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Smith Manoeuvre Portfolio – October 2008

For those of you just joining us, this is my portfolio that is leveraged with money borrowed from my home equity line of credit (HELOC). As the money borrowed is used to invest, the interest charged is tax deductible. For more detail, check out the modified smith manoeuvre strategy.  It almost sounds like a giant mistake waiting to happen with the current market conditions.

I will be honest, the leveraged portfolio hasn’t been pretty the past few months and extremely volatile.  I will admit that leveraged investing in this market volatility can make an investor queasy.  In spite of the occasional dry heave, I think that sell offs are an opportunity for long term investors.

To put my money where my mouth is, instead of selling and going to cash during the sell off, I have been buying more dividend stocks.  To be more specific,  I added to my position in Husky Energy and Fortis in addition to initiating small positions in Petro Canada and Teck Cominco (thanks DAvid).

Here is my SM portfolio thus far:

Stock Symbol Shares Avg Buy Price Total Div/Share Yield
Royal Bank RY.T 75 $47.62 $3,571.25 $2 4.20%
CIBC CM.T 45 $67.14 $3,021.25 $3.48 5.18%
Power Financial PWF.T 105 $35.14 $3,689.65 $1.25 3.56%
Scotia Bank BNS.T 75 $46.20 $3,465.23 $1.96 4.24%
Manulife Financial MFC.T 75 $38.03 $2,851.99 $1.04 2.73%
Fortis Properties FTS.T 100 $26.69 $2,669.49 $1 3.75%
TransCanada Corp TRP.T 50 $36.87 $1,843.25 $1.44 3.91%
FTSE RAFI US 1500 Small-Mid ETF PRFZ.US 20 $51.50 $1,029.99 $0.42 0.82%
AGF Management Limited AGF.B.T 50 $22.71 $1,135.49 $1.00 4.40%
Bank of Montreal BMO.T 25 $44.17 $1,104.24 $2.80 6.34%
Husky Energy HSE.T 85 $35.90 $3,051.28 $2.00 5.57%
Petro Canada PCA.T 50 $30.57 $1,528.49 $0.79 2.58%
Teck Cominco TCK.B.T 100 $15.35 $1,534.99 $1.00 6.51%

Total Portfolio Cost Base (including commissions): $30,496.59

Portfolio Holdings Value (excluding cash) on Oct 28, 2008 : $25,451.82

Total Dividends / Year: $1,102.75

Portfolio Dividend Yield: 3.62%

Even though the portfolio value is currently less than my borrowed amount,  I am still fairly happy with the progress of the Smith Manoeuvre because of the fairly high yields of the strong dividend payers.  As you may have noticed, the portfolio is starting to get a bit diversified away from the financials where they represent about 62% of my entire portfolio now.

In hindsight, if I waited a bit longer before adding to my positions, I would have a lower adjusted cost base.  I guess there may be something to the saying “never try to catch a falling knife.”

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FT About the author: FT 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.

{ 26 comments… add one }
  • Nurseb911 October 29, 2008, 8:45 am

    Glad to see you’re still sticking with AGF after knowing what your avg. cost was. Hopefully those stocks bounce back eventually – but at least you have good predictability with dividends in that portfolio. They always make me happy regardless of what I’m down. Like my BNS dividend today :)

  • PhilC October 29, 2008, 8:59 am

    Frugal,

    How fast are you adding to your Smith account? 2000$ / month? and how big are you planning to make it? 100k$? 250k$? as much as they will lend you?

    I’m currently sizing one up for myself, just curious on how you sized yours.

    What’s you worst case scenario for how high interest rate can go?

    Philippe

  • FT FrugalTrader October 29, 2008, 9:15 am

    Nurseb911, it is quite painful watching a stock fall as much as AGF has. The only way that I would consider dropping that position is if AGF halts or significantly cuts their dividend.

    PhilC, i’m planning to make the HELOC size as large as my house value will allow. Right now, I don’t have a planned schedule on when to invest, just whenever stocks appear cheap. In terms of interest rates, it’s anyones guess how high rates can go. I believe historically, rates average around the 6-8% mark.

  • Dividend Growth Investor October 29, 2008, 11:00 am

    Wow being leveraged in this market is probably a hard feeling. As long as your dividends are stable and increasing you shouldn’t worry too much about capital gains.

    Also as long as you are within your comfort limits, keep investing. But please do not bet the house. Stocks will come back up, the problem is that noone knows when. You don’t want to have to cover a margin call at the bottom of the market, locking in losses, just because you were oveleveraged.

  • DAvid October 29, 2008, 12:17 pm

    Frugal Trader said: “In hindsight, if I waited a bit longer before adding to my positions, I would have a lower adjusted cost base. “

    I don’t think you’re alone in that! I’ve wished I’d waited a few days on a number of purchases this month, however, like you, I am choosing for dividend returns first, and capital gains second. There truly are some great buys in the market just now!

    DAvid

  • cnidog October 29, 2008, 2:28 pm

    I’d be interested in knowing how much interest you are paying on your HELOC (actual $ amount, not interest rate) to see how it compares with your dividends.

  • PhilC October 29, 2008, 2:38 pm

    Prime is 4%, so 30k$ @ 4% is about 1200$ a year of interest.
    The portfolio is probably 100$ in the red per year until dividend growth kicks in.

  • FT FrugalTrader October 29, 2008, 2:40 pm

    cnidog, the HELOC is currently at prime (4.0%) on a balance of around $51k, which equates to around $170/month or $2040/year. Note that some of the borrowed amount is sitting as cash at the discount brokerage waiting to be invested. If my entire cash balance was invested, my dividend income would be close to $1,820/year at my current average yield.

  • Chris October 29, 2008, 4:55 pm

    I was always under the impression that the Smith Manoeuvre suggests holding securities that have a higher dividend rate and not depending on capital growth/gains for income/cash flow? I can see you’ve got a few decent ones here (BMO for example), but what’s with the 0.82%, 2.58%, 2.73%, etc?

    Why were these added to the portfolio when they’re not generating a significant yield compared to other securities you own? I know they’re expected to grow and all (both capital and dividend growth), but wouldn’t it be better to start out high (like you have with BMO and Teck Cominco)?

  • Finance_Addict October 29, 2008, 5:15 pm

    Re Chris:

    My feeling with the Smith Maneuver is to simply take out HELOC and use ANY proceeds from it (i.e. both capital gains and dividend income) and use both to pay down mortgage debt. The idea that the dividend income alone will cover your mortgage payments entirely I feel can easily throw one a curve when any one of the following occur (dividend cut, increase in lending rates including prime interest rate increases.) If the idea of the Smith Maneuver is simply to choose investments that have higher yields than your borrowing costs…You may be left with a handful of income trusts or abnormally high yielding stocks that are ripe for a dividend cut. I feel one would eventually face a losing battle with certain interest rate hikes. Call it what you want but using the proceeds from a HELOC to buy stock and diligently using the proceeds from your HELOC investments to pay down your mortgage is what I think makes most sense. That includes the obvious benefit of claiming your interest costs and using that refund also to pay down mortgage debt. I use a HELOC but I don’t limit myself to just nose bleed high yields for it to work.

  • Matt October 29, 2008, 7:02 pm

    “take out HELOC and use ANY proceeds from it (i.e. both capital gains and dividend income) and use both to pay down mortgage deb”

    Withdrawing capital gains decreases tax deductibility of the HELOC. You can use the capital gains to pay the interest on the HELOC, however.

  • Chris October 29, 2008, 7:48 pm

    Finance_Addict – I see what you mean. But another part of investing in high(er) dividend yielding stocks is to choose stocks that have paid an increasing dividend for many years without any cuts. This will ensure that your cash income won’t decrease when/if the price of the shares drops (as is happening now). Plus you use drops in share prices to pick up some of your favorite high yielding stocks at bargain basement prices.

    I’ve always viewed capital gains investing with a bit of skepticism. I think it’s better left to pros. That doesn’t mean I don’t ever invest for a capital gain, but I don’t think you should borrow money to do it – especially against your house!

    I usually pick up stocks when they’re selling lower and their yield has increased. I never sell (except for one time) so you can see why I dislike investing in something for capital growth only.

  • Finance_Addict October 29, 2008, 9:16 pm

    Chris – I’m all about choosing strong dividend yielding stocks. However I think most would agree that investing for potential capital gains is a very good thing. Increasing capital gains and dividends typically go hand in hand. There is no one better to invest your money than to do it yourself, regardless of investing approach. I understand your “Derek Foster” approach to investing and I do follow it. However there is nothing wrong with choosing good high quality (dividend) paying stocks for the purpsoe of selling them once they have gone up in value. Doing so with borrowed money aginst my house is the best thing I have ever done, even in this market. In Derek Fosters’ latest book he describes the benefits in doing so. I highly recomend using a HELOC instead of trading on margin to invest. I will end up elliminating my mortage much much sooner than I could have without a HELOC.

  • DAvid October 30, 2008, 1:17 am

    If our host is in the 43% tax bracket this year, and is fully invested, he will get a tax return reducing his loan cost to about $1160, and retain $1383 in dividend income. As long as interest rates stay below about 5% on average, this should be a winning proposition for the first year. As the stock values and dividends increase, this plan should work even more to Frugal Trader’s advantage.

    Buy low — sell to your grandchildren.

    DAvid

  • mike h October 30, 2008, 3:17 pm

    Most HELOC’s have recently gone to prime + 1%, which certainly makes this strategy less attractive. Of course, BoC prime is set to go down, and interest rates are at historical lows so I’m still considering taking the plunge.

  • FT FrugalTrader October 30, 2008, 3:27 pm

    Mike, yes the new rate is true for NEW Helocs only. HELOCs already in existence keep their pre negotiated rate (most are at prime).

  • cannon_fodder October 30, 2008, 11:32 pm

    FT,

    Thanks for the post. I, too, wish I hadn’t plunged into the market as quickly as I did but I take some solace in the fact that I’ve seen the experts on CNBC and BNN say that they couldn’t have predicted this. I’m sure that even now many are buying when the markets tank (typically on Monday’s) but still not convinced that the bottom has been hit.

    However, there are some signs which suggest we may be in the process. We tested certain lows and managed to fight back quite nicely. Secondly, I’ve begun to notice that in spite of bad news, the markets still go up (e.g. look at the energy stocks today in spite of the price of oil; look at the Dow and S&P despite the GDP and consumer confidence numbers this week).

    Your choice of Teck wasn’t one that I had considered before. According to 14 analysts, 1 rates it a strong sell, 1 a sell, 3 a hold, 5 a buy and 4 a strong buy. And, the biannual dividend will be paying out in January – assuming there is no disruption to it.

    My portfolio is still at a 4.44% overall yield but the cost to service has gone down quite a bit (with LIBOR and the Bank prime rate). Not even considering tax advantages, the cost to service is 3.62%. By the time the interest rates start rising, I’m sure that the stocks, and the dividends, will also have risen. However, I’m expecting that the dividends will rise more slowly than the stock prices since these yields are unusually high.

    So, although my stocks are 12% below book value, at least my dividends will more than pay me to wait… and wait… and wait…

    What are you going to do as you feel comfortable to put more $ into investments? Buy some new stocks or invest in some of the worst performers (e.g. AGF)?

  • Nabloid.com October 31, 2008, 10:27 pm

    I don’t usually agree with people about taking on more debt, even good debt, for investing. That said, I looked at your particular investments and the majority of those companies look really strong and have been battered recently. Almost each of those companies will still be around 10 years from now and will be even stronger…

    The biggest thing I’ve noticed is I have this tendency to invest my money AS SOON AS I GET IT, to avoid missing out on gains, but sometimes that causes me to buy an investment too soon and at too high a price… Sometimes it’s best to put a low ball limit order out there, and let it sit for a few weeks. You’d be surprised how much extra gains you will get in the long-run (or how much lower your losses may be). Even on days when the stock does go higher, it may trade up and down all day long, so the closing price isn’t necessarily the lowest price you can buy the stock for! So why pay the sticker price? The only reason is fear that the price will increase… and I’m slowly learning patience is a very useful thing… there are plenty of opportunities and if you miss one, there’s always another one around the corner – so NEVER overpay and NEVER pay the sticker price. I can’t underline how important a lesson this has been.

    I now put out low ball bids on companies I like, and let it sit there for a week or so, and then I re-evaluate my limit price if the trade wasn’t executed. Example, even shaving $1 off a $20 stock might end up saving you 5% (or making you 5% depending on how you look at it, and that can be half a years profit based on the common expectation of 10% rate of return per year)… and even if that stock never closed below $20, I might be buy it at $19… I’ve been able to make my low ball bids at a big discount due to the massive ups and downs our current markets are experiencing at much higher discounts than 5%! So I’m hoping for much bigger gains on my newly invested money – maybe that will offset some of my losses? Oh well, I think my losses won’t be losses forever, so I’m not worried.

  • MultifolDream$ November 1, 2008, 8:02 pm

    How far you go with your Smith Manoeuvre as investment leveraging vehicle?
    I see that you leverage you home (mortgage & SM) up to 64%, if my calculations are right, but you can go up to 80%.

  • FT FrugalTrader November 2, 2008, 8:37 am

    multifoldream, yes, you are right, i’m only borrowing a portion of my total available amount. Based on LTV, I still have about $40k in credit available, not including the cash just sitting in my leveraged investment account.

  • peter rawlings November 2, 2008, 8:26 pm

    Hi FT,

    what’s the reasoning behind being so financial sector heavy for your SM portfolio? I realize that the financial sector is high dividend yielding but right now it might be the best place to be in. Why isn’t there any investment in alternative energy via an ETF or some such? Are the yields not high enough?

    pr

  • FT FrugalTrader November 2, 2008, 9:46 pm

    peter, my portfolio is primarily focused on “strong” Canadian dividend payers as I’m invested for the income. If there is a strong dividend “alternative” energy ETF out there, I would love to hear about it. Do you know of any such security?

  • Qubikal November 5, 2008, 4:48 pm

    FT – thanks for sharing your transactions during the month/quarter. I enjoy following your progress and am moving towards modelling my portfolio like yours. Too many mistakes made picking some risky items over the last year for my SM portfolio.

    I see that you don’t have any positions in the telecom industry. Comparing to the XDV ishares etf, they hold MBT that pays out a pretty good div rate. What are your thoughts?

  • FT FrugalTrader November 5, 2008, 5:03 pm

    Qubikal, MBT has a good yield, but they haven’t increased their dividend since 2004. My focus is on companies who have a history of increasing their dividend and fairly low payout ratios. I just took a peek at their balance sheet, and it seems that they pay out more in dividends than their earnings produce which is another warning flag for me. I’m not sure if that’s a reporting error or if there’s more behind that story.

  • Inski November 26, 2008, 11:36 pm

    How are you able to buy a few shares, less thann 100, and not get dinged on the base commision?

  • Inski November 26, 2008, 11:37 pm

    How are you able to buy a few shares, less than 100, and not get dinged on the base commision?

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