If you have not invested before and are not knowledgeable about investing, it is best to get professional advice. If you invest yourself, you are very likely to end up making the same amateur mistakes made by most amateurs – following the herd, buying high and selling low, not researching their investments, not understanding the risk of their investments or the risk they can tolerate, etc.

Even though the stock markets always go up in the long run, most investors lose money over the long run because they follow their gut.

Try getting educated with the quiz on “Stock Market Risks” on this site.

Ed

P.S. If you are just getting your readvanceable mortgage, don’t fall into the “5-Year Fixed Mortgage Trap”.

With regards to investing, it depends on what type of investor you are. If you don’t have time (or interest) to constantly watch and research companies, then I would highly suggest that you look into indexing with either mutual funds or ETF’s.

Let me know if you have any questions.

In February, I will be getting a readvancable mortgage and starting the Smith Manoeuvre… now I have to figure out what is the best way to invest? Any advice??

Thanks,

Adam

Could you not just have 2 credit lines instead of one, so that you can keep the deductible amounts separate? Better yet, many bank credit lines products allow subaccounts, so you could separate the non-deductible amount within the same credit line product. The separate non-deductible portion could be setup either as a credit line or as a mortgage with PI payments.

Ed

I just noticed your post. Until recently, Scotia STEP did not readvance automatically. Now there is a new version out, but they seem very confused about it. Each of our clients that have a mortgage there are told something different – some readvance automatically now, some readvance only after the first one is $5,000, some still can’t readvance, and some readvance only at monthend.

You also cannot invest directly from the credit line in the Scotia STEP.

Those are the main 2 disadvantages, which can just mean you have a few manual things to do each month to make the Smith Manoeuvre work.

Ed

Yes, I know that it is better to have two separate accounts (in fact, I do have two). I’m just trying to squeeze some additional money from my house before it is too late and one of the pre-approved by a bank options I’m currently considering (mainly due to combination of penalties, fees, rates and etc.) is to have one large L/C with embedded non deductible portion. Due to time constrains I have to decide quickly, so I really need to understand how the mortgage prepayments will work.

Let’s say I’m mixing the tax deductible and non-deductible amounts in one mortgage (50/50 for example). Does it mean that any mortgage prepayments have to be “divided” 50/50 (for taxation purposes) between these two amounts?

Your message did clear some things up. I will set up two mortgage portions to properly track the interest. I was also intending on getting the LOC with the STEP to readvance further funds to invest, so I wouldn’t lose out on the power of the SM.

What are the disadvantages of STEP?

You are mixing the tax deductible and non-deductible amounts in one mortgage, which means that you can only claim the proportional amount of interest as a tax deduction. Any mortgage prepayment will also pay down the tax deductible debt the same amount.

If you want the lower interest rate, you can have 2 separate mortgages within the STEP, so that they are separate. You can then pay over 40 years on the deductible mortgage, but much faster on the non-deductible.

I understand why you are looking for the lower interest rate, but that means you are also paying down your deductible debt, which means your tax deduction is dwindling. It will take more cash to cover a principal and interest payment, as well. We looked at some scenarios like that and found that keeping the tax deductible amount as an interest only credit line almost always ends up with a higher long term benefit. The reasons are the higher tax refunds and that you can allocate more cash to paying down your mortgage.

You seem to still believe in the Sacred Cow and want to be debt-free, including your tax deductible debt. That is nice, but will have only a fraction of the long term benefit of the SM.

It sounds like you are not looking at any form of readvance, so the disadvantages of the STEP over all the other banks may not be an issue for you.

Ed

I have been reading this blog and I am impressed with the information you provide about the SM and also about 1 year or variable rate mortgages ending up better in the long run.

I am going to refinance my house and start the SM in the next couple of months. The house value is $400,000 with a mortgage of $180,000. This leaves me with $140,000 of equity to invest.

My plan was to refinance so I have an outstanding mortgage of $320,000 at P-.75% using the Scotia Step mortgage so I will have a starting LOC of $0.

I will be paying a lower rate of interest on the initial $140,000 of equity I am using to invest. Besides a bit of hassle claiming the interest from my year end mortgage statement can you see any other issues arising ?

Thanks for your input.

Here are some ideas of how you might implement the SM. You can borrow up to 80% of your home value or $340,000. With a mortgage of $230,000, you could borrow up to $110,000 to invest.

Your mortgage payment of $826 bi-weekly would pay $406 bi-weekly of principal. You will need $200 bi-weekly to cover the $110,000 investment (at 4.75% prime), which would still leave you $206 bi-weekly to invest. In total, this could give you $110,000 plus $206 bi-weekly to invest – all without using your cash flow.

You will probably be best to break your mortgage and replace it with a readvanceable mortgage at a lower rate. Calculating all the variables to see if this is better than any other option (such as just getting a top-up credit line until your mortgage comes due) can be complicated. We have an in-depth spreadsheet to calculate this. It is probably worth it for you, though, since you can now get a mortgage at 4% or less.

Looking at all parts of your finances can also yield a lot of other opportunities. For example, you could do the “Singleton Shuffle” by selling all of your non-registered investments and paying them down on your mortgage. Then you can immediately reborrow to buy back the investments, which would immediately make $126K of your mortgage tax deductible.

Also, we have a strategy called the “Debt Miracle” to combine other debts into your mortgage, including the payments you are making. It can accelerate the SM to roll all of your $20K liabilities into your mortgage.

The risks of the SM relate almost entirely to the investments. The key is to invest effectively and tax-efficiently – and to always look at is as a long term strategy. Looking at the SM as a part of your retirement goal can help to make sure you always keep it as a long term strategy.

Ed

The only clawback that I would be concerned with is OAS which would occur @ 65 and older. I’m not particularly concerned with this clawback as it is 35+ years away. Who knows if it will still exist at that time.

How are you planning on avoiding certain clawbacks when you retire considering that dividend income accelerates (due to 145% gross up) this possibility?

I’m playing devil’s advocate of investing in dividend producing equities vs. tax advantaged mutual funds which only would result in capital gains. The dividend producing equities would, in my opinion, lessen the risk that the CRA would deny interest deductibility. On the other hand, their income would not be as favourably treated as capital gains.

Current Home Value: 425K
Purchase Price: 400K
Current Mortgage: 230K 4 Year Fixed Rate @ 4.8% with 2 years left.
Remaining Amortization: 14 Year(s) 11 Month(s)
Bi-Weekly Mortgage Payments: $826.00
Current Non-Registered Portfolio: 100K
Current Non-Registered: 26K
Liabilities: 20K

Thanks in advance for all the input. I’d also love any other kind of recommendations like literature, websites and etc…

Tom

So as not to plagiarize, he provided an example of the effective returns from leveraging.

Let’s compare 3 scenarios: what is common to all is that the borrowing rate is 5%, the MTR is 40% and the amount invested is $100,000. In one of the scenarios (#1), the $100k assumes no leverage and the investments grow at 8%. In the other two scenarios, you put up $50k and borrow the additional $50k but in one case (#2) the investments gain 8% while in the other case (#3) they lose 8%.

Let’s assume that this runs only 1 year, that you cash out (thus triggering capital gains/losses), your interest costs are deductible and that you have capital gains previously that you can use to offset the incurred losses in scenario #3.

Since I can’t easily embed a table the summary is that the effective returns are: #1 – 6.4%; #2 – 9.8%; #3 – (15.8%).

As others have stated, leveraging can amplify returns but it can GREATLY amplify losses.

With that in mind, Tim Cestnick goes on to include 8 Rules of Leveraging. I happen to be leaning toward FT’s way of thinking with respect to NOT using tax efficient mutual funds but rather blue chip Canadian dividend paying stocks.
Like FT, I will be tapping in to the large amount of equity built up in my home to provide a “Big Bang” SM.

I’ve run various scenarios through my calculator and there is a certain appeal to having a portfolio that is net cash flow positive from the beginning (factoring in tax deductions from borrowing and income tax from dividends). I believe a self-funding HELOC/Investment Portfolio would allow one to sleep a little easier and it satisfies four (almost 5) of the 8 rules:

Rule 3: You need stable cash flow. If for some reason you need to scale back your mortgage payments due to loss of income, that would also scale back the principle paydown and amount to reborrow to service the HELOC. The self-funding setup where your dividends (after tax) cover your HELOC interest costs (after refund) remain unaffected.

Rule 4: Have a long time horizon (> 10 years). There should be no need to sell during tough times because even if the market value < book value, the dividends will usually (although not always as we have seen very recently) keep up with interest costs. This should allow one to keep the same structure for a long time.

Rule 6: Structure your leverage so that interest costs are deductible.

Rule 7: Ensure you take on the right kind of loan, and a HELOC is the preferred one (vs. margin loans at a brokerage that could suffer from margin calls at the worst time).

Ultimately, this may not be the ideal investment portfolio for net worth improvement, but perhaps it is an appropriate choice when borrowing heavily upfront. Certainly, investing in individual stocks is really only an option when working with large lump sums. A typical SM scenario involves investing only hundreds of dollars at a time and that is where mutual funds would be at an advantage.

Ah, right. Looking back at comment #112 in the Anti-SM post, I see Acorn was referring to a return on capital.

Thanks for the clarification.