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

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.

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

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.

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

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.

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

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.

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

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.

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

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

“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

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

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.

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