costs you nothing to set up at the bank, zero to carry and can be tapped only as you require it. Go, get one now.
· The best way to own preferreds is through an ETF, where you can hold a basket of high-qualify assets. An example would be CPD (just an example – this is not a recommendation), which pays investors a dividend yield of 4.3%, which is twice the return of a GIC and it’s still 100% liquid. But there’s more. This exchange-traded fund has increased in value (besides the dividends paid) by 12.7% in 2017 – which far outstrips the 3.8% return of the TSX in general. Since the beginning of last year (when prefs were sooo cheap) the gain in capital value has been 28%. (CPD also went on sale Wednesday after the latest Bank of Canada report. Sweet.)
· But all he need do to effectively slash his long-term interest costs is to switch from a monthly-pay to a weekly-pay mortgage. Over the course of 12 months he’ll make the equivalent of one extra payment (no big deal) and it will end up shortening his amortization by years, saving more than a variable-rate loan ever would. He just needs to ensure he gets the right kind of weekly mortgage, since some of them are bank rip-offs. May 2017 – Current Recommended Weightings
· cash, 5%;
· corporate bond 6%;
· provincials 3%;
· short-term bond 5%;
· high-yield 3%;
· preferreds 18%;
· Cdn equity 16%;
· REITs 5%;
· US equity 21% (some hedged);
· international equity 18% (some hedged). Investment Portfolio Breakdown - Greater Fool – September 20th 2017
· Start with the TFSA. When that’s full split money between an RRSP (to shift tax into other years) and a non-registered portfolio (to benefit from capital gains and dividends). Stick with it, max the tax-free account with pre-authorized debits from your bank account and never, ever listen to [email protected]
, eschewing costly mutual funds and brain-dead GICs.
· Have a balanced portfolio, with 40% in safe stuff and 60% more growth-oriented. Since rates are rising, keep the bond exposure slim (they pay nothing but reduce volatility) but have lots of rate-reset preferreds which swell along with bond yields. Carefully weight Canadian, US and international assets, taking into consideration that we’re currently on fire, Trump’s a time bomb, the US is expanding, Europe’s in recovery and nobody should bet against China. Never hold individual stocks (unless you have seven figures to invest and can achieve diversification – which requires about 60 positions).
· If you have a little money, hold three or four ETFs. If you have a lot, then 17 should be about right. And keep a small cash position, since that’s a defensive asset as well as ammo if an opportunity arises.
· So, 2% cash in a HISA, 20% in a mixture of government, corporate, provincial and high-yield bonds plus 18% in preferreds make up the safer stuff. Put 5% in REITs, then hold 16% in Canadian equities, an equal amount in US markets and 23% in internationals, for the growth portion. Rebalance once a year. Put higher-taxed stuff (bonds) in a tax shelter. Reserve the TFSA for fast growers (like emerging markets). Enjoy a 50% tax break on capital gains in your non-registered. And don’t forget about income-splitting with your squeeze, which can be done through a spousal plan or maybe a joint account. Why TFSAs are the #1 Priority
The long-term growth, free of tax, is epic. Invest $5,500 this year, then add $100 a week for the next three decades in growth assets making 7%, and you end up with $576,338 of which $414,838 is growth. Besides tax-free compounding of investment returns, the real benefit of this thing is that it will throw off income in retirement (or anytime else) which is not counted as income. So in the example just given, forty grand a year could be earned with zero tax payable on it.
Now let’s look at two 40-year-olds who have wisely maxed their TFSAs with $52,000 in each. If they keep their accounts topped up and full of ETFs giving the same return, at 65 they’ll claim $1.26 million, of which almost nine hundred grand is taxless growth. In retirement that amount can provide an annual income of about $90,000, and these guys can still collect their CPP and OAS without having any of it clawed back (assuming no other income source). If they had $1.26 million in RRSPs, the after-tax income would be about $52,000 and they’d have a marginal tax rate of 29.65%. No contest.
For anyone with a good company pension plan, and especially for the Aristocracy Among Us with gold-plated, defined-benefit schemes (teachers, cops, retired finance ministers) investing in this vehicle is far better than feeding an RRSP. At age 71 all registered retirement plans must be partially unwound, with the income being added on top of pension payments, often boosting you into a higher tax bracket. But no matter how much is skimmed off a fat TFSA, nothing is taxed or even recorded as income.
Of course, TFSAs can be used for income-splitting, too. You can gift your spouse or your adult kids money to invest in one. None of the gains will be attributed back to you. You can withdraw money and, unlike an RRSP, put it back the following calendar year. Unused room can be carried forward indefinitely. And a tax-free account can hold almost any investment asset, so keeping a moribund high-interest savings account or a brain-dead GIC in there is a big fail. Why Mutual Funds Suck:
S&P regularly provides its SPIVA Scorecard, which examines the performance of actively managed Canadian mutual funds versus that of their benchmarks and corrects for survivorship bias. Survivorship bias? Yes, mutual fund companies have this habit of discontinuing funds that have poor performance thus, ostensibly, wiping away that unflattering data forever. The SPIVA Scorecard attempts to account for this performance, essentially holding the mutual fund companies’ feet to the fire. The data reveals, unsurprisingly, that the vast majority of mutual funds underperform their benchmarks—with high management fees being the main reason. The table below shows their dismal long-term track record. S&P, by the way, also does a scorecard for US mutual funds with similar results.
📷No doubt, there are financial advisors who have a careful and highly effective system for identifying the 9% or so of equity mutual funds that actually do outperform their benchmarks over the long term. More power to these advisors. However, what I’ve seen more often is a less rigorous due-diligence system of simply selecting the funds that are ranked highest by Morningstar, the industry’s most widely known mutual-fund evaluator. However, as a recent article by The Wall Street Journal has shown, chasing the best star ratings has its drawbacks. The Journal pointed out, after examining the performance of thousands of funds, that only 12% of 5-star-rated funds maintained this rating after five years. Basically, the Journal highlighted that the Morningstar five-star rating is not a good indicator of future outperformance. Source: The Wall Street Journal
Here are a few things to remember. First, on mutual funds (since most people own them): fees are significant, and buried in the cost of ownership. The person selling you these animals at the bank will tell you s/he doesn’t charge anything to perform that charitable service. In reality, the funds turn out trailer fees so every month you stay invested, somebody gets paid. To Rob’s point, mutual fund fees aren’t tax-deductible. So if you own a fund with a 2.5% MER and you’re in the 40% tax bracket, that’s actually costing 3.5%. Ouch.
The same principle applies to ETFs, all of which have embedded fees which are not deductible. The big difference is the average fee across a portfolio made up of exchange-traded funds might be 0.2% – or one tenth of the cost of owning a mutual.
What about other fees and investment costs?
Management fees, charged by fee-based advisors, are 100% deductible from taxable income on non-registered accounts. With RRSPs, the money taken to pay an advisor is not counted as taxable income. That means you got a tax break for putting that in, but there’s no tax when it exits – so the government is also subsidizing you. Fees on TFSAs, however, are non-deductible. Somebody in the top tax bracket, then, with accounts run by a professional offering tax advice and portfolio management who charges 1% will end up paying closer to 0.6% – while the poor single Mom with a few grand in the bank’s funds will shell out 2.6%. Unfair? You bet. But that’s the law.
So, fees are deductible. Commissions are not. MERs are embedded, invisible and can kill returns. If you remember just those three facts, they’ll serve you well. More on Mutual Funds – Dec 11 2017
What’s a mutual fund? It’s a pot of money made up of contributions from many investors that a manager then uses to buy stuff. Like stocks or corporate and government bonds. Managers charge big money to do this job (they have Porsches, too) which is charged back to the investors, and in return try to add ‘alpha’. That’s financial speak for ‘special sauce’, which means they attempt to get better returns than you’d achieve just buying the same assets and holding them. In doing this job they buy and sell frequently, often generating capital gains taxes, which the unitholders also pay.
Trouble is, most of these cowboys fail.
Last year, for example, the number of Canadian mutual funds which focus on US stocks and which outperformed the index was… zero. Nada. Donuts. Not one. In the States almost 70% of fund managers investing in large-cap stocks failed to match the index and yet charged big bucks to do so. Over the last 15 years, the failure rate among managers is 90%.
Ouch. Makes you wonder what you’re paying for. What also hurts is that the fees these non-alpha dudes charge are buried within the funds themselves, unseen by investors who cannot even deduct them from any gains they might make for tax purposes. Meanwhile the so-called advisors who collect the trailer fees from selling funds do not actually engage in any investing themselves and often collect an extra upfront fee for selling them to folks, or create a seven-year mutual-fund prison that penalizes anyone trying to get out. Difference between Mutual Funds and ETFs
Simple. ETFs are like Teslas – they drive themselves. There is no manager, so there’s no fat management fee for investors to pay. They don’t compensate some fancy guy to try and beat the market, then have to explain why he didn’t. They just pace the market itself. What the S&P 500 does this year, for example (up 18.4%), is what an ETF holding those 500 companies does. Plus, they’re traded on the stock market, which means you can buy or sell with the click of a mouse and get instant liquidity. Try doing that with a mutual fund (you can’t). In fact, most funds have the ability to halt redemptions, so if a crisis emerged you might not be able to sell when you wanted (just like Bitcoin).
ETFs are not free, however. Across a balanced portfolio you can expect to pay an embedded cost of about 0.2% – which is a hell of a lot cheaper than 2.0%.
Now, mutual fund salesguys, for obvious reasons, hate it when they hear such talk. And being in sales, they are daunting adversaries, able to woe naive investors with tales of giant, throbbing Alpha and heaving bosoms. (I may have exaggerated there.)
Jane, in fact, encountered exactly this schtick after she told her mutual fund guy she was leaving to embrace ETFs.
“I talked to him today for the formal “thank you and best of luck” nicety and needless to say he thinks I’m making a huge mistake. I feel quite defenceless when it comes to talking to financial advisors. My boyfriend tried to do his best to help explain it and then reverted to “Ask Garth.” For ease I will just lay out what was said by mutual fund guy in bullet form and hopefully you can help me out
- ETFs are cheaper but that is because they have a much lower rate of return. So if you compared mutual funds to ETFs, Mutual funds are far better.
- Fee-based advisors are cheaper because they do not actively manage my account, unlike mutual fund account managers. He said the MER is to pay for someone to manage my account. ETFs don’t charge this because no one is managing anything.
- ETFs are for old people in their 50’s that can’t absorb a loss.
- In 2008 ETFs took a much harder hit than mutual funds (50% compared to 20%)
- Young people should be aggressively investing and diversity is for old people and wusses
“Can you shed some light on this for me? My mutual fund guy did make me feel a touch uneasy. I would appreciate the insight just for building my own knowledge and confidence.”
You betcha, Janey. ETFs are cheaper because they don’t come attached to some Bay Street smartie with three kids in private school. They are pure reflections of a transparent market. The rate of return for nine out of ten has been higher than an actively-managed mutual fund, at a fraction of the cost. Fee-based advisors (who should collect a fee of no more than 1%) actually build and manage client portfolios. They all shop at Costco and recycle their socks.
ETFs for old people? Did he mention dwarfs?
As for the 2008-9 crisis, a balanced ETF portfolio declined 20% while the stock market slid 55%. It recovered all lost ground in a year, then advanced 17%. It’s not the structure of the asset that is owned (active or passive fund), but the weightings between various asset classes that will protect you in declines. You can be as conservative or aggressive as you want with either kind of funds. But if you like paying more for less, mutuals are for you. (He was really zooming you on that one.) The benefit of Bonds in a Portfolio
Bonds help reduce volatility
One common way to measure volatility is using standard deviation, which measures the variability of returns around the long-term average – the higher the number the higher the volatility. Over the last 10 years, the TSX has exhibited price volatility of 14.1%, meaning that TSX returns have been 14.1% above/below the long-term average return over the last 10 years. Volatility (standard deviation) has been 11.4% for the S&P 500 over this period. And for the average Canadian balanced portfolio, the standard deviation has been much lower at 8.3%. So, we prefer balanced portfolios to an all-equity portfolio since the ride is much smoother and with more consistent yearly returns.
📷Volatility of Different Investments
The other important reason we like balanced portfolios is because bonds often zig when equities zag. This dynamic is why a balanced portfolio exhibits lower volatility.
In good economic times corporate profits rise and investors feel more optimistic about the outlook that they are willing to pay higher multiples (e.g., P/Es) for stocks. This combination of rising corporate profits and valuations pushes stock prices higher.
Central banks in turn tighten monetary policy by hiking interest rates. This helps to push bond prices lower (prices move inversely with yields). So stocks go up and bond prices go down, generally, in a strong economy.
📷Conversely, in a weak economy stocks typically decline and central banks lower interest rates to help spur growth which leads to higher bond prices. Again, bonds zig when equities zag. This is perfectly captured in the chart below which shows the relative performance of Canadian bonds and the TSX. Note how bonds will outperform stocks over certain periods (in green) and underperform stocks in other periods (in red). This chart captures the essence of why a solidly constructed and well-managed balanced portfolio works!
Bonds/Equities Out/Underperform Over Time
Finally, how should investors structure their bond holdings in this rising interest rate environment?
First is to focus on lower duration bonds. Duration measures a bond’s price sensitivity to changing interest rates. If a bond (or in our case a bond ETF) has a duration of 8, it means the bond will decline approximately 8% for every 1% increase in interest rates, or rise 8% for every 1% decrease in rates; the higher the duration the higher the price sensitivity to rising rates.
Given our view that rates are going to continue to slowly rise, we are positioning our balanced portfolio with lower duration bond ETFs so as to minimize the impact of rising rates. Later when interest rates are higher we’ll look to reverse this call and shift into higher duration/yielding bond ETFs.
The other key strategy for bonds in a rising rate environment is to overweight corporate bonds versus government bonds.
With the Fed and BoC now hiking rates, government bond yields are moving up and prices lower. This of course weighs on all bonds but corporate bonds tend to outperform when rates rise. This happens for a few reasons. First corporate bonds offer higher coupons (yields), which help lower the duration relative to lower yielding government bonds. Second, because investors are feeling more optimistic about the economy and financial markets they are more willing to buy corporate bonds, which pushes up their prices relative to government bonds resulting in compression of the yield spread over government bonds.
Below is a chart comparing US investment grade corporate bond yields to comparable US government bond yields. Currently with US corporate bonds yielding 4.25% and US government bonds yielding 2.35%, this results in a “spread” of 190 bps. As the economy picks up this spread compresses which results in corporate bonds outperforming government bonds. We believe this spread could compress a bit further resulting in additional outperformance from corporate bonds. We’ll look to reverse this trade as we start to believe the economy is rolling over.
US Credit Spreads
📷We get it. In a raging bull market like we’ve been in for some years, bonds can be disappointing and cause us to deviate away from a balanced portfolio, focusing more on equities. But as we’ve shown, the benefits of including bonds in a portfolio are to reduce volatility and provide more consistent returns. And we’re not always going to be in a bull market so you’ll need protection against this inevitability. I feel confident that our client will call me up to thank me for our recent portfolio adjustments, likely when that dreaded bear market rears its ugly head. How are you positioned for this eventuality? Well, here are ten of my fav ways to reduce your tax bill thanks to two simple words – income-splitting (as opposed to sprinkling).
10 Ways to Reduce your Tax – Oct 29
- If you make more money than your spouse (in a higher tax bracket) take your piteous crumbs and use them to pay the household expenses. Have your spouse devote all of his/her take-home income to investing. Because your squeeze has a lower marginal rate, your family will keep more of the investment gains.
- Open a spousal retirement plan for a less-taxed partner. The full deduction comes off your bigger income but the other person gets the money. Wait three years, and it can be withdrawn at the lower spousal rate. Can result in big savings.
- Swap stuff. She gives you her departed mother’s irreplaceable jewelry (for God’s sake, don’t lose it) and you give her a bunch of ETFs. Now the financial assets are still in your family, but taxed in her hands at a lower rate (assuming there’s an income disparity between you).
- Take the beefy monthly cheque T2 now sends you for having kids and invest it in growth assets in their names. Capital gains made here will not be attributed back to you. If they grow up and become rock stars, you keep it.
- If you’re a wrinkly, split your CPP or pension with your spouse.
- Give money to your adult children. No, not for a condo down payment, but instead to maximize their TFSAs – on the understanding they give it all back (with gains) when they turn 50 and leave the basement.
- Loan your spouse a whack of money to invest. You will need to collect a tiny bit of interest annually on the loan (the rate is just 1%) but all the money the other person makes will not be attributed back to you. So if your partner’s in a lower bracket, it’s a big win. Plus the interest paid is tax-deductible.
- Max your RRSP, of course. Not so much for retirement, but for tax-shifting between periods of your life. Layoffs, job losses, mat leaves, sabbaticals – there are many times when regular income drops and tapping into money which grew tax-free can save your marriage.
- Stick the max into an RESP for your kids. No deduction for doing so, but the money will grow without tax and the feds will send a grant worth up to 20% of what you contribute annually. Open a family plan, not singles. And beware the hospital-stalking baby vultures with their crappy offerings. Go self-directed.
- Hire your spouse or your kids to labour in your small business doing useful things. Yes, this is exactly what Bill Morneau is throwing a hissy-fit over, but you’ll get the immense satisfaction of watching some CRA goon burn up hours of time only to conclude that, yes, your wife is actually a productive, contributing human being worth being paid. Plus, she’s deductible. What a turn on.
- You can get free money to educate your children simply by opening an RESP using cash the government sent you because you have children. The guaranteed return on investment is 20%, which beats buying a semi in Toronto. The rules allow you to go back and make up missed contributions (collecting the grant a year at a time), and if your kid becomes a rock legend instead of a dentist most of the tax-free growth can be wrapped inside your RRSP.
- If you think income-splitting is kaput, you’re mistaken. You and your lower-income squeeze have a plethora of ways to starve Mr. Socks. If you make more money, pay your spouse’s taxes so s/he can invest at their lower tax rate. Ditto for the household expenses. You can certainly open a spousal RRSP, writing off the contribution against your high taxes but making the money the property of your less-taxed spouse. Open a joint investment account, splitting taxable gains instead of paying them at your fat rate. And lend your spouse money to invest at the CRA’s proscribed and silly rate of 1%. So long as s/he pays you interest (tax-deductible) no money made by the investments will be attributed back to you.
- Don’t forget the registered retirement account, either, which is actually more of a tax deferral device than a way to fund your later years. RRSP room jumps with your income, so it’s of greatest benefit to those old, rich, high-earning guys that everyone currently hates. Revenge. Sweet. Having a ton of RRSP room sure helps if you get a retirement package or a pension to commute, so bear that in mind. Meanwhile you can borrow money to invest, then use the refund to pay down the loan, ending up with free equity. Or just transfer assets you already own into an RRSP (called a ‘contribution in kind’) and Justin will send you money for selling yourself something you already owned. There are no words.
- Borrowing to invest increases risk, but it sure is tempting. A secured line of credit against your house costs 3.7% and the interest is 100% tax-deductible. Meanwhile a balanced portfolio in 2017 returned 11%. Last year it was 8.5%. Looks like more is coming. So you can keep all that equity sitting in a house doing diddly, or put it to work. Just promise me you will not buy Bitcoin.
- Do you and your squeeze both work? If one earns more than the other, have the chief breadwinner pay all of the regular expenses – mortgage, rent, food, daycare, weed, insurance, booze, clothes, rehab. Make the lesser-monied spouse the chief investor in the family, so the returns (capital gains, dividends, interest) will be taxed at a lower rate.
- Ditto for registered retirement savings. If you earn considerably more than s/he does, or have a defined-benefit pension, use up all your RRSP room for a spousal plan. You write the contribution off your higher taxed income while your spouse gains control of the money. After three years it can be withdrawn at their lower rate – so you’ve just sprinkled!
- Here’s another one, if there’s an income disparity between you: loan your less-taxed spouse a bunch of money for investment purposes. S/he puts it into a nice little non-registered account and starts collecting dividends and earning capital gains in a tax-efficient way. Even though it’s your money, none of that income is attributed back to you – so long as this is set up as a loan at the CRA’s prescribed rate of interest which is, believe it or not, just 1%. Interest must be paid annually by the end of January but all of that is tax-deductible. Yes, your spouse can write it off the investment returns. This works for kids over 18, too. More sprinkling!
- Also with income-splitting: if you are a wrinkly collecting CPP (everybody should start taking it at 60, no exceptions), this can also be split with your less-taxed spouse.
- If you didn’t listen to the advice on this blog, bought individual equities and were handed your rear end by Mr. Market, sell those dogs before Christmas in order to realize a capital loss which can be used to reduce taxes on capital gains. Losses can be used to neutralize gains not only in the current tax year, but going back three more years. This can help you recover taxes that you paid as far back as 2014.
- You can also take crap assets that dropped in value and dump them on your kid. Another great reason to have children! Investments can be transferred to a minor child and that will also trigger a tax loss in your hands which can be used to offset gains. Now your spawn has an asset that, when it recovers in value, will be essentially tax-free with none of the gain attributed back to you.
- Fill up your TFSA, obviously. Also that of your spouse. And your kids over the age of 18. Gift money to all of them with no gains TFSAs attributed back to you. Remember, $5,500 a year for 35 years earning 7% will result in $819,000, of which more than six hundred grand is compound growth. So ensure these are not savings accounts, but investment accounts – no GICs, HISAs or other dorky stuff. Also when you retire, a $819,000 TFSA will give you about $50,000 a year in taxless income which will not reduce your CPP or OAS by one cent.
- If you’re 71 and have to convert an RRSP to a RRIF, be thankful you robbed the cradle and married a babe younger than you. Your mandatory retirement fund withdrawals can be based on the age of your spouse, keeping them to a minimum and allowing your nest egg to grow larger, longer.
- Obviously put money into a RESP for your kids. The feds will give you an automatic grant equal to 20% – so for a $2,500 contribution you receive $500, up to a lifetime total of $7,200. Free money. Duh. Why would you not do this? If your kid grows up to be a rock star or a high-net-worth, Mercedes-driving plumber you can fold much of the RESP money into your RRSP. Remember to buy growth assets. Establish a family plan for multiple kids, not separate ones. And, for God’s sake, avoid the RESP-flogging baby vultures that skulk around hospitals. Go self-directed.
10.And, yes, use RRSPs. They’re still the best tax-shifting vehicle around, allowing you to write off up to $25,000 in taxable income a year. You can borrow money cheap to contribute, then use the refund to pay much of it back. Or open a plan, shift in assets you already own, and get paid money by Bill Morneau for selling yourself stuff you already own. That should make his head all splody. Legal aspects of selling a house
If you’re selling a house – with more market declines ahead thanks to the new stress test – make damn sure the deal is solid. No long close. A mother of a deposit (ask for 10%). No buyer visits prior to closing. Deposit held in your lawyer’s trust account, not that of the listing broker. No condition on the buyer finding ‘satisfactory’ financing. And a clause giving you a day or two for legal approval of the offer.
Also do something radical – find out who the buyer is before you enter into a contract with them. Job? Circumstances? Background? Can they afford it? After all, you’d never rent your cheapo condo to someone without a credit application, references, credit check and income/employment verification. Why sell a $1.5 million house to a stranger and make huge life changes based on a closing months away that may never happen? HELOC & Risk Investment Strategy – August 7th
So he wrote me with an idea and a question:
I’m curious to know if you’d recommend pulling out 100k in equity in a house NOT to buy a rental house but to invest in a diversified portfolio and hopefully make a 6% to 8% yearly return only to turn around and put it back down onto the mortgage to pay it off faster? I’ve been contemplating on things to do to pay down the mortgage and create some income, no good having this equity just sitting here when it can be working for us! Seems starting a corporation is out of the question now thanks to T2 and his finance guru.
Given that real estate’s fat days are behind us but debt isn’t going anywhere, does this make sense? Maybe. Let’s roll it around.
Millions of people have, collectively, billions in real estate equity. When house prices stop going up, this becomes dead money. The only value you can really ascribe is what it might save you in equivalent rent. For example, a $1.5 million house can normally be rented for $3,000 a month. The family with a $500,000 mortgage and $1 million in equity is spending $2,400 (monthly) on the mortgage plus about $600 in property tax, insurance and utilities (water, sewer) that renters never pay. So they ‘own’ a home for the same monthly outlay as the family who rents it.
But they have put down $1 million to live there. If that were conservatively invested, and returned 6% annually, it’s $5,000 a month. So the house actually costs $8,000, and could yield a non-deductible capital loss as easily as a non-taxable capital gain.
In other words, in a declining, flat, comatose or normal housing market, the cost of ownership when real estate has climbed to these levels is insane. Renters who invest win, ten times out of ten. If interest rates creep up and mortgages renew higher, the economics of owning get worse. In the current environment, a lot of people have to be asking themselves – like Kevin – if there isn’t some way to use that dead equity which is no longer supporting a rising asset.
Yes, a HELOC is one way of unleashing equity. It’s a line of credit secured by real estate, which means the debt is registered against the property but also that it comes with a preferential rate of interest. That’s normally prime + 0.5%. These days that equates to 3.45% (and it may rise to 3.7% in October). The line’s rate is almost always variable, so it will increase along with the bank prime. And HELOCs are demand loans. If real estate prices truly collapsed or another credit crisis hit, the bank could ask you for the money back in, oh, 30 days.
The good news is all of the interest is deductible from your taxable income if the money is used to generate more money. Yup, that could be real estate paying you rent or (wiser) a balanced and diversified portfolio of financial assets. So, if you earn $120,000 and live in BC, for example, you effectively reduce the loan interest rate by 41%. Now the HELOC costs you just 2%.
Given that well-managed, non-cowboy, globally-balanced and diversified ETF portfolios have pumped out an average of 6.5% over the last seven years (two of which were market stinkers), this mean a spread in the 4% range. Last time I checked, that was better than the 0% home equity is currently paying.
So to Kev’s question. If he borrowed $100,000 on a HELOC and invested it for a 7% return, then used the cash flow generated ($7,000) to pay down his existing mortgage faster, would it make sense? Well, interest-only payments on the line would cost $3,450, but he’d reduce his income tax by $1,400 (if he earns enough). So he’s up five grand. That’s cool – it can be used as a pre-payment on the amortized mortgage. But wait. Kevin now owes another $100,000. But wait again. He has a $100,000 liquid investment portfolio.
By removing equity and borrowing, the Harley dude has (a) diversified his net worth, (b) reduced his income tax bill and (c) accelerated the mortgage payments, saving a whack of interest.
This is not a slam-dunk strategy for everyone. If rates rise and the payments get hard to make, you lose. If the world goes to crap and the loan is called, you lose. If your house craters and the bank finds out, you lose. If your job fades, you lose. If you invest in the wrong stuff (like gold, bitcoins, weed stock or junior oil & gas), you lose. If the feds drop the hammer on HELOCs again, you lose.
Debt is debt. The world’s soaked in it. Most people would be unwise to shoulder more.
The best strategy, history will show, is to trash debt by selling high. This is high. Complex home buying tax strategy, courtesy of Derek Holt – the chief economist at Scotiabank
· Make a $19.2k RRSP contribution just three months in advance of buying a home… • …assuming a 30% tax rate, deposit $6k tax refund back into RRSP… • …then withdraw the allowed $25k maximum under the HomeBuyers’ • …to be repaid to the RRSP in equal installments over 15 years starting 2 years after withdrawal with no interest penalty and the payments are not counted in mortgage serviceability calculations… • …at, say, a 4% rate of interest, this equals $8k in interest savings over 15yrs… • …which means the initial $19.2k RRSP deposit has been parlayed into an effective down payment of about $33k, or an extra 70%+ • No restrictions on the source of the original RRSP deposit (can borrow for it, ‘gift’, etc). • ie: the zero-down mortgage can still theoretically exist • If a couple, and both are first time homebuyers, double all of the math above (ie: turn $38k from liberally allowed sources into a $65k down payment)
· If a major bank’s showing clients how to take $38,000 and game it into $65,000 through exploiting the system, it might indicate we’ve all hit a tax wall. And this is even before T2 Hoovers out the savings of small business operators, vets, docs and the local John Deere dealership.
The first version of the Internet was no faster than a local DMV branch, simple in approach, and mostly used for decentralized communications. Internet 2.0 is comprised of the programmable Internet that you see today, including everything from content and networks to search engines and browsers. Decentralized Autonomous Organizations are Blockchain 2.0, the “programmable version”; allowing all participants to exchange information and data on an irrefutable and distributed ledger. In doing so, it cuts out many of the traditional middlemen seen in corporations. DAO’s have the potential to create peer-to-peer networks utilizing self-executing smart contracts, independent of interpretation from outside influences
. Whatever means of exchange is used within the DAO is both meant to power smart contracts, and as a means of voting so the community can reach consensus.
While DAO’s represent a novel opportunity to disrupt many existing legacy systems, Decentralized Autonomous Organizations should also be viewed with skepticism and much of the excitement surrounding them can reasonably be described as fraudulent. While their decentralized nature promises to create an economy of the likes the world has never seen before, the vast majority of these organizations are neither decentralized nor ready for the complicated real world use cases they claim to solve.
While many advocate for the security provided from many points of failure, a DAO’s lack of centralization could also lead to increased vulnerability. For example, when a project runs on code that is centralized at a single point, fixing the issue is as simple as solving the problem, and fixing whatever issue in the code that exists. In a truly decentralized ecosystem, each individual node needs to update its code. This becomes even more important if the issue is time sensitive. Though decentralized systems are harder to compromise, if a route for doing so is found, the results are far more dire.
DAO’s create a tremendous amount of problems from a legal perspective as well. If investor funds are stolen through a leak or problem in the code, who is to be held accountable? Some argue it should be the programmers, while others argue in practicality, every single individual could be held accountable. (Levine, M. (17 May 2016)."
) Additionally, the SEC in the United States has ruled that some of these DAO’s are illegal securities. Others promote projects claiming to be DAO’s, when in reality the parameters that can be voted on are so limited it can best be described as a ruse, or all voting tokens are under the control of the overarching organization and the system is only slightly distributed, not decentralized. Additionally, in a true decentralized system there is no one that wants to sign paperwork for an organization that’s path is far out of his or her realm of control.
The most famous use of a complex DAO thus far took place by a company called Slock.it, which ran on the Ethereum Network. After a token sale of 150 million dollars worth of Ethereum, the team began to fund proposals and expand the network. Feeling pressure from lofty expectations, the founders of The DAO,
took huge risks. However, when the codebase was debated, it was entirely flawed. A hack immediately siphoned 50 million dollars worth of investor’s Eth into a “Child DAO”. Because this represented such a large breach in the Ethereum network, the Ethereum foundation decided to step in and use their massive influence and voting power to fork the network.
This action runs contrary to the original goal of a DAO; to be independent of any formal central governing body. When the Ethereum Foundation stepped in to hard fork the network, the novelty of an autonomous decentralized organization immediately disappeared. In order for a DAO to be successful in its mission of truly being autonomous, it must be released with a strong enough foundation to stand the test of time and update to reflect necessary changes based off of voting procedures. By stepping in to fork the network, Ethereum not only sacrificed the integrity of The DAO,
but they also sacrificed the integrity of the entire Ethereum network. With so many Ethereum tokens locked up in The DAO
, the Ethereum Foundation had a conflict of interest. A loss of investor funds would lead to severe problems both internally and publically and could lead many to write off their promising emerging technology. Additionally, members of the Ethereum foundation controlled 70% of the DAOs voting power. The voting for the fork lasted only 12 hours and made minimal effort to inform token holders. Instead of The DAO
failing as an independent organization, it was absorbed into Ethereum. (Price, Rob 7 June 2016)
This is strikingly similar to the conflicts of interest seen in 2008 during the financial crash. John Allison, the longest serving CEO of a top 25 financial institution wrote “Many of the financial institutions that should have been allowed to fail had a history of being crony capitalists; that is, these companies did not advocate limited government but instead sought special favors for themselves… Crony socialist is probably a better name for these individuals and firms,” (John Allison, 6). Governments help of their friends and donors have created a precedent that allows failing institutions to continue to thrive. When the Eth team decided that the DAO
was too big to fail, they did not allow free markets and token holders to make the best decision for the organization, they simply used their undue influence for a cyber Coup D’état. Failure should be encouraged to promote conscious investment and out of fairness to organizations that have been successful. Instead, the Ethereum Foundation abused its power and hard forked the network to help out their friends.
While The DAO
has failed, a more simple approach has shown that it can succeed. Released in open source code in 2009, Bitcoin is a DAO in the simplest terms. Though imperfect and controlled completely miners, it has been under attack every day and has never been breached. Time has shown that its fundamental foundation is rock solid. As a result, despite being considered slow and outdated by some, Bitcoin holds nearly a majority of the crypto cap. Investors have seen that Bitcoin is capable of running without outside interference for nearly ten years now and responded with capital infusion and investor confidence. Additionally, Bitcoins slow governance model can create confidence that the rules wont quickly be changed from under holder’s feet. Bitcoin has survived and will continue to be successful because it has remained mostly autonomous. Though, it is important to note that Bitcoin still struggles with mining decentralization due to the efficiency of ASIC processors. Bitcoin is not a traditional bank, but is certainly showing it has the capabilities to transform traditional stores of value and to be part of challenging the Federal Reserve.
With true Decentralized Autonomous Organizations, free markets will cause some to fail miserably with the strongest disrupting the worlds most important and antiquated legacy systems. Free markets of this magnitude revolved around banks during the Wildcat Banking Era from (1837-63). This era, marked by extremely lax banking laws saw many banks fail and declare bankruptcy. However, the problems of one bank where not contagious to others and banks that survived conducted themselves in a manner that would not require a bailout or special favors to be successful. Additionally, the era saw increases in banks educating its customers and a general increase in knowledge regarding financial institutions (Arthur J. Rolnick, Warren E. Weber). John Allison would argue that this same model should to be taken by DAO’s in the future to insure we don’t have a repeat of the Federal Reserve. By allowing faulty DAO’s to fail, investors will lose their money and be incentivized to make more informed decisions.
“Exchange is the lifeblood, not only of our economy, but of our civilization itself,” (Murray Rothbard, 1990). For the United States and much of the world, exchange runs through a thoroughly bureaucratic and inefficient institution called the Federal Reserve. The tribulations of the Federal Reserve have caused a laundry list of problems for the entire world. Despite this, the Federal Reserve see’s no competition and has been encouraged to operate on a failing model. The overlay of Decentralized Autonomous Organizations and Cryptocurrency promise to, at the very least, “bring discipline on a very discretionary organization,” (John Allison).
Today, the Federal Reserve of the United States no longer uses precious metal to back up its reserves. Instead, a U.S Dollar is based on the full faith of the U. S Government. In effect, the Government wants you to believe that the dollar is based on the countries GDP. The United States and many others have attempted at their own demise, to print themselves to prosperity.
Crony practices such as quantitative easing have left the world at the brink of financial ruin with the Fed even teasing the idea of negative interest rates for the next recession. (Kenneth Rogoff, American Economic Association) Once again, massive conflicts of interest persist. In some countries, corrupt governments who control the money supply are estimated to be worth hundreds of billions of dollars of stolen money while their citizens starve, [The Independent]. Meanwhile, these same Governments create social policies and minimum wages they cannot pay for. To combat that problem, they simply print more money. By overprinting money, the Fed has devalued the U. S dollar as many central banks worldwide have done in the past. This has destroyed purchasing power and made market basket goods far more expensive. Often, this type of economic meddling is a precursor for authoritarian style governments, as seen in Chavez’s Venezuela, Mugabe’s Zimbabwe, and countless other examples that clearly demonstrate the horrifying end result of central planning.
Friedrich Hayek famously said, “Money is one of the greatest instruments of freedom ever invented by man.” Unfortunately our freedom is directly controlled by the highly discretionary and corrupt organizations of the world, central banks. A DAO for financial transactions, would increase transparency and financial freedoms in ways otherwise unimaginable.
Bitcoin has caught the attention of both markets and governments worldwide due to its lack of a Government backing. The greatest minds spanning from Aristotle to Allison agree on what money needs to be. Durable, transferable, divisible, scarce, recognizable and fungible. “Government issued” is certainly not one of those specifications. Especially when the concept of scarcity falls of a cliff entirely. Government does not mean that governance and structure of some kind are not essential. In its current state, Bitcoin is best as a digital gold. Along with its properties of being transferable, auditable, fungible and divisible, Bitcoin is also exceptionally difficult to change. In order for a new policy to be implemented in Bitcoin, miners have to form a 95% consensus on it. Because the rules are unlikely to ever really change from under you, Bitcoin is best compared to digital gold with the advantages that it doesn’t require duplicate paper receipts or wheel barrels to exchange.
However Bitcoins lack of maneuverability can also lead to issues. In order to radically challenge the global monetary system, others will have to play leading roles alongside Bitcoin. In the Bitcoin network, if a consensus is not met between the different groups of miners, two forms of the same currency could be fork, IE Bitcoin Cash. Every Bitcoin Wallet is accredited with an equal amount of the new currency (Bitcoin Cash). These forks create many dilemmas. First and foremost, this is the equivalent of fools gold. Second, it creates unadopted competition, artificial inflation and rampant confusion leading to the loss of funds. There have been innumerable examples of people trying to use Bitcoin Cash as Bitcoin and losing their funds. At present, there are a slew of Bitcoin posers including Bitcoin Cash, Bitcoin Private, Bitcoin Diamond, Bitcoin Gold and more likely to come. None of these are or can be accepted as Bitcoin. Additionally, the threat of a looming fork makes it extremely difficult to make the necessary changes to the protocol.
Those who validate transactions are the governing body that supports Bitcoin; the miners. As there is no salary dedicated to developers in the block reward, developers rely on donations. With these donations come conflicts of interest arise. Bitcoin has become relatively centralized and those who hold and transact the currency are not the ones who decide its fate. This is an inherently flawed system.
One project that truly shines is Decred- a lesser-known cryptocurrency developed from the original group of overarching founders of Bitcoin. Like Bitcoin, its creator is unknown and the coin was not distributed via an ICO. Instead, developers paid for 4% of the supply while another 4% was dealt to those who were able to solve complex puzzles via airdrop.
Decred presents a proof of stake/proof of work hybrid form of governance. In this format, nodes stake coins and validate blocks, giving the stakers of the currency part of the block reward as pay for their work. This system allows the actual holders of the currency to decide the direction of the network because miner’s blocks cannot be confirmed without stakers approval. This system is not a democracy- each individual staker gets voting power based off of how much skin they have in the game.
The block reward of Decred is set up so that 60% goes to Proof of Work miners for creating blocks, 30% goes to Proof of Stake miners for validating the blocks, and 10% goes to development for future improvements. As stakers get a portion of the Block Reward simply for staking their currency, staking coins can be a form of passive income for holders. The 10% development reward goes directly to the Decred Autonomous Organization. When a member of the community has an idea for an improvement to the network, they stake a fee to have his idea presented to the community on a Reddit-like forum called Politeia. All proposals, comments, and votes and are time stamped on the blockchain to ensure transparency. Additionally, any censorship is public and a dialogue can always be publicly opened. This stops shadow banning and supports freedom of information and ideas. If members of the community vote, and decide to develop, they also vote to decide where to allocate every single cent. Through the proposal system, anything can be proposed. If members of the community feel that developers are not performing to standards, they can vote to replace them. If members of the community think a certain initiative should be taken to change the currency, for example- privacy, it is proposed and voted on with history permanently encoded and time stamped onto the Blockchain.
Once the new proposal for the network, is completed, miners and nodes receive a code base with the old and new code. Miners run the version of it that they prefer, signaling their vote. If 75% percent of the miners run the new code and have their blocks confirmed by stakers, the network uses smart contracts to automatically fork and begins to only accept transactions following the rules of the new protocol.
In effect, holders are not only investing, but are also the key role players in the organization. It is stakeholder’s final decision to decide which protocol the network should follow and that for transactions to be confirmed. Under the Howey test, it is unlikely that Decred will be considered a security. There is no investment contract and stakeholders are receiving reward for their work, not that of others.
Additionally, the way in which tokens where distributed gave 4% to developers as reward for their work, and 4% to members of the community who worked to solve puzzles which granted access to an airdrop of Decred. Fair distribution from the beginning makes it far more likely that this project will be a success in the long term. This coin is better suited to fight ASICs and centralization and is far more autonomous than Bitcoin because developers don’t have to accept donations creating conflicts of interest. Developers and funding answers only to voting.
Like Bitcoin, Decred plans to only have 21,000,000 tokens and no Government exists to print more Decred. However, non-traditional inflation in the form of tail emissions after the 21 millionth block is something that can be voted on by the community if they feel it is necessary. Decred maneuverability to overcome and evolve along sound, calculated development makes it primed to be another catalyst in the dismantling of central blanks worldwide.
Though money remains the most immediately rewarding and possible undertaking of Decentralized Autonomous Organizations, many more promising possibilities exist. One example that springs to mind is a decentralized versions of Uber or Airbnb with, service and user being directly connected without the transfer of data, or a portion of the price transferred to a “trusted” third party. The holy grail of DAO’s is revolutionizing social media to a truly open platform that allows open communication and expression without censorship, similar to Decreds Politeia. All of this must be done without violating the privacy of its users and manipulating their brains with dopamine shots from likes, shares and comments from conforming to whatever particular status quo is beneficial politically, economically or socially to the third party running the algorithm. The Decentralized Autonomous revolution is not just about regaining control of our money or retaining our privacy, it is about returning to humans that think with the brains they are born with instead of fed.
Central planning behind the world's most important organizations have led us down a disastrous path that will only lead to worse. Humanity has been given an opportunity to radically transform our institutions by harnessing the powers of technologies such as DAOs. The consequences of continuing down a path of irresponsible inflation and poorly disguised central planning is dire. Time after time, this has proven to be a recipe for authoritarian regimes and destroyed economies. Citizens of the United States are happy to look at the horrors of the situation of others and criticize the path they have taken to get there, when in reality, they are on an eerily similar path. Though we at the very beginning of experiments with decentralized autonomous organizations and many of their ICO’s are useless, there is reason to be cautiously optimistic about their future. Change is on the way and the revolution will bring, at the very least, competition to the highly bureaucratic, corrupt and antiquated legacy systems of the world.
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A lack of commitment in monetary policy can, however, undermine saving and, thus, the cost of using tokens to fund start-up costs is potential inflexibility in future capital raising. Crypto tokens can also facilitate coordination among stakeholders within digital ecosystems when network effects are present. Download. MIT NewS: "Bitcoin study: Period of exclusivity encourages early adopters ... There are four major Bitcoin companies in the Czech Republic: SatoshiLabs, Paraleni Polis, General Bytes and Bitcoinpay.com. Recently in January, a company named WBTCB launched a service which allows people to buy Bitcoin on 8,000 terminals located in post offices. Czechs can buy Bitcoin almost everywhere, which is definitely going to help the dozens of merchants that are accepting BTC. American Economic Journal: Microeconomics. 2013, Vol. 5, Issue 1, ... Co-director, Market Design Program, Stanford Institute for Economic Policy Research, 2004-2006; Mentor, CeMent Mentoring Workshop, AEA/CSWEP, 2006; Young Faculty Nominating Committee, Center for Advanced Study in the Behavioral Sciences ; Associate Editor, American Economic Review, 2002-2005; Associate Editor, RAND Journal ... Discusses the Government Regulation Paradox of cryptocurrencies, which is that cryptocurrencies need government regulation for stability but one of the reasons that investors are buying it in the ... Jun 29 ‘Bitcoin not built to last, despite recent surge’ – NYPost $11,882.51 Jun 27 ‘Bitcoin’s crash hurts the latecomers once again’ – MarketWatch $10,695.37 Jun 24 ‘None more foolish than what’s being said to rationalize the Bitcoin bubble’ – Twitter $11,041.85 Jun 06 “Stark warning for crypto fans – ‘it’ll all be worth zero’” – Express $7,806.72
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