Financial Jungle

The landscape of tax-sheltered investing will forever be changed as the 2008 Canada Federal Budget unleashed the new Tax Free Saving Account (TFSA). When my co-worker, Tony, first mentioned the name “Tax Free Saving Account”, my first guess was a high interest saving account that grows tax-free. To my pleasant surprise, you can pretty much throw any instrument at it. My understanding is that anything that’s eligible for RRSP is also eligible for TFSA. This includes GIC, bonds, stocks and income trusts.

In a nutshell, here’s how TFSA works:

• Starting in 2009, Canadians aged 18 and older can save up to $5,000 every year in a TFSA.
• Contributions to a TFSA will not be deductible for income tax purposes but investment income, including capital gains, earned in a TFSA will not be taxed, even when withdrawn.
• Unused TFSA contribution room can be carried forward to future years.
• You can withdraw funds from the TFSA at any time for any purpose.
• The amount withdrawn can be put back in the TFSA at a later date without reducing your contribution room.
• Neither income earned in a TFSA nor withdrawals will affect your eligibility for federal income-tested benefits and credits.
• Contributions to a spouse’s TFSA will be allowed and TFSA assets can be transferred to a spouse upon death.

I have attached a few TFSA references below, so I won’t regurgitate too much. What I pray is that the 15% US dividend withholding tax won’t be applied to TFSA. Since my RRSP is already congested with US dividend payers and Canadian income trusts, I can use a little breathing room with TFSA.

Secondly, I hope they’ll modify the rules such that people over 18 can reclaim their contribution room retroactively. Someone turning 18 this year will stand to benefit the most, but what about me? I’m 33 year-old. I want my contribution room from the past 15 years. (15 x $5,000 = $75,000)

Either way, I’m thrilled about TFSA.

More resources from:
Jonathan Chevreau
National Post
Canada.com
Canadian Capitalist
Michael James
Thicken My Wallet
Tax Free Saving Account calculator

All right, that’s it! Those ETF bullies have tormented us dividend stock pickers long enough. I’m retaliating. My headgear is on. My gloves are strapped. Give me your best shot.

1. Less MER - In fact, buy-and-hold dividend investors pay no MER at all. Regrettably, iShares CDN LargeCap 60 ETF (XIU.to) and TD Canadian Index eSeries seize 0.17% and 0.31% respectively. Which means, dividend investors have a 0.17% to 0.31% head start each and every year.

2. More Diversified - Most investors refer to the other types of diversification: by sectors and by geographical locations. This is a non-issue for investors with 30 or more stocks. As long as your eggs are properly spread amongst different baskets, the portfolio will achieve similar volatility as the general market. At least one study found that 90% of the unsystematic risk can be diversified away with as little as 12 stocks.

Sure, diversification does alleviate uncertainties in a portfolio due to particular sectors or countries, but there is a much bigger monster in the room, and that is market sentiment. No matter how much you slice and dice your portfolio, all sectors are still subject to market sentiment. The past few months are a testament of how every sector limps along while the market is howling over its PMS. No one can escape the carnage. The way I see it, dividend investing is the only remedy to help us cruise through the turbulence while remaining fully invested in the stock market. Just look at Bank of Nova Scotia. It’s basically the same old boring bank as yesterday, last week, last month, last quarter and last year, but its 1 year chart resembles 6-flags roller coaster. All that while, their distribution policy is steady as she goes.

So, dividend investing offers you another dimension of diversification by easing reliant on market speculations, and rewarding you with real hard cash straight from the operations of your high-caliber businesses.

3. More Tax Efficient - A $35,000 salaried British Columbian profiting from a $5,000 capital gain must pony up an extra $615 in taxes. The same British Columbian receiving a $5,000 dividend would pocket a $175 tax refund. (That’s almost enough to pick up 4 more BNS shares!) So, ETF investors must overcome both the MER and the tax refund every year.

4. Extended Investment Horizon - Due to market sentiment described in point 2, ETF investors must gradually shift their equity exposure toward bond to protect their nest eggs from market volatility. Consequently, a 25 year old ETF investor may only have a 30 to 35 year weighted investment time horizon before reaching 65. This is a double whammy for them: the investments have less time to compound, and the turnovers create tax-drags against the portfolio return. And don’t forget that bonds are taxed as regular income.

On the other hand, dividend investors can prolong a carefully crafted portfolio because dividends are never at the mercy of market turbulence. By sticking to stocks with a history of rising dividends, or businesses that provide essential goods and services, you can afford to hang on to the portfolio longer. I think the best defense is the best offence. If anyone can prolong a dividend portfolio for 40 years, the dividend compounding coupled with the preferential tax treatment will deliver enough capital cushion to hold to the stocks forever.

5. Less Market Timing - Contrary to popular belief, a thoroughly hands off approach to investing is an illusion. Eventually, a retired ETF investor will have to live off his equities. Unless he turns over 100% of his portfolio to bonds (I smell capital gain taxes), the 4% withdrawal rule is going to pinch during bear markets. If hysteria sinks the market down 15%, can he afford to devour another 4% and erode his already undervalued capital? If euphoria drives the market up 15%, should he take out a little more in anticipation of a trend reversal? You see? There are so many crucial market timing decisions. Doesn’t sound to me like a relaxing golden age.

A retired dividend investor doesn’t need to fiddle with his portfolio whether the market is sad or happy, because the dividend stream is more dependable even when the market is tumbling. And courtesy to points 1, 3 and 4, a dividend portfolio should enter retirement with a much larger base and yield, and be able to outpace inflation and cushion any unforeseen dividend cuts.

Further reading: A brief history of high yield stocks

Psst! Did you know a British Columbian couple can earn as much as $99,200 in dividends and not pony up a dime for income tax? Legally?

BC is truly Canada’s most exhilarating province where the government begs you to splurge on mountain hiking, skiing, fishing, sailing, golfing and urban living, at least in Vancouver. Best of all, you can do all that tax-free with passively generated dividend income from qualified Canadian corporations.

What’s the secret to this tax-free nonsense?

Everyone, please hail to the power of dividend tax credit. Simply put, dividend tax credit (DTC) reduces the amount of tax you pay to the government. You can calculate this tax credit by following my post on How To Calculate Dividend Tax Credits. In a nutshell, all dividend incomes are “grossed-up” to 145% of the actual dividends received. In the eyes of the taxman, you earned 145% of the received dividends for the year. This sounds terrible, because the more money you earn, the more tax you pay. However, the DTC turns around and slashes your tax bill based on a combined federal and provincial rates. The federal DTC rate is fixed at 18.97%. On the other hand, the provincial DTC rate ranges anywhere from 6.65% in Newfoundland to 12% in British Columbia and New Brunswick.

If you’re like me, these calculations make you cross-eyed. To skip this dividend gobbledygook, surf to this online tax calculator from TaxTip.ca. To calculate your total tax payable, simply select your province at the top, and punch in the dividend amount at the “Cdn dividends eligible for enhanced div tax credit (public companies)” field.

I used to believe the first $66,000 in dividends is tax free until confronted with the sneaky Alternative Minimum Tax, which targets high earning individual awash with certain tax advantages. Some web sites are still quoting ~$66,000 as the maximum tax-free dividend earning in BC, but I’d be more than ecstatic if anyone can provide proof.

Probably the most hostile criticism to dividends is the how the 145% gross-up amount robs seniors from certain government supplements, most notably the Old Age Security. Seniors (over 65) can receive up to $502.31 per month from OAS, but problem is the government starts to hold back certain amount for seniors earning above $64,718, and the entire OAS payment vanishes completely by $104,903. The dividend gross-up amount is a real concern because it’d only take $44,634 in dividends to enter the $64,718 territory.

Despite the warning, I believe the pros outweigh the cons. Policies change from year to year, so you never know if OAS is sustainable amidst the dramatic aging population shift over the next few decades. Even then, the prudent course is to clasp the guaranteed tax-savings today, reinvest and compound the profits for years to come.

Reference:
How to optimize dividend tax income by Million Dollar Journey
The other way to retire by Canadian Dream

The market is weird. Every time one guy sells, another one buys, and they both think they’re smart.

Being a stock picker, this is one statement that I dread the most. How do you respond when you’re cornered into a no-win rhetorical statement? Do you pretend snobbishly that you’re smarter than the other guy? Otherwise, why become a stock picker at all?

My typical response is, even though the market is smarter than I, behaviour science teaches us that the market is perpetually stuck in a moody state where traders tend to exaggerate positive and negative news. The idea of stock picking is to avoid the herd mentality, and think independently.

The point of this article isn’t whether the market is efficient. Rather, even assuming all stocks are priced at equilibrium, market participants can still reap tangible value because stocks are priced inefficiently relatively to the individuals’ objectives and holding structures. Maybe a few examples will clarify things.

I picked up 100 BMO shares a few weeks back when they announced some derivatives trading losses. Someone must have sold the 100 shares to me, but I have no clue who that was. Maybe it was an American*, which would make perfect sense due to the lack of preferential tax treatment — BMO is worth more in my hands because Canadians receive the dividend tax credit.

Or, perhaps the seller was a Torontonian. Once again, BMO is worth more in my hands since Vancouverites benefit more from a higher dividend-tax-credit rate than Torontonians.

The seller could also have been a retiree who has a much shorter time horizon and looking to swap his BMO holding to something more conservative like bonds.

How about income trusts that distribute ample of interest incomes? As most know, the government will strip the preferential tax treatment for most income trusts by 2011. In the meantime, income trusts avoid paying the corporate tax as long as they distribute all earnings to shareholders. This delights RRSP shareholders more because the resulting pre-tax distributions are generally higher and tax-deferrable, while non-registered shareholders must report the distributions as regular income for the year.

Once the rule changes in 2011, the opposite is true. Income trusts must pay corporate tax on all reported earnings, however the trusts can distribute dividends to shareholders, who can then claim the dividend tax credit. The new rule favours non-registered holders because the after-tax distributions are essentially the same as prior to the rule change. On the other hand, the new income trusts are worth less in RRSP holders’ hand because the corporate tax reduces the distributable cash, and the dividend tax credit is lost inside RRSP.

As you can see, there are scenarios where win-win transactions can take place, and I haven’t even touched on portfolio rebalancing or hedging yet. The only time when it’s a zero-sum transaction is when it’s between two investors with similar goals.

For my own purchases, I don’t worry about who’s at the other end of the trade, because we can both be right.

* Since BMO is inter-listed on both Toronto and New York, I’m not sure if Americans receive preferential tax treatments if they purchase BMO from New York.

There’s absolutely nothing that tastes better than a deferred capital gains tax. Many investors consider investment loans as good debts because the interests are tax-deductible, but the deferred capital gains tax is even sweeter. Never mind tax-deductibility; it is interest-free!

If you double your $10,000 investment to $20,000, you owe Canada $2,000 in capital gains tax assuming you’re in the 40% tax bracket. (Only half of the capital gain is included in your taxable income.) By being a buy-and-hold investor, you defer the tax indefinitely until you liquidate the investment. Effectively, you’re borrowing money for free. The fruits of your patience also grow over time. Due to the compounding effect, the longer you hold the investment, the faster you accumulate interest-free debts.

The deferred capital gains tax is much friendlier than margin loans because it has no margin calls, so you’re not forced to sell a piece of good business at the cheapest possible price. Furthermore, the capital gains tax acts as your first line of defense during market setbacks; the government generously forgives the loan before you start to lose money. On the other hand, when you borrow money on margin, it is your equity that fortifies the lender. Market correction is not the time to be brave.

When you have an embedded capital gains tax in your investment, think hard before trading it with another investment. In the above example, such a swap will trigger a capital gains tax and shrink your capital by 10%. Think about what you’re giving up. You’re losing a layer of cushion that absorbs the price volatility, and you miss out on future compounding on the 10%.

In investing, it’s rare to uncover a value stock compelling enough for you to abandon 10% of your capital, and hope it will catch up to the stock you just sold. Note the difference; the 10% loss is guaranteed, while the new purchase is an educated guess, but still a guess.

If the government offers to subsidize your investment, don’t be rude. Accept the gift graciously by holding on to your investment. As Charlie Munger puts it:

Just sit on your ass!

Canadian Capitalist is graciously hosting the third Canadian Tour of Personal Finance Blogs. There is no way I am passing up this opportunity to be mentioned in his blog. This will be my second participation to this tour. Enjoy!

Organizing your portfolio into neatly divided asset classes appears to be the sensible thing to do, but what if your financial advisor is offering you only a half-baked solution? Take my friend, Mel, for example. He and his wife walked in to a bank seeking an optimal way to invest a $10,000 windfall. The advisor had them fill out a Know Your Client form to learn their financial goals, risk tolerance, investment knowledge, time horizon and financial position. Based on his assessment, the advisor recommended a 70/30 split between equity and bond funds commanding a hefty 2% in management expense ratio (MER.)

What’s wrong with this picture? Like typical young couples, Mel and his wife still owe an approximate $200,000 worth of mortgage. Since homeowners pay mortgage interests with after-tax money, a 5% mortgage rate is costing Mel 7.14% of pre-tax income - assuming he’s in the 30% tax bracket. None of these bond funds could have guaranteed that rate, especially after MER. Why lend his money to a bond fund, only to borrow it back in his mortgage at a higher rate? He may as well pay down the mortgage instead of buying bonds.

The problem with the financial industry is that it’s not in their best interest if you pay down your mortgage. It’s a double-whammy for them:

• They stop collecting mortgage interests from you.
• They stop collecting MER on the bond fund.

A better solution – in my opinion – is to reduce the scope of your portfolio. Instead of investing $3,000 in bonds, pay that toward the mortgage. A dollar saved is a dollar earned. Paying down your mortgage is equivalent to earning 7.14% guaranteed. The net result is a reduced $7,000 portfolio invested 100% into equities. Sounds scary at first, but simply imagine the other $3,000 is invested in your mortgage. 7.14% guaranteed is a yield on steroid, that no one else can match.

I’ve been noticing that a number of bloggers - including myself - are topping up their BMO positions as the stock is rattled by commodity trading losses. Money Diva initiated 400 shares of BMO earlier in the week. My own BMO position grew to 250 shares last week with a new adjusted cost base of $63.20. BMO, to me, has the best balance of high yield and dividend growth. At $68.69, the stock is yielding a cool 3.99%, while its dividends surged from $1.20/share to $2.26/share over the past 4 fiscal years. At this price point, I think this is a window of opportunity for aggressive investors to snatch up some BMO with leverage, and still maintain a positive cash flow.

Continuing with my dividend tax calculation post, a BC resident in the 30.65% bracket wouldn’t pay any dividend taxes. If you leverage to buy BMO, you’d receive 3.99% in dividends tax-free and a small tax refund. The loan interest rate would be 5.75% from Interactive Brokers, but the interest is tax-deductible. If your tax bracket were 30.65%, your after-tax cost would be 3.99%, thus canceling the dividend yield. In other words, it’d cost you nothing to invest in BMO with borrowed money.

The reward is in the dividend growth. Granted that part of the recent growth came from rising payout ratio, but even with a modest projection of 6%/year growth, the yield can still overcome the interest rate by 1.35% in 5 years. The beauty of this setup is that you’re never forced to sell. Leveraging alone isn’t dangerous, as long as you can afford the interest.

This is a short little post to remind readers and myself how to calculate the dividend tax credits.

Dividend Tax = (Grossed Up Dividends x Marginal Tax Rate) -
(Grossed Up Dividends x (Federal + Provintial Tax Credit Rates))

Step 1: Figure out the marginal tax rate
Follow this link to TaxTip.ca, select the province or territory, scroll to the bottom, and write down the marginal tax rate.

Step 2: Figure out the grossed-up dividend
Grossed-up dividend is 145% of the dividend received.

Step 3: Figure out the federal and provincial dividend tax credits
The Federal dividend tax credit is 18.97% of the grossed-up dividend income. Add this to the provincial tax credit here:

Example

• Personal income = $40,000 in BC
• Marginal tax rate = 30.65%
• Received $5,000 of dividends
• Grossed-up dividends = $5,000 x 145% = $7,250
• Federal + BC Dividend Tax Credit Rates = 18.97% + 12% = 30.97%
• Dividend Tax = ($7,250 x 30.65%) - ($7,250 x (30.97%) = $23

Not only do you receive $5,000 worth of dividends free and clear, there is a $23 tax-refund too.

Darren Rowse from ProBlogger is hosting another get-together among bloggers. The mission is to write a top 5 list on any topic relevant to the blog, and the winning price is a cool $1001. But more importantly, I want to elevate Financial Jungle’s presence in the blogging ecosystem, and mingle with fellow bloggers who share similar interests.

A discussion over at MillionDollarJourney prompted me to do a little digging into Market Growth GICs offered by Canadian banks. Many investors are risk-adverse, while not wanting to relinquish the growth potential of the stock market. This is why Market Growth GICs are so seductive. Investors’ original principal is guaranteed regardless of what the market is doing, while the performance is linked to the market indices tracked by the products. Being a cynic, I’ve investigated and uncovered the following five gremlins of Market Growth GICs:

1. No Dividends – They stole my precious!
Although Market Growth GICs do track the underlying index, investors forgo the dividends issued by the securities along with the juicy dividend tax credits. As an example, the iShares S&P/TSX 60 ETF rewards their investors with 1.66%, which isn’t available to Market Growth GIC investors.

2. Higher Tax Rate - Give it to us and wrrrriggling! You keep nasty chips.
Since Market Growth GIC investors don’t actually own a piece of the index, gains on GICs are taxed as regular income instead of the more favourable tax treatments from conventional capital gains. For instance, if you’re in the 40% tax bracket, you owe 40 cents for every dollar made in GICs, while you owe only 20 cents in ETFs.

3. No Tax Deferral - NO! That would kill us. Kill us!
Taxes are due each year with GICs, while you can defer capital gain taxes for as long as you hold the ETFs. Let’s do a quick example. If you start with a $1,000 GIC that returns 10% each year, you keep only 6% after tax. Compound this to 5 years and you’re left with only $1,338. On the other hand, you can zoom ahead with ETFs by deferring taxes until the very last year, and are left with a generous $1,488.

4. Capped Return – Don’t follow the light.
A five-year Market Growth GIC offered by TD Bank caps the cumulative return at 60%. This is an annualized compounded return of 9.8%, which is the approximate long-term return for stock markets. As a result, investors have no upside potential relative to the index, while the down side relative performance is –9.8%.

5. No Capital Tax Loss Saving - Stupid fat hobbit, it ruins it.
In the event the market is still down after five years, the principal protection feature kicks in and you recover your loses, however you waive the tax-loss saving to offset capital gain taxes of your other investments.

Principal protection to me is an illusion, because inflation alone will erode the future purchasing power, which is ultimately what you’re trying to protect. If maintaining purchasing power is your objective, stop fooling around with Market Growth GICs, and buy a traditional a 5-year GIC instead at 4.47%. If you still want some exposure to the stock market without exposing yourself to market setbacks, segregated funds are good alternatives. Even though they’re somewhat expensive, you’re compensated with other benefits, which include estate planning advantages, automatic reset of death benefit guarantee, and creditor protection. An example of a segregated fund is CI Signature Dividend GIF which has a price tag of 4.18% MER.

Further readings:
- TD Canada Trust Market Growth GIC.
- How Segregated Funds Protect Your Investments (CI)
- How segregated funds work (Million Dollar Journey)

ps. thank you Canadian Capitalist for bringing this event to my attention.

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Two of my most admired personal financial blogs are pressing the hot button on a very sensitive topic: leveraged investing. To read more on the lively discussions, check out The Canadian Capitalist and Million Dollar Journey.

The pro-leverage group believes that when done properly, leveraging is an effective way to build wealth. The anti-leverage group advocates the old fashion method, which is to pay off your mortgage and invest with cash. It is not necessary to leverage your portfolio in order to reach your financial goals. As The Canadian Capitalist put it:

If you are like me, you want to pay off your home, save for retirement, send your kids to University and eventually, not having to depend on a paycheck. You are not aiming for a spot on the Forbes 400 and couldn’t care less about the list. Do you need leveraged investments to achieve your goals? Not really. A far simpler and less-risky path is to spend less than you earn and invest the difference in a low-cost, diversified portfolio. Why take more risks than you need to?

Just to throw in my two cents. I pick the middle of the road. Most investors concentrate on capital appreciation, but my investment strategy is cash flow centric. Since time is on my side, a moderate amount of leverage is safe as long as I’m getting a positive cash flow out of the portfolio. In Canada, investment loan interests are tax-deductible, while dividends are tax-free for most people. If you’re in the 33% tax bracket, a 3.85% dividend yield is enough to cover a loan interest rate of 5.75% after-tax assuming you leverage your entire portfolio. At the moment, my portfolio has about 17% cash in a high interest saving account, but I’m comfortable with up to a 15% leverage. There’s still plenty of free cash flow left for reinvestments, or paying down debts.

A lot has been said of asset allocation, but can we do better than bonds or GIC’s for our fixed-income asset class?

The best current 5-year GIC rate is 4.40%. After paying for taxes, you only keep 3% depending on your tax bracket. That’s barely above inflation! A better option may be to pay down your mortgage. The going rate for a 5-year fixed mortgage is 5.1%. Since a dollar saved is a dollar earned, saving 5.1% on your mortgage is a better deal than earning 3% from bonds or GIC’s. After all, why lend your money to the financial industry just to re-borrow it back at a higher rate?

A growing number of Canadian homeowners are making their mortgage interests tax-deductible.  Last year alone, my wife and I received a $1,613 tax refund, simply by following the Smith Manoeuvre to rearrange our financial affairs.

Our US cousins down south have it easy; not only do they benefit from lower income taxes, but their mortgage interest is also tax-deductible.  This is significant when you consider a typical person pays 72% of the first year’s mortgage payments toward interest.  Unfortunately, Canadians do not receive this tax advantage.  We do get a break on investment loans.  To remedy this tax drag, Fraser Smith popularizes a technique to convert mortgage debts into tax-deductible investment debts. 

The gist of it is to actively pay down your mortgage via cash surplus, and re-advance the principal to fund your investments or businesses.  The benefit is the interests on the converted loan are now tax-deductible, which means you’ll receive tax refunds each year, enabling you to pay down your mortgage even faster. At least this is the high level goal. The nuts and bolts of the Smith Manoeuvre are different depending how your finances look today and your investment risk profile.  Picture the Smith Manoeuvre as going from point A to point B. We know point B is to make mortgage interests tax-deductible, but everyone has a different starting point A.  I’ll go over some common scenarios later on, but first, a little background on Home Equity Line of Credit.

In almost all situations, the Smith Manoeuvre works best by opening a Home Equity Line of Credit (HELOC) secured by your home. A HELOC gives you the flexibility to re-advance your mortgage principal, therefore making your debts more tax-friendly. In our case, we used the President’s Choice just because we have a joint account with them. I have yet to find one lender that offers less than prime.  If you know one, feel free to post it here.

Alas, there are a few caveats with HELOC. Firstly, the homeowner must cover the legal and appraisal fees.  Secondly, to qualify, you must have more than 25% of equity in your home.  The equity over and above the 25% is your credit limit.  For instance, if the market value of your home is $400k, and you have $250k left on your mortgage, then you can qualify for ($400k-$250k) - ($400k x 25%) = $50k.

Below, I’ll outline a couple of common scenarios:

Flintstone Flip

This is the situation that we were in several years back.  We had a lump sum of investable cash, but needed to deploy it in the most tax-efficient manner. Suppose you have a $50,000 investment portfolio.  Assuming it has little embedded capital gains, you can unload the portfolio, pay down your mortgage, re-borrow $50,000 from your HELOC, and re-purchase the same investments.  At the end of the day, nothing really changed.  Your overall debt level remains the same, and you still hold the same investments. The only difference is you’ll start receiving tax-refunds, because the interests on the $50,000 are now tax-deductible.  You have just transformed $50,000 of bad debts into good debts.  The actual refunds depend on the loan interest rate and your tax bracket.  Assume the interest rate is prime rate or 6%, and you’re in the 40% bracket, the tax refund works out to $50k x 6% x 40% = $1,200. 

Cash Flow Dam

Similar to investment loans, converting your mortgage debts into business debts means more money in your pocket. This applies to homeowners with an existing unincorporated business that has revenues and expenses.  It works with an unincorporated business, because the tax department treats the business and you as one entity.  Consequently, the tax department treats revenues from your business identically as your employment salaries. If you can make mortgage payments with your pay cheques, you can make mortgage payments with your business revenues.  The next step is to withdraw cash from your HELOC to pay the business expenses.  Since you’re borrowing the money to pay business expenses, you’ll receive tax deductions on the HELOC interests.
For a more in-depth look at cash flow dam, check out this document from Fraser Smith.

As some of you already know, I’m a die-hard dividend investing fan.  Although I don’t remember Fraser Smith mention this specifically, I should be able to apply the Cash Flow Dam concept against a leveraged dividend paying stock; the revenues are the quarterly dividends, while the expenses are the loan interests.  Say I borrow money to buy BMO today, the dividend yield is 3.7% and loan rate is 6%. Every year, I pay down the mortgage with my 3.7% dividends, then re-advance 6% to cover the interest expense, provided that the HELOC account has available credits.  Since the 6% is tax-deductible, I’ll get 2.4% back if I am in the 40% bracket.

As always, don’t take advice from a guy on the Net.  Talk to your accountant if you’re interested in the Smith Manoeuvre. You can read more about it here:

• www.smithman.net
• Jonathan Chevreau, Dec 2004
  
• Jonathan Chevreau, Sept 2006
• IE Money: Manoeuvre money from your house
• National Post: Making your mortgage tax-deductible
• National Post: Borrow your way to tax freedom
• NewsPoint: The $500 billion mortgage opportunity
• 50Plus: Mortgage Manoeuvring
• Western Investor: Tax-deductible mortgages
• Fraser Smith, July 2004
• TheTaxDeductibleMortgage.com
• John Chow on the Smith Manoeuvre
• MillionDollarJourney
• The Cen-Ta Group, David Ingram