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3 Sep

Cottage v. mutual fund: Which is better?

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Posted by: Kimberly Walker

Cottage v. mutual fund: Which is better?

 In one of the hottest real estate markets in history, where would your money have grown faster?

 Ted Rechtshaffen

 Globe and Mail Update Published on Friday, Sep. 03, 2010 6:00AM EDT Last updated on Friday, Sep. 03, 2010 6:35AM EDT

 Last week I wrote about four reasons to sell your cottage now.

 There was a great deal of feedback, much of it related to the family values and lifetime of memories that a cottage can provide. To that I say – “To those who love their cottage, I salute you!” My personal philosophy with clients is that all decisions need to be based on what is important to you, and that the financial piece is simply a tool to support achieving those goals.

 Having said that, last week I touched mostly on the non-financial aspects of the own versus rent a cottage discussion.

 From a purely financial perspective, I would strongly argue that the investment markets are better place for your money. Even in one of the best real estate markets in history, cottage investment has underperformed an average mutual fund (and I believe that you could do much better than investing in mutual funds, but that is another article).

The example I will use came from a reader who said: “My cottage purchased 18 years ago for $125,000 is now worth over $400,000. I’m sure this is a better return than your investing clients realize.”

 The Cottage as an Investment

 On the surface, turning $125,000 into $400,000 in 18 years is a 7.1 per cent return before taxes (there will be capital gains taxes on the cottage, assuming it is not the owners principal residence).

 However, the real return on owning a cottage must factor in the upkeep costs. Between property taxes and annual upkeep I have assumed 1.8 per cent of the value of the cottage a year. This number is different depending on the property and location, but I would argue that for most the number is in the 1.25 per cent to 2.5 per cent a year range. For the purpose of simplicity, I simply deducted these 18 years of costs from the final price. This is being a little generous to the cottage argument, as it doesn’t take into account inflation.

 To compare investments properly, you also need to be able to realize your gains. For a cottage this requires a sale. Between real estate commissions, legal work and some extra funds to prepare the cottage for sale, I have assumed 7 per cent of the sale price goes towards expenses. I assumed 1 per cent extra costs on the purchase price.

 Now the actual pretax return on the cottage after expenses drops to 5.1 per cent. It is the equivalent of the original investment of $125,000 plus 1 per cent in costs, growing to $294,500 today (after all costs were stripped out).

 Investing in a Mutual Fund

 I assumed the investment alternative was a mutual fund (with all expenses included) that has been around for roughly 18 years.

 Below is a list of four funds that were rated two-star and three-star (out of five) by GlobeFund, that meet the criteria:

 Acuity High Income Fund – 3 stars – 6.8 per cent since inception 18 years ago

 CIBC Dividend Growth – 3 stars – 7.57 per cent since inception 19 years ago

 Co-Operators Fixed Income – 3 stars – 6.34 per cent since inception 18 years ago

 Invesco Canadian Balanced – 2 stars – 7.32 per cent since inception 18 years ago

 A better performer is RBC Canadian Dividend (rated 4 stars), which actually returned 11.36 per cent over the past 17 and a half years, but I won’t use this as an example.

 So instead of buying the cottage 18 years ago for $125,000, you could have put those funds in the Invesco Canadian Balanced fund. After 18 years this would have grown to $415,400.

 To be more tax efficient, you could have purchased the CIBC Dividend Growth fund, and it would have been worth $432,175.

 In either case, after costs, you would have an extra $120,000 to $137,000 in your pocket today (pre tax) by purchasing an average performing mutual fund than by owning this particular cottage over the past 18 years.

 With that $120,000+, you could have paid for some very nice cottage vacations over the past 18 years, and still had enough money to buy a couple of nice cars to take you there and back.

 Just imagine what would have happened if the real estate market hadn’t been on fire. You might have been able to buy a cottage with the extra cash from investing in mutual funds.

Read more: http://www.theglobeandmail.com/globe-investor/personal-finance/cottage-v-mutual-fund-which-is-better/article1693671/?cmpid=rss1&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+TheGlobeAndMail-Business+(The+Globe+and+Mail+-+Business+News)