Million Dollar Journey

The biggest argument I can think of against the Smith Manoeuvre is that the lender for the HELOC usually has the right to “call” the loan at any time, which is possible if the loan amount keeps increasing without significant payments being made on it.

I could see it being a possibility if, for example, the HELOC is constantly maxed out, only the minimum (interest) payments are made (both of which are key features of the Smith Manoeuvre), and something else happens to make the lender question the creditworthiness of the borrower (say, they build up a lot of credit card debt at some time, or default on another loan). I’m not saying it’s likely, I’m just saying that it’s a possibility.

I think I am one of the anti-Smith people you are referring to :)

A couple of comments: I dislike making statements such as “will outperform”. Investing is a field of probabilities and I’ve always said that the SM works logically.

The trouble is people panic when they see losses in the market. When they panic they might do something silly like sell their investments (its so easy. Just the click of a mouse or a phone call). Its very different with a house. They will see that houses are not selling in their neighbourhood but they are hardly going to call their broker and say “I want to sell my house!”. I’ve noticed that people generally overestimate their risk tolerance.

I also disagree that home equity is “just sitting there”. We’ll take a simple example. Say I own a $250K home that is mortgage-free. Let’s say that I would rent a townhouse for $1,500/month if I did not own a house. Also, let’s assume that maintenance + property taxes are $6,000 a year. My house is providing me a benefit equal to $12,000 a year or almost 5% return. But remember that I pay no taxes on this return. In my world, that is a pretty darn good guaranteed rate of return.

Canadian Capitalist: “I also disagree that home equity is “just sitting there”. We’ll take a simple example. Say I own a $250K home that is mortgage-free. Let’s say that I would rent a townhouse for $1,500/month if I did not own a house. Also, let’s assume that maintenance + property taxes are $6,000 a year. My house is providing me a benefit equal to $12,000 a year or almost 5% return. But remember that I pay no taxes on this return. In my world, that is a pretty darn good guaranteed rate of return.”

CC,

When a person applies Smith Manoeuvre on his/her principal residence, he/she still enjoys that darn good tax free return of saved rent. And, on top of that, he/she can enjoy the investment return (or loss) generates by the manoeuvre. The manoeuvre provides the mean to get the fund for investment, but never gaurantee any return on the investment.

By the way, your “anti-SM” perspective is good for the SM prospectives and promoters like myself, it makes us think through the entire investment strategy carefully. As you pointed out, SM is not for those who chase after rally and run after crash. SM will work for investors who truely understand the power of the dollar cost averaging investment strategy. And, apply it to the appropiate investment vehicle like index funds or dividend funds.

EZ

Fernando: If you don’t mind me asking, what is your investment strategy?

FT

Fernando: ETF’s is an area of investing that I need to do more research in. Is it common for an ETF to have capital distributions throughout the year? I’m looking to minimize taxes while using the SM.

FT

Seems SM is nobrain for person who has paid off morgage. The worst case, you sell your investment. Your home will not be in risk.

Anybody wants to discuss what kind of investment is qualified for tax deduction? Have anyone got any trouble from RCA on any investment cost claim?
It is very unclear to me if you read Tax Guide. Index fund has no income or dividend will not be qualified?
Thanks for comment.

FT,
Thanks for comment. I called RCA and the agent said as long as there is “potential” you will earn income or dividend from funds/stocks you buy, you can claim the cost. Even US funds is ok.
I am ready to go that direction, but I don’t see any funds has anual dividend more than 6%. Any suggestion on what combination should I go for?

Guys,

Is 6% a good HELOC rate for now? All banks pretty much are the same in that rate.

Thanks.

Answering FT’s comment from Feb 13th:

FT: “In 2003, according to Tim Cestnick who is Canada’s tax guru, the govt put in a tax rule that stated that in order for an investment loan to be tax deductible, the investment must have an expectation of profit. This means that your dividend return must be greater than the interest that you’re paying. This is difficult in this environment as interest rates are around 6%, however, with strong dividend paying stocks INCREASING their dividends every year (historically speaking), it’s only a matter of time before your dividends exceed your interest. The Smith Manoeuvre has been challenged in court a couple of times, and the supreme court has ruled it legit.”

I am afraid my deat FT, your memory deceives you. The relevant section says “a reasonable expectation of earning an income,” so, you can invest in anything as long as you have that reasonable expectation. This doesn’t mean that a certain level of performance is expected from the investment, nor that it must be a certain type of investment. It goes without saying that GIC’s woudn’t qualify, while stocks, funds, real estate and many other types would.
This was also the outcome of the Singleton case in the Supreme Court, that opened up even farther the possibilities of benefiting from taking some risk by leveraging.

Sandor

Dear FT:

To your first comment about the donation of life insurance I must say that it doesn’t have to be a whole life type policy. In fact, the charity would be better served if it were a universal life policy, because, as the owner of the policy, the charity could access the accumulated cash within the policy, (just like any other “person”), even during the life of the donor. (The pertinent CRA document is this: IT-244R3 Gifts by Individuals of Life Insurance Policies as Charitable Donation)

Your other coment about the management fees of segfunds is a bit too general. I do know that many people share this opinion, but the security is richly worth the 0.1-0.5% of extra fee. Particularly as they are combined with other neet features that wouldn’t be available othervise and also save money.

As to the book; I don’t know it, but I am certain, the author made damned sure that he is quoting the relevant passage correctly. But since the CRA is really the authority and not the book, I suggest you look it up on the CRA website.
My source (PriceWaterhouse Cooper) is quoting CRA:
“To deduct interest expense on borrowed money, generally four conditions must be satisfied:
• The interest must be paid in the year or payable in
respect of the year.

• There must be a legal requirement that the borrower
pays the lender interest.

• The borrowed funds must be used for the purpose of
earning income from a business or property..

• The rate of interest on the borrowed money must be reasonable under the circumstances. This means that if the interest rate on a loan is 10% but the market rate for a comparable loan (i.e., a loan of the same term, same principal and same risk) is only 6%, interest of only 6% will be deductible.

The requirement that the borrowed money must be used by the borrower for the purpose of earning income from a business or property can be the most difficult condition to satisfy. Accordingly, when disputes concerning interest deductibility arise between a borrower and the Canada Customs and Revenue Agency (the ‘CCRA”), this condition is often the focus of the dispute.”

Well, If we can believe Fraser Smith, in the case of the Smith Maneouvre CRA never raised a challenge in twenty years, so I think everybody should do it, if they qualify for it and are comfortable with the vagaries of the complicated process.

Thanks for the gracious welcome

Sandor

>> “In any case, I must take issue with your method here, because a rtue picture can be obtained only if you add up all the incomes and deduct all the costs.”

Let’s test with an example. Please verify the numbers.

Suppose you’ve been holding BNS for 5 years. You started with $10,000 and now it’s worth $23,000. You have 2 choices: continue to hold, or sell it and reborrow from your HELOC to repurchase. If you sell, and you’re in the 40% tax-bracket, then you lose ($13,000 x 50% x 40%) $2,600 to capital gain tax. Now you only have $20,400 remaining to pay down your mortgage to reborrow. With a smaller capital, your portfolio won’t grow as quickly as before.

If your mortgage rate is 5.1%, then $20,400 would’ve $1,040 of interests or ($1,040 x 40%) $416 of tax saving. Since HELOC has 0.9% higher interest, it would’ve cost you an extra $183.6 of pre-tax interests or $110 after-tax. So you net positive is $416-$110 = $305/Year.

The lost $2600 could’ve generated $260/year of tax-deferred capital gains assuming 10% rate of return. $390/year if you assume 15% rate of return.

So it’s not a clear cut. You can also play around with the example by increasing the capital gain built in to the BNS investment, or by adding in DSC if you own a mutual fund. What if you throw in $150 for the DSC, plus another $150 for the HELOC setup fee? Add that to the $2,600 for a total of $2,900 of lost capital.

Dear Silverm and Ezboy,

I am afraid you are both mistaken, because you regard this transaction as a one time occurence. This however, is a process that is completed over a few years. While it is true that initially the set-up will cost some money, the repeated and increasing tax refunds combined with the rapid conversion of the mortgage into line of credit will break even in 1 or 2 years and make gains after that.
There are als a couple of intangible benefits as well.
First; it will enable people, who can barely make ends meet, to accumulate some investments, that otherwise they would never be able to do.
Second; the elimination of the mortgage in short order, that by itself is worth a great deal.
So I ask you, wouldn’t you pay a fee of $2900 for reducing the pay-off of your mortgage in 12 years, instead in 25?
I think you would both agree that it is worth that price.
By the way if you are reluctant to pay it the SM can be done without it too, except it may take an other year to complete.

Sandor

Silverm: Don’t get me wrong. I am all for the SM, but my simulation shows that trying to speed up the conversion through selling and repurchasing investment doesn’t neccessarily increase the investment return. Sometimes, it reduces it.

By the way, my simulation is conducted as a series of 300 monthly transactions and all tax refund and dividends are reinvested.

EZ

>>”So I ask you, wouldn’t you pay a fee of $2900 for reducing the pay-off of your mortgage in 12 years, instead in 25?”

I’d if you can show us the math. By the way, I never assume it’s a one time transaction. Not only must SM make up the lost $2900 capital, but also all the future “could’ve” profits.

Gentlemen, Silverm and Ezboy,

You must excuse me for not providing a full plan for your SM, but it is impossible without the numbers necessary for the calculations. So no exhortations can lead me to do that, nor would it be responsible for me to do so.
However a reduced version, based on the above $20400 would look something like this:
So, you paid your 2900 “fee”
Now your mortgage is reduced by 20400, so you can re-borrow the same amount; your investment is: 20400 add 10% gain, (as you stipulated,)a year later you have 22440. Plus you get a tax refund of 538 Total balance at the end of year 1:22978. So, at the end of year 1 you are only few dollars short of recapturing the 2900 fee.
In year two you can pay down on the mortgage 2578, then re-borrow it and add to the investment. At the end of year 2 you have:25276 investment, plus a 551 tax refund. In total: 25827.
By this time not only recuperated the initial cost, but you are ahead by 1827. (1089 of which is the tax refund!)
Now, as you notice above. the tax refund is growing year after year as you increase the amount borrowed. This has the distinct advantage of adding to the gain. But even beyond that, as long as you keep the investment fund in place, you will receive the tax refund regardless the fact that you may have paid off the mortgage a long time ago.
Of course, relying on this small amount alone will not pay off your mortgage, but if you combine it with the other components of the SM it will make a very substantial effect.

But the 260 opportunity cost in comparison to the 551 tax refund in the second year alone seems to be a really paltry sacrifice.

Sandor

Sandor, Silverm: Thanks to both of you for sharing the math. Despite Sandor has left out the 10% gain on the non-SM scenario, it appears that the SM scenario indeed can catch up with non-SM scenario much faster than I originally thought. Allow me to re-do the math for both scenarios.

For the non-SM scenario, at the end of year one, we have 23,000 x (1.1) = 25,300 of investment. Factoring in the capital gain tax pending of (25,300 - 10,000) x 50% x 40% = 3,060, the after tax worth of the investment is 25,300 - 3,060 = 22,240.

For the SM scenario, we have 20,400 x (1.1) = 22,440 of investment. Factoring in the capital gain tax pending of 2,040 x 50% x 40% = 408, the after tax worth of the investment is 22,440 - 408 = 22,032. The interest cost from HELOC is at 6%, so we pay 20,400 x 6% = 1,224. The tax refund at 40% will be 1,224 x 40% = 490. If we had left this investment alone, we only would have paid the lower mortgage rate of 5.1%. The difference in interest rate is 0.9%; therefore, the interest cost is 20,400 x 0.9% = 184. Substract this extra interest cost from the tax refund, we get 490 - 184 = 304 dollar left. So, the after tax worth of the SM scenario will be 22,032 + 304 = $22,338. This is $98 ahead of the non-SM scenario.

If we repeat the calculation for a 15% investment return rate, the SM scenario will be $6 behind at the end of year one. But, it will catch up by second year because of the surplus of tax refund against the extra interest cost.

EZ

Silverm: Did you check on the Firstline Matrix Mortgage? The RBC Homeline is offering 5.38% and has free HELOC adjustments.

>>”The $2,600 capital gain tax belongs to CRA in the first place”

Ahh… that’s where the difference is. Personally I think converting all figures back to after-tax is unfair because that dicounts the advantage of tax-free loans from the government. The power of the non-SM scenario is preciously the higher earning power coming from the larger pre-tax capital. I’ll demonstrate:

Non-SM scenario is easy. You start with $23,000. Compound 10% over 15 years and you get $96,076 pre-tax. ($76,860 ONLY IF you decide to cash out, but you SHOULD NOT. Just leave it alone.)

SM scenario is complicated. You start with $20,400. Each year you earn 10%, but you pay capital gain tax, so after tax return is only 8%. You take that 8%, pay down your mortgage and reborrow it back for reinvestment.

That same year you also receive tax-refund, which is 6% interest of your investment loan times 40% tax rate. That equals 2.4% of the investment loan. This is offset by the extra 0.9% interest rate over regular mortgage rate. 2.4% - 0.9% = 1.5%. Again, you pay down your mortgage and reborrow it back for reinvestment.

Now your investment is really growing at 8% + 1.5% = 9.5% annually. Compound 9.5% over 15 years and you get $79,586 after-tax.

At the end of 15 years, you might say the after tax figures are in favour of SM, but who in his right mind is foolish enough to cash it out all at once? If both parties stay invested and compound @ 10%, non-SM will receive $9,607 of capital gain per year, while SM will only receive $7,986. Non-SM’s portfolio has HIGHER earning power, even though the after tax capital is lower.

Has anyone used the SM with the BMO Mortgage cash account?

Thanks for producing the spreadsheet. I will adopt to your method of only swapping once at the beginning.

I’m not following the formulas behind HELOC interest and Mortgage interest. How come they are in relation to “InsideSMInvestment”? As you said, the swap is a one-time deal. The investment should grow at a rate of 15%, while the HELOC balance should grow independently at a rate of 6%. If you use the “InsideSMInvestment”, I think you might be over estimating the HELOC interests, thus over estimating the tax-refunds.

I added a new column for HELOC balance, and changed to formulas to base on the HELOC balance. According to the new spreadsheet, it took 8 years for SM to catch up afer-tax, and 20 years pre-tax. By the end of 25 years, SM has $764,356 pre-tax while non-SM has $757,136. SM has a very slight edge in earning power.

Again, this is not a clear cut. If you lower the tax rate to 32%, non-SM wins. If you lower the rate of return, SM wins again.

Well gentlemen, first thanks for the very interesting spread sheet and allow me to conclude that even if it takes for ever for the SM investment to catch up to the outside investment, we must not loose sight of the goal, namely to get you rid of your mortgage in a few short years.
Supposing, but not allowing, this small shortfall in investment results, their duration is as long only as you pay down your mortgage. After that your disposable income increases, your ability to save is magnified and the quality of your life is elevated.
So, if you don’t think it is “clear cut” based on the investment results alone, then you must agree that it is certainly clear cut if it includes the benefit of retireing the mortgage in a fraction of the time.
I hope you agree.

Sandor

silverm,
The advantages of the SM are much reduced in the instance you describe. Smith’s examples depend very much on not only the conversion of debt, but also the conversion of the Black’s from conservative investors with a long term mortgage, to what you & I would call responsible mortgage payers. I commented on this on Canadian Capitalist’s blog, http://www.canadiancapitalist.com/2006/04/03/book-review-the-smith-manoeuvre#comment-20136
where I indicated that though there are some advantages to implementing the SM, they aren’t always as great as the book suggests. The SM returns also depend on being in the early years of a long term mortgage. Based on my calculations, at the time my mortgage is paid out (which is about the same time as I could take early retirement) the increase in net worth would be about $17,000. not a huge amount. However, were I to continue contributing (& working) the portfolio takes off.

David

David, thanks for the link to Canadian Capitalist. You raised some good points including that in real life, you may not start implementing SM at the very beginning.

Ezboy, thanks for updating the spreadsheet. According to it, the pre-tax performance breaks even at around the 15th year for 10% ROR.

Here’s the truth. I’ve never read the Smith Manoeuvre by Fraser Smith, but I was running some sort of manoeuvre even before I read articles about the SM. Let’s face it, Smith didn’t invent this manoeuvre. Many people have been practicing the manoeuvre even before he published the book. If you know a thing or two about tax-deductability, you can come up with different manoeuvres based on the problems that you’re trying to solve.

>>”But BOTH scenarios could be enhanced by doing the Smith Manoeuvre, investing bi-weekly by readvancing from your mortgage principal payment.”

What I’m confused about is I thought SM is a tax strategy, not an investment strategy. A tax strategy should simply work without changing the risk profile of the investor. It should not be necessary to INCREASE his leveraged portfolio for SM to work. SM should be able to operate within the scope of the existing investments and mortgage.

Silverm: “What I’m confused about is I thought SM is a tax strategy, not an investment strategy….”

I never read the SM book either, I just learn about it on the internet. The way I understand SM is that it just makes the investment fund available through the home equity loan. As long as the investment return beats the cost of borrowing, you win. The tax deductability just lower the borrowing cost or boost the investment profit. After all, it is the investment part that will make you richer or poorer.

EZ

>>”SM is that it just makes the investment fund available through the home equity loan.”

Surely we don’t need a fancy name to describe a leveraged investment. :) I’m glad I didn’t squander money away on this book.

>>”you can get “extra” fund for investment by re-appraise your house and increase the credit limit on your HELOC.”

This falls outside of the Smith Manoeuvre, which is to make current mortgage interests tax-deductible. The extra HELOC limit coming from the reappraisal is available to both SM and non-SM, and doesn’t affect the existing mortgage balance. The balance can only be lowered if you feed money into it.

Since I haven’t read the book, I don’t know which tax problem he’s trying to solve, but who cares? Already amoung ourselves, we came up with a few and surely we have enough brain muscles to solve them. Here are what we uncovered so far:

1) Investment Equity
If you have an investment portfolio with a positive equity, how can you make your mortgage interest tax-deductible? You can swap the equity with mortgage debt, but that will trigger capital gain tax and other expenses. The pre-tax portfolio balance will have to over come these losses. The duration depends on a number of factors. This may not be a clear cut.

2) Differencial Investment Profits
When your investment portfolio returns profits each year, how can you make your mortgage interest tax-deductible? You can either leave the profits alone, or trigger the capital gain tax and swap with mortgage balance. This is similar to (1) above. This may not be a clear cut either.

3) Tax-Refunds
What to do with the tax refunds? I think to make this a fair comparison (and in favour of SM), use the tax refunds to pay down the mortgage, but reborrow to invest. Reason is keep the net debt balance the same between both cases. Secondly, the reinvestment will boast SM’s performance. Clear cut.

4) New Investments From Regular Principal Payments
Ed talked about buying new investments by reborrowing the principal back from regular mortgage payments. Looking at regular mortgage payments in isolation (without mixing external money), if the person is determined to invest, he has no choice but to leverage the capital from HELOC since he has no more funds outside. This is not a debate between SM and non-SM. He simply doesn’t have a choice. If he still has left over cash after making regular payments, then the cash would fall under (6) below. It’s a separate decision.

Couple that we have not covered
5) Business
If you own a business, how can you make your mortgage interests tax deductible? A business has revenues and expenses. Apply your revenues against mortgage principal, and reborrow from HELOC to pay for your expenses. Clear cut.

6) A Windfall
This is a broader category of (3) above. Anytime you have new cash to invest, you should automatically apply it against the mortgage first, and reborrow to invest. Clear cut.

silverm,
With respect to #5 above, I believe Smith calls this the “Cash Flow Dam” (though I have not read the book either). A lot of people seem to question how the CRA would view this. I’m not sure how one would go about filing their taxes in this case (i.e. for rental properties).

Ezboy: Thanks, I had forgotton about the never-ending spiral of interest capitalizion. I was focussed on the idea of making continued mortgage payment equivalents. Smith’s book indicates that the homeowner would continue to make ‘mortgage payments’ for the full 25 years. It is the period between the bank being paid, and the 25 years expiring that really builds the portfolio. At the end of the 25 years (the Black’s retirement day) no further payments are made to the portfolio. As I indicated, I plan to retire before the 25 years are up.

Also, of course, depending on the market you are in, the house value may not have increased that much — ask FT about his local housing market. Now if we were in Toronto, Calgary or Vancouver……

Smith repeats ad nauseaum about the twenty-five year mortgage, even when his example (the Balcks) has the ability, within their current income to pay the mortgage in far fewer years, admittedly without creating a portfolio. For those who are not looking at a 25 year time horizon to invest, the numbers of course, are much smaller. However, Ed Rempel sent the following comment on the Whites of my earlier link to Canadian Capitalist’s site: “Your story of the Whites is interesting, but essentially shows the “Sacred Cow” – the way Canadians normally do it. A fair comparison is not the Blacks to the Whites, but the Whites to the Whites with the SM. I put your numbers into the SM Calculator and the benefit over the first 7 years until the mortgage is paid off is $43,428. The investments are up to $193,428 from $150,000 borrowed over 7 years.” So, while not an astronomical figure, not exactly pocket change either. Ed further states: “From that point, the $193,428 would grow to $977,676 over the next 17 years at 10% [with no further contributions - David]. The interest cost over the 17 years would be $102,000 (your example assumes prime is 4%) and the tax refunds would be $31,620. The net benefit of adding the SM to the Whites plan over 26years would be $757,296. Of course, the expected benefit will be far higher when you include the benefit during 25 years of retirement.” Ed closes with: “So, but why not get an extra $757,296 from doing the SM, since it requires no extra cash flow?”

So, accordingly, here are the numbers
Smith’s Blacks $1,962,770
David’s Whites $1,154,723 to $1,762,556
Rempel’s Whites $757,296 (17 years post mortgage)
(who make no further contributions after the mortgage is paid, but keep the LOC)
Bright Whites $2,439,470 - $5,577,380
(who do the full SM for 25 years, and obtain 10% to 14% on their investments)

silverm: Smith’s twist on the use of the use of home equity was to encourage Van City Credit Union to create the re-advancable mortgage. This enabled investors with less equity to enter the market, use dollar cost averaging to advantage, and start to build their portfolio sooner. Previous to that time, most advisors would suggest one or more “Flintstone Flips” where large amounts of equity would be converted at less frequent intervals, or the “Garth Manoeuvre”, where you waited until the mortgage was paid before engaging in the use of the equity. The main thing Smith did was to popularize the idea, and suggest the means by which anyone could engage in building a portfolio. As Sandor said, it could help a homeowner with little extra cash at the end of the month to build a portfolio where previously financially impossible. The other twist is getting all those people (me included) to buy the book!

Re: 1) Investment equity — This is known as the ‘Flintstone Flip’ and I believe Singleton was the one who first challenged this idea in the courts and won, paving the way for the rest of us.

2) Differential Investment profits — Unless you have a huge portfolio, this would not make a big difference to your mortgage. Step 1 would have beter effect.

3) Tax refunds — your comment is exactly what Smith recommends.

4) Smith will tell you to ‘capitalize’ the interest by re-investing the mortgage principal reduction LESS the interest cost of the loan. In effect, you will make ever smaller investment purchases each month, as your interest cost climbs. This is how he claims that no additional cost is incurred. It is twisted logic to try and follow.

5) Is described by Smith in the book as ‘The Cash Flow Dam’

6) Or put it in your RSP (or buy something to keep the spouse happy?!?) (A little bit of ant & grashopper here!)

Bootsie: The cashflow Dam has been court tested. It will only work in a closely held sole proprietorship. Tax Accountant David Ingram describes it in his November 2001 newsletter:
http://www.centa.com/CEN-TAPEDE/november_2001.htm
I think the ‘Shoe Store’ example describes your ideas.

David

Ed,

Quick question for you. If a person get non-sheltered capital gain regularly, do you know if CRA will ask for tax instalments on the capital gain?

Thanks.

EZ

FrugalTrader: “Quarterly tax installments are required from all individuals who receive more than 25% of their income from sources that do not withhold tax.”

That is what I thought. I just wonder how it works for one-off capital gain. When I liquidate a significant investment position that has a lot of capital gain, like ten times the size of the BNS position Silverm mentioned in his example, what will happen? If I report the $130,000 capital gain in April and pay the $26,000 tax then, will CRA come to me next year and ask for tax installment?

EZ

In Post 57, I said:
So, accordingly, here are the numbers
Smith’s Blacks $1,962,770
David’s Whites $1,154,723 to $1,762,556
Rempel’s Whites $757,296 (17 years post mortgage)
(who make no further contributions after the mortgage is paid, but keep the LOC)
Bright Whites $2,439,470 - $5,577,380
(who do the full SM for 25 years, and obtain 10% to 14% on their investments)

However, I should further add that Ed Rempel suggests maintaining the tax strategy far beyond the 8 years to pay down the mortgage. Thus the $757,296 represents the benefit of early investing, and the Bright Whites represent a combination of wise financial choices in mortgage selection (low rate, short term, rapid payout) with a re-advancable mortgage option such as the SM.

David

Ed,
Unless I receive a windfall, retirement can reasonably occur any time after my mortgage debt is paid (about 10 years). I might hang on at work through the winter months, and enjoy retirement in the warmth of spring. While I had originally planned to retain investments, I had not considered retaining the LOC, however, you make compelling points.

Interesting that the combination of “Rempel’s Whites” & “David’s Whites” is closer to the Blacks, rather than the “Bright Whites.”

Still awaiting the opening of your ‘BC Branch’ ;-)

David

Ed,

Thanks for the info on the capital gain tax instalment. I will factor that into the spreadsheet when I revise it.

David,

Once you use up your extended HELOC credit limit, you can keep your investment contribution going through borrowing on investment margin account. Most online brokers, including those own by the big banks, offer interest rate of prime plus one. If your loan balance is high enough ($100K or above), some broker even offer you prime rate. For example, RBC Direct offer prime rate on their Royal Circle Investment Account for loan margin over $100K at 6% :

http://www.rbcdirectinvesting.com/RBC:RgmKF471A8cAAtd2vJk/account-interest-rates.html

Of course, if you decided to use margin to finance the investment contribution, you have to be very careful on your investment choice and proper margin management. On blue chip investment which rise in value faster than the long term interest rate, i.e. 10%, I will do no more than 30% margin. For any other investment, I will do none.

EZ

Cannon Fodder,
In message 57 above, where I quoted Ed Rempel, was for a particular example, where I had compared an SM strategy against a non-SM strategy. Ed did a comparison of MY non-SM (the Whites) by using the SM for the period of the rapid payout of the mortgage, showing that with no change in costs, the family would be nearly $800,000 better off by implementing the SM. Thus it was ME, not Ed that suggested stopping payments after 8 years. From the correspondence I have seen from Ed, he would undoubtedly suggest maintaining the SM for the longest possible period.

Hope that clears the confusion.

Having read all the opinions I can find on the ‘net, I can see that the SM has definite advantages for those who wish to engage in it. I would want to be very choosy in my selection of an advisor, though.

David

silverm said: “If you re-borrow the principal to invest, it’s not a SM/tax decision.”

Smith would disagree with you. In the book, he clearly describes the manoeuvre as not requiring an existing portfolio. He suggests the leverage is adopted when the mortgage is first assumed, and the Manoeuvre is a rearrangement of those finances. In many cases, the adoption of the SM does require the homeowners adopt a different (usually highrer) risk level with regards to the investments they might hold in their new portfolio.

The SM REQUIRES that you reborrow the equity you build as the mortgage is paid down, and slowly purchase an appropriate portfolio that will generate tax deductions. There is no expectation in the SM that the home will increase in value, though if it does, that may provide additional opportunity, should the homeowner choose to use it. The combination of the two loans, mortgage & HELOC does not exceed the original mortgage amount. The appropriate application of additional funds to the mortgage before reborrowing, and adding the tax refund to the mortgage accelerates the payout of the mortgage. IF you choose to borrow additional funds due to your home increasing in value, that IS leveraging, and may or may not be appropriate, depending on the individual borrower’s situation.

Smith also states that the investor should keep the (now deductible) HELOC in perpetuity, as the portfolio continues to grow faster than the interest cost. Your estate pays the bank.

While you may not agree with Smith’s postulates, that does not change them. If you do a comparison of non-SM vs SM as described by Smith, it is quite easy to seperate the two. I have looked carefully at this from a very skeptical point of view, and have found that there is a financial advantage to following Smith’s thesis. How great the value, and the individual’s comfort with engaging the SM may vary, but that does not change the fact that there is some advantage to applying this financial plan.

Google “Smith Manoeuvre Powerpoint” and read the speaker’s notes there attached, and you will be able to confirm this. While I can agree with you about some of the returns you have described, I suggest that you review the book, or the PPT, to more clearly understand Smith’s comments.

David

David, I have complete trust in you regarding what’s said in the book.

I’m sorry. English isn’t my first language, so sometimes I have problem expressing myself.

The way I imagine is looking at a pie with many slices of possibilities. One slice says swapping good and bad debts. SM took that slice. But hold on. He’s not done yet. He wants the leveraging slice too. He keeps claiming the good slices and leaving the bad ones to the non-SM. The problem I have is the non-SM guy should be free to adopt leveraged investment slice without the debt swapping slice. If both are practicing the leveraged investment, then effectively, they cancel each other out. My point is the advantage of a leveraged investment shouldn’t be in the SM’s bucket only when comparing SM vs non-SM. Am I making any sense? Otherwise people are over estimating the power of SM. Yes, swapping good and bad debts are good, but not that great.

Truth is, I don’t like how the name “Smith Manoeuvre” is stuck, because I was already practicing these techniques even before I knew about Fraser Smith. I know I’m not the first person either.

David, I’ll make a few comments below in no particular order.

(1) Earlier I said SM is a tax strategy, not an investment strategy. By investment strategy, I meant extending ordinary leveraging by increasing risks and expected returns. Ed Rempel countered saying SM is both a tax and investment strategy. Now you are saying “Smith never suggests an investment any greater than the original mortgage.”. If the 2 person who have read the SM book can’t agree on the boundary of SM, how did you agree on the manitude of SM’s benefits?

(2) A manoeuvre is a tatical action. If an action is mandadory, then it’s not tatical, therefore not a