A 47-year-old Toronto gynecologist
inherited her great uncle's cottage in Muskoka last May.
The place had been neglected over the years and the doctor
had a summer place of her own in the Thousand Islands
so she decided to sell it. She priced it for quick sale,
the timing was good with the summer season about to get
underway and it sold in a week. The physician netted $65,000
after taxes on the deal. The question became, what should
she do with the money? She had, essentially, two choices.
Should she invest it or use it to pay down the $110,000
mortgage with 15 years to run on her Mississauga home?
She was paying 5.25%, which she
had locked in for five years a few months earlier. Given
low prevailing interest rates conventional wisdom would
have her paying down the mortgage and getting on with
it. But she wanted to maximize her return. Here are
some of the factors she considered.
WHERE
TO PUT THE MONEY
She first took a stab at estimating housing prices in
2020, 15 years hence. If prices rose about 5% a year,
which she judged to be a conservative estimate, her
house currently valued at $475,000 would be worth $987,491
and the $65,000 portion of it would have grown to $135,130.
Significantly, she wouldn't have to pay taxes on that
amount given that her principal residence was free of
capital gains.
To match that in an investment
she'd have to earn an additional 25% to cover the capital
gains tax or about $170,000, which would require close
to 7% annual return.
In many ways she preferred the
second option. She'd done well with her RRSP investments
in the 1990s and hadn't suffered much in the dot-com
drop in the early 2000s. She liked having a hand in
the market and was attracted to the idea of playing
with money outside her RRSP. She was convinced that
over 15 years, the market would outperform nearly any
other investment. Significantly, last summer she was
convinced that stock markets were out of the woods and
were headed up again. Now, she reasoned, was the time
to buy, estimating that she could reasonably expect
an 8% return or $206,190 on her $65,000 investment by
2020 and might make as much as $271,521, or 10%. Assuming
it was all capital gains she might come away with over
$200,000 after tax dollars to launch her retirement.
Thank you, Uncle.
SAFETY
vs RISK
Yet she hesitated. So much was unknown. Suppose the
market performed up to expectations over the 15 years
but hit a downturn in the year she wanted to cash in?
What about taxes? Personal taxes seemed to be about
as high as they'd go but what about the capital gains
tax? The government had often played around with it.
On the other hand, what would happen if gain on your
principal residence were made taxable in exchange for
a deduction of mortgage payments, for example.
There were so many variables; this
clearly wasn't a straightforward matter. A lot of crystal
ball gazing was involved. In the end she elected a third
alternative. She decided to pay down the mortgage and
invest the monthly reduction in her payments in the
stock market. She's investing $300 a month and has so
far put away $2,400 for an annual rate of return of
12.25%.
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