One of the things that I really like about our website here at Y & T is that you get a variety of perspectives and thoughts from a few different professionals who all know their stuff. Now knowing your stuff doesn’t always mean that everyone is going to agree on everything.
Young isn’t alone in thinking that the SM isn’t for her, in fact I’ve noticed more and more really smart people that I respect talking about how the SM probably shouldn’t be used (Young mentioned Ellen Roseman as one example). I just fundamentally disagree with this analysis. Maybe I look at things different because I’m a bit of a personal finance geek, and as such, I tend to interact with other personal finance geeks far more than most people. That being said though, I think that a lot of people get irrationally scared of the math behind the SM.
Getting of Bed in the Morning Causes Risk Too!
Here’s the basic math IF you manage to take human emotion out of the investing process (admittedly a huge IF): Is a 7-8% return better and a 4% loan better than paying off a 6% loan? Of course it is. If you agree with that math, and you have enough equity/capital/net worth that you won’t ever have to dip into your housing equity for consumer needs or daily expenses, then you should do the SM. It is that simple in my mind.
I should mention that I’m also assuming you have some investing basics down and that you implement the SM properly by reading the book or one of the web resources that Young mentioned in her article.
So where do I get these numbers you might ask? Well, the stock market has returned 10.4% on average over the last couple of centuries. I’m not talking real returns here, I’ll keep it fair in both calculations. Obviously for me to use a number like 7-8% I’m assuming a long-term investing strategy (30 years+ in my case) and someone who understands that most investors cut themselves off at the knees by buying and selling at the worst times.
If you simply buy and hold a very basic, diversified portfolio over the next few decades and focus on cutting investment/management fees to the bone, there is no reason you can’t attain a 9-10% return and then depending on your tax efficiency (for investments to qualify for the SM they must be placed outside of your tax-advantaged accounts like RRSPs and TFSAs) you can likely pencil in something around 7%.
I don’t assume that you should know everything about picking stocks and other cute stuff, and to be honest, usually I’d just recommend buying a basic index ETF – but in this case buying an ETF means all kinds of tax headaches down the road. The next most simple thing to do is just buy the top companies listed in each basic market index – your results are almost guaranteed to mirror the index if you don’t try to get too cute.
Related: Read our eBook on ETF Investing
The Beauty of a HELOC
The 4% loan I’m referring to is the real rate of interest your home equity line of credit (HELOC) will cost you. Before you all yell, “Interest rates are about to shoot up and end the world – you shouldn’t depend on such low interest rates!!” Just relax… Interest rates will likely average somewhere around 6-7% over the long term, but this isn’t the number you need to know about for the SM. The reason the SM is such a great strategy is that it makes your borrowing tax-deductible.
Since we live in a maple syrup-flavored socialist utopia it’s a safe bet for many people with home equity that they’ll be looking at a 30-40% tax reduction. There are all kinds of other fancier calculations if you get into “capitalizing the interest” and a few other adjustments, but all these really are is applied middle school math. If you can understand percentages and can spare a couple hours of reading I bet you could get your arms around it pretty quick!
It’s also worth noting that the relative returns on the SM have tended to work better in high-interest environments since equities usually respond well during those times and it also means a higher tax return.
Build Up Your Entire Portfolio at Once
One of the nice side benefits of this strategy is that the investing is done outside of your registered account, so it still leaves all of that good room to build a nest egg with. Admittedly most people will never make/save enough to worry about maxing out their registered investment accounts, but it’s something us young folks should be considering as our current pension outlook is foggy at best.
Turning your mortgage into a tax-deductible HELOC and re- investing the tax returns, while gaining high ROI on your housing equity is a pretty good deal from where I’m standing. Of course this math all falls apart if you need to tap into your equity for other reasons or plan on moving fairly often. All the same, it’s certainly worth looking into if it has the potential to make you tens- or even hundreds of thousands over the next few decades right?