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Anti-Smith Manoeuvre?


There has seem to be an anti-Smith Manoeuvre movement across some Canadian finance blogs as of late. For readers out there who don’t know about the Smith Manoeuvre, you can read about the strategy here. The SM is basically a financial strategy to convert your non-tax deductible debt (like a mortgage) into good tax deductible debt (like an investment loan).

Here are some of the arguments against the Smith Manoeuvre:

Maxing out your RRSP and investing for the long term will outperform the Smith Manoeuvre.

  • I will agree with this statement due to the fact that your RRSP can grow tax free where the Smith Manoeuvre, even with tax deductible interest, is taxed on the dividends and capital gains. However, I don’t believe the SM is a replacement for your RRSP, but a replacement for your non-registered portfolio. The optimal strategy would be to maximize your RRSP, then if you have any money left over, pay down the mortgage, which in turn would increase your HELOC balance. Take the money from the increased HELOC balance and put it into stable dividend paying blue chips. For those of you who don’t understand what I’m talking about, you’ll have to read my article on the Smith Manoeuvre again.
  • There is a increased risk involved with leveraging your investments, so before you attempt any of this on your own, you better be pretty darn comfortable with investing. Either that, or find a good financial planner to put you in tax efficient, low-cost ETF’s or mutual funds.

Paying off your mortgage then start investing in a non-registered portfolio will out perform the Smith Manoeuvre.

  • I will argue against this because with the Smith Manoeuvre you are paying down your mortgage at an accelerated rate AND investing in a non-registered portfolio at the same time. Time and compound interest should make the difference. Not only that, you pay NOTHING out of pocket to maintain your HELOC. You simply withdraw the interest owed monthly from your HELOC and re-deposit it. The only issue is that in order to make the SM work, you’ll have to reach an investment return that is greater than the interest that you are charged. For example, today’s HELOC will charge 6%, if you’re in a 40% tax bracket, your effective interest is 3.6% after your tax deduction.
  • If you have a non-registered portfolio before you start the Smith Manoeuvre, all the better! Sell your investments, and pay down your mortgage, then re borrow and re-purchase the stocks again! Now you have a head start in paying off your non-deductible mortgage AND you can use the HELOC funds to repurchase your investments.

There is simply too much risk in betting your home on the market

  • I will agree to this to a certain extent. You are in effect leveraging your home to invest in the market. HOWEVER, you are also using fairly stagnant home equity that would just sit there otherwise. I think it really depends on how aggressive you are with investing and what stage of life you are in. As a young investor, I feel that now is the time for me to be aggressive.

Do you have an argument against the Smith Manoeuvre? Comments are now open for discussion.

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FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 249 comments… add one }

  • JG February 1, 2009, 12:13 pm

    Thank you both,

    I found both arguments sound, I am 39 and my risk tolerance is medium (3 in a scale 1 to 5). I think I can afford a bit of downside.

    I have not gone that far yet as for the details for the mitigation strategy, I have considered the TFSA as one measure but any suggestions are welcome.

    As for the investment strategy, in the first years I am expecting a return that will not jeopardize my tax deduction claim, there might be one or two years where there return may not match the interest from the HELOC, would the CRA ding me then?

    Thank you

    JG,

  • Ed Rempel February 1, 2009, 2:02 pm

    Hi JG,

    There seems to be a misconception from many people on this site that receiving income is required for interest to be deductible. Let me quote directly from IT-533. To be deductible, you need to have “borrowed money used for the PURPOSE of earning income”. The key is the word “purpose”, which is also bolded in IT-533.

    “Normally, however, the CCRA considers interest costs in respect of funds
    borrowed to purchase common shares to be deductible on the basis that there is a reasonable expectation, at the time the shares are acquired, that the common shareholder will receive dividends. Nonetheless, each situation must be dealt with on the basis of the particular facts involved. These comments are also generally applicable to investments in mutual fund trusts and mutual fund corporations.”

    Then it gives 2 examples. Interest is not deductible for R Corp. that has a specific restriction of not paying dividends, but interest is deductible for S Corp. that always reinvests all of its cash flow and never pays a dividend. This is because it COULD pay a dividend sometime in the future.

    It also spcifically says: “courts should not be concerned with the sufficiency of the income expected or received.” Whether your investment ever pays enough dividends to cover interest is not relevant. As long as you invest for the PURPOSE of earning income and it COULD one day pay income.

    In short, almost any mutual fund or stock is fine. We generally focus on very tax-efficient investments that may pay little or nothing in taxable income for many years. Any tax you pay along the way generally reduces the long run return of the SM.

    The best advice is to invest based on the risk/return of the investment. Buying investments that pay dividends is generally a sound and somewhat defensive strategy, but it does usually leave you with very little diversification – and the payment of a dividend is NOT relevant to the intest deduction.

    Ed

  • Ed Rempel February 1, 2009, 2:18 pm

    Hi JG,

    About your situation, Royal usually will allow you to convert your regular mortgage to the Homeline with no cost (or at least our contact does). So, you can start the SM without paying a penalty.

    It would not be worth the cost of the penalty for a mortgage coming due this year, but in your case, you can avoid the penalty. In November, you can shop around for the best SM mortgage.

    There are 7 mortgages that work in varying degrees for the SM. Only 3 are available through mortgage brokers. Generally the best ones are with the major banks and are not available from mortgage brokers. Royal is quite good, but has some restrictions.

    There are a couple of articles on MDJ about what to look for in the best SM mortgage, but in short, you would want to have the credit line limit automatically increase with each mortgage payment and to be able to invest directly from the credit line. Banks are almost always wrong for some reason about whether or not you can invest directly from their credit line, so don’t take their word for this.

    If you want a referral in November, we have a free SM mortgage referral service if you answer 10 questions on an article on MDJ.

    You may not necessarily be right for the SM, though. The risk of leverage is higher than investing your own money. You state your risk level as “moderate”, you seem concerned about making a profit every year, and you seem to want to time the market by waiting until it hits bottom. All 3 of these imply the SM may not be right for you.

    The SM is effective as a long term strategy for those that can tolerate the higher risk. Many tests have consistently shown that trying to time the market reduces your returns a lot. This is especially true near market bottoms. In generally, we would strongly recommend against trying to time the market while doing the SM.

    Ed

  • wx_junkie February 3, 2009, 9:16 pm

    Ed, you stated:

    “The SM is effective as a long term strategy for those that can tolerate the higher risk. Many tests have consistently shown that trying to time the market reduces your returns a lot. This is especially true near market bottoms. In generally, we would strongly recommend against trying to time the market while doing the SM.”

    That being said, would you not concurr that with the market conditions the way they are right now, it may be an optimum time to start an SM implementation? Alas, I suppose this is nullified by the fact that LOC borrowing in the early goings of an SM would be small, due to the high-interest/low-principal condition of the mortgage payment.

  • Undecided February 26, 2009, 11:28 am

    Hello, I’m trying to decide if SM is for me, weighing out the difference between my current tactic of making large payments against my mortgage and ignoring any investments, against being much less aggresive against the mortgage and starting to form an investment portfolio. However, the in person advice I receive is inevitably biased, ie the advisor is likely working in their best interest, not necessarily mine. With that here are my facts:

    Self Employed for 10 years, with highly variable income. Very aware of my finances. Single, 37, . Earn between 50K – 100K per year. My home is my only investment. I’ve never used an RRSP or the savings plan. I already have the STEP product from Scotiabank, with 110K unused Line of Credit at Prime. I live in Calgary, and my house is worth around 400K, and likely depreciating. I have 250K remaining on my 5.35% 5 year fixed closed conventional mortgage,. The original principle was 327K. 2years remain on the term. I frequently make double mortgage payments and have made the maximum 15% (50K) prepayment against my mortgage last year and am thinking of doing the same this year. Any investments I had went into my downpayment, 3 years ago.

    My credit is quite strong. I have no pension plan. I mistrust financial professionals, and their motives, but admit good ones have a place.

    Although I’m not much of an investor, actually not an investor at all right now – except into my house, I am quite aware of financial matters and products. Although, my mortgage is amortized for 40 years, I disregard the payment plan, through prepayments and double payments. Remaining Amortization is scheduled for 15 years.

    Given the Prime on my 110K LOC at 3%, the extreme market volatility (I don’t know of a solid investment that would even break 3%, my highly variable income, and the crappy housing market, I’m torn if SM is for me, or if doing what I’m doing is the best route.

    I suspect that with the accelerated mortgage plan I’m on (I used the calculator, constructed for this SM comparison) the tax deductible interest payments will have a very small effect for me. Leaving SM as a leverage tool for borrowing during a less than ideal time to make a Large first lumpsum payment.

    Thanks for any unbiased opinions! (Yes I know that’s what a financial planner is for, but their opinions are the ones I trust the least, I trust my limited knowledge over the biased actions of a planner).

    cl.

  • Sandor: falconaire@sympatico.ca February 26, 2009, 2:48 pm

    Dear Undecided,

    You are definitely decided.
    If you do not trust anybody else, why turn for unknown people for advice?
    But, be that as it may, your misgivings are not well founded.
    I am proudly biased and can submit to you that this difficult time is ideal for investing (in the right instrument!) and the market is not volatile now but rather clearly sinking.
    If your house is loosing value then you should take advantage as long as it is worth its present value.
    You do not need an advisor to think about the long term prospects you are facing:
    If you pay off your house first, all you will have at the end is a paid-off house whose value has diminished in comparison to what you paid for it. At the same time you shall miss out on the market.
    If you do the SM, you will have taken advantage of the turn around in the market, having bought investments at a huge discount, and will have accumulated value that will far outstrip the value of your house.
    In other words your present strategy and the SM are moving into opposite directions. The latter having a definite advantage.
    See what each would do for you in 10-12 years!

    Sandor

  • Undecided February 26, 2009, 4:12 pm

    Sandor,
    Thank you for your reply.
    It’s true I am turning to unknown people in this forum for advice/opinion. I find a variety of opinions of less risky than a single opinion. Granted most people on this forum would be for SM, otherwise they wouldn’t be visiting, they wouldn’t care.

    Also, nobody on this forum has a personal interest if I invest or walkaway. That is, your opinions are not paying your bills. This morning, I have had 2 opposite opinions from advisers as to the suitability of the SM for me, strangely each advisor worked for the same company, and each had different ideas of what investments work best. Yesterday, I had a mortgage broker tell me the Only way the SM would work is if I got a firstline mortgage and dumped my Scotia STEP mortgage, incurring the $2300 penalty. If it were not for the online information I would believe her ludicrous statements.

    Although I know you are biased, based on your earlier posts, thank you for admitting it.

    You are partially right.
    I have decided.
    I have decided that paying down a mortgage as fast as possible, sacrificing investing, not even holding a single investment, is not the best plan for our population.

    But is it right for a self employed single individual, who may need to change his course of action in the next few years – examples, move to a different residence(causing a refinance on primary residence), prolonged unemployment/career change, the strong possibility that the prime rate will rise in the next 5 years (I suppose this applies to everyone), narrowing the necessary margin.

    But as I see it, and even the book coincides, the tax deduction’s effect is not nearly as great as the investment appreciation. The question I need to figure out is do I want to become an investor, and if so do I wish to become a leveraged investor? (yes I know the book says it’s not leverage, debt transfer instead, but I call it as I see it). I suppose when I really look at it, I’m scared. The Interest deductability portion of the SM makes sense, but has a negligible effect. You mentioned, I’d be taking advantage of a turn around in the market, and this comment is what scares me. I’m not especially risk adverse, but when the dollars are sizable like they are, things change.

    If there is one single thing that makes a great amount of sense in investing at this volatile time in the world is that the time for the market to recover has a long time span, whereas investing after I’ve paid my house off will provide a much shorter time span.

    At its root SM is more of an investment plan than a tax avoidance plan. And I need to choose if I’m to be an investor.

  • Sandor: falconaire@sympatico.ca February 26, 2009, 11:18 pm

    Undecided,

    There are too many uncertain ruminations and too few actual calculations in your reply.
    Indeed you must decide what you want to be when you grow up. The question is, how long are you planning to delay that decision. If you like, you can send me your phone number in private, I call you and we can sort out the philosophy problems. The rest you can do yourself easily.

    Sandor

  • Undecided (Now Decided) March 5, 2009, 6:59 pm

    Sandor, Thank you for your offer to point me in the right direction. I have been in contact with a few financial advisors, including the firm that Ed Rempel is involved with. I am moving forward with the SM. Though at this point, I’ve only done the mortgage side of things not the investment.

    I do note that there are side effects to this manoeuvre.

    1) Should a couple start SM with a larger house, then find their house has become an empty nest and decide to downsize, they may need to liquidate a portion of their portfolio earlier than they had expected, thus the timing of their house sale will also be when some of their portfolio may need to be sold. For me, single, younger, with a larger house appraised at 440K – Heloc based on 80%, a mortgage of 250K, and 100K LOC, (350K Global limit) if I moved I would probably have to take a new mortgage on a smaller house, (using Stated Income as I’m self Employed) and therefore the institution would lend only 65% of appraised value. I would have to liquidate much earlier.

    2) Credit Rating, This one is a bit of a mystery for me as I’m uncertain how much this is affected by a maxed out LOC. Some people may not utilize the entire LOC, only using 75% or so, but since the LOC can’t be used for much else except investing (due to the CRA necessity of interest tracibility) , you give up a lot to preserve the credit score.

    Still working on a solid investment portfolio. Looking at 25% of portfolio in dividends. Remainder in Equities. In the immediate near term I’ll leave the equity side alone. I need more help in this investment side. The advisors that I’ve met so far seem to more skilled at tax, than at well researched mutual fund setups.

    thoughts?

  • Sandor: falconaire@sympatico.ca March 5, 2009, 7:22 pm

    1) The SM goes with you when you sell, or move.
    If you buy a second house you can start it with a second SM. Your property situation doesn’t influence your SM situation. Only your income and your credit rating does, if you have to make changes.
    This is in effect, of course only after you established your Plan.

    2) Although applying for credit does lowers your credit rating in general, once you have your LOC, you qualified for it, the only thing that matters is your payment habits. Pay your monthlies on time and your rating will be fine.
    That in turn will help you when you buy a second house.
    If you just change your house for an other one, as long as LTV and credit rating is ok, you will have no difficulty to carry with you your SM Plan. Nor would it be necessary to liquidate any investments.

  • Ed Rempel March 6, 2009, 2:03 am

    Hi, Now Decided,

    Downsizing your home in the future should not be a problem, since you presumably would be buying a new home for less money. You can take the difference and pay your mortgage/HELOC down to the point you need or can finance on the new home.

    The issue with moving is mainly if you move to a more expensive home, since you need to be able to make the down payment.

    From all your comments, the SM might not be right for you. You seem quite concerned about the markets, which makes me wonder if you would be able to stay invested the next time your markets go down.

    You seem to be trying to get info from a bunch of places and then decide yourself what to do, but you do not sound very knowledgeable about investments. Dividends would also come from equities, so being 75% equities and 25% dividends would be the 100% equities.

    If a prolonged period of no income with a career change is possible for you and since you are single, this is also an issue. You need to be able to maintain the SM as a long term strategy to be confident it will work for you, which means it is best if you are confident that you will always be able to make your mortgage payment.

    This can be dealt with, however, if you have an adequate emergency fund and protecting your income.

    This may make sense as a calculated risk, however, since all you need to do to maintain the SM is to maintain your mortgage payment. Even in a worst case scenario if you cannot make your mortgage payment, you could always draw on the investments to help make your mortgage payment. This would affect the tax-deductibility of your investment credit line, but is still an option in an emergency situation.

    Ed

  • Undecided (Now Decided) March 6, 2009, 5:55 am

    Sandor & Ed,
    Sandor my comments about moving are based on my recent inquiries how my lending institution (Scotiabank) would handle a move. Fraser’s book notes that a routine collateral exchange type document could be used. In practice, if I moved, the entire Readvancable Mortgage & LOC would be wiped out. A new application from scratch would be done. For some, probably a small %, this could present an issue.

    Ed, Thanks for your feedback. I do wonder if you’ve arrived at your suspicion of non suitability for SM without sufficient evidence. In the past few days I have researched a great deal on leveraged borrowing. Here’s more.

    First, regarding point about my knowledge, I believe I’m much more knowledgeable around investments than you suspect (Bachelor of Commerce degree – book knowledge granted), and yes I’d agree that I was not using terms dividend & equity properly. ‘Income’ 25% & ‘Growth’ 75% would have better terms. I do admit I’m not nearly knowledgeable or experienced enough to put together a proper portfolio, nor do I wish to.

    The financial planner’s job is to select suitable investments/funds, develop a plan etc. My job is to determine the proper financial planner, and to follow his plan.

    As you pointed out, I do carry risk by the very nature of being single, and with a variable income. For this reason, I’m very careful with my finances, I make substantial prepayments on my mortgage when I can (62K last year) and take comfort in knowing that I can ‘skip’ multiple mortgage payments if I’ve made doublepayments or prepayments in the same calendar year. Also, I have secondary income, that pays 75% of my mortgage. I do anticipate that a financial plan suited to me would address variable income issues, and likely I’d end up sacrificing some long term growth to mitigate the this risk. I’ve been self employed in oil & gas consulting for 8 years, and I think I put in safeguards to address variation in income.

    I’m somewhat caught. I wish to establish distance between myself and the activities of my yet to be determined financial planner. Yet, I feel a little knowledge goes a long long ways. I’ve averted huge mistakes by asking around and informing myself. I do not have the experience to know when I’m being ‘sold’ a financial fund/policy/product that I’m not suited for, so I do ask more than one source, searching for discrepancies. So no, I’m not deciding what to do with the information I gather from multiple sources, I’m determining (as best I can) whose opinion is suitable and sound, and whose is suspect.

    I disagree with your inclination that I may be one of the people who don’t stick it out over the long haul. Here’s why: Unfortunately, I did witness someone leverage their house who was very risk adverse, she was in her 60s, her time horizon was intended to be long, but she bolted, and liquidated her assets with a small loss. If I go into the SM, I do so with evidence that those who react/invest/divest based on natural market fluctuations are have a high likelyhood of being hurt. I’m a believer in DCA, and long term, buy and hold strategy. I feel that I’m extra likely to tough it out when the markets are bearish, due to what I witnessed.

    Ed I feel the SM is not where the risk lies. The risk lies in the investments themselves. I’m cautious about talking myself into something that I should steer clear of. I’m also aware that I need to start to establish a pension plan, as I won’t have an adequate one on my own. If I go ahead with SM, I do so to establish a pension. I do take stock in your comments about my suitability. If you truly think that SM would be a bad decision, I admit it would weigh heavily on my decision. This is why I’ve given you extra details.

  • Undecided (Now Decided) March 6, 2009, 6:11 am

    Here a little development I received from Scotiabank today, and their STEP product. Now, you can do up a single form, that *automatically* readvances the principle reduced on the Mortgage to the LOC. I’m told I don’t have to make a phone call or anything.

    This used to involve going into the branch for an adjustment each month.

    I gather from the opinions on this blog, the Scotiabank STEP is not a well suited product for SM. *It would appear that it has improved.* But that is not necessarily to say it’s a good fit with SM.

    I’m using STEP because I’m halfway through a closed term with them already, because I was approved for 80% of my 440K appraised house 2 years ago, (vs 65% of the current value of 400K) and because my LOC is at prime (instead of prime +1, which appears to be the going rate).

  • Sampson March 6, 2009, 2:23 pm

    Undecided (Now Decided):

    If I were you, I’d be a little careful treading so quickly into the SM. From your posts, it sounds like you don’t have too much experience with investments – so my question is why would you borrow money to buy investments? Instead of making such huge prepayments, invest your earned money.

    My view of the SM is that there are two significant risks. One, you mention is of the holdings themselves, if the investment vehicles selected have decent growth and will yield some form of steady and appreciating income (whether interest or dividends or capital gains).

    The second risk comes from the leveraging aspect. If the above falls through (i.e. dividends get cut, you suffer capital losses, inflation overtakes and eats away at fixed income returns) – then you are left with a significant loan.

    If you don’t do the SM and invest – if you lose, you can cut your losses there. With the SM – not only is there a possibility of eating those losses, but also getting stuck with a nasty loan.

    If sounds like you have significant earning potential – so if you can bank $62k to top up your current mortgage, why don’t you just split that in this coming year, start a solid investment portfolio (simply by maximizing your RRSP contribution you have thousands of $ returned/saved every year in taxes) – and if your advisor can prove their ability, then and only then consider the SM.

    Good luck!

  • Undecided (Now Decided) March 6, 2009, 3:50 pm

    I’m a little perplexed by part of your post, Sampson.

    “If you don’t do the SM and invest – if you lose, you can cut your losses there. With the SM – not only is there a possibility of eating those losses, but also getting stuck with a nasty loan.”

    If I can make reference to Ed’s advice to me earlier, these are the words of an investor with a shorter term horizon for investing. I will not know if I won or lost for several years. If I invest right now I fully anticipate I will be on the downside for 2 years or so, but the investment certainly doesn’t end in 2-3 years. In fact cashing out in 2 years or so is what I think Ed is cautious of me doing. He’s probably seen tons and tons of people do that. Cutting the paper losses is a short term view. I’m assuming the losses will not continue for 15-20 years (assumption from historical returns on stock exchanges). How would I get stuck with a nasty loan? Yes, if I cashed in early the leveraged investments would greatly amplify a loss. Over the long haul I believe I will be ‘stuck’ with a significant gain.

    I’m viewing the SM in the same way as a typical couple views their house. If the value of their house dips, they don’t sell, they need a place to live for the rest of their lives. Sure if my portfolio drops in value I won’t sell, I still need a pension for the remainder of my life. The average couple may change houses as their needs change, and yes over time the fund manager/financial adviser, would alter things in my portfolio.

    So let me ask you this, in order for you to defend your position: If you had 10K and 10K left of RRSP room to contribute, and No SM in place at the time, would you put it into RSP in Investment A, or would you use the SM and only leverage $10K of your home’s equity and invest the 10K in investment A ? Obviously there are benefits and drawbacks to each.

    Earlier, I mentioned how I ask in several places and look for discrepancies, you seem to lean towards RRSPs first, while Fraser Smith leans the other way.

  • Sampson March 6, 2009, 5:16 pm

    Hi Undecided (Now Decided),

    I’ll have to admit, I read your first post, then the most recent, skimmed some of Ed’s comments – For some reason I had the impression that there was a distinct possibility of uncertainty regarding your employment, and the possibility of moving also.

    Given those assumptions, I thought there was a chance you might have to liquidate in the near-term – of which you obviously understand the risks.

    I suppose my point is that instead of deciding to go all in, or not, you can take a balanced approach. Since it sounds like you had not been investing much in equities in the past, you probably have a somewhat limited feeling for the sting of watching your portfolio drop by >40%. My understanding is that you feel you would be able to stomach the volatility – but its impossible to know until you are tested.

    So to your example of the 10k, you might have sitting around. Instead of using all of it for SM (i.e. paying into your mortgage and readvancing the HELOC), why not (i) pay $5k into the mortgage and borrow $5k for SM – put the remaining $5k into the RRSP and reinvest the return (either directly, or using the SM).

    This ‘partial’ strategy would mitigate some risk – offer exposure to leveraged investing and the potential rewards, give you some time to assess the ability of your advisor, expose you to the stock market, pay down your mortgage, deduct taxes from RRSP contributions and the HELOC.

    This does mirror my current approach – First, I do fully contribute to RRSPs. Then I apply the remaining funds (over the year) and the tax rebate to my non-registered portfolio then mortgage at 70% to 30% rate. I have seriously considered the SM (a partial version anyway) – but would like for the World economic situation to settle down and stabilize.

  • Dave September 4, 2009, 6:33 pm

    I would like to add to the following points to the discussion:
    1) An index equity life insurance policy as talked about in one book I read would seem to solve the investment issue with the smith maneuver. First they have a guarenteed minimum of 1% and a max of 14% (seems a little high in the current environment). these policies are tied to a major index but you are guarenteed 1% as a floor, but limited to 145 (or whatever) if the index skyrockets. The downside protection is well worth it if it guarentees no risk to your mortgage home equity. BUT…I haven’t yet figured out if these insurance policies are available in canada since my source is american. It is tax free on the way in and out. No estate taxes and the policy continues to rise with no tax penalty for cash withdrawls.

    2) Isn’t it better to use your equity a second investment property anyway? (rather than invest the equity in the market). Given all the investment steams investment property gives you can have renters paying several properties for you. OPM my bretheren!

  • www.falconaire.com September 4, 2009, 8:40 pm

    Hi Dave!

    Although the very “policy” you describe is not available in Canada, there is a variant of it, with a floor of 7% and no ceiling. I use this myself. All else is the same.

    There is no reason why an other property could not be used for investment, except that the real estate values are slow to rise in value, in some markets it is stagnating for many years. The other thing is that it prevents diversity although that would be desirable in any investment strategy. So, I would suggest to have a property, but have also some equity and some dividend investment as well.

  • Ed Rempel September 20, 2009, 8:08 pm

    Hi Dave,

    With a life insurance policy, you have to pay the insurance premiums. The amount you can invest is based on the size of the policy. Unless you need life insurance and will need it for the rest of your life (not just till you retire), then this method is far too expensive.

    Also, you would pay more in MER for the principal guarantee after 10 years. Since the markets are so rarely down after 10 years, this extra MER is probably not worth it.

    If you exclude the Great Depression, the last 10 years are the only 10 calendar year period in which the S&P500 was down since 1871. That’s 1 time in 130. To protect against this rare chance of being down, you have to pay a higher MER of .5%/year.

    If instead you have high quality investments and have faith enough to stick with them when they are down, you have about a 99% chance of beating the investments you would buy inside the insurnace policy.

    This probably becomes 100% once you include the insurance premium, which can be very high for the UL policy you would need to buy.

    You can of course use your equity to invest in more real estate. However, growth of real estate has been far less than the stock market. The average house in Toronto in 1977 was $65,000 and was $379,000 in 2008. That’s growth of 5.9%.

    The TSX in the same period has grown 10.5%. If you had invested that same $65,000 in the TSX in 1977, you would now have $1,430,000 and could buy 3 1/2 houses.

    The rent generally only creates positive cash flow if you have equity tied up in your home.

    Virtually every story I’ve ever heard about someone making money in real estate was actually a story about leverage working. Almost always, it is a good return resulting from the leverage effect on a slow-growth investment.

    Most people are not aware that you can leverage similar amounts in faster growing investments. This can give you a far higher return than rental real estate over time, without the PITA factor of renting – that is if you are comfortable with the risk level and can stick with your investments long term.

    I was heavily into rental real estate decades ago until I realized that I could make a lot more money without all the work.

    Ed

  • Aolis November 24, 2009, 2:47 pm

    Your first point really nails the arguement. The person that has just purchased a house and has a large mortgage is unlikely to be maxing out both their RRSP and TFSA contributions. Few people would have a long term non-registered portfolio at that point in their lives. I mean, few enough people have a long-term registered portfolio.

    The real problem with the Smith and its variants is that they really confuse the issues of long term investing and paying down the mortgage. On one hand, you are simply borrowing money to invest and using your house to secure the loan. On the other hand, you are moving money around to try and get a tax deduction on a portion of the interest you are paying on your mortgage.

    In the first case, you should be putting 18% of your salary into your RRSP and $5K into a TFSA first. In the second, the interest rate is so low right now and has been for some time that the tax savings are not very substantial but the risk is still high.

    In the examples, most of the difference comes from assuming that the leveraged investment does well. You are going to be in alot of trouble when you decide to sell your house after a 20% drop in the market. That is a probable outcome yet easy to ignore when it is twenty years down the road.

    In my mind, the real purpose behind the Smith idea is to get people to consider leveraged investing, who might not otherwise. The idea is hidden underneath a blanket of paying down a mortgage. However, RRSP and TFSA are clearly superior investment choices and the tax deduction on the very low interests rates we have now is negligible.

    The real catch to all this comes when the financial advisor proposing this plan starts suggesting investments that are profitable to themselves. Suddenly, you are investing money you that you didn’t have before and the advisor is making 1% of that each year.

  • Ed Rempel November 26, 2009, 3:44 am

    Hi Aolis,

    RRSP and TFSA are clearly better than SM or leverage? That depends on your assumptions, your risk tolerance and your time frame.

    Leverage magnifies the gains and the losses. If you invest effectively for a long time frame and can tolerate the risk, leverage has a very good chance of making much higher returns than RRSP or TFSA.

    For example, if you have $4,000/year of cash, you could contribute it to your RRSP and get a $4,000 tax deduction. If instead you borrow $100,000 to invest @4%, you have payments of $4,000/year and have a $4,000/year tax deduction, but you have $100,000 in investments, not just $4,000.

    If the $100,000 makes a good return, then clearly I am way ahead (after interest costs and tax), and if it loses money, clearly I am way behind.

    The 25-year rolling returns of the S&P500 since 1871 have ranged between 5.0%/year and 17.4%/year. So, if you do this as a 25-year strategy, your odds are quite good.

    Also, when we compare the SM to a TFSA, the SM normally creates refunds each year, since the tax deduction on the interest is usually more than any tax on the investments, especially if you invest in tax-efficient funds and don’t sell.

    RRSPs provide a tax-deferral and TFSAs are tax-free, but leverage and the SM normally create tax refunds each year.

    Ed

  • Aolis November 26, 2009, 1:37 pm

    Hi Ed,

    “if it loses money, clearly I am way behind.”

    I’m going to retire regardless so I really shouldn’t be choosing a strategy where I can end up way behind.

    Risk tolerance isn’t just how aggressive I feel, it also depends on my ability to absorb loss. If I am already contributing the maximun to my RRSP and TFSA, then if I do leverage my house, the debt is only a fraction of all my investments. If it goes bad, I can pay it off from my RRSP and still have retirement funds left over.

    Aolis

  • Ed Rempel November 27, 2009, 3:07 am

    HI Aolis,

    I agree with your comments about risk.

    However, if you are going to avoid any strategy where you could end up way behind, should you also abandon equity investing?

    What do you mean by “if it goes bad”? Do you mean going to zero?

    The risks of both equity investing and the SM decline over time. For example, the S&P500 has never had a loss over a 15-calendar-year period (including during the Great Depression) and has never made less than 5%/year over a 25-calendar-year period.

    If you have a solid investment strategy, the ability to maintain your payments long term, the risk tolerance to stay invested during major declines and the discipline to avoid behavioural mistakes, then the worst-cases scenario is usually manageable and is not “going to zero”.

    The risks do decline a lot over long time frames (eg. at least 15-20 years).

    Ed

  • Aolis November 27, 2009, 4:22 pm

    Hi Ed,

    As I get closer and closer to my retirement, I will indeed abandon equity investing and switch to fixed income.

    Bad means that I actually make less money that I paid in interest and am left with not much to show for my retirement. The S&P500 not having a loss is a big difference from doing better than my interest costs. Interest rates are all good and low right now but they got pretty high in the eighties.

    With an RRSP or TFSA, I don’t have to worry about interest rates and even with a zero return, I still have the initial savings that I put in.

    Aolis

  • Lorne November 29, 2009, 7:25 pm

    it is always interesting to read someone state that “as i get closer to retirement, I will indeed abandon equity investing and switch to fixed income.” then in their next breath, state that they do not have to worry about interest rates, and even a zero return (on invested dollars) would be acceptable.

    assuming that person is ‘Average’ – retirement age around 62, life expectancy of 90 ish – and will be looking forward to a roughly 30 year retirement time frame, i would think he would rather have a prettty good idea about what interest rates are going to do, or a plan to invest and draw sufficient income no matter what they do, because a fixed income strategy in a rising cost retirement is not a conservitive plan at all. it is far more ‘risky’ than investing in equities whose dollar value on a piece of paper will fluctuate up and down with regularity.

    finally, it is just an observation that a person who has not been advised of this fact, and has not been helped with a plan to allow for it, is the same person who when shown a potentially excellent strategy on how to increase net worth and future income potential, would make the assumption that an advisor is only – or mostly – showing this in order to make a 1% commission on the assets invested, if someone is shown and helped through a strategy and a Plan that increases their net worth by, for example, $500 000, does it matter that they compensate the person responsible for this increase. unfortuneatly, this is common for DYI investors who always focus on MER’s and doing things the cheapest way they can find.

    just some thoughts.

  • Ed Rempel December 14, 2009, 1:29 am

    Hi Lorne,

    Great points. We think one of the most costly mistakes made by most people is to invest much to conservatively when they get near retirement. They still probably have 30+ years in front of them, so having too little in equities can cut retirement income by a huge amount (and cost more tax).

    If we do end up with higher inflation, bonds can be quite risky. They have historically been far worse at keeping up with inflation than stocks over the long term.

    The benefit of a financial advisor is often far more obvious after you are retired, since having an appropriate asset allocation and planning for the least tax (such as planning around tax brackets and avoiding all the clawbacks) have easily quantifiable benefits.

    Ed

  • Duncan Macpherson December 23, 2009, 4:25 am

    I always find it amusing when people comment on “Risk” tolerance and time frame as the most important aspects of a financial plan. The often overlooked and major flaw with this is that it assumes past averages equal future returns. It also assumes that the more time you have ahead of you, the greater the amount of “risk” one should take on. Let’s assume that all things being equal, someone begins investing at age 20 and places 75% of their savings in stocks, and the rest into GIC’s or bonds and they continue this trend for the next 45 years. Every 5 years they reduce their exposure to equities until they hold a maximum of 20% in equities and the rest in fixed income assets in the final 10 years prior to retirement. If markets remain stable, this should be a somewhat sound strategy. However, what happens if 30 years into their plan the markets are flat and inflation rears it’s head, eroding the purchasing power of what’s left of their nest egg? The fixed assets they hold don’t pay nearly enough to cover living expenses (in real purchasing power). If they held bonds, they also likely have lost value taking away a good chunk of their nest egg. Sound far fetched? Maybe. But history has shown us that markets can and do behave irrationally. Fine and good if a crash happens early in an investing career, but what if it occurs towards the end? I’ll leave you with a story of two farmers. One purchased and raised an ox over the course of 2 years. He kept it well fed and invested an enormous amount of his time and income looking after the beast so that eventually he could sell it’s meat for a profit to the local butcher! Another farmer bought a cow and also placed a great deal of his income into maintaining its health. Yet every day the man milked the cow and sold it along with cheese and butter at the local market for a modest profit. At the end of two years, the first farmer slaughtered his ox and went to the butcher for his payday. Unfortunately when he arrived, the butcher explained that ox prices are way down due to a lack of demand. Reluctantly, the man sold the meat at half of what he’d originally paid and went home wondering how he could recover his losses! The second farmer bought two more cows with his steady profit stream and hired a young boy to milk the cows for him while he retired in comfort to a steady stream of income. The moral is never wait to get paid tomorrow if you can instead get paid today.

  • cannon_fodder December 23, 2009, 11:21 am

    Duncan,

    With your allegory, are you trying to steer us in a particular direction?

    Did the first farmer have to comply with Sarbanes-Ox regulations?

    I’m not sure I saw a recommendation from you as to the proper course of investing. One can always come up with a hypothetical scenario in which a strategy does not work.

    Even though I’m (hopefully) 10 years from financial independence, I am planning to need another 40 years of income after that point. Although I am very highly invested in equities, most of my investments are dividend payers. I hope that this provides some stability and, ideally, a sufficient income stream that will not require the disposition of any capital.

  • Stressed Investor October 12, 2010, 1:09 am

    In 2007 we invested in the Smith / Snyder Manoeuvre. In my opinion the risks were understated and the benefits strongly exaggerated.
    After 3 years our $750,000 B2B LOC that was paying out through the Stone Capital fund approximately $10,000 a month has now been completely changed. We lost numerous shares and our $750,000 is worth more around $400,000 and paying out around $3000/mth that is currently just paying out the amount of interest on this still remaining $750,000 loan. Not only that but our house value is probably down about $100K and our reinvestments into the funds we are required to buy to satisfy the B2B loan requirements are doing very poorly.
    We are under extreme stress over the entire ordeal and don’t know whether it is better to stay the course or get out and take our 300 to 400K loss. Our biggest current stress is the fear of interest rates rising and having nothing to reinvest and struggling to pay the interest only on the B2B loan.
    I realize there are many details missing here as that would take pages, but any advice would be greatly appreciated.

  • Brian Poncelet,CFP October 12, 2010, 3:19 pm

    Stressed Investor,

    The biggest concern is not so much the interest rates going up is your investments going down. My thoughts are to get a second opinion from a couple of different advisors who can give you some direction.

    Brian

  • FrugalTrader FrugalTrader October 14, 2010, 1:22 pm

    This was written by Ed Rempel:

    Hi Stressed Investor,

    Sorry to hear you fell for the Smith/Snyder instead of doing the real Smith Manoeuvre, Stressed.

    Just so you are clear, the difference is that the Smith Manoeuvre involves borrowing against your home equity over time to invest in investments that grow and compound usually into a large number over many years.

    The Smith/Snyder, on the other hand, involves taking out a large loan to buy an income fund that tries to make you think you are paying off your mortgage very quickly. However, it replaces it with a NON-deductible investment loan.

    And sorry to tell you that the bad news is not over for you – probably only about half of your investment loan is tax deductible now. This is because you have been taking out the distributions from the income fund.

    We call the Smith/Snyder the “Reverse Smith Manoeuvre”, since it it a process of converting a tax deductible investment loan into a NON-deductible loan.

    There are 3 main problems with the Smith/Snyder:

    1. It does NOT reduce your non-deductible debt. Every dollar of distribution you take out of the fund and pay onto your mortgage is a dollar of your investment loan that is no longer tax deductible. So, you still have the same amount of NON-deductible debt. Once you pay off your mortgage, your entire investment loan is NON-deductible, so you may as well convert it into a new mortgage. There is actually zero benefit from taking out a distribution (in fact negative). Unfortunately, the Smith/Snyder was heavily marketed because it falsely looks like it pays your mortgage off fast and many people were not told of the tax problem. It will likely fail a CRA audit.

    2. Instead of buying investments that are the best based on risk/return, investments with the Smith/Snyder focus on getting a high distribution. Most funds are not available with this option, and the ones that have it usually are income/balanced funds with reduced long term growth potential (and are less tax efficient). So, you lose much of your long term growth potential.

    3. The benefit of the Smith Manoeuvre can be quite large if you leave good quality investments to grow and compound over many years. The Smith/Snyder is focused on getting income and trying to look like it is paying down debt – and misses the main benefit of the Smith Manoeuvre.

    I understand your stress. We have saved a few people from it, but it is difficult and takes some negotiating with your investment loan. However, if you have it structured like some others we have seen, doing nothing will likely mean things keep getting worse.

    Are your B2B loan payments principal plus interest now? What percent is your version of the fund paying out now?

    We have seen a few situations that we call a “Race to Zero”. Which will hit zero first – your investments or the loan? Let’s hope it is the loan, but the ones we have seen will be close. This is no way to make money!

    If you sell, though, you will lock in your loss.

    There is good news, though:

    – There is a rescue plan that works!
    – Investment loan rates are back to quite low again.
    – If you keep your mortgage, you should be able to keep the same credit line limit, even if your home as dropped in value.
    – If you keep you non-deductible debt separate, it can all remain deductible even though the investments are down a lot (other than the amount you have taken out in distributions).

    Here is what you need to do to fix it, Stressed. You need to convert to the real Smith Manoeuvre:

    1. Apply to B2B to change your investment loan to interest only payments. To do this, you will need to stop taking the distribution out of the fund and start making the B2B loan interest payments. You can pay them from your SM credit line (which is how the SM is supposed to work). You might have to add money or pledge new assets to qualify.

    2. Change your investment to one with zero distribution and something that will grow over time.

    3. If possible, you should reinvest the total of all the distributions you received from the fund since you started. If you don’t do this, then you will need to calculate each year how much of your investment loan is still deductible. For example, if you have received $200,000 in distributions since you started, then the interest on $200,000 of your investment loan is no longer deductible. It is up to you to make this calculation – CRA can just disallow everything and force you to calculate it. It is not the end of the world, though, since it only means you get a smaller tax deduction.

    The other option would be to change your mortgage so that $200,000 of your investment credit line becomes a mortgage again. That way, the remainder of your credit line would be deductible and you can do the SM on that $200,000 again.

    4. Depending on your mortgage payment, you might be able to start a monthly investment, in addition to paying the investment loan and credit line interest all from your investment credit line. This is the real Smith Manoeuvre.

    These 4 steps may sound difficult, but they should solve all 4 problems:

    – your cash flow issues
    – your fear about higher interest rates
    – your tax problem (would probably fail a CRA audit)
    – your investment loss (over time).

    The key is that, if you stop taking money out of the investments, then they can start to grow and should eventually regain the loss.

  • Eva November 26, 2010, 3:08 pm

    I understand this strategy, but have this question. Let’s say I bought my house a while ago at a low price and the market value is much higher.
    If I go the route you are describing, will I have to pay tax on capital gain if I sell my house? Will the fact that I use the mortgage to make money make me loose personal residency exemption on my house?

    • FrugalTrader FrugalTrader November 26, 2010, 11:09 pm

      Afaik, using a heloc to invest does not effect the tax deductibility of the heloc interest.

  • Ed Rempel December 15, 2010, 2:25 am

    Hi Eva,

    No. Using your home as collateral to borrow from a credit line to invest does not affect your principal residence status. There is no problem using your available credit to make money.

    Ed

  • Tiffany Clark July 19, 2011, 2:15 pm

    Smith Manoeuvre when applied through a disciplined program like the TDMP – will allow clients that do NOT have discipline to accelerate repayment of their mortgage, facilitate a forced savings plan and can act as a pension type plan for those that are self-employed. The type of investment solution that is used to employ this strategy is going to differ depending on the client risk/comfort.
    I believe that for MANY Canadians this is solutions to grow wealth and reduce debt instead of building equity to finance BOATS, LUXURY LIFESTYLES, and generally just keeping up with the “JONES'”.

    I am a mortgage broker and am proud to offer this strategy to my clients…… a plan to get ahead… not a Peter PAN mortgage.

  • Ed Rempel October 3, 2011, 1:16 am

    Hi Tiffany,

    The Smith Manoeuvre is not that difficult to manage and usually involves only one manual transaction per month.

    TDMP does not do the Smith Manoeuvre. They do the Smith/Snyder, which involves 4 unnecessary transactions each month that don’t actually do anything at all. With all that complexity and losing tax deductibility of the investment loan, professional help may be necessary.

    However, it is easier just to avoid the “4 Meaningless Transactions” and do the real Smith Manoeuvre. The difference is that with the Smith Manoeuvre, there are no monthly distributions each month to reduce the benefits and you are not restricted to only investments that pay high monthly distributions.

    Ed

  • Johnny Canuck (Oakville) October 26, 2011, 3:13 am

    Fantastic discussion on the Smith Manoeuvre. I considered this a number of years back, but I personally cannot stomach the idea of leverage, and did not proceed with it. Instead, I setup a self-mortgage through my RRSP in March 2008. Lucky timing for me, as I sold most of my RRSP holdings to get the mortgage advance and avoided the late 2008/2009 financial collapse.

    Just wondering if the posters who proceeded with the SM back in 2007 would be willing to share their experience with this over the past 4 years. In Oct 2007, TSX Composite was 14,000. Four years later TSX Composite is at 12,500 (-10%) and in between hit a low of 7500 (-50%).

    If you are willing to share your experiences in this time period, we could all benefit from it.

  • Ed Rempel December 7, 2011, 4:38 pm

    Hi Tiffany,

    I should add to my post 246, that it has been pointed out to me that TDMP has a different process now and my comments may no longer be fully accurate.

    A few years ago, they were doing the Smith/Snyder strategy. I am told they have a different method now and I don’t fully know what they are doing now, so I don’t know whether my comments still are true.

    I believe they are using portfolio managers directly, instead of mutual funds, which would mean they would not have the tax advantages that mutual funds offer. (Pooling in your cost base in a mutual fund and using corporate class mutual funds is usually far more tax efficient. With tax-efficient mutual funds you can often invest for many years with zero tax on the growth until you eventually sell, which you can’t normally do using portfolio managers directly.)

    I also believe that using portfolio managers directly allows them to not have a financial planner giving advice. I believe that they are having mortgage brokers give financial advice, instead of using a financial planner. It may also allow the mortgage broker to actually get a referral fee on the investments (even if they are not licensed for investments). Again, I am guessing here based on bits and pieces I have heard.

    I believe their process would still require a monthly payment from the investments (even though we don’t see any advantages of getting monthly payments), but this payment may be partly or fully taxed as a dividend (or something else). If it is a dividend, that would allow them to maintain the full deductibility of the credit line (unlike the Smith/Snyder).

    If they are still taking a monthly payment and it is not taxed, then these payments are probably still “return of capital” (ROC) for tax purposes, which would probably mean that they would essentially still be doing the Smith/Snyder and my previous comments would still be true.

    I believe that my comments probably still apply, but if they don’t, then I stand corrected.

    I welcome you or anyone that knows about their new process to explain exactly how it works now on this blog. Then we can see whether or not my comments are still true.

    Ed

  • Linda February 28, 2012, 6:49 pm

    We almost lost our home as a result of the Smith Manoeuvre. You have to be investment-wise and have excellent advice. We didn’t have either.

  • Brian Poncelet, CFP February 28, 2012, 11:02 pm

    Linda,

    Could I ask what company set this up and what kind of returns were you expecting or told? Also the time frame (like 10 20 years to reach your target, vs paying down your regular mortgage)

    Brian

  • MAC March 18, 2012, 6:45 pm

    can you explain the advantage of a self mortgage using your RRSP money.

  • Ed Rempel July 12, 2012, 10:37 pm

    Hi MAC,

    No. We think the self-mortgage using your RRSP is one of the worst ideas out there with no advantages.

    I can get a mortgage today at 2.69%. If I invest properly, I should get a decent equity return long term in my RRSP of, say 10%. This gives my RRSP a return of 7.3% above my mortgage rate.

    With an RRSP mortgage, you give up this entire 7.3% and pay fees to do it. Why would anyone want to do this?

    It may make sense for GIC-only people, but in my opinion, nobody under 80 should be GIC-only. If you are over 80 and still have a mortgage – maybe. :)

    The RRSP mortgage makes you think you don’t have a mortgage, but you still do. A trust company administers your mortgage for your RRSP. If you can’t make the payments, your RRSP will foreclose on you and sell off your home, exactly the same as if you have a mortgage with the bank.

    I know the strategy well, MAC, but no, I cannot explain the advantages.

    Ed

  • Ed Rempel July 12, 2012, 10:53 pm

    Hi Linda,

    What happened with you? Do you want to elaborate?

    It sounds from your description like you were doing the Smith/Snyder, not the Smith Manoeuvre. The Smith/Snyder involves taking monthly income from your investments – the Smith Manoeuvre does not.

    If you were taking monthly income, say 8% from mutual funds through 2008-9, you are probably still down a lot – and probably well below your investment loan.

    Is that what happened with you, Linda?

    If so, then I have good news and bad news for you.

    The bad news is that you may be worse off than you think. If you have been taking monthly income from your investments and claiming all the interest, then you are at risk of a tax audit. Not nearly all of your investment loan interest is still tax deductible. Every dollar of monthly income from your investments (assuming it is ROC) reduces the tax deductibility of your investment loan.

    The good news is that there is a fix, Linda. We have helped some people out of it.

    The fix is to convert to the actual Smith Manoeuvre. This works because it allows you to stop taking money out of your investments, allowing them to grow over time. With a good quality equity investment and no withdrawals from it, your investment should recover and even give you good growth over time.

    To do this, you should start paying your investment loan and investment credit line from the credit line linked to your readvanceable mortgage. Then you can change your investments to stop the monthly withdrawals.

    If you have an investment loan that is under water, you may be making principal + interest payments. If you stop taking monthly withdrawals from your investments and if you qualify, you may be able to convert your investment loan back to interest-only payments.

    The advantage here is that, once you don’t need monthly withdrawals from your investments, you can invest based on the best risk/return only, without restricting your investments to those paying large monthly payouts.

    I am guessing at your situation, but is that helpful, Linda?

    Ed

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