Advice with no-margin loan investment

2356 Views 2 Replies 2 Participants Last post by savemoney, Dec 6, 2009

savemoney

Discussion Starter · Dec 2, 2009 (Edited)

Hi Everyone,

Here is the scenario: I signed up for a $50K no-margin loan about 4 years ago and the interest rate (payable) is adjusted annually on the anniversary of the loan. With this loan I bought $50K of a mutual fund that paid out a monthly distribution as a return of capital. With the distribution, a portion went to pay the interest and balance went towards buying another fund within a RRSP. The benefits: tax deductible interest for the funds borrowed to invest in a non-registered investment and an RSP deduction for the mutual funds I bought with the net proceeds. I knew the risks I was getting into if the market were to take a downturn.

Then we had the signs warning of a meltdown and the Mfund temporarily suspended the monthly distributions, (awhile later announced a reduction in the distribution). At the time I thought about repaying the loan by selling off the mutual fund and eating a $2-3K loss. Overall, I was still to upside with the net proceeds I invested in another mutual fund within an RSP.

The stupidest thing I did was to listen to my so-called financial advisor who convinced me not to sell when I heard the monthly ROC distributions were temporarily suspended. In fact, he actually suggested increasing the no-margin loan to lower my ACB. That was the most absurd thing I ever heard! Since the distributions were reduced, I used the net proceeds to buy GICs and haven't given this much thought until I revisited this recently after promising my wife to do so for the last year or so.

The MV of the fund is worth ~$30K but I owe about $49K. The mutual funds and GICs I bought with the proceeds held in an RSP are worth about $9K, so I figure I'm down ~$10K. I've been patiently watching the market recover slowly over the past few months and started to think about about making a lump sum in December for the difference I am down, or just start making a monthly payment with net monthly distribution to reduce the total debt. Luckily this investment/loan represents a minor % of my net worth and I still have a long time to go before retiring.

Anyone else in with this kind of no-margin loan investment arrangement or any suggestions from seasoned investors on this forum would be much appreciated.

Thanks.

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Four Pillars

· #2 · Dec 2, 2009

I'm afraid to ask how much the interest rate is.

You've gotten some really bad advice. There's nothing really wrong with borrowing to invest (I did it myself until recently) but you need to be able to handle the volatility if things don't work out perfectly.

If nothing else you need to do the taxes properly - I don't know how many times I've heard people tell me that "professional" financial advisors said that they can get ROC distributions without any problem.

Getting an ROC dividend (or part of a dividend) is the same thing as a withdrawal from the investment account of the original principal. You need to reduce loan amount by the ROC or that portion of the loan is no longer interest-deductible.

If you get audited by the CRA then you are going to get nailed for declaring all the interest of your investment loan when it should only be a portion.

As for what to do now? I have no idea.

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savemoney

Discussion Starter · #3 · Dec 6, 2009

Bad advice is an understatement because I was re-assessed last year on the interest deduction...at least that is out of the way.

The interest rate used to be ~8% as it was prime plus a couple % points but it was masked by the fact that the monthly distribution was higer than the interest due. Because of the credit crisis, I am inclined to make a lump sum payment to reduce the outstanding balance owed given the deductible interest I can clain is much lower now.

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