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The Smith Manoeuvre Resource

Over the past year so, MDJ has posted many articles on the topic of using a HELOC to invest in equities aka: The Smith Manoeuvre.

As I’ve been receiving quite a number of emails regarding the Smith Manoeuvre lately, this article compiles all the posts into a single Smith Manoeuvre Resource. Hopefully, you’ll find it useful.

The Basics

The Contrarian

Readvanceable Mortgage Options/Reviews

Smith Manoeuvre Variations

Calculating Smith Manoeuvre Returns

Tax Considerations

Leveraged Investing

FAQ

Feel free to bookmark this page as I will be updating it as new SM articles are written.

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

{ 53 comments… add one }
  • David March 5, 2008, 12:42 pm

    I’m not certain how this will apply, but people should be aware that the Supreme Court of Canada will be hearing the case of Ludco, and will likely making a statement about the ability to deduct interest for investment purposes.

    While Ludco is an interesting case and there are a lot of issues that don’t apply to a person doing a SM, the Supreme Court doesn’t take cases unless they want to make pretty broad statements on the law.

    I don’t know if they will overrule Singleton, the case that opens up the law for SM, though it was possible before the decision, but if you’re planning on doing it, or are doing a SM, pay attention to this case.

    • FrugalTrader March 5, 2008, 1:08 pm

      David, i’m skeptical that they’ll cut out the tax deductibility of investment loans. If they cut that out, that would mean that they would have to cut out the tax deductibility of expenses for a business! Afterall, that’s what business expenses are, they are used to produce INCOME for the business which is exactly what an investment loan does.

  • David March 5, 2008, 4:01 pm

    FT, they may suggest that such loans are still available for active business income, rather than passive. The ITA draws this distinction already.

    I’m not going to lay odds on it, but the CRA has been negative on the “Singleton Shuffle”, so the Supreme Court may use this opportunity to tell the CRA to allow the deductions, or they may agree that GAAR, which was not argued in Singleton, applies and this is merely an avoidance technique for people investing in passive streams.

  • Deborah March 5, 2008, 10:19 pm
  • The Financial Blogger March 6, 2008, 8:28 am

    Great resource!
    I think I will review some of them… It is always good to go back to the basics after a while…

  • str8jkt March 6, 2008, 1:09 pm

    Might want to add your latest post – the blueprint one, to this thread..

  • Chinstrap May 14, 2008, 1:13 pm

    First of all, great website!

    I have used a simple version of the SM in the past – credit lines on my principal residence, plus dipping into margin in my brokerage accounts. This has allowed substantial tax deductions in the past..

    But Question.. now that our mortgage is paid off, what rules, guidelines do people follow to determine how much leverage to put on the house to then invest in equities, mutual funds, etc.?

    I managed to pay off my principal residence through stocks but mainly via buying and selling principal houses/condos.. Perhaps another discussion point

  • FrugalTrader FrugalTrader May 14, 2008, 1:19 pm

    ChinStrap, if you have your principle residence paid off, you can borrow up to 80% of it’s value in the form of a HELOC without incurring any CMHC fees. If you have a higher risk tolerance, and a little more aggressive, you can use that money to invest in equities and claim a tax deduction on your interest paid.

    That’s in essense what the SM ends up to be. When the non ded mortgage is paid off, the tax ded investment loan will remain.

  • PhilC September 18, 2008, 5:06 pm

    For a smith manoeuvre:
    If the house is jointly owned and the HELOC is joint. Does the investment account need to be joint also? Does this affect tax-deductibility?

  • Ed Rempel September 18, 2008, 9:57 pm

    Hi Phil,

    The tax ownership and the legal ownership can be different. You can borrow jointly but invest the money in an account in your name, your spouse’s name, or a joint name. Then you can decide who has officially borrowed and that person(s) can claim the interest deduction and claim any taxable income on the investments.

    However, once you claim it once, you cannot really change it in the future without repaying the loan and reborrowing again – so think carefully about who you consider to be borrowing to invest. It should be the one that would benefit the most over the long term.

    Ed

  • Ray November 19, 2008, 2:25 pm

    Can the Smith Manoeuvre be used in Quebec?

  • Jay Day January 29, 2009, 11:11 am

    Frugal,

    Just wondering if you know how the TFSA will affect the Smith Manouvre. Will you be able to start the SM and use the TFSA as well to maximize your investment/ paydown of your Mortgage by using the dividends and or capital gains to pay down your debt quicker?

    Thanks

  • FrugalTrader FrugalTrader January 29, 2009, 11:23 am

    Jay Day, on the surface, the TFSA and SM accounts are completely separate. You lose the tax deduction if you use the investment loan within a TFSA. However, you can use the TFSA distributions (if you buy income securities) to pay down your mortgage which can then be reinvested within your SM portfolio without any tax penalty.

  • Jay Day February 4, 2009, 4:26 pm

    Thanks Frugal,

    Thought it might be too good to be true. Unfortuneately, the only way to come up with the capital to invest in the TFSA is to borrow on the secured line of credit. I guess with the prime rate so low (3%) if you find some good dividend paying securities you could use the TFSA and the dividends from within it to pay the interest costs and still have some left over to increase your SM. Does that make any sense to you.

    Thanks

  • Tron February 27, 2009, 1:26 am

    Hello.

    I love your web site!. Brilliant!.

    I am planning to start the SM and was wondering how people set up Quicken to manage it. I am not sure how I would set it up at all.

    I was thinking of setting up a liability sub account for the LOC under my mortgage account. Then, I would transfer from the LOC account to my SM brokerage account and purchase from there. By doing the LOC as a sub account of the mortgage, as the mortgage is paid down and the LOC is increased, the total balance (debt) should stay the same.

    How are others doing it in Quicken (or KMyMoney)?

    If this not the correct place to post a question like this…Sorry!!!

  • My Own Advisor August 19, 2014, 10:43 am

    Wow, killer resource list!

    Will link to this weekend!

    Thanks,
    Mark

  • on the fence August 19, 2014, 2:02 pm

    Great resources.

    My understanding is that at the beginning of implementing the SM, FT and others liquidated their non-registered investment holdings and applied the funds to reduce the initial required mortgage.

    I have about $25K non-registered investment, but I wonder if it is better to take the full mortgage and make extra payments every week/by-week (to double the original, which is usually the max. allowed by banks), by selling the non-registered investment?

    This way you accelerate the mortgage conversion from a larger bad debt to larger good debt, borrow back the extra payment to HELOC and invest it back to create a larger investment portfolio – repeating it until you run out of the original non-registered investment to cover the double extra payment.

    Basically, for extra short term interest cost (you have $25K higher initial mortgage, but you reduce the extra $25K fast with the doubled regular payment) you get a larger investment portfolio and larger tax refund?

    • FrugalTrader FrugalTrader August 19, 2014, 3:09 pm

      @on the fence, the HELOC credit limit maximum is based on the value of your home. Paying down your mortgage does not affect the maximum allowed, it just fees up credit available.

  • on the fence August 19, 2014, 4:01 pm

    @ FT, in my case, the HELOC credit limit, based on the home value ($900K) is high enough that I could pay off the entire $200K mortgage amount with a single payment, borrowed from the HELOC, and I also have the $25K non-registered investment available.

    I wonder what would be the best strategy in this situation?

  • FrugalTrader FrugalTrader August 19, 2014, 4:24 pm

    If you use the HELOC to pay off the installment portion of the mortgage, that portion of the HELOC is not tax deductible any more. I would recommend keeping the HELOC separate from any non investment purchases.

  • on the fence August 19, 2014, 5:38 pm

    @ FT …”If you use the HELOC to pay off the installment portion of the mortgage, that portion of the HELOC is not tax deductible any more.”

    Thanks, this is critical information…

    How about a setup which is exactly like your BMO setup and money flow chart (http://www.milliondollarjourney.com/the-smith-manoeuvre-money-flow.htm) – but beside your “Main Bank Account” (not with BMO) you also have a second LOC, at an other financial institution?

    Is there any way to utilize that separate, second LOC account to make extra tax-deductible payments into the original SM setup?

  • Ed Rempel August 19, 2014, 11:15 pm

    Hi On the Fence,

    The best strategy for you depends on what you are trying to do. You can borrow up to 80% of your home value, which would give you over $500,000 to invest. If you are new to this, not confident and not thinking long term, then borrowing a large amount like that is probably not a good idea, though.

    Paying the $25K onto your mortgage and reborrowing to invest means you are invested sooner than if you just take a bit out each month and slowly pay it down on your mortgage.

    Paying it down bit by bit allows you to “dollar cost average” in, which can reduce your risk, but is a much slower way to get invested.

    Ed

  • on the fence August 20, 2014, 12:08 am

    @ Ed Rempel – thank you for your advice.

    Let me run the numbers, if you don’t mind – to make sure that I understand it correctly.

    If I started up SM now, I would have
    1) $200K mortgage debt,
    2) $500K HELOC credit available,
    3) $25K non-registered investment.

    Would it make more sense to apply the $25K before starting the SM, so I would start off with only $175K?

    Probably yes, because I would have less interest to pay and I can not claim the entire interest associated with the $25K – only 43% of it (based on income tax rate), right?

    If my HELOC credit limit is $500K, could I theoretically invest this amount immediately and claim tax refund, that I would pay into the mortgage?

    I thought with the SM I was limited by the mortgage payments: I could borrow back from the HELOC only what I actually paid into the mortgage, either as a weekly/by-weekly payment or lump-sum payment, or extra payment from tax refund or dividend.

    Maybe this assumption is wrong and the amount to create investment portfolio is limited only by the HELOC limit, it does not have to be a mortgage payment first – and the equal amount immediately borrowed back from the HELOC?

    Thanks again.

  • Cashinstinct August 20, 2014, 11:37 am

    It makes me bearish when there is so much interest in leverage in the market.

    (Disclosure: invested in equity index funds, do not sell, keep adding monthly DCA, but no leverage…).

  • jason August 20, 2014, 12:54 pm

    @ on the fence,

    I am not sure you are grasping the concept of the SM.

    If you decide to invest 500K borrowed from your Home Equity LOC and your HELOC is @ 2%: 10K of interest expense would be tax deductible per annum. That is the SM.

    If your HELOC available credit is 500K and you put 25K at your mortgage; your HELOC available credit would increase to 525K. Your HELOC is calculated based on Home Value *0.8 – mortgage amount.

    In Canada, Mortgage Interest is not tax deductible. If you are American, this conversation is not applicable.

  • on the fence August 20, 2014, 2:15 pm

    @ Jason

    Thanks for your comment.

    I think I understand the general principle of the SM – and yes, I am in Canada.

    What I am unsure of is the “mechanics” of the implementation, in order to not lose tax deduct-ability.

    I was not clear if the amount of paying off the mortgage debt determines the amount that I can borrow to invest from the HELOC – in terms of tax rules.

    The SM book and other sources typically say that on the same day when you make a mortgage payment, you also make the exactly same amount of withdrawal from the HELOC account and transfer it to the investment account you use strictly for the SM.

    This gave me the impression, that in order to be eligible for the tax deduction, I can transfer from the HELOC to the SM investment account only the same amount that was paid into the mortgage – regardless of how much credit I have from the bank.

    Based on the comments it looks like that in order to maintain the SM, I can withdraw and transfer to the SM investment account more than the mortgage payment I make.

    The limit is the bank credit limit, not the amount paid into the mortgage, as an assumed eligibility requirement by tax rules – if I understand it now correctly.

    I also have questions about some other possible rules of execution that must be followed in order to stay eligible for tax refund:

    – eligible/non-eligible securities on SM trading account (if any)
    – cash on SM trading account between deposits and trades (if any rules)
    – eligible/non-eligible trading practices on SM trading account: any requirements to hold specific securities, for certain time (can you day trade / swing trade), options trading, etc. (if any)

    All the questions above is strictly from the aspect of maintaining eligibility for tax deduction for the SM.

    Thanks again.

  • Chinstrap August 20, 2014, 2:55 pm

    Simply put, any time you borrow to purchase investments (stocks, bonds, real estate) with the expectation of receiving future dividends and profit, you can write this tax off.

    I don’t run a straight SM but I am sure I invest with LOCs and margin knowing that our mortgage on our principal residence is down the 35% of value.. Plus, I have other mortgage debt on rental properties that I can write 100% interest off on.

  • Dr. Philosophy August 20, 2014, 3:53 pm

    On the fence—
    Your questions and comments clearly demonstrate you DO NOT grasp the SM. Please, for the love of God, do not borrow money against WHERE YOU LIVE if you do not understand EXACTLY what you are doing. The people on this blog, including FT, are providing information, NOT advice–tax OR investment. “Running the numbers” with them is not consistent with what they do. It is CRUCIAL that you understand the distinction between information and advice and the limitations of what you read here. Otherwise, you might well just make a decision with BAD AND PROLONGED consequences for you and your family.

    TREAD VERY CAREFULLY. As has been said a million times by FT and others, leveraged investing in general is not for the faint of heart. It can RUIN LIVES. The risk of this escalates EXPONENTIALLY relative to incremental increases in lack of relevant knowledge. If you think the SM is such a great idea, DO NOT let information stand in for advice; spend the proper money on expert advice to minimize your risk.

  • Robin August 20, 2014, 8:27 pm

    Is it possible to use your HELoC for other things (i.e. vacation, renovations) and calculate the interest on only the amount borrowed to invest and subsequent interest on that for the Smith Maneouvre?

    Though, even if allowed, properly calculating the interest would be such a pain a separate line of credit even at a slightly higher rate would likely be easier…

    As a bonus, what is the rationale for excluding investments that only accrue in the capital gains department?

  • S August 20, 2014, 9:45 pm

    On The Fence,
    To start, perhaps you should discuss your current situation with your mortgage provider and your accountant (and financial planner if you use one) to see what your options are and develop a plan of action.

    I always consult with my branch manager and accountant when it comes to investing and taxation questions.

    One bit of general advice, find your leverage comfort zone and stick to it.
    Personally, I have never gone above using 40% leverage of total assets value. I have a healthy respect for debt and have found over time, this is where I operate most comfortably.

  • on the fence August 21, 2014, 2:12 am

    @ Chinstrap – thank you for your comment.

    @ S – thanks… I am in the process of looking for mortgage to replace the current one, which expires in two months. I am in touch with a mortgage specialist, experienced with SM, kindly recommended by FT.

    I don’t have financial planner and I am finding that out of the five corporate accountants I approached only one was familiar with the SM. He is a CA, CPA and happens to be the accountant for my son’s business, we will meet up shortly.

    In the mean time I am reading, learning as much as possible.

    @ Dr. Philosophy – Thank you for your genuine concerns and care, I do appreciate it.

    I have a very clear understanding that what this site, the blog entries and comments are and what they are not.

    You can not know, of course, but I am fairly familiar with risk.
    Some form of leveraged investing is what I have done in pretty much throughout my life, one way or an other. Including moving to this country with kids, with virtually no money in my thirties.

    The ROI on that probably riskiest investment is decent, most importantly the family is together,

    One of the kids is leading professional in his field at his early twenties, running his own business before graduating from university. He has never been an employee, he never had any debt. He has savings to put down over 25% on his first home, a pre-approved mortgage. Since I convinced him a couple of years ago to start self-directed investing on a TFSA account, he has maxed out his contribution limit. We enjoy discussing investment ideas on a daily basis – but we both do our own investment decisions, with our own money. He is laughing now that he kept his first $10K for a year on a TFSA savings account. He is also watching closely my experiment with the SM.

    Our latest leveraged investment helped our other kid to fulfill her dream, she just completed 7-year combined post-grad studies in two schools, simultaneously to become a professional in medicine.

    Half of my mortgage amount accumulated to finance that risky goal, but we never hesitated to take on the risk, We are very excited and confident about the long-term ROI of that investment.

    I am also proud, that living our leveraged life did not need a penny of taxpayers bailout.

    Overall, I have the confidence that I will be able to handle the last $200K bad debt with the potential benefits of leveraged investment. If there is anything I regret is that I did not find earlier the SM book. I am saying this, based on the growth of our self-directed RRSP accounts over a decade.

    I tread very carefully, which includes not to be shy and ask all the questions I have, about the finest details, even at the risk of coming across of not grasping the topic. Eventually I will master it – and I am grateful for the resources FT put together and for all the information, opinion people share with me here.

    THANK YOU.

  • DrStan August 21, 2014, 10:47 am

    Borrowing to invest can be a long term tool. I have been using my home equity to leverage into dividend equities. Currently the loan is at about $75K. The interest is at 3%, fully deductible from income at marginal rate (let’s say 39%). So the net interest cost is something like 1.8%. The dividend stocks pay about 4-5%, preferentially taxed (about 20% tax), for a net of 3-4%. This is in a very long term perspective (20+ years). There have been some regular dividend increases as well to sweeten the pot. Highly risk tolerant investors should certainly look into it.

    • FrugalTrader FrugalTrader August 21, 2014, 1:06 pm

      @DrStan, i’m on the same plan! Would you mind sharing some of your holdings?

  • Ed Rempel August 22, 2014, 12:53 am

    Hi Robin,

    CRA allows you to use the “flexible approach” when you mix deductible and non-deductible debt in the same credit line. That means you can still claim the interest on the deductible portion.

    I would recommend against this, though. As you said, it can be complex to track this, especially if you are capitalizing the interest and investing regularly. Your tax deductibility can be okay, as long as you can provide a complete tracking when CRA asks.

    It’s much better to have separate credit lines for separate purposes. Most readvanceable mortgages allow you to setup multiple credit lines within the same overall limit all at the same interest rate.

    Ed

  • Ed Rempel August 22, 2014, 1:08 am

    Hi on the fence,

    You are right that the limit you can invest is the credit line limit. If you have a mortgage, then the regular payments have a principal portion that reduces the mortgage balance, which means that portion becomes available in the credit line linked to the mortgage.

    You can invest in essentially any investment that is not prevented by its prospectus from ever paying income. Stocks or mutual funds that have never paid a dividend are fine, as long as the manager could pay one someday if he wants. Options are not allowed though, since there is no chance of paying income.

    That is the mechanics. I agree with Dr. Phil-osophy. You don’t sound very knowledgeable about finance or investing. The Smith Manoeuvre is a risky strategy and should only be done if you know what you are doing or get professional advice.

    The Smith Manoeuvre is a power tool. It magnifies your gains and losses – a lot!

    The problem with it is that people often start when the markets look good, borrow a lot to invest and then the market crashes and they panic and sell. To do it, you need investments that you will be completely confident in, especially if they crash.

    In 2008, some of my leveraged investments were with fund managers that fell 40% or more. My only thought was “How much more can I buy?” I know the fund manager is one of the world’s best. An investment getting cheaper when nothing has changed is a reason to possibly buy more, not a reason to consider selling.

    Bottom line: If you buy an investment and it drops 40% and you even consider selling it, then you should never have bought that investment in the first place. You obviously are not confident with it.

    Think of the Smith Manoeuvre like a nail gun. If you know what you are doing, you can build that deck much faster and better than with a hammer. However, if you don’t know what you are doing or get emotional about it, you can shoot yourself in the foot – or worse!

    I hope you find that helpful, On the Fence.

    Ed

  • on the fence August 22, 2014, 4:02 am

    Thanks for all the kind responses. Extra appreciation for the voices of genuine care to avoid the dangers of investing on borrowed money. Your warnings are all true.

    This is coming from someone, who’s biggest leveraged investment was to come to this country at my mid thirties, with two kids and ridiculously little cash. While it was scary and forced to learn to tread carefully, as a long term investment it paid off, I am happy to report that the whole family is doing very well – and we did not even need a cent of tax payers “bailout”.

    I might come across as someone who does not sound “very knowledgeable about finance or investing” – and I don’t claim to be an expert at all.

    But that has not prevented me to build up some investment, starting with trading stocks on a self-directed account at a time when most orders were still placed over the phone. I decided to buy stocks after asking lots of questions from someone with a seven figure account and kind patience to answer all my stupid queries. I am very grateful, I may not be here now without him, asking more questions,

    When I look at Frugal Trader’s SM investment dividend portfolio I understand that my questions may sound odd.

    While about half of my portfolio is similarly static “buy and hold” with DRIP, I use the rest of it to trade relatively frequently, capturing profit on short term trades, ranging from one trading session to a couple of weeks. I don’t mind if that portion of my portfolio is in cash, ready for exploiting opportunities. Hence my questions about holding cash, options, etc. specifically in the context of executing the SM. I realize that frequent trading is not typical in SM investment holding and I will consider to adopt to that, but I still would like to know about different options.

    While I don’t mind to be partially in cash, in 2008 during the crash I happened to be fully invested. Like Ed, I have not sold a single stock and also bought as much as I could, despite my job was directly hit by the crisis.

    Ever since I trade, I lost money only two times, many years ago. I am considering to sell those shares now, to use the loss to off-set capital gains to sell even more non-registered investment, without little tax hit, in order to put an other $25K lump sum into the mortgage when I start up the SM.

    Again, thanks for all the kind concern and all the great advice.

    I think I will be fine. I am very excited, I can’t wait to meet the mortgage specialist next week and ask her about the lump sum payment on readvancable mortgage.

    I really hope that it would allow me to make a 25% lump some payment right at the beginning, without penalty for not waiting for the first mortgage anniversary. I have my spreadsheet ready with the dividend stocks to aim for.

  • Tony August 24, 2014, 3:23 am

    I have a question about maximizing leverage. Say I take an investment loan of $1,000 from the bank @ 4.00% annual rate, then I deposit this 1000 into my brokerage margin account which allows me to invest up to $2,000 with a marginal interest of 6.00%.

    At the end of the year, my interest total will be: 1000 x 4% + 1000 x 6% = $100, or 10% in effect. My question is is this $100 fully tax deductible, or only part of it qualifies for the deduction.

    Thanks in advance.

  • Chinstrap August 24, 2014, 11:18 am

    Hi Tony

    In the past, and to some extent currently, I borrow on a credit line and invest in stocks in a brokerage account. I’ve then taken the account into margin where the total assets are above the equity in the account and the brokerage charges interest.

    At the end of the year, you just include the interest from the credit line and the interest from the brokerage account as tax deductions when you file taxes. No biggie. Actually, my CIBC brokerage account tabulates interest charges on my US and Cdn account.

  • Amit October 20, 2014, 12:30 pm

    MDJ, a ton of thanks for making it simple for us. I had a question. In the SM investment portfolio, if I rebalance (or say simply sell a stock to buy another), for CRA purposes should I pay that money back and borrow again? Or can I just directly use the sale proceeds to buy the new stock?

  • FrugalTrader FrugalTrader October 20, 2014, 4:09 pm

    @Amit, technically, you could withdraw your gains to pay down the debt and reborrow again. But I believe that it’s generally accepted to leave the proceeds in the investment account and reinvest. You should double check with an accountant first though.

  • Ed Rempel October 20, 2014, 11:23 pm

    Hi Tony,

    If it’s all invested, all the interest should be tax deductible. I wouldn’t do your strategy, though. Using a margin account for the Smith Manoeuvre is a bad idea.

    Leveraged investing is a risky strategy and the #2 risk is guarding against a margin call. If once in the next 20 years, there is a temporary market decline and you are forced to sell at a low, then your 20-year leverage strategy is probably a bust.

    I would suggest to use the investment loan, if you are comfortable with it, but avoid the margin account. Don’t let the tax strategy drive the bus!

    Ed

  • Ed Rempel October 20, 2014, 11:26 pm

    Amit,

    No problem. Just buy the new stock. The key test is that you can trace that the borrowed money was invested and is still invested.

    Ed

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