As this blog has quite a bit of content regarding the Smith Manoeuvre, I often get reader questions regarding how to start the Smith Manoeuvre, and when is a good time to start. I have answered the “how” in the past, but what about the “when”?
What is the Smith Manoeuvre
Before we get started, lets take a couple steps back and explain what the Smith Manoeuvre is to newer readers. It is advertised as the “tax deductible mortgage” and markets the tax benefits where in reality, it’s an investment strategy. It’s where a homeowner obtains a readvanceable mortgage, and uses the increasing line of credit to invest in the markets. In other words, the home owner is borrowing against the equity in their home to invest. The borrowed amount is now tax deductible and your investments are now leveraged.
For more details, you can read this post on the ins and outs of how the smith manoeuvre works.
Ok, now that we have the preamble out of the way, lets get back to the reader question. The question is about the timing of the Smith Manoeuvre. Should I start the Smith Manoeuvre? If not, when is a good time?
Lets talk more about the strategy. As I mentioned above, although it’s advertised as a tax deductible mortgage, it’s actually a leveraged investment strategy. What does that mean? Leverage amplifies both gains and losses. When the going is good, the gains are great, and you are a investing genius. However, when markets go into bear mode, things can get ugly fast. Not only is your portfolio now underwater, you have a loan balance that’s greater than the value of your portfolio.
Evaluating Risk Tolerance
The point I’m trying to make is that the Smith Manoeuvre is all about risk tolerance. Sure, it can work in the long term providing that the investor sticks to their plan. However, most investors are swayed by their emotions of fear and greed, and tend to veer from the long term plan during extreme market conditions. For prime example, when the market significantly corrected in 2008, what did you do? Did you sell with everyone? Buy during the decline? or simply do nothing?
If you found that you were constantly worrying about your portfolio balance during the correction, then chances are is that your risk tolerance isn’t suited for leveraged investing. If, on the other hand, you kept confidence in the market and bought equities while the media was declaring the end of the world, then your personality may be well suited for leveraged investing.
If you have the risk tolerance to follow through with leveraged investing, the next speed bump in the process is the mechanics or the numbers. To start, the homeowner should have at least 20% equity in their home. That way, they eliminate the CMHC fee of getting the home equity line of credit.
Personally, I’m not comfortable leveraging 100% of the HELOC space. Thus far, I have $50k borrowed from a credit limit of almost $200k. However, this could change should the markets provide another buying opportunity for dividend stocks.
In an ideal world, all mortgages are tax deductible. Unfortunately, that luxury is only for houses in the U.S. In order to have anything similar in Canada, a home equity line of credit is needed and used to invest with. Sounds simple, but there are risks to leveraged investing that needs to be accounted for before starting the Smith Manoeuvre.If you would like to read more articles like this, you can sign up for my free newsletter service below (we will not spam you).