Past Performance is no Guarantee of Future Results

Learning how to invest is one of those exercises where it seems that the more you read, the more questions arise when reviewing stocks to purchase. When looking at “Value Investing”, there are many theories or systems that people use to identify stocks to put money into. I came across the site Old School Value which keeps track of the performance of around 15 different value investing stock screeners and tracks the performance of the method over the past 16 years.

I’m both a semi- uninformed investor, as well as a lazy optimist, it would be great if I could rely on achieving the long-term returns calculated for a system like “Magic Formula Investing”. An average of 11% return would allow me to follow the relatively easy system of selecting a couple of pre-defined stocks per month, hold them for a year and sell them. I could turn an initial investment of $20,000 into an average cashflow of around $15,000 with no further investment after 20 years, with minimal effort and minimal capital risk.

Of the 15 different “value” stock screeners outlined by the site, there were 11 in total that were able to beat the S&P 500 over the 17 year test period outlined. The volatility on the investments was fairly significant, which is what I would expect for this type of marginally high risk investment, but some are much more significant with others, with the majority of the long-term gains coming from a year or two of 200-300% returns, and the rest of the years ending up at or below (or significantly below) what could be arrived at investing in a large-sized index fund.

This is what causes me to pause before hitting the “buy” button on almost everything. No matter how strong I feel my hypothesis is when going to purchase a security, I understand there’s a moderate level of risk that I’ll never see the money I’m investing again, or at least a chunk of it before I chicken out and sell the investment, no matter how “safe” it seems at the beginning (see the three year drop in the S & P 500 in the early 2000’s and 2008 as a seemingly “safe” investment).

I think that the main characteristic that I need to acquire to be a better investor is to have even a bit of long-term faith in the stock market (or any market). I am by nature a pessimist, which makes going long on stocks a significant challenge – betting that things are going to get better. I need to have faith that the pile of research I’ve done, the ratios I’ve reviewed, the news and opinions I’ve collected regarding the investment I’m making is at least kind of on the right path, and that at the time of purchase I had some sort of reason to by shares in a company.

I have to have faith that the long-term past performance will at some point be reflected in the future, and that’s what I’m working on now, as I’m slowly being enveloped by my investing “career”. Whether it’s an individual stock or something more basic like a bond ETF, I’m always going to wonder if there’s a better place I could have put my money, or there was a different (and possibly better way) of examining the potential investment.

Invest Only in Canada?

As I write this, one Canadian dollar is worth about seventy four cents American. A few years ago, Canadian consumers were up in arms that our strong dollar was not being respected by Canadian stores selling goods from the US, which were still 20 or 30% higher than the readily available comparison prices that Canadians could see with a quick Internet search. There were so many articles written or shown on television about how much Canadians were feeling ripped off at the time.

Now, things are back to about what Canadians would have seen in about 2009. My wife and I are looking for places to travel to in April, and Mexico has gotten significantly more expensive for us than it was a year ago when we went. Our main huge “splurge” every year for the past four or five years has been an all-inclusive trip away, where we bring stacks of books and try to read them all between trips to buffets and bars. Going away someplace warm is something that we both really enjoy, so we’ll have to be a little more discerning with our destination this year and maybe go somewhere a little less fancy than we have been heading to the last few years.

Besides vacations, US securities have become much more expensive to buy. Being a frugal individual, buying stocks at a premium is something that I don’t really want to do, to watch my investments reduce in value over the next few years if the Canadian dollar recovers to previous levels.

The problem with any investment, is that it’s a bit of a gamble. When you put your money into a company, whether it’s in your own domestic currency or in foreign dollars, nobody has any idea of what the investment is going to do. If everything works as planned (this is my basic plan), the value of your investment over the long-term will hopefully increase. I would much rather know before I dropped a few thousand dollars on an investment that it was going to make me rich, but (as far as I know) nobody is privy to that sort of information.

While I would have preferred to have invested a bunch of money in US dollars a year ago when the Canadian dollar was much more valuable, I don’t think it’s a good idea to disregard the rest of the world’s market because nobody wants to buy Canadian securities. Even though the Canadian dollar is beaten up right now, staying diversified by investing outside of Canada seems like a better idea than depending solely on the Canadian economy in the long-term.

Besides being diversified, the Canadian economy could continue to significantly lag behind the US, given our reliance on natural resources for exports, which would make the current value of the Canadian dollar compared to US or other world currencies seem like a good deal.

The Gamble of Value Investing

      My eventual plan with my investing portfolio is to have five to ten percent of my investments in what will hopefully end up being “value” purchases, with the hope that these investments result in significant capital gains in our household’s available funds. So far, I have not made any of these types of investments, but have been doing a substantial amount of reading, hoping to accumulate as much knowledge from smarter investors than I probably ever will be.

My goal (investing-wise) is to have the following makeup:

10% – Bonds (ETF)
~80% Dividend-producing stocks
~10% in “value” stocks.

My current “obsession” with value investing partially has to do with diversification – moving away from the larger dividend-producing companies that I am currently focused on in order balance the portfolio with smaller and varied companies. The second reason for looking at value stocks as an alternative is the hope for the odd “home-run” on a minimal level of investment to increase the overall investment returns on the way to retirement.

At this point, I would say that I am in the range of “knows just enough to get my self into trouble” when looking at investing opportunities. I will not be fully investing my “Value” money immediately, while I take the time to learn all that I can about this way of looking at the market. Up until now, I was (at a basic level) looking at yield-producing companies and examining whether or not these entities would be able to continue to provide dividends to investors in the future.

Based on my limited knowledge of value investing, there seems to be the following steps involved:

  1. Identify stocks selling at a bargain.
  2. Research the stock extensively.
  3. Buy the stock at your target price.
  4. Wait for the market to figure out what you saw in the company, and buy the shares up to a profitable level.

 

Step one to three makes a lot of sense to me, and the stocks I pick and targets I set are mainly dependent on the research I do and the skill that I select stocks. It’s step four that depends on other investors either believing the same thing I did, or something happening with the company that is the concern with this type of investing. There are going to be times that I’m either wrong, or may enter a position too early that would result in initial losses on the purchase of a stock.

The gamble of investing in stocks that are currently undervalued, based on whatever metrics used to select the stocks is that nobody else will agree with the hypothesis that I’ve come up with, kind of like inviting everyone to a party and then nobody showing up – likely resulting in a similar feeling of dejection on my side.

For me, the potential gains from this portion of my retirement portfolio outweigh the risks associated with this type of investment, allowing for potential capital gains not available from the rest of the securities I have planned to purchase.

The Cellphone Option

Besides weather, the one thing that I’ve found can create a very passionate conversation with most people is their cell phone company and the cell phone plan that they have. I have yet to talk to someone who is completely satisfied with their cell phone or the plans offered by our Canadian cell phone companies. Operating as an oligopoly, the companies do not seem to have any redeeming qualities to consumers, with most people (including myself) having the feeling that the companies are out to “get” them personally.

I currently own a Samsung Galaxy S3, purchased about three and a half years ago. At the time, it was Samsung’s “flagship” phone and included all of the leading edge features. I use it mostly to read Reddit and text my wife, as well as using it as a golf GPS system in the summer. It’s a good phone, but is starting to break down – the charging port is kind of hit or miss (I think something is broken in there), and the battery life is kind of laughable, forcing me to go from plug-in to plug-in if I want to have any hope of being able to use the phone away from work or home. I could fix the phone and replace the battery, but that would cost about $100 to keep an aging phone going.

To “upgrade” to a new phone with Bell (my current carrier), I would have to change my contract around. I have a plan that gives me 6 gigabytes of data with unlimited texting for $60 after tax right now, which I can’t find anywhere else. The newest versions of phones are currently around $800 plus taxes, which is a little more than I would like to spend right now, if I would like to keep my current plan.

My solution to combat the terrible Canadian cell phone companies? Buy a phone straight from China. I found a phone I liked – it has 3 times the battery size of my current phone and runs a newer version of Android. Total cost of the phone is $300 Canadian after shipping. The phone (Innos D6000) is currently on-route to me via DHL shipping, and should be delivered at some point either this week or next week.

Buying my own phone outright made sense to me because:

  1. The phone I bought had features available to it that were not available in any phone being sold at comparable prices anywhere (or within $500).
  2. Buying a new phone allowed me to keep my generous data plan at a reasonable price. To get a similar amount of data per month would cost almost $500 more per year to get.

I’m hoping that my semi-sketchy purchase from China works out, but so far it’s been pretty easy – I research things incessantly before I purchase them anyways, so me watching more than a couple “unboxing” videos and demos of phones from China along with comparing various specifications from random websites and YouTubers isn’t a big deal. I’m excited for the extended battery life and interchangeable battery capability that comes with this phone, as well as maintaining my “as good as I think I can get in Canada” cell plan.

Thoughts on the Canadian Election

Over the course of the Canadian election that took place last Monday, our new Prime Minister made 174 different promises to Canadians. These promises were enough to win a majority government – something that according to most polls prior to the October 19th election wasn’t going to be possible. Someone much smarter than I am has started a site (TrudeauMetre.ca) that tracks all 174 of the promises made, as well as the sources of where these items were arrived at, which to me is important, because it provides some level of transparency to the site and would allow readers to know where the site author has pulled the information from.

I am an outlier when it comes to most of key demographics that the government is trying to effect through changes in government policy. I lean closer to Libertarian than any other party, if I were to call myself anything – I would prefer significantly less government involvement in my life and the money I make than I’m currently experiencing. Canada, being a semi-socialist country isn’t the best place to have this kind of political view, so I vote on the party that socially shares similar outlooks and assume that at the fiscal level, (based on previous governments) all of the parties are going to generally end up in the same place.*

I usually don’t get super interested in any kind of government platform, because they’re all the same. With the Liberal government, there were a few things that do interest me.

Tax Break of 1.5% – Anytime someone’s going to give me more money for doing basically the same thing and not really have it effect my life too much, I’m okay with that. I’m skeptical that the money will be made up by the new tax bracket created for income earners of over $200,000, but that’s not big news because I’m usually skeptical over most things that are promised to me by anybody.

The middle income tax bracket is on income from $45,000 to $89,000, so the most that this tax break will provide is around $600 ($150 per $10,000) – not a big deal to most people, but it’s a nice gesture.

End of First-Past-The-Post Voting – I would prefer that this kind of change to be coupled with a some sort of mandatory voting rule, with a token fine that would perhaps provide some incentive for citizens to vote. A change to the method of voting would give people a chance to actually make their vote count to the entire election. I live in an area that has voted in a Liberal government in every election provincially and federally for the past 18 years that I’ve lived here. Due to the makeup of the population, my vote has no impact on the entire population, which is pretty frustrating.

Marijuana Legalization – I am not a pot smoker / consumer, but the Liberal party’s stance that the current “war on drugs” that has been held for 30+ years is not effective in controlling drugs. The demand for pot has not really changed in the past few decades, but the only people making money off of this are drug dealers, who don’t pay taxes or offer legitimate taxable jobs. Creating a “cleaner” industry from a current illegal industry makes sense to me. It seems to have worked for Colorado and Washington, money rolling in and few problems created.

Other than these, I think I’m with the other approximately 45% of people who voted Liberal – I’m just hoping for some sort of change. I’m cynical, but to me, I really don’t think our previous federal government even tried to identify with the population – they had their own agenda of Canadian “Right Wing” politics and ran with that, no matter what the polls showed citizens wanted. If our new government fulfills even half of the 174 promises they ran on, I’ll be happy – to me, it at least acknowledges what people are interested in for their country.

 

 

*At both the provincial and federal levels, we work in this weird cyclical churn of parties where we vote one party into office, they do what they do for a few years and then we get mad at them about something they’ve done. The opposition parties provide new promises that will make our world better and we eagerly vote them in, only to have the cycle repeated. No Canadian political party is going to come in and slash income taxes (and the services associated with those taxes) more than a few dollars a year.

Playing the Game

The first job I ever had was horrible. I worked at a chicken farm gathering eggs on weekends. The job was very manual, and entailed me pushing a heavy-duty metal cart up and down very dusty and smelly rows of tightly caged hens picking up 4 eggs per hand and throwing them down into 30-egg flats over and over again for 3 to 5 hours (depending on what stage the chickens were at). At the end of the day, I would have averaged around 10,000 eggs gathered and needed to take a twenty minute shower to get the smell of the barn off of me. I was paid piecemeal, at (if I remember correctly) around four or five cents per dozen – it didn’t work out to a lot of money, but for an eleven year-old, it was quite a bit more than I had been making prior to that.

My parents instilled the habit of saving to me early, and would not let me just spend the money how I wanted to. I was “forced” to save money, and given very little access to the majority of funds. Through my parent’s investment advisor, a mutual funds investment, which I still remember (over 20 years later) being a Templeton emerging markets fund. Every weekend, I would check the finance section of the local newspaper and watch my “fortune” shrink and grow.*

One thing that I was allowed to buy was a Sega Genesis. My mom ordered this for me from the Sears catalog (I lived in a small town that had no electronics store, and this was pre-Internet 1991), and I had to impatiently wait the 3 to 5 business days for this awesome new toy to show up. My first ever game was “Sports Talk Baseball” and I probably played that for hundreds of hours – whenever nobody was watching our family’s one television that had 4 channels, I was on my Genesis, probably killing brain cells.

Since my Sega Genesis, I moved on to a Playstation 1, 2, and 3, as well as owning a Wii and X-Box 360. These days, I don’t play as many video games – It’s not due to anything other than I have other stuff I’d rather do – read more books or watch more sports, or spend more time with my wife. For 15 or 20 years of my life though, I probably averaged around two hours of video games per day. I liked the challenge of starting off in a game, being TERRIBLE at it, and slowly but surely getting better and better, gaining skills (useless skills in real life, but skills nonetheless) until I hopefully beat the game.

Personal finance is similar to video games. My personal finance life started with that terrible job, and having a savings plan strictly imposed on me by my parents, and continued on until today. Along the way, I have learned quite a bit from both experiences as well as following people’s lessons who are much smarter than I am. I somehow single-handedly paid for a University education, as well as the loans associated with those. I bought my first car, got a place to live, and paid off the entire mortgage of my house.

Similar to the video games that I probably spent too many hours playing, the whole process of personal finance is basically a grind. You save relatively small amounts of money, and slowly but surely through experience, luck or skill build up confidence and assets until you’re hopefully in a position that you can win. In my case, winning will be having a large enough portfolio that my wife and I will be financially independent by the time I’m 45.

Right now, I’m kind of at the beginning of the game – my portfolio is fairly small, the investments held are creating very little overall wealth on their own, and it’s kind of a frustrating process. I read as much as I can about investment planning and investment vehicles, but I am still pretty much a rookie at the whole “put money here and it will hopefully be worth more than it is now in a few years” strategy. Hopefully as time goes by, my odds of winning “The Personal Finance Game” will increase significantly.

*While I was writing this, I looked up the historical performance of this fund, and it has remained at essentially the same price point over the past 20 years.

A Different Kind of Anniversary

This past weekend, my wife and I had a few friends over for a barbecue. I cooked a bunch of meat and baked a couple of pies, and other than having to watch the Blue Jays go down 2-0 in the American League Championship series (I was one of those people who launched themselves onto the baseball bandwagon in August, after having given up on the team for the past decade or so) it was a really fun evening.

Besides celebrating a nice weekend in October that we were home for (as opposed to traveling somewhere in the province), we were celebrating a full year from my vasectomy surgery I had last year. I figured the opposite to the day of anxiety, pain, and mostly sitting around playing video games I had last year would be to have some friends over to enjoy a few drinks, some board games and have some fun – a “Vasectiversary” celebration is what my wife and I came up with for the occasion.

My decision to have this surgery a year ago was not made quickly – I did an excessive amount of research on the possible negative outcomes that could come from it, to the point that I pestered the urologist enough with questions that he ended up saying “Look, there are risks that will come from any surgery – I’ve done thousands of these, and have had almost zero complications reported from my patients. You’re aware of the risks and what the procedure entails, and have to decide whether the outcome is worth the minimal risk.” Besides the research, I gave myself 4 months between the consultation and the surgery, both to move the date until after golf season (VERY important to me). The four month break gave some more contemplation time after the surgery was booked and “real” – time to back out.

We made our decision to be “Childfree” after quite a bit of thought as well as looking at what our priorities in life would be. The decision for surgery was mine to make alone, although my wife was willing to go through the female version of the surgery as well – it just seemed easier and a less invasive procedure for me, rather than my wife to go through with it. A year later, both my wife and I are very comfortable with my surgery decision. The things we like to do with our life didn’t seem that it would be overly enhanced by adding dependents to – to the point that we don’t even own a cat as it would be abandoned while we left for weeks of vacation or weekends away from our house to visit friends or families around Ontario.

Financially, not having dependents to look after is a boon. While I understand children can be raised as economically as a parent wants, at the same time, not having the expense at all is significantly cheaper. One of the main reasons we can even contemplate Early Retirement is due to us being able to focus all of our “financial might” (of a moderate middle class dweller in Canada) towards this goal, instead of being dragged all over the place by conflicting priorities. The additional benefit of not having dependents is that we can be overtly selfish in our lifestyle and career. As long as we can support ourselves, there really isn’t any further obligation. If I felt like quitting my semi-stressful job tomorrow, in order to reduce the hours I work or restart a career in some other vocation, I could with no real effect to my household – this by itself is freeing.

The Savings “Addiction”

I’ve read personal finance blogs for over a decade, since blogging started to be a thing. My tastes in what I read have shifted from when I first started out my financial journey. Initially, I was very interested in authors who wrote predominantly about frugality and major money-saving techniques. This phase was probably the one that drove my wife completely nuts, as I was perhaps a little intense in implementing major money-saving techniques (something that she had never thought about doing). I never went as far as forcing the household onto single-ply toilet paper, re-using ziploc bags, or drying out paper towels for re-use, although if you asked my wife, I did go a little nutty for a while in an attempt to reduce the waste I saw in my house.

One blog that I still read on a semi-regular basis (although probably not as much as I should because there is a lot of goof information and analysis there) is Dividend Growth Stocks. One part of his blog that I really enjoyed reading about when it first came out was his pocket change portfolio.  I think the premise of this portfolio initially was to take the small amounts of money that was being made from writing posts, and turn that into dividend cash flows for a “fun” portfolio. After 7 years, his “pocket” change portfolio is making almost as much money as my wife and I would need to live on in retirement. I really like this idea, and have thought about doing it for a while. As a way of saving my change, I fill up an empty 100-ounce whiskey bottle (Canadian Club, from my younger and much more foolish days) and every year or two I’ve counted it out and spent it. With the abolishment of the penny, it’s taking me a lot longer to fill the bottle up this year, but it expect there to be significantly more money in there than the last few times.

The last time I emptied out the jar, my wife, who enjoys the tedious task of counting and rolling change, came up with a final count of about $450 – I’d think there would be at least $600 in there, which would be a good start to any sort of “mini-investment” project that I would take on. I could put $600 into an investment account and earn dividends off of it forever, much like the writer from Dividend Growth Stocks. This decision would be probably the most responsible thing to do – create more cash-flow for myself from “free” money forever.

My problem with any savings plan I implement, is that I have a hard time spending any money on anything. I allocate so much of the money I earn at my job to retirement savings right now that it doesn’t really leave a ton of money for some “fun” things – I’m more addicted to saving money than I am to spending it on anything – fun or not. While the savings addiction is beneficial to my current goal of amassing enough money, it is not beneficial when all I end up doing is having separate savings account for various future goals that I haven’t even thought of yet.

I haven’t really decided if it’s a good thing or a bad thing – I could use the $600 to buy a new cell phone next year, but my own “pocket change portfolio” funded with free money is probably a better idea – the decision I have to make is when to stop saving.

Expensive in a Couple of Ways

If I were to admit to a major vice that costs me more money than it should, it would be food. I love food – all kinds of it. One of the only reasons that I consistently go to the gym is to offset my habit of overeating on some weekend days, work “pot lucks”, or just a random Tuesday night when I decide it would be a good idea to hit an all-you-can-eat sushi restaurant (these aren’t consecutive food adventures, just inadvisable choices made from time to time).

The problem with eating out is that the cost of the meals adds up to
quite a bit of money over time. The cost isn’t enough to change my savings plan significantly, but between the money spent and the unhealthiness of most of the stuff I like to eat (because who I don’t normally choose healthy food), it’s not the best thing to do.

Six and a half days out of 7 days, I’m able to pretend to be a responsible adult and eat at least home-made food. My lunch staple is ground beef in either some sort of taco / burrito bowl (lettuce, tomatoes, salsa, maybe some avocados, and refried beans) or a pile of frozen vegetables, depending on how ambitious I am the night before. I make my lunch food the night before because I give myself basically enough time in the morning to make coffee and run out the door.

We buy our beef in bulk from one of my friend’s mom, and have been buying half a pig from a local farm over the past few years to add to our freezer stock.  Because of this stockpile of meat, we usually have enough food sitting around the house that I really shouldn’t be eating out at all. I know how to cook a lot of food, most of which is both delicious and much cheaper than something comparable at a local restaurant – I just choose not to some days.

Instead of taking 15 or 20 minutes at night to put together a lunch, which would result in me eating locally raised grass fed ground beef with healthy vegetables, I choose to continue watching baseball or football and shovel some of the worst food possible in my face. It’s one of the things that I do that makes neither financial or health sense, and could be easily remedied. Over time, this “habit” is probably costing me about $20 a week, just so I can eat food out that I already know how to make at home.

I try to spend my money efficiently, and me being lazy and semi-addicted to bad food is kind of the opposite of that. In the past, I’ve been able to talk myself into reducing the number of times I go out to eat to once every couple of weeks, which seems to work until I decide that I “deserve” more of the fun food that I want.

Given more time, I would probably cook for myself 100% of the time – something I look forward to when I’m done working full time in retirement.  I can figure out how to cook some fairly elaborate meals as part of a hobby, instead of rushing to put things in lunch containers for the next day. For now, I just battle my “vice” as
much as possible.

Better to Start Now

I meant to post this yesterday, but had to re-work some of my calculations in the examples below that didn’t make sense.  I’m definitely not advocating this type of investment for anyone, but wrote this post as part of my own investigation into possibly doing it for myself.

I am far from an innovative investor. I lean heavily on stealing other people’s ideas as my own, picking and choosing the best stuff that seems to fit into my own risk profile and investing strategy, as well as for the time I’m able to use to research the investments going into my portfolio. I continue to read books and blogs of people who are smarter (and probably more interested) at investing than I am.

Ever since I initially read “Rich Dad Poor Dad”, I had a dream of being a real estate mogul – of building a business that was outlined in his book from a couple of small houses to eventually a full portfolio of buildings that would make me a multimillionaire. I read that book over 10 years ago, during my initial rush of inhaling every personal finance book that I could. While I think that in general, most of what was talked about in the book doesn’t really apply to me, the picture of being a real estate “player” as a means to wealth never really left my mind.

One thing that has kept me out of the physical real estate market is that I really don’t like people. I know what I was like as a fairly responsible tenant during my renting days, and I wasn’t ideal – I can only imagine the problems that I could come across with some of the “horror story” tenants that I read and hear about from landlords. My wife and I can barely manage our own house, let alone look after several properties at a time. While I know I could hire a property management company to look after the houses I’ve bought, that would mean I’d have to hire and fire those “employees”, something I wouldn’t look forward to doing.

A couple of weeks ago, Nelson from Financial Uproar wrote about an alternative method of having a leveraged real estate portfolio.  Most of my adult life, I have been against most forms of debt, I don’t like to have it hanging over my head and have avoided most forms of borrowing as much as I can. I am generally a risk averse individual when it comes to investments, but this kind of leveraged investment has me intrigued. I am currently invested in a couple of REITs in my RRSP portfolio (RioCan and Dream Office), but these items make up a fairly small portion of my current overall investments. A much larger exposure to real estate wouldn’t really shift the diversification of my portfolio.

Example

As an example of how this investment would work, let’s say my wife and I were to start a “mini” real estate portfolio. Like most real estate starts, our intention is to use 20% of our own money (similar to how we would have started with buying a small house to rent to a small family or students) and borrow 80% of the amount from our bank using a home equity loan. I have made the following assumptions (taken from Nelson’s blog post, as well as September 15, 2015’s return for the REIT TSE:ZRE) :

Interest Rate Charge – 2.70%
Annual Charge = $2,160
Monthly Charge = $180

Return on the REIT investment – 5.71%
Annual Return = $5,710
Monthly Return = $476

I’m going to assume there is no change in distributions or interest rates for the period of testing.

Basic calculation:
On a monthly basis, we could, on a 20,000 investment earn $295.83 (distributions less interest charges) as long as interest rates never increase, or cash distributions aren’t adjusted in the for the index fund. Annualized, this investment would provide an additional $3,550 in income for our household – not a huge amount of money, but a pretty good return of 17.75%. If our goal at retirement is to have passive income of $25,000, we would be 14% of the way there, with minimal effort.

Paying down the debt:
If, over the next 9 and a half years (114 months) if we didn’t spend any of the income received from the investment and use the total net amount to pay down the principle on the loan, we would be making $382.22 per month ($4,586 per year). At the end of this period, we would owe $21,604 on the loan we took out

“Letting it Ride”
A more aggressive method of utilizing this kind of investment, would be to pay interest only, and utilize the money earned to purchase more shares. This kind of strategy would be similar to a “small-time” real estate investor starting with a single house, and using the equity created by the investment, to extend the investment to the maximum. At our projected retirement date, we would be generating annual income of $6,100 with our investment, an increase of $2,550 over the year 1 investment returns, or about an 8% increase on return (hopefully greater than inflation).

A Mix
The investment could be paid down like a mortgage, increasing the investment and paying down the debt at the same time. In month 1, the net return of the investment is the calculated $295.83. The $295.83 could be split in two, with half of the distribution used to pay down the debt and the rest used to purchase more of the security, more of a “blended” payment. This method of debt payment would reduce the debt outstanding, which might insulate any future impact of an increase in interest rates, while increasing income associated with the investment.

Tax Implications:
If I were to utilize this kind of investment, I would do it through a taxable account. With a taxable account, there are implications that need to be taken into consideration over holding a REIT in a tax-sheltered account.

On the taxable income side, REITs are much more complex than normal securities, due to the methods used to create income. The Globe and Mail wrote an article about tax filing for RioCan in previous years, which included the following items in income:

31.24% – Other income – taxable at the marginal rate.
1.72% – Capital Gains – 50% taxable at marginal rate
4.57% – Foreign non-business income – taxable at the marginal rate
62.47% – Reduction in adjusted cost base (return on capital or ROC) – A bit of a complex calculation – the Globe and Mail writer explained it as:

When you receive ROC, you are not taxed immediately on the amount. Rather, you subtract the ROC from the adjusted cost base of your units. This gives rise to a larger capital gain, or smaller capital loss, when you ultimately sell your units. Because of the tax deferral, ROC is considered tax-efficient income.

Interest on investments is an allowable expense, provided the investment is used to try to earn investment income (can’t be used for capital gains investments). This allowable expense will reduce the taxable liability on the interest earned, provided I would fill out a schedule 4 tax form.

Risks:

The two main risks with this type of investment would be a decrease in the distribution paid out, or an interest rate increase. Both of these risks are a little scary when it comes to the investment as a whole, but there is (currently) a 3% spread currently between the interest charge and investment return to “play” with.

Verdict:

I’m still not sure if I’ll do this or not. If I do make a leveraged investment, the earlier it’s made the better, as it would give more time to get either interest paid down or to increase the investment earnings by reinvesting into the security.