Ed Rempel Org

What is The Cash Flow Dam?

What Is The Cash Dam and How Does It Work?

 The Cash Dam (sometimes referred to as a “cash flow dam”) is a simple but powerful concept, and it’s an especially attractive option for those who are familiar with the Smith Manoeuvre or other tax minimization strategies. Cash Dam can help you with tax optimization if you have a mortgage and own either a small business or a rental property.

What is cash damming?

 The Cash Dam allows the owner of a small business or rental property to more quickly pay down their non-deductible mortgage on their home. It’s a variation on the Smith Manoeuvre, but without additional investing. The Cash Dam is essentially an expedient way to change bad debt into good debt.

For someone who’s using the Cash Dam, what it involves is using a line of credit to pay for business expenses. Then, while using the increased business cash flow, you pay down a non-deductible mortgage or loan. This, in turn, produces an increasing tax-deductible business loan, while paying down a non-deductible mortgage or loan. Be advised that the Cash Dam as described above will only work for those who own a non-incorporated personal or partnership-based small business or a rental property.

Example:

 If you own a small non-incorporated business that has $2,000 in expenses each month and you also have a readvanceable mortgage, then the $2,000 per month expense would be paid by the home equity line of credit (HELOC). You then use the additional $2,000 you have in your business expense account to make a payment on your non-deductible mortgage. Interest paid on money that’s borrowed for business expenses is tax-deductible; by using the Cash Dam, you’ll be left with a tax-deductible business loan and a non-deductible mortgage that’s been quickly paid down.

One of the keys to the Cash Dam, however, is capitalizing the interest on the business line of credit. That way, you avoid using any of your own cash flow and you keep the business line of credit tax-deductible.

How does the Cash Dam differ from the Smith Manoeuvre?

The Cash Dam relies on using a tax-deductible business loan to allow you to pay down a non-deductible debt, while the Smith Manoeuvre allows you to buy investments. Investing from your credit line is why the Smith Manoeuvre has much higher risk and return than the Cash Dam.

Potential applications

 Say that you’re a rental investor, instead of using your own cash flow to pay for rental-related expenses, you can use the Cash Dam and a line of credit. In this instance, using the Cash Dam would help you pay for your personal mortgage and help you satisfy your tax obligations as well.

And if you are a small business owner, the Cash Dam can be extremely advantageous. The strategy gives you a way to quickly pay down your non-deductible mortgage and convert that debt into a tax-deductible business loan.

Ed Rempel CFS

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Ed Rempel is a well known Canadian “Financial” Keynote Speaker and shares his enthusiasm and many years of experience to primed financial audiences that want, need and deserve more and better insight and information. Join Ed Rempel a senior financial industry expert with a host of other top speakers at the Canadian Financial Summit. www.canadianfinancialsummit.com September 13-16 Online Event.

 

 

A Preemptive, Timeless, Portfolio Protection Strategy

A participant in the morning Market Cycle Investment Management (MCIM) workshop observed: I’ve noticed that my account balances are near all time high levels. People are talking down the economy and the dollar. Is there any preemptive action I need to take?

An afternoon workshop attendee spoke of a similar predicament, but cautioned that a repeat of the June 2007 through early March 2009 correction must be avoided — a portfolio protection plan is essential!

What were they missing?

These investors were taking pretty much for granted the fact that their investment portfolios had more than merely survived the most severe correction in financial market history. They had recouped all of their market value, and maintained their cash flow to boot. The market averages seemed afraid to move higher.

Their preemptive portfolio protection plan was already in place — and it worked amazingly well, as it certainly should for anyone who follows the general principles and disciplined strategies of the MCIM.

But instead of patting themselves on the back for their proper preparation and positioning, here they were, lamenting the possibility of the next dip in securities’ prices. Corrections, big and small, are a simple fact of investment life whose origination point can only be identified using rear view mirrors.

Investors constantly focus on the event instead of the opportunity that the event represents. Being retrospective instead of hindsightful helps us learn from our experiences. The length, depth, and scope of the financial crisis correction were unknowns in mid-2007. The parameters of the recent advance are just as much of a mystery now.

MCIM forces us to prepare for cyclical oscillations by requiring that: a) we take reasonable profits quickly whenever they are available, b) we maintain our “cost-based” asset allocation formula using long-term (retirement, etc.) goals, and c) we slowly move into new opportunities only after downturns that the “conventional wisdom” identifies as correction level— i. e., twenty percent.

  • So, a better question, concern, or observation during an unusually long rally, given the extraordinary performance scenario that these investors acknowledge, would be: What can I do to take advantage of the market cycle even more effectively — the next time?

The answer is as practically simple as it is emotionally difficult. You need to add to portfolios during precipitous or long term market downturns to take advantage of lower prices — just as you would do in every other aspect of your life. You need first to establish new positions, and then to add to old ones that continue to live up to WCM (Working Capital Model) quality standards.

You need to maintain your asset allocation by adding to income positions properly, and monitor cost based diversification levels closely. You need to apply cyclical patience and understanding to your thinking and hang on to the safety bar until the climb back up the hill makes you smile. Repeat the process. Repeat the process. Repeat the process.

The retrospective?

The MCIM methodology was nearly fifteen years old when the robust 1987 rally became the dreaded “Black Monday”, (computer loop?) correction of October 19th. Sudden and sharp, that 50% or so correction proved the applicability of a methodology that had fared well in earlier minor downturns.

According to the guidelines, portfolio “smart cash” was building through August; new buying overtook profit taking early in September, and continued well into 1988.

Ten years later, there was a slightly less disastrous correction, followed by clear sailing until 9/11. There was one major difference: the government didn’t kill any companies or undo market safeguards that had been in place since the Great Depression.

Dot-Com Bubble! What Dot-Com Bubble?

Working Capital Model buying rules prohibit the type of rampant speculation that became Wall Street vogue during that era. The WCM credo after the bursting was: “no NASDAQ, no Mutual Funds, no IPOs, no Problem.” Investment Grade Value Stocks (IGVSI stocks) regained their luster as the no-value-no-profits securities slip-slided away into the Hudson.

Embarrassed Wall Street investment firms used their influence to ban the “Brainwashing of the American Investor” book and sent the authorities in to stifle the free speech of WCM users — just a rumor, really.

Once again, through the “Financial Crisis”, for the umpteenth time in the forty years since its development, Working Capital Model operating systems have proven that they are an outstanding Market Cycle Investment Management Methodology.

And what was it that the workshop participants didn’t realize they had — a preemptive portfolio protection strategy for the entire market cycle. One that even a caveman can learn to use effectively.

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401k Drawdown… OMG

“Drawdown” has become the most feared word in the 401k vocabulary, just as “Total Return” has become the most worshipped phrase. OMG, how will plan participants be able to retire if their portfolio market values stop rising!

“Well, yeah,” you might say, “isn’t that what investing is all about. If you’re in the right sectors and the right funds, your drawdown will be minimized.” Well , yeah, that could be a viable drawdown minimization scenario if we had a crystal ball that could identify the “right” vehicles.

We don’t, and a litany of supportive sector correlation statistics just doesn’t change the basic facts of investment life that still are referred to respectfully by some as the “Market Cycle”.

Can you remember how easy portfolio management once was, simply by applying basic “QDI” principles to portfolio content selection and profit taking disciplines? It was a time when navigating an investment portfolio through the unpredictable, cyclical, undulations was indeed, a labor of love and respect for economic fundamentals… with strategies based on cyclical realities.

MPT charlatans, with “Frankensteinian” creativity, have transformed text-book-defined speculation into a passive sector-timing process based on probabilities… games of chance yet to be tested through any form of market correction.

In a program with no promise of income and no concern for fundamentals, is it any wonder market value drawdown is so feared.

Place today’s ETF and Mutual Fund equity content into the three Major Meltdowns of the past 30 years, and it’s likely that you’ll see the very same drawdown numbers… or worse, because of the artificial demand for a finite supply of real securities.

Drawdown happens; corrections are inevitable. The same MPT hocus pocus that, theoretically, is placing 401k dollars in the right sectors is, perversely, exacerbating the problem by blowing up the highest security price balloon ever, even higher.

Keep in mind as well, advisors and fiduciaries all, while we wonder at the brilliance of those who have created this ethereal (surreal), market fantasy land, that it is they (not you and I) that wield the fatal “pin”.

When the bubble bursts, remember these thoughts:

Drawdown minimization is accomplished by: investing only in “investment grade”, high quality, securities (fundamentally speaking); then diversifying among them sensibly within two “purpose delimited” security buckets; and regarding realized “base income” as the primary purpose of the income allocation and the secondary purpose of the equities.

With strict buy, hold, and reasonable profit-taking disciplines governing portfolio operations, drawdown minimization, continual income growth, and rapid recovery is virtually a sure thing… a sure thing that isn’t possible in a 401k environment that has kicked fundamental quality and income growth principles to the curb.

What is a Mutual Fund?

A mutual fund is an investment company that pools investors’ money to invest in securities. An open-end mutual fund continuously issues new shares when investors want to invest in the fund, and it redeems shares when investors want to sell. A mutual fund trades directly with its shareholders, and the share price of the fund represents the market value of the securities that the fund holds.
There are several advantages that mutual funds offer individual investors. They provide:
Professional investment management usually at a low cost, even for small accounts;
A diversified group of securities that only a large portfolio can provide;
Information through prospectuses and annual reports that facilitates comparisons among funds;
Special services such as check writing, dividend reinvestment plans, telephone switching, and periodic withdrawal and investment plans;
Account statements that make it easy to track the value of your investment and that ease the paperwork at tax time.
Successful investing takes time and effort, and it requires special knowledge and relevant, up-to-date information. Investors must spend a considerable amount of energy searching for opportunities and monitoring each investment. Professional investment management is relatively cheap with mutual funds. The typical adviser charges about 0.5% annually for managing a fund’s assets. For an individual making a $10,000 investment, that comes to only $50 a year.

Of course, mutual fund investing does not preclude investing in securities on your own. One useful strategy would be to invest in mutual funds and individual securities. The mutual funds would ensure your participation in overall market moves and lend diversification to your portfolio, while the individual securities would provide you with the opportunity to apply your specific investment analysis skills.
If there is one ingredient to successful investing that is universally agreed upon, it is the benefit of diversification. This is a concept that is backed by a great deal of research, market experience, and common sense. Diversification reduces risk. Risk to investors is frequently defined as volatility of return—in other words, how much an investment’s return might vary over a year. Investors prefer returns that are relatively predictable, and thus less volatile. On the other hand, they want returns that are high, but higher returns are accompanied by higher risks. Diversification eliminates some of the risk without reducing potential returns.

Mutual funds, because of their size and the laws governing their operation, provide investors with diversification that might be difficult for an individual to duplicate. This is true not only for common stock funds, but also for bond funds, municipal bond funds, international bond and stock funds—in fact, for almost all mutual funds. Even the sector funds that invest only within one industry offer diversification within that industry. The degree of diversification will vary among funds, but most will provide investors with some amount of diversification.
Investors should realize that:
A load is a sales commission that goes to the seller of the fund shares;
A load does not go to anyone responsible for managing the fund’s assets and does not serve as an incentive for the fund manager to perform better;
Funds with loads, on average, consistently underperform no-load funds when the load is taken into consideration in performance calculations;
For every high-performing load fund, there exists a similar no-load or low-load fund that can be purchased more cheaply;
Loads understate the real commission charged because they reduce the total amount being invested: $10,000 invested in a 6% front-end load fund results in a $600 sales charge and only a $9,400 investment in the fund;
If the money paid for the load had been working for you, as in a no-load fund, it would have been compounding over your holding period.
The bottom line in any investment is how it performs for you, the investor, and that performance includes consideration of all loads, fees, and expenses. There may be some load funds that will do better even if you factor in the load, but you have no way of finding that fund in advance. The only guide you have is historical performance, which is not necessarily an indication of future performance. With a heavily loaded fund, you are starting your investment with a significant loss—the load. Avoid unnecessary charges whenever possible
It is best to stick with no-load or low-load funds, but they are becoming more difficult to distinguish from heavily loaded funds. The use of high front-end loads has declined, and funds are now turning to other kinds of charges. Some mutual funds sold by brokerage firms, for example, have lowered their front-end loads, and others have introduced back-end loads (deferred sales charges), which are sales commissions paid when exiting the fund. In both instances, the load is often accompanied by annual charges.

On the other hand, some no-load funds have found that to compete, they must market themselves much more aggressively. To do so, they have introduced charges of their own.

The result has been the introduction of low loads, redemption fees, and annual charges. Low loads—up to 3%—are sometimes added instead of the annual charges. In addition, some funds have instituted a charge for investing or withdrawing money.

Redemption fees work like back-end loads: You pay a percentage of the value of your fund when you get out. Loads are on the amount you have invested, while redemption fees are calculated against the value of your fund assets. Some funds have sliding scale redemption fees, so that the longer you remain invested, the lower the charge when you leave. Some funds use redemption fees to discourage short-term trading, a policy that is designed to protect longer-term investors. These funds usually have redemption fees that disappear after six months.

Some funds, usually index funds, may charge a fee, 1% for example, on all new money invested in the fund. This charge defrays the cost of investing the new money. In effect, the new investment pays its way rather than having the transaction costs charged to investments already in the fund.

Probably the most confusing charge is the annual charge, the 12b-1 plan. The adoption of a 12b-1 plan by a fund permits the adviser to use fund assets to pay for distribution costs, including advertising, distribution of fund literature such as prospectuses and annual reports, and sales commissions paid to brokers. Some funds use 12b-1 plans as masked load charges: They levy very high rates on the fund and use the money to pay brokers to sell the fund. Since the charge is annual and based on the value of the investment, this can result in a total cost to a long-term investor that exceeds a high up-front sales load. A fee table is required in all fund prospectuses to clarify the impact of a 12b-1 plan and other charges.

The fee table makes the comparison of total expenses among funds easier. Selecting a fund based solely on expenses, including loads and charges, will not give you optimal results, but avoiding funds with high expenses and unnecessary charges is important for long-term performance.

Investment Industry needs independent players!

The most recent print issue of Money noted that the big Canadian banks managed to earn $31.7 billion in 2012, just a few years after there was grave concern that they’d even remain solvent.

“There is no question that Canadian banks play a vital role; locally, provincially, nationally and inter-nationally. Without the banks, our economy could simply not function efficiently or effectively. But are the banks getting too big and going too far to gain market share and profits at the expense of their own customers?” (Quote from Spring 2013 issue of Money Magazine.)

In November of last year I published a piece entitled Banks own the investment industry! A good thing? In many respects allowing the banks to provide everything from our mortgage to investment services is incredibly convenient. But at what price? It has become near impossible for many smaller investment dealers to stay in business. Fraser Mackenzie is a recent victim of an industry that requires scale in order to compete:

At their shareholder meeting on April 29th, 2013 it was decided: “Our assessment of the current business climate has led the owners to conclude that deploying our capital in the continuance of our regulated investment dealer businesses can no longer generate an acceptable rate of return. Institutional interest in early stage mining and oil & gas companies, sectors to which we have been heavily committed, has dried up: as has the associated trading in the equities of early stage resource companies. Furthermore, the regulatory cost burden is increasing at a time that industry-wide revenues are declining. On balance, it makes sense for our shareholders to re-deploy their capital.”

Indeed, well over half of the total value of trading done on the TSX in a typical month is conducted by the banks.

My guess is their actual market share of all trading is far above half if we were to also include trading platforms not part of the Toronto Stock Exchange. The banks keep growing, and the regulatory burden also grows more onerous. In my estimation, the larger financial companies relish regulation as an additional barrier to entry. Regulatory oversight is a minor inconvenience to the big banks, whereas for less diversified specialty businesses (mutual fund companies, standalone investment dealers, investment managers) the added expense can be devastating.

Obviously there are huge benefits to scale – but do consumers really benefit or are these economies of scale all kept as bank profits? MER’s for their proprietary mutual funds might appear very reasonable, but it’s impossible to determine whether or not the plethora of fees I pay for other services are subsidizing these seemingly lower expense ratios. Transparency is near impossible. Although many banks did collapse as a result of the the financial crisis, the massive rebound in the profitability of those surviving banks (even though they lost ridiculous amounts of capital doing stupid things with asset backed securities, derivatives trading etc.) suggests that those everyday fees paid by consumers and businesses must exceed the marginal cost of providing these services by quantum leaps and bounds.

Another concern I have – besides the demise of competition in the financial services industry – has to do with motivation. It’s true that every business is designed to make money, but in days of yore a mutual fund company, investment manager or stock broker had to have happy customers in order to succeed. If they didn’t help the client make money, the client would go somewhere else. I believe that as each independent firm disappears, so does choice. Making a great deal of money from you no longer requires you to be served well. What are you going do? Go to another bank?

The prime directive (to borrow an expression from Star Trek) of the financial services behemoths is profits. The financial advisor’s role is to enhance corporate profitability. Financial advisors today are increasingly handcuffed not just by regulatory compliance, but also ‘corporate’ compliance. Wouldn’t an investment specialist whose only mandate is to do well for his client be more properly motivated (and less conflicted professionally)? Would your investment objectives be better served by an independent advisor who is rewarded only because you the client are earning profits (and not because you are earning his employer more revenues)?

It isn’t necessarily true that an independent advisor is any better than one employed at a bank. I personally know of hundreds of outstanding advisors working at banks and insurance companies. But it must also be true that a satisfied, properly motivated, objective and focussed financial professional will do a better job whether he/she is at an independent or a bank.

We can’t begrudge the banks their success but left to their own devices, they’d all have merged into one by now. In December of 1998 then Canadian Finance Minister Paul Martin rejected the proposed mergers of the Royal Bank with the Bank of Montreal and CIBC with the Toronto-Dominion Bank. We know from our U.S. history that government and regulatory authorities are frequently frustrated by the political muscle (lobbyists, lawyers) of the large financial firms. Ultimately having one gigantic Canadian bank – providing all our financial services, investment needs, insurance requirements – might (or might not) be a worthy corporate ambition, but it’s hard to imagine such a monopoly being good for the likes of us. After all, just consider the progress that has been made in telecommunications since Bell Canada (or AT&T) was forced to reckon with serious competition.

The banks need independent players. Not only should banks discourage the obliteration (by bullying or by absorption) of non-bank competition, they should use their political muscle to keep the regulators from picking on Independent players. Government agencies cannot help themselves – if they are impotent against the strong they naturally attack the weak – even though when all the weak are dead the regulators would have no jobs. You don’t need a police force when there’s nobody you can effectively police.

Independent players create minimum standards of service and ethics, and fuel industry innovation. In every instance, the independent is a bank customer too. Mutual fund and investment managers pay fees to banks, buy investment banking offerings, custodial services and commercial paper and also trade through bank facilities. Independent dealers provide services and financing to corporations deemed too small to matter by larger financial companies; that is, until these businesses grow into large profitable banking customers. Put another way, why not adopt the Costco model where smaller independents can shop for stuff to sell to their own customers, and higher end specialty shops and department stores can all remain standing, rather than the take-no-prisoners approach of Walmart?

Let’s hope that the few surviving independent firms can be allowed to thrive, and if we’re lucky perhaps new players will arise to provide unique services to Canadian clients and homes for advisors who are inclined to specialize in managing and not just gathering assets.

Mal Spooner