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Archive for July 2012

How Reverse Mortgages Work


What is a Reverse Mortgage?

–        A Reverse Mortgage allows a homeowner to access equity in their home while living in it.

–        Their home equity is used as collateral for a loan where, in some cases, the loan principle and interest becomes due on the homeowner’s death, or sooner if the individual sells their home.

–        The minimum age is 62 and the loan value ranges between 10% – 40% of the appraised value of their home.

There are 3 Common Types of Reverse Mortgages:

–        Reverse Annuity Mortgage:

  • Comprised of 2 parts:
    • A mortgage; and
    • An annuity.
  • The homeowner borrows a lump sum of money using their home equity as collateral. The loan proceeds are used to purchase an annuity which pays the homeowner a monthly income for the rest of their life.
  • The repayment of the loan is due at the time of the homeowner’s death, or sooner if they sell the home.

–        Line of Credit Reverse Mortgage:

  • The homeowner borrows a lump sum of money using their home equity as collateral. The loan proceeds are used to create a line of credit which the homeowner can borrow from when needed.
  • Debt repayment commences when the money is withdrawn from the line of credit.
  • This type of plan is valuable for people who require money at specific times and not on a regular basis.

–        Fixed Term Mortgage:

  • The homeowner borrows a lump sum of money using their home equity as collateral. The loan proceeds provides’ the homeowner with cash flow for a specific period of time, usually 5 to 10 years.
  • The repayment of the loan occurs at the end of the fixed term.
  • This is values for people who require cash flow on a regular basis for a short period of time.


–        Simple reverse mortgages and lines of credit are not tax-deductible since they are similar to a loan advance from a traditional mortgage.

–        When reverse mortgages are used for investment purposes the accruing mortgage interest is tax-deductible against any investment returns generated with the mortgage proceeds, providing individuals with tax-sheltered income.

–        While annuity income is taxable, annuity income generated from a reverse mortgage is not taxable.



*** Please note, a Reverse Mortgage may not be the ideal plan for everyone. There are certainly pros and cons, but for some people, it can be a feasible way to augment retirement income.

Build an Effective Portfolio: Understanding Measures of Risk


Investors constantly look for new ways to measure and manage the many risks affecting a portfolio. However, in order to manage risk, an investor must be able to identify it and have some methodology for measuring its reduction.


The standard risk reduction strategy is portfolio diversification. Diversification attempts to reduce potential loss by using a selection of assets. By reducing the prospect of suffering losses from one asset, the portfolio has reduced risk. Some studies have shown that a portfolio of stocks begins to experience the benefits of diversification with just a few stocks in the portfolio, provided that the assets in the portfolio provide adequate diversification. However, in order to actually reduce portfolio risk, it is necessary to combine assets that complement each other.


measures the covariance between two assets and is expressed as a number between -1 and 1. Zero expresses no correlation, with 1.00 expressing perfect correlation (the assets will always move in the same direction) and -1.00 expressing perfectly non-correlated assets. Ideally, a portfolio should contain assets that have low, zero, or negative correlation. By reducing the correlation between assets in the portfolio, the investor can achieve reduced risk and improved returns.


Standard deviation
measures the dispersion of data surrounding an assets mean price, systematic risk. Standard deviation provides a likely range of prices or returns above and below the average price or return. The greater the standard deviation of an asset, the more volatility it will see.


measures the change in a stock’s price given a change in the price of the broad market. A stock with beta of approximately 1.0 moves in the same direction and magnitude as the general market. Stocks that move less than the general market (defensive stocks) have a beta of less than 1, while stocks that move more than the general market (aggressive stocks) have a beta of greater than 1. Of course, using beta to measure risk makes the assumption that history will repeat itself, which it may not.


measures a stock’s performance compared to its benchmark on a risk adjusted basis. A stock with an alpha of 1 indicates the stock outperformed its benchmark by (1%); an Alpha of -1 indicates that the stock underperformed its benchmark by (-1%).


measures how much of a stock’s performance can be explained by the performance of a particular benchmark index. The data ranges from 0-100; a value of 100 indicates that the stock’s performance is directly correlated with the benchmark index. Typically a stock that has an R-Squared between 75 -1 00, behaves like an ETF to the index being measured. As an investor, who has a stock with an R-Squared of 75 – 100, it might be economical to move to an ETF since they have lower management fees compared to an actively managed fund.


Sharpe Ratio
measures how much of the stock’s performance is due to good management rather then systematic risk. It is calculated by subtracting the rate of return for a risk-free investment (i.e. Canada Savings Bond) by the stock’s rate of return, and then dividing by the standard deviation of the stock. The higher the Sharpe Ratio the more it’s performance is due to good management. The values used in the calculation will be in relation to the time frame which is being measured. ex. 1 yr, 3 yr, 5 yr etc.


** Please note that I have been referring to stocks.  Mutual funds, portfolios etc. can also use the above calculations to measure risk**