Smith Manoeuvre Strategy: The Rempel Maximum
Ed Rempel, a certified financial planner (CFP) and accountant, is a regular comment contributor to the “Smith Manoeuvre” articles on this blog. He has come up with a twist to the Smith Manoeuvre strategy that maximizes the tax and investment return on your leveraged portfolio.
He calls this strategy “The Rempel Maximum“. If this is the first time you are hearing about the Smith Manoeuvre, it is basically a financial strategy that converts your non-deductible mortgage into a tax deductible investment loan. You can read more about it my article “The Smith Manoeuvre: A Wealth Strategy“.
How exactly does “The Rempel Maximum” work?
- The “Rempel Maximum (RM)” is a variation of the Smith Manoeuvre (SM) that maximizes both your tax and potential portfolio return while using $0 of your own cash flow. When you use the SM, you will get a small increase in your HELOC balance as you pay down your mortgage which is then used to invest. With the RM, instead of using the small increase to invest, you use the increase to fund your investment loan/HELOC. This may result in obtaining an additional investment loan depending on the size of your principle payment. More on this below.
- This way, you get the tax deduction from the HELOC along with the tax deduction from the investment loan. Canadian tax rules state that you can deduct the interest from a loan that supports an investment loan.
- On top of that, you’ll have a large balance to work with initially to take advantage of compounding returns and time.
How is it implemented?
- You’re probably wondering how large of an investment loan can you obtain? According to Ed Rempel:
For example, if your mortgage payment pays $500/month of principal ($6,000/year), you divide the $6,000 by the interest rate (say 6%), which gives you $100,000. You increase the credit line limit on your readvanceable mortgage to 80% of your home value, which is often done for free at the major banks. Then you borrow and invest up to the credit line limit. If there is less than $100,000 available, then you finance the rest from an investment loan.
- Based on the above example, the banks will give you [principle payment/interest] as your maximum investment loan including your HELOC. Depending on how much equity you have in your home, you could end up with a fairly large investment loan.
What are the risks involved?
- This strategy uses the maximum leverage available to you based on your principle payments or how much your credit line is readvanced with every payment. Needless to say, the investor must be aggressive, comfortable with risk, and experienced with investing.
- As you probably already know, leverage amplifies your returns, good or bad.
What are the potential returns? How does it compare to the regular Smith Manoeuvre?
- Using the maximum available loan amount potentially means higher returns or bigger losses. If you are investing for the long term 25+ years, then your overall losses will most likely be minimized.
- Below is an example from Ed Rempel:
They have a home worth $400,000 and a mortgage of $200,000 at 5% and are paying $1,169/month (25-year amortization). They can reborrow at prime of 6%, the investments average 10% long term and they are in a 40% tax bracket. Each mortgage payment pays down $336 of principal x 12 months / 6% = $67,200. Since they have more than the $67,200 in available credit in their SM credit line, they can borrow this $67,200 to invest. The interest payment is $336/month which can be paid entirely from the SM credit line each month. Additional benefit of the Rempel Maximum over the SM: After 25 years: $410,000* Total benefit of the Rempel Maximum: After 25 years: $718,000
Who should use this?
There are 3 criteria that a person should consider before implementing this strategy:
- The investor must be experienced and comfortable with risk.
- The RM works best if your initial HELOC balance is small. ie. Someone who is just starting the Smith Manoeuvre with a little over 25% in equity.
- The investor must be in this for the long term, 20+ years.
Summary:
The Rempel Maximum is a way to maximize the potential returns from implementing the Smith Manoeuvre through the additional tax deduction and increased leverage. This can be an extremely powerful and lucrative strategy if used properly over the long term.
If you are considering using this strategy twist to the Smith Manoeuvre, make sure that you are comfortable with the maximum leverage applied to your portfolio. Feel free to ask your questions in the comments section, Ed Rempel has agreed to help explain the details if requested.
71 Comments, Comment or Ping
1. Cannon_fodder
Ed,
Do you recommend to any clients to borrow up to the full limit of equity available, not just what can be carried without additional cash flow?
Secondly, are you proposing that you keep the HELOC constant (i.e. Step II only of the SM) and your comparison is to a Step I and Step II of the SM without initially borrowing from the equity built up?
Apr 16th, 2007 @ 10:29 am
2. Brad 'Spazmogen" Ormsby
Ed:
I’m somewhat confused by the example above.
I have 2 credit lines set up for the SM. $5K & $14.5K I have yet to write a cheque to my advisor to buy the investments. For the RM am I to use the $14.5K available to secure an additional investment loan as well ?
Apr 16th, 2007 @ 8:22 pm
3. Brad 'Spazmogen" Ormsby
Ed:
Ignore my previous post. I found the answer in the mighty SM thread at Red Flag Deals.
Apr 16th, 2007 @ 10:59 pm
4. Cannon_fodder
Another question to Ed:
Whether you call it the Rempel Maximum or Turbo SM, would you still advise your clients to take that initial lump sum of equity built up (in your example above $67,200) and invest it in tax efficient mutual funds as you have stated before, or would you only put the periodic payments into those mutual funds (to minimize drag based on trading commissions)?
It seems to me that such a large sum of money could be invested directly into stocks.
Apr 17th, 2007 @ 12:56 pm
5. djg
Just wondering, if you already have a $20000 leverage loan, can you use this as an initial amount for the rempel maximum and add then add another leverage loan based on the initial principal payment you can afford? I guess my question is can you set up the Rempel maximum using a previous investment loan despite the fact that the investment loan was in place before you did the SM/Rempel strategy?
Apr 18th, 2007 @ 11:29 am
6. Ed Rempel
Hi Cannon,
Most of the time we do recommend our clients use the available equity in their credit lines. This is a “top-up”. Leveraging more usually helps them reach their goals more quickly and is usually appriate for the client. Sometimes this will require some of the client’s cash flow to carry.
The Rempel Maximum may be more or less than this ammount, depending on how much principal is paid down with each mortgage payment.
The HELOC itself continually rises in every scenario, but the total debt stays constant. This is true whether or not it makes sense to use extra leverage.
I have not heard the Rempel Maximum called the Turbo SM, although I’ve heard the Smith/Snyder called that. They are very different strategies.
Yes, we use mutual funds managed by “all-star fund managers” for all of the investing. This is because we believe the most important issue with stocks is the skill of the investor.
There are “all-star fund managers” that have beaten the indexes by wide margins over long periods of time. They all study the markets and know specifically what systematic market inefficiency they take advantage of. None are employees of anyone, since they own their own investment firm. These fund managers are easily worth more than their cost.
Investing directly in stocks may save some MER, but the quality of the stock selection and the strategyof when to buy and sell is far more important.
The Dalbar study showed that the average individual investor in mutual funds averaged only 3.5% over 20 years, while the average mutual fund they invested in averaged 11%. This is because of the consistent bad market timing humans are genetically programmed to do.
While I have not seen similar comprehensive studies of individual investors investing directly in stocks, from people I meet, I’m sure it is much worse than the average return of individual investors in mutual funds. This is because the same bad market timing will have a much bigger effect.
I did hear of one study of thousands of on-line brokerage accounts that tracked stocks sold vs. stocks bought. It showed that when investors sold a stock to buy another, the stocks investors sold out-performed the stocks they bought. In other words, the net benefit of all trades done by all individual investors is a negative number!
Investing with all-stars easily beats the average mutual fund. I’ve been studying them and get to meet them – and they are much smarter than me.
Remember, financial advisors and stock brokers are almost all amateur investors – not professionals. We don’t have a CFA or money management degree. We don’t have our own research team. We don’t have an established track record or beating the indexes.
Individual stocks are far more volatile than mutual funds. Even the bluest of blue chip stocks, such as Royal Bank are far more volatile than the average mutual fund. Individual stock portfolios are usually far more risky than the investor thinks.
Bottom line – why be an amateur stock picker or hire an average stock picker when you can hire the world’s greatest investors?
Apr 24th, 2007 @ 12:09 am
7. Ed Rempel
Hi Djg,
Sure. Using an existing leverage loan within the Rempel Maximum is as good as a new one.
In fact, if you are used to making the payments yourself on your existing loan, then you could add the amount of that payment to your mortgage payment and then readvance from the credit line to pay your leverage loan. This way, your cash flow is not changed, but you convert your mortgage to tax deductible more quickly.
Ed
Apr 24th, 2007 @ 12:15 am
8. Sam
hi ed,
would you know any means wherein loan/leverage is provided to invest in mutual funds..i know AIC funds allow you to borrow through tie ups with financial institutions..but their MER scares me off…..
Apr 24th, 2007 @ 1:35 pm
9. KK
Hi Ed,
I have a credit line of about 180k and a mortgage of 90k. When it’s time to implement the leverage, I’m thinking about leveraging with 100k only. Now, having seen that the market has been good for a few years, and no one knows when the peak will come, leveraging 100k at one time appears to be a bit risky (to me). So, I am thinking about cost-averaging the 100k, e.g., 5k every week for 20weeks. The composition of the funds stays
the same. My questions are:
(1) Will you do dollar cost averaging for the initial leverage? Frequency and amount?
(2) As I am not utilizing my full equity for SM, I assume the risks/benefits will be lower relative to utilizing the full equity. Any other drawbacks that I should be aware off?
(3) I don’t know whether the HELOC that I am getting is re-advanceable or not ( I was told it is, but it may involve a re-application and therefore inconvenience), but since I won’t be using the full credit available (80k available), I can still “capitalize the interest” by manually drawing funds from the LOC to pay the interests every month. Have I understood how it works correctly?
Thanks in advance for your help!
KK
Apr 25th, 2007 @ 2:53 pm
10. Cannon_fodder
I’m thinking of an additional enhancement to my Smith Manouevre SS. If one decides to tap into available equity built up (to a maximum of now 80%), and then buy appropriate securities, you could use those as part of a further leverage by using them in a margin account. The enhancement would be to calculate how much it would cost one outside of the normal cash flow of a ‘typical’ SM.
For example, if tapped into $120k of equity that could potentially be leveraged into another $280k. The $400k would probably cost about $24k in interest costs annually, or about $13k after the interest writeoffs. If those equities provided a dividend yield of about 4.3% then, after taxes, that would cover the interest costs. (I’ve used Ontario’s highest marginal tax rates.)
This assumes that the dividends are not used to pay down the mortgage faster, redrawn and reinvested. When you supercharge the LOC this way it would be good to know how much additional cash flow you need to provide to support this.
Apr 27th, 2007 @ 12:10 am
11. Ed Rempel
Hi Sam,
Yes, there are a variety of places you can borrow against mutual funds. We are all comfortable leveraging real estate, but leveraging mutual funds is relatively easy as well.
Most banks & insurance companies will offer leverage loans, but often they want you to buy only their funds. There are several trust companies that work through financial advisors only – B2B Trust and M.R.S. Trust – that do a lot of leverage and allow almost any mutual fund. They also manage them and allow transactions, issue consolidated statements, etc. In fact, the AIC program you mentioned is actually B2B Trust, since they do while label leverage for about 20 different fund companies.
Leveraging mutual funds is generally a sound strategy, since you are hiring professional investment management. It is critical with any leverage program that you have a sound investment strategy, buy high quality investments, and most importantly, that whoever is managing the investments knows what they are doing.
You mentioned the MER’s at AIC. Their MER’s are a little higher than most similar fund companies. The key issue with MER’s is not to get the cheapest fund, but to get value for your money. Much of the MER is what is paying the fund manager. Would you be proud if your fund manager was the lowest paid fund manager in Canada?
We study the fund managers and try to identify the smartest of the smart – and we call the ones we think are the world’s best fund managers “All-star fund managers” (since I like hockey). When we find them, most of them are not in low MER funds. But why would you expect them to be? Wayne Gretzky and Mario Lemieux, and now Jaromir Jagr and Joe Sakic, all are not among the low-paid hockey players. They are worth the high pay.
Similarly, the average mutual fund manager is not worth their cost, but the top fund managers are easily worth their MER and more. If your fund manager beats the index by 4-5% compounded for 15 years after his MER of 2.7%, is he worth it?
In fact, one fund manager we use has beaten the index by 4%/year for every rolling 5-year period over the last 25 years – after a 2.7% MER. Compared to an index fund, we sometimes look at it as a “negative 4% MER”.
The point is to look for value for your money, instead of trying to hire the cheapest money manager.
Ed
May 2nd, 2007 @ 1:35 am
12. Ed Rempel
We just finished our tax season! We do tax returns for clients, which has kept me quite busy the last few weeks. That is why I have not written much lately. As soon as I catch up on a bit of paperwork, I’ll have more replies here.
Ed
May 2nd, 2007 @ 1:38 am
13. Ed Rempel
I should add that our clients had a net combined refund of $350,000! And I think they will use that money more wisely than the government…
Ed
May 2nd, 2007 @ 1:39 am
14. sam
hi ed,
thanks again for your detailed reply…
you mention fund managers beating the index by a margin consistently…atleast from the various books i read…almost all of them say fund managers even fail to live upto to the indexes..
of course you would have read lots more of those books then me…is’nt your view against the popular view/thoughts of today…
i know you would’nt want to disclose the funds you use for your clients( ah that might be your trade secret)…but do those funds outscore the index(after taking the huge MER into account)..
thanks again for your valuable time….
May 2nd, 2007 @ 8:24 pm
15. Ed Rempel
Hi Sam,
Good question. This will be the subject of several future posts. The short answer though is that there is a big difference between the average fund manager and the top fund managers.
In the NHL, the average hockey player scores 8.8 goals each season. But that doesn’t stop Cheechoo, Jagr, & Ovechkin from scoring more than 50 goals.
You’re right that the average fund manager makes less than the index. The results vary depending on which index and which year, but generally only 30-40% of fund managers beat the index in any year and only about 20% beat it long term.
For some of these, it is luck and for some it is skill. Believers in the Efficient Market Theory would have us believe that it is always luck.
The average fund manager is just a salaried employee trying to keep their job. To keep their jobs, they don’t want to be much different than the market and they want to have less downside than the market. They follow traditional investing methods.
However, there are fund managers that have beaten the indexes by wide margins over many years after all costs, often quite consistently. Nearly all can tell you exactly why and what systematic market inefficiency they take advantage of. They have their own firm and no bosses, they have a specific strategy they consistently follow, and they intentionally invest quite differently than the markets.
For a variety of reasons, they usually manage different funds over their careers, so you can rarely see their exceptional records all in one fund.
One of the most important things we do is analyze fund managers and try to figure out which are the best and brightest vs. those that are lucky for a while.
The point is that “All-star fund managers” with exceptional track records that beat the indexes by wide margins after all costs do exist and are worth the effort to find.
Ed
May 6th, 2007 @ 12:58 am
16. Peter
I am having a little difficulty understanding the Smith Maneuver and subsequent Rempel Maximum. Where can I get a step by step of how it all works.
Thanks.
Jun 15th, 2007 @ 12:19 pm
17. David
With the Smith Manoeuvre, you use the increasing equity in your mortgage to buy a variety of investment instruments over a period of time.
If I understand the Rempel Maximum, you use the increasing equity in your mortgage to pay the interest costs on a loan to buy investments. The RM allows one to leverage a far larger portfolio.
If the SM would grow your investments at $500/mo due to reductions in your principal, the RM would allow you to immediately purchase a $100,000 portfolio, and use the $500/mo to service the interest cost. You could possibly increase the $100,000 by managing the tax credits you would obtain on the interest, and thus increasing the interest payment.
Jun 16th, 2007 @ 3:45 pm
18. Ed Rempel
Good summary, David.
Peter, is there a specific part of this you are not clear on? FT has written articles on both Smith Manoeuvre 1 and the Rempel Maximum. They are generally accurate, except for investing in income producing investments (which is FT’s addition).
Before we go through step by step on everything, which part of it is unclear to you?
Ed
Jun 16th, 2007 @ 8:10 pm
19. Jay Day
Ed,
Thanks for the running commentary it is very intersting. A few questions you can hopefully help me with. 350k assessment, 230k mortgage, 1280 payment, 340 to principle, 4.6% blended, 23 years left. My calculations have me at roughly 88k and change for the RM. How does the bank qualify you for the loan over the 80% of your assessed value approx 39k (350×80%-230K for SM value then the remainder for the RM)
Also with capitalizing the loan for ei., if the 50000 dollar SM set up costs 4200 in interest a year, and you simply withdraw and deposit from the HELOC, is your HELOC now approx. $54200 at year end. That is my understanding. Finally if it is, does that entire amount now qualify as good debt, which equals bigger tax break.
Lastly I am in Nova Scotia does your company do any work here. If not do you know any company the handles this type of thing.
Does Warren Buffet investments count as an all star?
Thanks
Jun 26th, 2007 @ 9:00 pm
20. Ed Rempel
Hi Jay,
Are you a fan of Toronto baseball? We had a Jay Day last year…
You have the concept right, Jay.
You can get the additional $39K you need for the Rempel Maximum from a number of trust companies that use the investments as collateral. They charge only a bit over prime and you can get them as a no margin call loan.
You are right about the capitalized interest being tax deductible. The tax rule is that if the interest on a loan is tax deductible, then the interest on the interest is also tax deductible. So, if the interest is $4,200 and you borrow on your credit line to pay it, all the interest is still decutible (as long as the tracing is clear).
I don’t quite get your figures. A $230K mortgage at 4.6% paying $1,280/mo. would give you $400/mo. of principal. At 6% prime, this would finance $80,000 of investments. Since you would have $39K at a bit over prime, the total may be slightly less – say about $77K of investments.
Yes, Warren Buffett is definitely an all star. What do you mean by “Warren Buffett investments”?
We are in the Toronto area, but we can take a serious client in Nova Scotia. Face to face meetings are better, but phone meetings and fax work fine for some of our long distance clients.
Other than that, the only one I know in your area is Lloyd Snyder, who invented the Smith/Snyder. He is in PEI, but uses a very different strategy than we do. The Smith/Snyder is more about living off of you equity, while the Rempel Maximum is more suited to people building wealth.
Ed
Jul 8th, 2007 @ 12:25 am
22. Felix
Ed,
What serves as a collateral for the larger RM investment loan?
Thanks,
Felix
Aug 14th, 2007 @ 12:58 pm
23. Ed Rempel
Hi Felix,
You can use equity in your home or use the investments as collateral. With the Rempel Maximum, we use equity while it is available, and then get a separate investment loan for the additional amount until the total payment equals the total mortgage readvance each month.
We have several trust companies that provide investment loans for 100% of the amount we want to borrow (subject to qualifying) and on a No Margin Call basis.
Ed
Aug 19th, 2007 @ 11:19 pm
24. Cannon_fodder
Ed,
I’ve continued to enhance my calculator originally created to help me understand the Smith Manoeuvre. I’ve added the logic for the Rempel Maximum. But, I’ve run into a conundrum.
If I use typical scenarios where the LOC interest rate is > than the mortgage rate, and if you borrow up to an amount dictated by the principle paydown of the 1st mortgage payment, you quickly run into a negative cash flow impact – in other words, you have to come up with additional money. I’ve also tried a different scenario where you borrow an amount that requires absolutely no additional cash flow through the entire process and is timed to balance the LOC interest costs with the original mortgage payment.
I’ve input your numbers from the article and at the end of the 10th month the LOC Interest expense had already surpassed the mortgage principal paydown (thus requiring additional cash) and grew to require an additional $173 per month once the mortgage was retired.
Of course, one could dip into the anticipated tax refund to help fund the additional cash required.
At this point, I can simply calculate the initial amount of the RM LOC so that it is based solely on the mortgage payment itself. This guarantees that you will never require additional cash to fund this maneouvre. However, it is far less aggressive.
I’d like to hear from you, the inventor of the process, so that I can properly adjust my calculator.
Aug 23rd, 2007 @ 1:41 am
25. Ed Rempel
Hi Cannon,
Sorry its taken me a while to respond to your question. We’ve been away on vacation.
I’m not sure exactly how your spreadsheet works, but we’ve done many and have not run out of room in the credit line. My guess is that it must have somthing to do with the mortgage interest calculation. The amount of principal being paid down on the mortgage rises with every payment.
If your mortgage rate is lower than the credit line rate, there is a small effect of the credit line rising a bit faster than the mortgage is being paid down. But this is very minor and should not cause a problem.
For example, we are using variable mortgages at prime -.85% now (5.4%). At this rate, it works out that the principal being paid down rises by 5.5% each year. If you compound all the interest and are paying prime (6.25%, then it works out that your credit line should rise by 6.4%. This is very slightly higher, but not a problem. With a $200,000 mortgage, this works out to $3/month after a year. The total difference between the growth of the credit line and the decline of the mortgage is only $20. This would generate a tax refund over $1,500 in year one, so if you put any of it on the mortgage, you are fine.
In practice, we generally leave $500-1,000 of the credit line uninvested as a “slush” so we don’t go over the limit because of the timing of a payment and so this slight increase doesn’t cause any problems.
Ed
Sep 9th, 2007 @ 6:53 pm
26. Cannon_fodder
Ed,
I will forward you some screen captures of my calculator to help me explain my issue better.
I agree that the growth of the LOC is faster by $3/month after the first year, but that this continues to accelerate due to the tax refunds and becomes quite significant by the end of the mortgage reaching more than 10% of the original mortgage payment.
You did mention the tax refund – if you are using the tax refund to offset this monthly difference, then applying the remainder to the mortgage, then I can see how you would achieve this without any additional cash flow. I had assumed that you put the entire tax refund against the mortgage as is typical with Step II.
Here is the input page
http://img411.imageshack.us/my.php?image=smcrm1aw9.jpg
Here are the first several months of results
http://img411.imageshack.us/img411/4303/smcrm2xo4.jpg
Sep 11th, 2007 @ 6:28 pm
27. Mortgage Confused
Hi Ed:
Ok, I’ve been following the SM and RM and I’m just starting to get the grasp of the whole concept. The one thing that I’m confused about is the mortgage terms and amortization. If you start the SM at 25 yr Amort, do you ever drop the Amort. down? It would make sense to drop it down in order to get mortgage paid off quicker,no? Yes your payments will be higher, but, in the long run the mortgage goes quicker. This is the concept, I’m having a hard time to to picture. My current mortgage is up for renewal in 10 months, when the new amort. will be 18 years.(Also paying accelerated payments) Do I then start the SM at 18 years Amort? If you did the SM with accelerated payments, would you not get the mortgage paid quicker, which in turn gives you more LOC to invest? Thanks in advance
Sep 13th, 2007 @ 2:05 pm
28. FrugalTrader
MC, one of the goals of the SM is to pay off your non-ded debt faster. So if you can, put as much money as you can towards the non-ded mortgage. In my scenario, the SM will decrease my amortization from 16 years to 12 years. With a few extra dollars pre payment every 2 weeks, it will bring it down to 9 years.
Sep 13th, 2007 @ 2:11 pm
29. Mortgage Confused
Ok FT, that makes sense, so what are your mortgage assumptions then,as far as your payment frequency and amort. to give you the 16 to 12 years savings? Do I assume that you pay bi-weekly then drop some extra on those payments to get it to 9 years?
Sep 13th, 2007 @ 4:28 pm
30. Cannon_fodder
FT,
To drop your “time to burn the mortgage papers” from 16 to 12 without a lot of extra payments, you must be implementing RM, too – correct?
And to then go from 12 to 9, well I don’t see how you can do with with just a “few” extra dollars every 2 weeks – unless you have a small mortgage.
Or, you could be using the cash flow dam. That is one VERY quick way to convert the non-deducti ble to deductible.
Sep 13th, 2007 @ 6:39 pm
31. FrugalTrader
Hey guys, yes to drop my mortgage down to 9 years, I would basically do bi-weekly payments (with extra on top), along with adding my regular “non registered” contributions towards the mortgage. On top of that, all tax returns and dividend distributions will go towards non-ded debt. I think it worked out to be around 9-10 years the last time I checked on a $160k mortgage.
Sep 13th, 2007 @ 7:19 pm
32. Ed Rempel
Hi MC,
With the Rempel Maximum, you can pay your mortgage down as slow or fast as you want. You should be getting much larger refunds than with the SM, so you could use these to pay down the mortgage faster.
The other advantage is that if you increase your payment to reduce your mortgage amortization, you can increase your leverage investments, as well.
For example, if you increase your mortgage payment by $100/month, with the SM you can also invest this $100/month. With the Rempel Maximum, though, you can increase your leverage investments by $19,000.
Go ahead and accelerate your mortgage payment as much as you want. Then work out how much more leverage investment you can do.
Ed
Sep 16th, 2007 @ 7:36 pm
33. Ed Rempel
Hi Cannon Fodder,
I’m inpressed by your calculator. It looks like the SM Calculator with a bunch of enhancements, such as adding the Rempel Maximum.
The SM Calculator does not calculate for many of the strategies we use, so we often have to supplement it with additional calculations. Have you verified the accuracy of your calculations?
In answer to your question, you can put the entire tax refund onto your mortgage. Every few years, you may need to readvance slightly less than the lump sum mortgage payment from your tax refund.
Ed
Sep 16th, 2007 @ 7:49 pm
34. Cannon_fodder
Ed,
So, with the Rempel Maximum in ‘aggressive’ mode (whereby you borrow enough money at the beginning so that the principal paydown would be equal to the LOC interest) there is a realisation that not all of the tax refund will be used to pay down the mortgage – unless you can handle the additional out of pocket cash flow. Is that correct? One way this could be handled is to set aside a certain amount of $ from the tax refund to help pay off the additional cost to service the growing LOC. Is that what you tend to do?
As for verifying the accuracy of the calculations, my calculator used to give the exact answers provided by Smith in his book and on his website. However, because I calculated in detail how everything worked, I believe I discovered an error in how calculations are made with respect to the investment portfolio. I since have changed my calculator so that the logic is sound and the results are still very close so the error in logic was not large. (The error has little impact except when it comes to cash flow damming with relatively large monthly cash flow. I am in contact with Smith to help resolve if my discovery as it applies to all scenarios is in fact correct.)
If you want to throw some scenarios at me, I can put them through the calculator and provide you answers. It would help me validate the logic as there are many enhancements my calculator has over the SM calculator. This leaves me without a comparable reference for accuracy.
I have already decided that I will be implementing RM when my mortgage comes up for renewal next year. Thank you!
Sep 16th, 2007 @ 10:58 pm
35. Djg
I am not sure if I understand the logistics behind this one entirely. I understand using the monthly increase in the equity loc to fund an investment loan. However, it seems that eventually the deductible debt in the loc will surpass the value of the initial investment loan. If you start with let’s say $300 in your line of credit and the use that initial and subsequent readvances to fund the interest on an investment loan where does the extra money come from for the SM? Does it come from the yearly tax refund?
Djg
Sep 18th, 2007 @ 6:25 pm
36. Ed Rempel
Hi Cannon & Djg,
With the Rempel Maximum, all of the tax refund is paid onto the mortgage. All of the interest on the leverage is paid out by readvancing the mortgage.
Depending on what interest rates are, the investment credit line might grow slightly faster than the mortgage declines – until the tax refund comes in. The tax refund is much larger with the RM than with the SM because there is a higher level of leverage.
We usually leave $500-1,000 available credit as a buffer in the credit line when we start to cover any interest shortage or to protect against a timing error and accidentally going over the limit.
The interest difference might eat up $20-30 (in the earlier example) of our buffer over the year, but then a refund of $1,500 is paid onto the mortgage, which would give us a huge buffer again. We can then reborrow all or nearly all of the $1,500 to invest.
There is no additional SM, generally. Once you have paid down the mortgage enough and are paying more principal with each mortgage payment, you might be able to increase your leverage.
The RM strategy is to use any available principal payment to maximize your leverage, instead of using it for a monthly investment with the SM.
Does that clarify your questions?
Ed
Sep 19th, 2007 @ 12:59 am
37. Dunk
I’m considering applying a variation of this myself. It involves leveraging and was presented to me by Fraser Smith’s son, Rob Smith! This is how it works! Sounds logical, although not without some risk….
1) Get out of my existing mortgage(21 yr amm. @ 4.75%, 5 years left) and into a re-advancable FIXED rate mortgage (25 yrs @ 5.90%, 5 yr term)that automatically readvances the principal portion of each mortgage payment to a Line of Credit (This will make sense – read on)
2) Take out my home equity, (less 25% which remains in the home[cushion equity]) and invest with a 2 for 1 loan at Prime(6%). In my case, my home at 450k less 25% =$337,500.00 less Existing Mortgage (FEES AND PENALTIES FOR TERMINATING THE MORTGAGE added) of $262,750 = (FREEBOARD EQUITY) $74,750
3) $74,750 + 149,500 (B2B LOAN) = 224,250 INVESTED WITH STONE ROC fund
4) Stone PAYS OUT A TARGETED DISTRIBUTION CALCULATED AT 4.5 CENTS PER UNIT PER MONTH(about 1% per month) = $2,850.64
5) THE FULL AMOUNT OF THE DISTRIBUTION GOES AGAINST PRINCIPAL paydown on fixed non-deductable mortgage. (WE ADD THE AMOUNT REDUCED FROM THE REGULAR MORTGAGE PAYMENT WHICH IS $399), THE LOC OPENS UP BY THE SAME AMOUNT = $3,249.65
6) RE-BORROW THE AMOUNT AVAILABLE ON THE LOC AND:
1. SERVICE INTEREST ON BORROWED MONEY on LOC & B2B loan (-$1,168)
2. REINVEST THE REST ($2,080 ROUNDED DOWN) INTO INVESTMENTS ELIGIBLE FOR DEDUCTIONS AS DEEMED BY THE CRA.
7) THE PROCESS REPEATS NEXT MONTH.
8) THE MODEL DOES NOT REAPPLY THE TAX DEDUCTIONS; IT ASSUMES YOU CONSUME THE REFUND
9) Mort. paid off in 5.42 years, the LOC BALANCE IS THEN THE AMOUNT OF THE ORIGINAL FIXED WHICH HAS BEEN CONVERTED($262,750.00), PLUS THE AMOUNT SENT TO B2B FOR THE TRIPLE-UP. ($74,750) YOU ALSO OWE THE AMOUNT LOANED TO YOU BY B2B ($149,500).
10) DIVERT THE MONTHLY DISTRIBUTION TO YOUR Personal Checking Account DIRECTLY TO YOUR Investment Checking Account INSTEAD FROM WHERE INTEREST IS WITHDRAWN AND THE REINVESTMENT TAKES PLACE.
Oct 3rd, 2007 @ 7:40 pm
38. FrugalTrader
Dunk, your strategy for the Smith Manoeuvre sounds very similar to mine:
http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-1.htm
Things to watch out for, make sure that the mutual fund that you picked does not pay out “return of capital”. If it does, it will slowly erode your deductible investment loan. What is the interest rate on the B2B loan? Is it interest only? Or principle + interest?
Oct 3rd, 2007 @ 10:28 pm
39. Ed Rempel
Hi Dunk,
The strategy you are describing is called the Smith/Snyder and is very different from the Rempel Maximum. It is being heavily marketed and sounds good, but I don’t use it – except for retirees needing income.
As FT mentions, there is a tax problem, since the distribution paid out is almost entirely “return of capital” (ROC). It is not the return of the fund – it is the amount of your own money the fund pays back each month.
The reason he assumes you spend the tax refund is because there is not much of one. Since you are getting your own money back with the ROC fund, you can no longer deduct that amount of the interest.
The Stone Groth & Income fund is a 2-star (below average) Canadian balanced fund that has averaged 4.9%/year for the last 10 years. Stone claims they will never reduce the distribution (in dollars), but since the fund earns nowhere close to its distribution, your balance goes down every year. It paid out 12% a year or so ago, but now pays out 15.1% (same payout but fund principal lower since it only made 2.7% in the last year).
Since you are getting your own money back at 15.1%/year, after 6.6 years, the investment loan is entirely NON-deductible. This means you have replaced your non-deductible mortgage at 4.75% with a NON-deductible credit line at 6.25% (after paying a penalty)!
Since the fund is 25% cash, 28% government bonds and 47% Canadian equities, you should expect it to earn perhaps 6-7%/year. Since it is paying out $2,822/month ($224,250 x 15.1%), the fund will be down to zero after 8.3 – 8.7 years.
In other words, less than 2 years after your mortgage is paid off, the fund is at zero and you owe the full amount of your mortgage – NON-deductible and at a higher rate (6.25% instead of 4.75%).
Projections show the expected long term benefit of the Smith/Snyder is tiny compared to the Smith Manoeuvre and much tinier still compared to the Rempel Maximum. This is because the SM and RM involve allowing your investments to compound exponentially over many years – and they fully maintain the tax-deductibility of the investment loan.
If you are a senior desparate for cash flow with lots of home equity, you may want to consider the Smith/Snyder (perhaps as part of a RRIF Meltdown strategy). But if you are in a wealth-building phase, I would stick with the SM or RM that have many times higher expected benefits.
Ed
Oct 4th, 2007 @ 12:26 am
40. Dunk
Ed,
Thanks for the comments. I was told the Stone ROC fund is just the “engine” to quickly convert my non-deductable mortgage over. The continued life long tax deductions come from re-directing my former mortgage payment toward interest and principle payments against the LOC and re-investing the funds into an eligable investment. I don’t know what you mean about the fund being at $0 at the end of 8 years? The distribution does not lower my principle invested amount does it? I wasn’t told this? Once the mortgage is converted in under 6 years, I’ll also have the funds from the 2,080/mo I’ve been investing throughout this time as well. I’ve received deductions on this all along as well. With my conventional mortgage gone, I’ll simply re-direct my usual monthly payment toward servicing the LOC, and re-borrow and invest again until I’m 130, getting the life time tax deduction the whole time! Is this not basically a faster way to building a sizable lump sum asset base to compound over time and then doing the basic smith manuever to continue the process for life?
Rob also said that Fraser and he are working on a second book as a sequel to the SM that uses this strategy. Would Fraser recommend this if it weren’t 100% sound?
Thanks for you feedback, I appreciate an objective and experienced opinion.
Oct 4th, 2007 @ 2:03 am
41. Dunk
Ed,
Thanks for the comments. I was told the Stone ROC fund is just the “engine” to quickly convert my non-deductable mortgage over. The continued life long tax deductions come from re-directing my former mortgage payment toward interest and principle payments against the LOC and re-investing the funds into an eligable investment. Once the mortgage is converted in under 6 years, I’ll also have the funds from the $2,080/mo this strategy has allowed me to invest ($150,000+/-). I’ve received tax deductions on this re-investment all along as well. With my conventional mortgage gone, I’ll simply re-direct my usual monthly payment toward the LOC and re-borrow and invest again until I’m 70, getting the tax deduction the whole time! Is this not basically a faster way to building a sizable asset base to compound over time and then applying the basic smith manuever to continue the process for life?
I was told that they’re working on a second book as a sequel to the SM that uses this strategy. Would Fraser recommend this if it weren’t 100% sound?
Thanks for you feedback, I appreciate an objective and experienced opinion.
Oct 4th, 2007 @ 2:18 am
42. Dunk
Ed,
Just got off the phone with Rob Smith and he explained the following that is missing from your above concern. I’d also be consistantly investing $2,080.00 per month over and above the stone fund using this model (based on the flow of funds). You are correct in that the NAV of the stone ROC has been steadily declining over the last few years between 3-4% and this could be cause for concern, but then again maybe not. So, after 8 years, a portion of the new LOC balance at 6.25% is indeed non-deductable, but the $2,080/month I’ve been making and continue to make does have interest deductable amount. Therefore, we end up with an extra 200k(approx) invested in my case at the end of 8 years, a portion of the LOC that IS indeed tax deductible, and the lifetime tax deductions on the $2,080.00/month I continue to invest throught the LOC using the simple Smith Manuver converting over the Non-Deductable portion. BTW: the re-invested amount of $2,080.00 is being invested the entire time into the Stone & Co Dividend growth fund which has an outstanding performance record AND the favourable advantage of the dividend taxation rate. Based on the declining NAV of the Stone fund, I’d also have approx $160k still invested in the Stone fund. Another consideration to mitigate the risk is the fact that I can cash out up to 10% per year penalty free of the stone fund and move it into the dividend growth fund for better performance and security by re-investing through B2B loans.
Does this now make more sense than just using a simple SM? It would seem that I build my Net worth more quickly using this method? Also, this model has NOT taken into consideration ANY tax deductions thus far as in a simple SM presentation. If you add these in over the 8 year period, the resulting gain in my net worth is even greater.
Is there anything else I should consider here that I’ve missed?
Many thanks!
Oct 4th, 2007 @ 5:11 pm
43. Dunk
FrugalTrader,
The loan is a 3 for 1 Interest only at prime. Because I’m also re-borrowing and re-investing the $2,080.00 per month, I get the deduction on the interest on this portion. You are correct in that the interest on the Loan portion servicing the ROC fund is reduced by percentage of the amount of returned capital each month. I’m still left with an investment worth approx. 200k(not even taking into account compounded interest) and the ongoing deductions on the continued monthly diversions on this amount when the LOC loan becomes non-deductible. Still seems to make sense, and any tax deductions I could have re-invested along the way have not even been added to this calculation which would make the net result even more promising!
Thoughts?
Oct 4th, 2007 @ 8:29 pm
44. Ed Rempel
Hi Dunk,
I’ve studied this in depth and almost all those transactions actually do nothing! I realize it sounds and looks amazing, but do the math on it and compare it to other options.
Fraser & I have been friends for a few years. He has been a huge help to me be showing me the SM, but we disagree on this strategy. Fraser learned this strategy from Lloyd Snyder, who we both know. Lloyd is in PEI and the strategy seems to work in that environment, where people tend to have lower home values and need more income.
Lloyd also does the “Snyder Tax Calculation” which shows the declining amount of your investment loan that is still deductible.
I’m guessing the reason you are asking about this is that is does seem too good to be true – doesn’t it? My opinion from doing the math is that it probably will benefit you – but not for the reason you think. And it is easy to beat with other strategies.
First, let’s look at what the distribution does. When $2,850 is paid out in a distribution, the interest on $2,850 of the investment loan is no longer tax deductible. Then you borrow $2,850 from a credit line and invest it. The net effect is:
Amount invested:
Stone G&I -$2,850
Stone Dividend +$2,850
Net invested $ ZERO
Amount owing:
Mortgage paydown (additional) -$2,850
Credit line (investment) +$2,850
Net owing $ ZERO
Tax Deductible Amounts:
Investment loan -$2,850
Investment credit line +$2,850
Net change in tax deductible amount $ ZERO
So, all that activity does nothing at all.
So, let’s look at this same strategy without all this activity.
Borrow the same amount $224,250, but let’s invest directly in the Stone Dividend fund (or an even better fund that we invest in because of its long-term risk/return and tax-efficiency). This is obviously a better fund than Stone G&I.
Your mortgage is being paid down by $400/month, which we can reborrow in a credit line to pay some of the interest on the investment loan. However, the total loan interest is $1,168/month, so we need another $769/month to cover this interest. Let’s take this $769 out of the investment.
Mutual funds allow a systematic withdrawal plan (SWP), which is any amount at all that we want it to send us every month. The taxation of this is only a bit different from having a distribution paid out, but it allows us to pick any amount we want.
If the fund pays us $769/month and we use it to pay interest on the investment loan, then the interest on the entire loan is still deductible.
(The tax problem with the Smith/Snyder is because the distribution from the fund is paid onto your mortgage. If you paid all of it onto the investment loan, then the loan is still entirely deductible.)
In summary, you borrow $224,250 and buy Stone Dividend (or a better fund). You make your normal mortgage payment, which pays down $400/month of principal. It is linked to a credit line, so we can borrow $400/month. The interest on the investment loan is $1,168/month, so the investment sends you the difference of $769/month.
This the Rempel Maximum Enhanced – with a larger amount borrowed to invest than the regular RM. How does this compare to the Smith/Snyder you described:
1. Investment is the same amount $224,250, except that it is invested much better. All is in the Dividend fund (or an even better fund), instead of the Stone G&I fund. (It is chosen ONLY because of its unrealistically high distribution.)
2. Tax deductible debt is the same – $224,250 total.
3. Non-deductible debt is the same in total, except that it is at lower interest rates. Now only the mortgage is non-deductible. The mortgage is at 5.9% (or better), while the NON-deductible part of the investment loan is at prime 6.25%.
Therefore, these 4 steps taken together have a NEGATIVE return:
1. Distribution of $2,850/month
2. This reduces the amount of the investment loan that is deductible by $2,850/month
3. Extra mortgage payment of $2,850/month
4. Reborrow $2,850/month from a credit line to invest (buy back the amount taken out by the distribution).
With the Smith/Snyder, so much is happening that is is hard to see what we are really doing. If you take out these 4 steps and do the Enhanced Rempel Maximum, it is much more clear.
You are borrowing $224,250/month to invest. The investment pays most of the interest cost, but should still grow over time. You can reborrow $400/month from the principal on your regular mortgage payment to pay the rest. All the interest on the investment loan is still tax deductible, so you don’t need to bother with the “Snyder Tax Calculation”.
The benefit of the Smith/Snyder is because it can get you to leverage much more than you would otherwise. However, putting it into a low return fund and then doing 4 meaningless transactions only reduce the benefits.
If you still don’t believe me, I can give you an exaggerated example that clarifies my point.
My other comments on this are:
1. Why lock in a 5-year rate at 5.9%??? We have been below that for 9 or the last 10 years with variable or 1-year rates – and rates look like they are starting to decline.
2. I agree that the Stone Dividend fund is a much better fund than the Stone G&I, but if you choose your investment strictly based on long-term risk/return and tax-deductibility, then there are many better choices.
Ed
Oct 5th, 2007 @ 10:16 pm
45. Dunk
Ed,
Thanks for the comments, you’ve been instrumental in my decision. I’m not going forward with my original plan based on your comments. Thanks for clarifying! I’m going with the Firstline Matrix mortgage as this seems the best product/rate for my needs. The fixed rate is actually 5.69% for 5 years, and the LOC portion is at prime. Since the sub-prime meltdown in the US, this is the best rate I can find on the product I need (where the principle paydown automatically increases my LOC). I’m not comfortable with the 3 for 1 leverage of the B2B loan, so I’ll simply use the 74,500 of equity to invest into something. Of course I must now decide in what to invest that lump sum, so that it will cover the monthly interest on the LOC without using additional funds from my cash flow! I could do a dividend fund mutual fund that pays out monthly or every 3 months, or take your idea of withdrawing an amount each month to cover the interest, then re-investing the principle paydown each month. Maybe I’ll use the re-advanced principle portion (approx $400.00/mo) to service the interest owing on the LOC(489.00/mo) and fund the difference as a withdrawal from the mutual fund ($89)? Then I’m capitalizing the interest on interest plus the interest on the loan!
It’s a lot to figure out, and I should probably do my homework and work with a financial planner! I’m in BC, but wonder if you could advise me and offer your services over the internet/phone?
Many thanks again!
Oct 9th, 2007 @ 9:48 pm
46. Ed Rempel
Hi Dunk,
Glad to hear it. I was not sure if my last post was too complicated.
The Smith/Snyder does sound good, but includes the “4 Meaningless Steps”. Taking the distribution from the fund, paying it down on the mortgage, reborrowing to invest again, and then having to do the “Snyder Tax Calculation” with your tax return all do nothing at all. They are basically the same as taking money out of your left pocket and putting into your right pocket, then pulling it out again and putting it right back into your right pocket.
Your mortgage is paid down very quickly, but you barely reduce your NON-deductible debt. This is because the investment loan becomes non-deductible by the amount of the non-taxable distribution. With the Stone G&I fund, in about 6 years, your mortgage is paid off but the entire investment loan is NON-deductible.
What is more is that after about 6 years, your cost base of the fund declines to zero, so then the entire distribution is taxable as a capital gain. The distribution is no longer tax-preferred.
The main disadvantage, however, is that wipes out most of the expected long term benefits. The long term expected benefits of the SM aned RM come from leaving your investment compound exponentially and tax-efficiently over many years. By constantly taking huge amounts out of the investment, you don’t get that compound growth.
Ed
Oct 14th, 2007 @ 4:43 pm
47. Ed Rempel
Hi Dunk,
To answer your questions, I have just written several articles on SM mortgages that will be posted soon. Read them before you do your mortgage. There are better choices than Firstline and taking a 5-year fixed consistently costs much more thanvariable or 1-year mortgages. I’ve blogged about this many times on MDJ.
Of the options you listed, I think the best is to readvance the $400 and only take $89 out of the investment. The other option is to increase your mortgage payment by $89/month, so you can readvance the entire $489 each month to pay all the interest. This will allow your investments to compound untouched. Your tax refund on the investment loan of $74,500 should be more than $89×12=$1,068, so you are not losing cash flow over the year.
We do have some long distance clients with whom we do have phone appointments for planning meetings. It can work almost as well as face to face. We are very selective in who we work with, especially for long distance clients. We only want clients that are serious about their financial goals who we feel will work with us 100% long term.
If this describes you, Dunk, call our office and ask for Ann with whom you can have a frank discussion about whether or not it makes sense for us to work together.
Ed
Oct 14th, 2007 @ 4:56 pm
48. Blink
Ed,
Thank you for your insight! Regarding the Snyder/Smith Maneuver above – its true that the majority of your Stone G&I investment loan interest will no longer be tax deductible after taking distributions for 6 years. But what about the fact that you have nearly $150,000 (+compound interest) invested in the Stone Dividend fund after the 6 years that IS tax deductible? Not to mention – the fact that you have just paid off your entire mortgage (!) after only six years and will now have that entire amount (previously put toward your mortgage) to add to your monthly investments from here on in.
Does that not far outweigh the fact that you are not able to write off the interest on the Stone G&I fund?
Nov 13th, 2007 @ 5:44 pm
49. Ed Rempel
Hi Blink,
Did you get your name from the book “Blink”?
It does sound good at first, doesn’t it? The problem is that you have not paid off your mortgage at all. You have replaced it with an investment loan or a credit line that is NOT deductible.
If you want to convert your mortgage into a non-decutible credit line, just call your bank and they can do it in 5 minutes. The main effect of the Smith/Snyder takes 6 years to do what you can do in 5 minutes with a call to your bank.
If you make the call and convert your mortgage to a credit line, can you say that your mortgage is paid off? This is the exact same situation as the Smith/Snyder. After 6 years, you have NOT paid off your mortgage – just converted it to a non-deductible credit line.
This happens by definition. Every dollar of distribution taken out and paid on the mortgage means one dollar of the investment loan is not deductible. There is no benefit at all from this.
You also don’t have the cash flow that you had paid onto your mortgage, because you now have to pay down your non-deductible investment loan with it.
Of course there is a benefit of borrowing the $150,000 that is deductible, but you could have invested more than this with the SM.
The Smith/Snyder is better then doing nothing, of course, but the long term projected benefit is usually only a small fraction of the SM or the Rempel Maximum, if you do the same amount of leverage.
In this example, with an adaptation of the Rempel Maximum, you could START with $224,250 invested in a proper equity fund, instead of getting $150,000 there over 6 years.
This is because the huge benefits of the SM over the long term comes from having your investments compound exponentially over many years. If you keep taking money out of the investments and water down the long term compound growth, the benefit is far smaller.
Ed
Nov 14th, 2007 @ 1:51 am
50. Dan Bajwa
Hi Guys,
Is it possible to get a copy of the spreadsheet calculator to look at a RM scenario?
Ed: How do I implement the RM at my local bank (Scotiabank)? Do I just ask for a personal loan? I have a STEP mortgage with a LOC for 90% loan to value. Currently paying approx $1400 principal per month with $17,000 available with the LOC.
Thx,
Dan
Jan 22nd, 2008 @ 1:21 pm
51. Ed Rempel
Hi Dan,
Since you are paying down $1,400/month, this would finance leverage of $240-280,000, depending on the interest rate at which you can borrow to invest. How you finance this depends on how you plan to invest it.
We have several trust companies that do investment loans secured by mutual funds. If you are a DIYer, then you should talk to your investment company or brokerage firm to see what type of investment loan or margin account you can get.
Ed
Jan 25th, 2008 @ 12:22 am
52. FrugalTrader
Dan, also note that if you go 90% LTV that you will have to pay CMHC insurance. My personal limit is 80% LTV as it will avoid the extra cost of CMHC.
Jan 25th, 2008 @ 9:29 am
53. Ed Rempel
Hi All,
Did anyone see the article critical of the SM in the Toronto Star on the weekend? It is at: http://www.thestar.com/living/article/345271 .
I found it quite funny and emailed the author, Bob Aaron. My comments were posted on a popular real estate blog: http://condopundit.com/wordpress/ , so I thought I should also pass on my comments here to MDJ readers.
The article in the Star is just plain wrong. Dan White cannot possibly be a tax specialist and Bob Aaron should be embarrassed that he published an article without checking any facts.
As a lawyer, I would assume he would be a professional and check his facts before publishing an article.
Any accountant or tax professional would be able to correct all the errors in tax knowledge in the article. Here are the tax errors:
1. The Smith Manoeuvre is a fancy name for borrowing to invest. The article seems to imply that CRA has a problem with borrowing to invest in stock market investments. For example, his article taken literally would mean that the Teachers Pension Plan would not be able to claim as a business expense any interest involved in buying Bell Canada. This is ridiculous. While it is technically correct that the Tax Act does say that there needs to be an expectation of profit excluding capital gains, taking this literally would exclude all borrowing to invest in any stock, since stocks rarely have very high dividends. The truth, however, is that CRA has never contested any interest expense in a simple borrowing to invest.
2. Using your home as collateral for a loan can in no way make the home at risk of being considered a business asset. If you run a business from your home and claim more than 50% as a business asset, it may be an issue, buy just using it as collateral for an investment cannot possibly have such an effect.
3. CRA is not money-hungry. In fact, there are many incentives built into the Tax Act available for knowledgeable people that know how to effectively apply it.
Please ask any accountant or tax professional you know whether my facts above are correct or whether the Star article is correct. Any knowledgeable tax person who read your article would have found it as humorous as I did.
I also read the original article by Dan White in REM magazine and it is obvious to any tax person that he is not a tax specialist. He does not appear to have any tax qualifications whatsoever. If he was a tax specialist, he would not be so blatantly wrong in all his tax interpretations. He is obviously just a real estate guy trying to persuade people to invest in real estate.
I have found over the years that people are most critical of what they are also guilty of. I find it curious that Bob Aaron can publish an article where the entire point is based on tax errors on which he obviously did not check his facts, and then be so critical of anyone who may not be impartial. Could it be that Bob Aaron is makes his money as a real estate lawyer promoting real estate instead of market investments and that he also is not impartial?
I am a financial advisor and accountant that uses the Smith Manoeuvre. I can tell you that the Smith Manoeuvre done properly (eg. if you don’t take distributions out of the fund) easily meets all CRA rules. It is just borrowing to invest, which is done by every company and every business owner in Canada every day.
Ed
Mar 18th, 2008 @ 6:39 pm
54. DAvid
Ed asks: “Did anyone see the article critical of the SM in the Toronto Star on the weekend?”
Yes, it has been discussed at length at Canadian Capitalist. The same question of White’s knowledge or qualification was raised there.
DAvid
Mar 18th, 2008 @ 11:41 pm
55. Hasanul Alam
Ed,
Thanks for pointing the Toronto Star Article either I would miss this.
The article quoted “It’s not good for the average person. Most of my clients wouldn’t understand it because it’s very complex.”
I think if someone can properly explain this, many “average” person will understand. I encourage those who are interested first read the book and then attend a seminar by Ed where you can ask questions to Ed directly, face to face and clear your confusions.
Hasan
Mar 21st, 2008 @ 1:11 pm
56. Graciela
Is there a financial planner in BC that understands the SM and the RM?
Thanks in advance.
Apr 3rd, 2008 @ 12:51 pm
58. Man From Atlantis
Has anybody quantified the difference between doing the RM and just doing a regular leverage progam but use the refunds to pay down the mortgage? I know why the RM will beat the leverage program (if followed properly) and I know there are lots of vairables to consider. Who has done the comaprison and what were the results?
Thank you.
Jul 20th, 2008 @ 11:31 pm
59. Sam
Hello,
Would youknow a firm familiar with this strategy in Montreal,Quebec.
Please advise.
Thank you,
Sam
Jun 23rd, 2009 @ 1:12 am
60. Aolis
I am very surprised that Ed Rempel is trying to promote active management mutual funds, especially on this site.
“Investing with all-stars easily beats the average mutual fund. I’ve been studying them and get to meet them – and they are much smarter than me.”
You suggest that you know who the all-stars are. Exactly how do we know that you are an all-star picker of managers?
Finding funds that have done well in the past is very misleading. If take a hundred random fund managers, one of them will have done very well and one of them very poorly. Is that all-star power or random luck?
The only thing we have any control over is the MER we pay and thus we should pay as little as possible, leading to index funds. This is especially true in Canada where the fees are ridiculously high. Pride in my fund manager’s salary doesn’t even enter into it.
Jul 6th, 2009 @ 10:43 pm
61. Ed Rempel
Hi Sam,
Sorry, I don’t know anyone doing this in Quebec. I’m not aware of anyone at all doing it, but there probably is someone. The SM does not work quite as well in Quebec either, because of the difference in tax rules.
There is different licensing, as well, so at this point, Quebec is the only province in which we are not accepting clients. It is possible that we would sit down and figure this out some time if there was enough demand.
Ed
Jul 19th, 2009 @ 2:59 am
62. Ed Rempel
Hi Aolis,
That’s a good question. The question of all-stars applies to any field of human endeavor. There are always some people that are superior, some below average and most are average.
If you randomly take 100 hockey players, some will have better stats. Was that luck or skill?
The statistics are a clue, but won’t on their own tell you. It takes a lot of research to figure this out. You need to watch them play, analyze their various skills, see how they play on a team, and see how good their “hockey sense” is.
Persnally, I would rather have a team with Crosby, Malkin, Ovechkin on offense, Lidstrom and Pronger on defense, and Brodeur in goal – than an average of all NHL hockey players – wouldn’t you? They won’t win all their games, but I do believe these players have signficantly more skill than the average NHL hockey player, so this team should have a higher chance of winning.
Each year, between 20-45% of fund managers beat the index, depending on which year and which index. This is considerably lower over many years, but there are always some that beat it even over many years.
The stats are also misleading. Actively managed funds look better because of “survivorship” bias, but worse because most fund managers don’t even try to beat the index (Most are just salaried employees trying to keep their job )and because the stats always include index funds when comparing mutual funds to indexes. Of course 100% of index funds make less than the index, but the comarisons never exclude index funds or “closet index funds”.
The best indication that there are superior investors is the classic Warren Buffett article. First of all, I don’t think anyone would doubt that Warren himself has superior skill. He has beaten his index by 11%/year compounded for 33 years – even when you take his return after tax and the S&P before tax.
In his classic article, he wrote about a bunch of guys he bumped into that all massacred their index over decades – all by at least 5%/year compounded after all fees, and some by more than 15%/year compounded.
His article was written in 1984, but the 3 managers he mentions that are still active today have all continued to massacre their index (2 of them are Warren and his partner.)
This article is about value investors, who take advantage of a systematic inefficiency in stock markets – the tendency to misprice companies, especially those that are out of favour. This inefficiency still exists. In fact, the markets are more manic today than they were decades ago.
Here is the link:
http://www.edrempel.com/pdfs/superinvestors.pdf
After you read it, tell me would you rather have an index fund or have any of these guys as your fund manager?
Ed
Jul 19th, 2009 @ 3:43 am
63. JJ
Ed,
I have recently met with Rob Smith as well and have been run through the same scenario as Dunk. It all seemed fairly logical to me as well but now that I have read your explanation of the other side of that strategy I have begun to question its effectiveness also. I must admit I have read your Rempel Maximum a few times trying to wrap my head around it (as I have with so many components of the SM) and am still trying to grasp the concept. If I understand correctly, rather than go through the extra steps that Rob has suggested, it would be easier to just use a readvanceable LOC, maximizing my available equity initially rather than grow it gradually as my regular mortgage decreases. This way I get full advantage of the investment loan tax breaks immediately, and the benefits of compounding interest on the investment sooner. Correct? The one think I’m not sure of is with the Smith/Snyder method my mortgage will be paid off in 4 years, what would it take with the Rempel Maximum? House 420,000, mortgage $150,000 at $1040 month 4.99% with 15 years left on amort. Thoughts, recommendations? I’ve got around 20 years until I want to retire.
Thanks,
JJ
Sep 15th, 2009 @ 7:06 pm
64. Ed Rempel
Hi JJ,
It is not really correct to say your mortgage is paid off with the Smith/Snyder, because it is replaced by a NON-deductible investment loan of the same amount – at a higher rate.
I put your figures into our calculator. First, your mortgage has 18.4 years left, but you can refinance it now at 2.4%. That will reduce your amortization to 14.25 years.
Then you can invest your available equity and do the SM. That would reduce your amortization to 12.3 years. More importantly, the projected net benefit of this strategy over 15 years is $568,000 (assuming 10% return and interest rates 1% higher than today).
If you do the Rempel Maximum, your existing mortgage payment would cover the cost of an additional investment loan of $60,000. Investing that would reduce your amortization to 11.8 years and increase the projected net benefit to $681,000 after 15 years.
At that point, all your debt would be tax deductible and you will not have touched your investments – just left them to compound.
There is probably a better strategy by combining your entire financial picture, such as combining other debt, possibly redirecting RRSP contributions, etc.
You should also project whether this strategy, plus what you are doing already, will be enough to give you the retirement that you want.
Ed
Sep 20th, 2009 @ 8:47 pm
65. JJ
Hi Ed,
Thanks for your response. You’re right, to say my mortgage will be paid off is misleading, the mortgage will be converted to an investment loan of the same amount in that time period. We’re using some new numbers now to consolidate some debt and do some house renos. We’re looking at a new mortgage of 187,00, converted in 5.25 years and a projected 15 year benefit of 725,458. It’s my understanding that the interest on the loan with B2B is tax deductible but only on the ACB. And as the ACB goes down over time and the interest deductibility is reduced, the balance on the LOC converted debt from the mortgage goes up and therefore so does the interest deductibility on it. Or am I not understanding something properly here? For the Rempel Maximum, I’m unclear how the 60,000 investment loan gets used to reduce the amortization on the mortgage. How does that all work?
Sep 20th, 2009 @ 11:36 pm
66. JJ
Ed, is it the tax refunds from the interest deductibility of the $60,000 investment loan that get applied to the mortgage on an annual basis which brings the amort down to 11.8 years?
Sep 21st, 2009 @ 2:01 pm
67. Adam Stanley
Hi Ed,
My wife and myself are both teachers and we’re at the top of our pay scale… we have no debt except for the mortgage and we have no major expenses in the next five years… everything major has been done to our house in the last two years… ie. bathrooms, roof, boiler, decks… I would love to start the Smith Manoeuvre but we don’t have 20% payed off of our mortgage… is there anyway to get a readvanceable mortgage or will we just have to wait for a couple more years and pay down the mortgage and have the value of the house increase???
Thanks for your help!
Adam
Sep 25th, 2009 @ 1:37 pm
68. FrugalTrader
Adam, IMO, the bare minimum equity required in your house to do the SM is 20%, otherwise, you’ll face expensive CMHC fees. If I were you, I would aggressively pay down the mortgage until your term is up, then get a new appraisal. If you are close to the 20% now, the new appraisal + paydown may put you over the threshold.
Sep 25th, 2009 @ 1:57 pm
69. Adam Stanley
Hey FT,
Unfortuately my term is coming due in January and I really want to lock into a five year fixed term for 3.75 – 4.00 %. Is it possible to make a deal with a bank to start a readvanceable mortgage a couple of years into my term?
Adam
Sep 27th, 2009 @ 2:15 pm
70. FrugalTrader
Adam, if you switch midway through the term, you will most likely be charged heavy penalties. If you’re set on getting a readvanceable mortgage, have you considered signing a shorter term so that you can get a readvanceable mortgage in a few years instead of 5?
Sep 27th, 2009 @ 2:25 pm
71. DAvid
Adam,
Speak to your bank. They may be prepared to make this work for you, even if they are not prepared to advance any funds until you hit the 80-20 point. Remember, if your house has increased in value, you will be calculating based on that price, not your mortgage amount.
Also, some banks will allow you to move to a re-advancable product with minimum charge if you maintain your current mortgage within the new product. We only had to pay the Notary fees to register the HELOC against the house.
DAvid
Sep 27th, 2009 @ 5:36 pm
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