The top one percent of Canada’s wealthiest families own over 25% of Canada’s wealth. Put another way, around 380,000 people share wealth of around $3 trillion dollars. That averages out to almost $8 million each and it is these few people who sit atop the Wealth Pyramid. Here’s what they all understand very, very clearly: non-tax-deductible debt tends to destroy wealth; tax-deductible debt can create wealth.
A Discussion About Debt
If interest is not tax-deductible, it is because you have borrowed to consume – buy cars, clothes, groceries, gas, and other similar items. These things you are buying with borrowed money start to decline in value or even disappear as soon as you buy them, and because the interest is not tax-deductible, if you paid $6,000 in interest on the borrowing for the year, that full $6,000 is gone.
However, if you borrow to invest with the reasonable expectation of generating income, you can deduct the interest. So, while you still may have paid $6,000 in interest on the borrowing for the year, if you are at the 40% marginal tax rate, then you get a tax refund of $2,400. That means that borrowing only cost you $3,600- that’s a big improvement over borrowing the same amount of money for depreciating items.
And better still, you can only deduct this interest if you have borrowed to invest – so now instead of purchasing items that cost you a lot in interest expense and decline in value – wealth destruction, you are purchasing assets which cost little in interest expense and increase in value – wealth creation.
The wealthy truly understand the above concept and that’s why they are wealthy.
The rest of Canadians are not at the top of the wealth pyramid for a reason – they borrow to consume. To a large extent, we don’t invest at all due to limited monthly income and ever-increasing expenses. The vast majority of Canadians are doing it backwards. Borrow to consume and then use cash, if or when available, to invest. Now we begin to see why the non-wealthy are not wealthy.
But by starting to behave like the wealthy you will be reducing your tax bill, you will be eliminating the expensive non-deductible mortgage debt much quicker than otherwise possible, and you will be building a substantial investment portfolio you can enjoy in your retirement.
A Discussion About Equity
To put it another way, the wealthy use the equity in their assets such as their house. They put that equity to work.
When you bought your house, you behaved like the wealthy because you got the required down payment together and borrowed the rest from someone else. You borrowed to buy an appreciating asset. But then you immediately stopped behaving like the wealthy because as you made your mortgage payments, you began increasing the equity in your asset, but you did nothing with it. You did not put it to work – you let that equity increase month after month earning you nothing.
The Problem – The Sequential Approach
Here’s the problem at hand: you have an expensive mortgage that needs to be paid and you have a retirement fund that needs to be funded – two money-related goals that are quite important to all of us. Certainly, neither of them can be ignored. And what do most Canadians do? The answer is quite simple – they decide to first pay down their mortgage and then once that’s gone, start saving in earnest for retirement. And this is understandable. Firstly, with such a large debt hanging over one’s head now and retirement so far away, the natural instinct is to try to be debt free as soon as possible. But there’s another reason – when faced with limited income, most Canadians simply can’t afford to do both. And so naturally they choose to make the mortgage payments, which is a contractual obligation, versus put that money away for retirement, which is optional.
The problem with this sequential approach, however, is that while you are busy paying off your mortgage, you are necessarily not busy investing for your retirement. While the mortgage balance is coming down (which feels good), the equity in your home rises (which also feels good), but what is happening is that you are creating potential wealth for yourself which is in turn doing nothing for you (which does not feel so good). In fact, you are not only earning zero percent on this unproductive equity, you are actually losing out to inflation (and that feels terrible). But what feels worst of all is that you are missing out on the magic of compound growth.
The Solution – The Simultaneous Approach
Canadians who discover The Smith Manoeuvre realize that they are able to reduce their tax bill, get rid of their expensive mortgage in record time, and begin to build a significant investment portfolio starting now and without the requirement of coming out of pocket with any additional monthly cash, meaning they do not have to sacrifice their standard of living.
The Smith Manoeuvre has been in continuous operation for almost 40 years but there are still many Canadian households who can benefit from implementation. The challenge, however, is that over the many years that financial professionals in Canada have been helping their clients, there have been numerous instances where the professional has not entirely understood the strategy – or misunderstood it completely. And this has been to the detriment of the client. But that has changed.
The Smith Manoeuvre Certified Professional Network
The Smith Manoeuvre on the surface is not a terribly complex strategy, but when it comes to set-up and implementation, there are a host of issues that must be considered – are you looking at the right type of financing? The wrong kind can get expensive. Are you looking at the right type of investment products? You don’t want to jeopardize your future financial security or your tax relief. Are you properly tracking eligible deductions? You do not want to get your reporting wrong – we’re dealing with the CRA here, after all. So you certainly don’t want to do it yourself and you do not want to take the guidance of any professional who may not have a good grasp of the strategy.
To help address these concerns, Victoria-based Smith Consulting Group Ltd. has built out the Smith Manoeuvre Certified Professional (SCMP) Network across Canada and homeowners are now able to access local, specifically trained professionals. Whether you are looking for a mortgage broker, investment adviser, accountant, insurance broker or realtor, with these SCMPs located across the country local expert guidance is available. And not only will your professionals be able to ask you the right questions and point you in the right direction, but unlike traditional holistic financial planning where your accountant may not know your financial adviser who doesn’t know your mortgage broker, etc., each of your Smith Manoeuvre Certified Professionals now each other, speak the same language, and are able to effectively communicate and collaborate not only with you but between themselves. To learn more about the strategy, please visit www.smithman.net.