Another RRSP Debate

31 responses so far ↓

• 1 Investorial // Mar 14, 2006 at 11:50 pm

  It’s another case of different strokes for different folks. I’d tend to agree that leveraged investing is not for the faint of heart or for the average non-financially educated joe. In fact, financial education isn’t the issue here, it’s emotional intelligence. Being able to control oneself (an attribute often talked about by the world’s greatest investors/business men).

  Leveraged investing amplifies potential gains and losses. Simple as that. Where I see it makes absolute sense is for the individual with little or no earned income to allow RSP contributions.

  If the argument is that an accelerated mortage paydown can be preferable, why switch one debt (mortgage) for another (leveraged investing)? I hope he’s not suggesting using the home’s equity for the leveraging. In that case, it’s even harder to control one’s emotion when the house is collateral.

  Renting out one’s house is also a great way to pay down the mortgage faster and getting mortgage interest tax deduction, but just because it sounds good logically doesn’t mean that practically it works out.

• 2 Canadian Capitalist // Mar 15, 2006 at 7:39 am

  I think that leverage should be approached with extreme caution. I don’t see how it is appropriate for low-income individuals. A little bit of leverage might be appropriate for someone who has a lot of assets and very little debt and could easily cover interest obligations whatever happens.

  A $6,000 interest obligation is very serious. What if a job loss occurs? What if interest rates suddenly shoot up for whatever reason?

• 3 Alex Givant // Mar 15, 2006 at 8:41 am

  I’m not quite get comparison of $6,000 you can deduct from investing loan vs. put it to RRSP. In both cases you get money back from CCRA, but in second case you still have $6,000 which may grow for long period. Am I missing something?

  Thanks.

• 4 Canadian Capitalist // Mar 15, 2006 at 9:59 am

  Alex: The details of the strategy can be found in Derek’s article found here. He is saying that instead of contributing to the RRSP, you can use the same amount to service an investment loan. But my point is exactly the same as yours: in the first case, you’d owe $100,000, but in the second, you’d own $6,000. There is a big difference!

• 5 Alex Givant // Mar 15, 2006 at 10:20 am

  Question to all of you, guys. Did anybody considered to take mortgage from self-directed RRSP and what are pros and cons of doing that? When I asked many financial advisor, they tell me that it stupid move, but nobody can explain it in a details. They tell that nobody does it, but heck, if you can take mortgage for 6.5-7% from yourself and you like this kind of returns, why not to do that? I aware of all (I hope so) fees involved with this more. What is a minimum amount of mortgage that make sense? Any input is highly appreciated.

• 6 Required // Mar 15, 2006 at 12:52 pm

  Come on! This guy is making a living off his book.

  Here’s a quote that shows he either has no idea what he’s talking about, or he’s trying to swindle everyone. When discussing the RBC dividend he says, “If you waited another 10 years and the dividend kept growing at the same rate (ambitious, but possible), your annual dividend income from your initial $100,000 investment would be over $60,000 each and every year!” Ambitious, but possible? Is he kidding. Does he know what dividends are about, and why some companies issue them and others don’t…

  How many examples besides the big banks does he have? It would have been great if he did this with GM in 1990. It would have been a phenomenal book then.

  Absolute craziness for the average person to pursue this. For every 10 people who do this, it will succeed for the 1 person who chose the right stocks. And once in a while, they’ll even be clever enough to write a book about so that they can actually retire.

• 7 Alex Givant // Mar 15, 2006 at 1:14 pm

  Required: that called “Survival Bias”. Other guys who invested by his scheme probably don’t have enough money to buy paper and/or computer to write their own great books.

• 8 Required // Mar 15, 2006 at 1:58 pm

  Alex: Good point.

• 9 Humble Investor // Mar 15, 2006 at 2:33 pm

  Hi CC,

  I agree with the concerns noted by yourself and my esteemed co-commenters with respect to leveraging, though in defense of the author, he would likely argue that comparing the leverage and RRSP models provided isn’t necessarily an apples to apples comparison, going back to earlier discussions on cashflow vs. nest egg approaches. Most, if not all RRSP investors have as a strategy to reach a certain long-term retirement savings target. Appropriate tactics support this startegy. As such, those with this goal, particularly as they get nearer retirement, would most certainly get panicky about bear markets impacts of 20 - 30% to their portfolio as you describe (whether leveraged or not).

  However, Foster has been emphatically clear (though perhaps speaking with the freedom one enjoys so far from a traditional retirement age) that he doesn’t care about the size of the nest egg. Even if his portfolio dropped 20 - 30% in underlying value, the types of investments he holds would most likely continue to produce the *cashflow* he invests for.

  For most people, I would agree this is a subtlety that is unnecessary, as ultmately is the same difference - i.e. those who are rightfully concerned about leveraging risks are likely also investing via an RRSP to grow a nest egg. I just think it is important to add to this discussion that leveraging (like RRSP investing) is not a strategy in itself - its a tactic to support a strategy. The difference in tactics is a reflection of the difference in strategy. Derek’s strategy (to invest for cashflow) will operationalise in a set of tactics that are understandably different that those that support a ‘build a nest egg’ strategy.

• 10 Required // Mar 15, 2006 at 3:33 pm

  Humble Investor wrote: “However, Foster … doesn’t care about the size of the nest egg. Even if his portfolio dropped 20 - 30% in underlying value, the types of investments he holds would most likely continue to produce the *cashflow* he invests for.”

  Are you referring to the dividend payments? If so, could you please show us the evidence they would likely continue to produce the cashflow? If a company experiences a 20-30% drop in capital (for a good reason) I’d expect its dividend to shrink.

• 11 Humble Investor // Mar 15, 2006 at 6:28 pm

  Required,

  I realize this is counter-intuitive, and I did a bit of a double-take myself when Foster made the claim in his book, and yes, this is referring to dividend payments. There is, of course, no *proof* that in any given company that drops 20-30% in value will continue to pay (or increase) its dividend, but history suggests that these events certainly occur with some of the greatest dividend achievers, creating excellent buying opportunities for the strong-willed. I should have been more specific, though for those familiar with Foster’s book, “the types of investments he holds” would have been understood.

  For example, between early July 1998 and August 31 of the same year, BMO dropped a whopping 34% from ~$42 to a low of $27.50. The dividend not only remained untouched, but actually increased the following year from 0.22/qtr to 0.235 (as it had in the year earlier from 0.20 to 0.22).

  Similarly, electrical utility Fortis (FTS) began a 2-year decline starting in April 1998 (at $46) and bottoming-out around Feb 2000 at $29.20, a drop of 36%. At the same time, they increased their dividend that year, as they have every year since 1972 - see http://www.fortisinc.com/InvestorCentre/FortisStock/DividendHistory.aspx.
  (Note - I own FTS).

  I pulled both BMO and FTS from the Mergent index of Canadian Dividend Achievers. Honestly, I would not be surprised if each member of that index didn’t, at some point in the last 10 years, show a decline of at least 20% and still raise their dividend. The universe of companies in the US that have increased their dividends over 10, 15, or even 25 years consecutively (much larger of course than in Canada) would also show such dips. Look at a 10-year chart for Procter and Gamble and you will see many such dips, including a precipitous drop in late 1999 and yet they recently announced their 50th consecutive annual dividend increase.

  Like I said, a little counter-intuitive, but dividends do not, historically, for mature, market-leading, big-brand, recession-resilient companies fluctuate dramatically based on share price.

• 12 Canadian Capitalist // Mar 15, 2006 at 8:11 pm

  HI: Thank you for your comments and your clarification. I still don’t think leveraging is a strategy for everyone. I think leveraging is ok only for someone who a) has a lot of assets and very little debt (including mortgage debt) b) can afford to easily meet the interest obligations even if something like a job loss occurs. My guess is the criteria would rule out the vast majority of the population.

  Actually, I do understand that Derek’s strategy could be quite profitable. In fact, he did something similar with his own portfolio with a leveraged bet on Philip Morris. Good for him that it worked out. I am not sure that many people would want to (or should) take that kind of risk.

• 13 Humble Investor // Mar 15, 2006 at 8:18 pm

  Thanks again for the chance to discuss multiple viewpoints, CC. As I opened in my initial response, I fully agree with the concerns noted by yourself and others regarding leveraging.

• 14 Canadian Capitalist // Mar 15, 2006 at 8:51 pm

  It was a good discussion HI. BTW, I personally love dividends (but only inside our RRSPs) and wish I had bought more a years ago when I was chasing tech stocks. Among my top 5 holdings, I find 3 good dividend payers: Altria Group, TD Bank and Anheuser-Busch.

• 15 Required // Mar 16, 2006 at 8:49 am

  Humble Investor, Thanks for comment #11.

  By chosing companies on the Mergent index, you are chosing companies that have been “post-selected” to have historically favourable dividends. The index drops and adds companies as necessary. What if we chose, instead, a company that used to be on the Mergent Index, but has been dropped. For example Heinz (they were dropped from the index 5 years ago). Their dividend has dropped, and their stock price has remained flat for 5 years or so. If you borrowed 100K @ 6% to invest in Heinz 5 years ago, when the stock was cheap, I’d think you’d be regretting it now.

  I guess all that really matters is whether your investment grows faster than your borrowing rate. (There are also tax issues in there that need to be considered) In the case of dividends, you would have to estimate the future value of all the dividend payments. If this investement grows slower than the borrowing rate, you stand to lose a lot of money.

  I think I erred earlier when I said something like “of 10 investors 1 will succeed”. I think a more precise statement is more like “for every 10 investors, 2 will come out ahead, 6 will more-or-less not have gained anything and 2 will come out way behind.” This is usual case with leveraged investments like this: if your timing is right, you will make a fortune. Way more than you would have just investing your own capital.

• 16 Average Joe // Mar 18, 2006 at 10:42 pm

  I saw you mention that you hold your dividend paying stocks in your RRSP. Not that there is anything wrong with that, but dividends are tax-advantaged income. By that I mean you pay less tax on it than if it was another form of income such as interest.

  By holding those stocks in your RRSP, you have taken away the tax advantage of dividends as all the income in your RRSP will be taxed at your marginal rate when you collapse the RRSP.

  That is where the big debate of keeping your fixed income within your RRSP and your tax advantaged income outside.

  I like Derek Foster’s idea of paying down the mortgage and using good quality dividend paying stocks to generate cashflow. I also see Required’s point of view: dividends tends to set a floor price for their stock. If a dividend paying stock takes a big hit of 20-30%, it is more than likely because investors feel that the dividend is in jeapordy.

  As for leveraging, that is a pretty risky maneuver and not for the faint of heart. I would not recommend that at all.

• 17 Derek Foster // Mar 19, 2006 at 6:28 pm

  Hello all - lively debate!!

  I am Derek Foster (author of STOP WORKING) and also the writer of the article that has created some interest. I would like to add my perspective to this debate.

  First off, the article was written for Canadian Moneysaver. My assumption was that people who subscribe to this sort of publication would be (at least somewhat) knowledgeable about investing. I agree this strategy would not be suitable for novice investors.

  The main point here was to offer alternatives to the RRSP (accelerated debt repayment and leveraged investing). There have been no arguments against mortgage prepayment, so wouldn’t a diversion of capital early on to accelerated mortgage repayment then borrowing to invest offer the same longer-term risk profile as simple gradual mortgage repayment coupled with constant RRSP investing in equities? In both cases, the borrower has the income to service the debt, with the only difference being that in the latter case the debt is tax-deductible.

  Cheers,
  Derek Foster (author STOP WORKING: Here’s How You Can!)

• 18 Derek Foster // Mar 19, 2006 at 6:34 pm

  A few more points for clarity….

  I used Royal Bank as an example, but in practice one would invest in a basket of stocks. It was just too cumbersome to give performance histories on many stocks.

  I would never invest in GM. I only invest in stable, recession-proof, dominant companies that have a long operating history of dividend increases. Over 95% of stocks are not worth owning at any price, IMHO.

  Stock market performance is irrational in the short-term and often DOES NOT REFLECT the underlying fundamentals of the companies they represent. If you focus on the cashflow (as in dividend income), flucuations become more or less irrelevant. In fact, market declines usually benefit the companies I own as they regularly buy back their own shares.

  Cheers,
  Derek Foster (author STOP WORKING: Here’s How You Can!)

• 19 Derek Foster // Mar 19, 2006 at 6:53 pm

  Required,

  Why do you say it wouldn’t be possible for Royal to pay out $60,000/year if dividends continued to increase at the rate they have over the last 10 years - I did the projections (but mentioned it’s ambitions).

  I back-tested it by getting the stock price on January 3, 1985. It was $7.74/share. The current dividend is $2.88/share (split-adjusted). So a $100,000 investment in 1985 would be earning around $38,500/year in dividend income - so the $60,000 figure is ambitious but possible, IMHO.

  Cheers,
  Derek Foster (author STOP WORKING: Here’s How You Can!)

• 20 Canadian Capitalist // Mar 19, 2006 at 8:16 pm

  Hi Derek: Thanks for stopping by and thank you for your comments. Since your strategy involves leveraging it will work wonderfully in the right circumstances. I am just pointing out the risks involved in any leveraging strategy.

  I think RRSPs have merit because of the tax deferral and tax sheltered growth. Yes, dividends have a low tax rate but in asset accumulation years I don’t want to pay any tax on investment income. Every dollar that is not taxed today could compound into a tidy sum in the future.

• 21 Derek Foster // Mar 20, 2006 at 7:47 am

  CC,

  Fair point on the leverage issue. I just wanted to clarify that if the investor focuses on the cashflow the portfolio generates rather than the traditional “nest egg” approach, and concentrates on recession-proof, dividend payers - the risk is greatly diminished. Often, investment professionals measure risk as volatility, but I think volatility is just noise.

  To quote Ben Franklin, “The definition of insanity is doing the same thing over and over and expecting different results”.

  Droves of people contribute to RRSPs (often in mutual funds) year after year and keep working well into their 50s or 60s. I followed a different strategy and retired at 34. Even without leverage, my strategy is a quicker (and safer) path to retirement. The traditional strategy enriches the financial industry more, but that wasn’t my goal.

  Cheers,
  Derek Foster (author STOP WORKING: Here’s How You Can!)

  PS I am not opposed to RRSPs, but soemtimes they are not one’s best option, but sometimes they are.

• 22 Canadian Capitalist // Mar 20, 2006 at 9:01 am

  Derek: I think RRSPs are not working for many people not because they saved in a RRSP but because they chase performance, don’t pay attention to costs (bulking up on mutual fund with high fees), not diversifying and loading up on hot stocks like Nortel. My guess is many people who save outside RRSPs commit the same mistakes. My argument is that a RRSP is a great place (for most but not all people) to put good dividend growth equities like you suggest in your book.

• 23 Investing Intelligently // Mar 26, 2006 at 4:03 pm

  Average Joe,

  If you like at the Phillips, Hager & North report, you will see that they simulated a 100% equity portfolio inside and outside an RRSP. They assumed an 8% return, 6% growth and 2% dividends. The RRSP portfolio still won out over the long run.

  Of course, if you have maximized your RRSP contributions, the first things you would be put outside of it would be tax-friendly things…

• 24 Investing Intelligently // Mar 28, 2006 at 11:42 pm

  Investing Inside an RRSP vs. Outside an RRSP…

  There were a couple of blog articles recently about investing inside an RRSP vs. investing outside an RRSP. Frugal Focus discusses a report by Phillips, Hagar & North called “The Retirement Savings Debate: Inside or outside the RRSP structur…

• 25 John // May 29, 2006 at 7:43 am

  This is a very interesting discussion. I find it particularily interesting that many of the early comments criticizing Derek Foster’s approach were looking for ways that this approach could fail. Personally, I would rather focus on ways in which the process could work.

  The proof is in the results in my opinion. And the reaction to this approach lies I suppose what your ultimate objective is. If you wish to accumulate a large nest egg inside of your RRSP a leverage approach is not going to work for you. If you wish to stop working for a regular paycheque then perhaps considering what Derek Foster has to say might be of interest since he has accomplished that.

  Leverage investing is definitely not for everyone, nor is being financially wealthy. There may be a connection between these two items or there may not be. I certainly think it is worth investigating.

• 26 ETFs Grow Leveraged Wings! (For Good Or Evil?) » Investments + Editorials: Dissecting the good, the bad, and the ugly of investment / financial media! // May 30, 2006 at 6:17 pm

  [...] Read The Fine Print… Or The Prospectus Dissappointedly, Marketwatch did not have the balls to warn about the magnified losses that can also come with leveraged investments. The closest they came to presenting the prudent point of view is: Still, investors shouldn’t expect these funds to deliver exactly double or the inverse of an index due to trading costs and other fees. And the turnover rate for the ETFs is expected to be greater than 100%, according to the prospectus. [...]

• 27 Kevin Malone // Jul 26, 2007 at 1:17 pm

  Derek said: The main point here was to offer alternatives to the RRSP (accelerated debt repayment and leveraged investing). There have been no arguments against mortgage prepayment, so wouldn’t a diversion of capital early on to accelerated mortgage repayment then borrowing to invest offer the same longer-term risk profile as simple gradual mortgage repayment coupled with constant RRSP investing in equities? In both cases, the borrower has the income to service the debt, with the only difference being that in the latter case the debt is tax-deductible.

  ====

  Holy smokes, that’s pretty similar to what I have been trying to say about the Smith Manoeuvre only your way sounds better lol.

  Every time an alternative to the traditional and to my mind illogical strategy of long mortgage + RRSP is proposed someone throws out “risk” or some other red herring when there really isn’t any evidence being shown that people who do things like the Smith Manoeuvre actually experience negative outcomes. On the other hand there’s people like me who’ve lived it and are in better situations than all sorts of smarter people (in terms of how effectively they can wax wise about investing) with higher incomes.

  I love the way Derek thinks and talks outside the box, but he’s up against an industry that is like the McDonalds of fast food…..it must be about 99.9% of people that believe in taking out the longest term of mortgage possible and putting as much as possible into an RRSP is the path to financial enlightenment when it seems to me that this is just doing what is good for the bank and not so much for the investor. If it works so well, why are so many people in a panic about their future and working way past traditional retirement age (not by choice).

  Kevin

• 28 Eric // Nov 21, 2008 at 2:17 pm

  Hello Derek and fellow bloggers,

  I’ve started initiating my 6yr old boy to the finance world. He has his own little bank at home in which he keeps currency from dozens of countries, he has his own savings account in which he follows and deposits funds.

  I want to investigate the possibility of investing directly in blue chip companies (DRIPs). What do you suggest for a 6 yr old? I want to incorporate a ‘fun’ factor, something to get him really excited about it …. more so than he already is.

  Looking forward to your insight,

  Regards,

  Eric

• 29 DAvid // Nov 21, 2008 at 4:35 pm

  Eric,
  Shareowner Magazine regularly published “Junior” portfolios containing stocks of companies kids would be familiar with. McDonalds, J&J, Hershey, P&G, ToysRUs, Coke, etc. might be considered candidates.

  DAvid

• 30 ETFs Grow Leveraged Wings! (For Good Or Evil?) | Investorial // Mar 9, 2009 at 10:40 pm

  [...] Or The Prospectus Dissappointedly, Marketwatch did not have the balls to warn about the magnified losses that can also come with leveraged investments. The closest they came to presenting the prudent point of view is: Still, investors shouldn’t [...]

• 31 Dale // Mar 24, 2009 at 1:03 am

  As as Scotia bank customer I was given credit in the form of an RRSP line of credit a few years ago. Have never used it as I can’t afford any more payments.
  Question: Should I use some of this credit, say, $10,000.00 to by a two year bridge mortgage from a mortgage broker, paying out at 12% to 14%, to top up my RRSP? In two years I will have been payed back the principal and interest, well above the line of credit interest I am paying. Pure leverage, with none of my own money. The interest will be free to me.

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