Smith Manoeuvre

[rain111]

Any homeowner here using the Smith Manoeuvre technique? I am a fan of leverage investing. I do not own a home at the moment but when I do, I probably will set up Smith Manoeuvre on it. I totally bought his idea of retiring without the house paid off but owing a lot more investments instead.
In long term, a prudent leverage strategy almost always trump a non-leveraging one.

[mart242]

Care to elaborate? There's not much info on their website and I don't feel like paying 25$ for something that I might not be able to do..

[dgg]

there was a post about this a little while ago, i replied as i am currently doing a half smith manoevre, ie don't yet have enough equity built up in the house to make the leveraging worthwhile. do a search on my posts and it should pop up.

good luck.

[mart242]

never mind...

[SirloinofBeef]

Fraser Smith himself has answered questions posted here in great detail which I think is great. I read his book and will likely implement the method after seeking a FA, doing the usual due dilligence and excel number cruching. What I got out of the book was to convert your mortgage payments into a tax deductable loan.

In the end you've:
1. paid off your mortgage
2. have a tax deductable investment loan equal to the original value of the mortgage
3. own investments that have been compounding returns and/or growing for the duration of the mortgage payment period which *should* offset the cost of financing the investment loan thanks to time and the interest mail in rebate :) from point 2
4. risks include investment performace and interest rates which comes from leveraging

There are more points but the selling point for me was the ability to build a portfolio on the relatively cheap and early.

[fraser]

Fraser Smith himself has answered questions posted here in great detail which I think is great. I read his book and will likely implement the method after seeking a FA, doing the usual due dilligence and excel number cruching. What I got out of the book was to convert your mortgage payments into a tax deductable loan.

In the end you've:
1. paid off your mortgage
2. have a tax deductable investment loan equal to the original value of the mortgage
3. own investments that have been compounding returns and/or growing for the duration of the mortgage payment period which *should* offset the cost of financing the investment loan thanks to time and the interest mail in rebate :) from point 2
4. risks include investment performace and interest rates which comes from leveraging

There are more points but the selling point for me was the ability to build a portfolio on the relatively cheap and early.

Hi Sirloin,

Pretty accurate summary, thank you.

You are correct that the power of the strategy comes from recognizing that if you have a mortgage, you have already leveraged your position to get your house. The problem is that this large debt costs huge amounts of interest that is non deductible. Most people wish they could gather other assets, but usually are following the custom of getting the house paid off first so that they can then divert the former mortgage payment towards investment gathering. Of course that means they will lose 20 or 25 years of compounding time for the investments you have not yet purchased. The Manoeuvre allows you to convert the bad mortgage loan to a good investment loan. As fast as you reduce your first mortgage, you re-borrow that new equity and purchase investments of your choosing. Your debt will therefore stay level, but most will recognize that if they can handle a 200,000 mortgage debt today, then they should be able to handle a 200,000 investment debt a month from now, a year from now, or forever. If it's deductible, you will get a maximum tax refund cheque in the mail every year for the rest of your life, just like wealthy people do.

Not only do you start building your investment portfolio starting right now, the cherry on the top is that the interest expense on your investment loan is a tax deduction, and the tax refunds obviously are available to make your mortgage go down faster, which means you can borrow back to invest faster. Faster is better when you are talking about getting rid of bad debt, and faster is also better when you are talking about building your investment portfolio, and faster is also better when it means tax refund cheques will be getting larger as each year goes by until the mortgage has been completely converted to good debt.

Wealthy people have debt too. The difference is that they paid large sums of money to expensive lawyers and accountants to show them how to make their debt deductible. Now you can do the same. I strongly recommend you work with a financial planner.

To get the full story, download my PowerPoint slides from my website at www.smithman.net. There is no charge.

Hope that helps,

Best regards,

Fraser

[str]

The only potential problems with the Smith Manoeuvre is that legislation might change. For example, in Quebec (provincial tax) now you can only deduce the interests from declared gains on the loaned investment, which makes the Manoeuvre less interesting (but interesting nonetheless). If the federal government was to change the law to something similar, then you would only be able to reduce your taxation when declaring income from the investment, which means you wouldn't be able to profit from the short term tax deduction.

[Paksis]

Hi Sirloin,

Pretty accurate summary, thank you.

You are correct that the power of the strategy comes from recognizing that if you have a mortgage, you have already leveraged your position to get your house. The problem is that this large debt costs huge amounts of interest that is non deductible. Most people wish they could gather other assets, but usually are following the custom of getting the house paid off first so that they can then divert the former mortgage payment towards investment gathering. Of course that means they will lose 20 or 25 years of compounding time for the investments you have not yet purchased. The Manoeuvre allows you to convert the bad mortgage loan to a good investment loan. As fast as you reduce your first mortgage, you re-borrow that new equity and purchase investments of your choosing. Your debt will therefore stay level, but most will recognize that if they can handle a 200,000 mortgage debt today, then they should be able to handle a 200,000 investment debt a month from now, a year from now, or forever. If it's deductible, you will get a maximum tax refund cheque in the mail every year for the rest of your life, just like wealthy people do.

Not only do you start building your investment portfolio starting right now, the cherry on the top is that the interest expense on your investment loan is a tax deduction, and the tax refunds obviously are available to make your mortgage go down faster, which means you can borrow back to invest faster. Faster is better when you are talking about getting rid of bad debt, and faster is also better when you are talking about building your investment portfolio, and faster is also better when it means tax refund cheques will be getting larger as each year goes by until the mortgage has been completely converted to good debt.

Wealthy people have debt too. The difference is that they paid large sums of money to expensive lawyers and accountants to show them how to make their debt deductible. Now you can do the same. I strongly recommend you work with a financial planner.

To get the full story, download my PowerPoint slides from my website at www.smithman.net. There is no charge.

Hope that helps,

Best regards,

Fraser


This is an idea for a small select few who can make it work, the rest will screw it up.

[rain111]

This is an idea for a small select few who can make it work, the rest will screw it up.

Care to elaborate why the rest will "screw it up"?

[fraser]

The only potential problems with the Smith Manoeuvre is that legislation might change. For example, in Quebec (provincial tax) now you can only deduce the interests from declared gains on the loaned investment, which makes the Manoeuvre less interesting (but interesting nonetheless). If the federal government was to change the law to something similar, then you would only be able to reduce your taxation when declaring income from the investment, which means you wouldn't be able to profit from the short term tax deduction.

Hi STR,

I suppose we always live with the possibility that the government will change the rules in anything that affects our daily lives. This is most unfortunate, because there is bound to be many folks who decide not to act in their own best interests because there might be a change in the future. The fact is that current Canadian tax law allows for the deduction of interest on loans made for purposes of investment to earn income, and it would be a shame if people avoided investing because there might be a change someday.

On the other hand, only about one third of the advantage of The Smith Manoeuvre comes from tax benefits. The bulk of the advantage comes from the fact that Canadians will use the equity generated in their home to borrow back to get it invested right now, on a monthly basis, instead of waiting to take out an investment loan secured by the house 15 years from now. Or, worse yet, taking a reverse mortgage at age 65 because they have not enough investments to provide income in their retirement. A reverse mortgage is the ultimate removal of the equity from your home, and it is totally avoidable if you are wise enough to make the equity work now instead of later.

So, if the government takes away deductible interest, which is one of the more hare-brained ideas ever dreamed up by Finance, Canadians will still be much further ahead to have implemented The Smith Manoeuvre to build their own personal retirement pension plan. In the meantime, you can have your own pension plan as well as excellent free tax refund cheques under current tax law.

Thanks for your comments.

Fraser

[Paksis]

Care to elaborate why the rest will "screw it up"?


You have to have the discipline to put the money where it is to go in the right percentages to the best investments. I've seen a number of people put the money into Uncle Ed's Condo Villa or exotic forex transactions, options, etc. etc. Lose the money and still have the debt. Not a good place to go. Human nature is short term for a lot of people, memory's are short and I just gotta have that wonderfull stock that's going to change the world. Remeber Nortel etc. etc.

For some it is a good idea, for other's not a good idea. Best investment in life is a pd up home. Not a 250,000 perpetual mortgage. Makes you a renter in life, not an owner. The people who think these things up are after the fee income associated with it, because your sure as hell not doing it for free. As soon as Canada Revenue changes the rules everyone disappears leaving the poor sap holding the bag. He/She is faced with financial devastion and the people who advised them into the mess are laughing all the way to the bank. Seen a lot of people take bad advice and then get shafted because of it.

Your Smith Manouvre might be fine, but might not. It depends. Markets can change, for real estate and for investments. If a person does this make sure you CYA, leave a healthy chunk of equity and hope like hell it works.

That's why far too many will "screw it up".

[gnunn]

Is this largely dependant on interest rates remaining low though? For example, carrying $200K of mortgage at 3.5% while investing the equivalent and getting a return of 7-8% is good, what happens when interest rates rise, does the Smith Maneouvre become less interesting the higher rates go?

[Agent_J]

Is this largely dependant on interest rates remaining low though? For example, carrying $200K of mortgage at 3.5% while investing the equivalent and getting a return of 7-8% is good, what happens when interest rates rise, does the Smith Maneouvre become less interesting the higher rates go?
also, what if the return % falls?

[guest913]

The first thing that came into mind is "risk". I am not too sure what the Smith Manoeuvre is but it is risky to use your home equity as investment, especially on an investment that earns 7-8%. You would also have to keep in mind that interest income from investments are also taxed, some higher than others. (Capital gains vs. Interest Income).

For the average Canadian who do not have a background in Finance, this may not work. Even if you sit with a financial planner, they may not have the skills or time to fully plan the perfect investment strategy.

Is there any calculations that can show that the SMith Manoeuvre works? I would be very interested in taking a look at it.

[rain111]

The first thing that came into mind is "risk". I am not too sure what the Smith Manoeuvre is but it is risky to use your home equity as investment, especially on an investment that earns 7-8%. You would also have to keep in mind that interest income from investments are also taxed, some higher than others. (Capital gains vs. Interest Income).

For the average Canadian who do not have a background in Finance, this may not work. Even if you sit with a financial planner, they may not have the skills or time to fully plan the perfect investment strategy.

Is there any calculations that can show that the SMith Manoeuvre works? I would be very interested in taking a look at it.

Smith's book explains the math in details. Borrow the book from the library and read it and you will see.
In most cases, capital gain get taxed the least (50% of capital gain is tax deductible). Dividend next because of dividend credit. Interest income ( ING direct or GICs or bonds) is taxed at full.

In executing Smith Manoeuvre as well as any other leveraging strategy, by default it is risky. However, if you are willing to invest in a long term horizon, say 20 years, the risk will be considerably reduced.

Smith manoeuvre also works better for wealthier people because the tax refund they get back each year will be higher because of their higher tax bracket.

I have read through the book and I find no logical and mathematical flaw in this strategy. Undoubtedly there is risk but always remember, risk and return is proportional.

[grant]

the main point of this technique is only to "convert" your existing mortgage debt, not to increase it pursuing investment options.

So what's the risk, that rates will rise? So what, you'd still be paying those higher rates whether or not the interest is deductible.

[me!]

yeah, I've been contemplating making my mortgage a tax - deductable expense too, but I never got around to being fully comfortable with the math. The concept is really quite simple, and I know the basic concepts of it but never took that next step.

[cannon_fodder]

The risk is simple... if you borrow to invest, and the investments go down, you now have a portfolio worth less than you paid for it and you also have to continue to pay interest on a loan.

Over time you would expect that you should come out ahead, but there are no guarantees. Wasn't the Nikkei about 3 times its present value 10 years ago? Wasn't the Nasdaq 2.5 times higher 5 years ago?

I've looked at the PPT that Smith put out, and it obviously paints a pretty bright picture. There doesn't seem to be a balanced approach at what could happen if things take a turn for the worse.

I also thought it was a poor example when they had a family, I think "The Blacks" who supposedly had $50,000 in a GIC or CSB's as their rainy day fund. Meanwhile they have a $200,000 mortgage at 7%. It never occurs to them that putting the $50,000 against the mortgage is a guaranteed 7% after tax investment (which in their 40% tax bracket would be like a guaranteed 11.5% investment) Instead, through the magic of the Smith Manuevre, they cashed it in put it against the mortgage and then reborrowed it to invest it in some equities that don't pay dividends or income and expect to get a return of 10%.

It seemed to me, and maybe I'm the only one, that this family is pretty conservative but lo and behold they decide to go from a nice safe investment in GIC's and borrow money to invest in equities. I think a financial planner would question what changed them so dramatically.

Maybe I'm a little cynical rather than skeptical, but while the concept seems fine, the devil is in the details. If I am paying $800 every 2 weeks, and only $200 goes to my mortage, that means that every 2 weeks I'm supposed to borrow the $200 and invest it in something that preferably defers all income until I'm ready to sell.

Well, I am not going to buy stocks, because the commission would kill me at $200. So, does that leave me with a mutual fund? I guess so. And frankly, as you are starting out adding $200 here and $200 there, that makes sense.

The cynical part of me was triggered because Smith mentions over and over that you need a financial planner. A financial planner would make money on this manuevre. The bank makes money from this manuevre (they have you paying interest longer). Who ends up with all of the risk? You.
If the investments go down, does the bank make less money? Does the financial planner help you out? You are own your own.

I honestly think it is intriguing, but I would welcome some comments / debate on this. After all, anything that can help me be better off financially with an appropriate amount of risk, is worth looking at. One idea I'd heard of was that if you take this approach, limit your downside by investing in segregated funds. I've never looked at them for details on returns on how you can lock in returns, but that may be appropriate for this type of investing where you are borrowing.

Also, it might be prudent to invest in a mutual fund family that allows switching without generating a capital gain. This way if you feel it might be time to shift your asset allocation around because of certain economic changes, you can keep all of the income deferred.

[me!]

Yeah, that is where I had trouble understanding the logic of the "Blacks" too.

Okay, let's say you had 50K in mutual funds and cashed them out, paid off 50K in your mtge, and then borrowed money against your house to repay the 50K in mutual funds you just sold. You will have to pay interest on the 50K loan and that interest is tax deductible. Your house mtge is not really 50K less because although you decreased your mtge by 50K you have a new loan of 50K for the mutual funds you just bought (to replace what you just sold.)

I believe this is the basics of the smith manouevre.

[GabL]

AGF has a investment loan service (http://www.agf.com/static/en/products_services/1866.html), my friend told me about it. And I asked around and most people will answer, it is never wise to borrow to invest. Just my 2 cents.

However, if you're willing to take the risk, it seems a pretty good thing, as basically you don't need to pay much to get all those tax return benefit and as well the chances of the investment you bought goes up.

[rain111]

AGF has a investment loan service (http://www.agf.com/static/en/products_services/1866.html), my friend told me about it. And I asked around and most people will answer, it is never wise to borrow to invest. Just my 2 cents.

However, if you're willing to take the risk, it seems a pretty good thing, as basically you don't need to pay much to get all those tax return benefit and as well the chances of the investment you bought goes up.

IMHO It all depends on your risk profile. If you are willing to take risk, by all means, this is a way to get the snowball rolling sooner. The no-margin is a good option as it really gives you peace of mind.

[shocknawe]

I voted for Ernie Eves in the last Ontario election. He promised to make mortgage interest tax deductible.

Politics aside, this tax cut certainly would have been a nice alternative to the Smith Manoeuvre.

[me!]

AGF has a investment loan service (http://www.agf.com/static/en/products_services/1866.html), my friend told me about it. And I asked around and most people will answer, it is never wise to borrow to invest. Just my 2 cents.

However, if you're willing to take the risk, it seems a pretty good thing, as basically you don't need to pay much to get all those tax return benefit and as well the chances of the investment you bought goes up.

Yes, it is true it is never wise to borrow to invest. That in itself is a prudent move for most of us out there, but the point of the smith manouevre is to replace non-tax deductible loan with tax-deductible loan money. So theoretically, even though you are borrowing to invest, the amount of extra risk (WRT to money borrowed) stays the same.

[TrevorK]

Yes, it is true it is never wise to borrow to invest.

Wrong.

If I can invest, and am willing to take the risk, why not invest my loaned money (Which costs 4.25% interest) in an investment garnering 10-12%?

Again there's risk - but to some of us we can find some risk acceptable.

[me!]

Wrong.

If I can invest, and am willing to take the risk, why not invest my loaned money (Which costs 4.25% interest) in an investment garnering 10-12%?

Again there's risk - but to some of us we can find some risk acceptable.

Not everyone can find an investment that they are comfortable with to garner 10 - 12% coupled with acceptable risk .

the higher the ROR generally equates to higher risk.

Sure, if I could get a ror equal to or better than the interest rate on the loan,I would go for it, but that ain't always the case. You may be doing 10 -12% now, but 6 months from now, a year from now, it could be 1 - 2%. Then what?

[shocknawe]

Yes, it is true it is never wise to borrow to invest.
If this were true, many businesses would never be started.

[me!]

If this were true, many businesses would never be started.


that's why most people are not business owners and end up working for someone else for a paycheque.

[Mark099]

I have used borrowed money to invest for almost 10 years now. Yes, there are risks involved, but if you invest wisely the payout can be great.

Think of it this way...

Option A (borrowing):

You borrow $50,000 at prime. For simplicity, we'll say your monthly interest payment will be $200. It will actually be ~ $170.

Option B (invest monthly):

Instead of borrowing the $50,000, you decide to invest that $200 per month you would've paid to interest.

Again, for simplicity, we'll say you invest in a mutual fund that has averaged about 10% over the last 15 years. Granted, future performance is not guaranteed, but let's say it's safe to estimate an 8% return over the next 15 years.

After 15 years you would have...

Option A: ~ $165,000 minus the $50,000 = ~ $115,000 net (before taxes)

Option B: ~ $69,000 net (before taxes)

Now, to make it more complex. Since the $200 interest payment for Option A is tax deductible, you will get part of that money back. Say you get $75 of it back. So, what if you also invest that extra $75 per month on top of the $50,000 lump sum. After 15 years, Option A now becomes even better....

Option A: ~ $191,000 minus the $50,000 = ~ $141,000 net (before taxes)

So, again, you have invested $200 a month for 15 years. This is a total of $36,000. Which would you rather have? $141k or $69k?

Where this arguement might break down is when you have higher interest rates. So let's look at how high the rates have to be before this theory falls apart.

Let's say prime increases to 7.25% and your monthly interest payment increases to $300. Remeber, all of that is still tax deductible and you'll get about $125 of that refunded. You will still reinvest that refund. So for Option B, you are going to invest $300 a month for 15 years. The results are...

Option A: ~ $209,000 minus the $50,000 = ~ $159,000 net (before taxes)

Option B: ~ $104,000 net (before taxes)

Even at prime = 7.25% Option A is still clearly the best option.

What if prime is 10%? Your monthly interest payments would be $420. Still tax deductible and say $175 of that is refunded. Invest as before for 15 years in the same mutual fund that will get you 8% a year.

Option A: ~ $226,000 minus the $50,000 = ~ $176,000 net (before taxes)

Option B: ~ $145,000 net (before taxes)

Granted -- income taxes and fluctuating interest rates makes these comparisons less black-and-white. But it should be clear that the strategy can pay off even when interest rates exceed the rate of return on the investment.

Other uses for the bigger tax refund you will get...

1) contribute it to an RRSP
2) pay down your mortgage
3) pay down the line-of-credit or investment loan
4) 2 weeks in Disney World
5) pay down any credit cards or car loans

Yes, I hate to admit it, but last year's income tax refund went towards our trip to Disney World. This year's refund went to the mortgage.

[TrevorK]

I didn't check over your calculations, but I didn't see you mention this.

I assume you counted the monthly interest you paid out to the bank and deducted it?

[Mark099]

I didn't check over your calculations, but I didn't see you mention this.

I assume you counted the monthly interest you paid out to the bank and deducted it?

LOL! Of course, and to be really official you can ask the bank/cu for a statement of the interest paid for any given year.

[me!]

I have used borrowed money to invest for almost 10 years now. Yes, there are risks involved, but if you invest wisely the payout can be great.
Yes, you make some very convincing examples here that is very short, and right to the point, unlike Fraser Smith's Power Point presentation. It is much clearer now to me about re-investing the tax deductions or paying down the mortgage with it.

thanks for the clarity :)

[GabL]

Yes, you make some very convincing examples here that is very short, and right to the point, unlike Fraser Smith's Power Point presentation. It is much clearer now to me about re-investing the tax deductions or paying down the mortgage with it.

thanks for the clarity :)

It all depends on one's own risk tolerance. If you're a risk taker and you do your homework on the market, then sure this is a good way to save and make money! But if you're conservative and too lazy to do any research, then probably stick to the old way of paying your mortgage month by month will be the way to go.

I was presented the AGF investment loan from my friend a while back, and everything looks sweet. But just I'm not willing to take the risk (high interest rate, prime + 2.5%), plus I'm too lazy to track the investment, so I backed off.

[shocknawe]

Back on topic...

First of all, I haven't read the book yet but plan to. However, I've read some of Fraser's posts.

Can the Smith Manoeuvre be done as a DIY? Do I just go to the bank, get approved for an investment loan and ask them to forward my mortgage payments to purchase a mutual fund? I can just imagine the puzzled look on the mortgage or loan officer's face when I ask for this.

Or are there banks that offer, the "SmithMan" mortgage along side their other standard mortgages?

[me!]

I am not saying that I am too risk aversive or a risk woos. I have in fact paid for mutual funds via a line of credit before and written off the interest. I have also taken out a equity loan on my first house to buy my second house. I had to separate between the first morgtage and the equity portion of the mortgage by means of pro-rating.

for example, my first mortgage was 150K and my equity mtge was 75K. The bank rolled it into one mortgage ot 225K. So I had to create an excell spreadsheet of how much interest went to first mtge and how much went to equity mtge. 150/225 = 66.67% for non-deductible interest and 33.33% interest was deductible.

Every year I had to calculate how much interest was for each. I could find out each month how much interest I was paying, and then I just used the 33.33% ratio to make as deductible mortgage.

I did this for several years till I sold the ppty. Never was questioned by CRA

[nixx]

Back on topic...

Can the Smith Manoeuvre be done as a DIY? Do I just go to the bank, get approved for an investment loan and ask them to forward my mortgage payments to purchase a mutual fund? I can just imagine the puzzled look on the mortgage or loan officer's face when I ask for this.



I helped a few of my clients with this strategy but a "toned-down" version of it. We didn't use the full 75% of the equity because it makes most people uncomfortable, and some probably wouldn't be able to sleep at night if we did.

The Smith Manoeuvre is not a task you should tackle yourself unless you're very knowledgeable in investments & taxation and how they inter-relate. This should be left to a professional who knows how to do it properly for you. Trust me, the banks are the last place you want to go to get advice for this because most of the departments that you need help from don't even work with each other; mortgage & investment depts, not to mention they don't have an accountant you can consult. Plus majority of them are just transaction takers, they don't give advice if any at all.

If you're really interested you should consult an independent financial advisor that works closely with his/her own team of accountants and mortgage brokers. Getting proper advice from professionals who have done it before is the way to go. If you needed your car engine to be re-built you would go to a mechanic, right? If you need financial advice then shouldn't you goto a financial advisor?

[rain111]

BMO Readiline is just the right product to execute this strategy.
http://www4.bmo.com/personal/0,4344,35649_2835404,00.html

[shocknawe]

This should be left to a professional who knows how to do it properly for you.
Does the Smith Manoeuvre recommend that you use a professional to execute this strategy?

I went to the public library to borrow the book but it was out on loan.

rain111, the BMO product looks like a typical HELOC. I am thinking that you need to exclusively use this line of credit for investment purposes just to keep a clean money trail.

[rain111]

Does the Smith Manoeuvre recommend that you use a professional to execute this strategy?

I went to the public library to borrow the book but it was out on loan.

rain111, the BMO product looks like a typical HELOC. I am thinking that you need to exclusively use this line of credit for investment purposes just to keep a clean money trail.
Hi shocknawe,

Yes it does look like a HELOC but if I'm not mistaken, traditional HELOC requires you to reapply again and again if you want a higher limit. This Readiline thing will automatically up your limit once you have paid off more your mortgage.
Correct me if I am wrong.

rain111

[Neil]

Over the last couple of years or so I've tried making these strategies work, but ran into a lot of practical limitations.

One was getting a readvanceable loan. (The BMO Readiline was not available.) I checked every lender in my jurisdiction but nobody could give me all three of these features:
- open, variable
- low rate
- free readvances

I could find lenders to give 1 or 2 but never all 3. The lender with the best rates & policies still wanted $100 per readvancement, which kills the deal. Getting the best rate means locking in and restrictions on repayment & readvancement. I could not find one loan that would meet all 3 criteria.

Second challenge was on finding a suitable investment. Guaranteed investments give negative net return after inflation, and investments with better potential generally don't allow small weekly or monthly purchases. The only possibility for a better potential investment of small regular amounts is a mutual fund. Which leads to the third challenge I ran up against....

I consulted an expert at CRA. This is a woman that all the toughest questions get escalated to after several other departments and levels are stumped. She is not bureaucratic either and is quite willing to share honestly how the rules can support a taxpayers right optimize their taxation.

Anyway, she explained the rule of being able to deduct loan interest must be for an investment that is producing or has the reasonable expectation of producing current income itself. So in other words CRA lets you write off the interest expense but only on the presumption that it will be at the same time as you are paying income tax on the investment's income. The wording is on available on the internet and when I read it I reach the same interpretation. I believe there are specific conditions mentioned for equity mutual funds.

Very few typical mutual funds would meet such a criteria since they generally aren't producing current income. Those that do produce current income have a low rate of return that also kills the deal.

You could still record your borrowing interest expenses over time and try to claim that as ACB (adjusted cost basis?) when you sell your mutual fund units. It might work, but it could also be a challenge, especially if you don't sell your fund units for years or decades.

I'm aware this idea of writing off investment loan interest may have been challenged in the tax courts and some taxpayers may have won their cases. But personally I am hesistant to open myself up for a battle with CRA that I may or may not win.

Lastly this is an aggressive leveraging strategy. Leveraging multiples your potential upside but also your potential downside. It's absolutely dependent on getting OK investment performance. From the globe and mail site today here are their numbers:

Canadian Equity mutual funds
5 year group average = 3.78%
5 year index average 1.74%.

That means someone doing this maneuver 5 years ago using typical Canadian equity mutual funds would not have made out that well. After inflation that's zero return, meanwhile you've been paying borrowing costs the whole time.

I'm aware these approaches have merit and in cases where all the factors can come together it can work. I know people in Vancouver that have found suitable loans, plus lenders and investment advisers that understand it, and lastly they are willing to attempt the potential challenges and complexities of trying to claim the CRA deductions.

In my jurisdiction & situation however I found a pure Smith maneuver wasn't feasible.

Instead I just apply similar principles as I have in the past:
- avoid and quickly repay all debt higher than about prime + 1%
- get as many low-interest loans as possible, and make as many of them 'interest-only' repayment terms
- channel the amounts that would have gone towards principle repayment into an investment
- segment the loans so it can later be proven a given loan was strictly for investment, not a mix of mortage & investments
- accelerate and use windfalls to pay down non-deductible loans first.

[Neil]

I am not saying that I am too risk aversive or a risk woos. I have in fact paid for mutual funds via a line of credit before and written off the interest. I have also taken out a equity loan on my first house to buy my second house. I had to separate between the first morgtage and the equity portion of the mortgage by means of pro-rating.

for example, my first mortgage was 150K and my equity mtge was 75K. The bank rolled it into one mortgage ot 225K. So I had to create an excell spreadsheet of how much interest went to first mtge and how much went to equity mtge. 150/225 = 66.67% for non-deductible interest and 33.33% interest was deductible.

Every year I had to calculate how much interest was for each. I could find out each month how much interest I was paying, and then I just used the 33.33% ratio to make as deductible mortgage.

I did this for several years till I sold the ppty. Never was questioned by CRA

Can you elaborate on:

#1 - how you deducted the interest, ie: what schedule or line of tax return?

#2 - what investment vehicle?

[Neil]

I refreshed my research on this. It seems the 2005 budget threatened to close the door on investment borrowing deductibility. But some are speculating that the government may back off from that stance. Bottom line is it is certainly a gray area at this time.

Here's an interesting article I found from a mutual fund company:

http://www.aimtrimark.com/AIM/Resources/Taxes/Tax_Bulletins/TBMITDE.pdf

[NoahVail]

Thanks for the article Neil, here's another (not advocating AIC, it's just that they've put together a lot of relevant info on the subject):

http://www.upvest.com/investor/index.asp

I couldn't discern from your post whether you had tried for a pure BMO Secured LOC (prime, interest only, fees waived) that seems to be the most effective vehicle for this methodology. I noticed that TD is currently waiving all the appraisal and legeal fees as well.

TD index e-funds might be a method to both acquire the income generation and the no-cost monthly purchase plan you're looking for. Distributions are annual (December) and while I automatically re-invest mine, they could be distributed as cash (income). As long as you stay with the e-series, MERs are quite low. At some point it when your accumulations arrived at board lot volumes, you could move the board lot portion of them into an EFT which have even lower MERs and the difference would cover the initial EFT discount broderage commission.

I'm interested in your CCRA conversation as the info I recieved stated that distribution generating index funds would meet the CCRA interest deductability requirements. Did you sense that this might not be the case?

Cheers.

NoahVail

[me!]

Can you elaborate on:

#1 - how you deducted the interest, ie: what schedule or line of tax return?

#2 - what investment vehicle?
well, i haven't done this in a while, but it is in the section where you have carrying charges and interest expense. I think it is line 221 or something like that. But you have to fill out a separate schedule 4.

I put down for the explanation: Interest expenses incurred to purchase mutual funds in one example, another one I used it for interest expenses to purchase rental property, or something like that.

[Neil]

Thanks for the article Neil, here's another (not advocating AIC, it's just that they've put together a lot of relevant info on the subject):

http://www.upvest.com/investor/index.asp

I couldn't discern from your post whether you had tried for a pure BMO Secured LOC (prime, interest only, fees waived) that seems to be the most effective vehicle for this methodology. I noticed that TD is currently waiving all the appraisal and legeal fees as well.

TD index e-funds might be a method to both acquire the income generation and the no-cost monthly purchase plan you're looking for. Distributions are annual (December) and while I automatically re-invest mine, they could be distributed as cash (income). As long as you stay with the e-series, MERs are quite low. At some point it when your accumulations arrived at board lot volumes, you could move the board lot portion of them into an EFT which have even lower MERs and the difference would cover the initial EFT discount broderage commission.

I'm interested in your CCRA conversation as the info I recieved stated that distribution generating index funds would meet the CCRA interest deductability requirements. Did you sense that this might not be the case?

Cheers.

NoahVail

I was given a bulletin that mentioned specifically mutual funds and how you probably couldn't deduct the borrowing costs to buy them because they are investments that just accrue capital value and don't pay current income.

But I just went on the CRA site now and looked at another bulletin that seems to suggest you can, although the message is mixed. Here it is:

http://www.cra-arc.gc.ca/E/pub/tp/it533/it533-e.html

Under the section "Borrowing for investments including common shares" they say:

"Normally, however, the CCRA considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that there is a reasonable expectation, at the time the shares are acquired, that the common shareholder will receive dividends."

and "These comments are also generally applicable to investments in mutual fund trusts and mutual fund corporations."

But in example 8, it's a person buying common shares in a company that does not pay dividends. In such a case they say " In this situation, it is not reasonable to expect income from such shareholdings and any interest expense on money borrowed to acquire R Corp. shares would not be deductible."

I guess one thing a person could do is find a mutual fund that has a track record of paying dividends.

[rain111]

http://www.dividend-growth.org/

Best site run by an amateur about DIY investing in dividend fund. have a monthly email report to subscribe for free. Excellent stuff.

[grant]

In my jurisdiction & situation however I found a pure Smith maneuver wasn't feasible.

Well the scheme you were describing isn't a "pure smith maneuvre"...

The basic premise is simply to make the interest deductible without buying new investments.

What you are describing is trying to make a profit off your home equity.

[shocknawe]

The basic premise is simply to make the interest deductible without buying new investments.
I thought that the Smith Manoeuvre involved building an investment portfolio with periodic investment purchases. Over time, the mortgage loan gets converted into an investment loan slowly transforming loan interest into tax deductible interest while your net debt remains the same.

This is what I understood from Fraser's posts and the slides on his web site.

[grant]

The point is to convert your existing mortgage into a tax-deductible loan- NOT to be a money-making scheme.

Investment portfolios are one way to do this. If you happen to already have an investment portfolio the size of your mortgage, it maybe the most convenient way.

But someone who increases their borrowing to buy an investment is off in uncharted waters and missing the point of this technique.

[shocknawe]

Neil's post is consistent with how I think TSM works. What part of it do you consider as the "money-making scheme" and how is it inconsistent with TSM?

The TSM does suggest reborrowing and constantly increasing your investment loan while decreasing your mortgage loan. However, your net debt remains the same.

[me!]

the way how the investment grows is by compounding the ROR in the investments and by infusing more funds into the investment by the tax savings of the tax that you will get back by making your "mortgage tax deductible". therefore, as the sm suggests, it may not be entirely monetarily wise to pay down your mortgage, because you want the keep the interest tax deductible as long as possible.

[grant]

Neil's post is consistent with how I think TSM works. What part of it do you consider as the "money-making scheme" and how is it inconsistent with TSM?

The part where he says he cannot find a suitable investment.

[temporalillusion]

BMO Readiline is just the right product to execute this strategy.
http://www4.bmo.com/personal/0,4344,35649_2835404,00.html

They just gave me prime - 0.5% on this product! Fully open revolving LOC at prime - 0.5% sounds pretty good to me.

I had no idea this was actually a "Manoeuvre", I first did this years ago when I got a condo.

Going to do it again on the house I'm currently building.

[Tiberius]

Hopefully this is a relatively simple question to answer...

How do you go about getting a loan/line of credit/whatever to use for investment purposes... and then, how does this reflect on your taxes? (i.e. what form / line number do you fill in on the tax form to have the investment loan be tax deductable?

Is there anything specific that you have to do with the loan/loc to have it be eligible to be deducted as an investment loan?

Any insight is appreciated!

[grant]

Tiberius if you can't figure out how to do your taxes, you should hire an accountant. Not to be sharp, but if you need answers to the basics like this on RFD, you're asking for a lot of trouble from CRA.

Any loan interest is tax deductible if the loan was borrowed to purchase/fund a profit-generating endeavor, eg., invest in your business or purchase stocks.

[Tiberius]

Hi grant,

I have no problems doing my taxes on my own - and they aren't always straight forward. ;)

I was only asking this question to see if there was specific guidance/knowledge available from people here to give me a "head start" on this particular topic. If I don't find that knowledge here, I will find it elsewhere and be just fine. :)

My question mostly was based on not knowing if things need to be documented in a certain way - to "prove" the funds went into investments. If there is a specific way to do things that avoids any "issues" that might arise, I would prefer to learn from other people's experiences... know what I mean?

[grant]

You do not include with your tax return a paper trail, but make sure you keep it in your files in case of audit!

Personally I have a copy of my cancelled cheque made out to my investment broker, for the exact same amount as my mortgage funding.

[chrishall1]

THINK..........There is one person who benefits from this move and its not you. In a perfect world you could benefit from it. However, you have to have some good disposable income to join in this Manoeuvre. If you perform this technique you will stimulate the economy on your own. Just think of all the investment fees/expenses you can encounter.
Unfortunately we all make the fatal mistake of thinking a house as a place to live and not, an investment. Or rent out 3/4 of your house and have someone else pay your mortgage. We all stimulate the economy and the Smith Manoeuvre is just another vechile to maximize your "economy stimulating potential". Here is the kicker you have to pay $25 for the advise.
Yes, if you are in a 50% tax bracket then you can afford to perform this technique and you don't really need to because you have offshore accounts set up.
For the average joe earning $30 - 50 thousand dollars a year you are out of luck. Work your butt off and pay down your mortgage ASAP. Maybe when you reach an acceptable mortgage amount you an perform this technique.
But, again what is an acceptable amount?

Isn't life great and full of wonders...........





Any homeowner here using the Smith Manoeuvre technique? I am a fan of leverage investing. I do not own a home at the moment but when I do, I probably will set up Smith Manoeuvre on it. I totally bought his idea of retiring without the house paid off but owing a lot more investments instead.
In long term, a prudent leverage strategy almost always trump a non-leveraging one.

[grant]

Chrishall, your only post on this board is on a 3-month-dead thread... your post is nearly incoherent, you're ranting like a conspiracy theory communist. Do you really expect anyone to take you seriously? Why did you waste your time typing out that nonsense?

It looks like you have some kind of axe to grind on the subject so you troll search engines looking for forums in which to unload that chip on your shoulder.

[IceMan77]

It may be dead, but I'm glad he posted. i almost forgot about this thread. There's some good techniques mentioned in this thread. Mark's example is especially good. I'm going to see if I can put this thing to good use.

[spesci]

Hi can anyone comment on whether they have successfuly or un-successfuly implemented the Smith Manoeuvre?

Thanks

[pitz]

Hi can anyone comment on whether they have successfuly or un-successfuly implemented the Smith Manoeuvre?


I've made pretty good money over the past couple years using the basic techniques, albeit I have used a margin account, and *not* real-estate secured borrowing to do so.

The advantage of the Canadian market is that its somewhat counter-cyclical to rising interest rates, because of its heavy commodity and commodity-derived content. But on the flip side, when the economy slows down, unlike the US markets, the Canadian markets do not see outsized gains like the US ones traditionally have. The Nortel incident of the early 00's aside, the Canadian markets have been among the least volatile and best performing anywhere -- perfect for the Smith Manouevre.

Basically put, you can only be reasonably successful at the Smith Manoueuvre if you do the following:

1) Dollar-cost average your borrowing and your investing.
2) Minimize all hidden costs, spreads, commissions, management fees, account fees, cash loads, etc.
3) Don't invest in tax innefficient assets.
4) Don't invest in stuff that is highly correlated with real estate.
5) Don't get too greedy. Just because you can leverage your borrowing several times doesn't mean its wise.
6) Match currencies. Don't invest Canadian-dollar borrowed funds in US securities unless you also buy Canadian dollar futures to hedge.
7) Don't invest in companies that have extremely high levels of debt on their balance sheets. This means, generally speaking, avoid all income trusts.

I'd probably also be wary of borrowing too much against inflated real estate values to a large extent, especially if you are going to be somewhat stretched to pay the loan off at the end of the term.

[pitz]

Might I also add that the arguments for the Smith Manouevre, especially from a dividend investing style, are better today, than ever, due to recent changes in the federal budget concerning dividend taxation. In fact, for some income levels, receiving dividend income will actually save you money on taxes (negative incremental tax rate) and increase benefits entitlement (such as GST credits).

Now if Harper would live up to the election 'promise' of deferring the capital gains tax on re-invested monies....

[grant]

I've made pretty good money over the past couple years using the basic techniques, albeit I have used a margin account, and *not* real-estate secured borrowing to do so.
The smith maneuvre by definition involves "real-estate secured borrowing" (on your primary/vacation residence).

While you may be a savvy investor, what you described is off-topic.

[pitz]

While you may be a savvy investor, what you described is off-topic.

Please read what I wrote before making blind comments. All of the attributes of margined investing also apply to the Smith Manouevre. To suggest otherwise is just being ignorant of what the Smith Manouevre is, and that is, leveraged investing.

[grant]

Please read what I wrote before making blind comments. All of the attributes of margined investing also apply to the Smith Manouevre. To suggest otherwise is just being ignorant of what the Smith Manouevre is, and that is, leveraged investing.
Actually the smith manouevre is about making your otherwise-non-deductible mortgage interest deductible.

I think you do a disservice to people when you call it simply "leveraged investing" (which implies increased risk) when in fact, the textbook Smith Maneuvre results in NO increased borrowing.

Furthermore, the typical smith maneuvre results in the mortgage funds being invested in the owners own small business. This is not 'leveraged' investing. (very few people have a large enough non-rrsp equities portfolio to use that as the target of their entire mortgage.)

It is very rude of you to call me "ignorant" when I have in fact spoken to several national experts on this subjects in person as well as reading their literature.

If you think the smith maneuvre is nothing more than "leveraged investing" then I am sorry that your otherwise sharp financial acumen is being wasted on this subject, and I respectfully suggest it's you who ought to read more.

[mork]

And I asked around and most people will answer, it is never wise to borrow to invest. Just my 2 cents.


I've done a fair bit of reading on investing, and one of the things I realized early was;

'Buy stuff with money you have. Invest with money you don't have.'
(let's call that the mork manoeuvre).

All for the exact reasons described here.. the interest on money borrowed for an investment is tax deductable..

Most people do the opposite of my above statement.. and think they should never invest with borrowed money as their investments could go south and they'd have nothing to show for it but debt.

However, let's take an example (let's forget real-estate all together for the moment) of some dude who plans to do 2 things this year:
1) Buy a new car for $25,000
2) Start his investment portfolio with $25,000

He has $25,000 in cash laying around. Most people would recomend he finance the car and invest the $25k... but why? He should buy the car for cash (with money he has) and take a loan to invest with (money he doesn't have).

Assume, in this world, his interest rate is the same in either case. He still spent his $25k, and still ended up with both the car and the investments. Only by spending the money he has and investing some borrowings, he now has 'good debt' - that is, the interest is tax deductable.

so far, no risk at all as best as I can tell. And if he is risk adverse, he can simply pay down his loan just as he would've paid off the car over a few years. At the end, he's got his car (which is probably now worthless, but that is beside the point) and his investments (regardless of their losses/gains) and for that period of time the interest was tax deductible.

another realization is that we are all consumers. Replace car with whatever - could be a new bedroom set, whatever..

where's the risk? (Assuming he would have otherwise invested anyways - and most advisors would suggest you start building a portfolio as soon as possible.. this allows people to do it even sooner!).

Maybe there's something I'm missing, but the Smith Manoeuvre aside (so far as real estate goes) seems to be a specific application of the mork manoeuvre, doesn't it? Essentially buying your house with money you have and buying investments with money you don't have.

so, in the situation above, is it not wise to borrow to invest?



Yes, it is true it is never wise to borrow to invest.


Let's go even simpler and smaller.. Your friend gives you a hot tip, he's getting a few people interested, and tells you it is an opportunity you should not miss. You have $1k to blow.. he's looking for an investment of $1k. You also need a new couch, and the one you want to buy is $1k. You decide to go for it! Invest your $1k and finance the couch to keep your wife happy.

I can't imagine there being much of an argument for doing that. You'd be better off buying the couch with cash and borrowing $1k to invest in your friends scheme. The interest on your borrowings is then tax-deductible (and probably at a better rate than you'd get from a financing through a furniture store).


Interesting thread!

[pitz]

Most people do the opposite of my above statement.. and think they should never invest with borrowed money as their investments could go south and they'd have nothing to show for it but debt.


Exactly! Fraser Smith, being the entrepreneur that he is, threw his name on it, applied the basic concepts to real estate, and sells a book that makes him a lot of money.

Any way you slice it, whether you want to call it the mork manouevre, the Smith manouevre, or tax-deductible leveraged investing, its all exactly the same thing.


where's the risk?

The risk is that you make the investments into things that lose their value. For instance, imagine that you are a young engineer who was given a $100k/year job in San Jose or Seattle at the height of the tech boom hiring. for a startup. You use the $100k/year job offer to get a mortgage on a million dollar house, using the $50k you have saved up for the downpayment.

2001 rolls around, your house has gone up by $200k, so you pull the equity out, and buy a bunch of tech stocks.

2002 rolls around, the startup has gone bankrupt, real estate collapses, and those tech stocks that you borrowed money to invest in are worthless. You have negative net worth at this point, no job, and live in one of the most expensive places to live in America. Unless you pull off a miracle and find another good job, you would be insolvent.

Plus mork, our profession expells us if we go bankrupt, and expulsions and bankruptcies are a matter of public record. The risk is also to our reputations. Try getting liability, or E&O insurance as a bankrupt, or even as a discharged bankrupt. Its going to expose you to a lot more scrutiny, and higher premiums, I can assure you of that.

[dark169]

to pitz's post:

you should never invest too much in the industry/sector you work in. As your job is probably your largest source revenue generation, if your loose your job in a industry downturn its quite a kick in the pants to have your remaining investments tank as well :lol: I dont have alot of sympathy for peopel who went from being very rich on paper to very broke in real life beucase they held lots of shares.

[mork]

The risk is that you make the investments into things that lose their value.

I still think the risk is in the investment itself.. not in the fact that you borrowed money to invest with. With the $25k car example I gave above, if he was going to invest $25k anyways, doing so with borrowed money I don't think adds any risk.

Now, if he was off to buy a car and had no intentions of investing, I'm not suggesting he should absolutley borrow money to invest - that is adding risk.

I guess I'm saying that if tomorrow I was planning to buy $5k of some stock, I'd do it with borrowed money. The general thinking is the opposite - 'oh, I've come into a few thousand dollars. I should invest it.' - These same people later finance a purchase of some kind. It's all opposite. :)

[canadiantofu]

Exactly! Fraser Smith, being the entrepreneur that he is, threw his name on it, applied the basic concepts to real estate, and sells a book that makes him a lot of money.

Any way you slice it, whether you want to call it the mork manouevre, the Smith manouevre, or tax-deductible leveraged investing, its all exactly the same thing.



The risk is that you make the investments into things that lose their value. For instance, imagine that you are a young engineer who was given a $100k/year job in San Jose or Seattle at the height of the tech boom hiring. for a startup. You use the $100k/year job offer to get a mortgage on a million dollar house, using the $50k you have saved up for the downpayment.

2001 rolls around, your house has gone up by $200k, so you pull the equity out, and buy a bunch of tech stocks.

2002 rolls around, the startup has gone bankrupt, real estate collapses, and those tech stocks that you borrowed money to invest in are worthless. You have negative net worth at this point, no job, and live in one of the most expensive places to live in America. Unless you pull off a miracle and find another good job, you would be insolvent.

Plus mork, our profession expells us if we go bankrupt, and expulsions and bankruptcies are a matter of public record. The risk is also to our reputations. Try getting liability, or E&O insurance as a bankrupt, or even as a discharged bankrupt. Its going to expose you to a lot more scrutiny, and higher premiums, I can assure you of that.

I think you are missing an initial piece in your interpretation of the smith manoeuvre.

The original intent was that the investor had both a mortgage and investment in place to begin the manoeuvre. The investment must be able to cover the mortgage amount.

In terms of carrying risk.... The investor would have been carrying (investment/business) risk in the first place in order for him/her to have the investment$$ portion of the flip.... Therefore, the net affect of risk is Zero.
E.g. I sell 100k of home depot today to pay off my mortgage, and then buy
100k of home depot tomorrow via my loan.
There would be no addition leveraging of equity. Just additional avenues for tax savings.

[spesci]

Thanks for the discussion guys, I really enjoy reading your posts.

Here is my scenario:
Age: 27 (don't think that matters)
Location: Toronto

In the proccess of buying my first house and I will likely carry about a 225K mortgage. I do not have much experience with investing, but have a general understanding of the various concepts etc..

I just can't see myself investing 225K which is what would happen if I executed the Smith Manoeuvre to the fullest, I don't think I could stomach the risk.

I think I will seek the aid of a financial adivsor to assist me in planning to start investing (with borrowed money of course).

Does anyone have any advise for me on where to begin and the general do's and don'ts?

Thanks in advance :cheesygri

[pitz]

In the proccess of buying my first house and I will likely carry about a 225K mortgage. I do not have much experience with investing, but have a general understanding of the various concepts etc..


You probably need to supply more information, for instance, how much of a downpayment you are applying.

The Smith Manoeuvre really doesn't work for people who don't have equity. Ideally, to make sure you don't get wiped out if real estate declines, you would require a minimum of a 25% down payment. This also avoids the CMHC insurance and qualifies you for conventional financing.

If you have the 25% down, you go to your banker and you request one of the following:

1) A line of credit style mortgage (ie: Manulife One, or similar) or HELOC.

or alternatively,

2) An amortizing mortgage, that also includes an embedded line of credit, where a credit facility is extended against the principal repaid on the amortizing mortgage.

Generally speaking, the second option is the one that works out the best, as the portion that amortizes can either be at a fixed rate, or floating, your choice, at a very competitive rate (LIBOR + 100bp is a decent rate, whereas most HELOCs or Manulife One charge LIBOR + 175bp).

Once you get that setup -- then you start making payments and building up equity in the property, reducing your non-deductible mortgage balance. You then 're-borrow' these funds from the LOC associated with the mortgage, and invest them.

The investments you choose will pay dividends. These dividends should be siphoned out of your investment account, applied against your non-deductible mortgage debt, and then cycled back out into your investment account through 'reborrowing'. The dividends re-invested, of course. So a user of the "Smith Manoeuvre" will want to ensure that they are not enrolled in any automatic dividend re-investment plans.

Minimizing costs and commissions is of the utmost importance, especially since you will be investing every month. I suggest you get an account with Interactive Brokers, because the fees are so low as to facilitate the investment.

Obviously it goes without saying that you want an investment portfolio that pays, to some extent, dividends, to accelerate the process of swapping non-tax-deductible debt with tax deductible debt. But of course, a cardinal rule when it comes to investing is never chase yield!. Buy stocks and indicies based on their fundamentals, never based on their 'dividend' or 'income' yield.

If you are going to work with a 'financial advisor' or 'financial planner', I would strongly suggest that you work with one that is not a salesman. Stay away from traditional mutual funds as well. They significantly reduce the probability of profit, usually don't pay much in terms of dividends, are tax innefficient, and often come with large charges to buy and sell.

Also, be careful about investing in foreign currencies. You might want to hedge your exposure to the USD or any other foreign currencies using futures contracts or derivatives, especially since your mortgage is denominated in Canadian dollars. Certain types of investments already have this hedging built-in, at a very nominal cost.

[grant]

Does anyone have any advise for me on where to begin and the general do's and don'ts?
Yes: borrow a book, surf the web, go to seminars until you understand the specifics.

Find an accountant or financial planner who understands this technique and will guide you.

Don't start borrowing & investing just because someone will lend you money. This is a technique to be used with existing investments.

Unless you have a $225,000 portfolio outside your RRSP, you will have to use this technique by flowing through your personal business. If your part-time endeavor has $25,000/yr cash flow, you can make your mortgage fully deductible in 9 years.

[AlexH]

I think you are missing an initial piece in your interpretation of the smith manoeuvre.

The original intent was that the investor had both a mortgage and investment in place to begin the manoeuvre. The investment must be able to cover the mortgage amount.

I haven't read the book, so this may be answered in it, but how would one take advantage of this if they don't have the investment in place, and are just beginning to build equity? I guess just pay off your mortgage as fast as possible vs putting money away in investments?

EDIT: Oops, grant's reply came in before I submitted my reply. n/m. :D

[don242]

Just a question about this. If you borrow money from your home equity using this smith manouvre, you now end up paying your monthly mortgage payment as well as an additional payment on the money you borrowed? So you must be in the position to handle additional monthly payments in order to do this?


I am not planning on doing this and would obviously need to do a lot more research. Just had the question for interest sake.

[pitz]

Just a question about this. If you borrow money from your home equity using this smith manouvre, you now end up paying your monthly mortgage payment as well as an additional payment on the money you borrowed? So you must be in the position to handle additional monthly payments in order to do this?

When you qualify for a mortgage, you are already qualifying for the maximum possible accrual of interest, and that is, at the beginning of the mortgage.

Unless of course you manage to find a 'negative amortization' mortgage in Canada. But as far as I know, those mortgages (where principal actually increases over time) are confined pretty much to the USA.

Essentially with the Smith Manouevre, instead of accumulating equity in your home, you accumulate equity in a stock portfolio. Fraser Smith, on his website, in an interview puts it best -- when you use the Smith Maneouvre, you are intending to take out a mortgage or loan that you never repay. If you follow Smith's advice, you will always be in debt. Not a bad thing, however, because its deductible debt that will save you $$$ on taxes every year that you keep the loan open.




I am not planning on doing this and would obviously need to do a lot more research. Just had the question for interest sake.

Do I see a pun there ? ;)

[natefive]

I have used borrowed money to invest for almost 10 years now. Yes, there are risks involved, but if you invest wisely the payout can be great.

Think of it this way...

Option A (borrowing):

You borrow $50,000 at prime. For simplicity, we'll say your monthly interest payment will be $200. It will actually be ~ $170.

Option B (invest monthly):

Instead of borrowing the $50,000, you decide to invest that $200 per month you would've paid to interest.

Again, for simplicity, we'll say you invest in a mutual fund that has averaged about 10% over the last 15 years. Granted, future performance is not guaranteed, but let's say it's safe to estimate an 8% return over the next 15 years.

After 15 years you would have...

Option A: ~ $165,000 minus the $50,000 = ~ $115,000 net (before taxes)

Option B: ~ $69,000 net (before taxes)

Now, to make it more complex. Since the $200 interest payment for Option A is tax deductible, you will get part of that money back. Say you get $75 of it back. So, what if you also invest that extra $75 per month on top of the $50,000 lump sum. After 15 years, Option A now becomes even better....

Option A: ~ $191,000 minus the $50,000 = ~ $141,000 net (before taxes)

So, again, you have invested $200 a month for 15 years. This is a total of $36,000. Which would you rather have? $141k or $69k?

Where this arguement might break down is when you have higher interest rates. So let's look at how high the rates have to be before this theory falls apart.

Let's say prime increases to 7.25% and your monthly interest payment increases to $300. Remeber, all of that is still tax deductible and you'll get about $125 of that refunded. You will still reinvest that refund. So for Option B, you are going to invest $300 a month for 15 years. The results are...

Option A: ~ $209,000 minus the $50,000 = ~ $159,000 net (before taxes)

Option B: ~ $104,000 net (before taxes)

Even at prime = 7.25% Option A is still clearly the best option.

What if prime is 10%? Your monthly interest payments would be $420. Still tax deductible and say $175 of that is refunded. Invest as before for 15 years in the same mutual fund that will get you 8% a year.

Option A: ~ $226,000 minus the $50,000 = ~ $176,000 net (before taxes)

Option B: ~ $145,000 net (before taxes)

Granted -- income taxes and fluctuating interest rates makes these comparisons less black-and-white. But it should be clear that the strategy can pay off even when interest rates exceed the rate of return on the investment.

Other uses for the bigger tax refund you will get...

1) contribute it to an RRSP
2) pay down your mortgage
3) pay down the line-of-credit or investment loan
4) 2 weeks in Disney World
5) pay down any credit cards or car loans

Yes, I hate to admit it, but last year's income tax refund went towards our trip to Disney World. This year's refund went to the mortgage.
Can someone explain this to me? Why would the net increase if the interest rates increased?

[don242]

Can someone explain this to me? Why would the net increase if the interest rates increased?
I think in the example, the net increase in Option B is because it is assuming you are investing your interest payments on the loan. As prime increases, so does your loan payments and therefore the amount you would invest in Option B.

[dark169]

Can someone explain this to me? Why would the net increase if the interest rates increased?

the amount at the end of 15 years in case B is the amount of intrest your would be paying if you went plan A. He's assuming that if your choice are to pay the intrest on a loan OR invest that same montly payment into an investment. so with higher rates he's assuming you can afford to pay the now higher intrest, some what flawed as your monthly payment (or investment) should be the fixed varible not the investmetn loan amount

[Da Man]

I've been doing something similar to this for myself and my clients. I do a more advanced version of this method. For myself on funds invested I have done from 40%-60%+ returns in some years. On average my clients due to their lower risks have done around the 20% range on average. The ones with much lower risk are around 8-9%+ returns. I personally believe in heavy leveraging, though it is not for everyone. If you make decisions upon greed and do not know what you are doing, then you will lose alot. If you make smart decisions based on knowing what you are doing, than you can make alot as well. It's a double edged blade.

[grant]

Just a question about this. If you borrow money from your home equity using this smith manouvre, you now end up paying your monthly mortgage payment as well as an additional payment on the money you borrowed? So you must be in the position to handle additional monthly payments in order to do this?
People in this thread keep missing the point.

The smith maneuvre is all about your existing mortgage.

It's not about borrowing more money!!

[JacobStile]

Hello,

Have been lurking on RFD for a while now but decided today to register and submit my first reply.

I am intrigued by this Smith process but would like to determine if I am a good candidate for it. Here is my current situation:

1) Vancouver condo purchased for $323K
2) $120K (37%) downpayment
3) $203K outstanding mortgage
4) variable rate mortgage, renews in 6 years
5) weekly mortgage payments of about $290/week
6) approved for up to $240K of mortgage from the bank
7) $10K LOC also available
8) approx. $10K in RRSPs
9) approx. $10K in stocks

Thoughts?

[grant]

would like to determine if I am a good candidate for it.
At this point, not really.



3) $203K outstanding mortgage
6) approved for up to $240K of mortgage from the bank
9) approx. $10K in stocks

those are the only points that matter.

1) Sell the stocks
2) pay down your outstanding mortgage to $193k
3) start a new HELOC
4) re-purchase that $10k in stocks.

Voila, now $10,000 of your mortgage accrues deductible interest. However, to convert the other $193k, you will need to be operating a small business.

[dark169]

Hello,

Have been lurking on RFD for a while now but decided today to register and submit my first reply.

I am intrigued by this Smith process but would like to determine if I am a good candidate for it. Here is my current situation:

1) Vancouver condo purchased for $323K
2) $120K (37%) downpayment
3) $203K outstanding mortgage
4) variable rate mortgage, renews in 6 years
5) weekly mortgage payments of about $290/week
6) approved for up to $240K of mortgage from the bank
7) $10K LOC also available
8) approx. $10K in RRSPs
9) approx. $10K in stocks

Thoughts?

So you havent made a single mortage payment yet? as your outastanding mortage is your purchase price - your down payment. anway.

grant has it right, now if your setting aside a portion of your takehome for investment savings, redirect that to mortage principal payment and then withdraw it from your HELOC and invest. Same goes for any income from your investments. So end of the day your debt load hasn't changes at all, your investing like normal and yet your shifting debt from nontaxdeductable to tax deductable.

[hello99]

Can the investment be another home like a rental property?

[JacobStile]

Many thanks to Da Man, grant and dark169 for their advice. Very much appreciated.

Sounds like what I will do is:

1) get approval for the BMO interest-only HELOC at around 39K
2) cash out the stocks
3) push cash out into mortgage
4) borrow against HELOC amount paid down on mortgage
5) reinvest
6) deduct interest charges on LOC come tax-time
7) do the happy dance

I suppose going into the future, whenever I find myself with money that I would put against the mortgage, I should do that (pay the mortgage down) and then just pull more out on the LOC.

Mortgage owing decreases. LOC owing increases. Overall debt remains the same.

I guess that's the basic principle. Does not seem that hard.

Thanks again.

[grant]

1) get approval for the BMO interest-only HELOC at around 39K
4) borrow against HELOC amount paid down on mortgage
6) deduct interest charges on LOC come tax-time

yes... you borrow from your HELOC and use the proceeds to purchase an investment.

Read a book, talk to an experienced professional, and keep your paper trail simple... it's simple to many people but as this thread demonstrates, it seems like black magic to many.

[pitz]

1) get approval for the BMO interest-only HELOC at around 39K
2) cash out the stocks
3) push cash out into mortgage
4) borrow against HELOC amount paid down on mortgage
5) reinvest
6) deduct interest charges on LOC come tax-time
7) do the happy dance


8) Use the dividends from your stocks to help accelerate the mortgage pay down. This will accelerate the process. DO NOT use automatic dividend re-investment -- this will be detrimental to your success.

As the stock account builds up, you can gradually move away from borrowing against the house, and instead, borrow against the stock portfolio. Eventually you can be mortgage-free (and free of any restrictive covenants related to mortgages), and any collapse in your stock portfolio would have limited recourse to your principal residence.

Plus, historically speaking, mortgages are more expensive than equity-secured borrowing if you shop around. If the rate of foreclosures starts picking up, especially in the United States, lenders are going to start demanding much wider spreads on mortgage lending, versus stock lending.

[dark169]

Can the investment be another home like a rental property?

yes as long as there is an expectation of income. It doesnt work if your renting the house at a loss or subsidizing someons rent (kid at school / parents ect)

[circa76]

When you qualify for a mortgage, you are already qualifying for the maximum possible accrual of interest, and that is, at the beginning of the mortgage.

Unless of course you manage to find a 'negative amortization' mortgage in Canada. But as far as I know, those mortgages (where principal actually increases over time) are confined pretty much to the USA.

Essentially with the Smith Manouevre, instead of accumulating equity in your home, you accumulate equity in a stock portfolio. Fraser Smith, on his website, in an interview puts it best -- when you use the Smith Maneouvre, you are intending to take out a mortgage or loan that you never repay. If you follow Smith's advice, you will always be in debt. Not a bad thing, however, because its deductible debt that will save you $$$ on taxes every year that you keep the loan open.



I don't see the point of never paying back the loan. I mean, yes you save on taxes but those savings won't even make up what you actually pay out in interest.

So when you have the "mortgage" paid off, and you're sittting on a 100% LOC loan, then the next move to make it pay down the loan (by now you should have enough in your investments to pay off the loan and still have money leftover for emergencies). Use the savings in interest to invest. Eventually, you'll own the house and not have a lein against it. That should be the end state of the Smith Manouvre IMO.

[dark169]

I don't see the point of never paying back the loan. I mean, yes you save on taxes but those savings won't even make up what you actually pay out in interest.

So when you have the "mortgage" paid off, and you're sittting on a 100% LOC loan, then the next move to make it pay down the loan (by now you should have enough in your investments to pay off the loan and still have money leftover for emergencies). Use the savings in interest to invest. Eventually, you'll own the house and not have a lein against it. That should be the end state of the Smith Manouvre IMO.

my understanding is you can pay back the loan (or LOC) at the same rate as you would have paid back your mortage. So for example if your expected to be mortage free in 15 years. At the end of those 15 years your mortage has long been transfered to your LoC and your LoC would have been paid off. But rathe rthen pay back the LoC you've been investing those same $$'s the idea being that the LoC's rate minus the tax deduction is less then a reaonsable reate of return.

[pitz]

I don't see the point of never paying back the loan. I mean, yes you save on taxes but those savings won't even make up what you actually pay out in interest.


If you believe that, then you should stay well away from the Smith Manouevre altogether.

The underlying assumption about the Smith Manouevre (or any form of leveraged investing) is that you use borrowed money to fund investments, with the investments returning more than the borrowed money costs (all on an after-tax basis, of course).

If that condition does not exist, then your losses are amplified. It is not a scheme without risk.



So when you have the "mortgage" paid off, and you're sittting on a 100% LOC loan, then the next move to make it pay down the loan (by now you should have enough in your investments to pay off the loan and still have money leftover for emergencies). Use the savings in interest to invest. Eventually, you'll own the house and not have a lein against it. That should be the end state of the Smith Manouvre IMO.

1) Typically, if you invest in liquid instruments (stocks, many mutual funds, etc.) and you want a lien-free house, you can simply pledge the investments as collateral to secure new loans to replace the housing-secured loan.

2) Since a quality portfolio of equity investments typically grows faster than a house does, in value, by the time you have the 'mortgage' (being the non-deductible debt) paid off, the investments have appreciated substantially in value.

Often, people will end up having a $600,000 portfolio, and a $300,000 LOC, and a $500,000 house, if they started out with a $300,000 mortgage and a $400,000 house. Now, houses may not continue to go up in value, and stocks might not continue to go up in value as well, but the user of the Smith Manouevre actually is reducing overall portfolio risk by being exposed to a much greater diversity of assets.


Think of it this way -- if someone told you to invest 100% of your portfolio in a single, illiquid, small-cap stock, that had a 5% commission to buy or sell, and required 2% of its value to be paid every year as 'taxes', would you buy that investment? Sounds absurd, eh? But thats exactly what happens when you buy a house, and is a terrible thing, long-term, for one's portfolio.

[circa76]

1) Typically, if you invest in liquid instruments (stocks, many mutual funds, etc.) and you want a lien-free house, you can simply pledge the investments as collateral to secure new loans to replace the housing-secured loan.



Well for me I just don't like having a lein against my home for any longer period of time than necessary. After all, there's a certain sense of freedom knowing you own your property outright.

And you're right, you can use your portfolio as collateral, but unfortunately at only 50% of its value.

[pitz]

And you're right, you can use your portfolio as collateral, but unfortunately at only 50% of its value.

25% (for S&P500 stocks), or 30% (for certain Canadian stocks on the LSERM list) margining is also available.

Generally speaking, you are investing in some fairly volatile/risky stuff if its not on the 25% or the 30% list.

[JacobStile]

Hello pitz,

I just got off the phone with CRA and spoke to a lady there regarding eligibility requirements for deducting interest expense. Her summary was:

-had to be a Canadian investment
-had to provide either a) dividends or b) interest return
-interest expenses are not deductable if the investment return results in a capital gain (ie. buy some common shares, sell them, earn $X profit, $X profit is a taxable capital gain and therefore interest expense is not deductable).

So I guess the trick now would be to find some killer Candian stocks or mutual funds that provide dividends.

Does this sound about right? I really was hoping to include US securities in my portfolio under this method.

Thoughts?

[pitz]

-had to be a Canadian investment
-had to provide either a) dividends or b) interest return
-interest expenses are not deductable if the investment return results in a capital gain (ie. buy some common shares, sell them, earn $X profit, $X profit is a taxable capital gain and therefore interest expense is not deductable).


A lot of mistruths there.

1) Doesn't have to be a Canadian investment at all. Country doesn't matter, nor does the denomination of the currency you borrow.

2) The test is much more complicated than just looking for immediate dividends or interest. In essence, the test is that you must invest in a business entity with a reasonable expectation of profit, or debt obligations that have a reasonable prospect of repayment.

3) Not entirely true. The test is whether or not the investment is *capable* of paying dividends or interest. Not the actual fact of payment of dividends or interest.


For example, if you invest in a growth stock that does not pay dividends, this would be an eligible investment, since there is the possibility that, at some point in the future, dividends would be paid.

If you invest in a bar of gold, however, this would not be an eligible investment, since gold cannot produce income or dividends, but can only produce a capital gain or loss.

Don't expect the CRA to give you detailled legal advice concerning the interpretation of the Income Tax Act. They are not in the business of doing so, and any 'advice' given by the CRA is not binding upon them anyways.


I really was hoping to include US securities in my portfolio under this method.

Sure, go for it! You might want to ensure that you are borrowing US dollars if you are investing in US securities however. Unless you are confident enough that they will rise substantially in value if the US dollar slides.

Borrowing USD also saves forex costs.

[Hubster]

Subject: National post article


Pe r s o n a l F i n a n c e
Strategy looks like a revolution

Making your mortgage tax-deductible
J O NAT H A N C H E V R E AU
Financial Post



Four years after Fraser Smith self-published an eponymous book named the Smith Manoeuvre, the mortgage industry has seized on his technique for helping Canadians make home mortgages tax deductible.

About 200 mortgage brokers and financial planners met yesterday in Toronto to team up to exploit the strategy. Some - like Victoria's John Gallo and Guelph, Ont.'s Walter Dixon - are building their practices around the technique. This amounts to paying down your mortgage as quickly as possible, then repurchasing securities with a tax-deductible investment loan.

Smith, whose speaking fee has soared to $10,000, says his book has sold 26,000 copies, with 10,000 more being printed. After spreading the word in British Columbia in the 1990s, Smith decided to let the rest of the country in on the secret in 2002, when he retired and wrote the book. It was a brief retirement. Now 68, Smith is about to publish a follow-up called the Smith/Snyder Manoeuvre, aimed at helping Canadians build up personal pensions.

But the buzz in the mortgage business revolves around the first book, which now uses Is your mortgage tax deductible? as the main title, with the Smith Manoeuvre relegated to subtitle status.

Unlike the United States, Canadian mortgages are not normally tax deductible. However, by properly restructuring one's affairs, it's possible to use certain types of flexible mortgages - the Matrix mortgage from First Line Mortgages in particular - that gradually convert non-deductible mortgage debt into deductible investment loans.

In a four-hour presentation that began to the beat of George Harrison's Taxman, Smith said wealthy Canadians routinely use such techniques. The average strapped home-owner/taxpayer tends to defer making non-registered investments until the mortgage is paid off. But if they wait until a 25-year mortgage is fully amortized, they'll have no time left to build up a decent investment portfolio. Smith says the Canadian "nightmare" is to pay off a mortgage on retirement day at 65, then go back into debt the next day with a reverse mortgage to fund cash flow.

Smith has a dim view of reverse mortgages, which he says should be used only as a last resort. But the banks are gearing up to market them because they know it's the future.

Smith uses the image of a double elevator to describe his manoeuvre. You start out with a $200,000 mortgage that is not deductible. Every spare dollar is pumped into paying down the principal. With the Matrix mortgage or equivalent, each dollar knocked off principal is pumped back into a loan to buy investments, the interest on which is tax deductible.

Gradually, the mortgage falls to zero and the investment portfolio soars to $500,000 - assuming 10% returns over 22 years (a net $300,000 if you subtract the debt which remains in place).

Smith doesn't consider this "leverage" because the total debt remains the same - the real leverage was borrowing to buy the house in the first place.

Karl Straky, president of the Mortgage Training Group Inc., says the technique is "spreading like wildfire" because of referrals from happy customers. "People don't realize that a $300,000 house costs them $1-million after interest and taxes."

Obviously, the big banks aren't greatly motivated to tell consumers about it and the government's revenue arm would just as soon the little people didn't emulate the wealthy in their tax-effective wealth accumulation strategies.

Smith says the technique has never been challenged by any accountant, lawyer or the Canada Revenue Agency. Nor does he expect the CRA to change the rules if the movement gets too popular. That's because the technique requires reinvesting back into the economy.

Strangely, the net result on Canadian society may be more positive than in the United States, where mortgage interest can be deducted with no strings attached. But Americans tend to spend the savings on everyday consumption rather than invest it in securities. Because of Ottawa's stinginess, those disciplined enough to adopt this perfectly legal strategy are forced to invest regularly. In the long run that's arguably best for both the individual and the country.

Smith's Web site at www.smithman.net lists 375 financial planners across Canada already using the technique. He foresees a huge opportunity in the $600-billion Canadian mortgage market. Citing Statistics Canada, Smith says

10.5 million families are evenly split between renters, homeowners with mortgages and those who own their homes free and clear. That means seven million families are prospects.

On the investment side, the technique uses Stone and Co.'s Flagship Growth & Income Fund Canada. It's a blue chip balanced fund that aims to distribute 1% of the investment per month via a tax-deferred Return of Capital method.

Judging by the gleam in the eyes of most attendees, Smith's manoeuvre is the real deal. It may be nothing short of a revolution.

jchevreau@nationalpost.com

[pitz]

Smith doesn't consider this "leverage" because the total debt remains the same - the real leverage was borrowing to buy the house in the first place.


Still leverage nonetheless. Smith has never lived in a country which experienced deflation, but his so-called 'manouevre' would be laughed at in Japan which has experienced prolonged deflation in both equity markets and housing markets.


Obviously, the big banks aren't greatly motivated to tell consumers about it and the government's revenue arm would just as soon the little people didn't emulate the wealthy in their tax-effective wealth accumulation strategies.


Banks are in the business of selling product and they do not employ staff, at the branch level, who are capable of giving professional tax advice.

Further, anything that accelerates the availability of funds for discharge of a mortgage is going to be resisted by the banks.



Strangely, the net result on Canadian society may be more positive than in the United States, where mortgage interest can be deducted with no strings attached. But Americans tend to spend the savings on everyday consumption


Not quite true either, mortgage deductibility is reduced or eliminated with Alternative Minimum Tax for certain high-income earners.

The Canadian system is actually more generous because it allows a full deduction against income, and any capital gains on the principal residence are tax-exempt.



On the investment side, the technique uses Stone and Co.'s Flagship Growth & Income Fund Canada. It's a blue chip balanced fund that aims to distribute 1% of the investment per month via a tax-deferred Return of Capital method.


If the fund is distributing 1% per month, eventually they are going to have to distribute capital gains. And of course, being a mutual fund, its statistically likely to underperform the index in after-tax returns.

I'd also be concerned about the fund holding bonds. With a flat yield curve, there is nothing to be gained by simultaneously doing the Smith Manouevre, and holding bonds.

Hedged foreign content should also help to reduce overall risk. The Smith Maneouvre obviously works best if one can take advantage of the Canadian dividend tax credit as well.

[rtsen]

So I went out and bought the book; it was an easy read and I finished it in a couple days. He seems to repeat a lot of the stuff in each chapter haha. The basic principle is fairly easy to understand however it seems like the method is more tailored for equity investment and not real estate investments.

Here’s a scenario:

1) Principle house mortgage - $200k@4%
2) Rental property mortgage – $200k@5%, rent = expenses = $1000/month
3) $100k in cash

So Smith Manoeuvre tells us to apply the $100k towards our first mortgage and reborrow the equity to invest. Assuming you get approved for 75% of your equity, you should have a $75k HELOC @ 6%.

What do you do now?
1) Invest the $75k into the rental property. That reduces the principle of your rental property but the interest % of the HELOC is higher than the mortgage. Also if the property is a rental, isn’t the interest already tax deductible?
2) Invest in another rental property? Since Smith Manoeuvre assumes your debt is constant and $400k is your max allowable debt, you have only have $75k to find another property; which is very difficult to find.
3) Invest the $75k into stocks and hope that your Rate of return is greater than 6%

Is this the idea?

2nd question: in the book, Smith mentions Cash Flow Dam, how does this work?
Using the scenario above:
1) Principle house mortgage - $100k@4%
2) Rental property mortgage – $200k@5%, rent = expenses = $1000/month
3) $75k HELOC @ 6%

Renter pays you $1000; you use that $1000 to pay your house mortgage on top of your regular monthly payments. Then you use the HELOC to pay the mortgage of the rental property. Is this right? If this is correct, then you pay off your house mortgage more quickly but the interest is the lowest of the 3. So you are paying more taxes per month then you have to but your tax-deductible portion is greater so you get a bigger tax return.

Damn, seems like a lot of writing and questions; I appreciate any help/explanations that people can give me. Thanks in advance.

[pitz]

1) Invest the $75k into the rental property. That reduces the principle of your rental property but the interest % of the HELOC is higher than the mortgage. Also if the property is a rental, isn’t the interest already tax deductible?


Sure, but the Smith Maneouvre is all about obtaining a tax deduction on your original mortgage.

Obviously, you can re-leverage equity a number of times, up to the margin requirements established by your lenders.

For instance, with stocks, you could use the $75k to purchase $300k of US stocks (on 25% margin), or even up to $1.5 million if you use futures contracts.

Of course, if you use too much leverage, you will experience margin calls, on either your house (the banker simply won't renew the mortgage if the equity falls below requirements, as might happen if housing drops 20-30%), or through your broker. If you can't cover the deficiency in equity, then your property is foreclosed upon, or your stock/futures account liquidated until equity requirements are met.



2) Invest in another rental property? Since Smith Manoeuvre assumes your debt is constant and $400k is your max allowable debt, you have only have $75k to find another property; which is very difficult to find.


And insane as well, because you are investing heavily into an undiversified, single asset, that is highly correlated with the performance of your other assets (your houses). You are far better off reducing the risk by investing in a diversified stock portfolio.



3) Invest the $75k into stocks and hope that your Rate of return is greater than 6%


You don't even need a rate of return greater than 6%, because remember, you are deducting the interest charges, and stocks have, if the portfolio is properly managed, tax deferral characteristics of their own.

If you are in a 30% tax bracket, your stock investments only have to return 4.2% on an after-tax basis (not hard at all) to break even.



Is this the idea?


Risk management is imperative for success. Smith advises working with a financial planner, and of course, your investments made with the cash probably should not be made into real estate or real-estate sensitive sectors.



2nd question: in the book, Smith mentions Cash Flow Dam, how does this work?
Using the scenario above:
1) Principle house mortgage - $100k@4%
2) Rental property mortgage – $200k@5%, rent = expenses = $1000/month
3) $75k HELOC @ 6%

Renter pays you $1000; you use that $1000 to pay your house mortgage on top of your regular monthly payments. Then you use the HELOC to pay the mortgage of the rental property. Is this right? If this is correct, then you pay off your house mortgage more quickly but the interest is the lowest of the 3. So you are paying more taxes per month then you have to but your tax-deductible portion is greater so you get a bigger tax return.

Damn, seems like a lot of writing and questions; I appreciate any help/explanations that people can give me. Thanks in advance.

Sure, every last dollar of cash flow you have, under the Smith Manouevre, that you don't need immediately for living, should be funelled right into paying down the non-deductible mortgage balance, and then 're-advanced'.

Basically you would be looking to minimize the payments on the mortgage taken out against the rental property, and maximize the payments against the non-deductible mortgage.

Maximize tax-deductible debt, minimize non-deductible debt. Devote all cashflow possible to paying down non-deductible debt.

[timmee21]

Great read through the many informative posts, I also picked up the book and read it :)

Just wondering, if you own a small business, would this process be accelerated in any ways? or be even more beneficial?

[ullyeus]

>

[Dark Lord]

BTW, there's no magic in this method. You can pay down your mortgage faster because of two factors.

a) You make your mortgage tax deductible.
b) You are taking a higher leverage.

And point a) is Smith's true contribution in this scheme while b) is just nature taking its course.

[ullyeus]

I am the OP of this threat but never imagined the replies balloon to 7 pages in a hour:)


Actually you aren't...you just don't know how to use the search engine so I bumped a nearly identical thread someone else made.

[Dark Lord]

I'm a Certified Accountant and I have only read the PP file, not the book itself.

Smith says borrowing on your house equity to invest and this is nothing new.

Smith proposes to pay down your mortgage with your investment return and this is nothing new either.

What's new is Smith says to take out "extra" loan on your mortgage after you've paid it down to compound its effect in the long run, essentially, converting your mortgage to a tax deductible loan, this is the central point of the whole theory.

I don't think it is very practical to do this manoeuvre monthly. But quarterly or annually should not be a problem just because it is very hard to find an investment that will give you a relatively even monthly cash flow stream.

The theory is in itself sound but Smith makes it look like any lay man could pull it off with ease which I don't think so.

The beauty of it is you can pay off you mortgage sooner but the downside is you risk is now higher.

Some people think of risk as the chance of losing money, I think of risk as the opportunity to make money.

[Dark Lord]

Actually you aren't...you just don't know how to use the search engine so I bumped a nearly identical thread someone else made.

Roger that.

[grant]

The beauty of it is you can pay off you mortgage sooner but the downside is you risk is now higher.
How exactly is your risk "higher" if you owe the exact same amount of money and maintain the exact same investments as you would have without using the maneuvre?

[don242]

How exactly is your risk "higher" if you owe the exact same amount of money and maintain the exact same investments as you would have without using the maneuvre?

How can the risk not be greater? You went from owing money on your home to owing money on investments. Yes your investments could do great, but if the markets fall, you take the risk of the lenders asking for their loan back and because it is secured in your home equity, you have to pay back those loans on demand. So it is a risk, especially if you don't have enough money elsewhere to cover the loan.

[Dark Lord]

How exactly is your risk "higher" if you owe the exact same amount of money and maintain the exact same investments as you would have without using the maneuvre?

If you haven't paid off you mortgage, you are not supposed to have any investment. With the manoeuvre, you'll have your mortgage and investment at the same time, so your reward might be higher but so is your risk.

[grant]

If you haven't paid off you mortgage, you are not supposed to have any investment. With the manoeuvre, you'll have your mortgage and investment at the same time, so your reward might be higher but so is your risk.
You obviously misunderstand the maneuvre's purpose. it has nothing to do with increasing the investments a person would not otherwise make.

and what's this about "you are not supposed to have any investment"?? says who??

[Dark Lord]

You obviously misunderstand the maneuvre's purpose. it has nothing to do with increasing the investments a person would not otherwise make.

and what's this about "you are not supposed to have any investment"?? says who??

The premise of the manoeuvre is that normally people will divert all their funds to pay down their mortgage. Until that happens (mortgage paid off), they will hold no other investments which is what Smith calls the Plain Jane method.

Smith’s method is to borrow from your house equity to invest. So you’ll have extra investment when you still have a mortgage comparing to Plain Jane, and hence your risk is higher. You can pay off you mortgage faster with the manoeuvre because you are taking on more/higher risks.

What is truly innnovative about the manoeuvre is that you are increasing your investment while paying down your mortgage (the readvancing mortgage part) and hence converting non deductible mortgage interest into deductible one. The rest is just nature taking its course (higher risk higher return, lower risk lower return). The down side is the manoevre cannot be done without taking more risks. Some people wouldn’t mind that but some would. It will be much better if there’s a way to convert mortgage into deductible interest loan while maintaining the same level of risk.

[grant]

The down side is the manoevre cannot be done without taking more risks.
Utterly ridiculous statement.

1) Mr. Jones has a $200,000 non-deductible home mortgage at prime - 0.9% and a $500,000 stock portfolio.
2) Jones hears about the smith maneuvre and implements it by juggling his portfolio.
3) The dust settles, and now Jones has a $200,000 deductible mortgage at prime - 0.9% and the exact same $500,000 stock portfolio.

THAT is the gist of the smith maneuvre. How can you claim his risk has increased when both his mortgage & portfolio are the same as before??

You still haven't explained who "they" are that say people "shouldn't" have any investments while they still have a mortgage. If "they" are so smart why haven't i heard of "them"?

[don242]

1) Mr. Jones has a $200,000 non-deductible home mortgage at prime - 0.9% and a $500,000 stock portfolio.
2) Jones hears about the smith maneuvre and implements it by juggling his portfolio.
3) The dust settles, and now Jones has a $200,000 deductible mortgage at prime - 0.9% and the exact same $500,000 stock portfolio.

THAT is the gist of the smith maneuvre. How can you claim his risk has increased when both his mortgage & portfolio are the same as before??



The difference is that the $200,000 mortgage at the end is not a standard mortgage. It is a loan that can be called back by the bank at anytime they wish. If for instance, you have that $200,000 invested in a stock portfolio and the markets crash, not only are you out your losses, but the bank can ask you to repay that loan immediately (whereas a mortgage won't). In your example, Jones should be ok to cover that loan because of the size of the portfolio. For those who do not have that size of an investment portfolio, they could be on the hook for that money, and when you can't pay, you lose your house.

Other than that, the risk is not different between the two senarios.

[dark169]

Utterly ridiculous statement.

1) Mr. Jones has a $200,000 non-deductible home mortgage at prime - 0.9% and a $500,000 stock portfolio.
2) Jones hears about the smith maneuvre and implements it by juggling his portfolio.
3) The dust settles, and now Jones has a $200,000 deductible mortgage at prime - 0.9% and the exact same $500,000 stock portfolio.



your right, the other case, for those of us who dont have a large stock portfolio but would like to buld one is this:

Have a 200000 mortage at x%, would like to contribute $500 a month into an investment portfolio.
Rather then put that $500 in the investment portfolio, pay down the prinicpal on the mortage and take out a secured loan for $500 (via LoC or larger lump sums) and buy the same $500 shares. rinse and repeat.

You would now have the same amount of secured debt and now have some tax deductable intrest, no where does risk change, introduce itself or increase. If one is happy paying down their mortage with every last penny and not investing a cent until their mortage is paid off thats fine thats what almost everyone does, doesnt mean its wise or any safer.

[dark169]

The difference is that the $200,000 mortgage at the end is not a standard mortgage. It is a loan that can be called back by the bank at anytime they wish. If for instance, you have that $200,000 invested in a stock portfolio and the markets crash, not only are you out your losses, but the bank can ask you to repay that loan immediately (whereas a mortgage won't). In your example, Jones should be ok to cover that loan because of the size of the portfolio. For those who do not have that size of an investment portfolio, they could be on the hook for that money, and when you can't pay, you lose your house.

Other than that, the risk is not different between the two senarios.

If that is the case they could simply take out a mortage on their now free and clear home and the hole situation would return to what it was before it all started, no risk still. The loan is secured with the home, so the value of the securities have little bearing on the conversation, even if the shares went to ZERO, they would still be ahead as their debt level is the same and tax bill is less

The plan doesnt increase your debt, it shifts it.

[don242]

If that is the case they could simply take out a mortage on their now free and clear home and the hole situation would return to what it was before it all started, no risk still. The loan is secured with the home, so the value of the securities have little bearing on the conversation, even if the shares went to ZERO, they would still be ahead as their debt level is the same and tax bill is less

The plan doesnt increase your debt, it shifts it.

Never thought of that. Good point. I guess that works no matter what levels of investables and debts you have. I guess as long as you could remortgage your house, then it should be fine.

[Dark Lord]

Utterly ridiculous statement.

1) Mr. Jones has a $200,000 non-deductible home mortgage at prime - 0.9% and a $500,000 stock portfolio.
2) Jones hears about the smith maneuvre and implements it by juggling his portfolio.
3) The dust settles, and now Jones has a $200,000 deductible mortgage at prime - 0.9% and the exact same $500,000 stock portfolio.

THAT is the gist of the smith maneuvre. How can you claim his risk has increased when both his mortgage & portfolio are the same as before??

You still haven't explained who "they" are that say people "shouldn't" have any investments while they still have a mortgage. If "they" are so smart why haven't i heard of "them"?

Your example is not entirely correct, if Jones starts out with $200K mortgage and a $500K portfolio and he uses the Smith’s manoeuvre.

Over time, the $200K mortgage will be gone, replaced by a $200K investment debt and he should have a $700K stock portfolio by adding the $200K investment debt to the original $500K portfolio.

The house is still the same, but the portfolio is $200K higher than before, hence, his risk/exposure is higher with the manouevre.

The last part is the part you missed. The conversion process on a 25 year mortgage will take about 22 years, according to Smith.

If you started out with $200K mortgage and a $500K portfolio. After 22 years, if you only ended up with a $200 investment loan and still a $500K portfoilio, where had all your mortgage payements gone?

The other thing about your example is that if you have a $500K portfoilio, you can just use $200K of it to pay off the mortgage. Take out $200K Home Equity Line of Credit to buy back the same investment, your loan interest will be tax deductible already and you don’t need this manoeuvre at all.

That’s why the author starts with no portfolio and a $200K mortgage as the premises.

[qubikal]

Sorry to re-open an old thread.

I'm intrigued at the entire process, but am a little fuzzy with the tax laws..

What I want to know is that, this whole process assumes that your investments income/dividend/cap gains is greater than your investment expense for the interest expense to be deductible?

or can it be deducted against salary income?

[grant]

if your investment isn't showing a profit after deducting interest expense, then you made a mistake with that investment!

However it's still deductible against other income if you had a bona fide intention to earn income when your purchased the investment. So if your mortgage is 5% interest and your investment only returns 3%, yes the 2% extra is a loss that reduces taxable income.

[Joseph88]

Sorry to re-open an old thread.

I'm intrigued at the entire process, but am a little fuzzy with the tax laws..

What I want to know is that, this whole process assumes that your investments income/dividend/cap gains is greater than your investment expense for the interest expense to be deductible?

or can it be deducted against salary income?

An old but educational thread.

Whenever you use a loan to invest in something that will pay a dividend, you can deduct the interest paid for the year against your income. Yes, even if a stock that you invested in isn't a dividend producing stock, it can be argued that there is a "possibility" that the stock will pay a dividend.

[regrus]

The Smith Manoeuvre talks about making sure you get a readvanceable first Mortgage instead of a HELOC. Anyone know which banks offer these types of Mortgages?

[dealguy2]

Ok how about this situation. You take a loan out on your house equity and then "invest" the money in a bank account. You lose money of course because of the spread but there's zero risk. So do I get a tax deduction on the loan interest and then get to decrease my income by the amount of the loss? If so then I'm way ahead right?

[qubikal]

The Smith Manoeuvre talks about making sure you get a readvanceable first Mortgage instead of a HELOC. Anyone know which banks offer these types of Mortgages?

Most banks will gladly set up a HELOC for you. If you have enough equity in your home (~25%), then they should give you a rate at prime (or very near it)


Ok how about this situation. You take a loan out on your house equity and then "invest" the money in a bank account. You lose money of course because of the spread but there's zero risk. So do I get a tax deduction on the loan interest and then get to decrease my income by the amount of the loss? If so then I'm way ahead right?

I think if you show that you're just going to invest it in something risk free, then you're intent is not to earn income via the investments... CRA will see you borrowing at prime and investing to earn risk free rate of 3% which doesn't make sense just by itself.



However it's still deductible against other income if you had a bona fide intention to earn income when your purchased the investment. So if your mortgage is 5% interest and your investment only returns 3%, yes the 2% extra is a loss that reduces taxable income.

Great, that's what i wanted to know. Some of my investments are a little riskier, unlucky (for example, buying some income trust funds on Oct 30... :mad:

[grant]

Ok how about this situation. You take a loan out on your house equity and then "invest" the money in a bank account. You lose money of course because of the spread but there's zero risk. So do I get a tax deduction on the loan interest and then get to decrease my income by the amount of the loss? If so then I'm way ahead right?
There is no reasonable expectation of profit if you borrow at x% and invest at a fixed x-y%. The deduction is not legal in this case.

Your losses in income trusts will not crystalize til you sell them. So enjoy the distributions & dividends you get til then.

[don242]

Ok how about this situation. You take a loan out on your house equity and then "invest" the money in a bank account. You lose money of course because of the spread but there's zero risk. So do I get a tax deduction on the loan interest and then get to decrease my income by the amount of the loss? If so then I'm way ahead right?

Also losses aren't deductable from your income. If you have investment gains, then your losses can be subtracted from your gains and therefore lower your income. But losses can't simply be used to lower your income. If you have no investments gains in a year but take a $1000 loss, your deduction is zero. If your investments make $2000 and you have a loss of $1000 then that loss would bring your investment income down to a $1000.

[Joseph88]

The Smith Manoeuvre talks about making sure you get a readvanceable first Mortgage instead of a HELOC. Anyone know which banks offer these types of Mortgages?

Firstline offers the Matrix Mortgage.
Manulife offers the Manulife One Mortgage
RBC offers the Homeline mortgage (requires 25% down)
Scotia offers a similar product, but you need to get approved for an increased credit limit every month.
CIBC doesn't offer anything close.
Not sure about BMO or TD.

[rain111]

Firstline offers the Matrix Mortgage.
Manulife offers the Manulife One Mortgage
RBC offers the Homeline mortgage (requires 25% down)
Scotia offers a similar product, but you need to get approved for an increased credit limit every month.
CIBC doesn't offer anything close.
Not sure about BMO or TD.

Readiline for BMO

[fsmontenegro]

Hi!

I'm doing my due dilligence to possibly apply the Smith Manoeuvre to our situation. I read the book once (will read it again). I think our relevant details are:
House estimated at 350k
Outstanding 200k 5yr mortgage @ 5.29%
20,000k in non-registered investments (100% equity via mutual funds)
We typically fill up our RRSPs on a yearly basis, so we could potentially divert this to accelerating the SM if it made sense.

I understand the point that SM is meant to be debt conversion, not leveraging.

Quick questions:
1) given the details above, looks like we could sell the non-reg, borrow and reinvest, and then divert the RRSP payments into the mortgage and reborrow as per SM. Is this right?
2) right now I already service the mortgage (bi-monthly payments). If I borrow from the second LoC established for SM, won't I be ADDING to my monthly expenses? Does the SM expect that the income/dividend from the investments will offset the interest on the second LoC? Is it possible to reduce the monthly payments on the first mortgage as we increase the LoC?
3) Has anyone put together an Excel spreadsheet with the supporting calculations that they can share? I know I can buy the calculator on Smith's site, but I'll learn better if I go through a spreadsheet...
4) are there any fee-only planners in the GTA to help set up a SM? If so, what kind of fees are we looking at to set this up? I'm a DIY investor and do not need support on the investment side, only MAYBE in setting this up...

Thanks! It was great to find this thread: very informative...

Cheers,
Fernando

[grant]

Does the SM expect that the income/dividend from the investments will offset the interest on the second LoC?
No, the implication is that the non-deductible interest will decrease by exactly the same amount as deductible interest increases. If you truly understand that this is simply debt conversion, then this fact is obvious.


Is it possible to reduce the monthly payments on the first mortgage as we increase the LoC?
It's up to your lender.


... and then divert the RRSP payments into the mortgage and reborrow as per SM. Is this right?
Does Smith really recommend cutting back on RRSP payments? If so, i'm surprised, RRSPs are great because they compound faster than non-RRSP investments.

[fsmontenegro]

No, the implication is that the non-deductible interest will decrease by exactly the same amount as deductible interest increases. If you truly understand that this is simply debt conversion, then this fact is obvious.
I understand that the debt will be reduced on the non-deductible loan and increase on the deductible loan. Perhaps I should rephrase my question (sorry, English not first language..):
- Even if I prepay my mortgage, the monthly amount (P+I) is still the same. Of course, my principal is reduced, but that doesn't affect the monthly payments - it just makes the amortization period shorter...
- With that in mind, if I set up a second loan and start borrowing against it, won't I ALSO have to start paying interest on it?


It's up to your lender.
I've been approaching this with the notion that I don't have to make any changes or special requests from the first lender. Smith alludes to this when he describes how VanCity "swiped the [big bank]'s asset before they even know it was gone" (p.109)



Does Smith really recommend cutting back on RRSP payments? If so, i'm surprised, RRSPs are great because they compound faster than non-RRSP investments.
Check p.50 on his book (chapter 4, "wealth accumulation"). He does qualify by saying "many, but not all cases" and that the financial planner should make the determination to cash in (or hold contributions) to the RRSP. But he does mention that it may make sense to withdraw from the RRSP and prepay the mortgage. He then extends that if it makes sense to do this, it also makes sense to redirect contributions to mortgage prepayment...

[Joseph88]

I understand that the debt will be reduced on the non-deductible loan and increase on the deductible loan. Perhaps I should rephrase my question (sorry, English not first language..):
- Even if I prepay my mortgage, the monthly amount (P+I) is still the same. Of course, my principal is reduced, but that doesn't affect the monthly payments - it just makes the amortization period shorter...
- With that in mind, if I set up a second loan and start borrowing against it, won't I ALSO have to start paying interest on it?


If the extra interest payments are too much for you, SMITH recommends that you use the brute force method where you withdraw the required payment from your HELOC and re deposit it. It will count as a payment. Keep doing so until your non-ded mortgage is paid off at which time you'll have enough cashflow to pay your interest.

[fsmontenegro]

If the extra interest payments are too much for you, SMITH recommends that you use the brute force method where you withdraw the required payment from your HELOC and re deposit it. It will count as a payment. Keep doing so until your non-ded mortgage is paid off at which time you'll have enough cashflow to pay your interest.

Yes, this is the "add interest to loan balance" approach that is mentioned (I don't have the book handy right now).

OK, so if I understand it right, there IS a need for extra payments (namely, the interest on the second loan while one still pays the non-deductible first loan).

Before someone says it, yes, I think that if someone can't cover these extra payments they shouldn't be considering the SM, or that they should be comfortable with leveraging (vis-a-vis simple debt conversion) etc, etc, etc... (pretty much the same way that if you can't handle an increase in your lending rates you shouldn't have a mortgage).

I'm just trying to be thorough and fully understand the process...

[Joseph88]

Yes, this is the "add interest to loan balance" approach that is mentioned (I don't have the book handy right now).

OK, so if I understand it right, there IS a need for extra payments (namely, the interest on the second loan while one still pays the non-deductible first loan).

Before someone says it, yes, I think that if someone can't cover these extra payments they shouldn't be considering the SM, or that they should be comfortable with leveraging (vis-a-vis simple debt conversion) etc, etc, etc... (pretty much the same way that if you can't handle an increase in your lending rates you shouldn't have a mortgage).

I'm just trying to be thorough and fully understand the process...

Yep, you are understanding it right. If you implement the SM, you'll get a new HELOC which will require an INTEREST ONLY payment on top of your existing mortgage (unless you pay it off before getting the new heloc). The HELOC interest only payment is TAX DEDUCTIBLE (providing that you invest the heloc money) which is the whole premise behind the SM. Also note that as the HELOC gets bigger, so will your interest payment. Use the brute force method until your non ded mortgage is paid off.

[fsmontenegro]

Ok, so to sum up:



1) given the details above, looks like we could sell the non-reg, borrow and reinvest, and then divert the RRSP payments into the mortgage and reborrow as per SM. Is this right?

Looks like we could do this, but the issue of RRSP vs mortgage is not clear cut.


2) right now I already service the mortgage (bi-monthly payments). If I borrow from the second LoC established for SM, won't I be ADDING to my monthly expenses? Does the SM expect that the income/dividend from the investments will offset the interest on the second LoC? Is it possible to reduce the monthly payments on the first mortgage as we increase the LoC?

This was a big question I had. Basically, YES, I do need additional funds to service the interest on the second loan. There are two options:
- Absorb the cost and move on
- Do the "brute force method" of adding the interest to the principal on the second loan and pay it off when the first loan is paid for.


3) Has anyone put together an Excel spreadsheet with the supporting calculations that they can share? I know I can buy the calculator on Smith's site, but I'll learn better if I go through a spreadsheet...
I haven't found a SM spreadsheet but I found enough info to put something together on my own. Will be a good exercise...


4) are there any fee-only planners in the GTA to help set up a SM? If so, what kind of fees are we looking at to set this up? I'm a DIY investor and do not need support on the investment side, only MAYBE in setting this up...
This is still unanswered. Any insights?

Thanks for all the information so far!

Cheers

[Joseph88]

Quote:
4) are there any fee-only planners in the GTA to help set up a SM? If so, what kind of fees are we looking at to set this up? I'm a DIY investor and do not need support on the investment side, only MAYBE in setting this up...
This is still unanswered. Any insights?


Why would you need a planner if you are a DIY investor? To make it legit, just keep careful records to prove that you are using the HELOC money to invest and not on other spending.

[grant]

- Even if I prepay my mortgage, the monthly amount (P+I) is still the same.
The monthly amount may be the same. The interest portion will definitely not.

The amount of interest you accrue every period depends on how much principal you owe. If you reduce the principal, then you must accrue less interest.

[fsmontenegro]

The monthly amount may be the same. The interest portion will definitely not.

The amount of interest you accrue every period depends on how much principal you owe. If you reduce the principal, then you must accrue less interest.

Yes, you're right of course. What happens is that each mortgage payment is the same amount, but the principal portion rises.

What would be needed to do a SM without ANY increase in payments (other than doing the 'brute force' method of adding the interest payments to the HELOC itself) would be to arrange for the monthly payments on the non-deductible mortgage to be reduced automatically. Not sure the lender (Scotia, in my case) is set up to do that...

[pitz]

Also, make sure you file the appropriate paperwork, when possible (CRA Form T1213), to have your withholding taxes reduced from your employer.

This will improve cashflow, which, in turn, can be used to augment the mortgage payment, which will accelerate the Smith Manouevre process and/or reduce your overall interest expenses.

If you pay $10k/year in deductible interest, at an effective rate of 4% (after-tax), that means an extra $200 directly on your bottom line just by having your withholding adjusted appropriately. Or when invested appropriately, $500/year extra.

Also, when using the Smith Manouvre, you can accelerate the process by selecting dividend-paying investments, as the dividends can be withdrawn from the brokerage account, placed against the non-deductible debt, and then re-drawn. Income trusts technically would be a better option, but, IMHO, many/most are still significantly overvalued.

[Joseph88]

Also, make sure you file the appropriate paperwork, when possible (CRA Form T1213), to have your withholding taxes reduced from your employer.

This will improve cashflow, which, in turn, can be used to augment the mortgage payment, which will accelerate the Smith Manouevre process and/or reduce your overall interest expenses.

If you pay $10k/year in deductible interest, at an effective rate of 4% (after-tax), that means an extra $200 directly on your bottom line just by having your withholding adjusted appropriately. Or when invested appropriately, $500/year extra.

Also, when using the Smith Manouvre, you can accelerate the process by selecting dividend-paying investments, as the dividends can be withdrawn from the brokerage account, placed against the non-deductible debt, and then re-drawn. Income trusts technically would be a better option, but, IMHO, many/most are still significantly overvalued.

Great tips Pitz on optimizing the Smith Manoeuvre. Never thought about using the dividends to pay down the non-ded mortgage.

[cannon_fodder]

Also, when using the Smith Manouvre, you can accelerate the process by selecting dividend-paying investments, as the dividends can be withdrawn from the brokerage account, placed against the non-deductible debt, and then re-drawn. Income trusts technically would be a better option, but, IMHO, many/most are still significantly overvalued.

I don't grasp the logic so perhaps you can explain this to me. I have assumed that a "dividend paying investment" is a stock.

Let's say I have 1,000 shares of XYZ (@ $20 each )and it pays out $0.19 a share per quarter. Each quarter I receive $190 (which I have to declare as income). I then use this to pay down the mortgage.

I then take that $190 out and try to buy, what, more XYZ? Any fee associated with it would be, I'm guessing, at least $10. So, I end up with 9 more shares.

Borrowing that $190 back would net about a $10 interest charge per year of which $4.63 at best would be returned to you as a tax refund.

If this XYZ stock had a DRIP plan, it seems to me it would be better to just have it reinvested, get 9 shares and $10.

I would declare the $190 as income which, I hope this is right, would be taxed at about 25% in Ontario. This would be the same regardless of whether I DRIP'ed or didn't, correct?

If I've done this right, then I'd have 1009 shares and have to declare $190 as dividend income. However, in the first scenario, I paid $10 to service the debt over 12 months and got a refund of $4.63. In the second scenario, I have a credit of $10.

Did I miss something? Wouldn't the best scenario for the SM to be invested in an income producing product that pays the least amount of income as possible?

[cannon_fodder]

For those that have argued for/against the idea that the SM is using leverage, please consider this. I recently attended a seminar held jointly by a FP and a Mortgage Broker. They talked about the "Turbo" SM and that is for those homeowners that have created additional equity in their home (because of paying down the principal and/or the increased value of the home).

Thus, you:

Purchased a home for $400,000
Took out a mortgage for $300,000

and then, 5 years later:
Home is worth $500,000
Mortgage principal is $250,000

You then convert your mortgage into a readvanceable mortgage of 75% of the home's current value. Thus,

$500,000 home
$375,000 readvanceable mortgage split into:
$250,000 mortgage and $125,000 LOC for investing

This way you get a significant investment portfolio from day 1. Putting it through the SM calculator shows a dramatic decrease in the time to pay down the mortgage and large tax refunds from the first year.

What is the general consensus on this 'wrinkle'?

[tarnator]

I suppose that I am now in the position to consider the 'accelerated' SM. We bought 3 years ago and our appt. has gone from $275K to about $550. Crazy.

We have no other debt. And my hubbie will be doubling his salary (hopefully!) in the second half of this year.

It seems reasonable that we use the line of credit to buy some RRSPs for hubbie (who has none) and anything left over becomes extra investment. The bonus is the LOC interest is a tax write-off. correct?

I will have to run this past some of my friends who know more about money than I....

[cannon_fodder]

You wouldn't be able to deduct interest on the investments that go into the RRSP. That would be a case of having your cake and eating it too.

If I'm not mistaken, if you borrow money to purchase investments to earn income and then you sell them or put them in an RRSP, you no longer can write off the interest. From the taxman's point of view, once you place those investments in the RRSP you have to consider them sold and declare any gains on them.

[inntents]

is it safe to assume that the SM should ONLY be undertaken once all other debt, especially revolving-credit debt, is completely wiped out? Step #1 of any financial planning is to get rid of credit card debt, no?

The SM sounds very intriguing, and as many others have posted, runs counter to how too many of us think about how we should handle our money. Great posts, all, and very informative, too. Thanks.

[pitz]

I don't grasp the logic so perhaps you can explain this to me. I have assumed that a "dividend paying investment" is a stock.


Sure. Or it could be preferred shares, or even GICs. It really doesn't matter, just so long as there are cash flows associated with the investment.

Obviously you wouldn't use a GIC because the typical after-tax return of a GIC is less than a typical mortgage. But there have been occaisons in the past where performing this form of arbitrage with preferred shares and/or GICs has been profitable and generated returns in excess of one's cost of capital.



Let's say I have 1,000 shares of XYZ (@ $20 each )and it pays out $0.19 a share per quarter. Each quarter I receive $190 (which I have to declare as income). I then use this to pay down the mortgage.
I then take that $190 out and try to buy, what, more XYZ? Any fee associated with it would be, I'm guessing, at least $10. So, I end up with 9 more shares.


My broker charges me $1/trade. I do agree that you need to consider fees under such a scenario, and ideally, minimize them.



I would declare the $190 as income which, I hope this is right, would be taxed at about 25% in Ontario. This would be the same regardless of whether I DRIP'ed or didn't, correct?


Yes, but the $190 hopefully would be eligible for a dividend tax credit or be in some other form of tax-advantaged form, and not taxxed at one's marginal rate.



If I've done this right, then I'd have 1009 shares and have to declare $190 as dividend income. However, in the first scenario, I paid $10 to service the debt over 12 months and got a refund of $4.63. In the second scenario, I have a credit of $10.

Did I miss something? Wouldn't the best scenario for the SM to be invested in an income producing product that pays the least amount of income as possible?

How is such a product possible? "an income producing product that pays the least amount of income possible" sounds like a contradiction to me.

Actually such a product does exist -- its called the BMO Dividend fund. The 'dividends' are extracted by its managers in the form of management expense, making its MER very expensive. If you have to pay an investment manager a management fee, you want to be paying it out of pre-tax income, and not tax-advantaged income such as Canadian dividends.

Any 'income' received from investments will accelerate the SM process so that the non-deductible balance is reduced as quickly as possible. The intent of the SM process is to, as quickly as possible, swap the entirety of your non-deductible consumer debt (ie: housing, credit cards, etc.) into deductible investment debt. Typically a house is used as the underlying asset, but other assets (an investment portfolio, for instance) can be similarly used.

[pitz]

For those that have argued for/against the idea that the SM is using leverage, please consider this. This way you get a significant investment portfolio from day 1. Putting it through the SM calculator shows a dramatic decrease in the time to pay down the mortgage and large tax refunds from the first year.

What is the general consensus on this 'wrinkle'?

The issues are:

1) Will your investment portfolio provide a return above and beyond the after-tax cost of capital?

2) Will your house retain its value and continue to appreciate and provide returns over and above the after-tax cost of capital.

3) Will you always be able to find willing lenders to obtain the desired amounts of credit.

If worldwide stock markets have a slow or negative year, and housing prices decline, then your overall level of equity (net worth) will decline.

You might want to look at Japan in the 1990s and recently for an example of how leveraged investment (in stocks, or in real estate) went bad. The housing market, and stock market simultaneously lost a substantial amount of value. Wages didn't grow. Plug those numbers into your favourite calculator and realize how well the Smith Manouevre works.

The SM works best during periods of high interest rates and high rates of inflation, because the real cost of capital is generally low, while inflation helps the performance of stocks and real estate. High nominal interest rates also increase the effectiveness of the tax deduction associated with the Smith Manouevre (while low interest rates inflate asset prices). So its not all bad, but modelling overall expected performance should be approached with caution.

As for point #3, while mortgage money has been very cheap, that always hasn't been the case. Once banks start taking losses on bad housing loans, credit will tighten, and more speculative forms of credit will entail higher interest rates and tighter restrictions and covenants. If you do not understand (and have not lived through a few iterations of) the credit cycle, do not attempt the Smith Manouevre.

[CoolEddie]

Is anyone here actually doing the Smith Manouevre? I'm a little bit puzzled.

Correct me if I'm wrong. If your mortgate payment is $1000 a month, wouldn't it stay at a $1000 a month despite the principle decreasing? Plus, every month you are taking out an investment loan on the principle you pay off on your house, say $200. And let's say interest rate is 5%. So now your monthly payments will be $1000 + 0.83. Then the next month it will be $1000 + 1.67, then 1000 + 2.50, etc. So is this suppose to happen?

[TrevorK]

Is anyone here actually doing the Smith Manouevre? I'm a little bit puzzled.

I am - I use a secured line of credit instead of a mortgage.



Correct me if I'm wrong. If your mortgate payment is $1000 a month, wouldn't it stay at a $1000 a month despite the principle decreasing? Plus, every month you are taking out an investment loan on the principle you pay off on your house, say $200. And let's say interest rate is 5%. So now your monthly payments will be $1000 + 0.83. Then the next month it will be $1000 + 1.67, then 1000 + 2.50, etc. So is this suppose to happen?

I think all your confusion lies in the fact that you are paying down a traditional style mortgage, so seeing the numbers / payoffs is much harder to do.

I don't see how people can use a traditional mortgage for the Smith Manoeuvre. They will either need to refinance into a:
- secured line of credit
- matrix mortgage (Mortgage portion, as it's payed down a secured line of credit against your home equity increases)
- HELOC (in conjunction with an existing mortgage)

Using a traditional mortgage you will pay it down, and you will then need a way to borrow back some of your equity (Which isn't a feature of a traditional mortgage). This is where the three options I listed above come into play.



I think you are grasping the basics, if you get a HELOC for the equity in your home, your existing mortgage payment is still intact. In addition, you will now have another interest payment on the money that you have borrowed through your HELOC. Which makes your monthly payment X + Y (Mortgage payment + HELOC interest payment).

The only products I have seen that allow the LOC portion to go up as you pay the mortgage portion down are the matrix style mortgages. Each bank has their own name for it, but basically it gives you a mortgage and LOC. As you pay down the mortgage, the principle becomes available on your LOC.


Does that make more sense?

[cannon_fodder]

I think the assumption is that as you get closer and closer to paying down the mortgage, your carrying costs of the entire LOC (part mortgage, part investment LOC) will continue to rise (assuming that you pay the interest portion of the investment LOC with after tax dollars via your monthly cash flow).

Your mortgage payments, if on a fixed interest rate, don't change. But, your interest charges for the investment LOC continue to rise.

Let's take an example:
$500,000 home
$375,000 "Matrix" mortgage or the like which could be composed of (in one person's particular case) representing 75% of the value of the home
$250,000 mortgage principal
$125,000 investment LOC

Assume you max out the investment LOC from day 1. Then the next payment period you would have both the mortgage payment (P+I) and the investment LOC (I only).

As you use the SM, you are paying down the mortgage principal and reborrowing the same amount (again, trying to cover interest charges with monthly cash flow) increasing your investment payments. In fact, at the end, wouldn't you have basically a mortgage payment + interest payment on the entire $375,000? This would make it very hard for most people to handle the cost of the SM without either:

selling some of the investment portfolio to fund the payments, thus reducing the interest charges writeoff;
borrow the mortgage principal payment, but pay for the interest charges out of the payment which means there would be very little to invest.

I haven't run the numbers... just trying to figure it out in my head.

I believe that is where CoolEddie is coming from... it certainly is what has me concerned.

[pitz]

I think the assumption is that as you get closer and closer to paying down the mortgage, your carrying costs of the entire LOC (part mortgage, part investment LOC) will continue to rise (assuming that you pay the interest portion of the investment LOC with after tax dollars via your monthly cash flow).


No, the carrying costs of the entire LOC remain level throughout the entire scheme. However, as you progress with the Smith Manouevre, 2 things happen:

1) The income stream associated with the investments generally grows, accelerating the paydown of the non-deductible portions.

2) The proportion of deductible interest increases, thus increasing the amount of interest deduction you can claim on taxes. This, in turn, accelerates cashflows available for paying down even more of the mortgage.

As you can sort of imagine, the process exponentially increases the rate of paydown of overall debt, by reducing the overall cost of capital. For instance, 6% mortgage, 40% tax bracket -- the effective after-tax cost of capital is a mere 3.6%.

Plug 3.6% into your favourite on-line mortgage interest calculator and plug 6% into your favourite calculator. You'll see that cutting the interest expense on a mortgage down dramatically reduces the repayment period.

Plus you build an investment portfolio simultaneously, which diversifies and reduces overall portfolio asset risk. Properly executed, the Smith Manouevre dramatically reduces the level of risk for the homeowner/investor.



Your mortgage payments, if on a fixed interest rate, don't change. But, your interest charges for the investment LOC continue to rise.


Sure, but as you increase the investments, the income from those investments should also increase as well. Plus the interest deductibility associated with the investment LOC provides a positive contribution to cashflow. Cashflow planning is important when executing/planning the SM, but if the proper types of investments are selected, cashflow generally doesn't become a huge concern.


Assume you max out the investment LOC from day 1. Then the next payment period you would have both the mortgage payment (P+I) and the investment LOC (I only).

Maxxing out the LOC from day 1 is taking on a lot of unnecessary risk. And yes, the cashflow associated with the scenario you provide is slightly higher initially, however, once you get your witholding adjusted, and start receiving a stream of dividends from the investments made from the LOC, most cashflow issues should dissappear.

Not paying a professional advisor a small fortune (ie: 2% MERs) is absolutely critical to the success of the SM. Pay a professional a couple thousand $$ up-front to help you plan your Manouevre if you must, but don't fall into the trap of giving away the entirety of your income stream from your investments.




As you use the SM, you are paying down the mortgage principal and reborrowing the same amount (again, trying to cover interest charges with monthly cash flow) increasing your investment payments. In fact, at the end, wouldn't you have basically a mortgage payment + interest payment on the entire $375,000? This would make it very hard for most people to handle the cost of the SM without either:
selling some of the investment portfolio to fund the payments, thus reducing the interest charges writeoff;
borrow the mortgage principal payment, but pay for the interest charges out of the payment which means there would be very little to invest.


The investments should buy income. If you are buying investments with no dividends and with nosebleed valuations and almost no earnings (ie: GOOG, SBUX, or whatever the latest fad stock is), then the Smith Manouevre isn't likely to work out for you.

As always, if you don't understand the math, don't even attempt this.

[pitz]

is it safe to assume that the SM should ONLY be undertaken once all other debt, especially revolving-credit debt, is completely wiped out? Step #1 of any financial planning is to get rid of credit card debt, no?


Yes, it goes without saying that other debt should be consolidated into the non-deductible mortgage debt whenever possible.

If you need to restructure your financing, you may be able to do the SM, and roll the CC/car loan debt all into one new loan.

The SM is not for the financially irresponsible though. If you were coming to see me for professional advice on the matter, I would inquire as to why you racked up other debts in the first place.

[inntents]

Yes, it goes without saying that other debt should be consolidated into the non-deductible mortgage debt whenever possible.

If you need to restructure your financing, you may be able to do the SM, and roll the CC/car loan debt all into one new loan.

The SM is not for the financially irresponsible though. If you were coming to see me for professional advice on the matter, I would inquire as to why you racked up other debts in the first place.

Points taken - thank you!

[regrus]

Some of you are reporting that you are using a HELOC for the Smith Manoeuvre. My main problem with a HELOC is that banks report HELOC's to credit reporting agencies as revolving debt wherein a readvanceable mortgage is not reported at all.

In my case I don't owe anything except for a $150,000.00 HELOC against a $400,000.00 home. It pisses me off when I check my credit report and it always says "my outstanding balance is too high in proportion to my available credit." This hurts my Score.

The way I look at it is I have a $150,000.00 credit against $400,000.00 property which is under 40% debt ratio. The credit agency looks at as I am using $150,000.00 of $150,000.00 available credit. Not good in their eyes.

[cannon_fodder]

No, the carrying costs of the entire LOC remain level throughout the entire scheme.

I challenge you to offer proof of that, because if you are successful then I will have greatly increased my understanding.
And I don't mean offsetting the costs with increased income from investments, or siphoning off a portion of principal redraws to pay the interest charges, but the actual total liability each payment period must increase.

My argument is based on these premises:

1. The mortgage payment continues unchanged until the mortgage is fully paid off. (Of course, the principal payment increases as the interest payment decreases, but each period payment is the same.)
2. The SM increases the deductible interest charges because the LOC liability also increases. In fact, near the end, you have to pay interest on the entire LOC AND a full mortgage payment.

While you MAY see an equivalent (or greater) offset due to tax refunds and investment income, that does not change the fact that the cost to service the SM increases.

However, the tax refunds are supposed to be used to pay down the mortgage faster, not service the deductible interest on the LOC, correct?

Perhaps you are suggesting that the investments should be chosen more for their income producing capability (like an income trust) rather than their solid, dependability (e.g. blue chip stocks with 5 year + history of increasing dividends). If so, then that is where we are coming at it from two different angles and your thinking might have merit that I have not been able to discern.

I'll try and develop a spreadsheet that attempts to mimic the SM and see what they tell me.

[pitz]

And I don't mean offsetting the costs with increased income from investments, or siphoning off a portion of principal redraws to pay the interest charges, but the actual total liability each payment period must increase.


If you borrow additional funds, sure, the liability increases.

With a conventional mortgage arrangement, your liabilities are the greatest at the beginning of the mortgage, and then they subsequently decline as you pay down the principal of the mortgage through an amortized blend of principal and interest payment.

With the Smith Manouevre, your liabilities remain level until you have completely swapped the entirety of your non-deductible debt for deductible debt.



1. The mortgage payment continues unchanged until the mortgage is fully paid off. (Of course, the principal increases as the interest decreases, but each period payment is the same.)

2. The SM increases the deductible interest charges because the LOC liability also increases. In fact, near the end, you have to pay interest on the entire LOC AND a full mortgage payment.


Sure, but the mortgage payment, at/near the end, is nearly 100% principal, and 0% interest. The payment on the LOC, at/near the end, is always 100% interest.

Don't confuse the payment of interest with the payment of principal. Principal contributes to capital/equity accumulation. Interest is the expense associated with renting investment capital.



While you MAY see an equivalent (or greater) offset due to tax refunds and investment income, that does not change the fact that the cost to service the SM increases.


Sure, the SM does produce a greater interest bill. But at the end of the manouevre, you have twice as many assets.



However, the tax refunds are supposed to be used to pay down the mortgage faster, not service the deductible interest on the LOC, correct?


Yes.



Perhaps you are suggesting that the investments should be chosen more for their income producing capability (like an income trust) rather than their solid, dependability (e.g. blue chip stocks with 5 year + history of increasing dividends). If so, then that is where we are coming at it from two different angles and your thinking might have merit that I have not been able to discern.


If you can find quality income trusts, then they are ideal for the purpose. Unfortunately, there are very few examples of quality income trusts in Canada, and certainly not enough to build anything resembling a properly diversified portfolio. Canadian Oilsands is the only trust i'd consider as part of a 'blue-chip' portfolio, and I think you can agree that it would be very highly risky to go 100% into COS.UN.



I'll try and develop a spreadsheet that attempts to mimic the SM and see what they tell me.

Sure, try and understand the math.

[pitz]

Some of you are reporting that you are using a HELOC for the Smith Manoeuvre. My main problem with a HELOC is that banks report HELOC's to credit reporting agencies as revolving debt wherein a readvanceable mortgage is not reported at all.


So replace some of the tax-deductible mortgage debt with tax-deductible margin debt. In other words, borrow from your broker, not from your mortgage lender.

Problem solved.

[cannon_fodder]

To pitz:

I think my understanding of the math is far better than you've given me credit for. Some of the statements you made could be misinterpreted, or were simply incorrect.

I, too, made some statements that did not accurately reflect what I was trying to say. For example, I said "1. The mortgage payment continues unchanged until the mortgage is fully paid off. (Of course, the principal increases as the interest decreases, but each period payment is the same.)" What I meant to say was that "... the principal payment increases as the interest payment decreases..."

I believe I have constructed an Excel spreadsheet which reflects the SM. It does not have a glossy front end, but it is probably a little bit more flexible in that I could put in any prepayments at any time (e.g. for winfalls, other components of my tax refund, etc.)

If you perform the Plain Jane SM at the end you should have a total payment that is equal to your mortgage payment + the interest portion of your first mortgage payment. This is because you have converted the mortgage to be a tax-deductible LOC. Since you are having to pay down the mortgage (both P+I) but you only have to pay the I on the LOC, then this makes sense.And my Excel spreadsheet confirmed that.

What I was driving at is that this is a real, and significant, increase in cash outlay. What I infer from your statements is that the income generated from your investments will be planned to substantially contribute, and perhaps completely offset, the increased cost to service the declining mortgage and the increasing cost to service the growing LOC liability.

That is an interesting perspective, but my initial reaction is that I'm now declaring additional, taxable income. Would you argue that all income you receive from the investments:

- should be used to pay down the mortgage even faster and then redraw the amount to invest,or
- should be split into two parts: only enough to cover the additional carrying costs; and use the rest to paydown the mortgage, redraw & invest, or
- something completely different?

I'll plug in some numbers to see how this affects everything if I receive income which:

- is returned at a level less than the interest costs of the LOC
- is returned at a level more than the interest costs of the LOC

I'm going to read the SM book again, but I don't think he adequately addresses the increase in cost to service the mortgage and LOC. Sure, he drills into you that the total liability does not change. BUT, he does not provide any information, yet alone numbers IIRC, that show that or how much your periodic payments increase.

[cannon_fodder]

Just saw that www.smithman.net has announced the formation of "Smith Manouevre Financial Corporation". They also talk about the "Freeboard Equity" program where you implement a readvanceable mortgage by tapping into the increased equity in your home since you took out your mortgage.

http://www.smfc.com/services/for_home_owners/

The approach suggested is one that others have implied - invest in income producing mutual funds with monthly cash distributions and pay down the mortgage first, redraw and invest.

[pitz]

What I was driving at is that this is a real, and significant, increase in cash outlay. What I infer from your statements is that the income generated from your investments will be planned to substantially contribute, and perhaps completely offset, the increased cost to service the declining mortgage and the increasing cost to service the growing LOC liability.


Is it really a 'cost' if its being used to accumulate equity? While analyzing for cash flows is important in the context of the Smith Manouevre, I think you should be taking the approach of analyzing for overall net worth. Think of the Smith Manouevre as giving you a discount on your mortgage interest rate at your highest marginal rate. If you were previously paying 6% on your mortgage in a 40% tax bracket, once you have the entirety of the debt swapped over, you will be paying an effective rate of 3.6%.

The technicalities of the Smith Manouevre (and the Income Tax Act) dictate that you must have the investment portfolio in order to receive the deduction, however, so you can't merely just accelerate your mortgage payoff as though you could if you truly were paying 3.6% on a cash basis.




That is an interesting perspective, but my initial reaction is that I'm now declaring additional, taxable income. Would you argue that all income you receive from the investments:

- should be used to pay down the mortgage even faster and then redraw the amount to invest,or
- should be split into two parts: only enough to cover the additional carrying costs; and use the rest to paydown the mortgage, redraw & invest, or
- something completely different?


I would argue that if you have non-deductible debt of any kind, it should be first repaid. Whether you choose to re-draw to invest is ultimately your decision. If you feel the stock markets are over-valued, then maybe just paying off the mortgage is the better idea.

I don't encourage market timing, but when Nortel was 45% of the TSX index, probably wasn't a very good time to consider investing in it. Generally speaking, you always want to invest in 'stuff' that produces after-tax GAAP earnings greater than your cost of capital.

Yes, over time, there is an increasing effect on your overall taxable income. However, hopefully you had the foresight to invest in instruments that provide income in the form of either capital gains or tax-advantaged Canadian dividends. This is a very valid point and should be included in your modelling.



I'll plug in some numbers to see how this affects everything if I receive income which:

- is returned at a level less than the interest costs of the LOC
- is returned at a level more than the interest costs of the LOC

I'm going to read the SM book again, but I don't think he adequately addresses the increase in cost to service the mortgage and LOC. Sure, he drills into you that the total liability does not change. BUT, he does not provide any information, yet alone numbers IIRC, that show that or how much your periodic payments increase.

The cashflows associated ultimately depend on the type of financing used.

Its possible to get a LOC, for the purposes of the Smith Manouevre, that does not have any 'payments' associated with it. Or you can use a margin account which doesn't require any 'payments' for a portion of the borrowing. There are lots of ways of managing the cashflows.

[cgtor]

i'm not exactly sure how the timing works with respect to the investment loans under SM method

i was just approved for a mortgage of approximately 200,000 and i came across the book

after having read the book, i am curious to learn how often the loans should be taken

for example, suppose i put a lump sum payment of $1000 this month, and $1000 next month, does it not seem odd to be approaching the bank every month to ask for a loan of $1000 for investing? is it better to do it this way, or better to do it semi-annually, say every 6 months?

[grant]

So replace some of the tax-deductible mortgage debt with tax-deductible margin debt. In other words, borrow from your broker, not from your mortgage lender.

Problem solved.
My margin account is prime + 1.5 or 2%. A HELOC would be Prime + 0%. So it's not an ideal solution.

[fsmontenegro]

To pitz:
I'm going to read the SM book again, but I don't think he adequately addresses the increase in cost to service the mortgage and LOC. Sure, he drills into you that the total liability does not change. BUT, he does not provide any information, yet alone numbers IIRC, that show that or how much your periodic payments increase.

Yes, that is my impression as well. The two approaches that have been recommended (both in the book and in the website) are:
- Pay the interest on the LoC from the amount that is borrowed. Example:
mortgage payment = $800 ($400 P + $400 I)
borrow from LoC = $ 400
assuming LoC interest due = $10
amount to invest = $400-$10 = $390

- Do the "guerrila" method (or something like that) and arrange for capitalizing the interest owned. In the example above, take $400, invest $400 and add the $10 to the LoC balance. Apparently not too many places will allow you to do this (any references to lenders that actually allow this? please let me know...)

Hope this helps.

Cheers,
Fernando

[cannon_fodder]

Well, I finally have a really good approximation of the SM calculator at least in that I can plug in his numerical examples and get the same answers within plus or minus a couple of bucks. There are certain assumptions that he made that I wasn't aware of but it seems to work.

I can see that, unlike the FP who talked to me about this method, the SM calculator DOES pay for the additional, and increasing, interest costs for the LOC through capitalizing interest and from siphoning off money that you withdraw. It does NOT require that you use any of the income that the investments generate to pay for it.

As an example, if we take the one quoted in his book:

$200,000 mortgage amortized over 25 years, 5 year term at 7% interest compounding semi-annually
Investment LOC at 5% interest supporting capitalization of interest(one of the many items that bother me in his book - if I have just put together this readvanceable mortgage why would my mortgage be at 2% higher than my investment LOC? No explanation as to why this strange difference.)
Investment growth at 10%
Tax rate 40%
Monthly payment at $1,400.83
Reinvest tax refunds
Assume mortgage begins January 1, 2007 for this example

On February 28, 2029, you make a mortgage payment of $1,400.83 as usual, you only have $563.30 to invest because about $15.23 goes to the mortgage interest and $822.30 goes to the investment LOC for interest.

I believe this is what pitz has been trying to get through to me that there is no additional strain put on your finances through this application of the SM. The FP who had sat down with me suggested a different, what he considered 'much better' approach, whereby the investment LOC interest was paid with external cash (e.g your salary). This, of course, would allow the full amount of any payment to the principal of the mortgage to be actively invested. I think I could say that both pitz and I were right, but we were coming at it from quite different angles. Sorry, pitz, for my stubborness!

Here are some key points I discovered in creating my spreadsheet:

The SM calculator assumes the tax refund will come in 6 months after the end of the year (e.g. start your mortgage on January 1, 2007 and your first refund will be used to pay down your mortgage June 30, 2008.)
The end calculations of tax refunds and investment portfolio amount are indeed at the end of the amortization period. I had mistakenly thought that this was what you would have as soon as the mortgage was discharged. I think this is a bit misleading, or at least, it should be made very clear. I would bet that I'm not the only person who didn't realise that you had to let this SM go on for the full 25 years to reach those numbers.

To be fair, it is probably the best way to compare apples to apples
- don't do the SM and this is where you are
- no mortgage and no investments, no tax refunds OR
- do the SM and this is where you are
- no mortgage, $510k in investments and a nice $4k in tax refunds each year and all it will cost you is $10k in interest charges which is less than the almost $17k you used to make in mortgage payments.

In the example he uses in the book, the mortgage is paid off 2.75 years earlier. At that point, the portfolio is about $361,079 and the tax refunds total about $32,400. But, for the next 2.75 years you keep paying the $1,400.83 into this SM (subtracting the $833.33 for the investment LOC carrying costs leaving $567.50 for investing) and keep applying the tax refunds and you will wind up with the figures he quotes.

Now I'm going to work on adding the "Freeboard Equity" wrinkle to my spreadsheet.

[pitz]

My margin account is prime + 1.5 or 2%. A HELOC would be Prime + 0%. So it's not an ideal solution.

My margin account is roughly Prime - 0.6%, or currently, approximately 5.3% (in Canadian dollars).

It certainly pays to shop around (http://www.interactivebrokers.ca) ;) .

[FrugalTrader]

i'm not exactly sure how the timing works with respect to the investment loans under SM method

i was just approved for a mortgage of approximately 200,000 and i came across the book

after having read the book, i am curious to learn how often the loans should be taken

for example, suppose i put a lump sum payment of $1000 this month, and $1000 next month, does it not seem odd to be approaching the bank every month to ask for a loan of $1000 for investing? is it better to do it this way, or better to do it semi-annually, say every 6 months?

That's why if you want to do the SM, you need to obtain a re-advancable mortgage. These mortgages will AUTOMATICALLY increase your HELOC credit limit as you pay down your non-ded principle. Some examples of these mortgages are:
First Line: The Matrix Mortgage
RBC: The Homeline Mortgage
Manulife: Manulife ONE

FrugalTrader
http://www.MillionDollarJourney.com

[noodles]

Would love to see that spread sheet, or one similar? I would like to pug in my numbers and see what it comes out with.

[FrugalTrader]

Would love to see that spread sheet, or one similar? I would like to pug in my numbers and see what it comes out with.

I second that. :)

[fsmontenegro]

Hi!

As I do my research for implementing the SM (see my earlier posts), I came across the M1 product from Manulife. For those interested in it, there's a couple of threads on this forum (just search for it) as well as a LONG and nice discussion on a separate blog (http://mork.ca/archives/51-Manulife-One-First-Impressions.html).

Has anyone here implemented SM with M1? Any experiences they'd like to share?

Thanks!

[FrugalTrader]

Hi!

As I do my research for implementing the SM (see my earlier posts), I came across the M1 product from Manulife. For those interested in it, there's a couple of threads on this forum (just search for it) as well as a LONG and nice discussion on a separate blog (http://mork.ca/archives/51-Manulife-One-First-Impressions.html).

Has anyone here implemented SM with M1? Any experiences they'd like to share?

Thanks!

The Manulife one product is definitely a candidate for the SM, the only thing I don't like about it is that they charge a monthly fee of $14.

[fsmontenegro]

The Manulife one product is definitely a candidate for the SM, the only thing I don't like about it is that they charge a monthly fee of $14.

Hi. Yes, the fee is annoying, but understandable. My opinion is that the benefit is worth it. Two things come to mind:
- my current bank requires me to leave $x balance at all times to waive fees (just under $10). This is money not really doing anything.
- I don't mind paying something for the benefit of automatic "mortgage prepayments" without having to double-up, prepay, etc... myself.

Between these two factors, I find the $14/month quite reasonable.

Cheers!

[cannon_fodder]

I have no problem with sharing what I've come up with. If you can make it better, please offer up some expertise.

I'm a perfectionist - so, IMO, my baby is still too ugly to show off. I'd love to develop some sort of front end for it and it is unwieldy right now if you want to go back and forth between monthly mortgage payments vs. biweekly, etc.

I'll keep playing around, but if anyone wants to send me some hypothetical numbers to plug in, I can do that. It might help me validate and improve it.

It is making me wonder why I need a mortgage broker who will charge me a fee to service the readvanceable mortgage (as explained to me). They will take care of the communication to the FP so that s/he is aware of what to expect in terms of PAC. If I have my own spreadsheet I can determine that.

[fsmontenegro]

Going back to my SM implementation, a few questions on tax deductability.

The SM is based on the notion that the interest paid on a loan made for investment purposes is tax deductible. Can anyone comment if there are any tax breaks/deductions for the following investment expenses:
- Legal fees and appraisal fees to set up a HELOC used for investment purposes.
- Brokerage comissions.
- (this is a stretch, but hey, if it works...) the management fees charged by a mutual fund.

Also, is it possible to have a higher income spouse claim the interest expense on one return and have the lower income spouse declare the dividends obtained? If so, any recommendations on how to best document it?

Thanks!

[pitz]

=
The SM is based on the notion that the interest paid on a loan made for investment purposes is tax deductible. Can anyone comment if there are any tax breaks/deductions for the following investment expenses:
- Legal fees and appraisal fees to set up a HELOC used for investment purposes.


I've always deducted expenses associated with setting up bank loan facilities under carrying charges, and have never been challenged.



- Brokerage comissions.


Brokerage commissions must be capitalized into the purchase price of the assets you purchase. For instance, if you buy 1000 shares of $10 each, and pay $29.95 commission, your total cost base is equal to $10,029.95.



- (this is a stretch, but hey, if it works...) the management fees charged by a mutual fund.


Management fees of funds are usually deducted, by the fund itself, against the investment income produced by the fund. If you are charged and pay an explicit cash management fee by your investment advisor, under certain circumstances, it may be deductible.



Also, is it possible to have a higher income spouse claim the interest expense on one return and have the lower income spouse declare the dividends obtained? If so, any recommendations on how to best document it?


Sort of. You need to apportion the expenses associated with the income received, and further, you need to do so along the lines of the original capital contributed I understand.

For example, if your spouse makes half of the interest payments, and provided half of the downpayment, its logical that she claims one half of the dividend income, and one half of the interest expense.

[cannon_fodder]

My Readvanceable Mortgage Excel Workbook is up for viewing (http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls). If anyone feels like contributing to make it better, please do.

I've noticed that my calculations don't match exactly with the ones published in the book (when it comes to Steps III and IV, as well as Cash Flow Dam, our investment portfolio amounts aren't identical). They are quite close however.

My longstanding thought is that I have made an error in my formulas or in the spreadsheets. But, after reviewing his book, I have noticed there are errors (e.g. page 100 last paragraph he writes an interest expense of $833.73 for a $200,000 loan at 5% interest, and then correctly reports it in the last sentence on the page). I can't figure out where my logic is wrong, especially since it works for the other situations but perhaps a fresh set of eyes can resolve it.

Whether he is right and I am wrong, or vice versa, or we are both wrong, at least the numbers come out quite close.

My Workbook allows you to specify the following additional parameters which I could not see from the book's screen shots of his calculator (perhaps they are included in a separate screen or a newer version):

- Cash Flow Dam check box and expense amount
- Amortization
- Number of payments per year (although I only have spreadsheets for 12, 24 and 26 - trying to make one spreadsheet cover all scenarios was driving me crazy)
- Starting LOC (for the "Freeboard Equity", "Turbo Smith Maneouvre" or whatever you want to call it. This is when you want to tap into equity built up and draw upon that to a 75% readvanceable mortgage)
- Tax Refund date (I get mine in early March, some people get theirs after April 30th.)

You'll also quickly see what the investment portfolio amount is once the mortgage is retired. The faster you retire it, the smaller the amount is. Taking the full 25 year period (as in his examples) gives more time for the portfolio to grow. I found it helpful as when I was reading the book I mistook the portfolio amount quoted to be when the mortgage was free and clear, not after the full 25 years.

The one thing I haven't allowed for is for you to specify a beginning date for the mortgage. I have placed January 1, 2007 as the starting point so if you look at the spreadsheets themselves you have to go from there. That could affect slightly the calculations because if you start your readvanceable mortgage late in the year, that first year will have a small tax refund but it will be applied before a full 12 months are up.

I hope it is helpful for others.

[Rosico]

great stuff - thanks!

[FrugalTrader]

My Readvanceable Mortgage Excel Workbook is up for viewing (http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls). If anyone feels like contributing to make it better, please do.

I've noticed that my calculations don't match exactly with the ones published in the book (when it comes to Steps III and IV, as well as Cash Flow Dam, our investment portfolio amounts aren't identical). They are quite close however.

My longstanding thought is that I have made an error in my formulas or in the spreadsheets. But, after reviewing his book, I have noticed there are errors (e.g. page 100 last paragraph he writes an interest expense of $833.73 for a $200,000 loan at 5% interest, and then correctly reports it in the last sentence on the page). I can't figure out where my logic is wrong, especially since it works for the other situations but perhaps a fresh set of eyes can resolve it.

Whether he is right and I am wrong, or vice versa, or we are both wrong, at least the numbers come out quite close.

My Workbook allows you to specify the following additional parameters which I could not see from the book's screen shots of his calculator (perhaps they are included in a separate screen or a newer version):

- Cash Flow Dam check box and expense amount
- Amortization
- Number of payments per year (although I only have spreadsheets for 12, 24 and 26 - trying to make one spreadsheet cover all scenarios was driving me crazy)
- Starting LOC (for the "Freeboard Equity", "Turbo Smith Maneouvre" or whatever you want to call it. This is when you want to tap into equity built up and draw upon that to a 75% readvanceable mortgage)
- Tax Refund date (I get mine in early March, some people get theirs after April 30th.)

You'll also quickly see what the investment portfolio amount is once the mortgage is retired. The faster you retire it, the smaller the amount is. Taking the full 25 year period (as in his examples) gives more time for the portfolio to grow. I found it helpful as when I was reading the book I mistook the portfolio amount quoted to be when the mortgage was free and clear, not after the full 25 years.

The one thing I haven't allowed for is for you to specify a beginning date for the mortgage. I have placed January 1, 2007 as the starting point so if you look at the spreadsheets themselves you have to go from there. That could affect slightly the calculations because if you start your readvanceable mortgage late in the year, that first year will have a small tax refund but it will be applied before a full 12 months are up.

I hope it is helpful for others.


Thanks for sharing!

[CoolEddie]

Great spreadsheet!! I gota learn how to make them that good.

[noodles]

I haven't read the entire thread as it's so long, but I do have some questions:


Has anyone here on this forum actually implememted the Smith Manoeuvre? If so, please give some details. Where? How?
I keep reading about the re-advanceable mortgage. Who offers these? Can I use a traditional mortgage?
This seems too good to be true. Is it?


I am not a financial expert. We have a financial advisor who invests a small amount for us in RRSP's, some mutual funds and an RESP for our daughter. He has done very well and the average return this year is about 15%. He works for Berkshire. Should I talk to him? Will he know what I'm trying to do? Can he set it up?

We are buying a new place in the new year, closing date is April 26, 2007 but could be pushed back, our mortgage is going to be somewhere between 300-350K, with also about 200K-250K of our own money. I would love to get this going from the start and I just really need some advice on where to go and who to talk to. I cannot do this on my own.

I would want this to all happen automatically every month or 2 weeks, I don't want to be having to shuffle funds myself somehow all the time. i'm surprised noone offers something like this and takes care of all the details for you.

[pitz]

I am not a financial expert. We have a financial advisor who invests a small amount for us in RRSP's, some mutual funds and an RESP for our daughter. He has done very well and the average return this year is about 15%. He works for Berkshire. Should I talk to him? Will he know what I'm trying to do? Can he set it up?



15% isn't that impressive for this year. But yes, he should be able to set it up.

The issue, however, is that the only way you can really make good money by using leverage insofar as investment is concerned is to aggressively manage costs and taxes.

A traditionally compensated 'mutual fund' advisor:

1) Won't put you into tax-efficient ETFs, but will rather place you into less tax efficient actively managed funds.

2) Won't put you into fee-efficient ETFs because the advisor does not receive compensation (beyond the initial commission).

3) Probably won't help you out with certain tax aspects or optimization aspects.



We are buying a new place in the new year, closing date is April 26, 2007 but could be pushed back, our mortgage is going to be somewhere between 300-350K, with also about 200K-250K of our own money. I would love to get this going from the start and I just really need some advice on where to go and who to talk to. I cannot do this on my own.


Simple, get a re-advanceable mortgage ("Matrix Mortgage" is one name) from your favourite mortgage broker. Open an account with Interactive Brokers. Every month, make your mortgage payment, and then transfer the amount of your mortgage payment from the line of credit associated with the mortgage to your brokerage account.

Invest the proceeds in a currency-hedged basket of ETFs. Do not invest in bonds or bond funds (as doing so is counter-productive).

When you receive dividends in the brokerage account, withdraw them from the account, and use the proceeds to pay down the mortgage. Withdraw the equivilant from the LOC and re-deposit to the brokerage account to purchase additional securities.

As I see it, the only professional advice you should really need would concern the overall composition of your portfolio, and how you can make the portfolio as tax efficient as possible.



I would want this to all happen automatically every month or 2 weeks, I don't want to be having to shuffle funds myself somehow all the time. i'm surprised noone offers something like this and takes care of all the details for you.

Its not that hard once you have the planning aspect of things down. Recycling the dividends from your investments should accelerate the process of transforming the mortgage from a non-deductible one to a deductible one.

Keep good records. Make sure there is a clear correlation between amounts removed from the Matrix Mortgage LOC, and the amounts deposited to the brokerage account. Make sure you currency hedge your investments (using hedged ETFs/funds, or through futures/options/forex borrowing).

99% of what you need to know can be found in these forums.

[ProStor]

Thanks for sharing, have been reading this thread for a while, very educational.


My Readvanceable Mortgage Excel Workbook is up for viewing (http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls). If anyone feels like contributing to make it better, please do.

I've noticed that my calculations don't match exactly with the ones published in the book (when it comes to Steps III and IV, as well as Cash Flow Dam, our investment portfolio amounts aren't identical). They are quite close however.

My longstanding thought is that I have made an error in my formulas or in the spreadsheets. But, after reviewing his book, I have noticed there are errors (e.g. page 100 last paragraph he writes an interest expense of $833.73 for a $200,000 loan at 5% interest, and then correctly reports it in the last sentence on the page). I can't figure out where my logic is wrong, especially since it works for the other situations but perhaps a fresh set of eyes can resolve it.

Whether he is right and I am wrong, or vice versa, or we are both wrong, at least the numbers come out quite close.

My Workbook allows you to specify the following additional parameters which I could not see from the book's screen shots of his calculator (perhaps they are included in a separate screen or a newer version):

- Cash Flow Dam check box and expense amount
- Amortization
- Number of payments per year (although I only have spreadsheets for 12, 24 and 26 - trying to make one spreadsheet cover all scenarios was driving me crazy)
- Starting LOC (for the "Freeboard Equity", "Turbo Smith Maneouvre" or whatever you want to call it. This is when you want to tap into equity built up and draw upon that to a 75% readvanceable mortgage)
- Tax Refund date (I get mine in early March, some people get theirs after April 30th.)

You'll also quickly see what the investment portfolio amount is once the mortgage is retired. The faster you retire it, the smaller the amount is. Taking the full 25 year period (as in his examples) gives more time for the portfolio to grow. I found it helpful as when I was reading the book I mistook the portfolio amount quoted to be when the mortgage was free and clear, not after the full 25 years.

The one thing I haven't allowed for is for you to specify a beginning date for the mortgage. I have placed January 1, 2007 as the starting point so if you look at the spreadsheets themselves you have to go from there. That could affect slightly the calculations because if you start your readvanceable mortgage late in the year, that first year will have a small tax refund but it will be applied before a full 12 months are up.

I hope it is helpful for others.

[noodles]

Pitz, Thanks for the help. Few more questions for you, please bear with me, I'm not a dumb person just not an expert in finance as it's not my field.

Are you doing the Smith Manoeuvre yourself?


15% isn't that impressive for this year. But yes, he should be able to set it up.

The issue, however, is that the only way you can really make good money by using leverage insofar as investment is concerned is to aggressively manage costs and taxes.

A traditionally compensated 'mutual fund' advisor:

1) Won't put you into tax-efficient ETFs, but will rather place you into less tax efficient actively managed funds.

2) Won't put you into fee-efficient ETFs because the advisor does not receive compensation (beyond the initial commission).

3) Probably won't help you out with certain tax aspects or optimization aspects.


Can you explain why the funds are less tax efficient? I am assuming they are taxed more than the ETF's you are talking about. Can you (or anyone) explain the difference between the 2 and why they are taxed differently?



Simple, get a re-advanceable mortgage ("Matrix Mortgage" is one name) from your favourite mortgage broker.


I assume not everyone offers this? Currently we're with www.wscu.com in the Vancouver area but I didn't see anything like it on their site. I obviously don't need to stay with them for the new mortgage, and I have no problem moving. Does PC Financial offer anything that could be used?



Open an account with Interactive Brokers. Every month, make your mortgage payment, and then transfer the amount of your mortgage payment from the line of credit associated with the mortgage to your brokerage account.


www.interactivebrokers.ca Is this the site?



Invest the proceeds in a currency-hedged basket of ETFs. Do not invest in bonds or bond funds (as doing so is counter-productive).


Why is it counter-productive? I understand bonds are usually lower interest rate, so I would probably stay away from them anyways, is this why?



When you receive dividends in the brokerage account, withdraw them from the account, and use the proceeds to pay down the mortgage. Withdraw the equivilant from the LOC and re-deposit to the brokerage account to purchase additional securities.


Understood.


As I see it, the only professional advice you should really need would concern the overall composition of your portfolio, and how you can make the portfolio as tax efficient as possible.





Its not that hard once you have the planning aspect of things down. Recycling the dividends from your investments should accelerate the process of transforming the mortgage from a non-deductible one to a deductible one.


I'm starting to understand, the longer you go the more the debt moves to the LOC and thus more tax deductions.



Keep good records. Make sure there is a clear correlation between amounts removed from the Matrix Mortgage LOC, and the amounts deposited to the brokerage account. Make sure you currency hedge your investments (using hedged ETFs/funds, or through futures/options/forex borrowing).

99% of what you need to know can be found in these forums.


I'm a newb, what does "currency hedge" mean?


Thanks again. Sorry if the questions seem simple, but I'm not going to know if I never ask.

[pitz]

Pitz, Thanks for the help. Few more questions for you, please bear with me, I'm not a dumb person just not an expert in finance as it's not my field.

Are you doing the Smith Manoeuvre yourself?


No. I do not own real estate. But I do invest using borrowed funds, and have advised individuals concerning the SM or similar techniques.



Can you explain why the funds are less tax efficient? I am assuming they are taxed more than the ETF's you are talking about. Can you (or anyone) explain the difference between the 2 and why they are taxed differently?


To make a long story short, there are 3 main types of 'income' possible from an investment in Canada:

1) Interest -- taxed at your highest marginal rate.
2) Canadian Dividends -- Taxed at a very low rate, in fact, almost tax-free until your income hits $60,000/year or more.
3) Capital gains -- taxed at one half the highest marginal rate, but deferrable.

Generally speaking, you want the majority of the return from your investment to comprise 2) and 3).

Dividends occur when they are declared by the company you are investing in, and paid out. Capital gains occur when an investment is sold.

Tax efficiency is the concept of optimizing an overall portfolio so that realization of capital gains (buying and selling of investments) is minimized. Generally the most well-known strategy for doing so is known as indexxing.

Indexxing is where you essentially buy a large representative sample of the stock market, rather than trying to beat the overall market. Because its basically a buy-and-hold strategy with minimal fees, it tends to outperform.

Indexxing is also highly tax efficient because rarely are stocks bought and sold.



I assume not everyone offers this? Currently we're with www.wscu.com in the Vancouver area but I didn't see anything like it on their site. I obviously don't need to stay with them for the new mortgage, and I have no problem moving. Does PC Financial offer anything that could be used?


PCF is just a front-end for CIBC anyways, as I understand. CIBC also owns FirstLine Mortgages, which offers the "Matrix Mortgage". Most other banks and mortgage lenders offer similar mortgages as well -- you just need to shop around. Make sure you get one with the lowest interest rates possible, and seperate billing for a re-advanceable line of credit, as well as a primary mortgage.

The seperate accounting keeps things neat and tidy, and also ensures that money is not co-mingled between deductible and non-deductible uses, when used properly.



www.interactivebrokers.ca Is this the site?


Yes. I like IB because of their very low commissions. But I do not recommend them if you are a beginner investor because the interface can be harder to use. But $2 Canadian stock purchases are pretty hard to beat.

If you want something thats a bit more idiot-proof but still low-cost, try Canadian Shareowner. Ideally you want something thats economical enough to buy investments on a monthly basis without costing you a fortune in commissions.



Why is it counter-productive? I understand bonds are usually lower interest rate, so I would probably stay away from them anyways, is this why?


Yes, there is no point to borrowing money at a higher interest rate than you will earn on your investments. Most mortgages are well over 5% these days, while most bonds, government and corporate, in Canada, only bear interest rates slightly above 4%. Borrowing at 5%, to invest at 4%, is a way of destroying capital.

If your asset allocation calls for bond component, then you need to just pay down the (non-deductible) mortgage instead.



As I see it, the only professional advice you should really need would concern the overall composition of your portfolio, and how you can make the portfolio as tax efficient as possible.

I'm starting to understand, the longer you go the more the debt moves to the LOC and thus more tax deductions.


Yes. At first, you will not receive much of a tax deduction overall. But as the investment LOC portion increases, so will the tax deduction, and the cashflow from your (dividend-paying) investments, which, in turn, compounds upon itself. Give it a few years, and eventually the dividends will be paying the entirety of your mortgage payment (freeing up cashflow for other things).
I'm a newb, what does "currency hedge" mean?



Thanks again. Sorry if the questions seem simple, but I'm not going to know if I never ask.

Currency hedging is where you hedge out risk associated with currency fluctuations by matching the currency of your assets with the currency of your liabilities. For instance, if you borrowed Canadian dollars to buy US dollar stocks over the past few years, you would have lost a lot of money because of the drop in the US dollar (relative to the Canadian dollar).

However, if you borrowed US dollars to invest in US stocks, you would have done quite well, with significantly less volatility overall. Or vice versa, if you borrowed US dollars in the 1990s to invest in Canadian stocks, you would have lost your shirt. The stock market is a risky enough place to begin with -- no need to add additional risk in the form of currency exposure, especially when investing on credit.

[cannon_fodder]

Please see http://taxtips.ca/ontax.htm

The 2006 changes in the dividend tax credit seem to imply that unless you exceed $110k that dividend income is most tax efficient.

Using the chart, I calculate that, in Ontario, if you earned $110,885 in dividend income you would pay $8,999.20 in taxes. If you earned the same amount in capital gains you would pay $8,999.21 in taxes. Would someone be able to verify that because I tried to find a site that would show the tipping point between capital gains and dividends and didn't find one.

I think, though, for low income seniors relying on capital gains or dividends, the gross up of dividends could cause claw back on certain benefits quicker than capital gains.

[FrugalTrader]

Keep good records. Make sure there is a clear correlation between amounts removed from the Matrix Mortgage LOC, and the amounts deposited to the brokerage account. Make sure you currency hedge your investments (using hedged ETFs/funds, or through futures/options/forex borrowing).


Pitz,

For tax purposes in proving that you used the LOC money for investment, do you only have to show that you transfered the money to your brokerage? Or do you also have to show the money being used to purchase an investment?

For those of you interested, here are the Smith Manoeuver summaries that I wrote:

Part 1:
http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-1.htm

Part 2:
http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-2.htm

[fsmontenegro]

Hi!

I don't mean to violate any forum rules on specific stocks/investments. If I'm out of line, please let me know and I'll drop the subject.

For those who have performed the SM or something similar, what has been your approach to building a non-reg portfolio? For now I'm assuming a dividend-focused portfolio...

a) Buy individual stocks that together make up a dividend-focused portfolio on a monthly basis via brokerage (I'll likely use IB for the low, low commissions). Achieve balance by buying different stocks throughout the year to make up a balanced portfolio.
b) Buy a dividend-focused mutual fund on a monthly basis
c) Buy a dividend-focused ETF on a monthly basis
d) Other (please elaborate)

Thanks!

[pitz]

For tax purposes in proving that you used the LOC money for investment, do you only have to show that you transfered the money to your brokerage? Or do you also have to show the money being used to purchase an investment?


Its not rational to borrow money on a LOC, and just deposit it to a brokerage account without purchasing an investment. The broker might pay you a pittance of interest on your cash balances, but it will be nowhere near your mortgage rate (and you will still have to pay taxes on the interest paid to you by your broker).

So why would you do that? Technically it should be deductible, if the broker pays you interest on cash balances, but it doesn't sound like a logical thing to do.

[fsmontenegro]

Its not rational to borrow money on a LOC, and just deposit it to a brokerage account without purchasing an investment. The broker might pay you a pittance of interest on your cash balances, but it will be nowhere near your mortgage rate (and you will still have to pay taxes on the interest paid to you by your broker).

So why would you do that? Technically it should be deductible, if the broker pays you interest on cash balances, but it doesn't sound like a logical thing to do.

I remember reading somewhere (maybe even in this thread) that the CRA could even rule that this scenario - investing in something that does not have the possibility of generating income afetr considering the loan costs - would not qualify for deductibility of interest.

Hope this helps.

[BHA1]

I have my LOC with my bank and have a brokerage account. I sent an EFT deposit from bank to brokerage in order to invest.

My bank statement shows "EFT of $xxx" but says it went to a clearing house (not the actual name of the brokerage). Funds were transferred out of the LOC on approximately Feb 1 06

My brokerage statement shows "EFT transfer in of $xxx" but doesn't say where it came from. Funds received on approximately Feb 4 06. Purchased some index funds the same day and have had them ever since.

Would CRA assume these two transactions were the same thing? I didn't write a cheque from the LOC, so I have no paper backup.

Do I need to get something from the bank showing where the funds went to, along with something from the brokerage showing where the funds came from?


Related question:
Purchased a rental property using the above mentioned LOC. The LOC was a combined "mortgage/LOC" product like Firstline's Matrix Mortgage. Amount of rental property was 1/5 of total mortgage amount (4/5 was for my home and 1/5 was for the rental property).

Refinanced mortgage 2yrs later with another bank. Now have both of the above pieces (home + rental property) as one mortgage.

Question: Can I write off 1/5 of the interest paid, since it relates to the rental property? Or should I be pursuing (ASAP!) a refinance of the rental property with its own mortage to be safer? Don't want to find out 5yrs down the road that CRA won't allow the interest!

[pitz]

Related question:
Purchased a rental property using the above mentioned LOC. The LOC was a combined "mortgage/LOC" product like Firstline's Matrix Mortgage. Amount of rental property was 1/5 of total mortgage amount (4/5 was for my home and 1/5 was for the rental property).

Refinanced mortgage 2yrs later with another bank. Now have both of the above pieces (home + rental property) as one mortgage.

Question: Can I write off 1/5 of the interest paid, since it relates to the rental property? Or should I be pursuing (ASAP!) a refinance of the rental property with its own mortage to be safer? Don't want to find out 5yrs down the road that CRA won't allow the interest!

Ick, your co-mingling of accounts definitely is something the CRA could challenge you on, and make your life miserable.

On the other hand, you might also have difficulty coming up with a refinance transaction satisfactory to the CRA without triggering capital gains tax.

You probably should seek professional advice. Not only that, but your overall debt allocation structure is sub-optimal. Interest on the primary residence mortgage is never deductible, while 100% of the interest on the rental property would be deductible.

[raj672]

This was a very good read. I am still not understanding as to how the payments will stay the same even though you will be paying the mortgage payment and the interest only payment on your loan???

It was mentioned that you can just withdraw from the same loc and deposit it as a payment(I don't think any bank will allow this as you will never pay them off !!!!!!)

What am i missing here???

Do you think an average person can do this on it's own and not deal with the smith man's team of (brokers/accountants/advisor's etc)

[pitz]

This was a very good read. I am still not understanding as to how the payments will stay the same even though you will be paying the mortgage payment and the interest only payment on your loan???


The combined effect of the tax savings associated with the interest deduction, as well as the dividends from a quality portfolio of ETFs or stocks, should take care of most of the increase in payments.

Undoubtedely, unless very carefully planned, there will be some short-term cash hickups. Which ultimately brings us to the solution you suggest below:



It was mentioned that you can just withdraw from the same loc and deposit it as a payment(I don't think any bank will allow this as you will never pay them off !!!!!!)

What am i missing here???


Its secured credit, the bank doesn't care whether its paid off or not, as they can always realize on their security if you default. But they need a monthly payment (irregardless of source), merely to prove to banking regulators that your loan isn't risky/delinquient.

Banks don't like having their loans classified as delinquient. It increases their borrowing costs and reduces the amount of leverage they are allowed to employ per government banking regulations.




Do you think an average person can do this on it's own and not deal with the smith man's team of (brokers/accountants/advisor's etc)

Each individual usually brings their own set of unique circumstances to the table, concerning investments, the size of mortgage, income, consistency of income, the industry in which income is derived, and their ability to access credit.

If you do not have expertise in the area, I feel its probably worthwhile to pay a couple thousand $$ for proper professional advice that is free of conflict of interest.

Avoiding Conflict of interest means that you don't receive your advice from a mortgage broker, nor a stock or life insurance salesman, nor from the government.

[raj672]

I think since it's failry new, we won't hear any horror stories anytime soon. It will interesting to attend one of their seminars to see how it is presented to a general public.

I would love to see a proper professional who can assess my situation and provide/recommend a proper course of action in attempting this.

so using a financial planner would not make sense b/c of conflict of interest then really who can u use to come up with a etf/stock plan and monitor on a regular basis :confused:

[ullyeus]

Some of you are reporting that you are using a HELOC for the Smith Manoeuvre. My main problem with a HELOC is that banks report HELOC's to credit reporting agencies as revolving debt wherein a readvanceable mortgage is not reported at all.

In my case I don't owe anything except for a $150,000.00 HELOC against a $400,000.00 home. It pisses me off when I check my credit report and it always says "my outstanding balance is too high in proportion to my available credit." This hurts my Score.

The way I look at it is I have a $150,000.00 credit against $400,000.00 property which is under 40% debt ratio. The credit agency looks at as I am using $150,000.00 of $150,000.00 available credit. Not good in their eyes.


simple question...but who cares what it shows when you have that much assets and already have a mortgage? Isn't the whole point in good credit so you can get a mortgage, and after that...who cares?

ps: Realize I am being somewhat "basic" here.

[pitz]

simple question...but who cares what it shows when you have that much assets and already have a mortgage? Isn't the whole point in good credit so you can get a mortgage, and after that...who cares?

Mortgages have to be renewed periodically, every 5 years or so is the typical term.

Borrowing from a margin account can be used to get around this problem instead of solely relying upon the HELOC. Interactive Brokers lends at a lower interest rate than most HELOCs.

[cannon_fodder]

Thanks to fsmontenegro's great suggestions, I have updated my Workbook to help with 'what if' scenarios for the Smith Manoeuvre that take into account common strategies used to pay down the mortgage faster.

Raj672, once you put in the various parameters on the Input sheet, you can then go to the respective tab (based on payments per year - 12=> Monthly, 24=> Twice Monthly and 26=> BiWeekly) and follow each payment to see how the money flows. It is based on the premise that no external money (through your regular cash flow or even through income from your investments) is used to help with the interest payments.

You can find it here:

http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls

[grant]

For tax purposes in proving that you used the LOC money for investment, do you only have to show that you transfered the money to your brokerage? Or do you also have to show the money being used to purchase an investment?
Yes, keep both. If you are not currentely receiving trade confirmations from your broker, get that started.


So why would you do that? Technically it should be deductible, if the broker pays you interest on cash balances, but it doesn't sound like a logical thing to do.
If the interest the broker pays is less than the interest the mortgage accrues, then there is no reasonable expectation of profit... thus non-deductible.

[pitz]

If the interest the broker pays is less than the interest the mortgage accrues, then there is no reasonable expectation of profit... thus non-deductible.

Are you 100% sure that the required test under the Income Tax Act is a reasonable expectation of profit (from the borrowing/investing itself)?

As far as I am aware, the reasonable expectation of profit only applies to the investment itself. For instance, the 'investment' must not be a total sham business that only subsists for the purpose of losing money (but enriching its directors/employees).

So, correct me if I am wrong, but theres no requirement in the ITA that the actual process of borrowing and investment have a 'reasonable expectation of profit', but only that the investments themselves are such that they have 'reasonable expectations of profit'.

Therefore, the interest on money borrowed to place on deposit with a broker/bank should be deductible. However, as I stated earlier, doing so is irrational.

[cannon_fodder]

This might provide some helpful information re: allowable deductions which appears to supports pitz' position.

http://www.camagazine.com/1/4/0/7/4/index1.shtml

[grant]

Are you 100% sure that the required test under the Income Tax Act is a reasonable expectation of profit (from the borrowing/investing itself)?
My research has been in regards to real estate investing. The issue has been dealt with a few times in the courts, for example, in the link that cannon_fodder presented:

Brian Stewart purchased four condominium units as rental properties. All units were highly leveraged, with Stewart paying only $1,000 in cash per unit. The developer's projections contemplated negative cash flows and tax deductions for a 10-year period, with the prospect of a gain at the end. The actual experience was even worse than projected. In the years in question, Stewart's interest expenses exceeded his rental income. The losses claimed consisted primarily of interest expenses. The CCRA disallowed these losses on the basis that Stewart had no reasonable expectation of profit, and therefore no source of income. Both the Tax Court and the Federal Court of Appeal agreed with the decision.

Why was the deduction disallowed? Because Stewart KNEW that he would be generating a loss. It is exactly the same as we discuss.


As far as I am aware, the reasonable expectation of profit only applies to the investment itself. For instance, the 'investment' must not be a total sham business that only subsists for the purpose of losing money (but enriching its directors/employees).

So, correct me if I am wrong, but theres no requirement in the ITA that the actual process of borrowing and investment have a 'reasonable expectation of profit', but only that the investments themselves are such that they have 'reasonable expectations of profit'.

Either you are borrowing to pursue a business venture, or you are not. You can't have it both ways. If you claim an interest expense as a reduction of your business's income, then it by definition is affecting its profitability.

However, Cannon_Fodder's link suggests there is precedent to ignore the REOP requirements when planning taxes, which if true would render this discussion moot!

[Joseph88]

My research has been in regards to real estate investing. The issue has been dealt with a few times in the courts, for example, in the link that cannon_fodder presented:

Brian Stewart purchased four condominium units as rental properties. All units were highly leveraged, with Stewart paying only $1,000 in cash per unit. The developer's projections contemplated negative cash flows and tax deductions for a 10-year period, with the prospect of a gain at the end. The actual experience was even worse than projected. In the years in question, Stewart's interest expenses exceeded his rental income. The losses claimed consisted primarily of interest expenses. The CCRA disallowed these losses on the basis that Stewart had no reasonable expectation of profit, and therefore no source of income. Both the Tax Court and the Federal Court of Appeal agreed with the decision.

Why was the deduction disallowed? Because Stewart KNEW that he would be generating a loss. It is exactly the same as we discuss.


Either you are borrowing to pursue a business venture, or you are not. You can't have it both ways. If you claim an interest expense as a reduction of your business's income, then it by definition is affecting its profitability.

However, Cannon_Fodder's link suggests there is precedent to ignore the REOP requirements when planning taxes, which if true would render this discussion moot!

What if you take the HELOC and invest in dividend paying stocks? You will EXPECT that the dividends will eventually grow to a point where they exceed the interest costs.

What do you guys think?

[pitz]

What if you take the HELOC and invest in dividend paying stocks? You will EXPECT that the dividends will eventually grow to a point where they exceed the interest costs.

What do you guys think?

Absolutely. And if history is any indication, its pretty insane to use borrowed money to invest in publicly traded securities that do not pay dividends.

The issue being outlined above is that if you intend to use the interest deduction in order to create a mockery or sham of the system, or if you intend to use interest as a means to create deductible 'expense' out of capital investment (through excessive rates of interest, for instance) outside of the capital cost allowance mechamism, the CRA will challenge such positions. Competent tax advice is a must.

But will the CRA go after someone who borrows at 6%, to hold money in short-term bonds as part of a balanced portfolio allocation for the Smith Manouevre, (even though such an arrangement is hardly profitable). Probably not. But doing so isn't exactly very intelligent either.

[circa76]

My research has been in regards to real estate investing. The issue has been dealt with a few times in the courts, for example, in the link that cannon_fodder presented:

Brian Stewart purchased four condominium units as rental properties. All units were highly leveraged, with Stewart paying only $1,000 in cash per unit. The developer's projections contemplated negative cash flows and tax deductions for a 10-year period, with the prospect of a gain at the end. The actual experience was even worse than projected. In the years in question, Stewart's interest expenses exceeded his rental income. The losses claimed consisted primarily of interest expenses. The CCRA disallowed these losses on the basis that Stewart had no reasonable expectation of profit, and therefore no source of income. Both the Tax Court and the Federal Court of Appeal agreed with the decision.

Why was the deduction disallowed? Because Stewart KNEW that he would be generating a loss. It is exactly the same as we discuss.


Either you are borrowing to pursue a business venture, or you are not. You can't have it both ways. If you claim an interest expense as a reduction of your business's income, then it by definition is affecting its profitability.

However, Cannon_Fodder's link suggests there is precedent to ignore the REOP requirements when planning taxes, which if true would render this discussion moot!

But the Supreme Court disagreed and sent the trial back for re-assessment.

Ref: 2002 SCC 46, 212 D.L.R. (4th) 577, 2002 D.T.C. 6969



Brian J. Stewart, Appellant v. Her Majesty The Queen, Respondent

VII. Conclusion

69 For these reasons, we conclude that the appellant's rental activities constituted a source of income. As a result, we would allow the appeal with costs throughout, set aside the judgment of the Federal Court of Appeal and refer the assessments for the taxation years in issue back to the Minister for reassessment on the basis that the taxpayer had a source of income from which he was entitled to deduct losses from the rental properties in question.


with I think the key point being in p.37 (emphasis mine)



37 It has been pointed out that, as a matter of logic, the fact that an activity carried on with a reasonable expectation of profit is a sufficient requirement for a source of income (the proposition from Dorfman) does not entail that a reasonable expectation of profit is a necessary requirement for a source of income (the proposition from Moldowan): see Brian S. Nichols, "Chants and Ritual Incantations: Rethinking the Reasonable Expectation of Profit Test," 1996 Conference Report, Report of Proceedings of the Forty-Eighth Tax Conference, Vol. 1 (Toronto: Canadian Tax Foundation, 1997), 28:1, at pp. 28:4-28:5; Sheldon Silver, "Great Expectations: Are they Reasonable?", Corporate Management Tax Conference 1995, Real Estate Transactions: Tax Planning for the Second Half of the 1990s (Toronto: Canadian Tax Foundation, 1996), 6:1, at pp. 6:6-6:7. In other words, it is argued that by taking the comments from Dorfman out of their particular context and applying them generally, Moldowan mistakenly equated "source of income" with " reasonable expectation of profit ."

[FrugalTrader]

Absolutely. And if history is any indication, its pretty insane to use borrowed money to invest in publicly traded securities that do not pay dividends.

The issue being outlined above is that if you intend to use the interest deduction in order to create a mockery or sham of the system, or if you intend to use interest as a means to create deductible 'expense' out of capital investment (through excessive rates of interest, for instance) outside of the capital cost allowance mechamism, the CRA will challenge such positions. Competent tax advice is a must.

But will the CRA go after someone who borrows at 6%, to hold money in short-term bonds as part of a balanced portfolio allocation for the Smith Manouevre, (even though such an arrangement is hardly profitable). Probably not. But doing so isn't exactly very intelligent either.

When you borrow on margin, is the interest tax deductible there? If so, what if the stock trader uses the margin to do short term trading? Is that still considered an "investment" loan?

[pitz]

When you borrow on margin, is the interest tax deductible there? If so, what if the stock trader uses the margin to do short term trading? Is that still considered an "investment" loan?

If the money borrowed on margin is used to invest in taxable securities that have a prospect of paying dividends in the future, then "yes", you can deduct the interest.

Canadian tax law does not differentiate between short-term trades and long-term trades, unlike US tax law. However, if the CRA deems you are running a 'business' of securities trading, they can force you to apply income treatment to the entirety of your investments.

I think its fairly reasonable to say that if you have a full time job, but also borrow a few thousand to flip a few (eligible) stocks here and there, that you could deduct the interest. If you are a daytrader, and don't have an 'other' job, then its possible the CRA could demand 'income' treatment of your gains.

[CoolEddie]

So what kind of investments are best for the Smith Manouevre? Stocks seem out of the questions since the commissions will kill any profit and it's hard to buy stocks for the exact amount your principle is. So index funds are out too (although this is recommended by Smith) for the same reasons. High interest savings accounts are out because there is no expected return since your LOC is going to have a higher interest rate than your account. So isn't the only viable option left mutual funds?

[pitz]

So what kind of investments are best for the Smith Manouevre? Stocks seem out of the questions since the commissions will kill any profit and it's hard to buy stocks for the exact amount your


I can buy stocks for $1 per trade (200 shares maximum). Commissions are hardly a big deal, but obviously you want to keep your overall commission/fee drag to a minimum, while maintaining a diversified portfolio.

This inevitably leads to index funds/ETFs as a tax-efficient means of implementing the SM.



principle is. So index funds are out too (although this is recommended by Smith) for the same reasons. High interest savings accounts are out because


Why would index funds be out? You can buy TD eFunds without explicit commissions and very low MERs. Or you can use the brokerage I use and buy ETFs for $1 per purchase.



there is no expected return since your LOC is going to have a higher interest rate than your account. So isn't the only viable option left mutual funds?

Sure, you can use mutual funds as well. Obviously you need to be careful to select ones that are relatively tax efficient, do not charge high fees/MERs, and ideally pay a tax-advantaged stream of dividends which you can recycle into paying down your non-tax-deductible debt.

If you do not understand the whole investment aspect of the SM, please seek professional advice, preferrably by a fee-only investment counsel. You may be charged $1000-$3000 for an investment plan that is compatible with the SM, but the money is well worth it.

[fsmontenegro]

So what kind of investments are best for the Smith Manouevre? Stocks seem out of the questions since the commissions will kill any profit and it's hard to buy stocks for the exact amount your principle is. So index funds are out too (although this is recommended by Smith) for the same reasons. High interest savings accounts are out because there is no expected return since your LOC is going to have a higher interest rate than your account. So isn't the only viable option left mutual funds?

Hi!

I won't quote specific investments here as it is not allowed by the forum rules. What I will say is:
- Comissions on stock purchases vary from $2/trade (Canadian) at InteractiveBrokers through $4.95/trade at Questrade, $9.99 at E-trade all the way to $19.99 at E-trade (if you don't have a large number of transactions each quarter) to the regular $29/trade at many brokerages.
- ETFs (Exchange Traded Funds) trade as stocks, so same comissions apply.
- Many mutual funds (INCLUDING index funds) can be purchased in relatively small lots after the first initial purchase. As an example, a fund may require an initial $2000 purchase and then accept increments of $50 or $100.
- High interest saving accounts are not recommended because their return is likely less than the LoC rate. If you use something like this, the CRA may actually challenge you on it...

Many of the recommendations I've seen (and the one I'm following) is to have a dividend-focused portfolio in your non-reg account. Canadian dividends get preferred tax treatment. I know different rules apply about US dividends than foreign (non-US, non-Canada) dividends. If someone can clarify, that would be great.

In summary, I think using a cheaper brokerage (IB or Questrade) and focusing on dividend generating stocks (in a balanced manner!) is a nice way to implement the SM. That's exactly what I'm in the process of setting up.

Naturally, nothing in this post constitutes financial advice. If in doubt, you MUST consult a licensed professional...

Cheers

[FrugalTrader]

Hi!

I know different rules apply about US dividends than foreign (non-US, non-Canada) dividends. If someone can clarify, that would be great.
Cheers

US dividends are taxed like interest, 100% taxable.

[raj672]

To:cannon_fodder

Thank you for doing all this work and sharing it with us. This will be most helpful as you have provided us with a snap shot of what the overall result would be ..

My mortgage doesn't renew until 2009. Do you guys think it would be ok to break up the mortgage or will it be better to wait until renewal to avoid fees and I will have more equity in my house by that time.

I don't have a sizeable portfolio of any kind (currently RSP of 5k). Debt would be of a car loan 20k-(no interest for 5 yrs) and student loan of 10k

[taxguru]

This might provide some helpful information re: allowable deductions which appears to supports pitz' position.

http://www.camagazine.com/1/4/0/7/4/index1.shtml

The Stewart case and the commentary in this article has been superceded by a proposed new "Reasonable Expectation of Profit" rule, announced on October 31, 2003. This was the Dept of Finance's response to the ruling by the Supreme Court of Canada in the Stewart case.

If this rule is enacted as drafted it will indeed mean that there must be a "Reasonable expectation of profit" or REOP in order to deduct a net loss in respect of a business or investment activity.

The REOP requirement is cumulative. This means that to deduct a loss in a particular year you must expect to earn a cumulative profit from the business or investment over its life.

According to the CRA:

"the relevant test is the expectation of cumulative profit over the whole of the profitablity time period, and a taxpayer would be able to claim a loss provided their expectations for a cumulative profit over the entire relevant time period were reasonable."

Also, capital gains and losses are not factored in to the calculation of income or loss for the purpose of this test. You must show a REOP excluding capital gains. This basically means you have to earn a profit from dividends, interests and rents after deducting carrying costs, such as interest.

This proposed REOP rule could have some very harsh negative consequences for leveraged equity investors, and the Dept of Finance is considering commentary from tax professionals (and I hope considering some relieving provisions) before this new rule becomes law.

[pitz]

This proposed REOP rule could have some very harsh negative consequences for leveraged equity investors, and the Dept of Finance is considering commentary from tax professionals (and I hope considering some relieving provisions) before this new rule becomes law.

Doesn't sound too scary to me, overall. Just means that you have to invest in 'stuff' that produces explicit growing dividends. Not being able to deduct interest incurred to invest in Nortel shares isn't the end of the world -- and maybe companies that destroy value (ie: Nortel, Air Canada) and don't pay dividends won't have such easy access to capital in the future.

Actually, forcing people to show a REOP actually might save many investors from themselves and their greed and their leverage. Imagine that, the tax department actually looking out for people!

[cannon_fodder]

To:cannon_fodder

Thank you for doing all this work and sharing it with us. This will be most helpful as you have provided us with a snap shot of what the overall result would be ..

My mortgage doesn't renew until 2009. Do you guys think it would be ok to break up the mortgage or will it be better to wait until renewal to avoid fees and I will have more equity in my house by that time.

I don't have a sizeable portfolio of any kind (currently RSP of 5k). Debt would be of a car loan 20k-(no interest for 5 yrs) and student loan of 10k

You are welcome. As for your question, I have used the workbook to help my with various 'what if' scenarios. It seems to come back, time and time again, the sooner you start the better - even with paying a penalty. Now, in my case, the interest rate on my current mortgage and a new one are almost identical. In your case perhaps your new mortgage rate would be substantially higher, or lower, which could have a significant impact on your decision.

[grant]

If this rule is enacted as drafted it will indeed mean that there must be a "Reasonable expectation of profit" or REOP in order to deduct a net loss in respect of a business or investment activity.

The REOP requirement is cumulative. This means that to deduct a loss in a particular year you must expect to earn a cumulative profit from the business or investment over its life.
Thanks taxguru. It sounds like the court case cannon_fodder mentioned was basically a mirage for people hoping to set up clever deductions for unsupported expenses.

As for the "best" way to implement the smith maneuvre, the "best" way (imho) is by continuing whatever investments or business ventures you are doing already. E.g. if you run a home based business, then use that to convert your debt.

[raj672]

wondering if any of the poster's have actually done this or intend to do it in near future.

I'm attending one of their workshop to see how they are presenting this, what investments they are using etc, will keep you posted. ;)

[fsmontenegro]

wondering if any of the poster's have actually done this or intend to do it in near future.

I'm attending one of their workshop to see how they are presenting this, what investments they are using etc, will keep you posted. ;)

Hi,

After sifting through a LOT of information, I made the decision to go ahead and implement this. I opened a line of credit with Scotiabank and I am in the process of setting up an account with Interactive Brokers. Once this is done, I will:
- sell the non-reg investments I currently have (not a lot, under $20K)
- apply to the mortgage as prepayment (I have enough room)
- borrow the same amount from the LoC
- invest in a diversified portfolio of Canadian equities with a tilt towards dividend generation.

Based on my own comfort level with the issues (investing, taxation, etc...), I saw no value in engaging a financial planner or mortgage broker, though of course others may feel differently.

Some of my sources for information were:
- Smith's book and website (I did not purchase the calculator)
- "Smith manoeuvre" threads at RFD (this one) as well as various Canadian blogs (Million Dollar Journey comes to mind, but there were others)
- additional info from Financial Webring Forum, a blog entry on the Manulife One product, as well as info from CRA (specifically IT533 on taxation of interest).

Hope this helps.

[FrugalTrader]

Hi,

After sifting through a LOT of information, I made the decision to go ahead and implement this. I opened a line of credit with Scotiabank and I am in the process of setting up an account with Interactive Brokers. Once this is done, I will:
- sell the non-reg investments I currently have (not a lot, under $20K)
- apply to the mortgage as prepayment (I have enough room)
- borrow the same amount from the LoC
- invest in a diversified portfolio of Canadian equities with a tilt towards dividend generation.

Based on my own comfort level with the issues (investing, taxation, etc...), I saw no value in engaging a financial planner or mortgage broker, though of course others may feel differently.

Some of my sources for information were:
- Smith's book and website (I did not purchase the calculator)
- "Smith manoeuvre" threads at RFD (this one) as well as various Canadian blogs (Million Dollar Journey comes to mind, but there were others)
- additional info from Financial Webring Forum, a blog entry on the Manulife One product, as well as info from CRA (specifically IT533 on taxation of interest).

Hope this helps.

Which re-advancable mortgage did you get with Scotia bank? The last time I spoke with a rep, they explained that if I want a new credit limit on the HELOC, I would have to fill out paperwork every time.

[circa76]

- additional info from Financial Webring Forum, a blog entry on the Manulife One product, as well as info from CRA (specifically IT533 on taxation of interest).

Hope this helps.

In case anyone is curious, this is the Interpretation Bulletin IT-533.

What he's doing here is "Restructuring Borrowings":



Restructuring borrowings

15. A taxpayer may restructure borrowings and the ownership of assets to meet the direct use test.

Example 1

Ms. A owns 1,000 shares of B. Corp., a corporation listed on the TSX. Ms. A also owns a personal use condominium that was financed with borrowed money. At this point, the direct use of the borrowed money was to acquire the condominium. Ms. A may choose to sell the 1,000 shares of B. Corp., use the proceeds from the sale of the 1,000 shares of B. Corp. for any purpose, including paying down the borrowed money used to acquire the condominium, and subsequently obtain additional borrowed money to acquire another 1,000 shares of B. Corp. At this point, the additional borrowed money is directly used to acquire 1,000 shares of B. Corp.


This is, at a high level, what the Smith Manouvre is about.

[fsmontenegro]

Which re-advancable mortgage did you get with Scotia bank? The last time I spoke with a rep, they explained that if I want a new credit limit on the HELOC, I would have to fill out paperwork every time.

I set up an "Total Equity Plan" (for 75% of the appraised value of my home) and a Scotialine line of credit under that plan.

You're right in that the increase is not automatic. However, it is not a difficult process - I can go to the branch, call my manager or even do it online.

In my particular situation it is not a problem, for two reasons:
- the monthly increase on my equity (and therefore the potential increase in my LoC) is barely $1K/month.
- I'm not going to use the full LoC for the manoeuvre. Out of the existing limit, I'm setting aside 50K or so to leave as an "emergency fund".

With this in mind, I'm absolutely OK with manually increasing my LoC limit (because of increase home equity) once or twice a year.

As always, YMMV.

Hope this helps.

[don242]

Which re-advancable mortgage did you get with Scotia bank? The last time I spoke with a rep, they explained that if I want a new credit limit on the HELOC, I would have to fill out paperwork every time.

I just finished talking to Scotiabank and they said the same thing as well, but it was simply to come in and sign a paper each time you want the limit increased. You are already approved for the full 75% value of your home, just increasing your limit requires your signature. I thought it was a little dumb as well but unless you are paying large chunks off your mortgage each month, the increases to your limit are minimal so to go in twice a year isn't that big a deal.

[don242]

1) Interest -- taxed at your highest marginal rate.
2) Canadian Dividends -- Taxed at a very low rate, in fact, almost tax-free until your income hits $60,000/year or more.
3) Capital gains -- taxed at one half the highest marginal rate, but deferrable.



I know this response was from awhile back (still trying to understand a few loose ends).

What I want to know is in regard to #2 above, how are dividends almost tax free? Depending on your bracket isn't the actual amount of dividends is grossed up by 1.45. Then the tax is applied on that amount at the marginal tax rate. Then the dividend tax credit is calculated at 19% of the grossed up amount. The dividend tax credit amount is then deducted from the income tax.

Here is an example of a person in a 30% tax bracket with $1000 dividends.
$1000 X 1.45 = $1450. 30% tax on $1450 = $435. Dividend tax credit on $1450 is $1450 X 19% = $275.50. Tax owing on the $1000 dividends is $435 - $275.50 = $159.50. So in this case the dividends are ultimately taxed at a rate of 15.95%.

[FrugalTrader]

I think Pitz means that dividend income is almost tax free when dividends are your PRIMARY income.

[ghostryder]

Here is an example of a person in a 30% tax bracket with $1000 dividends.
$1000 X 1.45 = $1450. 30% tax on $1450 = $435. Dividend tax credit on $1450 is $1450 X 19% = $275.50. Tax owing on the $1000 dividends is $435 - $275.50 = $159.50. So in this case the dividends are ultimately taxed at a rate of 15.95%.

You have only included the Federal DTC. You left out calculating the provincial DTC.

For example, for me (in my province), in addition to your above calculations I would get

grossed up div amount x 11%

$1450 x 11% = 159.50 Prov DTC

$435 - ($275.50 + $159.5) = 0


My real numbers would be slightly different since I have a combined FED/Prov MTR of 26.5%. I actually end up with a negative taxation rate on dividends which means that for every dollar in dividends I recieve the DTC offsets $0.05 of tax withheld from my income. So I get a (tiny) refund for every dollar in dividends that I get.

[don242]

Here is an example of a person in a 30% tax bracket with $1000 dividends.
$1000 X 1.45 = $1450. 30% tax on $1450 = $435. Dividend tax credit on $1450 is $1450 X 19% = $275.50. Tax owing on the $1000 dividends is $435 - $275.50 = $159.50. So in this case the dividends are ultimately taxed at a rate of 15.95%.

You have only included the Federal DTC. You left out calculating the provincial DTC.

For example, for me (in my province), in addition to your above calculations I would get

grossed up div amount x 11%

$1450 x 11% = 159.50 Prov DTC

$435 - ($275.50 + $159.5) = 0


My real numbers would be slightly different since I have a combined FED/Prov MTR of 26.5%. I actually end up with a negative taxation rate on dividends which means that for every dollar in dividends I recieve the DTC offsets $0.05 of tax withheld from my income. So I get a (tiny) refund for every dollar in dividends that I get.

Actually the 30% tax bracket approximation assumes both federal and provincial (22% fed + 9.15% Ont) and the tax credits were a combined credit. But you may be right, I need to double check using an actual tax return. Thanks.

[edrempel]

Hi, All,

I just noticed this blog thread and there is a fascinating discussion going on. We are the main advisors doing the SM in the GTA and have implemented it several hundred times. A few comments:

- There have been a lot of comments about REOP, but CRA has in practice accepted investments in stocks and mutual funds even if they don't pay any distributions, despite what he Act says. If there is an expectation that they will eventually be profitable in addition to the interest cost and an expectation that they could pay distributions, that is enough. Any stock or mutual fund could pay dividends - there is no requirement that they have to. Companies buy parts of each other all the time and should all the purchase interest be disallowed because the other company doesn't pay dividends? CRA considered this a few years ago, but seems to have abondoned it. They would have to deny interest deductions on millions of transactions to try this - most purchases of companies by each other, most leverage and most In fact, any stock or mutual fund that is 100% tax-efficient (has never paid a distribution) is still accepted by CRA.

- Dividends are tax-preferred - the tax is almost as low as capital gains for all but the lowest incomes. Dividends are tax-free if you have essentially NO other income and total income under $23,000, but hardly any of us fit this. Of course Deferred capital gains are taxed at the lowest possible rates - zero. Focussing on getting income just costs you tax. I've tested various scenarios and receiving income and paying it down on the mortgage and then reinvesting is still less effective than having a 100% tax-efficient investment.

- Scotia STEP mortgage is actually the most awkward of all the major banks readvanceable mortgages, since it doesn't readvance automatically and you can't invest directly from the credit line. CIBC has no readvanceable. The other 3 major banks all have good products that automatically readvance, each with advantages and disadvantages. We haven't found any mortgage broker product we like, except Merix, but it still has many technical service and cost issues. The best products are the other banks and the best choice depends on your individual circumstances.

- To raj, figuring out whether to pay the penalty now and implement SM now or wait till the due date is a complicated calculation that we do on a spreadsheet. The factors are the penalty cost, your current interest rate vs. the new rate, the benefit of the SM that you would lose if you wait, how much other debt you could refinance at the same time at lower rates, and tax consequences. In your case, you wouldn't roll in your car loan or RRSP, but probably the student loan. In practice, we find it almost always is worth paying a penalty if your mortgage is due in more than 2 years, and often not worth it if it is due in less than 1 year, so it is most likely worth it for you to pay the penalty.

- The risk of the SM is essentially only the investments - not really anything else including interest rates. Interest rates rising would only be an issue if they went to double digits, which is extremely unlikely. Demographics clearly point to long term continuing declining interest rates. Studies actually show that a breakeven on leverage over the long term is an investment return of 2/3 of the interest rate. So, if you borrow at prime (6% now) and invest in a reasonably tax-efficient investment and make 4% long term, you will find that after tax you broke even. This is because of the different tax treatments and because the gains compound while the credit line interest is flat. For reference, check out the leverage guru Talbot Stevens at www.talbotstevens.com. Since the risk is only the investments, make sure you have a sound, long term strategy and be tax-efficient.

- To circa, "restructuring borrowings" is only one of the added enhancements to the SM, not a high level of the SM. The SM in simple terms is reborrowing the principal from every mortgage payment to invest (eg. bi-weekly) and then compounding the tax refunds. Leverage combined with dollar cost averaging is very effective. In addition to the SM, there are various enhancements that can give you a much higher benefit, such as including restructuring existing non-RRSP investments as you mentioned, the "debt miracle" of rolling in other higher-rate debt and adding the payments to your new mortgage, and various strategies such as the "Rempel Maximum" to leverage more highly and have the extra leverage cost paid out of your mortgage. But don't forget the basics of the regular SM investment.

Ed

[pitz]

- Dividends are tax-preferred - the tax is almost as low as capital gains for all but the lowest incomes. Dividends are tax-free if you have essentially NO other income and total income under $23,000, but hardly any of us fit this. Of course Deferred capital gains are taxed at the lowest possible rates - zero.


The deferral becomes due at some point. Even if you use a 40-year hold period, 10%/year, and a 40% incremental rate, the annualized tax rate will still be around 8%. If you can receive Canadian dividends at a tax rate similar to the long-term annualized rate, and swap additional debt to tax-deductible status, I would argue that such a scenario is almost always superior.




Focussing on getting income just costs you tax. I've tested various scenarios and receiving income and paying it down on the mortgage and then reinvesting is still less effective than having a 100% tax-efficient investment.


Yes, a couple things:

1) Its a fairly well accepted fact out there that, on average, dividend portfolios outperform non-dividend portfolios. In fact, the stock market itself is just one giant discounting machine -- the stock market computes the net present value of all expected future dividends from a company. Without dividends, a stock, in the long run, is worthless.

Since the Smith Manouevre is also about investing for the long run, don't you really want to invest in stocks with good track records of regular dividend payment and regular dividend growth?

2) A 100% tax efficient investment isn't very feasible either in the context of a portfolio because portfolios require rebalancing. The payment of dividends helps to facilitate this rebalancing as cash is available from the portfolio to be directed into under-weighted assets. If you go with a 100% tax efficient stock (ie: no dividends), then you end up liquidating securities (and incurring cap gains tax prematurely) in order to perform rebalancing.



- The risk of the SM is essentially only the investments - not really anything else including interest rates. Interest rates rising would only be an issue if


But stocks, like bonds, are inversely correlated to interest rates. If rates rise, and you borrowed short, the liability remains, while it costs much more to service the liability. Further the value of the investment decreases due to this negative correlation.

I think you also need to look at currency risk. Most advisors recommend a diversified portfolio, including international equities, but very rarely do SM promoters actually provide proper hedging solutions. Hedging out currency is an important part, if you want to minimize the long term volatility in the portfolio.

[edrempel]

Hi Pitz,

Very good points. I have a few comments though.

On your tax on dividends scenario, your question isn't quite fair, since here in Ontario, dividends are only taxed around 8% with an income under $36,000 (income under $8,000/year for foreign dividends), while the 40% tax bracket starts at income about $72,000. You calculated average tax rates for 40 years, but with a 100% tax-efficient investment, you also get the compound growth on the tax payment for 40 years.

I ran the numbers anyway. With a 10% return with 8% tax paid on the dividends every year, $100 would grow to $3,095 in 40 years (for a low-income dividend stock investor). With a 100% tax-efficient investment and a 40% tax bracket (20% since it is capital gains) and the tax paid on sale after 40 years, the $100 grows to $3,312. If you assume the same low tax rate investor, so the tax bracket is 22%, the $100 grows to $3,673. In all scenarios, the dividend return is lower because of the tax paid every year.

Regarding your other 4 points:
1) Your point about dividend stocks out-performing is very interesting. It's funny there isn't specifically a study on this. In fact, even Jeremy Siegel (Stocks for the Long Run) shows in his 1998 edition that growth stocks out-perform over long periods. But then in his 2001 edition, he shows that value and dividend stocks out-perform over long periods. The greatest investors even disagree on this with some swearing by dividends and some claiming it is earnings that matter and the portion paid out is not really relevant. Small cap stocks have out-performed large caps long term, and they tend to pay much lower dividends.

Your quote on companies valued by their discounted long term dividends is meant hypothetically to include the final dividend on eventually winding up the company. Otherwise, it is not true. The best example is Berkshire Hathaway. It has never paid a dividend, but has widely out-performed all dividend-paying stocks. And you can't argue it is a worthless stock!

In general, you are right though, that the risk/return on dividend-paying stocks is generally very good and suitable for the SM. My issue here is Canada now is that we are arguably in a "dividend bubble". After the tech bubble, we seem to have gone to another extreme with mini-bubbles happening simultaneously in resource, precious metals, income trusts and dividend stocks over the last 4 years. Almost every individual investor I talk to has 100% of his money in 1 of these 4. Yield and defensive stocks have been king and have all 4 probably just had their best runs in history. Dividends are the latest income fad, since the income trust rules changed. The resource and income trust bubbles have now burst. Precious metals and dividend stocks are due for a period of under-performance. My question to you is - the next time dividend stocks under-perform the markets 5 years in a row (and it will happen again), will you stick with dividend stocks, Pitz? If so, then your strategy is sound.

2) We tend to use mutual funds, many of which come in tax-efficient corporate structures. Therefore, it is possible to invest in dividend stocks, but still never pay any tax until you eventually sell. With the SM, rebalancing is done bi-weekly by adjusting the automatic investment. Just add more of it to the under-performing holding and rebalancing will happen without ever having to sell anything.

In practice, 100% tax-effiency is difficult only because we search for the world's best fund managers with long term records of beating the indexes by wide margins - and not all are available in the corporate structures. Being 100% tax-efficient is very nice, but tax is only one of the considerations in choosing the best investments.

3) Your point about stocks being inversely correlated to interest rates, that may be true short term (if you exlude the fact that the markets are always anticipating), but isn't true long term. Long term, rates only rise if we have prolonged higher inflation. Companies can usualy adjust for inflation, so the stock market is a good inflation hedge long term (unlike bonds).

The same is true of currencies. They can add volatility and affect returns short term, but have little effect long term. In fact, a declining currency tends to make countries more competitive, which then stimulates the stock market, so it is largely self-adjusting in the long term. Your point about hedging to reduce risk is reasonable, though. Global fund managers that hedge currencies tend to have slightly lower long term returns, but noticeably lower volatility.



Ed

[Apcol2002]

The first thing that came into mind is "risk". I am not too sure what the Smith Manoeuvre is but it is risky to use your home equity as investment, especially on an investment that earns 7-8%. You would also have to keep in mind that interest income from investments are also taxed, some higher than others. (Capital gains vs. Interest Income).

For the average Canadian who do not have a background in Finance, this may not work. Even if you sit with a financial planner, they may not have the skills or time to fully plan the perfect investment strategy.

Is there any calculations that can show that the SMith Manoeuvre works? I would be very interested in taking a look at it.

I do design the Smith Maneouvre to the specifics of my clients and if you are interested, will be happy to do it for you too. By the way, risk is a secondary factor here. The main benefit is assured by the different compounding of interest rates in mortgages versus loans.
If you send me a private email we can discuss the details in an exchange and I shall calculate your case for you.

Sandor

[Apcol2002]

Hi!

I don't mean to violate any forum rules on specific stocks/investments. If I'm out of line, please let me know and I'll drop the subject.

For those who have performed the SM or something similar, what has been your approach to building a non-reg portfolio? For now I'm assuming a dividend-focused portfolio...

a) Buy individual stocks that together make up a dividend-focused portfolio on a monthly basis via brokerage (I'll likely use IB for the low, low commissions). Achieve balance by buying different stocks throughout the year to make up a balanced portfolio.
b) Buy a dividend-focused mutual fund on a monthly basis
c) Buy a dividend-focused ETF on a monthly basis
d) Other (please elaborate)

Thanks!

You can buy dividend funds and some minority equity as well, but look into segregated funds, because the capital in those are guarantied.
I invest exclusively in segfunds because of the guarantied capital.

Sandor

[don242]

I have been working on a spreadsheet that compares various scenarios of investing in your RRSP, paying down your mortgage, etc. I think cannonfodder already did something like this but unfortunately I don't have excel on my computer right now (must get it sometime) so I did mine in QuattroPro.

Anyway I ran a number of scenarios where the basic premise is using a fixed amount of money monthly to either pay down your mortgage (included required payment) or invest in your RRSP. Tax refunds could be applied to either RRSP or mortgage paydown. Once mortgage was pid, all payments would move to the RRSP.

When comparing without the SM, obviously investing in the RRSP with all money came out the best at the end of 25 years (because RRSP is the higher rate).

However, as soon as I include the SM that uses dividends taxed at 8.24% (assumed the marginal tax rate of 31.15%, Ontario) and the tax writeoff refund going to either RRSP or mortgage, the scenarios evened out, RRSP contributions vs paying down mortage (and leveraging). The only real difference (though not much) was that the scneario where paying off the mortgage was the priority after 25 years resulted in the same net amount as the RRSP scenario except that less of your money was in the RRSP and therefore already taxed. I believe this was partially what pitz has been saying all along (though I never had the means in place to actually run the numbers).

The SM itself provided only a small percentage (~15%) of the wealth in the end but served to even out the scenarios and provide wealth that is already taxed at retirement.

I realize that changing paramaters in each scenario changes the outcome and I didn't give all the details of each scenario but this was the general conclusions I found. I would be happy to share more specific details in interested. I am now planning to modify the spreadsheet to account for more real life savings methods. I also still have one flaw as the spreadsheet doesn't realize the contribution limits each year for your RRSP which may also lessen the value of the RRSP scenario since some growth will need to occur outside of the taxfree area.

[edrempel]

Hi, Don,

You've done some work on this. You should find that with the "Plain Jane" SM, the RRSP will initially get you ahead, since you get a refund on your entire new contribution, while the SM gives you a refund on only the interest. However, after you retire, this reverses, since the RRSP will be fully taxed on withdrawal, while the SM is only capital gains on a systematic withdrawal. This assumes you are buying similar investments in the RRSP and SM.

With some of the SM enhancements where you leverage extra amounts beyond just the credit line and have all the interest paid from your SM, the SM can do better than the RRSP.

Your scenario is interesting, but in practice, other considerations are more important. Hardly anyone invests all the mortgage payments, once it is paid off, which makes the mortgage scenario much worse in practice. The SM normally takes none of your cash flow, so you can still do all the RRSP you would otherwise. The best strategy usually is to plan so that by the time your retire, you have your mortgage fully converted to tax deductible plus your RRSP max'd.

I'm curious about what scenario you used where the SM provided only 15% of the wealth. I've done hundreds of practical scenarios and most of the time, the RRSP and SM end up at similar values at retirement.



Ed

[don242]

Hi, Don,

You've done some work on this. You should find that with the "Plain Jane" SM, the RRSP will initially get you ahead, since you get a refund on your entire new contribution, while the SM gives you a refund on only the interest. However, after you retire, this reverses, since the RRSP will be fully taxed on withdrawal, while the SM is only capital gains on a systematic withdrawal. This assumes you are buying similar investments in the RRSP and SM.

With some of the SM enhancements where you leverage extra amounts beyond just the credit line and have all the interest paid from your SM, the SM can do better than the RRSP.

Your scenario is interesting, but in practice, other considerations are more important. Hardly anyone invests all the mortgage payments, once it is paid off, which makes the mortgage scenario much worse in practice. The SM normally takes none of your cash flow, so you can still do all the RRSP you would otherwise. The best strategy usually is to plan so that by the time your retire, you have your mortgage fully converted to tax deductible plus your RRSP max'd.

I'm curious about what scenario you used where the SM provided only 15% of the wealth. I've done hundreds of practical scenarios and most of the time, the RRSP and SM end up at similar values at retirement.

Ed

Your points are all valid and I am beginning to understand everything more now that my spreadsheet is nearly completed. I am planning to show my advisor my spreadsheet this weekend in case I am missing something that will change things drastically but I am quite confident it gives a good representation now for comparing various scenarios.

As you mentioned, the scenarios I ran would require complete discipline (ie. investing your mortage payments after your mortgage is paid off) but the only true comparison can be a disciplined comparison. If you didn't invest your mortgage payments, then it would be expected, that paying off your mortgage as the priorrity would hurt.

I too came to the same conclusion in my scenarios, that both RRSP method and SM method are quite comparable after 25 years.

My statement about the wealth generated by the SM being only 15% included a continous monthly investment (say $800) into either mortgage or RRSP. And since the SM is capped at the value of your home (no other leveraged investments were considered since I am not at that point of understanding yet), the overall value of wealth is only about 15% since your RRSP grows considerably more because the investment value is so much higher (no cap as in the SM). Hopefully that made sense.

Basically my spreadsheet compares paying off mortgage as priority or paying toward RRSP as a priority or any combination between. The SM can then be applied to either scenario generated with tax refunds from SM and RRSP contributions being reinvested in your chosen priority. I have just recently added functions that allow me to change monthly contributions every 5 years, or change interest rates every 5 years to give a more variable (true life) future. I also just finished adding the RRSP maximum contributions to the spreadsheet which affect it. My original comparison didn't include the max contributions. I need to clean it up again to get a better comparison.

[cannon_fodder]

I have been working on a spreadsheet that compares various scenarios of investing in your RRSP, paying down your mortgage, etc. I think cannonfodder already did something like this but unfortunately I don't have excel on my computer right now (must get it sometime) so I did mine in QuattroPro.


Actually, all I did was craft a calculator that, I believe, mimics the Smithman Calculator with the various scenarios. You might say that is a first step in the evaluation process and yours is following after.

I'm sure people would appreciate if you would post/host your spreadsheet for others to utilize in their decision making.

I hadn't realised how myopic my perspective was... if you have the inclination and the time, would you mind going to:
http://www.microsoft.com/downloads/details.aspx?FamilyID=c8378bf4-996c-4569-b547-75edbd03aaf0&displaylang=EN
and see if the free Microsoft Excel Viewer 2003 allows you to use my calculator? Unfortunately, my PC has Excel and so it obviously works for me. Or, if someone can suggest a way I can export the Excel workbook with all its functionality so that anyone without Excel can view it that would be appreciated. (I know that individual spreadsheets can be exported in HTML but not the workbook - perhaps I could export the individual spreadsheets and link them?)

P.S. The calculator can be found here: http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls)

[don242]

Actually, all I did was craft a calculator that, I believe, mimics the Smithman Calculator with the various scenarios. You might say that is a first step in the evaluation process and yours is following after.

I'm sure people would appreciate if you would post/host your spreadsheet for others to utilize in their decision making.

I hadn't realised how myopic my perspective was... if you have the inclination and the time, would you mind going to:
http://www.microsoft.com/downloads/details.aspx?FamilyID=c8378bf4-996c-4569-b547-75edbd03aaf0&displaylang=EN
and see if the free Microsoft Excel Viewer 2003 allows you to use my calculator? Unfortunately, my PC has Excel and so it obviously works for me. Or, if someone can suggest a way I can export the Excel workbook with all its functionality so that anyone without Excel can view it that would be appreciated. (I know that individual spreadsheets can be exported in HTML but not the workbook - perhaps I could export the individual spreadsheets and link them?)

P.S. The calculator can be found here: http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls)


I will give that link a try tomorrow and see if I can get your spreadsheet to work. I did have excel somewhere at one time but it must have been on my old computer and I can't find the disc anywhere right now.

I will definately share what I have as well but give me the weekend since I want to go over some of it with my advisor to be sure I have most of my logic correct. Plus it is Quattro Pro so not sure how well it will convert but I will see what I can do.

By the way, do you or anyone know offhand the taxes on capital gains. Is it just 50% is taxable at your marginal tax rate or is there more to consider? I am meaning to check just thought I would ask if anyone knows offhand.

[don242]

Actually, all I did was craft a calculator that, I believe, mimics the Smithman Calculator with the various scenarios. You might say that is a first step in the evaluation process and yours is following after.

I'm sure people would appreciate if you would post/host your spreadsheet for others to utilize in their decision making.

I hadn't realised how myopic my perspective was... if you have the inclination and the time, would you mind going to:
http://www.microsoft.com/downloads/details.aspx?FamilyID=c8378bf4-996c-4569-b547-75edbd03aaf0&displaylang=EN
and see if the free Microsoft Excel Viewer 2003 allows you to use my calculator? Unfortunately, my PC has Excel and so it obviously works for me. Or, if someone can suggest a way I can export the Excel workbook with all its functionality so that anyone without Excel can view it that would be appreciated. (I know that individual spreadsheets can be exported in HTML but not the workbook - perhaps I could export the individual spreadsheets and link them?)

P.S. The calculator can be found here: http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls)


You got me curious so I tried the excel viewer now. Unfortunately it doesn't allow you to alter any of the numbers, only allows me to view what is currently there. The spreadsheet does look good though (a lot neater than mine is at this point) and yours has some functions that mine does not. I tended to design mine with our situation in mind so right now the marginal tax rate is not variable and I just assume monthly mortgage payments.

But as you said, it has been interesting and has certainly broadend the possibilities for potential wealth building scenarios.

Once I clean up my spreadsheet I will see if I can export it to something useful for those with excel. It isn't a perfect representation but should be close. There may be small (non significant) errors in due to logistics with payments made at the end or beginning of a month but that error (if there) is only in play for one month so the impact is minimal. The more I do, the more variables I want to include which makes it a little confusing.

[cannon_fodder]

By the way, do you or anyone know offhand the taxes on capital gains. Is it just 50% is taxable at your marginal tax rate or is there more to consider? I am meaning to check just thought I would ask if anyone knows offhand.

I don't know if it is the best site, but I have found it quite full of useful information - www.taxtips.ca

[FrugalTrader]

By the way, do you or anyone know offhand the taxes on capital gains. Is it just 50% is taxable at your marginal tax rate or is there more to consider? I am meaning to check just thought I would ask if anyone knows offhand.

You are right, you just take your profits from your stock sale - commissions/fees multiply by 50% and add that onto your taxable income for that year. Example:
Profit: $1000 from stock sale after commissions
Taxable: $1000 x 0.50 = $500 taxable
Tax Payable: $500 * marginal tax rate.

[edrempel]

Hi, Don,

The one variable you left out of your spreadsheet is that your home goes up in value over time. If you plan the SM to always stay at 75% of your home value, then there is a rising ceiling. A reasonable home increase assumption is 2% over inflation, which is the average for the last 30 years.

The tax on capital gains is that 50% is taxable, but the other variable is the tax-efficiency of the investment (or turnover). For example, if you hold stock for 30 years and never sell, the capital gains tax only applies at the end. Only the dividends are taxable. If your strategy involves changing investments now and then or rebalancing, then some capital gains will result.

With mutual funds, they publish their tax-efficiency, which relates to the amount of turnover inside the fund. Many that are in corporate structures manage to to be 100% tax-efficient, because they have various sectors and regions within the overall corporation, so they can always claim some losses somewhere to offset gains. They also allow switching funds without it being considered a taxable event.

Therefore, your spreadsheet should include an assumption of tax-efficiency, which will depend on your investment strategy.

You will find the RRSP is ahead until you retire and start withdrawing money, but after that the SM will catch up rapidly.

With the RRSP, what do you assume for the tax refund, Don? Is it added to the RRSP, or do you pay it down on the mortgage and invest it with the SM?

If you want to try something fun, try a version where the SM beats the RRSP, even before retirement. We have an enhancement to the SM we call the "Rempel Maximum" which is the theoretical maximum investment loan you can finance within the SM without using any of your cashflow. For example, if you pay $500/month of principal on your mortgage, instead of investing that $500 as in the "Plain Jane" SM, you can use that $500/month to make the interest-only payments on an investment loan of $85,000-$100,000 (depending on the investment loan rate). The loan can be increased every year or 2. The loan payments are always made from the SM until your mortgage is fully paid off and can often be made directly from your credit line in your readvanceable mortgage (depending on which bank it is at). This will also pay off your mortgage much more quickly, because you get much larger tax refunds early in the SM. The entire $500/month is fully tax deductible from the beginning.

You should try this enhancement in your spreadsheet. You will find it usually beats the RRSP before retirement and then widely beats it after retirement.






Ed

[pitz]

value, then there is a rising ceiling. A reasonable home increase assumption is 2% over inflation, which is the average for the last 30 years.


I'd dispute your very optimistic figures of home price appreciation. First of all, the statistics are skewed upwards because modern houses contain more 'toys', and are fitted with higher quality and more expensive finishes, HVAC systems, and other systems than ever before.

Secondly, appreciation has occurred against the backdrop of a decline in long-term interest rates that started around 1980 (when interest rates were 15% or higher), and bottomed out recently. Even if rates remain flat, housing isn't likely to see substantial capital gains.

And thirdly, cashflows, even imputed cashflows, do not even support valuations today for most residential real estate in the major centres in Canada. A house is only technically worth the net present value of the net imputed cashflows. This is a recipe for a decline, or at least a flattening of growth in housing values.



With mutual funds, they publish their tax-efficiency, which relates to the amount of turnover inside the fund. Many that are in corporate structures manage to to be 100% tax-efficient, because they have various sectors and


The 'corporate' structures are not immune to tax. They allow an individual investor to rebalance holdings according to their individual asset allocation model, but ultimately, do not provide a true shield of tax that they purport to.

Add in the additional fees associated with the structure (legal, audit, management), and the tax innefficiency they represent with respect to dividends, and I'm not convinced most investors are better off.



regions within the overall corporation, so they can always claim some losses somewhere to offset gains. They also allow switching funds without it being considered a taxable event.


An individual holding their own portfolio can do loss harvesting just as efficiently. And an individual can rebalance their own holdings by directing new contributions towards underweighted asset classes.



If you want to try something fun, try a version where the SM beats the RRSP, even before retirement. We have an enhancement to the SM we call the "Rempel Maximum" which is the theoretical maximum investment loan you can finance within the SM without using any of your cashflow. For example, if

Thats introducing additional leverage, and thus, additional volatility.

I'm pretty convinced, at least in my mathematical studies of RRSPs and mortgages, that one shouldn't contribute to a RRSP at all if they have a mortgage. Take all your free cashflow, throw it on the mortgage, and then have it re-advanced through the SM to invest in tax efficient non-registered equities.

Why? Because the investors' marginal cost of capital is reduced with the non-reg scenario, and RRSPs do not a meaningful long-term tax advantage compared to the non-reg scenario in a sufficient enough amount to outweigh the lower cost of capital associated with investment borrowing.

[FrugalTrader]

Hi, Don,


If you want to try something fun, try a version where the SM beats the RRSP, even before retirement. We have an enhancement to the SM we call the "Rempel Maximum" which is the theoretical maximum investment loan you can finance within the SM without using any of your cashflow. For example, if you pay $500/month of principal on your mortgage, instead of investing that $500 as in the "Plain Jane" SM, you can use that $500/month to make the interest-only payments on an investment loan of $85,000-$100,000 (depending on the investment loan rate). The loan can be increased every year or 2. The loan payments are always made from the SM until your mortgage is fully paid off and can often be made directly from your credit line in your readvanceable mortgage (depending on which bank it is at). This will also pay off your mortgage much more quickly, because you get much larger tax refunds early in the SM. The entire $500/month is fully tax deductible from the beginning.

Ed

Ed,

Could you explain this scenario further? I'm not quite sure that I understand what you are describing. Are you talking about getting an ADDITIONAL investment loan on top of your existing HELOC?

[minghia]

Does anybody know of a financial planner/bank that will assist me with the SM specific to my financial situation in the Montreal area?

Would like to get advice from a reputable financial planner who is experienced with the SM. I have asked my local TD Bank financial planner and he has never heard of the concept.

[cannon_fodder]

http://www.smfc.com/contact_us/

This is the Smith Manoeuvre Financial Corporation's "Contact Us" link. I'm sure if you fill this out you will be provided several names of FP's, Mortgage Brokers or both.

You could always go here as well (don't be fooled by the URL - it has both FP's and MB's):

http://www.smithman.net/locateplanner.html

[edrempel]

Does anybody know of a financial planner/bank that will assist me with the SM specific to my financial situation in the Montreal area?

Would like to get advice from a reputable financial planner who is experienced with the SM. I have asked my local TD Bank financial planner and he has never heard of the concept.


Hi, Ming,

I would suggest finding an independent financial planner at:

http://www.smithman.net/locateplanner.html

The SMFC is a new company being set up and we don't know what their quality will be yet. Look for a planner, not a broker, since a broker can only get you the mortgage, not advise you on the best way to implement the SM. The best SM mortgages are from some of the major banks and are not offered through mortgage brokers.




Ed

[edrempel]

Ed,

Could you explain this scenario further? I'm not quite sure that I understand what you are describing. Are you talking about getting an ADDITIONAL investment loan on top of your existing HELOC?

Hi, Frugal,

Sure. The "Rempel Maximum" is the maximum benefit you can get from the Smith Manoeuvre without using any of your cash flow. Essentially, it is the maximum additional leverage, which could be from the credit line portion of the readvanceable mortgage on your home or from an additional leverage loan.

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 75% 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.

With this strategy, the entire $100,000 is financed from your mortgage and uses none of your cash flow. Usually with the SM, the interest on the $6,000/year is tax deductible, but now the entire $6,000 is tax deductible. If you buy a 100% tax-efficient investment and never sell or take any distributions from your investment, then you can pay zero tax on the growth until you retire.

Yes, Frugal is right that this is extra leverage, but the SM works because it is a leverage strategy. If you invest effectively and believe in leverage, the Rempel Maximum maximizes all the benefits of the Smith Manoeuvre.





Ed

[Webhead]

This is a little late and I haven't read through the entire post but there was an article in the Toronto Star about Fraser Smith.
Sorry if this is a repost:
http://www.thestar.com/article/174167

[qubikal]

Might be an entirely new topic, but the question relates to the Smith Maneuver:

Situation: One is a higher tax bracket income earner; whereas the spouse is a lower tax bracket income earner.

In a simple financial planning world, you would have the higher income earner make all the usual family expenses, bill payments etc, and then have the lower income earner's income go towards investments as investment income is taxed at a much lower rate.

The question: How is this scenario affected if we are using the Smith Maneuver? Do you want to have the investments under the higher income earner because the tax refund on the deductible interest expense is higher? and therefore allowing you more cash flow to pay back into the mortgage?

or

Do you still want the investments under the lower income earner's name, because you assume that your investment rate of return is always better than the rate of borrowing?

Hope this didn't confuse anyone....:twisted:
Thanks

[edrempel]

The question: How is this scenario affected if we are using the Smith Maneuver? Do you want to have the investments under the higher income earner because the tax refund on the deductible interest expense is higher? and therefore allowing you more cash flow to pay back into the mortgage?


What a great question, since the interest deduction and the investment income are taxed to the same person(s). The short answer is that you usually want the SM taxed to the higher-income spouse, if in a significantly higher tax bracket. This is because, with tax-efficient investments, you should be getting tax refunds almost every year. Even after your investments have grown significantly and you are retired & starting to take income from them, you can still arrange to be very tax efficient by using a systematic withdrawal plan, so any small amount of capital gains will probably still usually be lower than the interest deduction. Taxing it all to the higher income spouse may well mean larger tax refunds all your life, since you can keep the interest deduction right through retirement.

This means that strategies that plan for income splitting after retiring, such as spousal RRSP's are more important. The new pension-splitting rules will help with this.




Ed

[cferneyh]

As someone who is using the Smith Manoeuvre, under what scenarios does it make sense for me to cash out my RRSPs, use the proceeds to pay down my mortgage, and then "re-borrow" and invest the same amount?

I've been using the Smith Manoeuvre for a few months now (with Manulife One), and I've got about $100K in RRSPs (all stocks and ETFs). Since I stopped contributing to my RRSPs once I started using the Smith Manoeuvre, I'm just wondering if it makes sense for me to cash out, cut a cheque to the government for $39K (I'm in Alberta where the highest marginal rate is 39%) and apply the $61K to my mortgage (and then do the Smith Manoeuvre - or even the Rempel Maximum with that $61K)?

Or should I just leave 'em be?

(Also, big thanks to cannon_fodder for the Excel worksheet - great stuff!)

[pitz]

Since I stopped contributing to my RRSPs once I started using the Smith Manoeuvre, I'm just wondering if it makes sense for me to cash out, cut a cheque to the government for $39K (I'm in Alberta where the highest marginal rate is 39%) and apply the $61K to my mortgage (and then do the Smith Manoeuvre - or even the Rempel Maximum with that $61K)?

Or should I just leave 'em be?


I doubt it would make sense to cash out existing RRSPs and pay the taxes early. But as you suggest, its best not to contribute any new money.

[FrugalTrader]

As someone who is using the Smith Manoeuvre, under what scenarios does it make sense for me to cash out my RRSPs, use the proceeds to pay down my mortgage, and then "re-borrow" and invest the same amount?

I've been using the Smith Manoeuvre for a few months now (with Manulife One), and I've got about $100K in RRSPs (all stocks and ETFs). Since I stopped contributing to my RRSPs once I started using the Smith Manoeuvre, I'm just wondering if it makes sense for me to cash out, cut a cheque to the government for $39K (I'm in Alberta where the highest marginal rate is 39%) and apply the $61K to my mortgage (and then do the Smith Manoeuvre - or even the Rempel Maximum with that $61K)?

Or should I just leave 'em be?

(Also, big thanks to cannon_fodder for the Excel worksheet - great stuff!)

If it were me, I would leave the RRSP alone and let it compound tax free. Perhaps you can withdraw from your RRSP during low income years.

[HoTiCE_]

Minghia,
Don't forget to inform yourself thoroughly with a financial advisor as fiscal laws are somewhat distinct (pun intended) in Quebec that limits (not completely) the advantages of the Smith Maneuver in La Belle Province.

Just thought I'd warn you before you plunge into anything...

[edrempel]

As someone who is using the Smith Manoeuvre, under what scenarios does it make sense for me to cash out my RRSPs, use the proceeds to pay down my mortgage, and then "re-borrow" and invest the same amount?

CF,

Cashing in your RRSP will mean a large tax bill right away and significantly lower investements than you have now. Keep your RRSP's for their tax-free compounding.

There might be an argument for cashing in RRSP's if you do a large leverage loan, such as the Rempel Max strategy, in order to give you more investments. However, in all likelihood, you could do it anyway and keep the RRSP's.

You should be able to do both fully during your work life, since the SM required none of your cash flow. You will likely fully convert your mortgage and max your RRSP's during your work life. While I am very confident in the benefits of the SM, RRSP's are also beneficial because you will likely be in a lower tax bracket when you retire, because of the tax-free compounding, and because you can use the refunds to your benefit over the years.

Do both the RRSP & the SM. They even work well together, since you can readvance the RRSP tax refunds in the SM.



Ed

[cferneyh]

CF,

Cashing in your RRSP will mean a large tax bill right away and significantly lower investements than you have now. Keep your RRSP's for their tax-free compounding.

There might be an argument for cashing in RRSP's if you do a large leverage loan, such as the Rempel Max strategy, in order to give you more investments. However, in all likelihood, you could do it anyway and keep the RRSP's.

You should be able to do both fully during your work life, since the SM required none of your cash flow. You will likely fully convert your mortgage and max your RRSP's during your work life. While I am very confident in the benefits of the SM, RRSP's are also beneficial because you will likely be in a lower tax bracket when you retire, because of the tax-free compounding, and because you can use the refunds to your benefit over the years.

Do both the RRSP & the SM. They even work well together, since you can readvance the RRSP tax refunds in the SM.



Ed

Thanks for the advice Ed. I've actually decided to cash out the portion of RSPs that are in my wife's name since she'll have a lower income this year (on mat leave) and her portion was only 15% of the $100K. Additionally, at her job she has a pension.

Would you mind sending me more information about the Rempel Maximum? I can be emailed at chris.ferneyhoughATgmail.com.

Thanks!

CF

[edrempel]

Thanks for the advice Ed. I've actually decided to cash out the portion of RSPs that are in my wife's name since she'll have a lower income this year (on mat leave) and her portion was only 15% of the $100K. Additionally, at her job she has a pension.

Would you mind sending me more information about the Rempel Maximum? I can be emailed at chris.ferneyhoughATgmail.com.

Thanks!

CF

CF,

Here is some info on the Rempel Maximum.

The Rempel Maximum is an enhancement to the SM that is the maximum possible benefit of the SM, without using any of your cash flow. The benefit is usually triple the Plane Jane SM (but depends on the situation).

It involves the maximum leverage that can be financed from the SM. For example, if you are paying down $500/month principal on your mortgage, instead of investing the $500, you multiple by 12 and divide it by the loan interest rate (say 6%) to get the maximum loan you can finance from the $500/month (in this case $100,000).

In short, instead of investing $500/month, you would borrow $100,000, but the payments are all made from within the SM, by readvancing the principal portion of the mortgage payment. So, you have a $100,000 investment on which you never have to make any payments from your cash flow.

The $100,000 will grow much faster than the $500/month would grow. And while the $500/month will increase as you pay increasing amounts down on your mortgage, you can use this to increase the loan every year or 2, still without ever using any of your cash to make any payments.

The investment loan could be from using your secured credit line within your readvanceable mortgage (if you have enough equity), or it could be a separate investment loan (or some combination of the 2).

The projected benefit of this is surpisingly high. For the SM, it is typically about double the starting mortgage over 25 years. The projected benefit of the Rempel Maximum is typically about triple that number, or about 6 times the starting mortgage.






Ed

[Da Man]

Sorry, I haven't gone through this entire thread, just the last few posts.

Using a more simple plan, you could take the $100k loan, put it into a return of capital fund that averages 10% a year, and has a distribution of 8%/year. So assuming your same $500/month principal and it being readvanced to your account. It becomes tax deductible if you just invest it. For simple purpose, put it into a corporate class fund. You get all the benefits now of a monthly pac into an rrsp structure, but none of the rrsp problems when removing the money. It'll be taxed as capital gain when money is withdrawn.

So now you've got $500/month tax deductible and growing tax deferred and taxed as capital gains. Also you have $666.67/month being paid out as return of capital(tax free for 12.5 years) and put it back into the principle of your mortgage. Readvance it all together so you will get 1167.67 a month thats tax deductible. $500/month for the $100k loan, + $666.67 going into a monthly pac. So you get about $14,000 in tax deductions a year. Ontop of it, you could get an rrsp loan if you feel.

This is a very basic version, this could get very complicated and make a hell of alot more money if done to its full potential. But you would use other components to help speed things up growth wise and could eventually reduce your taxes to 0.

Assuming an actual growth of 2% after distribution to the $100k, it will be roughly $164k in 25 years. Payback the loan so you pocket $64k. Ontop of that assuming around 32% marginal tax bracket, and $14k deduction, you would get an additional $4,484 of refunds that you can dump into the principal, draw back out, and repeat. Technically increasing your deduction each year. You could easily bank over $1M based on an assumed return of 10% avg. Easily. Best part is, at the end it will be capital gains.

[aphextwin2050]

Interesting post..anyone else have comments? I've been pre-approved for a 100K line of credit, and would the below work with a HELOC?

Sorry, I haven't gone through this entire thread, just the last few posts.

Using a more simple plan, you could take the $100k loan, put it into a return of capital fund that averages 10% a year, and has a distribution of 8%/year. So assuming your same $500/month principal and it being readvanced to your account. It becomes tax deductible if you just invest it. For simple purpose, put it into a corporate class fund. You get all the benefits now of a monthly pac into an rrsp structure, but none of the rrsp problems when removing the money. It'll be taxed as capital gain when money is withdrawn.

So now you've got $500/month tax deductible and growing tax deferred and taxed as capital gains. Also you have $666.67/month being paid out as return of capital(tax free for 12.5 years) and put it back into the principle of your mortgage. Readvance it all together so you will get 1167.67 a month thats tax deductible. $500/month for the $100k loan, + $666.67 going into a monthly pac. So you get about $14,000 in tax deductions a year. Ontop of it, you could get an rrsp loan if you feel.

This is a very basic version, this could get very complicated and make a hell of alot more money if done to its full potential. But you would use other components to help speed things up growth wise and could eventually reduce your taxes to 0.

Assuming an actual growth of 2% after distribution to the $100k, it will be roughly $164k in 25 years. Payback the loan so you pocket $64k. Ontop of that assuming around 32% marginal tax bracket, and $14k deduction, you would get an additional $4,484 of refunds that you can dump into the principal, draw back out, and repeat. Technically increasing your deduction each year. You could easily bank over $1M based on an assumed return of 10% avg. Easily. Best part is, at the end it will be capital gains.

[marnone]

Thanks for the great info.. I am going to buy a home in the next 4years and this will help me hoe to pay off the loan faster. Thanks again.

[Da Man]

Interesting post..anyone else have comments? I've been pre-approved for a 100K line of credit, and would the below work with a HELOC?

Yes it would. I have also done this with other clients and i am an advisor. Majority of my clients choose this method as it is very simple and alot more reasonably to them. With my more aggressive clients, I had done about 40%+ average, some 80% returns last year, but they are very aggressive. So big gains, but you can also see big losses. If you can't handle that, stick to the original thing I mentioned. Small reasonable gains that will be ALOT in 25 years. With very little worries if any.

[Sanchez]

Using a more simple plan, you could take the $100k loan, put it into a return of capital fund that averages 10% a year, and has a distribution of 8%/year. So assuming your same $500/month principal and it being readvanced to your account. It becomes tax deductible if you just invest it. For simple purpose, put it into a corporate class fund. You get all the benefits now of a monthly pac into an rrsp structure, but none of the rrsp problems when removing the money. It'll be taxed as capital gain when money is withdrawn.

So now you've got $500/month tax deductible and growing tax deferred and taxed as capital gains. Also you have $666.67/month being paid out as return of capital(tax free for 12.5 years) and put it back into the principle of your mortgage.

The problem (http://www.financialwebring.org/forum/viewtopic.php?t=104522&sid=f045cfaeb2bbd157ce4065c50130c984) is that RoC proportionally reduces the amount of interest you can deduct from your investment loan.


Thanks for the great info.. I am going to buy a home in the next 4years and this will help me hoe to pay off the loan faster. Thanks again.

Does ye hoe know you talk about her like that?

[edrempel]

So now you've got $500/month tax deductible and growing tax deferred and taxed as capital gains. Also you have $666.67/month being paid out as return of capital(tax free for 12.5 years) and put it back into the principle of your mortgage. Readvance it all together so you will get 1167.67 a month thats tax deductible. $500/month for the $100k loan, + $666.67 going into a monthly pac. So you get about $14,000 in tax deductions a year.

Sanchez,

You're right. Since there is a ROC distribution being paid down on the mortgage, the investment loan becomes non-deductible. If $8,000 is paid out of the fund and paid down on the mortgage, then only $92,000 of the $100,000 investment loan is deductible. After 12 years, the investment loan is entirely non-deductible.

In the example, the interest deduction is being double-counted, by claiming the interest deduction on both the original investment loan, even though $8,000 is paid out, and also on the readvanceable credit line as you readvance the same $8,000/year.

IF this would work, someone would create a 100%/day ROC distribution fund. Then I could make convert a $500,000 mortgage fully in 5 days with a $100,000 investment. (It would be nice...)

In fact, in the example, the correct return would be higher with zero distributions. Since the distribution is paid down on the mortgage and reborrowed from the credit line, which is at a higher rate, receiving the distribution actually reduces the return of the strategy.

There is no tax advantage from investing in a ROC fund.





Ed

[Da Man]

The problem (http://www.financialwebring.org/forum/viewtopic.php?t=104522&sid=f045cfaeb2bbd157ce4065c50130c984) is that RoC proportionally reduces the amount of interest you can deduct from your investment loan.


No sorry, it does not.

Sanchez,

You're right. Since there is a ROC distribution being paid down on the mortgage, the investment loan becomes non-deductible. If $8,000 is paid out of the fund and paid down on the mortgage, then only $92,000 of the $100,000 investment loan is deductible. After 12 years, the investment loan is entirely non-deductible.

In the example, the interest deduction is being double-counted, by claiming the interest deduction on both the original investment loan, even though $8,000 is paid out, and also on the readvanceable credit line as you readvance the same $8,000/year.

IF this would work, someone would create a 100%/day ROC distribution fund. Then I could make convert a $500,000 mortgage fully in 5 days with a $100,000 investment. (It would be nice...)

In fact, in the example, the correct return would be higher with zero distributions. Since the distribution is paid down on the mortgage and reborrowed from the credit line, which is at a higher rate, receiving the distribution actually reduces the return of the strategy.

There is no tax advantage from investing in a ROC fund.

Yes there is. As for you creating a 100%/day ROC distribution fund. That makes no sense.

[Sanchez]

No sorry, it does not.

Yes it does - did you read the link I provided? Can you imagine how it could work any other way? Note that whether it is allowed and whether you will be immediately caught if attempt it are two different things.



As for you creating a 100%/day ROC distribution fund. That makes no sense.

It would make perfect sense if what you say is true. It would, in fact, be Canada's best tax shelter, with the ability to turn any loan into a tax-deductible one overnight.

[edrempel]

Right on, Sanchez.

The distribution from a ROC fund is just giving you some of your own money back. If you take take your investment money back, you cannot expect the loan to still be fully deductible.

Sometimes, this can still be profitable, but you should be very careful using a ROC fund. The advisor will get his commission, but it is you that will be audited at some point and have to pay back your tax refunds, plus interest and possibly penalties. If you do this, insist that the advisor do your tax return and put his name in as preparer. Then if he is wrong, you can make him liable to pay your tax on audit.

We do tax returns for free for our good clients that work 100% with us. We stand behind the recommendations we make.

Most strategies with a ROC fund either screw up the tax deductibility, or are used to imply a higher return. For example, I've seen a few SM type advisors using the Stone G&I fund with a 14% ROC distribution. It is a 2-star (below average) Canadian balanced fund that cannot possibly be expected to make 14% long term (probably 6-8%). In fact, the distribution was 12% a few months ago, but is not 14%, since the fund has gone down. A 14% distribution is not a 14% return!

My issue is that the SM requires no cash flow, so why do you need an ROC fund? The key with leverage is to invest effectively (risk/return) and use tax-efficient investments. The true return of SM is almost always higher with a zero distribution 100% tax-efficient fund.





Ed

[Da Man]

Yes it does - did you read the link I provided? Can you imagine how it could work any other way? No whether it is allowed and whether you will be immediately caught if attempt it, are two different things.




It would make perfect sense if what you say is true. It would, in fact, be Canada's best tax shelter, with the ability to turn any loan into a tax-deductible one overnight.



What link??? The one where some guy named Mouly says it is so??? Ok... I hope you don't take all your advice from him than... As for you trying to claim that a 100% ROC would be tax efficient shows me you don't have a clue what you're talking about. It is equivalent to putting in $100 today, and withdrawing $100 tommorow. What's the difference? Where's the tax benefit in recieving 100% when you have no return? Your ACB would be adjusted to reflect that. Meaning it would be nil. Meaning you get no growth after. Meaning you just recieved your money back. So you're telling me the greatest tax shelter would be equivalent to depositing your money into an account, and trying to have it redistributed, 100% return back to you?? Wow.


Right on, Sanchez.

The distribution from a ROC fund is just giving you some of your own money back. If you take take your investment money back, you cannot expect the loan to still be fully deductible.

Please quote where it claims this on CRA's website. Also please explain to me how the distribution being an ROC, would effect the ACB. Also how does it reduce the tax deductible amount of the loan if the loan was never paid back? Let's make this easier to understand than. Let's assume this was an investment loan. 100%. XYZ company gives you $100k to invest in company A. Company A, pays out a distribution to you, of $6k/year in the form of ROC, and your growth is also $6k for that year. End of the year, XYZ mails you a slip for tax purposes on the interest you paid on this investment loan which is $6k for the year. You did not pay down the loan. Company A sends you a T3 slip stating their distribution of $6k for that year as well. So again, the loan is not paid back. How does this decrease the tax deductible amount?


Sometimes, this can still be profitable, but you should be very careful using a ROC fund. The advisor will get his commission, but it is you that will be audited at some point and have to pay back your tax refunds, plus interest and possibly penalties. If you do this, insist that the advisor do your tax return and put his name in as preparer. Then if he is wrong, you can make him liable to pay your tax on audit.

Audited and pay back tax refunds for doing nothing wrong?


My issue is that the SM requires no cash flow, so why do you need an ROC fund? The key with leverage is to invest effectively (risk/return) and use tax-efficient investments. The true return of SM is almost always higher with a zero distribution 100% tax-efficient fund.

It's too speed up things if a client chooses to do so and not be a one trick pony. Show people the options they have and let them decide based on their own risk tolerance aslong as they are well educated on the risks involved. Obviously it's common sense to know that the key to leverage is to invest effectively. I've just got 1 question actually... Do you even understand how return of capital works??

[pitz]

Most strategies with a ROC fund either screw up the tax deductibility, or are used to imply a higher return. For example, I've seen a few SM type advisors using the Stone G&I fund with a 14% ROC distribution. It is a 2-star (below average) Canadian balanced fund that cannot possibly be expected to make 14% long term (probably 6-8%). In fact, the distribution was 12% a few months ago, but is not 14%, since the fund has gone down. A 14% distribution is not a 14% return!


Yeah that fund is junk and selling it borders on professional negligence. Still, although your arguments with respect to RoC make perfect sense, do you have any references or tax rulings to support such?



My issue is that the SM requires no cash flow, so why do you need an ROC fund? The key with leverage is to invest effectively (risk/return) and use tax-efficient investments. The true return of SM is almost always higher with a zero distribution 100% tax-efficient fund.


Canadian dividends can be received by many Canadian investors at 0% or even negative marginal rates. And how on earth do you actually build a 'zero distribution 100% tax efficient fund' anyways? Basically any sensible investment plan in equities is going to have some dividend income, and some foreign income, in addition to capital gains arising from the rebalancing of the portfolio.

[Sanchez]

As for you trying to claim that a 100% ROC would be tax efficient shows me you don't have a clue what you're talking about. It is equivalent to putting in $100 today, and withdrawing $100 tommorow. What's the difference? Where's the tax benefit in recieving 100% when you have no return? Your ACB would be adjusted to reflect that. Meaning it would be nil. Meaning you get no growth after. Meaning you just recieved your money back. So you're telling me the greatest tax shelter would be equivalent to depositing your money into an account, and trying to have it redistributed, 100% return back to you?? Wow.

The investment would be a tax shelter because you claim the RoC will not reduce the interest deductibility of the loan. So you take a loan, for which you need to use the money for a house, for example, invest in the RoC fund. The loan is 100% deductible. The next day the fund pays out 100% of the NAV as RoC. The NAV is now zero, and your ACB is zero, as you mention - however, you still have the loan, and it's still 100% deductible (according to you).

Since you can turn your debt into deductible debt instantly using this method, why would anyone bother with the long, slow smithman technique?

Note that you completely reverse yourself in the next paragraph, explaining exactly how RoC used incorrectly in this way allows you a tax break. Somehow using the 6% number, rather than 100% makes it clearer for you, I guess.

[pitz]

The investment would be a tax shelter because you claim the RoC will not reduce the interest deductibility of the loan. So you take a loan, for which you need to use the money for a house, for example, invest in the RoC fund. The loan is 100% deductible. The next day the fund pays out 100% of the NAV as RoC.
Since you can turn your debt into deductible debt instantly using this method, why would anyone bother with the long, slow smithman technique?


Makes sense, but such a scheme would fail on another test -- an entity that is not capitalized (ie: has paid out 100% of the NAV) cannot generate income, and thus, on that basis, the deduction must be denied.

Personally I don't invest in anything that has a distributed RoC, but people buying income trusts on margin ought to be worried if they are playing this game.

[edrempel]

Pitz,

You asked about CRA references. Check out this link: http://www.cra-arc.gc.ca/E/pub/tp/it533/it533-e.pdf . The key issue here is in sections 12 & 13 of this IT bulletin (section 20(1)(c)(i) of the income tax act). The issue is "current use" of the money. This was illustrated in several Tax Court cases, including the Shell, Bronfman, & Singleton cases. In these cases, it was up to the investor to prove to CRA that the "current use" of the borrowed money is that it is still invested.

In the example by Da Man, the fund paid out a 6% ROC distribution. This money is either used as income or is paid down on the mortgage (in the earlier example). A ROC distibution is the fund "returning your capital" - giving you your own money back.

With an investment loan of $100,000, $6,000 was returned to the investor. Since the "current use" of that money is now that it was spent or paid on the mortgage (both of which are not tax deductible), that $6,000 of the original loan is no longer deductible. Therefore, only $94,000 of the loan is tax deductible and it is up to the investor to properly calculate that only 94% of the interest paid is tax deductible.

It is only logical. If I borrow to invest and then the fund gives me my money back and I spend it, how can I still expect to claim the interest deduction on the money borrowed that I have now spent?

The $6,000 distribution will also reduce the book value of the investment to $94,000. The calculation usually used in calculating the portion of interest deduction is by using the book value of the investment divided by the original book value.

I've seen many examples with 8% or 12% ROC distributions. The distribution is paid down on the mortgage and reborrowed to invest. This process actually accomplishes nothing at all. The client still owns $100,000 of the investment (+/- the growth), since 8,000 was paid out and then bought back. The client still has $100,000 deductible loan ($92,000 of the investment loan + $8,000 in the credit line reborrowed). The only difference at all is that the client has $8,000 lower mortgage, which has been replaced by $8,000 borrowed at a higher rate (the credit line and investment loan are both at higher rates).

Therefore, having the distribution paid out has no benefits and costs the client more interest.

What is more is that, after 12 years, the book value of the investment drops to zero, and after that the distribution is fully taxable as capital gains. Note that at the same time (12 years), the investment loan has become fully non-deductible.

I'm sure thousands of leverage investors in ROC mutual funds or in income trusts have not calculated this correctly - either the interest deduction or their book value. Many of these will eventually get caught by CRA, especially if they do this over many years.

The example Sanchez and I have been tossing about with the 100%/day ROC fund would work like this. IF Da Man's interpretation was right that the investment loan would be fully deductible even though the distribution was paid, then when I put $100,000 into our 100%/day fund, it gives me the entire $100,000 back that day. I pay it down on my mortgage and reborrow to buy the fund again the next day. The fund gives me my entire $100,000 back again the next day. After 5 days, I would have $100,000 investments, but would have an entire $500,000 mortgage plus the $100,000 investment loan all tax deductible.

This is an extreme example that proves the point.


Also, Pitz, there are hundreds of mutual funds that are structured to never pay out a distribution. Most are in "corporate class" structures. There are many mutual funds that are all considered different shares of the same corporation. This means:


1. The corporation usually includes mutual funds in many different sectors, so every year something will have gone down. They can crystallize losses from somewhere every year to off-set any gains realized during the year.
2. They use any dividends or interest earned to pay costs of operating the funds (pay MER), so none of them are taxable either.
3. You can switch between them and it is not a taxable transaction.

They often include some very good fund managers. Most have never paid any distributions at all, even though they've existed for more than 15 years.

They work very well with leverage or the SM. I can invest for 30 years and pay zero on the investment growth. This means zero tax on investment growth, until I eventually start systematically selling some to pay a retirement income. Meanwhile, I can fully deduct the interest every year, plus I can compound (capitalize) the interest in an investment credit line and still deduct it all.

Any investment strategy that has any tax at all on dividends, gains on buying/selling funds, or distributions would have to make a correspondingly higher return to be as useful.






Ed

[mjdavila]

ive read most of the book.. couldnt put it down after being referred from a friend.. the same friend who has been doing it and managed to pay off his mortgage in 5 years...

i'm totally meeting his financial advisor asap and setting this up..

this works guys.. trust me.

[pitz]

Also, Pitz, there are hundreds of mutual funds that are structured to never pay out a distribution. Most are in "corporate class" structures. There are many mutual funds that are all considered different shares of the same corporation. This means:


Then the mutual fund gets to pay taxes as a corporation. Are corporate income taxes lower than personal income tax rates? Even after you take into account the double taxation that would occur by investing in such a structure?



1. The corporation usually includes mutual funds in many different sectors, so every year something will have gone down. They can crystallize losses from somewhere every year to off-set any gains realized during the year.


An investor in traditional mutual fund trusts or individual securities can (and should) do this as well. No 'corporate' structure needed.



2. They use any dividends or interest earned to pay costs of operating the funds (pay MER), so none of them are taxable either.


But Canadian dividends are tax-preferred and generally attract tax rates 10% or less for most investors. Investors who suppress their income with the Smith Manouevre might even have 0% taxation on dividends. This is superior to long-term taxation rates of capital gains in most circumstances (generally, over 20-30 years, cap gains taxation is in the 8-10%/annum range).



3. You can switch between them and it is not a taxable transaction.


Only if someone else in the fund decides to make an offsetting trade. Otherwise the fund itself gets to pay taxes.



They often include some very good fund managers. Most have never paid any distributions at all, even though they've existed for more than 15 years.


Sure....but what are the costs versus a mutual fund trust structure? On an after-tax basis? And just because they don't pay distributions doesn't mean they aren't tax efficient; to wit: they may very well be paying full corporate income tax rates on retained earnings, instead of passing them to the fund owners who might experience lower tax rates. Especially with investors with large tax deductions; ie: Smith Manouevre investors.



They work very well with leverage or the SM. I can invest for 30 years and pay zero on the investment growth. This means zero tax on investment growth, until I eventually start systematically selling some to pay a


You do realize the underlying corporation gets to pay tax, right? And you have to pay an additional management fee for the structure.



Any investment strategy that has any tax at all on dividends, gains on buying/selling funds, or distributions would have to make a correspondingly higher return to be as useful.

My taxation rate on dividends is actually negative; to wit: I have a negative marginal rate on dividends. When I toss my numbers into Quicktax, my taxes payable are actually less when I include the dividend income, than without the dividend income.

Surely a 'corporate' structure wouldn't help me, eh? Its not that my income is low or anything, its merely that my use of borrowed funds to invest creates an interest deduction that is large enough to reduce my income substantially.

[mjdavila]

ive read most of the book.. couldnt put it down after being referred from a friend.. the same friend who has been doing it and managed to pay off his mortgage in 5 years...

i'm totally meeting his financial advisor asap and setting this up..

this works guys.. trust me.


i got a few PM's for the financial planner guys contact - got some feedback already - they loved him.. here's his contact info and a little blurb he said to me:


I LOVE referrals! Please refer me to as many qualified people you can so we can spread the good word about the Turbo Charged Smith Manoeuvre.

Qualified people have:
- Good credit history
- Minimum 25% downpayment
- Taxable income
- Desire to minimize their taxes and grow their net worth

Anybody who falls into this category and referred by you or my other clients should call me for a chat. In fact, if you can spread the good word about me on-line in the chat room, I would appreciate that very much!! The advantage that our office has over any other office that does the Smith Manoeuvre is that I am BOTH a mortgage broker AND a financial planner. So I can make sure that the right mortgage is set up followed by the right investments and the client can always call us if they have any questions about the process, whether it relates to mortgage or the investments.

Kindest regards,

Arpad Komjathy, MBA, FSU
Mortgage Planner
Financial Advisor
416-410-0892

Located at 401/Port Union in GTA..

I have yet to meet him cause I'm waiting for my mortgage situation to be finalized.. but I think everyone should have a financial planner.

[vr6man25]

Arpad Komjathy, MBA, FSU
Mortgage Planner
Financial Advisor
416-410-0892

Located at 401/Port Union in GTA..

:arrowu: totally agree
very imformative guy.
Knows his stuff , unlike others that don't/can't make the time to sit down with you because they are in a rush or Rsp season.
Called today and meet him today. within the Hour.
thanks for the referral :arrowu: :cheesygri

[monomono]

So the Smith Manoeuvre helps you pay off your mortgage faster. Once you've paid it off, what should you do?

[mjdavila]

So the Smith Manoeuvre helps you pay off your mortgage faster. Once you've paid it off, what should you do?

well.. once you paid off your mortgage (bad debt will be all gone)..

but you'll still have the total debt that you invested (good debt)..

but im not sure what to do at this point... you can either pay off the debt with your investment porfolio.. or keep the debt and keep your investments..

i havent gotten past chapter 4 in the book yet... smith you around?

[FrugalTrader]

well.. once you paid off your mortgage (bad debt will be all gone)..

but you'll still have the total debt that you invested (good debt)..

but im not sure what to do at this point... you can either pay off the debt with your investment porfolio.. or keep the debt and keep your investments..

i havent gotten past chapter 4 in the book yet... smith you around?

Smith advocates keeping the debt until you die. Personally, I would consider paying down the debt once I approach retirement.

[Bick Financial Toronto]

The whole purpose of having good debt is to reduce your taxes. Once you generate no taxable income other than capital gains from your portfolio as a result of implementing the Turbo Charged Smith Manoeuvre, it is time to eliminate the debt to reduce your exposure. The capital gains taxes you pay will be minimal at that point.

[grant]

So the Smith Manoeuvre helps you pay off your mortgage faster. Once you've paid it off, what should you do?
The smith maneuvre makes your personal mortgage interest tax deductible.

This may give you the ability to pay off your mortgage faster, but that's a totally separate issue.

[grant]

The whole purpose of having good debt is to reduce your taxes. Once you generate no taxable income other than capital gains from your portfolio as a result of implementing the Turbo Charged Smith Manoeuvre, it is time to eliminate the debt to reduce your exposure. The capital gains taxes you pay will be minimal at that point.
Another valid purpose of debt is to leverage investments. The amount of interest-deductible debt a person chooses to carry is unrelated to the smith maneuvre.

[edrempel]

Pitz,

You do have a lot of points. But you are not right about the way these corporate structure funds actually work.


Then the mutual fund gets to pay taxes as a corporation. Are corporate income taxes lower than personal income tax rates? Even after you take into account the double taxation that would occur by investing in such a structure?

The mutual fund corporation is not paying any taxes either. There are always enough losses to off-set gains. The process is a bit complicated, but if an investor sells a fund at a profit, the mutual fund gets to claim a credit for the gain that the investor will claim on his taxes. This is how some mutual funds with great returns actually have loss carry-forwards.


An investor in traditional mutual fund trusts or individual securities can (and should) do this as well. No 'corporate' structure needed.

The difference is that the corporate structure funds net the gains of one class against the gains of another. Therefore, as an investor, my capital gain can be netted against a capital loss that someone else had!


But Canadian dividends are tax-preferred and generally attract tax rates 10% or less for most investors. Investors who suppress their income with the Smith Manouevre might even have 0% taxation on dividends. This is superior to long-term taxation rates of capital gains in most circumstances (generally, over 20-30 years, cap gains taxation is in the 8-10%/annum range).

While dividends have lower tax rates than capital gains in most tax brackets, capital gains can be deferred for many years. So you should compate paying dividend tax rates today vs. capital gains tax in 20-30 years.


Only if someone else in the fund decides to make an offsetting trade. Otherwise the fund itself gets to pay taxes.

Not true. Switching funds is considered to be a share exchange (like swapping class A shares for class B shares). This is not a taxable transaction, even if all the switches are one way.


Sure....but what are the costs versus a mutual fund trust structure? On an after-tax basis? And just because they don't pay distributions doesn't mean they aren't tax efficient; to wit: they may very well be paying full corporate income tax rates on retained earnings, instead of passing them to the fund owners who might experience lower tax rates. Especially with investors with large tax deductions; ie: Smith Manouevre investors.

The MER difference between a mutual fund trust and mutual fund in a corporate structure is very minor. I just looked up several to find that in one case it was .06%, one it was .01% and one the MER's were the same. Compared to the tax savings from an indefinite referral, the cost is nothing.


You do realize the underlying corporation gets to pay tax, right? And you have to pay an additional management fee for the structure.

The mutual fund corporation is not paying taxes and the MER difference is zero or essentially zero. (see above.)


My taxation rate on dividends is actually negative; to wit: I have a negative marginal rate on dividends.

Valid point. For taxable incomes below $37,000 (Ontario), the dividend tax rate is negative. This is because the stock has already paid corporate taxes at rates higher than your personal tax rate. In your case, the deferral of capital gains does not matter, because you are not paying tax now anyway.





Ed

[edrempel]

What is the "Turbo Charged Smith Manoeuvre"? Is it not just the leverage into a ROC fund described by Da Man? Using a fund with a ROC distribution is rarely necessary when you look at the SM within a comprehensive financial plan. Using a ROC fund usually reduces the potential benefit of the SM, because of the above tax disadvantages, the selection of ROC is limited and excludes most of the best funds in risk/return, and because they are not available in corporate structures.






Ed

[edrempel]

What would be the advantage of being both a mortgage broker and a financial planner? As an advisor, I've considered also being a mortgage broker, but can only see disadvantages for my clients.

Firstly, the best mortgages for the SM are not available to mortgage brokers. The few SM mortgages available to mortgage brokers either require going to a branch to increase the SM credit line, faxing instructions readvance instructions monthly, don't have a variable or 1-year rate (that save money for the client), and/or don't allow investing directly from the credit line.

All of these problems can be avoided with SM mortgages at several of the major banks.

Second, I was concerned about conflict of interest. Can I as an advisor objectively recommend the best mortgage to my clients if I am paid by some financial institutions and not others, or am paid different amounts? How will my client know if I really have their best interests at heart? This is especially true in light of the first point, that the best mortgages are not available to brokers.

For financial planners, comliance is becoming over-bearing. Yet mortgage brokers are still very much a "Wild West", with little compliance or requirement to disclose their compensation or conflicts of interest to clients. They don't have to tell you how much more they are paid for a 5-year vs. a 1-year mortgage.

Third, the compensation for mortgage brokers is skewed so that they are often paid more for products worse for the client. The main example is the "5-Year Mortgage Trap". Brokers are paid more for locking you in for 5 years, even though it costs you money. I recently saw a study going back to 1950 that shows that taking five 1-year mortgages have cost less 100% of the time compared to one 5-year mortgage. Even when rates shot up to 23% in the early 80's, you would have saved money over the 5 years by taking five 1-year mortgages.

I've only met one mortgage broker so far that didn't have some lame excuse for trying to lock as many clients as possible into 5-year fixed mortgages.

We have a wierd interest rate environment today where 5-year rates are lower than 1-year rates. However, historically, this has only happend when everyone knows rates are going down. An "inverse rate curve" indicates a slowing of the economy. This inverse curve has happened a few times in the last 50 years, and yet every single time, taking five 1-year rates saved money.

With the SM, this is sometimes a bigger issue, since one of the many advantages of the SM not mentioned in Fraser's book is that you can usually reappraise your home every 2-3 years for free and leverage the increase. This is often problematic if you are in a 5-year fixed.

Another conflict of interest is that some mortgage providers, such as Firstline, actually pay the mortgage broker more if he gets his client to take a smaller discount on their mortgage rate.

While I am concerned about the lack of competition with the few big banks we have, my main concern is getting the best mortgage for my clients. We prefer to use a readvanceable that is:

1. Variable rate between prime -.8% to prime -.9%.
2. Allows multiple credit lines (add one for emergencies or for the Cash Dam)
3. Readvances automatically
4. Allows investing directly from the credit line
5. Is fully open.
6. No fees at all - no legal, appraisal, broker, or administration fee.

None of the mortgages available to mortgage brokers have more than 2 of these 6 features.

Therefore, even though we refer about 150 mortgages/year (more than many mortgage brokers) and we could make quite a bit of money from also being a mortgage broker, I have not become one or added one to my team, since I think it is much more important for us to be completely objective in getting our clients the best possible mortgage for the SM.






Ed

[edrempel]

Gary,

Ouch, I felt that.

Ed

[Bick Financial Toronto]

Another valid purpose of debt is to leverage investments. The amount of interest-deductible debt a person chooses to carry is unrelated to the smith maneuvre.

You are exactly right Gary! It has to do with taxable income. If someone is making no taxable income or has a low income tax rate due to drawing from funds generating capital gains then it becomes a personal preference how much leverage makes sense at that poitn. Many advisors, and I am one of them, prefer to take a measured approach to leverage, and our clients are comfortable with our somewhat conservative approach.

[Bick Financial Toronto]

What would be the advantage of being both a mortgage broker and a financial planner? As an advisor, I've considered also being a mortgage broker, but can only see disadvantages for my clients.

You raised many good points Ed. Conflict of interest is always an issue to consider. When a financial planner is also an insurance agent that could be a conflict of interest. When a financial planner is also a mortgage broker that could be a conflict of interest. When a financial planner is also an accountant that could be a conflict of interest. Not to mention the banks who are a shining example of conflict of interest situations! It is next to impossible to completely eliminate conflict of interest from our financial lives.

Although conflict of interest situations are to be approached with caution, in my view often they also provide benefits to consumers. A financial planner who is also an insurance agent may have a deeper understanding of how insurance products compare to different non-insurance products. A financial planner who is also a mortgage broker is able to assist clients with the logistics of actually executing the sometimes complex steps involved in a Turbo Charged Smith Manoeuvre program to convert the mortgage into a tax deductible debt well under 10 years. In our experience many clients need help and support to do the logistics correctly and that's what we are able to provide. This step is often underestimated by many financial planners.

When a financial planner is an accountant then the benefit is that the planner is able to assist with the client's tax filing. The income tax filing is a rather important, although somewhat simple process and that's why we do not have an accountant on our team but instead we refer our clients to a number of good accounting service providers to reduce the conflict of interest.

Banks are the perfect example of conflict of interest - and maybe the worst of them all! Yet too many people use them and trust them.

Our industry has high standards in the financial planning area and we have a fiduciary duty to represent the best interests of our clients. As long as clients work with someone reputable, especially if that person was referred, I believe that the issue of conflict of interest is well contained.

Ed you are correct in an absolute sense that deep discount variable rates are better (over the long run) than going with a discounted 5-year fixed rate. Many of our clients, however, look at ways to reduce their interest rate exposure and a 5-year fixed rate mortgage - using your example - will accomplish that. It is a form of interest rate risk hedging we often use for our clients. Yet other clients may prefer to go with a deep discount variable rate and willing to endure higher interest rate variability and then we go with that product.

We are a conservative firm in our implementation of the Turbo Charged Smith Manoeuvre and we take measured risks with our clients' financial lives. There is a lot at stake for them. We don't do seminars because we don't need them: we have many referrals thanks to our happy and satisfied clients. We do provide, however, a personalized service: people can call us and we spend time with them in our office to understand their needs and answer their individual questions. Sure there are potential ways to speed up the journey to financial independence even more, but what is the point of taking the Challenger that can blow up, when we can take an airplane and get there almost as fast but a lot safer? But then again, different folks, different strokes... We just happen to believe in our approach and we do respect what others believe in...

[frankal101]

Thanks for everyone's answers - they have helped me a lot in planning to implement sound financial future. I am at the stage where I am looking to make an offer on a place that is in Quebec and implement all the things talked about in this thread.

Since I am in Quebec, I actually need some capital gains or dividends to claim the interest deduction on the investment loan. I guess my main concern is who to go with on the mortgage? I have been looking at Manuone product form Manulife for its ease of control and impementation in regards to SM. The only thing that is somewhat negative is $14 monthly fee and prime variable rate on the mortgage (although it is also prime on the investment protion). It is seems to have 5 out of 6 criteria listed by Ed above. I guess #4 and 6 is violated. But the rep told me they cover appraisal and $500 of lawyer/notary fees.

Could you guys please comment? I agree that locking up for 5 years does not make sense. Also traditional mortgages (from bmo and royal are the ones i asked) have pre-payment limitations. Can you reccomend one that has all 6 criteria discribed by Ed?

We prefer to use a readvanceable that is:

1. Variable rate between prime -.8% to prime -.9%.
2. Allows multiple credit lines (add one for emergencies or for the Cash Dam)
3. Readvances automatically
4. Allows investing directly from the credit line
5. Is fully open.
6. No fees at all - no legal, appraisal, broker, or administration fee.

None of the mortgages available to mortgage brokers have more than 2 of these 6 features.

I am also exploring options to do what Ed described above (Rempel Maximum) as it seems a more efficient version of traditional leverage (no cf out of pocket is key here!). For the Rempel maximum side of things I was looking to use Income Trust Funds - I found Brompton funds lineup to look very promising with low MER (0.45%) and diversity of passive products. Here i would choose to receive distributions as Capital gains (based on ROC discussion above and avoidance of potential hassles in the future). Probably a 50/50 mix of:
- oil and gas trust fund - equally cap weighted passive portfolio with current yield of 17%
- passive index of top 200 trusts - equally cap weighted with current yield of 10%

This gives me a weighted avg yield of 13.5% and will give me net monthly yield of 7.5% (not counting tax benefit of interesting deductability at end of year). Once again the key is no cash out of pocket. Since original mortgage loan i rate= side investment loan i rate= inside SM readvanceable portion i rate i should be ok, right. Any money that is not needed of side loan will be transefered left inside the SM and readvanced to a conservative dividend portfolio just to keep things civil (I mean, this thing can really get out of hand with 7.5% or more net annual yield distributed monthly and additional personal salary - as good as the prospect of no mortgage in 5 years sounds, I would not want a $500k side loan trust portfolio)

I am looking to play the trust carry trade on the side loan until the gov't mandated change of rules (3 and some years) and then reassess the whole situation. Any negative change in value of trust portfolio at the end would be settled with the funds in the conservative SM readvanceable side - part of the risk. In addition, any net tax liabilities (net of rrsp contribution deductions, inside Sm loan interest deductions, and side loan tax deductions) would be paid out of the inside SM nest egg as well.

That is my plan - I am in Quebec and (believe it or not) capital gains are a good thing to make this work. I do not condone anyone leveraging to buy a pure trust portfolio, but it might suit some. I am an investment professional and the asset mix would be my personal doing. I guess that is something i am prepared to face. Any comments on the specific vehicles, however would be appreciated. Also any comments on the mortgage and anything else wold really help.

Thanks this board has been great and has answered many questions of the details!

FrankAl

[cannon_fodder]

I'm pretty convinced, at least in my mathematical studies of RRSPs and mortgages, that one shouldn't contribute to a RRSP at all if they have a mortgage. Take all your free cashflow, throw it on the mortgage, and then have it re-advanced through the SM to invest in tax efficient non-registered equities.

Why? Because the investors' marginal cost of capital is reduced with the non-reg scenario, and RRSPs do not a meaningful long-term tax advantage compared to the non-reg scenario in a sufficient enough amount to outweigh the lower cost of capital associated with investment borrowing.

pitz,

Have you created a mathematical model that shows a hybrid of RRSP contribution and leveraged investing or is it only one versus the other?

[edmacdonald]

I am interested in the "constant cash flow" SM. My understanding is that you make LOC interest payments by borrowing more from the LOC. So as time goes on, some of the debt in the LOC is in investments and some of it went to servicing the "real" investment debt. In this case it doesn't seem as if the interest on the LOC would be fully deductible.

What am I missing?

Thanks,

Ed

[cannon_fodder]

For those that don't have Excel but want to try 'what if' scenarios using a SM calculator, try this:

http://www.editgrid.com/user/cannon-fodder/Smithman

It is quite slow, unfortunately. You change the values and, IF the server doesn't time out, it takes about 30 seconds to calculate. Also, for the percentages, you have to enter them as a decimal (e.g. 5.25% is 0.0525).

I have tried to save the workbook as an HTML file but it grows to a few MB and still requires you to download a 17MB Office component plugin for IE.

I'd like to find a free utility to convert the XLS to a web-based calculator but haven't found anything which can accommodate this.

[tkl]

For those that don't have Excel but want to try 'what if' scenarios using a SM calculator, try this:

http://www.editgrid.com/user/cannon-fodder/Smithman

It is quite slow, unfortunately. You change the values and, IF the server doesn't time out, it takes about 30 seconds to calculate. Also, for the percentages, you have to enter them as a decimal (e.g. 5.25% is 0.0525).

I have tried to save the workbook as an HTML file but it grows to a few MB and still requires you to download a 17MB Office component plugin for IE.

I'd like to find a free utility to convert the XLS to a web-based calculator but haven't found anything which can accommodate this.

I tried the google free spreadsheet that's suppose to read excel files and it does some but not the xls file you submitted earlier.

I also loaded xls file you submitted earlier using Quattro Pro as I don't have Excel and it seems to work but I'm not sure how accurrate the formula conversion was.

Thanks for posting it though, I'll be looking around for my old 2003 excel disk somewhere in a box.

[don242]

I tried the google free spreadsheet that's suppose to read excel files and it does some but not the xls file you submitted earlier.

I also loaded xls file you submitted earlier using Quattro Pro as I don't have Excel and it seems to work but I'm not sure how accurrate the formula conversion was.

Thanks for posting it though, I'll be looking around for my old 2003 excel disk somewhere in a box.

If you are interested I did a calculator using Quattro Pro that I could send to you. The interface is a little messy as I haven't cleaned it up yet. Essentially it compares SM with RRSP and paying off mortgage in whatever % you want. I will clean it up a bit for anyone who is interested. Again, I only have Quattro Pro so it won't work on Excel most likely.

[Bick Financial Toronto]

I am interested in the "constant cash flow" SM. My understanding is that you make LOC interest payments by borrowing more from the LOC. So as time goes on, some of the debt in the LOC is in investments and some of it went to servicing the "real" investment debt. In this case it doesn't seem as if the interest on the LOC would be fully deductible.

What am I missing?

Thanks,

Ed

You are not missing anything, you are absolutely right. The interest on borrowed funds is tax deductible and the interest incured to service the original loan is also tax deductible. You just have to keep your loan statements to document that the investment was made to "earn interest and dividend income".

[edmacdonald]

...you are absolutely right. The interest on borrowed funds is tax deductible and the interest incured to service the original loan is also tax deductible.

I guess that would make me wrong. It is logical that it would be deductible since it is a net zero manoeuvre to keep the bank happy, but being logical rarely seems to be sufficient with tax laws. It surprises me that the two transactions (borrow/payment) wouldn't trigger something undesirable since the newly borrowed money isn't invested. Similar to the fact that I can't just cash out one RRSP and put the money into another.

Thanks

[cannon_fodder]

If you are interested I did a calculator using Quattro Pro that I could send to you. The interface is a little messy as I haven't cleaned it up yet. Essentially it compares SM with RRSP and paying off mortgage in whatever % you want. I will clean it up a bit for anyone who is interested. Again, I only have Quattro Pro so it won't work on Excel most likely.

Don,

Perhaps you could send it to me and I could take a crack at converting it to Excel. If it is small enough it might be convertable to a standalone calculator that could then be hosted.

[don242]

Don,

Perhaps you could send it to me and I could take a crack at converting it to Excel. If it is small enough it might be convertable to a standalone calculator that could then be hosted.

I put the file at http://home.golden.net/~farnaway/offers/plan2.wb3 . As I said it is for Quattro Pro so not sure how many will be able to use it. It may convert to Excel but my experience shows that it usually doesn't work. The file is about 8MB to download.

General comments and isntructions:

1. The spreadhseet is flexible in many ways allowing you to choose between mortgage paydown and RRSP contribution. It allows you to do the SM or not. You can compare 3 scenarios at a time over a 25 year period (results shown in 5 year intervals). However, it is also inflexible in many ways since the investing strategy is limited.

2. The basic premise is this. You have required monthly payments on your mortgage and a seperate amount for adding to "savings" either monthly or annually. Those savings can be broken up into RRSP or mortgage paydown. Once the mortgage is piad off, the full amount (minimum required payment and savings put toward mortgage) are automatically put into your RRSP. Once your RRSP contribution limit is reached, the savings are invested outside RRSP and taxed accordingly. All tax refunds from RRSP contributions (or using SM) are either directed towards mortgage pay down or RRSP investments depending on settings.

3. There are some minor flaws due to logistics but they have little impact on the final numbers. There is some research required to determine your own marginal tax rate and provincial dividend tax credits. For Ontario the current tax credit is 6.05%. I realize this number is changing every year over the next few years but unfortunatley I haven't added this to the sheet.

4. As with most finances, there is endless possibilities so it is hard to derive a scenario that can encompass them all. This was mostly developed for my own personal use so it caters towards comparing relevant scenarios to my situation.

Let me know if there is anything I can help with or explain and I will do my best.

[vr6man25]

Hey Arpad can you check your private messages please.
Thanks.




You are not missing anything, you are absolutely right. The interest on borrowed funds is tax deductible and the interest incured to service the original loan is also tax deductible. You just have to keep your loan statements to document that the investment was made to "earn interest and dividend income".

[Bick Financial Toronto]

It surprises me that the two transactions (borrow/payment) wouldn't trigger something undesirable since the newly borrowed money isn't invested. Similar to the fact that I can't just cash out one RRSP and put the money into another.

The rationale is that when you borrow money to invest and then borrow money to support the loan that was used for investment purposes, you are indirectly supporting the investment that was originally made.

[decroded]

Hi all,

I'm starting a new mortgage and have 25% down, but I'm planning to do the SM with my mortgage with Manulife One. Do you all think it's worth it to eat the CMHC premium and go with a high ratio mortage at 90% LTV, so that I can take the extra 15% and kick start the SM right away?

Crunching the numbers on an approx. $300k mortgage, it looks like the CMHC fees would be about $5500. This would let me put about $45k into deductible investments, which would incur interest of about $2800. This would net me a deduction of about $1000 in the 40% bracket.

So it would seem to come down to whether the $45k in play could produce dividends of more than $2800 and amortize the CMHC fee in a reasonable amount of time. This seems doable.

But if this is the case, aren't all SM mortgages best off starting with as high an LTV as possible?

Comments much appreciated. Thanks.

[cannon_fodder]

What would be the disadvantages to using the Horizons BetaPro S&P/TSX (HXU) ETF as part of the investment for the SM? I would imagine it still would distribute some measly dividends/capital gains income but, if you are long term bullish on the TSX, you would get 200% exposure (minus the MER which is somewhat high at 1.15%).

If you think the TSX would go experience 7% CAG over the next 10 years, buying and holding would get you a bit less than 13%.

[grant]

Do you all think it's worth it to eat the CMHC premium and go with a high ratio mortage at 90% LTV, so that I can take the extra 15% and kick start the SM right away?
No i don't think it's worth it.

but more importantly, you can't just take a larger mortgage and claim a portion of its interest as a deductible expense... because the entirety of the mortgage funds are traced to you purchasing your personal residence.


But if this is the case, aren't all SM mortgages best off starting with as high an LTV as possible?
SM means your mortgage interest is deductible. Nothing more.

What you are contemplating is leveraged investing. That's a totally different topic.

If you really want to get involved with leveraged investing, I suggest you get a conventional mortgage and then pursue a secured line of credit. Many banks will offer the LOC on the equity from 75% -> 85% (i.e., you can borrow 10% the value of your home on top of the mortgage).

This will have no effect on the tax deductibility of your original mortgage (i.e., it's not SM) but of course it puts you in a great position to increase the deductible LOC as repay the non-deductible mortgage faster than amortized, which IS the smith maneuvre.

[KEH]

Hi all,

I am currently considering TSM on my current mortage (in which I have 50% equity) and so this blog has been extremely useful. However, I would like more information on how effective TSM is if you use the mortgage principal re-advancement to invest in rental property rather than a portfolio. I am considering purchasing a rental property and wonder if it would be better to use TSM on my existing home mortgage to put the 50% equity towards the purchase of the rental property (and thus tax deductible interest) or carry out TSM in the normal way to get tax deductible financing for an investment portfolio and then just take out a separate mortgage for the rental property (which will have tax deductible interest anyway). Also, is the interest on a rental mortgage immediately tax deductible from the date of purchasing the property or only from the date you start renting out the property?

The cost of the current and rental properties are around $300k each.

Many thanks,

KEH

[Bick Financial Toronto]

Hi all,

I'm starting a new mortgage and have 25% down, but I'm planning to do the SM with my mortgage with Manulife One. Do you all think it's worth it to eat the CMHC premium and go with a high ratio mortage at 90% LTV, so that I can take the extra 15% and kick start the SM right away?

On the surface if you just look at mathematics it may make sense. You would be able to set up the mtg with 90% HLOC then dump the money back into one of the sub accounts so you can reborrow it. This way you would have two separate accounts: one for the regular non-tax deductible mortgage and one for the investment with the tax deductible interest.

The second issue that you may want to consider is where you invest the money. Earning a taxable interest income of $2,800 (or whatever) may not be the be the best use of the funds.

The third issue is the fact that Genworth or CMHC insured 90% HELOCs are interest only for 5 or 10 year and then you have to amortize the mortgage over the next 20 or 15 years to complete the mortgage pay-off within 25 years. Of course you can refinance later to get out of the high ratio insured HELOC structure but it is an added risk that you would be facing: what if the housing markets do turn down? It have happened before - see 1990 to 1995. You do not run into this potential complication with a conventional HELOC set-up.

[Bick Financial Toronto]

Hi all,

I am currently considering TSM on my current mortage (in which I have 50% equity) and so this blog has been extremely useful. However, I would like more information on how effective TSM is if you use the mortgage principal re-advancement to invest in rental property rather than a portfolio. I am considering purchasing a rental property and wonder if it would be better to use TSM on my existing home mortgage to put the 50% equity towards the purchase of the rental property (and thus tax deductible interest) or carry out TSM in the normal way to get tax deductible financing for an investment portfolio and then just take out a separate mortgage for the rental property (which will have tax deductible interest anyway). Also, is the interest on a rental mortgage immediately tax deductible from the date of purchasing the property or only from the date you start renting out the property?

The question is diversification by asset class more than anything else in my view. You already own real estate so now you have a sizable exposure to that asset class, so it may not make sense to own more real estate to have an even bigger exposure to that same asset class and have no exposure on stocks and bonds. Plus, you get one bad tenant and then you are at a major loss once you factor in property damage as well. Plus the associated costs of managing the property when somethings goes wrong... It is pain in the neck for most people who do not do property management as a full-time profession. But if real estate is your thing...

[gwexco]

I am still a little confused by the ROC versus Corporate Class debate. I realize ROC fund is probably not the most desirable due to the reduced interest deductability based on a reduced investment, however is a Corporate Class Mutual fund an investment that revcan considers viable. Is there an intention to have income, from what I can see it is structure not to return any income, interest or dividend or roc. Just interested if revcan has made any statement on that type of investment being eligible for interest deductability.

What are peoples view on the TD HELOC? The rate I was quoted for the variable was only prime. It readjusts automatically and they are willing to cover all costs.

[KEH]

The question is diversification by asset class more than anything else in my view. You already own real estate so now you have a sizable exposure to that asset class, so it may not make sense to own more real estate to have an even bigger exposure to that same asset class and have no exposure on stocks and bonds.


Thanks Bick FT. To add a bit more to my scenario, I do also have exposure to stocks and bonds through my RRSP and through other non-registered investments. I would also gain additional exposure if I used SM on my non-deductible mortage to invest in more stocks. Any more thoughts?

[tkl]

I put the file at http://home.golden.net/~farnaway/offers/plan2.wb3 . As I said it is for Quattro Pro so not sure how many will be able to use it. It may convert to Excel but my experience shows that it usually doesn't work. The file is about 8MB to download...............

Thank you very much for posting it. I've downloaded it and will check it out when I can.

[IshDisturber]

Admittingly, I have not read all the posts in this thread and am not an expert in the SM, so I apologize in advance if this has already been addressed....

Can one not get the same effect by purchasing their home on a LOC vs. a conventional mortgage and then using the $ one has paid off the principal to invest?

I have owned my home for just under 2 years. I was able to put down a 40% DP. I financed the balance with the following blend:

1. 1/3 in a conventional, 2-year fixed @ 3.65%
2. 2/3 in an open LOC, variable rate.

Now with this structure, I have been able to pay down my principal at a much larger pace than I could have with a conventional mortgage (30% of the amount of the LOC). IOW, every single penny from my pay check goes towards my LOC. When I need cash to pay bills etc, I just draw off the line. In addition, I have also re-invested about 50% of the 30% that I have paid off on the LOC. Thankfully, I have made some gains...and the best part is that the interest is tax-deductible.

The other 1/3 of my house debt is paid in bi-weekly payments as per a normal mortgage.

So far this has worked great for me.... just thought I'd share this you all.

[ninja6o4]

Admittingly, I have not read all the posts in this thread and am not an expert in the SM, so I apologize in advance if this has already been addressed....

Can one not get the same effect by purchasing their home on a LOC vs. a conventional mortgage and then using the $ one has paid off the principal to invest?

I have owned my home for just under 2 years. I was able to put down a 40% DP. I financed the balance with the following blend:

1. 1/3 in a conventional, 2-year fixed @ 3.65%
2. 2/3 in an open LOC, variable rate.

Now with this structure, I have been able to pay down my principal at a much larger pace than I could have with a conventional mortgage (30% of the amount of the LOC). IOW, every single penny from my pay check goes towards my LOC. When I need cash to pay bills etc, I just draw off the line. In addition, I have also re-invested about 50% of the 30% that I have paid off on the LOC. Thankfully, I have made some gains...and the best part is that the interest is tax-deductible.

The other 1/3 of my house debt is paid in bi-weekly payments as per a normal mortgage.

So far this has worked great for me.... just thought I'd share this you all.


Yes, the SM is the intention of converting as much of your mortgage interest as possible into an interest deductible investment. All gains would go into the mortgage to reduce non-deductible tax and then you'd turn around and withdraw that gained equity to put back into your investment, increasing your deduction, and thus your gains.. wash, rinse, repeat.

[Spazmogen]

Well, this has been a very interesting read.

So much so, that I bought Fraser's book & CD-ROM combo.

I look forward to working out the numbers.

I just need to find a way to get the wife to agree to this, all she knows is what worked for her parents.

[edrempel]

I am still a little confused by the ROC versus Corporate Class debate. I realize ROC fund is probably not the most desirable due to the reduced interest deductability based on a reduced investment, however is a Corporate Class Mutual fund an investment that revcan considers viable. Is there an intention to have income, from what I can see it is structure not to return any income, interest or dividend or roc. Just interested if revcan has made any statement on that type of investment being eligible for interest deductability.

Hi, gwexco,

RevCan has had no issue with corporate class mutual funds. They've been around for about 15 years. The issue is not whether they pay taxable distributions, but whether they COULD pay them, which is theoretically possible. In practice, RevCan has not had any concern with any equity type mutual funds.


What are peoples view on the TD HELOC? The rate I was quoted for the variable was only prime. It readjusts automatically and they are willing to cover all costs.

TD HELOC works quite well for the SM. Prime is the variable part, but you would have to lock in the main portion at a fixed rate. Don't get sucked into a long term fixed rate at the peak of the market. TD unfortunately does not have a variable option for the fixed portion of their HELOC.





Ed

[edrempel]

I just need to find a way to get the wife to agree to this, all she knows is what worked for her parents.

Hi, Spaz,

Is that picture you or your wife???

Yes, getting a partner that is not interested in finances to agree is a challenge. Her parents would obviously have taught her the "Sacred Cow". Education or trusting you are the only options. Suggest she read the book or go to a seminar.



Ed

[edrempel]

I financed the balance with the following blend:

1. 1/3 in a conventional, 2-year fixed @ 3.65%
2. 2/3 in an open LOC, variable rate.

Now with this structure, I have been able to pay down my principal at a much larger pace than I could have with a conventional mortgage (30% of the amount of the LOC). IOW, every single penny from my pay check goes towards my LOC. When I need cash to pay bills etc, I just draw off the line. In addition, I have also re-invested about 50% of the 30% that I have paid off on the LOC. Thankfully, I have made some gains...and the best part is that the interest is tax-deductible.

The other 1/3 of my house debt is paid in bi-weekly payments as per a normal mortgage.

So far this has worked great for me.... just thought I'd share this you all.

Hi, Ish,

How are you tracking what part of the credit line is tax deductible? Only the amount you can prove was invested and is still invested is tax deductible. It sounds like you have mixed deductible and non-deductible transactions into the same LOC, which means you need to maintain a record of all transactions to prove deductibility and always calculate the deductible portion. CRA can also assume a part of any payment is paid down on the deductible portion, if you cannot prove otherwise.

This will also make it difficult for you to capitalize the interest, since you have to calculate the deductible portion first.

I would suggest having 2 linked credit lines to separate the deductible from the non-deductible. As you pay your non-deductible LOC down, you can reborrow in the deductible LOC to invest.





Ed

[pitz]

The mutual fund corporation is not paying any taxes either. There are always enough losses to off-set gains. The process is a bit complicated, but if an investor sells a fund at a profit, the mutual fund gets to claim a credit for the gain that the investor will claim on his taxes. This is how some mutual funds with great returns actually have loss carry-forwards.


But eventually all asset classes will be subject to inflation, and taxable capital gains will be accumulated in the structure internally.

A flow-through entity can distribute those capital gains to the investor, who in turn, is taxed at his/her own tax rates, which are often less than corporate rates. A 'corporate class' mutual fund has to pay those capital gains taxes in the hands of the corporation itself. In the absence of offsetting losses within other asset classes represented inside the investment corporation, the corporation will have no choice but to declare a capital gain.

Basically the structure only works because, in the relatively short term, there are enough losing positions in the overall portfolio of the corporation to offset the realized gains in the winning portions of the portfolio. However, this is a short-term strategy, and I am not at all convinced it can stand up to longer term scrutiny, especially if the fund's underlying assets become allocated in a way that is completely inconsistent with the demand by the underlying investors/unitholders/shareholders.



The difference is that the corporate structure funds net the gains of one class against the gains of another. Therefore, as an investor, my capital gain can be netted against a capital loss that someone else had!


And you can do the same with flow-through funds (ie: traditional mutual funds). A popular transaction has been to sell shares in Nikkei (Japan) based funds, and use those capital losses to offset gains in North American equities throughout the 90s. Accomplishes the same goal, provides much more operational flexibility and predictability for the individual investor, costs less, and carries far less fund manager specific risk.



While dividends have lower tax rates than capital gains in most tax brackets, capital gains can be deferred for many years. So you should compate paying dividend tax rates today vs. capital gains tax in 20-30 years.


The underlying corporation will still be paying dividend tax rates on dividend income derived by the underlying portfolio. The first $60k of Canadian dividends, if its one's only source of income, is almost tax-free.



Not true. Switching funds is considered to be a share exchange (like swapping class A shares for class B shares). This is not a taxable transaction, even if all the switches are one way.


You have to consider the underlying portfolios held by the fund itself. If you want to move all your assets from a Canadian Equity allocation to a Japanese Equity allocation, and if the fund has no 'float' of Japanese Equity allocation to swap your share units into, then the fund will have to incur a capital transaction to sell some Canadian Equity, to buy Japanese Equity. These imbalances create capital transactions for the investment corporation/fund itself, and give rise to a current capital gains liability.

Just because its not taxable for *you* specifically doesn't mean its not taxable at all. The big issue is that you are paying for this so-called tax-efficiency by having the fund itself pay the taxes for you (actually you get double-taxed, as you have to pay capital gains tax when you actually sell appreciated units, so capital gains tax is both paid at the investment corporation level, as well as at the individual level).



The MER difference between a mutual fund trust and mutual fund in a corporate structure is very minor. I just looked up several to find that in one case it was .06%, one it was .01% and one the MER's were the same. Compared to the tax savings from an indefinite referral, the cost is nothing.


Its *not* an indefinite deferral. Investing through a corporation is just wrapping a veil around an investment portfolio, but such veil is still subject to taxation under certain circumstances. Another large risk, at least from a younger investors' point of view, is that such an entity will incur large internal portfolio changes to match the demographic make-up of its investors. What might start out as an overall portfolio that is heavily represented in equities, might migrate into a portfolio that is bond-heavy as investors in the overall pool alter their risk tolerances.

Why is that a concern? After all, you say, each investor has its own allocation of assets within the investment corporation? Its a concern because the overall fund will have to liquidate (and incurr capital gains upon) a good chunk of its equity allocation, in order to buy less risky securities. Even if you maintain your 100% equity allocation within the portfolio, capital gains taxes paid by the corporation get allocated to your 100% equity allocation. You could essentially end up paying a good chunk of Grandma's taxes if you buy a corporate class fund in your younger years, and hold for 20-30 years.



The mutual fund corporation is not paying taxes and the MER difference is zero or essentially zero. (see above.)


Not true. Mutual fund corporations are subject to taxes, just like any other corporation. Flow-through entities such as Mutual fund trusts are exempt on taxes on income that is distributed and attributed to unitholders.



Valid point. For taxable incomes below $37,000 (Ontario), the dividend tax rate is negative. This is because the stock has already paid corporate taxes at rates higher than your personal tax rate. In your case, the deferral of capital gains does not matter, because you are not paying tax now anyway.


I very strongly urge you to receive professional accounting advice if you are selling corporate class products to your client on the basis of tax efficiency alone. If you are an advisor, you really have a fiduciary duty to your clients to become properly educated on these issues so you can provide appropriate advice.

Also I would urge you to contemplate the specific case where a 'corporate class' fund starts shrinking in size, or stops growing in terms of new money contributed. This is the scenario in which the feces really hits the fan in terms of tax efficiency, as then, under such a scenario, every transaction by a shareholder would require a reallocation of the underlying portfolio, which gives rise to churn and taxes.

[pitz]

I am still a little confused by the ROC versus Corporate Class debate. I realize ROC fund is probably not the most desirable due to the reduced interest deductability based on a reduced investment, however is a Corporate Class Mutual fund an investment that revcan considers viable. Is there an intention to have income, from what I can see it is structure not to return any income, interest or dividend or roc. Just interested if revcan has made any statement on that type of investment being eligible for interest deductability.


In addition to my very serious reservations about the long-term efficacy of 'corporate class' funds (after all, for the SM, you want an investment product that you can likely hold tax-efficiently for 30-40 years, or as Smith puts it in his interviews, "till I'm dead"), corporate class funds would have issues in Quebec where tax deductibility, for the purposes of Quebec personal income tax, is limited to the amount of actual investment income received on a cumulative basis.

Overcoming these issues is where a portfolio of exchange traded funds really shines (ETFs). You get a stream of (growing) dividends, rebalancing flexibility, a high degree of tax efficiency, low ongoing costs, and potentially the ability to remove assets from management (ie: ETF 'in-kind' redemption) or to switch asset managers in the future*.


* I am referring to the fact that, with ETFs, if you own enough units, and don't like the investment philosophy of the ETF, you can redeem your ETF units for the underlying stocks, without incurring a capital transaction or taxes. Whereas with traditional mutual funds, you are making a very, very long term committment that is almost impossible to break without very punitive levels of tax.

[Sanchez]

I am referring to the fact that, with ETFs, if you own enough units, and don't like the investment philosophy of the ETF, you can redeem your ETF units for the underlying stocks, without incurring a capital transaction or taxes.

Except for HOLDRs, isn't this only true for institutional-level investors?

[pitz]

Except for HOLDRs, isn't this only true for institutional-level investors?

No. Its true for anyone who holds enough ETF units. And with technology, and splits in the future, its conceivable that the thresholds for redemption will be lower.

[monomono]

Has anyone looked at RBC's "HomeLine" product for the SM?
http://www.rbcroyalbank.com/RBC:Re2aBo71A8cAAoSqfs4/products/mortgages/homeline_plan.html

An RBC rep was explaining it to me. Basically they put a lien on 75% of your home. Then within that 75% you can put up to 5 secured loans, either mortgages or SLOCs. E.g. you can have 1 mortgage and 1 SLOC, and can set the SLOC credit limit to automatically increase monthly as you pay off your mortgage.

[edrempel]

Hi, Pitz,

That was quite a thorough analysis. However, there are a couple of things you need to understand about Corporate Class mutual funds. Also, you are confusing corporations in general with Corporate Class funds. And I don't need to get accounting help, since I am both an accountant and a financial advisor and understand the tax issues.

The policy of the corporate class mutual funds is to be flow-through vehicles, just like other mutual funds. Their policy is to never pay taxes at the corporate level - but to pass all taxable income through to the investors. So, your fear of double taxation doesn't actually happen. They also generally only include equity and balanced funds, so going to all bonds won't happen either.

You make a few good points in theory, but if you look at these funds, most have never or almost never paid a distribution (even though they have been around about 15 years) and most have large loss carrry-forwards on their books now.

These funds do several things that are somewhat technical in nature, but are behind much of the tax efficiency. In addition to the strategies individual investors can do, such as off-setting gains with losses and selling some holdings with to claim losses before year-end, they also:

1. Net any investment income against their MER's first. So, if the MER is 2.5%, then the first 5% of net capital gains realized by selling holdings in the portfolio won't attract any tax. Note this only includes any stock held inside the mutual fund actually sold during the year.
2. Claim losses whenever gains are claimed by investors. For example, if I sell my fund and have a capital gain of $10,000, then the fund claims a credit for $10,000 against any capital gains realized. It would be double tax to have the fund and the investor both claim the gain, so the fund gets to claim a credit. Therefore, investors that sell their holdings in the corporate class group of funds help out those that stay invested.
3. Off-set my gain with someone else's loss (as mentioned in a previous post). For example, I sell my resource fund at a profit and the corporate class of funds nets it against the loss someone else incurred by selling their tech fund, so the fund incurs no capital gain to pass through to me on my profit.

These 3 points are quite techinical, but are some of the main reasons why the corporate class mutual funds often maintain large loss carry-forwards for many years even in rising markets.

The other large factor, however, is the reliable bad investing of average investors, including most advisors and brokers. Average investors tend to all pile into whatever sector has been hot (buy high) and then dump them as soon as they decline (sell low). I've noticed over the years that average investors nearly all buy the same stocks and mutual funds at the same time. This "buy high and sell low" of average investors is very reliable and produces lots of losses for the fund to carry forward.

For example, in the late 90's, everyone bought tech funds, so the tech funds within the corporate class were a disproportionately large part of the fund near the market peak. In some cases, this did result in a taxable distribution in 1999 (for example), but the large tech losses now are large loss carry-forwards within the corporate class of funds.

Lately, everyone has been piling into income trusts (their bubble has burst), resources & gold (possibly in the process of bursting), and Canadian banks. You can always count on most holders of corporate class funds (like most investors in any invesment) to buy high and sell low, which creates a steady supply of loss carry-forwards. So, even if we are not over-weight in the latest fad, our fund will get tax credits because other investors are.

While some of the corporate class funds have much larger loss carry-forwards than others, choosing them properly should allow you to defer tax on your investment growth nearly indefinitely. Even where they are not 100% tax-efficient, they are almost always much more tax-efficient than other mutual funds.

I should add 2 things here, though. One is that, of course, any tax at all on your investments does reduce your long term return. However, there is often a tendency to have tax strategy drive investment strategy - which is a mistake. Having a 100% tax-efficient investment is only useful if it also has a good return and reasonable risk.

Therefore, it is still most important to choose investments and design your portfolio based on risk/return factors, with the tax-efficiency of your investments being only one of the factors you should look at.







Ed

[pitz]

That was quite a thorough analysis. However, there are a couple of things you need to understand about Corporate Class mutual funds. Also, you are confusing corporations in general with Corporate Class funds. And I don't need to get accounting help, since I am both an accountant and a financial advisor and understand the tax issues.


Sorry if my tone was perhaps a bit on the nasty side.



The policy of the corporate class mutual funds is to be flow-through vehicles, just like other mutual funds. Their policy is to never pay taxes at the corporate level - but to pass all taxable income through to the investors. So,


But can they actually pass taxable income through? Correct me if I am wrong, but this is an attribute of an entity that is formed through an indenture of trust, not an incorporated entity.

Of course, they can declare dividends, but unless an authorization from the CRA is received to 'reduce the amount of stated capital', such a dividend distribution comes directly from after-tax income of the mutual fund corporation itself, and is subject to whatever taxes an individual investor faces on dividend income.



your fear of double taxation doesn't actually happen. They also generally only include equity and balanced funds, so going to all bonds won't happen either.


In all fairness, the structure has only been around for 15 years or so, during a period of substantial dichotomy in the world markets (Japanese funds, and earlier, resource funds, have been a reliable source of losses in the past 15 years). Further, they all have been growing through new contributions for the past 15 years through new contributions -- new contributions which are directly used to purchase new holdings. I challenge anyone to show me examples of 'corporate class' funds that have remained stagnant in size, or even shrunk, that have not incurred substantial realized tax drags.



These funds do several things that are somewhat technical in nature, but


I'm a technical kind of guy, got any good references or further information on these moves?



1. Net any investment income against their MER's first. So, if the MER is 2.5%, then the first 5% of net capital gains realized by selling holdings in the portfolio won't attract any tax. Note this only includes any stock held inside the mutual fund actually sold during the year.


Sure, and an individual investor can do this by buying F-class mutual funds or ETFs and writing a cheque seperately to their advisor/broker. More efficient, IMHO, to be taking these tax offsets on one's own personal balance sheet, rather than taking them on the balance sheets of the underlying investments.



2. Claim losses whenever gains are claimed by investors. For example, if I sell my fund and have a capital gain of $10,000, then the fund claims a credit for $10,000 against any capital gains realized. It would be double tax to have the fund and the investor both claim the gain, so the fund gets to claim a credit. Therefore, investors that sell their holdings in the corporate class group of funds help out those that stay invested.


I will definitely have to study this mechamism. Is this accomplished through a reduction to the stated capital of the mutual fund corporation?



3. Off-set my gain with someone else's loss (as mentioned in a previous post). For example, I sell my resource fund at a profit and the corporate class of funds nets it against the loss someone else incurred by selling their tech fund, so the fund incurs no capital gain to pass through to me on my profit.


Yeah that's a legitimate point, distribute your tax liability across the entire pool of investors.

However, how do these funds value tax liabilities/assets? Or do investors who are invested in the corporations into poorly performing asset classes (ie: Japan equity, tech) end up losing the benefit of the tax assets their investments have generated?



These 3 points are quite techinical, but are some of the main reasons why the corporate class mutual funds often maintain large loss carry-forwards for many years even in rising markets.


Sure. Longer-term portfolios tend to be more aligned with the buy-and-hold philosophy, and its not hard for a buy and holder to build up a significant accumulation of carry-forward losses, and deferred capital gains.



For example, in the late 90's, everyone bought tech funds, so the tech funds within the corporate class were a disproportionately large part of the fund near the market peak. In some cases, this did result in a taxable distribution in 1999 (for example), but the large tech losses now are large loss carry-forwards within the corporate class of funds.


Just like they are in my personal portfolio of individual stocks and flow-through funds ;). I've never paid a dime in CG taxes in my life ;).



Therefore, it is still most important to choose investments and design your portfolio based on risk/return factors, with the tax-efficiency of your investments being only one of the factors you should look at.


Good point, and being mutual funds, actively managed ones at that, they are still subject to all of the usual criticisms of actively managed funds.

[FrugalTrader]

Has anyone looked at RBC's "HomeLine" product for the SM?
http://www.rbcroyalbank.com/RBC:Re2aBo71A8cAAoSqfs4/products/mortgages/homeline_plan.html

An RBC rep was explaining it to me. Basically they put a lien on 75% of your home. Then within that 75% you can put up to 5 secured loans, either mortgages or SLOCs. E.g. you can have 1 mortgage and 1 SLOC, and can set the SLOC credit limit to automatically increase monthly as you pay off your mortgage.

Hi Monomono,

Yes, the RBC homeline mortgage is definitely a candidate for the Smith Manoeuvre. Check out my review of the SM for more options.
http://www.milliondollarjourney.com/the-smith-manoeuvre-a-wealth-strategy-part-1.htm

[Huestar]

Hi,

I've been looking through this thread for a while and I recently decided to take the plunge and make a home purchase.
Since I'm relatively young and my girlfriend and I have outstanding student loans, we are only putting 5% down on the home and then using the remainder of our down payment to pay off our student loans.

So my question to the board is, is it possible to perform the smith manoever right out of the gates such as where I am?
The house is brand new and has yet to be built (closing date is July 2008) it will cost 425000 minus 22000 down payment (5%).

I've seen mention of a min. of 25% but no one has explicitly said that you absolutely need this. I would think that there must be a way start with less equity.

Thanks for all of the advice thus far!

[don242]

Hi,

I've been looking through this thread for a while and I recently decided to take the plunge and make a home purchase.
Since I'm relatively young and my girlfriend and I have outstanding student loans, we are only putting 5% down on the home and then using the remainder of our down payment to pay off our student loans.

So my question to the board is, is it possible to perform the smith manoever right out of the gates such as where I am?
The house is brand new and has yet to be built (closing date is July 2008) it will cost 425000 minus 22000 down payment (5%).

I've seen mention of a min. of 25% but no one has explicitly said that you absolutely need this. I would think that there must be a way start with less equity.

Thanks for all of the advice thus far!

You are a ways away from being able to do this. The basic idea is that you are getting a HELOC from which you borrow money to invest. The HELOC can be up to 75% of the value of your home. This means you don't get any line of credit until the first 25% is paid for.

[dark169]

Hi,

I've been looking through this thread for a while and I recently decided to take the plunge and make a home purchase.
Since I'm relatively young and my girlfriend and I have outstanding student loans, we are only putting 5% down on the home and then using the remainder of our down payment to pay off our student loans.

So my question to the board is, is it possible to perform the smith manoever right out of the gates such as where I am?
The house is brand new and has yet to be built (closing date is July 2008) it will cost 425000 minus 22000 down payment (5%).

I've seen mention of a min. of 25% but no one has explicitly said that you absolutely need this. I would think that there must be a way start with less equity.

Thanks for all of the advice thus far!

you can have a HELOC for more then 75% of the value but you endup getting hit with CMHC fees on the portion above 75%. So even if you could get the line of credit the gains are quickly wiped out by those fees and higher interest rates.

Have you run the numbers on your plan, if you have enough for 10 or 15% down and keeping the student loans that may make more sense as you'll save a pile of CHMC fees and your student loan's interest is tax deductible. CHMC fees are reduced every 5% more you put down.

[gwexco]

I also understand that I can't capitalize the interest on the investment LOC in Ontario. Therefore I will have to pay the interest on that portion, which presents a challenge if using Corporate Class funds instead of a Canadian Dividend ETF. I have heard of 'Gorilla Capitalization' but am a little unsure what that entails. RealEstate may be the best cash flow option but then it puts a lot of eggs in one basket. Thoughts?

[pitz]

I also understand that I can't capitalize the interest on the investment LOC in Ontario. Therefore I will have to pay the interest on that portion, which presents a challenge if using Corporate Class funds instead of a Canadian Dividend ETF. I have heard of 'Gorilla


But you can use a margin account in addition to the investment LOC, and simply make the payments from the margin account, to the LOC.

Of course, in the margin account, you would need marginable securities, ie: ETFs.

[edrempel]

we are only putting 5% down on the home and then using the remainder of our down payment to pay off our student loans.

So my question to the board is, is it possible to perform the smith manoever right out of the gates such as where I am?
The house is brand new and has yet to be built (closing date is July 2008) it will cost 425000 minus 22000 down payment (5%).

I've seen mention of a min. of 25% but no one has explicitly said that you absolutely need this. I would think that there must be a way start with less equity.


Hi Huestar,

The first step in the SM is to get a readvanceable mortgage. Most financial institutions that have an SM mortgage require 25% down to get it. A couple will do it with only 10% down. None will do it with 5%.

I agree with Dark. Put at least 10% down on your home and keep some of the student loans. Considering how much you will save in CMHC by paying more down, you may be better off paying nothing on the student loans and putting all available cash down on your home. The exception may be if you can pay one student loan off completely, and then use that payment to increase your mortgage payment.






Ed

[edrempel]

I also understand that I can't capitalize the interest on the investment LOC in Ontario. Therefore I will have to pay the interest on that portion, which presents a challenge if using Corporate Class funds instead of a Canadian Dividend ETF. I have heard of 'Gorilla Capitalization' but am a little unsure what that entails. RealEstate may be the best cash flow option but then it puts a lot of eggs in one basket. Thoughts?

Hi gwexco,

There is no problem capitalizing interest in Ontario. Who told you that? "Guerilla capitalization" is just capitalizing it manually, since none of the banks will allow a credit line to pay its own interest.





Ed

[grant]

you can have a HELOC for more then 75% of the value but you endup getting hit with CMHC fees on the portion above 75%.
Only mortgages require insurance (eg., CMHC) but many banks are happy to offer a HELOC on top of a 75% mortgage, which does not require any insurance.

For example HSBC gave me a 75% open variable mortgage and then a 10% HELOC in addition. I told my rep i plan to use the 10% as part of my down payment and she shrugged it off.

[Bick Financial Toronto]

Thanks Bick FT. To add a bit more to my scenario, I do also have exposure to stocks and bonds through my RRSP and through other non-registered investments. I would also gain additional exposure if I used SM on my non-deductible mortage to invest in more stocks. Any more thoughts?

If asset diversification between real estate and stocks/bonds is not an issue then the next consideration could be your expected return and your personal preference. You can buy a rental property with very little money down, but you can also leverage an investment portfolio as well. So from a leverage standpoint the two options will be fairly close. A leveraged investment portfolio in general is more transparent from a transaction cost and return standpoint (at least on the long run). Real estate is more "hands on" unless you outsource the property management and repairs, and in turn incur higher costs. With real estate you really have calculate/estimate your return - income from ppty, expected appreciation less expenses less additional capital investments if required.

There are a lot of factors that could make real estate better in certain times and a long term portfolio better in other times. I like investment portfolios better because they are liquid and require little on-going management, but there are people who enjoy real estate - it is a very tangible asset class.

[Spazmogen]

I just want to clarify this with you guys:

I'm looking at the RBC Homeline Plan (http://www.rbcroyalbank.com/RBC:Rf6hdI71A8cAA@@w54c/products/mortgages/homeline_plan.html) for the SM. I read about 4 posts above that its fine with the SM.

Because the big banks will not allow the credit line to pay its own interest (capitalization) I'll have to set up the Guerrilla Capitalization as described on page 77 of the SM book. I'll just have to move the money between the secured credit line which is part of the RBC Homeline Plan to the smaller unsecured credit line and back as needed.

Is that right ?

I'm getting set to do this just after April 4th 2007.

The Smithman Calculator was an excellent purchase with the book. Well worth the $58 in total for both.

[edrempel]

I just want to clarify this with you guys:

I'm looking at the RBC Homeline Plan (http://www.rbcroyalbank.com/RBC:Rf6hdI71A8cAA@@w54c/products/mortgages/homeline_plan.html) for the SM. I read about 4 posts above that its fine with the SM.

Because the big banks will not allow the credit line to pay its own interest (capitalization) I'll have to set up the Guerrilla Capitalization as described on page 77 of the SM book. I'll just have to move the money between the secured credit line which is part of the RBC Homeline Plan to the smaller unsecured credit line and back as needed.

Is that right ?


Hi Spaz,

Right on. The RBC Homeline is one of the better SM mortgages available. The main shortcoming is that it does not allow investing directly from the credit line with each mortgage payment. This just means a manual transaction every 2 weeks or monthly, though.

Not all banks will allow you to pay the interest from another credit line. However, if they charge it to your chequing, then you can do your Guerilla capitalizing by just withdrawing the exact amount from the SM credit line and putting it back into your chequing, so your cash flow won't be affected.





Ed

[cannon_fodder]

Hi Spaz,

Right on. The RBC Homeline is one of the better SM mortgages available. The main shortcoming is that it does not allow investing directly from the credit line with each mortgage payment.

Ed

Ed,

Do you have a list of questions/criteria that you would use to evaluate the various SM mortgages? If so, is this something you would be willing to share?

[edrempel]

Ed,

Do you have a list of questions/criteria that you would use to evaluate the various SM mortgages? If so, is this something you would be willing to share?

Hi Cannon fodder,

Sure. I provided this list earlier in this blog, but I'll add a bit of info. We prefer to use a readvanceable mortgage that has the following:

1. Variable rate between prime -.8% to prime -.9%.
2. Allows multiple credit lines (add one for emergencies or for the Cash Dam).
3. Readvances automatically.
4. Allows automatic investing directly from the credit line.
5. Is fully open - no penalties to break the mortgage or refinance under any conditions.
6. No fees at all - no legal, appraisal, broker, or administration fee.
7. Can go in 2nd position if your current mortgage is not due yet and worth keeping.
8. No legal or appraisal fees to have the home reappraised every year or 2 and the credit line limit increased, so we can increase the SM as the home value rises.

None of the mortgages available to mortgage brokers have more than 4 of these 8 features. You can get most or all of these from several of the major banks.





Ed

[Spazmogen]

Quick question about the SM & your credit rating.

I checked my credit rating, and its fine, I did not do my wifes, but she'll be in a better position than I am. She makes more than I, and most of the credit cards are in my name:lol:

Being that mortgages do NOT appear on your credit rating report, but your line of credit DOES, does the SM kill your credit rating, even though its a very smart thing to be doing with the mortgage ?

I'd hate to run into trouble qualifing for vehicle financing because of "too much debt". Dodge has 0% financing on 1500 series quad cab trucks, and Spaz wants a Hemi !

[vr6man25]

anyone here buy the Calculator from
the smithman.net website.
I'd like to know how detailed is it maybe someone could post a picture of it.
thanks

[Spazmogen]

anyone here buy the Calculator from
the smithman.net website.
I'd like to know how detailed is it maybe someone could post a picture of it.
thanks

I bought both the book and calculator software.


I'm @ work. I'll post it in the morning when I get home. I already have a screen capture of it.

[Spazmogen]

As promised. I highly recommend you buy the calculator software. You can tweak your numbers in many possibly ways and see the results in 2 seconds!

Yes, the numbers input really are my family's situation.
I opted to not include the $400/month RRSP contribution ($200 each) that we do each month. So I could shorten this by 2 more years...but I prefer to have 3 income streams going into retirement: pension via work, RRSP & SM. I am not counting on Canada Pension Plan at all. Spazette and I are both civil servants, so the pensions are excellent as well as the health benefits for life with our plan. I am 39 and she is 36. I should have this completed when I am 52. I retire at 58.

http://www.geocities.com/brad.ormsby@rogers.com/153k.jpg

and the graph for that:

http://www.geocities.com/brad.ormsby@rogers.com/smithman1.jpg


The horizontal black dotted line is total debt. Its flat, and remains flat.

The black line going from $153K down to the 15 year is the normal mortgage.

The blue line right beside the normal mortgage is the SM in action. It shaves years off the normal mortgage.

The bright red line going up like a rocket over 15 years is the investments that were bought and earning 8% in my case.

The purple line that goes up with the investments is your new line of credit, and it flat lines at $153K in my case. It will only ever go as high as the original mortgage.

[Guest8223]

When utilizing this approach on a jointly held house and mortgage how do you determine which spouse claims the interest expense? I would think the higher income spouse gains the greatest benefit by claiming all of the interest but I suspect our friends at CRA would not agree with this approach. Is the deduction split 50%/50% or "x"% based on income or ?? Great thread!

[edrempel]

anyone here buy the Calculator from
the smithman.net website.
I'd like to know how detailed is it maybe someone could post a picture of it.
thanks

Hi Gary,

The calculator is quite detailed and accurate for the "Plain Jane" Smith Manouevre. It is also accurate for versions of the "Flintone Flip", in which you pay down non-registered investments or monthly purchases into non-registered investments onto your mortgage and reborrow the same amounts to invest.

It also compares the SM to David Chilton's method (the "Wealthy Barber"), which is regular investing without leverage, and with Garth Turner's method (pay off the mortgage, and then borrow to 75% to invest).

I've verified the numbers and they are accurate. It does not work for any of the enhancements to the SM, which would involve additional leverage. It doesn't work for topping up your mortgage to 75%, the Smith/Snyder or the Rempel Maximum. Fraser is apparently coming out with a new version that should work with some of these enhancements. He sent me a Beta version, but it still did not have these. It only had the "Cash Dam" added.

If you are working with a financial advisor, you don't really need to buy it, since the advisor should be able to run it for you. For your situation, you will probably only need to run one or 2 scenarios with it.






Ed

[max88]

When utilizing this approach on a jointly held house and mortgage how do you determine which spouse claims the interest expense? I would think the higher income spouse gains the greatest benefit by claiming all of the interest but I suspect our friends at CRA would not agree with this approach. Is the deduction split 50%/50% or "x"% based on income or ?? Great thread!

Interest expense is claimed by the spouse who has taken the loan to invest and will claim gain/loss from the investment. Income percentage does not matter in this case. (Though the conventional income splitting strategy is that lower income spouse invest most if not all income, while higher income spouse takes care of all expenses including mortgage and possibly borrow to invest if leverage is desired.)

[Spazmogen]

Interest expense is claimed by the spouse who has taken the loan to invest and will claim gain/loss from the investment. Income percentage does not matter in this case. (Though the conventional income splitting strategy is that lower income spouse invest most if not all income, while higher income spouse takes care of all expenses including mortgage and possibly borrow to invest if leverage is desired.)

I was wondering that too.

Everything we have is joint. Lines of credit, mortgage etc. Everything.

Spazette lets me do the finances because she finds it confusing, yet she makes $80K and I make $62K. I assumed she would be getting the best tax reduction by claiming the investment loan interest. I believe we're both in the top tax bracket now.

[max88]

Investment gain/loss and loan interest will be split 50/50 if held in joint investment account. You cannot arbitrarily claim gain/loss or loan interest by one spouse over the other.

Individually you are not in top tax bracket... but a combined $140K income should provide comfortable living. And with some planning, you should be able to achieve optimal income splitting for 80K+62K.

[edrempel]

I was wondering that too.

Everything we have is joint. Lines of credit, mortgage etc. Everything.

Spazette lets me do the finances because she finds it confusing, yet she makes $80K and I make $62K. I assumed she would be getting the best tax reduction by claiming the investment loan interest. I believe we're both in the top tax bracket now.

Hi Spaz,

I have good news and 2 pieces of bad news for you.

First the good news. Tax ownership and legal ownership can be different. Even though it is registered jointly, you can claim the deduction and investment profits under either or both of you. However, the deduction and the taxable investment income need to be claimed the same way, and consistently from year to year. So, figure out once which is better for this year and future years and claim it that way, both for tax benefits and for tax consequences after you retire.

Now the bad news(s). You aren't in the top tax bracket (starts about $118K) and Spazette is in a higher bracket than you. The 32-34% brackets end about $73K. So, you are in a marginal bracket about 33%, but Spazette is in the 42% bracket. Wouldn't it be a pain to be keen on the SM, but have to claim none of it on your own return?

Spazette is only $7K into the higher bracket, so if she makes some RRSP contributions, then it is probably best to claim everything joint (without knowing the future or your incomes or how each of your incomes will look in retirement).






Ed

P.S. I've been dying to ask - whose picture is that - Spazette?

[grant]

Investment gain/loss and loan interest will be split 50/50 if held in joint investment account. You cannot arbitrarily claim gain/loss or loan interest by one spouse over the other.
It's not arbitrary & it's not necessarily 50/50. It's pro-rated by contributions.

[notanexpert]

OK, but if all accounts are joint, who is to say how much is contributed by each party?
I think CCRA will let you claim whatever you want, as long as it is consistent when later paying taxes on gains, and reasonable - i.e. your contribution to the investment does not exceed your income and/or borrowing means, etc.
m

Quote:
Originally Posted by max88
Investment gain/loss and loan interest will be split 50/50 if held in joint investment account. You cannot arbitrarily claim gain/loss or loan interest by one spouse over the other.

It's not arbitrary & it's not necessarily 50/50. It's pro-rated by contributions.

[Krox]

I have been casually following this thread for the last little while. The idea of the SM intrigues me and I have talked to partner about it. I do have one question and I apologize if it has been covered (this thread is very long). Is the SM beneficial if you foresee moving in the future. Or to put it another way, how long should you stay in one house in order to benefit from the SM? I would imagine it would be costly everytime you moved b/c you would have to cash in your investments.

[Spazmogen]

Hi Spaz,

I have good news and 2 pieces of bad news for you.

First the good news. Tax ownership and legal ownership can be different. Even though it is registered jointly, you can claim the deduction and investment profits under either or both of you. However, the deduction and the taxable investment income need to be claimed the same way, and consistently from year to year. So, figure out once which is better for this year and future years and claim it that way, both for tax benefits and for tax consequences after you retire.

Now the bad news(s). You aren't in the top tax bracket (starts about $118K) and Spazette is in a higher bracket than you. The 32-34% brackets end about $73K. So, you are in a marginal bracket about 33%, but Spazette is in the 42% bracket. Wouldn't it be a pain to be keen on the SM, but have to claim none of it on your own return?

Spazette is only $7K into the higher bracket, so if she makes some RRSP contributions, then it is probably best to claim everything joint (without knowing the future or your incomes or how each of your incomes will look in retirement).






Ed

P.S. I've been dying to ask - whose picture is that - Spazette?




Ed:

I sent you a private message.


I assume I'll have to give the tax deduction to my wife in this year and all future years, she will always make more than I do. She's a cop. I'm a dispatcher.

Now, can I sign the investment cheques or must it be her ? I'll be looking after all of this anyway...but it shaves the most off her income according to Quick Tax.

My avatar picture is in the private message I sent you.

[don242]

I have been casually following this thread for the last little while. The idea of the SM intrigues me and I have talked to partner about it. I do have one question and I apologize if it has been covered (this thread is very long). Is the SM beneficial if you foresee moving in the future. Or to put it another way, how long should you stay in one house in order to benefit from the SM? I would imagine it would be costly everytime you moved b/c you would have to cash in your investments.

You benefit from the SM immediatley and doesn't really matter how long you stay in your home for. I would imagine, if you move, you just take the credit line with you and put it against your new home. You shouldn't have to sell your investments as basically your "new" HELOC would just be used to pay back the "old" HELOC. The only time there would be a problem is if you move and have to renegotiate your mortgage and HELOC, that your financial situation has changed and it isn't possible to get approved.

[shassy63]

Hello everyone,

I understand that the LOC has to be invested in investments that return (or have the reasonable expectation of returning) dividend or interest income and not capital gains. I'm just wondering if, 10 years down the road, your investments aren't returning what you would like and you want to change them. Obviously selling them to buy new ones would create capital gains. Does the CRA then claw back all the deductions you used to buy them in the first place?

I"d hate to be locked into an investment for life.

shassy63

[Sanchez]

Does the CRA then claw back all the deductions you used to buy them in the first place?

No.

[shassy63]

No.

OK, I figured that must be the case, but then how does that work? Surely you can't take the LOC, buy a mutual fund (or stock), then sell it 2 months later for a gain, and buy something else. That would basically be trading, which isn't an allowable interest expense. How is the determination made?

[Sanchez]

OK, I figured that must be the case, but then how does that work? Surely you can't take the LOC, buy a mutual fund (or stock), then sell it 2 months later for a gain, and buy something else. That would basically be trading, which isn't an allowable interest expense. How is the determination made?

There is no hard and fast rule that is going to allow you to look at a particular investment strategy and understand whether it is acceptable under the letter of the law. Basically, the test is an "expectation of profit" - so your 10 year scenario above is probably fine. Trading in and out every two months chasing capital gains probably would not.

Everything in between, it's just a matter of whether CRA decides to challenge it or not.

[cannon_fodder]

Some good questions were sent to me as a result of playing around with the Excel SM spreadsheet I created and posted. They might help others (as it helped me understand Smith's concept) so I thought I'd share them.

But for the years remaining after you've finished paying your mortgage, the "$ to invest" column still shows an amount. Where does this money come from, if you've finished paying your mortgage and you aren't making any additional payments?

You continue to make your same "mortgage" payments, some of which goes to pay the LOC interest and the rest which goes into investments. You don't HAVE to do it this way but if you have lived for X years making those payments to pay down the P&I why not continue to make them to pay the LOC interest and increase your investments? The best move would be to not pay down the principal on the LOC - until your estate does. If, however, you wanted to liquidate your entire investment portfolio to buy that condo down in Florida, you would likely want to discharge the LOC as you would not be able to deduct the interest expense any longer.

You certainly could move to interest only payments once you have converted all of the non-deductible debt to deductible debt and then use the difference to do other things (e.g. vacations, new car, etc). It made sense to me (and I believe others who believe in the SM) that you would continue to funnel that money to investments. After all, on every payment up to then you are always investing something!

The portfolio amount after the mortgage is paid off seems to grow at the "earning rate" + the "$ to invest" amount and without regard to the "Interest Expense", which in this case is the interest on the original mortgage amount. How is the on going {LOC} interest paid for?
I will assume that the explanation above shows you why you continue to make your regular scheduled payments. You will continue to pay the interest on the LOC (which is maxed at the original amounts of Mortgage and LOC) flowing to investments and LOC interest even after the "mortgage" is paid off. This allows you to continue to deduct interest and not have to liquidate any of your investments and in fact continue to put new $ towards your investments.

[don242]

I understand that the LOC has to be invested in investments that return (or have the reasonable expectation of returning) dividend or interest income and not capital gains. I'm just wondering if, 10 years down the road, your investments aren't returning what you would like and you want to change them. Obviously selling them to buy new ones would create capital gains. Does the CRA then claw back all the deductions you used to buy them in the first place?

I"d hate to be locked into an investment for life.



Even the CRA knows that proper investing includes selling investments and buying different ones at time. I don't think it is unreasonable to redistribute your investments from time to time.

[notanexpert]

OK, I figured that must be the case, but then how does that work? Surely you can't take the LOC, buy a mutual fund (or stock), then sell it 2 months later for a gain, and buy something else. That would basically be trading, which isn't an allowable interest expense. How is the determination made?

The CRA will have no issues with you deducting your interest payments as long as you show that income is being generated from these investments, it can be 'other' income or dividends, as long as its taxable, they like you. If you only show capital gains, the rules are not clear, they may not like you and disallow your interest expense deduction. Dividend income would be the best from a tax perspective, if you make less than 118k per year, that's the most tax-efficient type of income I believe.

[escompton]

I have been following this thread and reading about the SM for a while now.

Then I see the other day that the Lipson case appeal was denied.

Anyone have any comments on this news with respect to the SM?

Comment on the original Lipson case from June 2006 here (see page 8 of document for summary):
http://www.marcil-lavallee.com/english/Documents/JUNE2006.pdf

The full Lipson appeal case is here:
http://www.canlii.org/en/ca/fca/doc/2007/2007fca113/2007fca113.html

[don242]

I have been following this thread and reading about the SM for a while now.

Then I see the other day that the Lipson case appeal was denied.

Anyone have any comments on this news with respect to the SM?

Comment on the original Lipson case from June 2006 here (see page 8 of document for summary):
http://www.marcil-lavallee.com/english/Documents/JUNE2006.pdf

The full Lipson appeal case is here:
http://www.canlii.org/en/ca/fca/doc/2007/2007fca113/2007fca113.html


Looks like a good try but it was obvious they were trying to avoid paying tax rather than proper tax planning. What I see in this situation is:

1. They took out the mortgage to pay off a loan. The original loan may have been for investments but the mortgage was not therefore no deduction.

2. The interest loss was greater than the income earned on the investment. No reasonable expectation of profit when the investment is paying out low dividends. Therefore again no deduction.

3. Investing in your own business and then using that as a personal benefit is going to always open up questions from the CRA.

The interest on the original loan may have been deductible if they invested the money from the original loan into something that would produce a profit greater than the interest expense. What they did was purely tax avoidance.

[Bick Financial Toronto]

anyone here buy the Calculator from
the smithman.net website.
I'd like to know how detailed is it maybe someone could post a picture of it.
thanks

I have it at my office. Next time you come by we can go through it. It is pretty basic but it confirms the validity of the concept and therefore it is a useful illustration tool.

[sweedy]

Started Smith Manoeuvre last month using STEP with Scotia Bank. As Ed mentioned earlier, STEP is the most awkward way to do it. I have to go to the branch every time I want to increase the credit limit. My mortgage will renew in 2009 and I will try to switch to one of the other banks.

My question is: how to make sure that the paper trail is still clear when I switch? Do I have to pay off the HELOC in Scotia Bank when I switch? Would that create problem in paper trail?

[Bick Financial Toronto]

Started Smith Manoeuvre last month using STEP with Scotia Bank. As Ed mentioned earlier, STEP is the most awkward way to do it. I have to go to the branch every time I want to increase the credit limit. My mortgage will renew in 2009 and I will try to switch to one of the other banks.

My question is: how to make sure that the paper trail is still clear when I switch? Do I have to pay off the HELOC in Scotia Bank when I switch? Would that create problem in paper trail?

Good question Sweedy. You will have to pay off the HELOC from BNS and that's the case for all HELOCs when someone tries to replace the 1st mortgage. Paying off BNS will not create a problem in your papertrail as long as the new 1st mortgage and the HELOC that sits as 2nd will be for the same amounts. You won't need an accountant to sort this out, just keep all your documents on file related to the transactions.

[pitz]

Surely you can't take the LOC, buy a mutual fund (or stock), then sell it 2 months later for a gain, and buy something else. That would basically be trading, which isn't an allowable interest expense. How is the determination made?

Actually such a situation would be allowable for the purposes of the interest deduction, providing that the mutual fund/stock itself produces, or has the potential to produce income or dividends from its activities at some point in the future. Note that 'future' can mean very distant future, ie: 50 years from now.

Even a daytrader that borrows heavily to daytrade can deduct their margin interest, providing that they purchase securities that have the ability, at some point in the future, of producing income or dividends. The daytrader may be forced to treat all gains in such securities as 'income' however, and would not receive preferrable capital gains treatment.

Examples of investments that would not be eligible:

Commodities, such as gold bullion, silver, copper.
Commodity futures.
Commodity ETFs (ie: GLD, SLV, USO) or claims such as certificates
Index futures
Options
Raw land
Mineral rights/leases
Timberlands/timber
Ore bodies

What do all of these investments have in common? They are not functioning, active businesses, they are not capable of generating income, and the only way you can make money on them is through capital appreciation.

So, if you use borrowed money to buy a precious metals fund, you probably should worry about being challenged by the CRA. Even royalty trusts could be challenged on the basis that much of the investment is based upon the ownership of an ore body, and not that of an active business, even though a royalty trust such as Fording Coal combines both an active business (coal mining), and the ownership of ore bodies.

[Rocky Mountains]

Also, for day traders, they are likely to be claiming their stock trades as business income/loss (and if not, CRA may deem it so). If that is the case, then the interest charges will also be deductible as a business expense.

[CoolEddie]

Perhaps a bit off topic, but on which line, or where would report the interest from your investment loan on your tax return?

[grant]

Perhaps a bit off topic, but on which line, or where would report the interest from your investment loan on your tax return?
It would be an interest expense for whatever you decide to use the money for.

for your personal business, it's an interest expense on your books.
for your real estate investment, it's an interest expense on on your sched 776.
etc.

[florch]

Thanks to Cannon_Fodder for the excel program. Wa wa woo wa!

I plugged in different values to see whether or not it pays to upgrade the digs. Not yet, but I'm going to play with it to see if or when it works out or at least causes the least penalty.

[Bick Financial Toronto]

Perhaps a bit off topic, but on which line, or where would report the interest from your investment loan on your tax return?

This is an excellent question CoolEddie. Sometimes people think that you need an accountant to take care of this detail, but usually that's not the case. If you borrow money to purchase securities to earn interest and dividend income, you could claim the interest expense in Schedule 4 of the T1 General in Section IV. Our clients just enter the interest expense (it has to be well documented), enter the explanation to specify what it was and keep all supporting documentation on file. You could get this done at accounting firms like H&R Block (we supply a sample Schedule 4 form to our clients to help out the folks at H&R Block) or if you use an accounting software then you could do it yourself.

I hope this helps.

[frankal101]

here is a question about the investment side of the SM - I am looking to use a low cost income trust sector index fund for a portion of my portfolio ( i love the yield and its future prospects). This vehicle pays out all the distributions in the form of capital gains. There is also another version of the same vehicle that pays out the distributions in the form of ROC.

I have read about the concerns some have voiced about ROC in the SM (portion of LOC inside SM becomes non-tax deductible as more ROC is earned), and would rather avoid potential future headaches, so I am leaning with the cap gains version of the vehicle. Will i get in trouble for deducting interest on my LOC if it is used to buy a vehicle that only produces cap gains in a predictable fashion (ie - buy and hold no frequent trading in and out of a vehicle)?

Anyones help would be greatly appreciated. This is a big point for me, since i am in Quebec and need returns to claim the interest tax-deductibility...

Thanks

[Bick Financial Toronto]

Will i get in trouble for deducting interest on my LOC if it is used to buy a vehicle that only produces cap gains in a predictable fashion (ie - buy and hold no frequent trading in and out of a vehicle)?

Anyones help would be greatly appreciated. This is a big point for me, since i am in Quebec and need returns to claim the interest tax-deductibility...

If you are buying the vehicle as a collector then all you can expect from the investment is capital gains and therefore the interest expense on the LOC you used to buy the investment is not tax deductible.

If you are buying the vehicle as part of your business then the interest expense on the LOC you used to buy the investment is tax deductible.

As to when you will get into trouble depends on when they audit you. The CRA is profit oriented. Big fish and greedy fish gets audited mostly and they never audit for one year but usually for three. From a practical standpoint you want to plan for an audit when you start to become a big fish.

[dark169]

If you are buying the vehicle as a collector then all you can expect from the investment is capital gains and therefore the interest expense on the LOC you used to buy the investment is not tax deductible.

If you are buying the vehicle as part of your business then the interest expense on the LOC you used to buy the investment is tax deductible.

As to when you will get into trouble depends on when they audit you. The CRA is profit oriented. Big fish and greedy fish gets audited mostly and they never audit for one year but usually for three. From a practical standpoint you want to plan for an audit when you start to become a big fish.

I think he was using the word vehicle in the finical vehicle, not a motor vehicle.

To the question, my understanding is as long as theres a reasonable expectation of future earnings your ok.

[Bick Financial Toronto]

I think he was using the word vehicle in the finical vehicle, not a motor vehicle.

To the question, my understanding is as long as theres a reasonable expectation of future earnings your ok.

Yes, of course, my wrong. Pretty funny actually.

Corporate Class/Capital Class mutual funds fall into the category of producing capital gains (mostly) and the interest on the LOC would be tax deductible. It sounds like your income trust index with capital gains distribution is similar to that concept.

[florch]

OK, I'm sold on the SM, I believe I have my head wrapped around the concept and execution, I have my mortgage set to switch over to a readvancable LOC, and I am ready to kiss my non RRSP (stock) investments good bye, to re-emerge bigger and better on the tax deductible side.

Now I have to decide what to invest in. I would normally consider rental real estate (runs in the family) as part of the portfolio, but don't believe that the current ROI's justify the PITA factor. Maybe in the future.

I'm leaning towards ETF's. From what I've read fixed income is out (who cares), and so are foreign dividends. This narrows the search considerably if I want to stay on CRA's sunny side, and have dividend producing investments. There are about a dozen Barclays ETF's that fit the bill (among others, but for this example...), but would leave the diversification a little narrow for my liking being entirely Canadian in content. There are 2 (Barclay's) international choices that used to be considered Cancon for the RRSP back when that mattered. Does anyone have an educated view if they could be considered Canadian for the purposes of being a Canadian dividend producing investment?

Thanks in advance

[houska]

This narrows the search considerably if I want to stay on CRA's sunny side, and have dividend producing investments. There are about a dozen Barclays ETF's that fit the bill (among others, but for this example...), but would leave the diversification a little narrow for my liking being entirely Canadian in content. There are 2 (Barclay's) international choices that used to be considered Cancon for the RRSP back when that mattered. Does anyone have an educated view if they could be considered Canadian for the purposes of being a Canadian dividend producing investment?


Depends on the size of your investable assets overall, but you might want to overweight Canadian in your SM investment and overweight foreign in your RRSP. You don't necessarily want to be exposed to currency risk on the spread between your HELOC (and house) on one side, and your investments on the other. All this needs to be balanced against the diversification potential of some foreign in your portfolio as an uncorrelated asset class.

Doesn't negate what you said, just balance of factors may be a bit different than without SM.

[pitz]

Depends on the size of your investable assets overall, but you might want to overweight Canadian in your SM investment and overweight foreign in your RRSP. You don't necessarily want to be exposed to currency risk on the spread between your HELOC (and house) on one side, and your investments on the other. All this needs to be balanced against the diversification potential of some foreign in your portfolio as an uncorrelated asset class.


Nothing is stopping one from taking out a portion of the loan for a leveraged investment (such as the SM) in foreign currency. For instance, once you've built up some margin with a broker, they will advance you foreign currency secured with your Canadian-dollar based investments.

Borrowing in a foreign currency like US dollars also has some other advantages. US interest rates are higher, so the tax deduction is larger. And you don't have to convert currencies when you borrow in the native currency.



Doesn't negate what you said, just balance of factors may be a bit different than without SM.

I'd be looking at the Canadian indicies and asking myself, "which sectors are not represented here". Ostensibly, the answers will lead to consumer staples and consumer goods, technology, pharmaceuticals, entertainment, manufacturing/industrial, advanced materials, semiconductors, software, defense, and healthcare.

So basically you'd want to add funds/components/geographies where these sectors are heavily represented, of course, being mindful that sector funds have excessive fees that are to be avoided.

[florch]

Pitz

So you can do this with Vanguards or ETF's and still be eligible to write off interest?

(I have a thick skull...I really did read the whole thread +++)

Florch

[pitz]

So you can do this with Vanguards or ETF's and still be eligible to write off interest?


Absolutely! You can invest in practically any functioning business on the planet and still deduct interest expense as an individual.

If the cost of your foreign investments, including re-invested dividends, exceeds $100k Canadian, you will have to file some additional paperwork with the CRA when you do your taxes. And you have to claim foreign tax credits. And you might be subject to estate taxes in some countries such as the United States. But otherwise... (and yeah...Vanguard+++ ;))

[edrempel]

Hi Florch,

I have good news for you. You are worried about a bunch of things that are not issues. CRA's requirements are that an investment have a "reasonable expectation of profit" and invested for the "purpose of earning income". Note there is no requirement to earn a "net income" - just that it is for the purpose of earning income.

This means that all you need is an investment that COULD pay income. Some of our clients have 100% global investments that are 100% tax-efficient. We expect they will have little or no taxable income on the investments until they retire in 15-20 years - and they will only get capital gains and they will all be foreign.

But the COULD pay income, since they are invested in many stocks that COULD pay income. That is all you need. CRA has consistently accepted global, tax-efficient mutual funds.

Therefore, essentially any ETF or mutual fund would be fine for the SM. All your worries are not necessary.

In your investment decisions, ignore all these issues. Just invest in whatever will give you the best return within your risk tolerance, and try to be tax-efficient. And most importantly, buy something you can stick with for many years.

While I would never buy them myself, if you are a do-it-yourslefer (DIYer), then ETF's are a good choice. By definition, any index investment is "average returns at low cost". Studies consistently show that at least 80-90% of DIYers earn far below average returns in the long run. This is because the human brain is conditioned to consistently do bad market timing.

If you are convinced you will make a profit in the long run and your investment COULD possibly some day maybe pay some income, then the interest is deductible.





Ed

[pitz]

Therefore, essentially any ETF or mutual fund would be fine for the SM. All your worries are not necessary.


Just to slightly expand on the above; the only ETFs that I am aware of that would not be eligible:

GLD/IAU --> ineligible because they are merely claims on physical gold bullion.
USO --> just transacts in commodity futures
SLV --> ineligible because this just represents claims on silver bullion
U --> Uranium Participation --> an ETF with claims on uranium yellowcake U308

Basically, stay away from pure investments in commodities, and you'll do just fine.

Precious metals funds might attract scrutiny from the CRA as well, for the same reasons as above. In theory, the CRA could deny the portion of the interest deduction used to purchase a portion of a precious metals fund that stores value in actual precious metals, rather than actual functioning miners and processors.

[pitz]

Mr. Rempel, whats your view of obtaining USD$-denominated financing for a portion of the Smith Manouevre and investing directly into US-based instruments/funds, instead of paying someone (like Barclays) significant fees to do it for you here?

My relatives who are doing the SM (or versions thereof) really like it because the dividends give them US cash (and Euros) every year to spend on holidays without having to lay out a fortune on bank service charges and forex fees.

Does a wise user of the SM diversify not only the currencies of investments, but also the currencies of borrowing?

[samson]

I have been reading about SM for over a week now and would like to see how this would help me. After reading through this entire post, i noticed there are some financial planners on board who use different techniques. Is there anyone on here willing to run my numbers (privately of course) and tell me what technique they find the most suitable for my situation. I am not sure if there are initial consultation fees associated with your practise but I would like a high level briefing. Btw, I do fulfill the qualifications that are required.

Let me know via PM. Thanks

[vr6man25]

:arrowu: pm Bick Financial

[mark89]

A great thread on an intriguing subject ...

A simple question about the 'Plain Jane' SM:

How do I service an amortized mortgage payment and an ever increasing investment loan without increasing my cash flow commitment? and without relying on investment income to service the investment loan?

example:

current mtg
-----------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment

with SM
--------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment (P+I)
and then each month, borrow the equivalent of the principal (P) payment
above and invest it

investment loan @ 6.00%

month 1 (borrow $459)
month 2 (borrow $464)
month 3 (borrow $498)
... and so on

by the end of the first year, my balances look like this:

mtg balance = $194,151
investment loan = $5849

mtg payment is still $1342 per month (will remain the same until mtg is paid off)

investment loan is now costing $29.45 (will increase each month as additional funds are borrowed to invest)

My cash flow commitment will continually increase month by month, even though my debt level remains the same.

[BatKid]

The official answer is to re-capitalize the interest, so take out the money from your LOC and deposit it back into the account as an interest only payment.

[FrugalTrader]

If you guys are interested, I have a new article on my site today that runs through some of the numbers of using the Smith Manoeuvre in my personal situation.

http://www.milliondollarjourney.com/using-the-smith-manoeuvre-my-scenario.htm

[mensrea]

Some really good reading... this really fascinates me but can someone with no prior knowledge of investing jump into something like the SM?

We are moving into our next home in Feb and the mortgage should be around 190-200k while the value of the house will be well over 300k. We have no other investments and a small savings. Would we be able to do the SM? Has anyone here lost money because of the SM??

[grant]

We have no other investments and a small savings. Would we be able to do the SM? Has anyone here lost money because of the SM??
No one has ever lost money because they legally made a previous undeductible expense tax deductible!

[FrugalTrader]

Some really good reading... this really fascinates me but can someone with no prior knowledge of investing jump into something like the SM?

We are moving into our next home in Feb and the mortgage should be around 190-200k while the value of the house will be well over 300k. We have no other investments and a small savings. Would we be able to do the SM? Has anyone here lost money because of the SM??

The SM is both a tax and investment strategy. If you don't have investment knowledge, you should consult a financial advisor to help you out. Remember, when you borrow to invest, you magnify your gains AND losses. So, you have to ask yourself, if your portfolio returns turn negative, will you still be able to sleep at night knowing that you have borrowed against your home to invest? Everything "should" turn out ok if you're in it for the long term, but can you stomach the potential loss?

Those are the questions you have to ask yourself before using leveraged investing.

[mjohare]

A great thread on an intriguing subject ...

A simple question about the 'Plain Jane' SM:

How do I service an amortized mortgage payment and an ever increasing investment loan without increasing my cash flow commitment? and without relying on investment income to service the investment loan?

example:

current mtg
-----------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment

with SM
--------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment (P+I)
and then each month, borrow the equivalent of the principal (P) payment
above and invest it

investment loan @ 6.00%

month 1 (borrow $459)
month 2 (borrow $464)
month 3 (borrow $498)
... and so on

by the end of the first year, my balances look like this:

mtg balance = $194,151
investment loan = $5849

mtg payment is still $1342 per month (will remain the same until mtg is paid off)

investment loan is now costing $29.45 (will increase each month as additional funds are borrowed to invest)

My cash flow commitment will continually increase month by month, even though my debt level remains the same.

This is exactly the the same concern I have with the SM.

In his book Fraser Smith spends almost 50 pages going on and on like a freaking broken record about the virtues of the manoeuvre before finally addressing the elephant in the room (how to service the interest on the new investment loan). When at last he does address this problem he rather glosses over it by breifly discussing interest capitalization. He completely fails to point out that any money used to capitalize interest is now unavailable for investing. I havent' gone over his numbers closely or developed my own calculations, but I would not be surprised if his calculations include this 6% in the investments.

The SM might indeed be a very smart financial decision. But the sleezy sales pitch tone of the book and the near complete lack of critisism of the SM in this thread leaves me rather suspicious. Doesn't anyone else think there is problems with this manoeuvre?

[notanexpert]

This is exactly the the same concern I have with the SM.

In his book Fraser Smith spends almost 50 pages going on and on like a freaking broken record about the virtues of the manoeuvre before finally addressing the elephant in the room (how to service the interest on the new investment loan). When at last he does address this problem he rather glosses over it by breifly discussing interest capitalization. He completely fails to point out that any money used to capitalize interest is now unavailable for investing. I havent' gone over his numbers closely or developed my own calculations, but I would not be surprised if his calculations include this 6% in the investments.

The SM might indeed be a very smart financial decision. But the sleezy sales pitch tone of the book and the near complete lack of critisism of the SM in this thread leaves me rather suspicious. Doesn't anyone else think there is problems with this manoeuvre?

I don't think there are problems with the manouver. If you have no financial "manouvering" room, then no "manouver" is doable for you.
The interest you pay against your investment loan is no more than the interest that you are saving every month on your mortgage because you are paying it down. Some of it can be covered by dividends you receive from your investments, some can be capitalized if you wish to do that (I don't - I just pay it out of money I would have otherwise used to pay down the mortgage).
And yes, you are leveraging to buy investments, with all the risks and benefits of doing that. When people make huge highly leveraged bets on real estate they don't cry about risk nearly as much as they do when the bet is on equity markets, even though equities have over the long term performed much better than real estate (on average about 5% per year better, over the past 50 years or so). Maybe this is because you can get a quote on your equity profolio any minute while you can't check the value of your real estate every minute? :confused:

[fsmontenegro]

This is exactly the the same concern I have with the SM.

In his book Fraser Smith spends almost 50 pages going on and on like a freaking broken record about the virtues of the manoeuvre before finally addressing the elephant in the room (how to service the interest on the new investment loan). When at last he does address this problem he rather glosses over it by breifly discussing interest capitalization. He completely fails to point out that any money used to capitalize interest is now unavailable for investing. I havent' gone over his numbers closely or developed my own calculations, but I would not be surprised if his calculations include this 6% in the investments.

The SM might indeed be a very smart financial decision. But the sleezy sales pitch tone of the book and the near complete lack of critisism of the SM in this thread leaves me rather suspicious. Doesn't anyone else think there is problems with this manoeuvre?

I've been implementing the SM since earlier this year. I've read the book and I agree that there is a "broken recordness" to it... After reading the book, I'll say that most of the really useful information I got on the SM came from this forum and from an early collaboration with cannon_fodder on the spreadsheet.

Besides the issue of the extra cash flow for the interest on the LoC, my other concern is that the SM assumes that the investment portfolio will deliver a return greater than the LoC interest costs. This can be a significant issue if the markets go south...

There is plenty of criticism of the SM on Canadian blogs. See the comments on http://www.milliondollarjourney.com/anti-smith-manoeuvre.htm as an example.

My personal take on it is that it is not a "sure thing" (especially if markets go down) but it is a sensible approach to converting "bad debt" to "good debt". If nothing else, the SM reminds us that one must consider one's ENTIRE financial picture - investments, taxation, insurance, cash flow, etc... - when thinking about finances...

Hope this helps.

[fsmontenegro]

Hi!

As I mentioned earlier, I've been using the SM since earlier this year. My original plan was to hold dividend-paying Canadian and foreign equities in a non-registered account. I've accomplished this so far with an account at Interactive Brokers and positions in dividend-focused ETFs such as XDV and CDZ. (I hope I'm not violating RFD's terms by mentioning these securities. This is not a recommendation, merely a description of my scenario...)

As life throws us a few curve balls, I find myself needing to review the investments I planned...

Can anyone comment if I can still deduct interest from investment loans if I use the loan to purchase foreign real estate and collect rent on it?

Thanks!

[notanexpert]

The SM might indeed be a very smart financial decision. But the sleezy sales pitch tone of the book and the near complete lack of critisism of the SM in this thread leaves me rather suspicious. Doesn't anyone else think there is problems with this manoeuvre?
There are criticisms of the SM!
There was a thread on this recently, and I did make a post about a long term bear market in equities. If there is a decade of negative equity returns (as in the 70's) then yes, anyone making the SM will have a whole bunch of nasty things to say about it. What are the chances of a long bear market? With the demographics as they are, very low.

[florch]

Thanks all, especially edrempel and Pitz. I appreciate the dialogue and advice.

In my particular experience, the worst I've done with my money was when I was starting out and trusted it to a commission based mutual fund salesman. (I refuse to call someone of his ilk a financial planner.) I've done much better since I've been self directed - learning curve and all. I have had good access to mentors and role models. The best have been my parents who have retired early thanks to real estate.

In my career I'm away a lot but have lots of down time in hotels. This makes RE hard and stocks easy to research.

There was never a doubt as to whether I would leverage to invest, the question was always how. I haven't ruled out a fee based planner, but I will only invest in etf's and stocks. Mutual's with high MER's are the bain of the small investor as far as I'm concerned. I'm sure a few can outperform, but I don't trust any one to pick which ones.

Fortune favours the bold, and the biggest risk of all is never taking any. Over the long term I'd rather retire in 15 years than 30.

Cheers
Florch

[cannon_fodder]

A great thread on an intriguing subject ...

A simple question about the 'Plain Jane' SM:

How do I service an amortized mortgage payment and an ever increasing investment loan without increasing my cash flow commitment? and without relying on investment income to service the investment loan?

example:

current mtg
-----------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment

with SM
--------
$200K mtg @ 5.25% (amort is 20 years) = $1342 monthly payment (P+I)
and then each month, borrow the equivalent of the principal (P) payment
above and invest it

investment loan @ 6.00%

month 1 (borrow $459)
month 2 (borrow $464)
month 3 (borrow $498)
... and so on

by the end of the first year, my balances look like this:

mtg balance = $194,151
investment loan = $5849

mtg payment is still $1342 per month (will remain the same until mtg is paid off)

investment loan is now costing $29.45 (will increase each month as additional funds are borrowed to invest)

My cash flow commitment will continually increase month by month, even though my debt level remains the same.

I'm still working on an enhancement suggested by FrugalTrader to allocate divdends from the investment portfolio to paying down the mortgage even faster (and then of course reborrowing to reinvest) but if you can tell me your marginal tax rate (and your expected investment return in percentage terms), I can run the numbers for you and send them privately in an HTML file. You will be able to see, month by month, how your mortgage declines, your LOC grows, your investment portfolio grows but your cash flow stays the same.

It was for this very reason (how can I do this without any additional cash flow) that led me to create my own calculator. I wanted to see "under the covers". That and I am too cheap to buy SM's calculator.;)

[pitz]

Can anyone comment if I can still deduct interest from investment loans if I use the loan to purchase foreign real estate and collect rent on it?


You probably would be liable for income tax both in the jurisdiction you own the real estate, as well as in Canada, and further, liable for capital gains tax in the jurisdiction of ownership, as well as in Canada.

I would tread very cautiously and obtain professional accounting advice (from someone qualified to give advice in the specific area) if you intend to make direct investments into foreign properties.

[Spazmogen]

A great thread on an intriguing subject ...

A simple question about the 'Plain Jane' SM:

How do I service an amortized mortgage payment and an ever increasing investment loan without increasing my cash flow commitment? and without relying on investment income to service the investment loan?

Page 77 (in chapter 5) of the book explains how to capatilize the interest on the HELOC so you do not need to service it out of your day to day spending.
Fraser speaks about how to use 2 credit lines and a seperate chequing account to pay each other's interest. He calls it "Guerrilla Capitalization (http://www.smithman.net/faqs.html#heloc)". Its #15 on the list.

My cash flow out of pocket will be static as a result. I will not actually pay any real interest on the HELOC or the 2nd LOC until the mortgage is paid off in full. Then the interest will be paid from my bank account, just as the mortgage used to be. Once the mortgage is paid off, there is no need to capitalize the interest anymore.

The Royal Bank had no trouble setting up my Homeline Mortgage with the 2 creditlines like I asked. I went into the branch and opened the other chequijng account. I made sure that the interest on both creditlines is deducted only from the new chequing account. I will manually have to move money from a creditline into that new chequing account each month, but the results will be worth the extra transaction each month.

[pitz]

Page 77 (in chapter 5) of the book explains how to capatilize the interest on the HELOC so you do not need to service it out of your day to day spending.
Fraser speaks about how to use 2 credit lines and a seperate chequing account to pay each other's interest. He calls it "capitalize the interest anymore.


You could also use a margin account (secured with your investments) to do the same, eventually transferring the security for your investment loans away from your house, to your actual investments.

Helps those who like the idea of a 'paid-off house' sleep a bit better at night in the long run.

[Spazmogen]

You could, but then the investments are not 'free and clear' as there could be a margin call if conditions warrant it. ie: book value is more than market value (you've lost $) you could expect a margin call.

My advisor offered a margin account, which I declined, even though he will be doing the investing for me anyway.

But it is a viable option for those who wish to use margin.

[leftcoast]

A question for the knowledgeable folks on this board…

Can the SM only be established when starting a new mortgage? Or can an existing mortgage somehow be “Smith Manoeuverized”? For example, if I have a standard 3-year fixed mortgage at BMO with another 1.5 years until renewal time, is there anyway I could setup a SM without paying termination penalties on this mortgage and opening a new one? Or would I pretty much have to wait until it’s time to renew?

Somewhere in his book, Smith mentions a specialized SM LOC at VanCity that “wraps around” your existing mortgage at a big bank. Anyone know what he’s talking about?

I’m still a little fuzzy on the logistics of setting this up.

[pitz]

Can the SM only be established when starting a new mortgage? Or can an existing mortgage somehow be “Smith Manoeuverized”? For example, if I have a standard 3-year fixed mortgage at BMO with another 1.5 years until renewal time, is there anyway I could setup a SM without paying termination penalties on this mortgage and opening a new one? Or would I pretty much have to wait until it’s time to renew?


Basically, if you have a reasonable amount of equity in the home, you can obtain a 2nd mortgage and/or a LOC ontop of the first mortgage. If such 2nd mortgage/LOC still keeps the loan to value greater than 75%, then its usually not a problem to get a good rate.

Depending on your circumstances, you might be a good candidate to use some margin borrowing in addition to a 2nd mortgage/LOC, an unsecured line (if you have very good credit), and/or options and/or futures contracts to lower your overall effective cost of financing in light of the penalties that might be levied.

A more detailled analysis would be required of what would be optimal for you, and such analysis would have to take into consideration the availability of derivatives against your proposed investments, the rate of investment you are proposing, the cost of investing, the amount of equity available, your ability to access credit on favourable terms, your tax bracket, etc.

[don242]

There are criticisms of the SM!
There was a thread on this recently, and I did make a post about a long term bear market in equities. If there is a decade of negative equity returns (as in the 70's) then yes, anyone making the SM will have a whole bunch of nasty things to say about it. What are the chances of a long bear market? With the demographics as they are, very low.

Some say we are at the start of a long bear market right now. Of course, I prefer your optimism. So we will have to see how this all plays out.

[edrempel]

There are criticisms of the SM!
There was a thread on this recently, and I did make a post about a long term bear market in equities. If there is a decade of negative equity returns (as in the 70's) then yes, anyone making the SM will have a whole bunch of nasty things to say about it. What are the chances of a long bear market? With the demographics as they are, very low.

This is from the category - "no, just the opposite". There has been a lot of writing about the great bear market in the 70's. The one problem is - it didn't happen! The TSE300 was up 10.4%/year in the 70's & the S&P500 was up 6.8%.

Charts of the indexes show no growth for a period from 1966 to the bottom in 1982, except that these charts excluded dividends. Back then, dividends were a much higher portion of the return and averaged 4-5%. So, $1,000 invested Jan.1/66 would be worth about $2,100 at the end of 1982.

Interestingly, the longest bear market since the 1930's for the S&P500 was 7 years - the great bear market of 2000-2007! With all the speculation on whether we are at the beginning of long bear market - we are actually at the end of the greatest one!

We haven't seen this same effect in Canada, since the tech bubble collapse became a resource bull (bubble?), so the declines of 2001-2 were surpassed by 2004.

The truth is that the TSX might be at the beginning of a bear market, since our market is 75% in only 3 sectors - all 3 of which have just had one their largest runs in history. If oil drops back to $45/barrel as many believe it will (including me), then oil, resource, probably gold, and most likely bank stocks will all collapse, which may take a while to recover.

The answer is to invest globally or in the U.S., since the global and U.S. indexes are still down this decade.

The only 2 declines for the S&P500 from the top to bottom over 40% since the 1930's have 1973-4 & 2000-2 - both times just over 40%. In 73-74, it took 6 years to be back in the black and this time we are 6 years and not quite back.

When is a better time to invest than at the END of the greatest bear market? (Well the bottom would have been better...)







Ed

[leftcoast]

Basically, if you have a reasonable amount of equity in the home, you can obtain a 2nd mortgage and/or a LOC ontop of the first mortgage. If such 2nd mortgage/LOC still keeps the loan to value greater than 75%, then its usually not a problem to get a good rate.

Hi Pitz - Thanks for the reply. In this not-so-hypothetical example, we have about 50% equity in the home, so qualifying for a HELOC at a good rate would hopefully not be a problem. I'm just curious if it's possible to get the same features that one gets from the "pre-packaged SM mortgages" such as Readline or Homeline (i.e. automatic readvances, interest capitalization, etc.) without setting up a whole new mortgage.


Depending on your circumstances, you might be a good candidate to use some margin borrowing in addition to a 2nd mortgage/LOC, an unsecured line (if you have very good credit), and/or options and/or futures contracts to lower your overall effective cost of financing in light of the penalties that might be levied.

Thanks for the ideas... Unfortunately my risk tolerance is such that I don't think I'd be comfortable using unsecured credit or margin for my investments. I'd be worried about getting a loan or margin call if they fell in value.

As far as derivatives go, I'm not sophisticated enough as an investor to be swimming in those waters. For example, I don't really even understand how options and/or futures could act as an alternative to a HELOC in a SM.

I do appreciate the suggestions, though.

[don242]

This is from the category - "no, just the opposite". There has been a lot of writing about the great bear market in the 70's. The one problem is - it didn't happen! The TSE300 was up 10.4%/year in the 70's & the S&P500 was up 6.8%.

Charts of the indexes show no growth for a period from 1966 to the bottom in 1982, except that these charts excluded dividends. Back then, dividends were a much higher portion of the return and averaged 4-5%. So, $1,000 invested Jan.1/66 would be worth about $2,100 at the end of 1982.

Interestingly, the longest bear market since the 1930's for the S&P500 was 7 years - the great bear market of 2000-2007! With all the speculation on whether we are at the beginning of long bear market - we are actually at the end of the greatest one!

We haven't seen this same effect in Canada, since the tech bubble collapse became a resource bull (bubble?), so the declines of 2001-2 were surpassed by 2004.

The truth is that the TSX might be at the beginning of a bear market, since our market is 75% in only 3 sectors - all 3 of which have just had one their largest runs in history. If oil drops back to $45/barrel as many believe it will (including me), then oil, resource, probably gold, and most likely bank stocks will all collapse, which may take a while to recover.

The answer is to invest globally or in the U.S., since the global and U.S. indexes are still down this decade.

The only 2 declines for the S&P500 from the top to bottom over 40% since the 1930's have 1973-4 & 2000-2 - both times just over 40%. In 73-74, it took 6 years to be back in the black and this time we are 6 years and not quite back.

When is a better time to invest than at the END of the greatest bear market? (Well the bottom would have been better...)







Ed

Interesting post and view on the markets. Looking at just the market indexes alone shows a different story, but as you said these indexes don't include dividends which does change things. Your optimism regarding 1966 to 1982 is interesting and does make that period look better than the index charts show. However, slightly more than doubling your investment in 16 years is not a period I hope would repeat itself. There still does seem to be a number of indicators showing room for further correction in the future meaning this bear market may still have some ways to go.

[pitz]

Thanks for the ideas... Unfortunately my risk tolerance is such that I don't think I'd be comfortable using unsecured credit or margin for my investments. I'd be worried about getting a loan or margin call if they fell in value.


Yet you're considering the Smith Manouevre? You do realize that you won't be able to renew your mortgage if your house's value drops and the loan becomes undercollateralized. That's just like, in essence, a margin call.



As far as derivatives go, I'm not sophisticated enough as an investor to be swimming in those waters. For example, I don't really even understand how options and/or futures could act as an alternative to a HELOC in a SM.


Lets say that you are proposing to borrow $100,000 to invest, and you can only obtain $30k or so from existing sources without refinancing your mortgage. And lets assume, for the sake of discussion, that your mortgage comes up for renewal in a year and a half, and the penalties for refinancing (costs, etc.) are hefty if you do so prematurely.

Instead of spending the cash to refinance, you could simply buy a futures contract or in-the-money calls to expire 1.5 years from now, with your $30k, obtain the same market exposure, and not have to pay a dime in premature refinancing penalties.

When you go to refinance a year and a half from now, you simply take the proceeds from your refinancing, exercise the options or take delivery on the futures, and your portfolio will be populated with your assets of choice.

Thus you have avoided the heavy costs involved with refinancing, you have purchased the $100k of market exposure you desire, and if you bought options, you won't incurr a tax liability either when you exercise.

[notanexpert]

...
The truth is that the TSX might be at the beginning of a bear market, since our market is 75% in only 3 sectors - all 3 of which have just had one their largest runs in history. If oil drops back to $45/barrel as many believe it will (including me), then oil, resource, probably gold, and most likely bank stocks will all collapse, which may take a while to recover.

The answer is to invest globally or in the U.S., since the global and U.S. indexes are still down this decade.
...
Ed

Thanks for your bear market comment, I did only look at charts, so I missed the high dividend rates of the 70's, that changes the picture a bit.
There are as many different views on the market as there are participants. I personally don't think that oil or gold are about to roll over. Not without significant tightening of the money supply anyway. So I don't agree with you on that one. I do agree though that diversifying globally is prudent, and the longer this TSX bull runs, the more important this gets.

[edrempel]

Yet you're considering the Smith Manouevre? You do realize that you won't be able to renew your mortgage if your house's value drops and the loan becomes undercollateralized. That's just like, in essence, a margin call.

Hi Pitz,

Actually the banks have not hesitated to renew a mortgage when the home value drops below the mortgage. This happened in Calgary & Vancouver in the early 80's when home values had plunged 40-50% after their last boom. A large number homes were then worth less than the mortgage, including for some people I know. The banks routinely renewed their mortgages. I don't believe there is any "margin call" on declining home values.



Ed

[edrempel]

Thanks for your bear market comment, I did only look at charts, so I missed the high dividend rates of the 70's, that changes the picture a bit.
There are as many different views on the market as there are participants. I personally don't think that oil or gold are about to roll over. Not without significant tightening of the money supply anyway. So I don't agree with you on that one. I do agree though that diversifying globally is prudent, and the longer this TSX bull runs, the more important this gets.

Hi Not,

I agree - nobody knows the future. I think there is a significant risk of a major downturn in Canada because oil & gold might fall back to reasonable levels - and in the past when the did this, it was usually quite sudden.

Major bear markets like this with declines of 40% from top to bottom have only happened about every 30-40 years (2000-2002, 1973-1974, 1929-1932). Since the global and US markets have still not fully recoverd from the last bull market that ended in 2002 and they are far more diversified than our Canadian market, the risk of a new major bear market now so soon after the last one is very low.




Ed

[leftcoast]

Yet you're considering the Smith Manouevre? You do realize that you won't be able to renew your mortgage if your house's value drops and the loan becomes undercollateralized. That's just like, in essence, a margin call.

And that is exactly why I'd also be very uncomfortable getting a zero-down mortgage. At present, however, our home value would need to drop by over 50% before it was worth less than our mortgage balance. That's not beyond the realm of possibility, I suppose, but it does seem significantly less likely than the possibility that my SM investment portfolio might, at some point, drop below the LOC balance.

I'm comfortable with the idea of borrowing to invest with a long time horizon (15+ years), as the past would suggest this is a relatively safe bet. But the knowledge that my loan could be called at any time in the near future would probably keep me awake at night if (when) the market turned.


Lets say that you are proposing to borrow $100,000 to invest, and you can only obtain $30k or so from existing sources without refinancing your mortgage. And lets assume, for the sake of discussion, that your mortgage comes up for renewal in a year and a half, and the penalties for refinancing (costs, etc.) are hefty if you do so prematurely.

Instead of spending the cash to refinance, you could simply buy a futures contract or in-the-money calls to expire 1.5 years from now, with your $30k, obtain the same market exposure, and not have to pay a dime in premature refinancing penalties.

When you go to refinance a year and a half from now, you simply take the proceeds from your refinancing, exercise the options or take delivery on the futures, and your portfolio will be populated with your assets of choice.

Thus you have avoided the heavy costs involved with refinancing, you have purchased the $100k of market exposure you desire, and if you bought options, you won't incurr a tax liability either when you exercise.

Cool, thanks for taking the time to explain this.

[houska]

Lets say that you are proposing to borrow $100,000 to invest, and you can only obtain $30k or so from existing sources without refinancing your mortgage. And lets assume, for the sake of discussion, that your mortgage comes up for renewal in a year and a half, and the penalties for refinancing (costs, etc.) are hefty if you do so prematurely.

Instead of spending the cash to refinance, you could simply buy a futures contract or in-the-money calls to expire 1.5 years from now, with your $30k, obtain the same market exposure, and not have to pay a dime in premature refinancing penalties.

When you go to refinance a year and a half from now, you simply take the proceeds from your refinancing, exercise the options or take delivery on the futures, and your portfolio will be populated with your assets of choice.


Interesting idea. But am I missing something? In this case the mortgage on the $70k is not tax deductible. So you gain the avoided premature refinancing penalties (about 3 mos worth of interest - is that right?) but lose the tax benefits (40% or more of interest paid over the 18 mos). Seems that in most cases it would make sense to break, if indeed you are happy with the wisdom of the investment/leverage strategy in the first place. Depends on current mortgage rates vs what you've got, too, of course.

[pitz]

Interesting idea. But am I missing something? In this case the mortgage on the $70k is not tax deductible. So you gain the avoided premature refinancing penalties (about 3 mos worth of interest - is that right?) but lose the tax benefits (40% or more of interest paid over the 18 mos). Seems that in most cases it would make sense to break, if indeed you are happy with the wisdom of the investment/leverage strategy in the first place. Depends on current mortgage rates vs what you've got, too, of course.

A LOC you might be paying 6% on. Options or futures often have implied interest rates very close to the Bank of Canada/Federal Reserve overnight rate or the rate implied by the equivilant term of T-bill.

So while you lose the tax deductibility on the 6%, you reduce your financing costs to what might be 4.25%. For some combinations of tax brackets, and mortgage refinancing penalties/costs, this might be a more effective strategy. Each case should be judged on its own merits, using numbers that make sense given the circumstances.

[CDNPatriot]

How much would your investments have to drop before the bank calls on you for the loan amount?

[CDNPatriot]

Vancity does not offer their mortgage products to Ontario residents.

But https://www.citizensbank.ca/Personal/Products/Mortgages/CreditlineMortgage/

does. Was wondering if anyone had experience with them.

[pitz]

How much would your investments have to drop before the bank calls on you for the loan amount?

Generally with traditional mortgages, a bank cannot 'call' a loan unless it is in default.

LOCs are different however typically. Most brokers in Canada require at least 30% margin (you must have 30 cents of equity for every $1 in assets in your account) for stock positions, a limit that is set through IDA regulation, and many stocks require 50% or more.

It depends on what exactly the type of loan you have, etc. Some loans, business loans especially, have certain covenants such as the requirement to file audited financials, certain operating cashflow and EBITDA requirements, etc., and can be called if any of those covenants are violated.

[smilodon]

Ok! I have not bought the book nor read it. I have not met any financial planner either. But I have read this thread at least twice despite its never-ending, constantly-increasing length. So I must now be qualified to perform the SM on my own, right? :cheesygri

Just a little comment: from reviewing your spreadsheet, cannon_fodder, I have the feeling it does not factor that in Canada, interest on a mortgage loan is only compounded semi-annually. If this is right, this makes the mortgage payment schedules (last three worksheets of the workbook) somewhat inaccurate and the inaccuracy is amplified as you advance in time. This is a detail but as we all know the power of compounding, the effect should be quite significant and apparent after, say, 10 years. But then again, it would only go to show that the SM is even more beneficial than reported.

Nonetheless, I am also moving forward with the SM.

I've set up an IB account.
I've filled all the paperwork for Firstline's Matrix Mortgage.
I've got a checking and secondary line of credit account set up.

All I am waiting for is for the house purchase to close in May. Until then, I'm looking into what investment tools/vehicules to invest in.

So, the following questions come to mind. Perhaps we can all have fun at taking a crack at them?

If I'll be using two lines of credits to roll the interest costs of the HELOC portion every month, although quite tedious a process, I do not need to invest in dividend-paying investments anymore, right?
If I do invest in dividend-paying shares and and elect to have those dividends automatically reinvested, why isn't that good? Less worries & transaction fees to me, no? Rolling the interest of the HELOC/LOC is already quite troublesome every month!
Say you all tell me dividends are a must (as pitz will undoubtedly say), consider the following example of XDV iShares (for illustration purposes only, not a stock recommendation!):

$70,000 in average of $25 per unit shares = 2800 shares.
The dividends paid each quarter since the first quarter of 2006 would be: $209.61; $427.98; $589.48; $504.28; $452.45.
The interest rate on the HELOC is 6% per year for monthly interests of $350.

The quarterly dividends are nowhere close to the monthly cost of interest! Along with the transaction costs, is the trouble of withdrawing the dividends to pay the mortgage down (with automatic re-advances into HELOC), withdrawing from the HELOC into IB, and finally purchasing new shares worth it?
Aren't ETFs, by nature, highly diversified investment vehicules; reducing the need to hedge the investment as long as I hedge by purchasing ETFs from different industry sectors?
If yes, would 100% investment in different ETFs be tax-efficient?
I believe in the SM, but I'm a little queasy about myself. What are your thoughts on using only $35,000 of the HELOC for, say, 6 or 12 months, and re-evaluate my position then before using the next $35,000?
I haven't read much about Firstline's Matrix mortgage. Why aren't more people using it? In essence, the ones who have gone with RBC or Scotia, why?


That's about it for now. Hope this can spawn some good discussions :)

Cheers & thanks to all!

[pitz]

If I'll be using two lines of credits to roll the interest costs of the HELOC portion every month, although quite tedious a process, I do not need to invest in dividend-paying investments anymore, right?


Why wouldn't you invest in dividend-paying stuff? Not only does the dividend tax credit give you a very low rate, the dividends also help to reduce your overall interest bill. Further, dividend-paying stocks tend to be less vulnerable in recessions -- especially companies with conservative dividend policies.



If I do invest in dividend-paying shares and and elect to have those dividends automatically reinvested, why isn't that good? Less worries & transaction fees to me, no? Rolling the interest of the HELOC/LOC is already quite troublesome every month!


Because the dividends could be put against non-deductible debt, reducing its overall magnitude. Essentially, the goal of the SM is to swap non-deductible debt for deductible debt ASAP. Dividends accelerate the process.



Say you all tell me dividends are a must (as pitz will undoubtedly say), consider the following example of XDV iShares (for illustration purposes only, not a stock recommendation!):

$70,000 in average of $25 per unit shares = 2800 shares.
The dividends paid each quarter since the first quarter of 2006 would be: $209.61; $427.98; $589.48; $504.28; $452.45.
The interest rate on the HELOC is 6% per year for monthly interests of $350.

The quarterly dividends are nowhere close to the monthly cost of interest! Along with the transaction costs, is the trouble of withdrawing the dividends to pay the mortgage down (with automatic re-advances into HELOC), withdrawing from the HELOC into IB, and finally purchasing new shares worth it?


Absolutely. A 3% dividend yield will pay down $2100 of non-deductible debt in a year. If deductible debt costs you 3% after-tax, and non-deductible debt, 5%, you will save $42/year by recycling just the first year worth of dividends against the non-deductible debt. This $42/year continues each and every year, and compounds, while the $42/year will be another $42/year each and every year.

Its a compounding process. In the first year you use the strategy, you'll save $42/year. In the second year, you'll save $84/year, etc. Plus compound gains on the compounded gains. An exponentially growing process, that does not result in the increase of overall debt, but rather, a more efficient swap of non-deductible debt to deductible debt.



Aren't ETFs, by nature, highly diversified investment vehicules; reducing the need to hedge the investment as long as I hedge by purchasing ETFs from different industry sectors?


I was referring to currency hedging. If you are investing in US ETFs such as SPY, I would suggest that you take out some of your SM loan in US dollars instead of Canadian dollars. This should reduce volatility as well.



If yes, would 100% investment in different ETFs be tax-efficient?


ETFs are among the most tax efficient instruments available that offer reasonable diversification.



I believe in the SM, but I'm a little queasy about myself. What are your thoughts on using only $35,000 of the HELOC for, say, 6 or 12 months, and re-evaluate my position then before using the next $35,000?


Absolutely! The SM is something that should be done slowly, even if you have big lump sums available. With an IB account, you can buy 5, 10, 25, 100 ETF units at a time, to dollar-cost average into your positions, with reasonable levels of commission.

Borrowing through IB might even be less expensive than your HELOC if you have sufficient margin available, and IB has multi-currency lending, which might not be available through your HELOC.

[notanexpert]

I think if you don't need the cashflow from the dividends to pay interest, you can go for dividend re-investment. Some people will say that you can use the dividends to pay down your non-deductible debt faster, therefore increasing the benefits of the SM.

I would probably not dump $70k into the market all at one time but rather put some in now, and put some more in when there are market corrections over the next year or so. Maybe do it once a quater when you think there is an opportunity.

[pitz]

I think if you don't need the cashflow from the dividends to pay interest, you can go for dividend re-investment. Some
people will say that you can use the dividends to pay down your non-deductible debt faster, therefore increasing the benefits of the SM.


The argument for dividend re-investment usually revolves around commission costs; to wit: spending $29.95 at a traditional discount brokerage in Canada to re-invest $100 of dividends makes little sense.

With the $1 commissions at Interactive Brokers, re-investing dividends, or putting the dividends against the non-deductible debt, and then drawing additional deductible debt (or easier yet, just draw on an IB margin facility, since its cheaper than Firstline's HELOC) really avoids the commission trap.

And don't forget -- dividend re-investment makes no sense if a stock is overvalued, or if it throws your asset allocation out of whack.




I would probably not dump $70k into the market all at one time but rather put some in now, and put some more in when there are market corrections over the next year or so. Maybe do it once a quater when you think there is an opportunity.

I concur. If you obtain an external datafeed with IB (perhaps from a traditional bank discount brokerage account), you essentially get $10/month of commissions to spend 'for free'. You could do 5 Canadian stock transactions, 10 US transactions, or some combination thereof. I have a relative who is doing the SM very slowly on her condo mortgage, and she has even placed orders to buy 1 unit of VWO (her Emerging Markets exposure), as funds become available, and as she sticks with an asset allocation model and rebalances the portfolio through her contributions.

Another benefit of dividends -- if you lose your job and you are in the middle of the SM, dividends will give you cash to make the mortgage payments as they grow, reducing the overall risk of the SM as time goes on. Eventually dividends can be used to reduce/eliminate the entirety of the mortgage debt, if you, like many Canadians, are not comfortable/able to enter retirement with a lot of outstanding debt.

And yet another benefit -- sometimes ETFs have significant capital gains distributions, especially during periods of dramatic market turbulence, or M&A action. A stream of dividends gives you cash to pay the taxes on these capital gains, while if you own stuff that doesn't have dividends, if you get hit with a large capital gain, you might be forced to sell shares, triggering yet more capital gains, to pay income taxes.

Further, dividends can be used to purchase 'other' investments outside the SM accounts, that are at a higher cost base, and can be consumed either in earlier retirement, at a significant tax savings, or used to fund the purchase of consumer items. Whereas, a non-dividend-paying investment is relatively illiquid, and is effectively 'locked' in at a very low cost base (thus high rates of taxation for all sales/withdrawals).

[pitz]

If I'll be using two lines of credits to roll the interest costs of the HELOC portion every month, although quite tedious a process, I do not need to invest in dividend-paying investments anymore, right?

Don't forget that you can borrow from IB as well, and their rates are lower than most LOCs I am familiar with. Don't see why you would need a 2nd LOC, when IB already provides a stock-secured lending facility.

[smilodon]

Don't forget that you can borrow from IB as well, and their rates are lower than most LOCs I am familiar with. Don't see why you would need a 2nd LOC, when IB already provides a stock-secured lending facility.

But since I'll be rolling the payments from LOC to HELOC back to LOC, no interest rate is involved....no?? What about this example:

HELOC outstanding balance: $70,000
Interest rate: 6% per year (prime)
Monthly interest cost: $70,000 x (0.06/12) = $350
There's probably a portion of the principal that needs to be paid too, say 3%, which is $2100.

So, at the end of Month 1, $2450 is due. I transfer $2450 from LOC to HELOC. I then immediately re-transfer $2450 from HELOC to LOC. Net effect is nothing, or a few cents of interest for the day where LOC was negative.

Am I right?

[smilodon]

Hey, what about Questrade instead of IB?

They won't ding us for up to $10 per month due to inactivity. Since the whole premise of SM is to buy and hold and minimize transaction costs, The account should see minimal trading beyond the first initial month...

The possibility of only paying maximum $9.95/trade when trade occurs and not incur $10/month in fees sounds pretty good, no?

From what I read on Questrade:

The $4.95 Plan
This plan allows you to trade unlimited shares of US or CDN stock for 1 cent per share commission, with a minimum charge of $4.95. For instance, if you purchase 300 shares, your cost would be the minimum of $4.95. If you purchase 800 shares, your cost is $8.00 and if you purchase 3000 shares, your cost is $30.00. This plan is most cost-effective for traders who typically purchase less than 1000 shares per trade.

The $9.95 Plan
This plan allows you to trade unlimited shares of US or CDN stock for a flat fee of $9.95. This plan is most cost-effective for traders who typically purchase more than 1000 shares per trade.

Once you've chosen your commission plan or if you wish to change your plan, please go to myQuestrade, click on My Accounts and choose Select A Commission Plan. On the right-hand side of the new page, choose your account and plan from the drop-down menus. New client plans will be activated when accounts are fully funded. If current clients want to change their plan, the change will be activated at the beginning of the month following receipt of the request.


So, sign up for the $9.95 plan at first, do all trades to max out HELOC funds during first month, then switch to $4.95 plan from second month on. And use that plan to adjust portfolio with new fund influx into HELOC at each mortgage principal payment!

Any error in this thinking?

[pitz]

So, at the end of Month 1, $2450 is due. I transfer $2450 from LOC to HELOC. I then immediately re-transfer $2450 from HELOC to LOC. Net effect is nothing, or a few cents of interest for the day where LOC was negative.

Am I right?

The Firstline Matrix Mortgage product only requires interest payments on the LOC portion.

So your bill would look like this:

Normal Mortgage Payment = whatever.
LOC Payment = $70k * 6%/12 = $4200/12 = $350
------------------------------------------------

So I don't see why you have the 2nd LOC.

Now, since IB charges less than prime, it would make most sense to pay the LOC from a margin loan from IB. So you withdraw $350 Canadian each month from IB, and you put that against the LOC interest (keep a good paper trail).

When dividends flow into your IB account in Canadian dollars, you withdraw them, and apply them as pre-payments to the normal mortgage.

If you borrowed US dollars from IB, as I suggested, to fund the US portion of your investment portfolio, then the dividends from those stocks would serve to reduce your US dollar indebtness.

Alternatively, you could withdraw US dollar dividends to supply your US dollar needs, for example, if you are going to take a vacation or go cross-border shopping.

This has a few advantages:

1) You gain currency hedging and don't have to worry about converting currency.

2) You only need the Matrix Mortgage and the IB account

3) You gradually convert your debt to below prime through IB.

4) You accelerate your elimination of non-deductible debt.


Basically, the only major thing you have to watch for is that the IB account does not get into the danger zone for undercollateralization.

If you are intending to invest $70k of borrowed money, and need a 30/70% split between USA and Canadian investments, this is what I would suggest:

Borrow $49,000 from the Matrix Mortgage LOC, deposit to IB.
Buy $49,000 worth of Canadian securities.
Buy $21,000 *0.89 = $18,700 of US securities on margin.

[pitz]

They won't ding us for up to $10 per month due to inactivity. Since the whole premise of SM is to buy and hold and minimize transaction costs, The account should see minimal trading beyond the first initial month...


But the whole purpose of the SM is to gradually swap debt over time. By definition, you need to be making relatively frequent purchases, ie: adding to your portfolio monthly.



The possibility of only paying maximum $9.95/trade when trade occurs and not incur $10/month in fees sounds pretty good, no?

The unused balance of the $10/month minimum commission is a deductible expense for the purposes of income tax, and the decreased margin rates, and the multicurrency support, IMHO, make IB a much better value proposition.

For instance, to achieve currency hedging by any other method other than what I describe above, will have substantial costs. You could buy hedged ETFs like XSP or XIT, but you are talking a 30bp premium over VTI, IVV, or SPY. On $20k invested, thats $60/year extra alone, not to mention the cheaper after-tax borrowing costs in USD which will also benefit your bottom line. And XIT and XSP's tax efficiency is horrible compared to what you could achieve on your own by borrowing USD to invest in highly efficient US-domiciled ETFs.

[smilodon]

But the whole purpose of the SM is to gradually swap debt over time. By definition, you need to be making relatively frequent purchases, ie: adding to your portfolio monthly.

Right, but the incremental amount each month will be very small, say less than $1000. You can't buy much securities with such amount, hence the number of shares will be very low and Questrade would be more cost-effective in this scenario, no?


The unused balance of the $10/month minimum commission is a deductible expense for the purposes of income tax, and the decreased margin rates, and the multicurrency support, IMHO, make IB a much better value proposition.

For instance, to achieve currency hedging by any other method other than what I describe above, will have substantial costs. You could buy hedged ETFs like XSP or XIT, but you are talking a 30bp premium over VTI, IVV, or SPY. On $20k invested, thats $60/year extra alone, not to mention the cheaper after-tax borrowing costs in USD which will also benefit your bottom line. And XIT and XSP's tax efficiency is horrible compared to what you could achieve on your own by borrowing USD to invest in highly efficient US-domiciled ETFs.

Nahh... this is complex enough with Canada only, I'm not even considering US currency & securities!

The unused balance of $10/month is a deductible expense at 100%? Meaning if I pay a total of $100 for the whole year, my annual income will be reduced by that exact amount come income tax season? If it's only deductible at a certain percentage, not paying that expense at all would be better, no?

[pitz]

Right, but the incremental amount each month will be very small, say less than $1000. You can't buy much securities with such amount, hence the number of shares will be very low and Questrade would be more cost-effective in this scenario, no?


Well if you make even one purchase of XIU or XDV, that's $4.95. But if you have to spread that money into 2 ETFs, then you are back to $10.



Nahh... this is complex enough with Canada only, I'm not even considering US currency & securities!


Unless you believe in a continued commodities boom, I don't know how wise this would be. The TSX is essentially 1/3rd energy stocks, 1/3rd banking stocks, and the balance is mining stocks with a very minimal contribution from other sectors.

At least if you have a modest amount of foreign exposure, you gain access to other sectors such as technology, and diversification beyond Canada, which should reduce your overall risk.



The unused balance of $10/month is a deductible expense at 100%?
Meaning if I pay a total of $100 for the whole year, my annual income will be reduced by that exact amount come income tax season? If it's only


Its a carrying cost/expense, just like interest. So deductible from income at 100%, which would reduce your income tax at your marginal rate, just like interest expense is concerned.

[cannon_fodder]

Just a little comment: from reviewing your spreadsheet, cannon_fodder, I have the feeling it does not factor that in Canada, interest on a mortgage loan is only compounded semi-annually. If this is right, this makes the mortgage payment schedules (last three worksheets of the workbook) somewhat inaccurate and the inaccuracy is amplified as you advance in time. This is a detail but as we all know the power of compounding, the effect should be quite significant and apparent after, say, 10 years. But then again, it would only go to show that the SM is even more beneficial than reported.


I hope if you take a look at it you will see that the mortgage is compounded semi-annually. The LOC interest rate is compounded monthly because that is what I've been told is the way it is done. Perhaps it was only BMO that does it that way but I've run various numbers (with help of someone who has the SM calculator) and I can duplicate his numbers exactly. (SM calculator and I differ philosophically on one important point - when it comes to liquidating assets and applying it to the mortgage I apply it from day 1 where his calculator applies it at the end of the first month.) I've also compared it with online mortgage calculators (for some reason I always gravitate to this one - http://www.canadamortgage.com/calculators/amortization.cgi - maybe I'm a sucker for graphs).

Thus, I believe my calculator is consistent with Canadian methods of mortgages and LOC. If you can provide some help that shows I'm wrong I would really appreciate it because I do want it to be of benefit and that can only happen if it is accurate!

[cannon_fodder]

Unless you believe in a continued commodities boom, I don't know how wise this would be. The TSX is essentially 1/3rd energy stocks, 1/3rd banking stocks, and the balance is mining stocks with a very minimal contribution from other sectors.

At least if you have a modest amount of foreign exposure, you gain access to other sectors such as technology, and diversification beyond Canada, which should reduce your overall risk.


It is for this reason, combined with the fact that my wife and I have no non-registered portfolio but a relatively valuable portfolio in RRSP's, that I would tend to concentrate RRSP's higher in foreign equities and the non-registered portfolio in Canadian equities. My thinking is it will be easier, without suffering significant loss of performance nor increased exposure, than trying to purchase US denominated securities along with Canadian ones.

I have no doubt that there are sophisticated investors, like yourself, who could handle this relatively comfortably, but I'm not in that category.

[pitz]

It is for this reason, combined with the fact that my wife and I have no non-registered portfolio but a relatively valuable portfolio in RRSP's, that I would tend to concentrate RRSP's higher in foreign equities and the non-registered portfolio in Canadian equities. My thinking is it will be easier, without suffering significant loss of performance nor increased exposure, than trying to purchase US denominated securities along with Canadian ones.


Putting one's US dividend-paying exposure into a RRSP, if possible, is a no-brainer because RRSPs are exempt from US withholding taxes.

ex-US, it becomes more difficult because you are subject to foreign withholding, and inside the RRSP, you would lose the foreign tax credit.

[notanexpert]

Putting one's US dividend-paying exposure into a RRSP, if possible, is a no-brainer because RRSPs are exempt from US withholding taxes.

ex-US, it becomes more difficult because you are subject to foreign withholding, and inside the RRSP, you would lose the foreign tax credit.

How are ADR's of European or Japanese companies that are traded on US exchanges treated in terms of dividend taxation?

[pitz]

How are ADR's of European or Japanese companies that are traded on US exchanges treated in terms of dividend taxation?

The country of origin typically would apply a withholding tax, paid out of dividends.

Your broker should not withhold anything on an ADR because the IRS has no jurisdiction to tax them for Canadians.

The withholding tax paid by ADR to the country of origin should be recoverable by the beneficial owner in Canada, in the form of a foreign tax credit. However, the entirety of the dividend would be subject to income tax at 'income' rates.

[CDNPatriot]

When dividends flow into your IB account in Canadian dollars, you withdraw them, and apply them as pre-payments to the normal mortgage.



I thought IB had $100 withdrawal fees.

[FrugalTrader]

Smilodon,

Can you tell us a bit more about the matrix mortgage? What is your non-ded mortgage rate? Can you connect your matrix mortgage directly to CIBC online banking? What are the pre-payment rules?

Also, if you're looking to re invest your dividends, IB may not be your best choice as you have to pay a transaction fee to re-invest EVERYTIME. Perhaps opening an account with CIBC Investors edge would be a better deal as they charge a one time fee of $395 for 50 trades with FREE dividend re investment.

The reason why Pitz recommends using the dividends to pay down your non-ded mortgage is because the only way to withdraw from your deductible investment account without affecting the tax-deductibility of it, is to withdraw the income produced from the account. That is, providing that the income produced doesn't have a RETURN OF CAPITAL (ROC) portion to it.

Best of luck!


Ok! I have not bought the book nor read it. I have not met any financial planner either. But I have read this thread at least twice despite its never-ending, constantly-increasing length. So I must now be qualified to perform the SM on my own, right? :cheesygri

Just a little comment: from reviewing your spreadsheet, cannon_fodder, I have the feeling it does not factor that in Canada, interest on a mortgage loan is only compounded semi-annually. If this is right, this makes the mortgage payment schedules (last three worksheets of the workbook) somewhat inaccurate and the inaccuracy is amplified as you advance in time. This is a detail but as we all know the power of compounding, the effect should be quite significant and apparent after, say, 10 years. But then again, it would only go to show that the SM is even more beneficial than reported.

Nonetheless, I am also moving forward with the SM.

I've set up an IB account.
I've filled all the paperwork for Firstline's Matrix Mortgage.
I've got a checking and secondary line of credit account set up.

All I am waiting for is for the house purchase to close in May. Until then, I'm looking into what investment tools/vehicules to invest in.

So, the following questions come to mind. Perhaps we can all have fun at taking a crack at them?

If I'll be using two lines of credits to roll the interest costs of the HELOC portion every month, although quite tedious a process, I do not need to invest in dividend-paying investments anymore, right?
If I do invest in dividend-paying shares and and elect to have those dividends automatically reinvested, why isn't that good? Less worries & transaction fees to me, no? Rolling the interest of the HELOC/LOC is already quite troublesome every month!
Say you all tell me dividends are a must (as pitz will undoubtedly say), consider the following example of XDV iShares (for illustration purposes only, not a stock recommendation!):

$70,000 in average of $25 per unit shares = 2800 shares.
The dividends paid each quarter since the first quarter of 2006 would be: $209.61; $427.98; $589.48; $504.28; $452.45.
The interest rate on the HELOC is 6% per year for monthly interests of $350.

The quarterly dividends are nowhere close to the monthly cost of interest! Along with the transaction costs, is the trouble of withdrawing the dividends to pay the mortgage down (with automatic re-advances into HELOC), withdrawing from the HELOC into IB, and finally purchasing new shares worth it?
Aren't ETFs, by nature, highly diversified investment vehicules; reducing the need to hedge the investment as long as I hedge by purchasing ETFs from different industry sectors?
If yes, would 100% investment in different ETFs be tax-efficient?
I believe in the SM, but I'm a little queasy about myself. What are your thoughts on using only $35,000 of the HELOC for, say, 6 or 12 months, and re-evaluate my position then before using the next $35,000?
I haven't read much about Firstline's Matrix mortgage. Why aren't more people using it? In essence, the ones who have gone with RBC or Scotia, why?


That's about it for now. Hope this can spawn some good discussions :)

Cheers & thanks to all!

[smilodon]

Well if you make even one purchase of XIU or XDV, that's $4.95. But if you have to spread that money into 2 ETFs, then you are back to $10.

Yes, I guess both QT & IB are essentially equivalent at this point.


Its a carrying cost/expense, just like interest. So deductible from income at 100%, which would reduce your income tax at your marginal rate, just like interest expense is concerned.

But I still end up with more money in my pockets at the end of the day if I don't have to pay those fees, right? So why pay them with IB if QT allows me not to?

[smilodon]

FrugalTrader, first of all, I gotta say that your blog has been very enlightening and instrumental to my understanding of all this. So, thanks! :)


Smilodon,
Can you tell us a bit more about the matrix mortgage? What is your non-ded mortgage rate? Can you connect your matrix mortgage directly to CIBC online banking? What are the pre-payment rules?

Mortgage portion is 4.99% fixed, 5-year term, bi-weekly.
HELOC portion is 6.00% variable at prime.

Mortgage payment can be increased by up to 25% annually without penalty.
Downpayments of up to 20% of original mortgage amount can be made annually.

HELOC can be connected to TD Canada Trust (for sure - that's my bank; and most certainly CIBC as well, since Firstline Mortgage is a subsidiary of CIBC) once you order their "internet package" and sign up (all free). This allows you to withdraw or deposit/make payments electronically at no cost. Otherwise, you can order checks at $11.xx for 25 units.

Internet account also allows you to change your monthly payment and input downpayments online.


Also, if you're looking to re invest your dividends, IB may not be your best choice as you have to pay a transaction fee to re-invest EVERYTIME. Perhaps opening an account with CIBC Investors edge would be a better deal as they charge a one time fee of $395 for 50 trades with FREE dividend re investment.

Ok, too troublesome, won't take dividend-paying securities. Or, in fact, let's say I do get dividends. Then, to those I add the extra amount available from the HELOC on a quarterly or semi-annual basis. All that should come to a sum conducive of investment (>$1,000) while minimizing transaction fees?


The reason why Pitz recommends using the dividends to pay down your non-ded mortgage is because the only way to withdraw from your deductible investment account without affecting the tax-deductibility of it, is to withdraw the income produced from the account. That is, providing that the income produced doesn't have a RETURN OF CAPITAL (ROC) portion to it.

But if I don't want to withdraw from the deductible investment, I'm safe, right?

[pitz]

I thought IB had $100 withdrawal fees.

1 free withdrawal a month from IB, after which, each additional withdrawal, through electronic funds transfer, is $1.

The strategies I described shouldn't require more than 1 withdrawal per month, so essentially the cost is 'free'.

[pitz]

But I still end up with more money in my pockets at the end of the day if I don't have to pay those fees, right? So why pay them with IB if QT allows me not to?

If you truly believe that its prudent to stick to one stock or ETF, then I admit, QT might very well be less expensive. I don't feel its very sensible though to restrict yourself strictly to a single ETF, especially since you are putting your entire financial future 'on the line' with the SM. And if you are buying 2 or 3 ETFs monthly, then IB's commission structure still is less expensive.

IB's interest rates also save you money. You can borrow from IB less expensively than you can borrow from a HELOC. If, eventually, you shift your $70k of borrowing to IB (after building sufficient equity, of course), you can expect to save $175/year over the mortgage-based LOC. This is something you want to aim for. The SM is great and everything, but everyone should have an eventual exit strategy, and dividends are an integral part of that.

[FrugalTrader]

Smilodon,

Thanks for the info. I've been looking for info on the first line matrix mortgage, but there doesn't seem to be much literature on it. Were there any "notary" or extra fees involved with setting it up?

Yes, provided that you only withdraw the dividend/interest amount, you should be fine. Check out an article I wrote on keeping your investment loan deductible (http://www.milliondollarjourney.com/key-tax-considerations-on-an-investment-loan.htm).






FrugalTrader, first of all, I gotta say that your blog has been very enlightening and instrumental to my understanding of all this. So, thanks! :)



Mortgage portion is 4.99% fixed, 5-year term, bi-weekly.
HELOC portion is 6.00% variable at prime.

Mortgage payment can be increased by up to 25% annually without penalty.
Downpayments of up to 20% of original mortgage amount can be made annually.

HELOC can be connected to TD Canada Trust (for sure - that's my bank; and most certainly CIBC as well, since Firstline Mortgage is a subsidiary of CIBC) once you order their "internet package" and sign up (all free). This allows you to withdraw or deposit/make payments electronically at no cost. Otherwise, you can order checks at $11.xx for 25 units.

Internet account also allows you to change your monthly payment and input downpayments online.



Ok, too troublesome, won't take dividend-paying securities. Or, in fact, let's say I do get dividends. Then, to those I add the extra amount available from the HELOC on a quarterly or semi-annual basis. All that should come to a sum conducive of investment (>$1,000) while minimizing transaction fees?



But if I don't want to withdraw from the deductible investment, I'm safe, right?

[smilodon]

If you truly believe that its prudent to stick to one stock or ETF, then I admit, QT might very well be less expensive. I don't feel its very sensible though to restrict yourself strictly to a single ETF, especially since you are putting your entire financial future 'on the line' with the SM. And if you are buying 2 or 3 ETFs monthly, then IB's commission structure still is less expensive.

No, no! Of course, all eggs must not be in one ETF basket! With initial investment of $70,000 in Month 1:

ABC > $30,000 for 1200 shares (QT: $9.95) (IB: $12)
BCD > $30,000 for 600 shares (QT: $9.95) (IB: $6)
CDE > $10,000 for 10000 shares (QT: $9.95) (IB: $50)

QT is far better. For Month 2, switch to QT $4.95 plan.

After six month of non-trading, pump HELOC increase of a little less than $3000 into QT and do a trade for $4.95. Can't get more than one single trade with $3000!

In six more months, repeat. So, essentially, the portfolio gets rebalanced every six months and only by a small amount anyway. If a major rebalancing is required, switch back to the $9.95 plan and proceed.

Overall, all the $10/month savings from IB should cover a major rebalancing at QT.

Am I missing something still?


IB's interest rates also save you money. You can borrow from IB less expensively than you can borrow from a HELOC. If, eventually, you shift your $70k of borrowing to IB (after building sufficient equity, of course), you can expect to save $175/year over the mortgage-based LOC. This is something you want to aim for. The SM is great and everything, but everyone should have an eventual exit strategy, and dividends are an integral part of that.

Indeed, the margin's interest rate is somewhat lower than the HELOC, but by this logic, why not put the house as collateral against an IB margin account instead of a HELOC? Can this be done?

Also, if I understand correctly, the IB margin account is being compounded daily while the HELOC is compounded monthly. That has got to make a difference, no?

[pitz]

ABC > $30,000 for 1200 shares (QT: $9.95) (IB: $12)
BCD > $30,000 for 600 shares (QT: $9.95) (IB: $6)
CDE > $10,000 for 10000 shares (QT: $9.95) (IB: $50)


What on earth are you buying? Penny stocks? How wise, honestly, do you believe that is?



Indeed, the margin's interest rate is somewhat lower than the HELOC, but by this logic, why not put the house as collateral against an IB margin account instead of a HELOC? Can this be done?


No. Which is why you will have to 'bootstrap' an IB account with some initial HELOC borrowing, but eventually, as your account grows, you can gradually reduce the amount of HELOC borrowing, and increase the amount of IB borrowing. Eventually you can have a mortgage-free house, and all of your debt confined within the IB account.

Mortgages can be a hassle to renew every 5 years, and sometimes they cause your property taxes and/or insurance costs to be higher than they otherwise would be. And If you borrow >$115k Canadian from IB, the rates drop to 5.25%, which is 0.75% less than a HELOC.



Also, if I understand correctly, the IB margin account is being compounded daily while the HELOC is compounded monthly. That has got to make a difference, no?

IB's compounds monthly; they accrue interest daily, but its billed to your account monthly, onto which, additional accruals occur.

[grant]

ABC > $30,000 for 1200 shares (QT: $9.95) (IB: $12)
BCD > $30,000 for 600 shares (QT: $9.95) (IB: $6)
CDE > $10,000 for 10000 shares (QT: $9.95) (IB: $50)
What on earth are you buying? Penny stocks? How wise, honestly, do you believe that is?

$30,000 / 600 shares = $50/share
$30,000 / 1200 shares = $25/share
$10,000 / 10,000 shares = $1/share

I believe shares worth $1+ are not "penny" stocks.

[smilodon]

Ok, all discussions of IB vs. QT aside, when does the HELOC or IB margin account (as may be the case) get paid back?

At this point, the mortgage is completely paid off, and only the HELOC/margin account remains. Say the investment underlying that debt has grown to $200K and the borrowed debt is $100K. If I liquidate $100K to pay for the debt, what are the implications (capitalized gain? income taxes? what of the remaining $100K?)?

But really, owing tax-deductible interest is good, but not owing any interest sounds better, no? Because even if you do pay $10K in interest and 30% of it comes back to you, you still paid $7K out. Not paying any interest would mean that the full $10K stayed in your pockets.

[Spazmogen]

Ok, all discussions of IB vs. QT aside, when does the HELOC or IB margin account (as may be the case) get paid back?

At this point, the mortgage is completely paid off, and only the HELOC/margin account remains. Say the investment underlying that debt has grown to $200K and the borrowed debt is $100K. If I liquidate $100K to pay for the debt, what are the implications (capitalized gain? income taxes? what of the remaining $100K?)?

But really, owing tax-deductible interest is good, but not owing any interest sounds better, no? Because even if you do pay $10K in interest and 30% of it comes back to you, you still paid $7K out. Not paying any interest would mean that the full $10K stayed in your pockets.


Just take out a term-100 life insurance policy to cover the balance on the HELOC.
For about $25 a month you need not worry about paying it back.

if its getting you about a $10,000/year income tax deduction, why pay it back ?

You paid out $10K in interest, wrote off $10K in interest on your tax return as an investment loan AND you get about 30% back in income tax return.

[pitz]

Ok, all discussions of IB vs. QT aside, when does the HELOC or IB margin account (as may be the case) get paid back?


It gets paid back when you either:

a) Receive dividends that exceed the interest payable on the account, ie: the principal balance declines,

*or*

b) Find someone to sell your investments to, in order to redeem the debt.

Alternatively, you could pay back the HELOC/margin account using your other income.



At this point, the mortgage is completely paid off, and only the HELOC/margin account remains. Say the investment underlying that debt has grown to $200K and the borrowed debt is $100K. If I liquidate $100K to pay for the debt, what are the implications (capitalized gain? income taxes? what of the remaining $100K?)?


You would owe capital gains on the gains realized. Which is why I highly recommend dividend-paying investments, and building up 'tranches', so that you can unwind the Smith Manouevre, lock in a low cost base on a portion of your investments, and sell higher-cost-base investments to extinguish the debt. The dividends also help reduce the magnitude of the debt if you so desire as you go along.

This is also why I highly recommend *against* automatic dividend re-investment.



But really, owing tax-deductible interest is good, but not owing any interest sounds better, no? Because even if you do pay $10K in interest and 30% of it comes back to you, you still paid $7K out. Not paying any interest would mean that the full $10K stayed in your pockets.

Well the assumption is that the after-tax growth rate of the investments will exceed the after-tax cost of the investment capital (borrowing) you will use to fund the investments. If this condition remains true going forward, then the SM will provide additional value. Further, there is an element of tax arbitrage at work here -- you get to deduct interest expense, much like you would be able to a RRSP contribution -- at your top marginal rates, while capital gains can be deferred for many years, and only taxed at one half the rate of income.

If this assumption breaks down, for whatever reason, then the SM will be unsuccessful, and will actually end up costing you money.

[pitz]

You would owe capital gains on the gains realized. Which is why I highly recommend dividend-paying investments, and building up 'tranches', so that you can unwind the Smith Manouevre, lock in a low cost base on a portion of your investments, and sell higher-cost-base investments to extinguish the debt. The dividends also help reduce the magnitude of the debt if you so desire as you go along.

This is also why I highly recommend *against* automatic dividend re-investment.



Just to elaborate a bit further:

Lets say you are investing your $80,000 into just Canada ETFs alone. You would probably pick either XIU or XIC, which are essentially identical. You buy 1000 XIU for $80,000 today. Your average per share cost is $80.

Now lets say you intend to stop there, and not re-invest anything. 25 years from now, you go to unwind your Smith Manouevre as you are 65, and want to retire debt-free. Lets say that XIU's are worth $250/share then.

To extinguish $80,000 of debt with $250/share XIU units, and 1500 shares of XIU (at a cost base of $108), you would have to sell 320 shares, and would have a capital gain of $45,440.

Now, what you could do, is re-invest your dividends into XIC, gradually. Every year, for 25 years, you would get approximately enough dividends to buy 20 units of XIC, so you would have, after 25 years, 500 units of XIC (plus your original XIU investment).

The average price on XIC would be approximately $165.

You go to sell 320 units of XIC to pay off the debt, and the realized capital gain would only be ($250 - $165) * 320 = $27200.

So as you can see, by re-investing dividends into a 'complimentary ETF', you are creating a structure that allows for a greater deferral of taxes upon windup of the SM, than would be possible if you just keep re-investing into the same ETF. Of course, by cycling dividends back onto non-deductible debt, and then taking on new deductible debt, you also benefit from lower after-tax interest costs.

(note: if you want to get even fancier, you could cascade your dividends into a 3rd ETF, and make this strategy even more effective at locking in a low cost base. Or you could stop buying XIC at year 10, and buy something else, also locking in a higher cost base on newly acquired shares with dividends.)

[houska]

Well the assumption is that the after-tax growth rate of the investments will exceed the after-tax cost of the investment capital (borrowing) you will use to fund the investments. If this condition remains true going forward, then the SM will provide additional value. Further, there is an element of tax arbitrage at work here -- you get to deduct interest expense, much like you would be able to a RRSP contribution -- at your top marginal rates, while capital gains can be deferred for many years, and only taxed at one half the rate of income.

If this assumption breaks down, for whatever reason, then the SM will be unsuccessful, and will actually end up costing you money.

The best articulation I have seen of the assumptions/risks of the SM, deserves to be highlighted.

I ran some quick #s a week ago. I assumed borrowed at bank prime rates (as a HELOC) and invested in a portfolio whose performance would mimic the RN Croft Growth Real World Index (google it). Data is available since 1997. Assuming a marginal tax rate of 47% on income/interest expense and a blended 30% tax rate on the investment returns (this is likely too high), the annual after-tax returns would have been

1997 7.2%
1998 4.6%
1999 9.6%
2000 -2.9%
2001 -9.2%
2002 -9.0%
2003 6.9%
2004 3.9%
2005 6.4%
2006 6.4%

Over 5 year periods, the average annualized compound returns are

1997-2001 1.6%
1998-2002 -1.7%
1999-2003 -1.2%
2000-2004 -2.3%
2001-2005 -0.5%
2002-2006 2.7%

This is no great shakes. So unless I'm missing something, the pure leveraged investing/tax-arbitrage component of the SM will only be attractive if you pay particular attention to the tax efficiency and tax deferral/cash flow elements of your portfolio, or if you borrow below prime.

I think it becomes more interesting if you look at SM to be a vehicle for being able to afford a bigger house, yet still maintain a bigger diversified overall investment portfolio instead of being too concentrated in one asset (your home, whether with mortgage or not). I've run some numbers when you add in the tax-free capital gains on the larger principal residence, and those come out much better even after attempting to compensate for increased property taxes and maintenance (will not share since that depends on your local real estate market).

Note that this all ignores the gradual tax efficiency part of the SM by converting bad debt to good debt if you already own a home with a mortgage. I'm in fact analyzing a flip instead.

Finally, it's harder to get historical data to run a similar analysis pre-1997, but certainly the leveraging part would have been a bad idea around 1990 with prime rates over 10%.

Please poke holes in this argument....

[KawaiiTentacleBeast]

Lets say you are investing your $80,000 into just Canada ETFs alone. You would probably pick either XIU or XIC, which are essentially identical. You buy 1000 XIU for $80,000 today. Your average per share cost is $80.

Now lets say you intend to stop there, and not re-invest anything. 25 years from now, you go to unwind your Smith Manouevre as you are 65, and want to retire debt-free. Lets say that XIU's are worth $250/share then.

To extinguish $80,000 of debt with $250/share XIU units, and 1500 shares of XIU (at a cost base of $108), you would have to sell 320 shares, and would have a capital gain of $45,440.

Now, what you could do, is re-invest your dividends into XIC, gradually. Every year, for 25 years, you would get approximately enough dividends to buy 20 units of XIC, so you would have, after 25 years, 500 units of XIC (plus your original XIU investment).

The average price on XIC would be approximately $165.

You go to sell 320 units of XIC to pay off the debt, and the realized capital gain would only be ($250 - $165) * 320 = $27200.

I am lost. First you state that it is better to re-invest dividends in to a second ETF instead of the first, but then you compare the tax advantage of re-investing into a second ETF versus not reinvesting at all? :confused:

So what's the difference between reinvesting in XIU instead of XIC? Why is the cost base for XIC higher than XIU if they are identical?

[pitz]

I am lost. First you state that it is better to re-invest dividends in to a second ETF instead of the first, but then you compare the tax advantage of re-investing into a second ETF versus not reinvesting at all? :confused:


No, I compared investing and re-investing in a single ETF, versus re-investing in a second ETF.

The tax advantage occurs when/if you want to cash out the investments to extinguish the loan.



So what's the difference between reinvesting in XIU instead of XIC? Why is the cost base for XIC higher than XIU if they are identical?

The cost base for XIC (assuming dividends are re-invested into it) is higher because it is the recipient of the dividend re-investment, a process that takes place over a relatively long period of time after the initial investment into XIU.

Lets say that you have an investment of 1000 units @ $80 of XIU. The price of XIU jumps to $160. You go buy another 1000 units @ $160, so cost base = $120/share. Some misfortune besets you the next day and you have to sell 1000 shares worth (@$160) to pay for something.

Well guess what? You're going to owe a bunch of tax because the CRA requires that cost bases be 'averaged'. In fact, you will have incurred a capital gain of $40,000, on money that you invested yesterday.

Had you just bought XIC instead of XIU for the 2nd purchase, you wouldn't have much of a gain (loss), and you could withdraw your money without realizing any capital gain.

The same idea is applied to the Smith Manouevre in my earlier post. Build up an initial pool of investments cheaply, and leave those investments locked-in at a low cost base. Build a higher cost base pool of investments as time progresses. Use this higher cost base pool of investments to extinguish the SM loans (if you so desire), or for any consumption/re-investment/rebalancing purposes.

[KawaiiTentacleBeast]

Lets say that you have an investment of 1000 units @ $80 of XIU. The price of XIU jumps to $160. You go buy another 1000 units @ $160, so cost base = $120/share. Some misfortune besets you the next day and you have to sell 1000 shares worth (@$160) to pay for something.

Well guess what? You're going to owe a bunch of tax because the CRA requires that cost bases be 'averaged'. In fact, you will have incurred a capital gain of $40,000, on money that you invested yesterday.

Had you just bought XIC instead of XIU for the 2nd purchase, you wouldn't have much of a gain (loss), and you could withdraw your money without realizing any capital gain.


Got it. But in this case, we are talking about a one time purchase at $80, and another one time purchase at $160. If we are talking about reinvesting dividends annually for 25 years, dividends at year 1 to buy 10 units at $85, 10 units at year 2 at $90, etc. untill at year 20, your cost basis for units of the second fund are also going to be averaged over 20 years, correct?

[pitz]

Got it. But in this case, we are talking about a one time purchase at $80, and another one time purchase at $160. If we are talking about reinvesting dividends annually for 25 years, dividends at year 1 to buy 10 units at $85, 10 units at year 2 at $90, etc. untill at year 20, your cost basis for units of the second fund are also going to be averaged over 20 years, correct?

Absolutely. But averaging, 10 units a year in purchases going forward of a different ETF will have a much higher average than averaging 10 units a year in addition to a large number of units purchased initially.

Ideally, you would buy a different ETF each time you invest more, but that's not very practical, especially since there might only be 2 or 3 ETFs that cover the asset class you are interested in.

For instance, in the US, IVV, SPY, VTI, VV, NY, and DIA are fairly similar in content/performance. No reason you couldn't start out life buying VTI, and then eventually gravitate to IVV, then SPY, then VV, then NY, then DIA. For EAFE exposure, EFA = VPL + VGK. etc.

[pitz]

Please poke holes in this argument....

I wonder what happens when you currency-hedge everything? A good chunk of a 'global' portfolio includes US investments, and those have been absolutely bludgeoned by the declining US dollar. A liability-based hedging approach (aka take out part of your SM mortgage in US dollars) would likely have mitigated much of that.

Other than that, and 30% being way too high for taxes on capital gains and dividends (I would use 15%), your argument is pretty sound.

[brunes]

I've read through this threat from begin to end, and while the manovre does sound interesting, something keeps coming up in my head that doesn't seem to be being discussed here.

The whole idea behind this manover is that you take the equity out of your house as you build it up so you can use it now against tax-deductible investments. Now, from my point of view - this would only be profitable if you assume that your investments are going to be appreciating faster than your house, correct?

I mean, to me, that is a huge assumption. If you look at appreciation rates on houses in my area over the past 20 years, you're looking at around 20-25% return easy. You would have to have a pretty aggressive portfolio to match that I would think.

What is the opinion on this? From my math I can't see how the tax benefits would match the difference in appreciation vs. a standard portfolio return. Couple that with the added "security" of equity in your house vs. in a liquid market.... anyway am I way off base here?

EDIT: Just to make myself clear here - I know that the current "boom" will some day subside and we won't be looking at 20% return anymore... still however it is highly doubtful that appreciation on average will ever drop below 10% in any area... and even if it does temporarily the market is cyclical so it would likely come back around again.

[pitz]

The whole idea behind this manover is that you take the equity out of your house as you build it up so you can use it now against tax-deductible investments. Now, from my point of view - this would only be profitable if you assume that your investments are going to be appreciating faster than your house, correct?


Incorrect. The condition for SM profitability is that the (after tax) *investments* are growing at a faster rate than the after-tax rate of growth of debt. The profitability has absolutely nothing to do with the appreciation/depreciation in the value of your house. The house only acts as security on the loans that people use to execute the SM.



EDIT: Just to make myself clear here - I know that the current "boom" will some day subside and we won't be looking at 20% return anymore... still however it is highly doubtful that appreciation on average will ever drop below 10% in any area... and even if it does temporarily the market is cyclical so it would likely come back around again.

10%? Are you out of your mind? Even the brightest economists TD and BMO have to offer only predict a doubling in the next 20 years, which is pretty much appreciation at the rate of inflation. And their estimates are fairly optimistic. Housing prices cannot, in the long run, reasonably exceed that of inflation, especially since housing (and taxes) are amongst the largest expenses of individuals. Unless you figure most of Canada will be homeless?

[controlyar]

10%? Are you out of your mind? Even the brightest economists TD and BMO have to offer only predict a doubling in the next 20 years, which is pretty much appreciation at the rate of inflation. And their estimates are fairly optimistic. Housing prices cannot, in the long run, reasonably exceed that of inflation, especially since housing (and taxes) are amongst the largest expenses of individuals. Unless you figure most of Canada will be homeless?

:lol: 10%

CIBC World Markets just released an economic report on that same figure of 20 years. Using the rule of 70, it will only increase to a similar rate of inflation.
Too many individuals become house rich and investment poor. Real estate is an illiquid investment and in my opinion, should only be used as a hedge against inflation. The SM allows the house rich to also become investment rich. Just need to make sure we select the appropriate investments. I'd rather go the alternative investment route. ETFs? That's so last year. :lol:

[pitz]

:lol: 10%

CIBC World Markets just released an economic report on that same figure of 20 years.

Yeah, lol, why would any Canadian actually work for a living, when all they have to do is buy a $500k house, pay interest-only (or even neg-am), and reap a tax-free yearly profit equal to that of an average Canadian worker?

Really reminds me of the high tech boom, where it was obviously more profitable for the intelligent to sit in front of a computer screen and daytrade, than it was to actually be in the trenches building high-tech systems. Obviously not very sustainable.

[controlyar]

Yeah, lol, why would any Canadian actually work for a living, when all they have to do is buy a $500k house, pay interest-only (or even neg-am), and reap a tax-free yearly profit equal to that of an average Canadian worker?

Really reminds me of the high tech boom, where it was obviously more profitable for the intelligent to sit in front of a computer screen and daytrade, than it was to actually be in the trenches building high-tech systems. Obviously not very sustainable.

That example definitely puts it in perspective.
If only it were true. :lol:
There are way too many opinions floating around with no substance.

Real estate is ridiculous. The market is letting Canadians enjoy a lower standard of living. Low income earners are purchasing $300,000+ homes, when their income only calls for below $200,000. This translates into cost cutting measures such as less vacations or no retirement savings. Many Canadians cannot even afford homes, but still purchase them because it is the norm and also carries a sense of pride. No calculations are completed and in many cases, individuals are actually losing money! Using NPV and cash flow methods, its simple to create models that show renting can be superior. Oh, if only people became educated about the facts of personal finance.

[notanexpert]

...
I mean, to me, that is a huge assumption. If you look at appreciation rates on houses in my area over the past 20 years, you're looking at around 20-25%return easy. You would have to have a pretty aggressive portfolio to match that I would think.
...

Do you realize that even a 20% annual return compounded over 20 years means a nearly 40-fold increase in values? I believe you can still find a pretty nice home in New Brunswick for $200k, are you saying that a nice home in 1987 could have been had for $5k? I think your past performance figures are out of whack. 20% return maybe over the past 3 or 4 years, but definitely not 20!

In Toronto, the long term rate of return (i've checked since the 60's) has been about 1.5% above inflation. I'm not sure if this is because we are picking an exceptionally favourable end-point now, or maybe TO prices rise above inflation because the city has grown so big that there is additional pressure on downtown prices with a lot of people unwilling to spend many hours in their cars commuting from the burbs. Maybe it just has to do with the fact that this city got more immigrants over the last 50 years than any other in Canada. In rural areas and smaller towns, I'd not count on 1.5% real return on real estate!

[cannon_fodder]

Do you realize that even a 20% annual return compounded over 20 years means a nearly 40-fold increase in values? I believe you can still find a pretty nice home in New Brunswick for $200k, are you saying that a nice home in 1987 could have been had for $5k? I think your past performance figures are out of whack. 20% return maybe over the past 3 or 4 years, but definitely not 20!


Moreover, it has to be the SAME homes that, on average, have increased to 38 times (if 20% annual return) or 87 times (if 25% annual return) of their original price. Not simply that in the area newer homes are 38 or 87 times more expensive than homes in 1987. The average home in 1987 could have been much smaller, with fewer features/upgrades than your typical home built today.

If the New Brunswickian saw that homes are now 400% to 500% of their original purchase prices, then that translates into a 300% to 400% return over 20 years. That computes to a 5.6% to a 7.2% CAGR with no income tax implications but those legal fees and commissions to sell will be about 6% of the selling price.

[cannon_fodder]

To extinguish $80,000 of debt with $250/share XIU units, and 1500 shares of XIU (at a cost base of $108), you would have to sell 320 shares, and would have a capital gain of $45,440.


I think I'm missing a step... how did we arrive at 1500 shares of XIU when you originally said we wouldn't reinvest anything and it was a one time purchase?

[cannon_fodder]

http://www.redflagdeals.com/forums/showthread.php?t=433769

I wonder if this will impact the SM as well? I.E., currently one thinks of an FI allowing you to implement a combined mortgage/HELOC to 75% of the house's appraised value -will this now rise to 80%?

[pitz]

I think I'm missing a step... how did we arrive at 1500 shares of XIU when you originally said we wouldn't reinvest anything and it was a one time purchase?

XIU's dividend yield is ~2%. So each year, an original purchase of XIU will allow you to buy an additional 20 units. (of course, there will be compounded dividends on the additional units bought....but we'll ignore that for now). Over 25 years, I get an additional 500 units.

Of course, you aren't re-investing the dividends directly, you are applying them to the mortgage (doing the swap from non-deductible to deductible debt), and then, in turn, re-investing the proceeds from deductible SM debt.

Understand the distinction? You get a bigger 'bang' for the buck by 'washing' the dividend proceeds through the mortgage, than you do just directly re-investing them in the account.

[brunes]

Moreover, it has to be the SAME homes that, on average, have increased to 38 times (if 20% annual return) or 87 times (if 25% annual return) of their original price. Not simply that in the area newer homes are 38 or 87 times more expensive than homes in 1987. The average home in 1987 could have been much smaller, with fewer features/upgrades than your typical home built today.

If the New Brunswickian saw that homes are now 400% to 500% of their original purchase prices, then that translates into a 300% to 400% return over 20 years. That computes to a 5.6% to a 7.2% CAGR with no income tax implications but those legal fees and commissions to sell will be about 6% of the selling price.

Yeah I see my errors now I totally screwed up and forgot about all the compounding :P

[NFtoBC]

The whole idea behind this manover is that you take the equity out of your house as you build it up so you can use it now against tax-deductible investments.

Actually, according to Smith, you only convert the value of your original mortgage. The increased value that accumulates in your home over the years is yours to use as you wish. If you want to further leverage that equity, you could -- I believe Ed Rempel uses that technique; if you don't want to further leverage your home equity, then just complete Smith's plan, and have an outstanding, deductible loan of the value of your original mortgage.

[KawaiiTentacleBeast]

Yeah I see my errors now I totally screwed up and forgot about all the compounding :P

Just substitute "rental property" for "ETF" and it's the same thing. Except you'll be reaping those 20% YoY "real estate always up" gains and leaving us less savvy investors in the dust. :lol:

[pitz]

Actually, according to Smith, you only convert the value of your original mortgage. The increased value that accumulates in your home over the years is yours to use as you wish. If you want to further leverage that equity, you could -- I believe Ed Rempel uses that technique; if you don't want to further leverage your home equity, then just complete Smith's plan, and have an outstanding, deductible loan of the value of your original mortgage.

Theoretically, if your home continues to appreciate in value, you could have it re-appraised, and obtain a mortgage (or extension of the LOC) for an additional amount.

Most people have their mortgages renewed/refinanced every 5 years anyways, so if the LOC is to be augmented, it occurs at that time.

[leftcoast]

I ran some quick #s a week ago. I assumed borrowed at bank prime rates (as a HELOC) and invested in a portfolio whose performance would mimic the RN Croft Growth Real World Index (google it). Data is available since 1997. Assuming a marginal tax rate of 47% on income/interest expense and a blended 30% tax rate on the investment returns (this is likely too high)...

...
Finally, it's harder to get historical data to run a similar analysis pre-1997, but certainly the leveraging part would have been a bad idea around 1990 with prime rates over 10%.

Interesting, thanks for sharing your work. I ran a similar backtest a few weeks ago, mostly to get a feel for the risk of leveraging over different time horizons.

I used historical S&P 500 returns for the portfolio performance, mainly because historical data going back several decades is readily available. I also used Cdn bank prime rates, going back to 1950.

Other key assumptions in my numbers:
1.) Modeled a "Flinstone Flip" rather than a true SM, so there's no gradual conversion or dollar-cost averaging.
2.) Assumes a buy-and-hold investment strategy; capital gains are deferred until the end of the time period.
3.) Marginal tax rate is 43.7%; dividend tax rate is 31.5% (non-eligible dividends in BC).
4.) Does not account for the effects of currency fluctuations, as pitz pointed out.

Here is the historical spread between the after-tax portfolio CAGR and the average annualized HELOC interest:
1950-1964 ... 9.56%
1951-1965 ... 8.96%
1952-1966 ... 6.90%
1953-1967 ... 8.57%
1954-1968 ... 6.14%
1955-1969 ... 3.40%
1956-1970 ... 3.11%
1957-1971 ... 4.75%
1958-1972 ... 3.48%
1959-1973 ... 1.56%
1960-1974 ... -0.65%
1961-1975 ... -0.27%
1962-1976 ... 1.62%
1963-1977 ... -0.31%
1964-1978 ... -1.12%
1965-1979 ... -1.16%
1966-1980 ... 0.93%
1967-1981 ... -1.38%
1968-1982 ... -1.21%
1969-1983 ... 0.58%
1970-1984 ... 0.56%
1971-1985 ... 1.34%
1972-1986 ... 1.18%
1973-1987 ... 2.69%
1974-1988 ... 6.16%
1975-1989 ... 5.75%
1976-1990 ... 3.77%
1977-1991 ... 6.27%
1978-1992 ... 6.54%
1979-1993 ... 6.30%
1980-1994 ... 4.70%
1981-1995 ... 7.97%
1982-1996 ... 8.49%
1983-1997 ... 9.27%
1984-1998 ... 11.00%
1985-1999 ... 10.50%
1986-2000 ... 8.45%
1987-2001 ... 7.10%
1988-2002 ... 4.35%
1989-2003 ... 4.50%
1990-2004 ... 5.75%
1991-2005 ... 4.32%
1992-2006 ... 4.79%


Over the past 42 years, there have been seven 15-year periods in which this would end up costing you money, all of which spanned the stagflation years of the 1970's. Over shorter time periods, however, it's a different story. And with a 25-year horizon, I'd be willing to bet that there's never been a period in which you'd come up short at the end.

I'd also appreciate any feedback on flaws in my assumptions, etc.

[pitz]

3.) Marginal tax rate is 43.7%; dividend tax rate is 31.5% (non-eligible dividends in BC).


In the context of foreign dividends, you should be counting dividends at the same marginal tax rate as income.



with a 25-year horizon, I'd be willing to bet that there's never been a period in which you'd come up short at the end.

I'd also appreciate any feedback on flaws in my assumptions, etc.

No major flaws, other than, fees are ignored, and actually investing in the S&P500 is something that would have been impossible. ETFs and index funds didn't exist until the 80s/90s. The only indexxers were certain pension funds.

US interest rates historically have been a tad bit lower than Canadian.

On a true 'mark to market' basis, it is very possible that this 'absolute return' strategy, in fact, would be less risky than that of directly investing in the S&P500 index with cash.

For example, if interest rates go up, typically the stock market goes down. But since you are leveraging against a mortgage with a much higher duration, the value of the mortgage, on a mark to market basis, also would go down, especially during the late 1970s. Such a portfolio would earn an absolute return (the spread between two types of assets, bonds, and stocks), rather than a specific return (the return of stocks against that of cash).

[notanexpert]

Interesting, thanks for sharing your work. I ran a similar backtest a few weeks ago, mostly to get a feel for the risk of leveraging over different time horizons.

I used historical S&P 500 returns for the portfolio performance, mainly because historical data going back several decades is readily available. I also used Cdn bank prime rates, going back to 1950.
...

Did you use the S&P 500 returns including dividends or excluding dividends?
Those negative numbers over a 15 year period in the 70's worry me a bit if the S&P500 return you used includes dividends.

[leftcoast]

Did you use the S&P 500 returns including dividends or excluding dividends?
Those negative numbers over a 15 year period in the 70's worry me a bit if the S&P500 return you used includes dividends.

Dividends are included, although I got the dividend tax rate wrong, as pitz pointed out. So the real numbers are actually a wee bit worse than those shown.

Keep in mind that the negative returns shown for those years do not represent negative returns for the S&P 500. They simply mean that the total after-tax returns from the S&P 500 did not keep up with the after-tax compounding happening in a HELOC over the same period of time.

The worst 15-year period for the S&P 500 on its own was 1964-1978, when the pre-tax CAGR was +4.7%. Unfortunately, the average annualized prime rate over the same period was 7%, so it wasn't a good time to be leveraged.

[pitz]

Dividends are included, although I got the dividend tax rate wrong, as pitz pointed out. So the real numbers are actually a wee bit worse than those shown.


How did you compute the tax on capital gains? I don't see any disclosure of the rates you were using? 50% inclusion?

Basically if you can cut your borrowing costs below prime (for instance, IB charges Prime - 0.75% and even Prime - 1.25% on larger amounts), you can reduce the number of negative periods down to 4 in 42, or less.

Thats why its very, very important to seek out the cheapest investments and cheapest borrowing possible. If you are borrowing at rates above prime, to invest in mutual funds with 2.5% MERs, the success rate really is diminished dramatically.

[leftcoast]

How did you compute the tax on capital gains? I don't see any disclosure of the rates you were using? 50% inclusion?

Yes, capital gains are taxed at half the marginal rate, which in this case is 21.9% (BC). The model assumes zero turnover in the portfolio, so capital gains are not realized/taxed until the end of the period.


Basically if you can cut your borrowing costs below prime (for instance, IB charges Prime - 0.75% and even Prime - 1.25% on larger amounts), you can reduce the number of negative periods down to 4 in 42, or less.

Yup, cutting your borrowing cost to [Prime - 1.25%] does indeed reduce the number of negative periods down to 4. What's IB's threshold amount for that rate?


Thats why its very, very important to seek out the cheapest investments and cheapest borrowing possible. If you are borrowing at rates above prime, to invest in mutual funds with 2.5% MERs, the success rate really is diminished dramatically.

Very true! There's definitely an element of luck to this, as with any endeavour, but there are also ways to stack the deck in your favour, at least over the long haul.

Having said that, I am personally still nervous about borrowing on margin. It's the whole long-term vs. short-term risk thing. If the markets crash, I am quite confident they'll eventually recover. So if I'm in it for 15+ years, and don't need to worry about repaying the loan before then because it's secured to my home, then I'm (probably) okay. But if I've borrowed on margin, don't I run the risk of getting a margin call as soon as the market turns south? I never get the chance to wait out the storm; I'm just dead. Or am I missing something altogether about the mechanics of borrowing on margin? I'd love it if someone could show me why my fears are unfounded.

Likewise, I'm conflicted about dividends. I really like all of the arguments put forward about their benefits in the SM, but they also increase the overall tax drag on your portfolio, especially in the highest tax bracket which is "unfortunately" where I reside. Sticking with just Canadian dividend stocks cuts the dividend tax by more than half (to 18.5%), but then you miss out on diversification, further increasing risk. Is it just that the benefits of dividends outweight the costs/risks? Or do you think there's some optimal asset allocation % for Canadian dividend stocks in this scenario?

[pitz]

Yup, cutting your borrowing cost to [Prime - 1.25%] does indeed reduce the number of negative periods down to 4. What's IB's threshold amount for that rate?


$1.2 million for Prime - 1.25%, and 115k for Prime - 0.75%.



to my home, then I'm (probably) okay. But if I've borrowed on margin, don't I run the risk of getting a margin call as soon as the market turns south? I never get the chance to wait out the storm; I'm just dead. Or am I missing something altogether about the mechanics of borrowing on margin? I'd love it if someone could show me why my fears are unfounded.


Well you could use a combination of a HELOC, and margin borrowing. Use the margin facility to do as much borrowing as is safe (figure out what amount of equity in your account is required to withstand a 20% drop), and supplement using the HELOC.

If the markets crash, transfer money from the HELOC to re-inforce the margin account.



Likewise, I'm conflicted about dividends. I really like all of the arguments put forward about their benefits in the SM, but they also increase the overall tax drag on your portfolio, especially in the highest tax bracket which is "unfortunately" where I reside. Sticking with just Canadian dividend stocks cuts the dividend tax by more than half (to 18.5%), but then you miss out on diversification, further increasing risk. Is it just that the benefits of dividends outweight the costs/risks? Or do you think there's some optimal asset allocation % for Canadian dividend stocks in this scenario?

I feel that SM users should go with a globally diversified portfolio, with a portion of their investment loan drawn in foreign currency, matched to the underlying currency of their investments.

If you are investing in US equities, you should do so with a US-dollar loan. If you are investing in Japanese equities, you should do so with a Yen loan. Etc.

[Paksis]

http://video.google.com/videoplay?docid=-2757699799528285056

What goes up usually comes down.

The most dangerous investment is an investment dependent on a tax loophole. Which can be closed at anytime. Try selling your investments in a down market and remember the tax implications as well.

[Spazmogen]

Fraser Smith is on tour this Spring!

HERE's (http://www.smfc.com/seminars/) his tour schedule. Seminars are free!


I'm already booked into the London, Ont seminar on May 30th.

May 28, 2007 Greek Community Centre Belleville, ON
May 29, 2007 Waterloo Inn & Conference Centre Waterloo, ON
May 30, 2007 London Convention Centre London, ON
May 31, 2007 Caboto Club Windsor, ON
June 26, 2007 Calgary Sheraton Cavalier Calgary, AB
June 28, 2007 Westin Bayshore Vancouver, BC

[pitz]

Fraser Smith is on tour this Spring!

HERE's (http://www.smfc.com/seminars/) his tour schedule. Seminars are free!


Take good notes; I am interested in the sorts of funds that his company recommends.

Ask him about the return of capital issue that has been identified earlier when investing in mutual fund trusts with borrowed money. The response should be....interesting...to say the least.

[Spazmogen]

Take good notes; I am interested in the sorts of funds that his company recommends.

Ask him about the return of capital issue that has been identified earlier when investing in mutual fund trusts with borrowed money. The response should be....interesting...to say the least.

pitz:
You need to go to the library and read his book. Its obvious you have not. Your financial knowledge is beyond mine, but you would not have made a comment about that, if you had read the book.

Fraser has written in his book, that he does not make investment recommendations other than anything that will make money, like mutual funds or stocks. He plainly says its between you & your advisor to choose what you want to invest in. He simply does not make recommendations as everyone has a different risk tolerance.

I am sure I will be one of several hundred in attendance there. If I get a chance to speak to him, it will be about my own personal situation. The seminars do not cost anything. Try attending yourself and asking him.

I plan to take excellent notes.

I am going for the sole reason of refining the technique of the Smith Manoeuvre. My investment advice comes from the branch manager of my local RBC DS office (http://www.rbcds.com/) which is why I pay the man. What I invest in, will be kept private. Only an idiot would try to do something like this themselves, by using a discount brokerage firm or online broker. If anyone is going to try this, get a professional full service advisor involved.

[notanexpert]

...
Only an idiot would try to do something like this themselves, by using a discount brokerage firm or online broker. If anyone is going to try this, get a professional full service advisor involved.

If I pay someone big bucks for investment advice, am I guaranteed that he will be able to beat the market for me??? If that is so, what if everyone did that? Are all people then going to be able to beat the market? No one's return will be below the average, everyone above? How's that possible?

All I'm saying is full service advisors are for suckers, OR for people who REALLY don't have a clue what they're doing.

[leftcoast]

This is from the FAQ section of the Smithman website:


15. Q: If my mortgage payment is a fixed amount every month but I'm increasing my loan on the line of credit (LOC) every month, I need to service the interest on that loan - so how can it be that no new money is required from me when this loan is increasing and my mortgage payment doesn't change?

A: On the west coast of Canada, several credit unions will let you capitalize the interest on the line of credit. ...

Does anyone have any experience using one of these CU's for the SM? Have any fellow British Columbians looked into them at all? (In his book Fraser frequently promotes Vancity as being the first institution to create a SM-friendly mortgage product.)

I'd be curious to know how many of the features on edrempel's list these CU's offer and how they compare overall to what the big banks offer:

1. Variable rate between prime -.8% to prime -.9%.
2. Allows multiple credit lines (add one for emergencies or for the Cash Dam).
3. Readvances automatically.
4. Allows automatic investing directly from the credit line.
5. Is fully open - no penalties to break the mortgage or refinance under any conditions.
6. No fees at all - no legal, appraisal, broker, or administration fee.
7. Can go in 2nd position if your current mortgage is not due yet and worth keeping.
8. No legal or appraisal fees to have the home reappraised every year or 2 and the credit line limit increased, so we can increase the SM as the home value rises.

[FinancialJungleGuy]

pitz:
Fraser has written in his book, that he does not make investment recommendations other than anything that will make money, like mutual funds or stocks. He plainly says its between you & your advisor to choose what you want to invest in. He simply does not make recommendations as everyone has a different risk tolerance.

If everyone has a different risk tolerance, why does he recommend leveraging? When you follow the SM, by definition, you will want to invest in securities that have a chance in beating the HELOC interest rate. Naturally, Fraser Smith expects you to take on higher risks when you practice his manouevre.

[pitz]

If everyone has a different risk tolerance, why does he recommend leveraging? When you follow the SM, by definition, you will want to invest in securities that have a chance in beating the HELOC interest rate. Naturally, Fraser Smith expects you to take on higher risks when you practice his manouevre.

Back when Smith got started doing the SM, you could leverage practically any sort of asset and make a profit. Even if you just leveraged GICs or long term bonds, you would come out with a profit for most of the 1980s and 1990s. Not very risky overall; and the nature of interest and taxation payments on GICs led to some time arbitrage as well.

Things have changed somewhat however. There is practically nothing you can leverage in terms of fixed income to generate a positive return. Preferred shares still can produce a positive return with the SM, but you have to be an expert on those, and you can get really burned with duration. Real estate returns going forward likely won't provide much 'juice' for additional returns. The income trust jig is up. And the sustainability of bank profit increases and commodity price increases is quite questionable.

On the matter of income trusts, IMHO, a lot of people have very serious misconceptions of how they work. Income trusts typically involve equity/capital stripping, which means that, eventually, the underlying assets will be impaired. A qualified professional planner could steer a leverager away from trusts, while an amateur might go, "lets bet the farm on this trust, it has an 8% yield and my interest is only 5%", even though the underlying asset might be an old pipeline with decrepit pumping facilities and a serious amount of maintenance work required going forward on the line itself.

[Spazmogen]

If everyone has a different risk tolerance, why does he recommend leveraging? When you follow the SM, by definition, you will want to invest in securities that have a chance in beating the HELOC interest rate. Naturally, Fraser Smith expects you to take on higher risks when you practice his manouevre.

its the age old risk vs reward.

Read his book as well. Its the process that is important here, not so much the investments.


Leverage: borrowing money to invest. Ie: going into debt to do it. Correct ?
You can spend time debating if the SM is leverage or not.

My thoughts:
SM is not leverage. The leverage occurred when you were approved for a mortgage. You bought a house with money that is not yours. Any equity built up in it over time IS yours. And unless you 'borrow' your $ back from the bank, it will always return you 0%.

SM is a static debt conversion. You do it with out increasing or lowering your current debt. So, its not technically leverage per say, but you're welcome to keep debatng that point. I won't be in that discussion.

Go back to page 23 of this thread and look at post 335 (http://www.redflagdeals.com/forums/showpost.php?p=4849680&postcount=335) by me. Look at that graph.
The horizontal black dotted line is total debt. Its flat, and remains flat throughout.

Lets keep this topic online guys, the purpose of the SM is to accelerate the payoff of your mortgage, the investments are secondary but still important. Merely having the investments at all, allows for the income tax break that is used to pay down the mortgage.

[leftcoast]

My thoughts:
SM is not leverage. The leverage occurred when you were approved for a mortgage. You bought a house with money that is not yours. Any equity built up in it over time IS yours. And unless you 'borrow' your $ back from the bank, it will always return you 0%.

SM is a static debt conversion. You do it with out increasing or lowering your current debt.

Depends on whether you capitalize the interest or not. The SM can be either debt-neutral or cash-flow-neutral, but it can't be both, and either way there are some risks involved.

From reading through this thread a couple of times, my impression is that most people here are capitalizing the interest on their loans. (I might be wrong on that?) Fraser certainly seems to endorse the idea in his book and website.

[NFtoBC]

My thoughts:
SM is not leverage. The leverage occurred when you were approved for a mortgage. You bought a house with money that is not yours. Any equity built up in it over time IS yours. And unless you 'borrow' your $ back from the bank, it will always return you 0%.

However recent modifications to this term have apparently been applied that are at odds with Smith on this one. Still to a certain extent is is in the hands of the mortgagor.



... the purpose of the SM is to accelerate the payoff of your mortgage, the investments are secondary but still important.

I understand it to be just the opposite: The SM is the conversion of non-deductible debt to deductible debt to build a portfolio, with the secondary process being the accelerated payment of the mortgage. See Page 1 of the book.

[leftcoast]

I feel that SM users should go with a globally diversified portfolio, with a portion of their investment loan drawn in foreign currency, matched to the underlying currency of their investments.

If you are investing in US equities, you should do so with a US-dollar loan. If you are investing in Japanese equities, you should do so with a Yen loan. Etc.

You know, you could probably write a book on this technique, call it "The Pitz Ploy," and go on tour. ;)

[Spazmogen]

I understand it to be just the opposite: The SM is the conversion of non-deductible debt to deductible debt to build a portfolio, with the secondary process being the accelerated payment of the mortgage. See Page 1 of the book.

I read it to be the opposite way that you did.

Because he mentions that once the mortgage is paid off, the user can at that point keep the loan and pay the interest out of pocket or collapse the investments & pay off the loan and walk away. He recommends that you keep the loan in place of course.

I can't quote the page # as the book has been loaned out to the 3rd person in 2 months.

Either way, its dependant upon the users intentions.
I intend to use it to accelerate my mortgage paydown. Instead of 15 years, its more in the 11-12 year range. After that, I don't know. It will depend upon the market conditions at the time around 2019.

[NFtoBC]

I read it to be the opposite way that you did.

Because he mentions that once the mortgage is paid off, the user can at that point keep the loan and pay the interest out of pocket or collapse the investments & pay off the loan and walk away. He recommends that you keep the loan in place of course.

Yes, I had great trouble accepting that for a long time after reading the book, however, if you accept that the increase in portfolio value is greater with the loan in place than by repaying it, then you keep the loan. Essentially, your estate pays it (or your Smith-wise children have been named as co-applicants!)


I can't quote the page # as the book has been loaned out to the 3rd person in 2 months.

I waited a long time for the return of my copy -- I'm not so free to lend it now! Have a look at chapter 1 when you have your copy in hand.



Either way, its dependant upon the users intentions.
I intend to use it to accelerate my mortgage paydown. Instead of 15 years, its more in the 11-12 year range. After that, I don't know. It will depend upon the market conditions at the time around 2019.

If that is how you choose to use the SM, then fly at it -- you & I appear to choose similar paths on that one. However, a financial planner, may offer options in managing your finances in manners that you had not considered. Have a chat with your choice of CFP, and see what results!

[florch]

I'm determined to keep this thread at the top of the heap.

I'm debating my asset allocation. It's sort of going along with whether to continue investing in my RRSP or not.

Here's my situation: Portfolio $100000<$500000
RRSP ~= 45% of my savings, distributed in low MER ETF's as:
40% Europe, Australia, Far East
20% US blue chip
20% US total market
20% Emerging Markets, or for well researched speculation.
I will move into a fixed income portion - later, we're still early thirties.

Non RRSP/SM ~= 55% and increasing
Canadian dividend producing ETF's 100% using Pitz's cascading method of reinvesting to mitigate capital gains.

Is the CanCon too high overall at 55%? It seems to be the most tax friendly way of doing this, I know this is at the expense of worldwide diversification.

Fire Away, please, that's how I learn.

[CDNPatriot]

I've concluded that going with a pure "smith manoeuvre" mortage results in a neglible advantage over a regular home line of credt.

Product One
Regular home line of credit
4.9% on mortgage of 156000
6% on home line of credit (75% leverage on home equity) $23750

Product Two
Bank readvancing product
5.14% on mortgage of $156000
6% on home line of credit (80% levarage on home equity ) $25000

Also, between two banks one bank stated that if I use all of my home equity in a leverage that insurance would kick in if I go over 80%
The other bank stated that this would not occur having to pay insurance on leveraged equity at over 80%

[fsmontenegro]

I'm determined to keep this thread at the top of the heap.

I'm debating my asset allocation. It's sort of going along with whether to continue investing in my RRSP or not.

Here's my situation: Portfolio $100000<$500000
RRSP ~= 45% of my savings, distributed in low MER ETF's as:
40% Europe, Australia, Far East
20% US blue chip
20% US total market
20% Emerging Markets, or for well researched speculation.
I will move into a fixed income portion - later, we're still early thirties.

Non RRSP/SM ~= 55% and increasing
Canadian dividend producing ETF's 100% using Pitz's cascading method of reinvesting to mitigate capital gains.

Is the CanCon too high overall at 55%? It seems to be the most tax friendly way of doing this, I know this is at the expense of worldwide diversification.

Fire Away, please, that's how I learn.

Hi lflorch,

Similar situation (age, net worth) here. Until now my allocation has been about:
1/3 Canada (1/2 each Active and passive index)
1/3 US (1/2 active, 1/2 passive index)
1/3 EAFE (1/2 EAFE index, 1/2 emerging market index)

So far about 80% in RRSPs and 20% non-reg/SM. No fixed income (after all, I have a mortgage to deal with first...)

My thoughts:
- Other than employer-matched RRSP contribs, we're putting a hold on RRSP contributions for now. Two reasons: accelerate SM and have flexibility with non-reg content (think "daycare costs"... :-) )
- I'm reducing Canadian exposure from approximately 33% down to no more than 10-15%. Ratonale: resource run has been great but will eventually wind down. Also, Canada accounts for ~3% of WW markets, so I'm trying to reduce the overweight we currently have. This overweight in Canada we had was a combination historical (remember that we need 70% Canadian content in RRSPs until recently...) and early decisions (1/3 each major region).
- While I'm still searching for the best place (reg/non-reg) for each type of investment, I'll say don't forget that dividends from foreign investments in a non-reg account are taxed as income... Also, it *seems* to me that the best way to hold US assets is direclty through a *US* ETF in an RRSP (as opposed to a Canadian one), as the Canada-US tax treaty specifies no tax withholding on distributions for Canadian retirement accounts.

Take what I wrote above with a grain of salt. I'm not an accountant, lawyer or financial planner....

Keep the discussion going...

Cheers!
BTW: Can you ellaborate a little on the cascading method you mentioned?

[florch]

Two reasons: accelerate SM and have flexibility with non-reg content (think "daycare costs"... :-) )


Tru dat


- I'm reducing Canadian exposure from approximately 33% down to no more than 10-15%. Ratonale: resource run has been great but will eventually wind down. Also, Canada accounts for ~3% of WW markets, so I'm trying to reduce the overweight we currently have. This overweight in Canada we had was a combination historical (remember that we need 70% Canadian content in RRSPs until recently...) and early decisions (1/3 each major region).

I agree but...with trying to expand my SM, we have to choose between Canadian stocks for the dividend advantages or non-Canadian stocks for the diversification. That's why my entire RRSP portion is now non-Canadian. I guess the big question is how to manage the non-RRSP/big picture...


- While I'm still searching for the best place (reg/non-reg) for each type of investment, I'll say don't forget that dividends from foreign investments in a non-reg account are taxed as income... Also, it *seems* to me that the best way to hold US assets is direclty through a *US* ETF in an RRSP (as opposed to a Canadian one), as the Canada-US tax treaty specifies no tax withholding on distributions for Canadian retirement accounts.

Take what I wrote above with a grain of salt. I'm not an accountant, lawyer or financial planner....

Me either, (obviously) - I feel like I've learned a lot on this thread. I'd be more confident that I could ask a CFP or CA intelligent questions now and not get stick handled into something I don't want.




Cheers!
BTW: Can you ellaborate a little on the cascading method you mentioned?

Search Pitz's comments in this thread regarding cascading. I'd just butcher it;)

[cannon_fodder]

IIRC (and this may be pertinent to those going into the SM who have significant Canadian content in their RRSP's and little non-registered assets) one can transfer 'in kind' assets between a non-registered and registered portfolio.

If there is a loss, you can't claim it when transferring into the RRSP, and if there is a gain, you are deemed to have sold it before it goes in. Likewise, you get no benefit when transferring out (nor do you get a hit).

If that is true, this may help people balance out their total investment structure without having to sell anything.

For example, let's say you had $100k in RRSP's, of which 50% were CDN dividend paying funds/equities. You start the SM and you tap into some additional equity built up to the tune of $50k. You could buy $50k of foreign equities and then 'swap' them with the CDN equities that were in the RRSP. This way your registered portfolio doesn't suffer any penalties for foreign dividend income and you get the benefits of having CDN dividend income treated efficiently when in a non-registered portfolio.

Of course, if I'm wrong, ignore everything I've said. And even if I'm right, there are probably a long line of people who could poke holes in my thinking.

[pitz]

For example, let's say you had $100k in RRSP's, of which 50% were CDN dividend paying funds/equities. You start the SM and you tap into some additional equity built up to the tune of $50k. You could buy $50k of foreign equities and then 'swap' them with the CDN equities that were in the RRSP. This way your registered portfolio doesn't suffer any penalties for foreign dividend income and you get the benefits of having CDN dividend income treated efficiently when in a non-registered portfolio.


I'm not so sure that you can just substitute investments, and keep the interest deductible.

I'd prefer to structure an arrangement where you continue to have a very clear trail between money borrowed, and investment purchased.

For instance, just sell all your Canadian equities in the RRSP, and replace them with foreign, and then use the proceeds of your investment loan to buy Canadian equities outside. No swapping required, and the money trail remains clean.

Might cost you a few commissions, but, IMHO, its very worthwhile to keep everything neat and tidy, just in case the friendly CRA decides to scrutinize your transactions and deductions.

BTW, in a RRSP, you are exempt from US withholding, but you are still subject to withholding from other countries. The preference, obviously in a RRSP, is to use US dividend-paying equities.

But beware of exhorbiant forex charges by the banks. The banks often require you to convert your dividends into Canadian dollars (at the high rates), before you can re-invest them.

[CDNPatriot]

Was considering using Berkshire Hathaway as an investment for my SM. Any pitfalls to using this rather then dividend yielding ETFs?

[CDNPatriot]

I want to figure out which 5 year term mortgage is better for me does the smithman calculator help with this or is it like the other calculator someone posted on here a while ago that doesn't work for this comparison.

[Spazmogen]

CDNPatriot:
I was the guy that posted the screen shots of the Smithman Calculator.
It does not take into consideration what type of mortgage you have. It assumes you have an open mortgage.

In the book, Fraser only briefly touches upon mortgages. he says: "stay short & open & variable and you'll save thousands." Fraser could have done us a better service by delving to what types of mortgages work best. That way, he could explain it without making recommendations about banks.


I chose the RBC Homeline (http://www.rbcroyalbank.com/RBC:hmln07springdrtve/products/mortgages/campaign/homeline_mar07_a.html) because it has automatic re-advances and those advances are free. I split my mortgage into 2 parts inside the homeline: 5 year fixed (my current mortgage, which is up Aug 2nd anyway) and a 5 year open-variable @ 5.25%. This way I can hammer down the open-variable part for now. When the fixed portion comes up in Aug 2007, I will convert it to open & variable as well. Or see if I can merge them into 1 open-variable mortgage in August. Mortgage interest rate is prime -.75 and HELOC @ prime.

I didn't even bother to ask if I can capitalize the interest. I just had them set up a smaller credit line for $5K. I'll manually capitalize the interest every month.

[pitz]

Was considering using Berkshire Hathaway as an investment for my SM. Any pitfalls to using this rather then dividend yielding ETFs?

Unless you are in Quebec, there are not really any pitfalls, other than currency risk. BRKA/BRKB are still eligible for interest deductibility because the potential exists that the company may pay dividends.

Perhaps take out a portion of your mortgage or LOC in US dollars to mitigate this risk? (by this, I mean, have the loan written to be repayable in US dollars).

Although one could argue that BRKA/BRKB's operations are international in nature, and as such, are somewhat naturally hedged against US dollar declines.

You do run the risk that something bad will happen to the company once its main shareholder passes away however. I certainly wouldn't devote the entirety of a SM portfolio to one stock in lieu of exposure to a broader index such as the S&P500.

[john kason]

I have had the process implemented for 3 years now and the process is easy and legal

there are several things that make the process easier

at least 20% equity in your home
a non registered portfolio
a time frame of at least 5 years
some understanding of investment risks
an advisor that understands where the new investment funds have come from
investments that generate dividends that at least match the net after tax benefit of borrowing (this is a John Rule)
A income that is at least in the 30% marginal tax bracket

An advisor that can sell you both mutual funds and stocks
A mortgage person that can provide a home equity mortgage that also acts as a chequing account and can be subdivided out

www.johnkason.com

[CDNPatriot]

I've asked this question before but wanted some clarification.

I'm thinking of going with a simple home equity line of credit as the one year rate is the lowest out of all the 5 year smith manoeuvre mortgage products (RBC and Firstline). I'm thinking of waiting a year as I lose money the first year if I go with the matrix or the RBC one. So I'm opting for the one with the credit union. Other then the 75% as opposed to 80% and the fact that it does not readvance are there any other ramifications to using simple leverage using home equity line of credit?

[pitz]

I'm thinking of going with a simple home equity line of credit as the one year rate is the lowest out of all the 5 year smith manoeuvre mortgage products (RBC and Firstline). I'm thinking of waiting a year as I lose money the first year if I go with the matrix or the RBC one. So I'm opting for the one with the credit union. Other then the 75% as opposed to 80% and the fact that it does not readvance are there any other ramifications to using simple leverage using home equity line of credit?

Typically the profitability of the SM is enhanced when one obtains the lowest interest rate possible on borrowing.

HELOCs are typically at prime. Actual amortizing mortgages with principal + interest payments typically are below prime, often close to 1% below prime, or fixed.

Borrowing at 6% isn't the end of the world, but with the equity markets getting pretty heated lately, the threshold for profitability is somewhat higher than it would be with lower-cost borrowing.

[jjpjjp]

Just went through a proposal with a mortgage broker and a financial plannner with Smith Man calculator. I am curious to know what others have/are paying to set this up...this particular group was asking for $1500 set up fee + appraisal cost on house + $40 per month (minimum one year). A bit rich IMO as the Planner and broker will be making commissions on mortgage and investments as it is. I appreciate any feedback as I think the SM has merit.

[jjpjjp]

Another question that arose during the presentation...what happens if you purchase another property and then designate it as your principle residence, AND keep the original property (now your secondary property) which the SM is set up with? Can you 'unwind' the plan or transfer the plan to your new residence? As seasonal properties are very valuable nowadays it may make sense in some cases to keep them as principle residence designations for Cap gains purposes.

[netwise]

Another question that arose during the presentation...what happens if you purchase another property and then designate it as your principle residence, AND keep the original property (now your secondary property) which the SM is set up with? Can you 'unwind' the plan or transfer the plan to your new residence? As seasonal properties are very valuable nowadays it may make sense in some cases to keep them as principle residence designations for Cap gains purposes.

Shouldn't it just be okay to leave it as is? The point for the SM is to make the investment interest tax deductable to build a portfolio with. If you designate the property as secondary or revenue, isn't any interest associated with it (line of credit or primary mortgage) all tax deductable anyway? That said, I can see how it would make sense to refinance the secondary completely, so it has as much mortgage interest as possible, and use the funds to pay down the new principal residence so you can have free equity to use again for the secured line of credit. Something like that anyway.

[florch]

Just went through a proposal with a mortgage broker and a financial plannner with Smith Man calculator. I am curious to know what others have/are paying to set this up...this particular group was asking for $1500 set up fee + appraisal cost on house + $40 per month (minimum one year). A bit rich IMO as the Planner and broker will be making commissions on mortgage and investments as it is. I appreciate any feedback as I think the SM has merit.

Do you feel confident you could do it yourself, as in are you a DIY investor already? Or maybe shop around to another CFP. I wonder what other posters think of just setting it up with an accountant at an hourly rate. It seems like your people are sucking the fun out of it.

You can try the Manulife One Mortgage as one example to make it much easier to DIY. For all the bashing people on here do about the Manulife one mortgage, it solves some problems such as absorbing mortgage transfer costs, and most appraisal costs. After that $14/Month X 12= $168 per year in fees, but if you normally keep a $2000 buffer in the chequing account (like we did) you recoup $100 of that in interest, the rest could be written as convenience for not having to manually readvance your LOC. My time is worth something.

As for the higher rate it could blend out as low as .5% over the best rate if you lock in 75% and blend the rates. Half a point on $100k = $500, about the cost of closing down a HELOC and reopening it to capture paid down principle. I admit this falls apart if your mortgage is much higher, but this doesn't even touch on the capital gains that could be involved to do this.

I hope I didn't overwhelm you, but I don't have a lot of love for Mortgage Brokers. My feeling is that they provide a convenience but no benefit in results. The results you'd get by shopping yourself is worth the effort. Then they want to stick their fingers in pies they haven't earned...(I have a story for you one day...)

[florch]

I just did a 25 year excel comparison of
A) paying off my house at the current rate and investing the balance in my RRSP until the house was paid, then continuing to invest everything in my RRSP
B) paying off my house at the current rate and investing the balance in my Non-RRSP until the house was paid, then continuing to invest everything in my non-RRSP
and C) doing the SM until my house was paid off, continuing to invest outside my RRSP for the balance, still leveraged at the original amount (with thanks to Cannon Fodder)

At 8% return, the numbers are close, with A providing the biggest nest egg, slightly larger than C. Using 2007 tax rates, A & B would provide a similar take home, and C would provide a slightly better retirement (which I had hoped, given the risk and initiative taken.)

At 10% return, C is the clear winner, regardless of any tax considerations, although a hybrid of C & A may be a good way to shed risk of tax law changes or forced capital gains in the interim if you feel the need to change investments/rebalance or whatever.

Not within the scope of the exercise was fluctuations in interest rates or dollar cost averaging to take advantage of the market, so any conclusion could be drawn, but I believe in the very long term 6% interest is near average. Also, if a $200K LOC looks daunting today, it may not in 15 or 20 years, when it's worth about 50K in today's dollars.

Your mileage may vary...

These are just my specifics, but I felt like it was a worthwhile exercise...

[FrugalTrader]

Just went through a proposal with a mortgage broker and a financial plannner with Smith Man calculator. I am curious to know what others have/are paying to set this up...this particular group was asking for $1500 set up fee + appraisal cost on house + $40 per month (minimum one year). A bit rich IMO as the Planner and broker will be making commissions on mortgage and investments as it is. I appreciate any feedback as I think the SM has merit.

That is a bit expensive. In my opinion, you'd be better off finding your own mortgage, and taking the HELOC money and bringing it to a good financial planner.

[edrempel]

Just went through a proposal with a mortgage broker and a financial plannner with Smith Man calculator. I am curious to know what others have/are paying to set this up...this particular group was asking for $1500 set up fee + appraisal cost on house + $40 per month (minimum one year). A bit rich IMO as the Planner and broker will be making commissions on mortgage and investments as it is. I appreciate any feedback as I think the SM has merit.

Hi JJPJJP,

I know who you mean. They are mortgage brokers that runs seminars and then hire financial advisors that just do the investments.

All those fees are just for the mortgage broker and are the highest I am aware of. I believe the standard mortgage broker fee is on top of that. The best SM mortgages are through some of the major banks and are not available to mortgage brokers.

Your best bet is to use your advisor or find a financial advisor that understands the SM and all the enhancement strategies and can figure out the best implementation for you. Then get your SM mortgage from a major bank, where you can avoid all those fees.



Ed

[edrempel]

[QUOTE=florch;5097712]At 8% return, the numbers are close, with A providing the biggest nest egg, slightly larger than C. Using 2007 tax rates, A & B would provide a similar take home, and C would provide a slightly better retirement (which I had hoped, given the risk and initiative taken.)QUOTE]

Hi Florch,

If you are comparing the size of the final nest egg, your 3 options are not comparable. Option A is a before tax portfolio, while options 2 & 3 are after tax portfolios.




Ed

[edrempel]

I've asked this question before but wanted some clarification.

I'm thinking of going with a simple home equity line of credit as the one year rate is the lowest out of all the 5 year smith manoeuvre mortgage products (RBC and Firstline). I'm thinking of waiting a year as I lose money the first year if I go with the matrix or the RBC one. So I'm opting for the one with the credit union. Other then the 75% as opposed to 80% and the fact that it does not readvance are there any other ramifications to using simple leverage using home equity line of credit?

Hi CDNPatriot,

Why would you want to go with a 5-year mortgage? Unless it is a variable, you should always avoid the "5-year fixed mortgage trap". While mortgage brokers and banks always encourage them, they have cost more than variable or 1-year mortgages 100% of the time since 1950. Stick with variable mortgages or short term, such as 1 year.

Why would you be losing money in the first year with Matrix or RBC, but not with the credit union? Other than this, what advantage is there of the credit union mortgage. While I support the credit union movement, they don't currently have a proper SM mortgage.



Ed

[phildc]

Why would you want to go with a 5-year mortgage? Unless it is a variable, you should always avoid the "5-year fixed mortgage trap".
Ed

For the past 5 years I've gone variable since it was the lowest possible rate. I just renewed mine at 5% fixed for 5 years vs (Prime-.75) == 5.25% Open variable at RBC. Why take the added risk of the open variable rate when you can get rate stability at a lower cost?

[florch]

Hi Florch,

If you are comparing the size of the final nest egg, your 3 options are not comparable. Option A is a before tax portfolio, while options 2 & 3 are after tax portfolios.




Ed[/QUOTE]

You are right, and I know...I guess that the size of the nest egg makes the taxation relevant. Somebody said to me the other day, "The point of an RRSP is to put money away taxed deferred so that when you retire you can withdraw it, hopefully at a lower rate."

I said "Hopefully not at a lower rate..." I don't know if it was the dumbest thing I've ever heard but it isn't my ambition to retire in the lowest tax bracket.

[NFtoBC]

I said "Hopefully not at a lower rate..." I don't know if it was the dumbest thing I've ever heard but it isn't my ambition to retire in the lowest tax bracket.

It strikes me that even if you remain in the same tax bracket, you will pay less tax on with drawl of an RSP. Your deduction is at your Marginal Rate, while your withdrawal in retirement is at your Average Rate.

Still, you may be far ahead to have a tax advantaged un-registered portfolio than pay full taxes on withdrawal from an RSP. Here in BC you can have a considerable dividend income without taxation, so planning is essential to derive the greatest benefit.

[florch]

It strikes me that even if you remain in the same tax bracket, you will pay less tax on with drawl of an RSP. Your deduction is at your Marginal Rate, while your withdrawal in retirement is at your Average Rate.

Still, you may be far ahead to have a tax advantaged un-registered portfolio than pay full taxes on withdrawal from an RSP. Here in BC you can have a considerable dividend income without taxation, so planning is essential to derive the greatest benefit.

Good point, re:avg. vs. marginal rate - I learn something every day! I was thinking about advantaged rates for cap. gains and dividends, although these rules do seem to change over the years. May be a good reason to split your savings to some degree.

[CDNPatriot]

"Why would you want to go with a 5-year mortgage? Unless it is a variable, you should always avoid the "5-year fixed mortgage trap". While mortgage brokers and banks always encourage them, they have cost more than variable or 1-year mortgages 100% of the time since 1950. Stick with variable mortgages or short term, such as 1 year."

I tried but my broker stated that Firstline Matrix would not give me a variable rate due to the fact I was leveraging and added risk. Was this just a sales pitch?

"Why would you be losing money in the first year with Matrix or RBC, but not with the credit union? Other than this, what advantage is there of the credit union mortgage. While I support the credit union movement, they don't currently have a proper SM mortgage."

I would be losing money as the credit union offered me 4.90 percent one year but wanted to stick it to me for an appraisal fee. Matrix was 5.19 with 5.6 on the line of credit. And RBC offered me 5.09 with 6 on the line of credit.

[CDNPatriot]

I'm planning on using the following portfolio.
(all ishares)
CDN Composite Index Fund XIC 6%
CDN S&P 500 Index Fund XSP 30%
CDN MSCI EAFE Index Fund XIN 24%
CDN Bond Index XBB 40%

will rev Canada be on my case for investing in a bond index?

[pitz]

CDN Composite Index Fund XIC 6%
CDN S&P 500 Index Fund XSP 30%
CDN MSCI EAFE Index Fund XIN 24%
CDN Bond Index XBB 40%


Ditch the Bond Index fund and re-allocate accordingly. Also, you are making a tremendous bet against the TSX index; I would suggest going 46% XIC.

The quality of dividend income (ie: tax preferrence) is better with XIU than XIC as well, and liquidity is much better with XIU and lower spreads.



will rev Canada be on my case for investing in a bond index?

Well it doesn't provide expected returns greater than the mortgage's interest rate. So why bother investing in it; if you want a fixed income allocation, merely reduce the amount of SM you are going to execute.

For instance, the SM is based on the concept that for every $1 in principal you pay down, you borrow back $1 and invest it.

If you want a 40% bond allocation (because of risk tolerance), merely only borrow back $0.60 for every $1 in principal paydown.

And no, the CRA won't have a problem with it, but it just doesn't make sense.

[CDNPatriot]

It was my understanding that bonds move the opposite of stocks and that from Jan 1990 to Dec 2002 Canadian bonds averaged 9.7 % and cdn equities 7.2%

[pitz]

It was my understanding that bonds move the opposite of stocks and that from Jan 1990 to Dec 2002 Canadian bonds averaged 9.7 % and cdn equities 7.2%

Sure, but do you understand *why* that occurred? I do -- it was entirely to do with horribly depressed resource prices, and a long-term fall in interest rates (not to mention all the stuff in Quebec, and some very investor unfriendly governments in power). Also, the after-tax return on cdn equities still was better because of the preferential nature of capital gains tax, and the dividend tax credit.

You really have to think of your mortgage as being a 'negative bond', or a 'short' position in bonds, because a mortgage itself is a bond.

Basically put, if you borrow $1000 from the bank at 5.5%, and invest it at 4.5%, are you making money? No, and in fact, you are losing money. But that is exactly what you are doing when you invest mortgage proceeds into a bond fund today.

Start another thread and you'll get others explaining much of the same to you; if your risk tolerance doesn't call for a 100% equity allocation for your SM investing, you should merely cut back on your use of the SM, rather than try and use the SM entirely, and invest in a bond fund.

[CDNPatriot]

Thanks Pitz. Does anyone know of any ETFs that have lower fees then ishares and that are in Canadian currency?

[pitz]

Thanks Pitz. Does anyone know of any ETFs that have lower fees then ishares and that are in Canadian currency?

Personally I'd suggest getting yourself an Interactive Brokers account, and investing directly in Vanguard's ETFs in US currency, at least for the US portion of your portfolio.

Instead of borrowing Canadian dollars through your mortgage (ie: Smith Manouevre), borrow US dollars through IB, for the US portions of your investments.

Thus, you save on currency hedging, and Vanguard's ETFs are much less expensive than iShares.

Also, Vanguard has a new fund coming out, called "VEA", which provides the EAFE exposure, but costs roughly half of the iShares EFA, and roughly a third of the cost of XIN.

[edrempel]

It was my understanding that bonds move the opposite of stocks and that from Jan 1990 to Dec 2002 Canadian bonds averaged 9.7 % and cdn equities 7.2%

Hi Patriot,

Wouldn't a true patriot believe in stocks - not bonds???

The return of the TSX from 1990 is 11.2% vs. TSX Broad Market Bond index of 9.3%. You picked a rare point at the bottom of a bear market at the end of 2002. You can pick the odd specific time period where bonds perform okay, but long term the returns are much lower than stocks.

Bonds have had the highest possible perform you can ever expect since 1982, since interest rates have declined almost every year since then. How many more decades of continual interest rate declines can you anticipate now?

Long term, since 1950, bonds have averaged 7.7% vs. 10.5% for the TSX and 12.2% for the S&P500. $100 in 1950 would have grown to $6,092 in bonds, $25,743 in the TSX and $60,688 in the S&P500.

In short, bonds have had less than 1/4 of the return of stocks long term.


Bonds moving the opposite of stocks is a commonly held myth. In fact, the correlation is near zero, which means that it moves opposite to stocks 1/2 the time and moves with stocks 1/2 the time. You can get almost as good diversification with boring stock sectors that have low correlations, such as consumer staples, utilities, and real estate without giving up so much growth - and without giving up the tax advantages of stocks.

Even the S&P500 has had a relatively low correlation to the TSX lately.

If you properly diversify your portfolio, you need little or no bonds to keep the risk level of your portfolio to a reasonable level. And having bonds really dampens the tax advantages of the Smith Manoeuvre.




Ed

[florch]

At the risk of being gonged, does anyone have thoughts on using <a diversified US-based, non-dividend-paying conglomerate> for this?

It seems to be a well diversified business that routinely outperforms and doesn't pay dividends. I know that the Founder is getting older, but he seems to be in good health, interested in continuing for now, and has a plan for both a seamless transfer of leadership to well chosen and groomed managers and non-disruptive removal of capital.

They are also of the size where a small change in thinking (succession) or ability to buy meaningful assets could precipitate dividends. Would this satisfy the CRA enough to keep interest deductible? My thinking is that a US ETF that produces no income, only cap. gains will continue to do so as its mandate and therefore be ineligible, whereas most growth stocks eventually settle down to paying dividends, thereby a more than reasonable expectation of income from holding any given stock.

[pitz]

At the risk of being gonged, does anyone have thoughts on using <a diversified US-based, non-dividend-paying conglomerate> for this?


Would you hedge out the currency risk (by taking out your loans in US dollars)? Do you know how much of the business is derived from activities outside of the US?



They are also of the size where a small change in thinking (succession) or ability to buy meaningful assets could precipitate dividends. Would this satisfy the CRA enough to keep interest deductible? My thinking is that a US


Yes, such an investment should be deductible.



ETF that produces no income, only cap. gains will continue to do so as its mandate and therefore be ineligible, whereas most growth stocks eventually settle down to paying dividends, thereby a more than reasonable expectation of income from holding any given stock.

I don't think deductibility is the issue. The issue, at least for a Canadian, is the extent of currency hedging applied, and of course, whether you want the extreme amount of turbulence this stock could perhaps bring when its leader passes away.

[florch]

Well, as per your advice and my own DD on same (thank you) I was going to open an IB account for the exchange rate, as opposed to the US portion of my TD account. Seems like I could win on interest and exchange.

Speaking of interest, If I were to use an IB account for margin I would reduce my SM leverage accordingly, but if I'm living below my means, I wouldn't necessarily have to, would I?

For instance, if we bought a larger home, I could take on more debt than the current 75/80% of equity, so would a TDS ratio be reasonable for assuming an LOC+margin maximum debt, or is there another ratio, maybe to do with portfolio equity (beyond your margin rate). I hope I'm making sense. I don't intend to do such a thing yet, but once this is operating for a couple years, if it's successful, we may look at this as opposed to extending our LOC again. (Wife is working PT until the kids are in school.)

BTW, the reason this company is of interest is that we are already using ETF's inside the RRSP's, but may need more US content to keep our portfolio in line as the SM grows. I know there could be the perception of weakness when the leader moves on, but I really don't believe he'd leave it in bad hands. Buying opportunity at the time if anything, IMHO.

[pitz]

Speaking of interest, If I were to use an IB account for margin I would reduce my SM leverage accordingly, but if I'm living below my means, I wouldn't necessarily have to, would I?


Well theoretically you could take out the full loan from your HELOC, and then put it all into futures with IB. That would give you a crazy amount of leverage.

Quite frankly, you need to assess your risk tolerance, and act accordingly. Stock market returns will not remain swell for the rest of eternity, and there will be volatility along the way.



For instance, if we bought a larger home, I could take on more debt than the current 75/80% of equity, so would a TDS ratio be reasonable for assuming an LOC+margin maximum debt, or is there another ratio, maybe to do with portfolio equity (beyond your margin rate). I hope I'm making sense. I don't intend to do such a thing yet, but once this is operating for a couple years, if it's successful, we may look at this as opposed to extending our LOC again. (Wife is working PT until the kids are in school.)


There is no set formula, but I think you should calculate what your financial position would be if your house and your portfolio simultaneously lost 30% of their value. Would you survive or not?



BTW, the reason this company is of interest is that we are already using ETF's inside the RRSP's, but may need more US content to keep our portfolio in line as the SM grows. I know there could be the perception of weakness when the leader moves on, but I really don't believe he'd leave it in bad hands. Buying opportunity at the time if anything, IMHO.

Sounds reasonable. But I certainly wouldn't put 100% of a US portfolio into one stock, no matter how diversified the underlyings are, compared with at least some S&P500 (or Total Stock Market) exposure. Don't obsess too much over dividend taxes either.

[florch]

Quite frankly, you need to assess your risk tolerance, and act accordingly. Stock market returns will not remain swell for the rest of eternity, and there will be volatility along the way.

There is no set formula, but I think you should calculate what your financial position would be if your house and your portfolio simultaneously lost 30% of their value. Would you survive or not?

Sounds reasonable. But I certainly wouldn't put 100% of a US portfolio into one stock, no matter how diversified the underlyings are, compared with at least some S&P500 (or Total Stock Market) exposure. Don't obsess too much over dividend taxes either.

Yeah, we are implementing the SM over about a year anyway to get used to the interest differences and to use dollar cost averaging (as a risk reducer in a high market - I know theoretically the returns may be worse). After that we would decide to take it further, and then in small increments. Like I said, we currently live below our means with very likely an increased family income in about 4 years, so our cash flow is very good and improving. We could buy a bigger house today, but are delaying the gratification to help meet our longer term goals.

Using margin is an afterthought, and I am a very controlled person, so would figure out our tolerances before hand. I have a year to understand margin better, so it's not like I'm jumping in, just priming the idea pump.

The US portfolio like I said is in our RSP's in ETF's and this would be the start of a small supplementary US portion maybe 5 to 10 stocks totaling up to 30% of our US interests. The alternative is to purchase more RSP's. Thanks for the dividend point (I'll relax on that now:)), and re: volatility, we managed to buy June's portion late Thurs. so hopefully got what will eventually be a discount;) I know it cuts both ways.

[sstackho]

One thing that I haven't seen discussed in this thread too much is what people are being charged on the HELOC portion of the loan. It sounds like the standard is prime, although I saw one post from two years ago that referred to prime - 0.5%.

Can anyone get better than prime on the HELOC portion from their readvanceable mortgage lender?

I see that pitz has referred that IB's margin loans are at a better rate - and that also seems like the best (only?) way to get a USD-denominated loan. But this isn't an option until some equity has been built up.

[controlyar]

One thing that I haven't seen discussed in this thread too much is what people are being charged on the HELOC portion of the loan. It sounds like the standard is prime, although I saw one post from two years ago that referred to prime - 0.5%.

Can anyone get better than prime on the HELOC portion from their readvanceable mortgage lender?

I see that pitz has referred that IB's margin loans are at a better rate - and that also seems like the best (only?) way to get a USD-denominated loan. But this isn't an option until some equity has been built up.


A Heloc also requires equity too.
CIBC has prime - 1.01 until Oct.30/2007 and then it raises to prime.

[notanexpert]

...
I see that pitz has referred that IB's margin loans are at a better rate - and that also seems like the best (only?) way to get a USD-denominated loan. But this isn't an option until some equity has been built up.

Most brokers offer margin in US$. I know for a fact that BMO Investorline, TD and CIBC offer US$ margin loans. The interest rate is not as attractive as a HELOC. IB will offer more attractive interest rates.

[sstackho]

Since the BMO Readiline product isn't portable, we are considering on going with a conventional mortgage and a HELOC.

I am trying to figure out the exact disadvantages of this approach vs being with a true re-advanceable mortgage (e.g. Readiline). Our plan is to take out a mortgage+HELOC for 65% of the house appraisal value at the time of sale. However, we will not max out the HELOC right away. Our plan is to start with a smaller amount of investments (say $50,000), and then convert the mortgage into the HELOC over time.

As far as I can see, the main disadvantage will come when we max out the HELOC, and then we will have to apply to get it increased. Is this that much of a downside? I don't know if there are additional fees associated with this at the time of the increase.

One downside for sure is that the conventional+HELOC approach costs an extra $140 in fees upfront - but at least then we can move (if necessary) without having to pay thousands of dollars in interest penalties if we took the non-portable Readiline mortgage.

Opinions appreciated!

[florch]

We used to have a PC HELOC, but never used it for the SM. The problem (at least for PC) was that when I went to ask for an increase, the response was that I had to close out the old HELOC in order to open a new one at a cost of about $450 IIRC. I didn't get around to asking if I could transfer the balance to the new one, just went straight to M1 (which is portable). $450 every couple years more than pays for the fees associated with M1. If you had to pay it out to transfer it, that would include Cap Gains etc, so that would be even worse if that's the case.

To do it all over again, I might have checked out Firstline's Matrix Mortgage or similar, but I'm not going to dick around with something that's not portable or that I have to go to a branch in order to reclaim the LOC.

[sstackho]

Hi all,

I have some accounting questions.

What are all of you doing in terms of your brokerage account, and keeping it separate (or not) from any investments that are not part of the SM?

I will have some investments outside of SM (e.g. money put aside for renovations in the short-term) and I am worried about the funds commingling with investments from funds that I want to be tax-deductible under SM.

Can this all be done in one brokerage account (with proper paper trails of deposits), or should I open a completely separate account for SM investments?

[pitz]

I will have some investments outside of SM (e.g. money put aside for renovations in the short-term) and I am worried about the funds commingling with investments from funds that I want to be tax-deductible under SM.


Personally I maintain a seperate LOC for that purpose, and remain fully invested. If you shop around and have otherwise good credit, you can still get a 8% LOC, on an unsecured basis. Or even one of those Capital One credit cards at Prime + 1% (7%).



Can this all be done in one brokerage account (with proper paper trails of deposits), or should I open a completely separate account for SM investments?

If you insist on a seperate pool of investments (not as efficient, IMHO, as laundering excess cash through the SM first), then yes, you should open a seperate account just to simplify the bookkeeping.

Basically, with a SM investment account, the only withdrawals that should *ever* be made from the account are the dividend payments. Removing any portion of the investment will lead to a loss in deductability.

Of course, if you receive no dividends, then I really have to question whether you have implemented the SM properly. Investing in stocks without dividends, especially during this portion of the economic cycle with so much excess liquidity, borders on insanity.

[florch]

Pitz - this interests me re: sstackho

I am in a similar situation regarding having a separate investment in the same trading account as my SM holdings.

I have some shares gifted to me from my job. I can't sell them until September without being taxed. (Aside - at that time I'll sell them, put them against the mortgage and re-buy them as I am still responsible to give them back (or their value) if I were to leave in the next 2 years. I normally would never buy shares in the company I work for, or an income trust, but I can't bet against these guys, so selling before 2 years would be like shorting a company that has upside surprises every quarter, plus ~9% yield).

As far as I've read, and not professing any expertise, the main issue was co-mingling LOC's, not trading accounts. In any case, I'll keep a good paper trail. Will this cause trouble:?:

[cannon_fodder]

Since the BMO Readiline product isn't portable, we are considering on going with a conventional mortgage and a HELOC.


When you say the Readiline isn't portable do you mean if you were to sell your house and buy another house you would have to terminate the set up and start up a new one?

[CDNPatriot]

Can anyone give me a sample portfolio that is balanced and diversified that does not include bonds?

[pitz]

Can anyone give me a sample portfolio that is balanced and diversified that does not include bonds?

This is what a family member does for the SM:

55% S&P/TSX60 Index
20% S&P500 Index
12.5% MSCI Pacific Index
12.5% MSCI Europe Index
5% MSCI Emerging Markets Index

The reasoning is, because she is a Canadian, she should logically have an overweight on Canadian stocks (esp. to take advantage of the dividend tax credit), and the rest of the foreign content is roughly in balance with worldwide asset allocations by market capitalization.

The portfolio is funded by:

55% of the borrowing is in Canadian dollars
25% in US dollars
6% in UK pounds
6% in Euros
6% in Yen
2% in Hong Kong Dollars

So basically, its an almost fully hedged globally diversified portfolio with an overweight on her home country, Canada.

The Canadian dollar borrowing comes from her mortgage, via the normal Smith Manouevre. The US/UK/euro/etc. borrowing comes from her margin account. In keeping with the stated goal of the SM not to increase risk, she only borrows, from her mortgage LOC, only 55 cents of every $1 she is eligible to borrow.

Since the foreign ETFs she uses to implement the SM are 30% marginable, and the Canadian ETF, 50% marginable, on average, she only needs to put down 40% margin, which basically means her portfolio can withstand a 38% loss (inside the margin account) before any additional re-inforcement would be required from the LOC.

The overall MER for the portfolio is ~0.17%. And she will be reducing that MER further later this year when Vanguard introduces their new EAFE fund.

Transaction costs, including regular monthly contributions and any required forex rebalancing, costs her $120/year in total.

[sstackho]

When you say the Readiline isn't portable do you mean if you were to sell your house and buy another house you would have to terminate the set up and start up a new one?

Yes, that's what we've been told. If we moved before the mortgage expires in 5 years, we would have to pay a penalty of 3 months interest.

We have decided, for several reasons (primarily our risk tolerance) to employ a "partial SM" as I will call it. We won't be maximizing our line of credit, but we will start slow and see how it goes from there. On that note, we decided to go with a conventional mortgage and a fixed HELOC that is higher than what we plan to use (i.e. not a re-advanceable mortgage).

[cchiu]

I don't completely understand Fraser's statement below. While it's true that my debt will remain level, my monthly payment does not remain constant. While my mortgage balance is declining, the lender is still expecting the same payment amount every month. However, as the size of the loan I take out to invest is getting bigger, I'm expected to pay more.


"Your debt will therefore stay level, but most will recognize that if they can handle a 200,000 mortgage debt today, then they should be able to handle a 200,000 investment debt a month from now, a year from now, or forever."

[florch]

I struggled with that too. But some mortgage products require only interest payments, so are flexible - (readvanceable mortgage).

My M1 has no real set repayment period, so forgetting the SM for one second, if I lost my job it would be easier to tread water for one example by just keeping up with interest, a great security feature.

Your principle portion will be lower if you add nothing, no doubt about that. Any extra cash will of course therefore accelerate things, and don't forget tax deductions and dividend distributions which should be applied against the mortgage. I lost interest in the problem after that because our mortgage payments were highly accelerated in the first place.

Hopefully Pitz or others will have a more eloquent explanation. Also, have you read the entire thread? Time consuming, but highly worth it for the dichotomy of opinions. Seeing something from all sides made many lights come on for me. The book was anticlimactic.

[pitz]

I don't completely understand Fraser's statement below. While it's true that my debt will remain level, my monthly payment does not remain constant. While my mortgage balance is declining, the lender is still expecting the same payment amount every month. However, as the size of the loan I take out to invest is getting bigger, I'm expected to pay more.

True, this is how many of the mortgages such as the "matrix mortgage" work, the monthly payment on the 'fixed' portion remains constant, while you still must make additional payments on the LOC portion.

*But* a few things can also be said:

a) As you pay off your mortgage, your salary should also be climbing over time. This will give you extra cashflow to pay down the mortgage more.

b) As you swap more of the debt to being deductible, you will receive increasingly large tax refunds and/or have less taxes taken off your paycheque if you file a T1213.

c) If the extra cashflow is a significant bother, you can always borrow against the investments themselves, ie: through a margin account.

d) Your investments should be paying (increasing) dividends, which will help you make those extra payments.

So in the practical sense, if you are receiving 2% worth of dividends from your investment, and another 2% in the form of reduced income tax expense, the effective additional cashflow you require on the loan is pretty miniscule, only 2%.



"Your debt will therefore stay level, but most will recognize that if they can handle a 200,000 mortgage debt today, then they should be able to handle a 200,000 investment debt a month from now, a year from now, or forever."

Fraser is making the point that if you have taken out a mortgage, you have decided to accept a certain level of debt, lets call it $200,000.

Typically, with an amortizing mortgage, the level of risk involved is gradually reduced as the principal of the loan is reduced.

Fraser is telling you to forgo that reduction of risk inherent in the loan.

The danger you run is that, if you put 20% down for your house, and if housing values drop by 30%, that the bank simply won't renew your mortgage without additional payments or a higher interest rate.

It can be a valid concern, especially for very poorly capitalized home buyers in a housing bubble.

With respect to the SM, I would always recommend that you buy investments that can, themselves, be used as loan collateral, in a competitive lending environment.. This means buying investments that are relatively liquid, marginable, publicly traded with a good price discovery mechamism, and diversified, just in case you are forced to liquidate them to refinance. Dividends provide a measure of liquidity because at least, on a regular basis, you receive some cash from your investment.

[Vitalogy]

Hello,

I'm sure I'm missing something here, but I can't see where I'd be making all that much money from. Perhaps one of you can correct my way of thinking because I'm obviously looking at it the wrong way.

For example, if I have a 100,000 mortgage and have already paid 30,000 off of it, this manuevre is telling me to invest that 30,000 as well as whatever else I pay off in the coming months.

So initially, I invest 30,000 with my bank at a rate of return of say 10%. Basically I'm borrowing this money at probably around 6% (higher in the near future probably) with a secured Line of Credit.

So with this way of thinking, wouldn't I be basically earning around $3,000 a year in interest, paying about $1,800 in loan interest for a net gain of $1,200. Then I would have to declare the $3,000 in earnings on my taxes, but also the $1,800 would be tax deductible so wouldn't I just have to pay the taxes on the $1,200 gain of around $400.

So using my numbers above, I'd be making around $800 a year. That doesn't seem worth a 30,000 risk seeing that I'm not guaranteed to get 10% if there are market problems and my interest rate that I'm paying is probably going up. I'm sure I'm not seeing something, so if anyone could help, I'd greatly appreciate it.

Thanks

[pitz]

So initially, I invest 30,000 with my bank at a rate of return of say 10%. Basically I'm borrowing this money at probably around 6% (higher in the near future probably) with a secured Line of Credit.

So with this way of thinking, wouldn't I be basically earning around $3,000 a year in interest, paying about $1,800 in loan interest for a net gain of $1,200


No, the idea is that you earn $3000 a year in capital gains, or tax-advantaged dividends, or some combination thereof. Capital gains are taxed at one-half the rate of ordinary interest.

Of course, you would defer the realization of those capital gains, thus reducing the effective annual rate of tax further. For example, if you hold a stock for 20 years and it returns 10%/year, the effective rate of tax is only ~10%.



. Then I would have to declare the $3,000 in earnings on my taxes, but also the $1,800 would be tax deductible so wouldn't I just have to pay the taxes on the $1,200 gain of around $400.


But you defer the capital gains, or you receive them in the form of tax-advantaged dividend income.



So using my numbers above, I'd be making around $800 a year. That doesn't seem worth a 30,000 risk seeing that I'm not guaranteed to get 10% if there are market problems and my interest rate that I'm paying is probably going up. I'm sure I'm not seeing something, so if anyone could help, I'd greatly appreciate it.


You are not treating capital gains nor dividend income correctly in your analysis.

[cannon_fodder]

I don't completely understand Fraser's statement below. While it's true that my debt will remain level, my monthly payment does not remain constant. While my mortgage balance is declining, the lender is still expecting the same payment amount every month. However, as the size of the loan I take out to invest is getting bigger, I'm expected to pay more.


"Your debt will therefore stay level, but most will recognize that if they can handle a 200,000 mortgage debt today, then they should be able to handle a 200,000 investment debt a month from now, a year from now, or forever."

I didn't quite grasp this either which is why I created my own SM calculator using Excel. Then I could easily see that my monthly payments do not change, i.e. there is no additional cash flow required.

Basically what happens is you withdraw an amount equal to the principal paydown after every mortgage payment. You take a portion of that and apply it to the interest portion only (not the principal) of the LOC. The remainder is to go towards investments. Your LOC goes up by the full withdrawal amount. The amount available to invest decreases (assuming your mortgage rate is less than your LOC rate) because the interest payable on the growing LOC outweighs the increasing rate at which you pay down the mortgage.

So, regardless of tax writeoffs, dividend income, etc. as long as you can just pay down the interest on the LOC, the SM can be done with no additional cash flow.

[florch]

you withdraw an amount equal to the principal paydown after every mortgage payment. You take a portion of that and apply it to the interest portion only (not the principal)

Bingo - clear now.

I've done spreadsheets in the past for similar financial ideas. Amazing the clarity that working something out for yourself brings.

[redprimary]

This is an idea for a small select few who can make it work, the rest will screw it up.

LOL..nice.. now thats the most honest statement i have heard all day

[Man from Atlantis]

Cannon I was playing with your calculator and noticed that it only seems to work with 26 payments/yr. Is it me or the calculator? Also, I noticed that you are paying off the interest accumulation at the end of each year. Is this what you are acctually doing or is it the way the calculator works? I believe Smith is accumulating it until the non deductible mortgage is converted. Finally, have you ever thought of adding Ed's method to the calculator, where you use the principal payments to support a leveraged loan rather than dollar cost average into a fund?

By the way your calculator does a nice job showing just how the Smith Man works. It is more useful than Smith's calculator. Thanks.

[florch]

Regarding bank fees, can these be written off as well?

My M1 has the $14 per month, but this account also contains my mortgage and personal spending in separate sub accounts. Can I write off all or a portion of the fee?

[pitz]

Regarding bank fees, can these be written off as well?

My M1 has the $14 per month, but this account also contains my mortgage and personal spending in separate sub accounts. Can I write off all or a portion of the fee?

Sure, I would... I guess you could pro-rate it, but personally, I would include the whole thing, and let a CRA auditor challenge it.

[florch]

Thanks Pitz

(once again....)

[Man from Atlantis]

I see it has been discussed that if you have a dividend paying portfolio you should use the dividends to pay down the MLOC. Has anyone looked at this: Follow Ed's method and use the principal payments to fund a larger leverage loan into a fund or group of stocks. Then every 4 to 5 years sell the fund/stocks, pay off the investment linie of credit and use the remainder to pay down the MLOC. This way you would only pay tax when the investments are sold and it would all be capital gain. Then you repeat the process and you can get a larger loan/portfolio. I am just wondering how this would compare to other methods discussed. Any thoughts?

[cannon_fodder]

Cannon I was playing with your calculator and noticed that it only seems to work with 26 payments/yr. Is it me or the calculator? Also, I noticed that you are paying off the interest accumulation at the end of each year. Is this what you are acctually doing or is it the way the calculator works? I believe Smith is accumulating it until the non deductible mortgage is converted. Finally, have you ever thought of adding Ed's method to the calculator, where you use the principal payments to support a leveraged loan rather than dollar cost average into a fund?

By the way your calculator does a nice job showing just how the Smith Man works. It is more useful than Smith's calculator. Thanks.

M from A - which version of the calculator are you using? Do you have any numbers that you are inputting which suggest that the calculator does not work for 24 or 12 payment periods per year (it should work equally as well except for the use of taking dividend payments from the investment portfolio to accelerate, which only works for 12 payment periods per year).

The calculator does not pay the cumulative interest at the end of the year - I simply put that there to make it easier for me to calculate what the interest expense write off will be for the tax refund. The interest expense is actually paid from the withdrawal of the principal paydown.

Thanks for the questions.

[Man from Atlantis]

Cannon Fodder - I have version "readvanceable_mortgage2.xl" When I enter any number other than 26 in the payments/yr. field I get ###. It doesn't seem to matter what number I input I can't get the twice monthly and monthly pages to work, both pages come up ####.

I noticed in your reply you can take into account dividend distributions. I assume I would enter the dividend amount in the field "Divert Periodic Investments"?

Thank you.

[cannon_fodder]

Cannon Fodder - I have version "readvanceable_mortgage2.xl" When I enter any number other than 26 in the payments/yr. field I get ###. It doesn't seem to matter what number I input I can't get the twice monthly and monthly pages to work, both pages come up ####.

I noticed in your reply you can take into account dividend distributions. I assume I would enter the dividend amount in the field "Divert Periodic Investments"?

Thank you.

I'm guessing you have quite an old version. I haven't worked on it for awhile, but I was improving Version 1.2 when I got sidetracked with other things (good weather, travel, life). I've posted Version 1.1 here:
http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls

Version 1.2 corrects some errors in earlier versions when you have some extreme cases. When it is 'ready' I will post that. If you use 1.15 and find some issues, please let me know as I may have not found every error.

I hope that this helps.

[edrempel]

I see it has been discussed that if you have a dividend paying portfolio you should use the dividends to pay down the MLOC. Has anyone looked at this: Follow Ed's method and use the principal payments to fund a larger leverage loan into a fund or group of stocks. Then every 4 to 5 years sell the fund/stocks, pay off the investment linie of credit and use the remainder to pay down the MLOC. This way you would only pay tax when the investments are sold and it would all be capital gain. Then you repeat the process and you can get a larger loan/portfolio. I am just wondering how this would compare to other methods discussed. Any thoughts?

Hi, Man from Atlanitis,

We've looked at your scenario. We found that the tax cost out-weighed the benefits of paying down your non-deductible debt more quickly.

We tried selling the investments, paying the capital gains tax, using the profits to pay down your mortgage, and the reborrowing the entire amount to invest. However, we found that net worth (after tax) grows more quickly if you just keep holding and deferring the tax as long as possible.





Ed

[Jero]

Regarding bank fees, can these be written off as well?

My M1 has the $14 per month, but this account also contains my mortgage and personal spending in separate sub accounts. Can I write off all or a portion of the fee?

You cannot writeoff a service charge from the bank. I used to have a Man1 account. Unless you pay a fee for the purpose of an investment with the expectation of a gain, you cannot write off their service charge.

[pitz]

You cannot writeoff a service charge from the bank. I used to have a Man1 account. Unless you pay a fee for the purpose of an investment with the expectation of a gain, you cannot write off their service charge.

A portion of that fee is part of the cost of borrowing for investment. I would suggest that you, at the very least, could write off a pro-rata share of the monthly fee.

Even service charges on taxable interest-bearing chequing and savings accounts is deductible, providing that the accounts actually do bear interest, even if it is a nominal amount at best. There is no 'reasonable expectation of profit' test.

[Hubster]

A fairly comprehensive list of re-advanceable mortgage products, specifically for applying the Smith Manoeuver:

http://www.myvirtualmortgagebroker.com/Smith-Manoeuvre-Mortgages-Smith-Maneuver.html


H.

[florch]

Nice find Hubster!

[florch]

oops

[sstackho]

Interesting. That page claims that the BMO Readiline product is portable (but requires a re-application) whereas I was told by the bank that it is not portable, and a 3-month interest penalty would be charged if I moved during the mortgage period.

[DanielCarrera]

If you truly believe that its prudent to stick to one stock or ETF, then I admit, QT might very well be less expensive. I don't feel its very sensible though to restrict yourself strictly to a single ETF, especially since you are putting your entire financial future 'on the line' with the SM. And if you are buying 2 or 3 ETFs monthly, then IB's commission structure still is less expensive.

Why would you buy 2 or 3 ETFs monthly? If you want to buy only ETFs you can buy a different ETF every month. Now any given ETF is only being bought once every 2 or 3 months and every month you buy only one ETF. You could reduce it to 2-3 ETFs/year if you put your money in an index fund throughout the year and then transfer to ETFs on Canaday Day or something.


IB's interest rates also save you money. You can borrow from IB less expensively than you can borrow from a HELOC.

How much does IB charge for that?

[DanielCarrera]

I'm interested in pitz' suggestion of using a margin account at IB instead of a HELOC to perform the SM.

- What's interest rate does IB charge on the margin account? I couldn't find the answer on their website.
- Is that interest also tax deductible?
- How much can you borrow? I assume it's a % of your net worth at IB. What would be a reasonably safe % to borrow long-term for the purpose of the SM?

I'm thinking of putting my money mainly in three ETFs or so (Vanguard Large Cap, Small Cap, EAFE and I'm not sure what to do for the Canada portion - suggestions welcome). I only plan on buying ETFs once a year, and meanwhile I plan on putting the money in TD's eSeries funds. Is that a good idea?

Thanks for the help.

[pitz]

I'm interested in pitz' suggestion of using a margin account at IB instead of a HELOC to perform the SM.

- What's interest rate does IB charge on the margin account? I couldn't find the answer on their website.


http://www.interactivebrokers.com/en/accounts/fees/interest.php?ib_entity=llc

Basically, for Canadian dollars, its 0.25% less than prime on the first $115k borrowed. In the US, its roughly 6.8%.




- Is that interest also tax deductible?


Providing that you use the money borrowed for eligible purposes, absolutely, its no different than a HELOC.



- How much can you borrow? I assume it's a % of your net worth at IB. What would be a reasonably safe % to borrow long-term for the purpose of the SM?


Going anywhere above borrowing $0.50 for each $1 in equity really places you at a significant risk of a margin call/liquidation.



I'm thinking of putting my money mainly in three ETFs or so (Vanguard Large Cap, Small Cap, EAFE and I'm not sure what to do for the Canada portion - suggestions welcome). I only plan on buying ETFs once a year, and meanwhile I plan on putting the money in TD's eSeries funds. Is that a good idea?


If you have IB's low commissions, heck, buy every month or even twice a month. As for the Canada portion, there are ETFs available that cover the TSX60 and the TSX Composite Indicies available. (not allowed to mention their names here however).

[DanielCarrera]

http://www.interactivebrokers.com/en/accounts/fees/interest.php?ib_entity=llc

Basically, for Canadian dollars, its 0.25% less than prime on the first $115k borrowed. In the US, its roughly 6.8%.

Thanks.


Going anywhere above borrowing $0.50 for each $1 in equity really places you at a significant risk of a margin call/liquidation.

I'm fairly risk-adverse. I mean... I'm ok with the stock price varying wildly. I won't retire for another 35 years, so I can wait. But really don't want to be forced sell low. Do you think borrowing $0.25 on the $1 puts me in a safe place?


If you have IB's low commissions, heck, buy every month or even twice a month.

I'm concerned about the $120/year minimum commission with IB. The only thing I can think of that could make it worth while is a margin account, but I won't have $100K to invest for some years (that seems to be their minimum).


As for the Canada portion, there are ETFs available that cover the TSX60 and the TSX Composite Indicies available. (not allowed to mention their names here however).

Gotcha. iShares XIC, XIU and XCS. Thanks! :-) Hmm... 0.17% MER... I like it.

Are you sure that mentioning those is against the forum rules? It doesn't look like a stock tip to me.

Oh! I notice that they have a "social" index with an MER of 0.5%. I've never heard of the Jantzi Social Index so I'll need to figure out what that is, but my gf and I wanted to have a socially-responsible component in our portfolio.

Cheers,
Daniel.

[pitz]

I'm fairly risk-adverse. I mean... I'm ok with the stock price varying wildly. I won't retire for another 35 years, so I can wait. But really don't want to be forced sell low. Do you think borrowing $0.25 on the $1 puts me in a safe place?


Absolutely; With 1.25X leverage, at no time during history, the crash of 1929 aside, would you have received a margin call.



I'm concerned about the $120/year minimum commission with IB. The only thing I can think of that could make it worth while is a margin account, but I won't have $100K to invest for some years (that seems to be their minimum).


1) Its tax deductible (the portions you don't use, against your income);
2) $120/year can be saved on interest easily if you borrow;
3) You can start a margin account with as little as $5k US.
4) What you save on ETFs alone can make it worthwhile as well in terms of fees.

I guess its really a value judgement for you, but being able to dollar-cost average into low-cost ETFs has a ton of benefits. 10 ETF purchases a month really spreads your risk, compared to a couple big lump-sum ETF purchases a year, or the higher MERs of index funds.



Gotcha. iShares XIC, XIU and XCS. Thanks! :-) Hmm... 0.17% MER... I like it.


Yeah no Vanguard in Canada yet :(.



Are you sure that mentioning those is against the forum rules? It doesn't look like a stock tip to me.
Oh! I notice that they have a "social" index with an MER of 0.5%. I've never heard of the Jantzi Social Index so I'll need to figure out what that is, but my gf and I wanted to have a socially-responsible component in our portfolio.


I've looked at that "Jantzi Social Index", and the iShares ETF. The problem is illiquidity. Not many shares of that index are traded, and if it doesn't sell very well as a product in the future, Barclays might discontinue it, and leave you with a large capital gain/loss prematurely. (TD used to offer ETFs as well, but they discontinued them, sticking their unitholders with huge realized capital gains....) Just a quick check on the website shows they've sold almost no units of the fund, and its been out for a couple months now. At least wait a few years until it becomes more mature.

Quite frankly, I've looked at the companies, and can't figure out why certain ones would be included or not included. Its a no-brainer to not include tobacco firms, but it seems to me that gold and diamond miners don't really belong in a 'social index' as well.

Also, Transcanada Pipeline is mysteriously absent from that list, while Transalta is included. Makes no sense to me at all. I think you really should study the methodology of picking companies and weightings for that index, because, quite frankly, it looks like a lot of nonsense to me.

[DanielCarrera]

1) Its tax deductible (the portions you don't use, against your income);
2) $120/year can be saved on interest easily if you borrow;
3) You can start a margin account with as little as $5k US.
4) What you save on ETFs alone can make it worthwhile as well in terms of fees.

Thanks for the info. $5K is well within my reach. I'm saving that much per quarter.

I'll have to wait a while before I can do the Smith M. though. I don't yet own a house, I'm saving. But by the time I buy a house I should also have enough ETFs that a 1% margin savings should pay for IB's commission.

Is it possible to start with another broker and then transfer?


I guess its really a value judgement for you, but being able to dollar-cost average into low-cost ETFs has a ton of benefits. 10 ETF purchases a month really spreads your risk, compared to a couple big lump-sum ETF purchases a year, or the higher MERs of index funds.

That's a good point. Btw, I plan to use Value Averaging instead of Dollar Cost Averaging. But the point of buying ETFs more often than yearly is just as valid for VA as it is for DCA.

Value Averaging:
http://www.amazon.ca/Value-Averaging-Strategy-Investment-Returns/dp/0470049774/ref=pd_bbs_sr_1/702-4616088-9167204?ie=UTF8&s=books&qid=1186437020&sr=8-1

Let's see... Holding the money in TD eFunds might cost me an extra $25/year or so in MER. Buying ETFs with TradeFreedome would cost between $30 and $60/year (3-6 trades)... I'll do the numbers more carefully later, but I'm seriously considering using IB from the start.

Isn't IB very difficult to use? I don't have previous experience with stock brokers. I know lots of theory, and have good book knowledge, but I lack real-world experience.


I've looked at that "Jantzi Social Index", and the iShares ETF. The problem is illiquidity.

Hmm. I didn't notice that. Thanks.

Cheers,
Daniel.

[DanielCarrera]

Let's see... Holding the money in TD eFunds might cost me an extra $25/year or so in MER. Buying ETFs with TradeFreedome would cost between $30 and $60/year (3-6 trades)... I'll do the numbers more carefully later, but I'm seriously considering using IB from the start.


Ok, I'm satisfied that starting with IB is a perfectly good choice. It might cost me $5/month the first couple of years but in the greater scheme of things that's counting pennies. I think that what's really troubling me is just fear that it might be too complex and I might screw something up.

Maybe I'd start with the HTML-based WebTrader. IB says that it has a limited number of features. Maybe that's exactly what I want when I'm getting started. I just took a look at the demo and I think I can manage.

[pitz]

Ok, I'm satisfied that starting with IB is a perfectly good choice. It might cost me $5/month the first couple of years but in the greater scheme of things that's counting pennies. I think that what's really troubling me is just fear that it might be too complex and I might screw something up.


Thats a very valid concern. IB doesn't accept accounts from people with no experience (unless you lie).



Maybe I'd start with the HTML-based WebTrader. IB says that it has a limited number of features. Maybe that's exactly what I want when I'm getting started. I just took a look at the demo and I think I can manage.

Yeah its not that hard. Basically, use limit orders for everything. Never use a market order. If you start small with $5k, the worst that you could do is blow your account up. By the time you have $100k in there, you should be an expert at using the interface.

I've taught my 89-year old grandma how to enter orders in IB, so I'm sure a young chap like yourself can figure it out ;).

[DanielCarrera]

Thats a very valid concern. IB doesn't accept accounts from people with no experience (unless you lie).

Hmm. I don't like to lie. How much experience do they want? Can I use a different broker for 18 months and then switch to IB?


Yeah its not that hard. Basically, use limit orders for everything. Never use a market order.

Yeah, I was wondering about those. What is a limit order and a market order? Also, what is the "smart" exchange? I was expecting to find NYSE or AMEX when I searched for Vanguard ETFs but instead I found "SMART". What is it?

And for example, when I search for Vanguard's new EAFE ETF (VEA) I get the options to buy it from SMART, ARCA and ISLAND. I don't know what those are. I was expecting AMEX or NYSE.


If you start small with $5k, the worst that you could do is blow your account up. By the time you have $100k in there, you should be an expert at using the interface.

I've taught my 89-year old grandma how to enter orders in IB, so I'm sure a young chap like yourself can figure it out ;).

:-)

Edit: Does IB offer RRSP accounts? It looks like it doesn't. I guess that an ETF is very tax-efficient anyways... If my equities are all in ETFs and my fixed-income is my house, can I still benefit from an RRSP?

[florch]

DC - IB does not offer RRSP accounts (as of yet)

I have a question that may also have been rehashed on here before, regarding income splitting: I am the primary earner, (wife's on mat, then plans part time till kids are in school, and in any case earns far less) so I'd planned to do all of the non-rrsp investing in my account because the interest tax break was much higher.

Do others believe this to be the case, or should I not be dismissing the future effects of income splitting on capital gains and dividends. Is this clear cut, or does it depend on our individual situations, for instance: maybe I should hold long term investments that may not be cashed in ever or certainly until after retirement, while she holds or we both hold short term investments that are likely to have large capital gains?

[pitz]

Hmm. I don't like to lie. How much experience do they want? Can I use a different broker for 18 months and then switch to IB?


Well to get my 'experience', I bought TD eFunds about 100 times over the period of a few months ;). Up until a few years ago when I got onto IB, the only 'experience' actually trading I had was maybe 1 or 2 transactions with a big-bank discount broker a year.

My relatives have been 'trading' with discount and/or full service brokerages since the dawn of time, so they qualified for accounts on that basis.



Yeah, I was wondering about those. What is a limit order and a market order?


Oh my. A limit order is basically the maximum you are willing to pay for a security, or the minimum you are willing to sell for.

A "market" order is basically an order that will buy or sell no matter what the price is.

Market orders are dangerous. Its like walking into a shoe store, saying, "i want a pair of shoes no matter the price". If they only have 1 pair your size in stock, and its a $1500 pair of Italian shoes, you're gonna be paying $1500.



Also, what is the "smart" exchange? I was expecting to find NYSE or AMEX when I searched for Vanguard ETFs but instead I found "SMART". What is it?


"SMART" is an order-routing system that automatically routes your order to the most efficient exchange for execution.



And for example, when I search for Vanguard's new EAFE ETF (VEA) I get the options to buy it from SMART, ARCA and ISLAND. I don't know what those are. I was expecting AMEX or NYSE.


You would route to SMART. SMART would then route it to ARCA, ISLAND, or the AMEX as appropriate for an execution. Or you could route it directly to the AMEX, but the SMART system can often identify other pools of liquidity for a stock and save you some money on your order (ie: get you a better execution).




Edit: Does IB offer RRSP accounts? It looks like it doesn't. I guess that an ETF is very tax-efficient anyways... If my equities are all in ETFs and my fixed-income is my house, can I still benefit from an RRSP?

No RRSP accounts at IB. But you'll want a seperate account anyways for free quotes (if you get quotes from IB, you have to pay for them), so you may as well open a Questrade RRSP account and contribute at least the minimum to keep it open.

Otherwise, to correctly price limit orders, you have to buy expensive packages of real-time quotes from IB.

[houska]

Good discussion here on finding the best rates for borrowing for investments. Typical HELOCS that form the basis for the textbook Smith Maneouvre will be at Prime. Pitz has brought to our attention that borrowing on margin from your brokerage can be an attractive option, e.g. essentially P-0.25 or even P-0.75 based on your balance at IB. It's worth mentioning that a fully open variable rate mortgage can be comparable. We just bought a house and are financing with Scotiabank Total Home Equity program, which is giving us P-0.75 fully open variable amortized over 40 years on the part we will use for equity take-out for investing.

This option probably makes the most sense for those who aren't trying to max out their Smith Manoevre potential on a month to month basis, but those who want to do a sizeable but not maximum possible equity takeout for investment purposes, and who are comfortable with the hassle of adjusting the value of the mortgage when they want to do more or less leverage. In addition, it means (due to the 40 year amort rather than interest-only payments) the cash flow to support is about 10% higher, though you can of course take that principal repayment back out whenever you feel like it (an in fact the cash flow is almost exactly the same as the interest only at prime). A 0.75% difference versus a HELOC at Prime more than compensates for the hassle.

I have of course not done the calculations from the point of view of the bank, but my gut feel is that this is mispricing on their part. I view a fully open variable mortgage with a long amort as being "closer" as a product to a HELOC than to a closed term mortgage. Yet the fully open variable rate, at P-0.75, is a lot closer to the P-0.9 or so on a closed variable mortgage than the P-0 on the HELOC.

[Vitalogy]

What sort of investments can I use that has the interest non tax deductible? I'm not very comfortable with investing by myself right now so I was looking at a fund like a ScotiaBank mutual fund...will this count?

Thanks for the help.

[pitz]

What sort of investments can I use that has the interest non tax deductible? I'm not very comfortable with investing by myself right now so I was looking at a fund like a ScotiaBank mutual fund...will this count?


Basically, stuff that's not eligible (this isn't an exhaustive list):

Gold/Silver/Metals/Artwork
Mineral rights
Oil and gas leases
Raw land
Trusts or funds containing ineligible investments.
Options
Futures
Uninvested cash

I would advise against traditional mutual funds as well; here's why:

The stock market traditionally has only returned roughly 4% more than 'risk-free' investments over long periods of time.

A line of credit has a 1.75% premium over the risk-free rate. A typical mutual fund charges a management fee of 2.5%. 2.5% + 1.75% = 4.25%. 4.25% in fees is greater than the historic pre-tax profit margin one would expect, over the long term.

Basically, unless you aggressively control your costs, in the long term, its not likely you will make much money.

Here's a much better example: Say you borrow for the risk free rate (4.5%) + 1%. And you invest at a total management cost of 0.2% with ETFs. The total cost is 1% + 0.2% = 1.2%, which leaves a very healthy profit margin of 2.8% (+ whatever tax benefits you gain).

The way to be successful at the SM is to aggressively control costs on both the borrowing and investment side. Otherwise, you are just running on a treadmill, taking a lot of risk with your money, but you aren't likely to get ahead.

[houska]

Building on Pitz' post, an equity takeout or SM derives value from two sources. First, you are betting on a continued positive spread between the return of your investment portfolio and your expenses (as Pitz pointed out, these are both the interest rate plus your investment expenses, e.g. MER, advisor fees, etc). If you aggressively manage expenses, as Pitz pointed out, this spread can go up to 3.5-4% (expected long term average) but if you let expenses slide, this could go negative. Second, as an additional kicker, you get a tax arbitrage opportunity from (if everything works out) full tax deductibility of the interest while some of the gain is taxed lower as cap gains and dividends. This can amount to another 1-2% based on how the numbers work out.

However, nothing is free. This is a risk tradeoff through the additional stock market vs interest rate spread risk you are taking on. A key number is the expected volatility of your investment returns or of this spread. If you know Monte Carlo techniques or are comfortable making calculations with normal distributions, you can actually evaluate what is your approximate chance (under the assumptions you have made) of losing money over whatever time period and see if you are comfortable with that. It also means you may make a cost vs volatility tradeoff - in my case, I'm paying an investment advisor a fee of essentially 1% to put together and manage a portfolio with an MER of 0.2% and an annualized stdev (based on historical performance) of 8%, which is better than I would build myself given the limited time I have to dedicate to my finances. It all means that based on reasonable assumptions, I expect to make a net post-tax return of about 3% with a 30% chance of losing money over a 1 year horizon and an 10% chance over a five year horizon.

Note that Nassim Taleb's Black Swans (unexpected risks - the unknown unknowns) can always strike, so the risk is likely somewhat understated.

[pitz]

I'm paying an investment advisor a fee of essentially 1% to put together and manage a portfolio with an MER of 0.2% and an annualized stdev (based on historical performance) of 8%, which is better than I would build myself given the limited time I have to dedicate to my finances. It all means that based on reasonable assumptions, I expect to make a net post-tax return of about 3% with a 30% chance of losing money over a 1 year horizon and an 10% chance over a five year horizon.


Here's a tool that does some long-term modelling of returns of the various indicies for volatility, and is applicable for Canadians:

http://www.ndir.com/cgi-bin/downside_adv.cgi

Throw in your proposed allocations, and test over the interval 1961-2006 (this captures an entire interest rate cycle...and is more useful than just testing 1980-present).

For instance, the average return of T-bills (ie: short-term risk-free borrowing) has been ~7%. The average return of the TSX over the same interval has been 10.60%. So we're only dealing with a 3.6% spread there historically speaking.

[pitz]

I'm paying an investment advisor a fee of essentially 1% to put together and manage a portfolio with an MER of 0.2% and an annualized stdev (based on historical performance) of 8%, which is better than I would build myself given the limited time I have to dedicate to my finances.

I'd be *very* interested in hearing how your advisor can manage to do that, without including a lot of bonds (which have negative carry) into the portfolio. 8% sounds very low. Just tinkering with numbers, I haven't been able to build a portfolio with such low volatility that doesn't include components with greater expected return than the cost of borrowing ('negative carry').

The solution to negative carry, in this environment (ie: assets that yield less your cost of borrowing), is simply to reduce leverage, ie: borrow less through the SM, instead of borrowing to invest in bonds that don't even yield enough to pay the interest expense.

Don't get too caught up on trying to get the volatility down *too* much, especially if you are buying the portfolio with debt (which is volatile itself). In fact, if risk and return are related (the 'Sharpe Ratio'), it is mathematically impossible to achieve a volatility lower than the volatility of your loan, while still receiving a positive rate of return spread.

[Vitalogy]

Basically, stuff that's not eligible (this isn't an exhaustive list):

Gold/Silver/Metals/Artwork
Mineral rights
Oil and gas leases
Raw land
Trusts or funds containing ineligible investments.
Options
Futures
Uninvested cash

I would advise against traditional mutual funds as well; here's why:

The stock market traditionally has only returned roughly 4% more than 'risk-free' investments over long periods of time.

A line of credit has a 1.75% premium over the risk-free rate. A typical mutual fund charges a management fee of 2.5%. 2.5% + 1.75% = 4.25%. 4.25% in fees is greater than the historic pre-tax profit margin one would expect, over the long term.

Basically, unless you aggressively control your costs, in the long term, its not likely you will make much money.

Here's a much better example: Say you borrow for the risk free rate (4.5%) + 1%. And you invest at a total management cost of 0.2% with ETFs. The total cost is 1% + 0.2% = 1.2%, which leaves a very healthy profit margin of 2.8% (+ whatever tax benefits you gain).

The way to be successful at the SM is to aggressively control costs on both the borrowing and investment side. Otherwise, you are just running on a treadmill, taking a lot of risk with your money, but you aren't likely to get ahead.


Thanks a lot for the help Pitz. I'm sure you're right but where/who can I go see that will help me purchase ETF's that will lower my costs. I don't have the investment knowledge at this time but still want my money to start working for me.

[houska]

Pitz - interesting website and perspective on the volatility #. Will need to look into, so no reply for a few days.

[blkgprince]

For those who have read the book on the Smith Manouvre. I was reviewing the numbers for the "Plain Jane" example on page 20 and was unable to get the $414,207 the calculator generated for the 'value of investment portfolio at end of amortization period'. I created an excel spreadsheet to calculate this value. Has anyone succeeded in getting that number? If so, could you let me know how you did it?

[pitz]

With respect to the SM, I would always recommend that you buy investments that can, themselves, be used as loan collateral, in a competitive lending environment.. This means buying investments that are relatively liquid, marginable, publicly traded with a good price discovery mechamism, and diversified, just in case you are forced to liquidate them to refinance. Dividends provide a measure of liquidity because at least, on a regular basis, you receive some cash from your investment.

Just wondering....since investment illiquidity has been at the root of the current financial crisis, does Fraser actually make the same recommendation in his book?

Or is he all about pushing high-cost mutual funds and expensive HELOCs?

I notice that he likes Stone funds when he does radio interviews, but they seem to have some of the highest costs around.

[Spazmogen]

Fraser makes no recommendation in the book on what brand of investments to buy. He pretty much does not care what you buy, as long as it has the probability of going up in value. That keeps the interest deductible as far as CCRA is concerned. Stocks, mutual funds, even your own business or someone elses business! Its all good.


The HELOC is only the investment vehicle used to make the purchase of the stocks, bonds or mutual funds etc. It allows you to make interest only payments. Expensive is better than cheap when the interest is tax deductible. I'd rather get 40% of $10,000 back, rather than 40% of $6,000 back anyday. Go ahead and charge me more interest! Its Guerrilla Capitalization at work: I'm not paying the interest out of my pocket. The more they make me pay in interest, the faster I pay down the mortgage. And I'm not paying the interest out of my pocket!

My open mortgage is prime -0.75
My HELOC is PRIME.

My banker was curious what I was doing and I gave her my presentation. She really liked the idea and found it to be solid. That was at my local Royal Bank branch too. Obviously, the bank likes to loan you $ back at a higher rate than you just paid them for it in the form of a mortgage.

The fact that I am investing with RBC Dominion Securities (http://www.rbcds.com/) helped too, I'm sure. Its not just for high networth clients anymore.

[pitz]

My banker was curious what I was doing and I gave her my presentation. She really liked the idea and found it to be solid. That was at my local Royal Bank branch too. Obviously, the bank likes to loan you $ back at a higher rate than you just paid them for it in the form of a mortgage.


Sure, but when you have the mortgage (non-deductible portion) paid off, you will refinance the whole HELOC into a Prime - 0.9% amortizing mortgage, correct, to save on interest costs?

Or will you just take out an investment-secured margin loan to pay off the HELOC?

And certainly, if your broker would lend you money against your investments at a lower cost than a HELOC against your house, you would jump at that, right?

[Spazmogen]

Pitz:
When the mortgage is paid off, I will decide at that point what to do with it. My preference right now is to pay off the HELOC by cashing out the investments. But market conditions may dictate otherwise. If its smoking, I'll just pay the interest out of pocket at that point, which will still be 1/2 of what my mortgage is costing per month.

As long as the mortgage is being paid off, I would NOT accept my investment advisor's offer of a cheaper margin account. He's already tried! Using a HELOC means there can be no margin call on my account. A margin call is something to avoid at all costs. Besides, as I want the mortgage to be paid off as quickly as possible, a high interest rate on the HELOC is better for me.

Once the mortgage is paid off, a margin account would make sense.

For me, The Smith Manoeuvre is a mortgage reduction strategy, not an investment strategy. When the mortgage is paid off, market conditions dictate whether I keep the investments going or collapse it all and walk away.

[cannon_fodder]

For those who have read the book on the Smith Manouvre. I was reviewing the numbers for the "Plain Jane" example on page 20 and was unable to get the $414,207 the calculator generated for the 'value of investment portfolio at end of amortization period'. I created an excel spreadsheet to calculate this value. Has anyone succeeded in getting that number? If so, could you let me know how you did it?

A person after my own heart! I, too, constructed a calculator using Excel to try and understand how the SM works.

The biggest issue was that Smith used an investment growth rate of 10% not compounded annually, but monthly. Plug 10.471307 into your calculator for growth and you should come out to the dollar.

Wait until you get to step 3... that took me awhile to figure out what he was doing there since I don't have his calculator and only the examples in his book.

[cannon_fodder]

Pitz:
Besides, as I want the mortgage to be paid off as quickly as possible, a high interest rate on the HELOC is better for me.


The logic in this statement eludes me. A higher HELOC rate means, ironically, the mortgage is paid off faster, with all else being equal, than a lower rate. But, at the same moment in time, where ever you project it, your networth is greater if you have a lower HELOC rate.

Try plugging in a $200k mortgage, 12 year amortization, 7% interest rate, 12 payments/year, Step 1 and Step 2, 10% compounded investment growth (a la Smith's calculator - that's 10.471307% for the rest of us), Marginal Tax rate of 40%, and then alternate between 6% and 7% HELOC rate.

You will pay the mortgage off 1 month early with the higher HELOC and have $41,183 portfolio net of LOC. With the lower LOC, you will have a mortgage balance of $1,999 but a $51,869 portfolio net of LOC at the same point in the future.

I know what I'd rather have... if you want, I could try to loan you money at 1,000% interest and replace your HELOC. Sounds like it would be a win-win situation. ;)

[pitz]

When the mortgage is paid off, I will decide at that point what to do with it. My preference right now is to pay off the HELOC by cashing out the investments. But market conditions may dictate otherwise. If its smoking, I'll just pay the interest out of pocket at that point, which will still be 1/2 of what my mortgage is costing per month.


But by then...won't your investments have a relatively low cost base, and thus, a fairly large accrued capital gains liability? And won't you need investments for a potential future retirement?

Converting to an amortizing mortgage, even a variable rate one, IMHO, once the entire amount is tax deductible, isn't a bad idea at all, if mortgages are still available on favourable terms.



As long as the mortgage is being paid off, I would NOT accept my investment advisor's offer of a cheaper margin account. He's already tried! Using a HELOC means there can be no margin call on my account. A margin call is something to avoid at all costs. Besides, as I want the mortgage to be paid off as quickly as possible, a high interest rate on the HELOC is better for me.


Sure, you don't want margin calls, but if you have the HELOC sitting there as backup, you can transfer cash on-demand to meet those margin calls if necessary.

Also, a moderate amount of margin borrowing against a diversified portfolio poses practically no risk (a 1929-like event aside) of a margin call.



For me, The Smith Manoeuvre is a mortgage reduction strategy, not an investment strategy. When the mortgage is paid off, market conditions dictate whether I keep the investments going or collapse it all and walk away.

Sure, I can see that making sense, if you happen to finish the SM when the market is obviously at some peak, ie: the Nortel bubble 7 years ago. But if it sucks for a year or two; like seriously, how many rolling 5-year periods have there been of negative gains in the worldwide stock markets? Not many. And you still need a retirement portfolio ;).

[florch]

My SM's been up and rolling for a few months now.

We are entering a new investment and have decided to split the investment between my wife and my self on this one. Previously, all SM investments were in my name to take advantage of my higher tax rate.

In this case, the investment is shorter term and capital gains are the bigger concern. So a portion of it will be in her name. We share banking and HELOC accounts (which is bad enough), but should I be writing separate cheques for the investment for paper trail purposes, or will simple notations in my record keeping suffice? Is there a big drawback to writing only one, or just more explaining?

Thanks

Florch

[netriones]

Assume interest rate of 6% and 10% annual return from stock market.

You borrow at 6% from equity to invest get a 10% return.(With huge risk to someone doesn't know about investing.) Let say you get 20% refund on the interest you paid on the investment interest. 10%-6%*(0.8)=5.2% net return. This 5.2% return has market risk and risk from not knowing how to invest. eg. They speculate instead of invest.

Where as if you just paid down the mortage, you get 6% guarantee return on interest by paying down the mortgage.

Unless you're an investment genious like warren buffet that can make 15 to 20% return consistently, this method is not for everyone.

:!: :!:

[don242]

Assume interest rate of 6% and 10% annual return from stock market.

You borrow at 6% from equity to invest get a 10% return.(With huge risk to someone doesn't know about investing.) Let say you get 20% refund on the interest you paid on the investment interest. 10%-6%*(0.8)=5.2% net return. This 5.2% return has market risk and risk from not knowing how to invest. eg. They speculate instead of invest.

Where as if you just paid down the mortage, you get 6% guarantee return on interest by paying down the mortgage.

Unless you're an investment genious like warren buffet that can make 15 to 20% return consistently, this method is not for everyone.

:!: :!:

The whole point of the manouvre IS to pay down your mortgage. That way you get to borrow more for investing. The point is that you are using the equity in your home (which is doing nothing otherwise) to make money.

[bluedcfive]

The whole point of the manouvre IS to pay down your mortgage. That way you get to borrow more for investing. The point is that you are using the equity in your home (which is doing nothing otherwise) to make money.

And the obvious tax benefits of being able to deduct the interest expense doing so...

[cannon_fodder]

Can anyone recommend an individual (especially at Van City) who is familiar with cash damming and the SM? Ideally that individual would be close to Delta, BC

[brunes]

A fairly comprehensive list of re-advanceable mortgage products, specifically for applying the Smith Manoeuver:

http://www.myvirtualmortgagebroker.com/Smith-Manoeuvre-Mortgages-Smith-Maneuver.html


H.

Hey everyone.

It took me quite a bit of reading and searching through this thread to garner enough into as to a) what the manovre entails, and b) the common products that can be used for it (listed above).

Might I suggest to rain111, mart242, or anyone else who owns one of the first few posts, to update their post with some of the more pertenent info an links? This way people curious on the topic don't have to spend hours to find out if it fits their individual strategy and financial situation.

[alanbrenton]

Is the Smith Manoeuvre equal to the Singleton Shuffle?

If it is, then it is underattack by the CRA. This is an article from today's (September 8 issue) National Post.

http://www.canada.com/nationalpost/financialpost/story.html?id=e9aa9316-5b01-4260-8027-7eac471e0739

[pitz]

alanbreton, its probably a case worth watching.

Basically, the Lipsons sold shares in a family business, paid-off their house, and then re-mortgaged it, using the proceeds to repurchase the family business shares.

The transaction the Lipsons engaged in was done between related parties and wasn't 'arms length'.

This thread (http://www.financialwebring.com/forum/viewtopic.php?t=105077&view=previous&sid=4894ab94d51659a378ac0fa9add950bf) on the financialwebring is one worth looking at for a more detailled discussion and more links.

I would expect the Court of Appeal, or the Supreme Court to act definitively concerning this, and, probably institute an economic test of the transaction. Under an economic test, the Smith Manouevre would continue to qualify, while a simple rearranging of affairs to avoid tax would not.

[Spazmogen]

As pitz has mentioned, the SM will probably continue to qualify.

Both the Lipsons and Singleton cases were involving the businesses they owned and how they took equity $ from those businesses to pay off their personal mortgages and then borrowed against the equity in those houses to pay back the company. Those transactions were done in one fell swoop with the plan being to avoid taxes.

That is different than the Plain Jane SM, which is done over a period of years. And since you're paying your taxes all along on the investments, CCRA is happy. Its obvious to CCRA that it is not a get rich quick scheme or a lets avoid taxes this year scheme.

Regardless, I am keeping detailed notes of every transaction, what was bought etc. Just incase of an audit.

[reddie]

I am a little confused with this Smith Manoeuvre.

what i don't understand is how much of your mortgage is tax-deductible?
in the beginning, only say 25% is shuffled into investments. does that mean you can only claim 1/4 of your mortgage's interest?

thank you, this answer will clear up a lot of me as my financial advisor i believe pulled a fast one on me...

[Spazmogen]

I am a little confused with this Smith Manoeuvre.

what i don't understand is how much of your mortgage is tax-deductible?
in the beginning, only say 25% is shuffled into investments. does that mean you can only claim 1/4 of your mortgage's interest?

thank you, this answer will clear up a lot of me as my financial advisor i believe pulled a fast one on me...

Your mortgage itself is not deductible.

What we're doing is gradually transfering the mortgage onto a credit line. The entire creditline's interest is tax deductible (as long as only investments are on it and nothing else).

I'm writing off about $130/month in interest right now, and I've only had the SM going for about 4 months. My tax return should be about 40% of the yearly total of interest paid on the creditline. The tax return goes against the mortgage of course. Near the end of the process for me (in 11 years) my monthly interest should be around $600. Which is less than 1/2 of what I pay a month for the mortgage now.

[joeyjoejoe]

I have a question about SM.

As time goes on and you take your tax refund from the HELOC interest payments and put it against your mortgage(which then gets reinvested into the HELOC), won't you monthly interest payments go up?

Theoretically, you will be investing more (and thus gaining a higher return). But won't it get to the point where the interest payments get too high to manage?

[Spazmogen]

I have a question about SM.

As time goes on and you take your tax refund from the HELOC interest payments and put it against your mortgage(which then gets reinvested into the HELOC), won't you monthly interest payments go up?

Theoretically, you will be investing more (and thus gaining a higher return). But won't it get to the point where the interest payments get too high to manage?

Better scan this thread for Guerrilla Capitalization. Its been covered before. The interest payments do not come out of your pocket anyway.

[joeyjoejoe]

Better scan this thread for Guerrilla Capitalization. Its been covered before. The interest payments do not come out of your pocket anyway.

Thanks. I get it now...

I think I will go with edrempel suggestion of: "Not all banks will allow you to pay the interest from another credit line. However, if they charge it to your chequing, then you can do your Guerilla capitalizing by just withdrawing the exact amount from the SM credit line and putting it back into your chequing, so your cash flow won't be affected."

It seems more simplistic than keeping two LOCs open... or at least the set up is easier in my case.

[Spazmogen]

Thanks. I get it now...

I think I will go with edrempel suggestion of: "Not all banks will allow you to pay the interest from another credit line. However, if they charge it to your chequing, then you can do your Guerilla capitalizing by just withdrawing the exact amount from the SM credit line and putting it back into your chequing, so your cash flow won't be affected."

It seems more simplistic than keeping two LOCs open... or at least the set up is easier in my case.

There is something to be said about keeping it simple.

In my case, when we set up the Royal Homeline Mortgage, I had the mortgage person take my available equity and split it into a static $5K LOC and one LOC that automatically readvances with every mortgage payment. I opened a seperate chequing account solely for the creditlines to withdraw their interest from. I manually put $ in there from one of those creditlines. So, I was able to keep this at arms length from my day to accounts. Simple and clean.

Keep a good record of your transactions in case you ever get audited by CCRA.

[brunes]

There is something to be said about keeping it simple.

In my case, when we set up the Royal Homeline Mortgage, I had the mortgage person take my available equity and split it into a static $5K LOC and one LOC that automatically readvances with every mortgage payment. I opened a seperate chequing account solely for the creditlines to withdraw their interest from. I manually put $ in there from one of those creditlines. So, I was able to keep this at arms length from my day to accounts. Simple and clean.

Keep a good record of your transactions in case you ever get audited by CCRA.

One thing I wonder about this plan in case of an audit.

Is the interest on your second credit line really going to be considered a tax deduction? Because really, you are not withdrawing form it to pay on an investment at all. Rather, you are withdrawing from it to pay the interest payment on a credit line that was withdrawn on for the investment.

Was wondering if anyone has actually heard from a tax lawyer/accountant on this because it seems to me like a grey area in the whole thing. Of course if your LOC allows interest re-capitalization then it's a non issue.

[Spazmogen]

One thing I wonder about this plan in case of an audit.

Is the interest on your second credit line really going to be considered a tax deduction? Because really, you are not withdrawing form it to pay on an investment at all. Rather, you are withdrawing from it to pay the interest payment on a credit line that was withdrawn on for the investment.

Was wondering if anyone has actually heard from a tax lawyer/accountant on this because it seems to me like a grey area in the whole thing. Of course if your LOC allows interest re-capitalization then it's a non issue.

I'm going by what Fraser said in his book: interest owed on money borrowed to invest is tax deductible. So is compound interest. Compound interest is what the 2nd credit line is really doing. In my case, $4200 of the $5000 static line went to buy mutual funds. The remainder was used to cover the interest owed for BOTH credit lines.

[brunes]

Can anyone recommend an individual (especially at Van City) who is familiar with cash damming and the SM? Ideally that individual would be close to Delta, BC

Fodder - been playing with your spreadsheet (pretty cool). one thing I noticed that I found interesting. When taking advantage of the Manover, at least according to this, it actually works out to your advantage to do monthly mortgage payments, rather than bi-weekly. I found this interesting since it runs opposite of conventional mortgage wisdom.

[cannon_fodder]

Fodder - been playing with your spreadsheet (pretty cool). one thing I noticed that I found interesting. When taking advantage of the Manover, at least according to this, it actually works out to your advantage to do monthly mortgage payments, rather than bi-weekly. I found this interesting since it runs opposite of conventional mortgage wisdom.

I don't know about that version, but the current version of my calculator shows that it is a very small difference and 24 payments/year does work out better. That is assuming that you keep the payments the same - i.e. take half of the monthly payments and put that in the override payment field. Otherwise, what you are comparing isn't really apples to apples. The mortgage payment calculator shows that paying 24 payments/month on the same amortization actually takes fewer pennies out of your pocket each year than a 12 payment/month scenario.

[iamdogdog]

After reading this entire thread, my wife and I have the following understanding. Are we on the right track?

Basically this SM thingie is borrowing money(equal or less then the principal that you paid down) and investing it.

1. We will be better off to borrow at lower interest rate than higher, and therefore HELOC is one obvious solution. Or other mortgage products. Or someone suggested the margin account way.

2. We will be receiving tax refund depending on our tax bracket and this extra cash might either
A) bring down mortgage
B) use to pay the interest to sustain the HELOC

3. Inside our investment portfolio, we better have some "dividend" or "income" generated funds/equity becasue we want some sort of funding to sustain or cover some of our interest.

4.What ever investment that we go for, try to keep all admin fees as low as possible.

Question from us:

1. We have our mortgage locked and fixed for another 3.75 years@4.79% and we think that it is not a good idea now to implement this SM approach becasue we would need to pay apprasial fee about 300 to 400 to setup. In additional, we cannot find rate better than 4.79%. We are thinking to implement this SM approach when the term is up, any comments?

2. I understand that investing in funds/equity for a period of 10 to 15 years is quite safe but this is what I am worrying(seems like nobody brought it up yet), which is the following scenrio:

At a particular moment, our portfolio is dropped to 50% of the original investment becasue of market investment. We know that we can then hold on to it becasue we are rational investors. However, let say if I die at that point, which means my wife would suffer that 50% capital loss. Even worst, this 50% loss will not be able to offset her future captial gain.

Am I right about the above scenrio or I am missing something here?

Thanks.

[pitz]

Question from us:

1. We have our mortgage locked and fixed for another 3.75 years@4.79% and we think that it is not a good idea now to implement this SM approach becasue we would need to pay apprasial fee about 300 to 400 to setup. In additional, we cannot find rate better than 4.79%. We are thinking to implement this SM approach when the term is up, any comments?


It might be possible to add a HELOC as a 2nd mortgage to your existing property. The HELOC would likely be at 6.25%, which, on an after-tax basis, 30% tax bracket, comes to 4.375%.

You are correct in saying that you wouldn't want to break your existing mortgage, especially when it is locked in at such a favourable rate.



2. I understand that investing in funds/equity for a period of 10 to 15 years is quite safe but this is what I am worrying(seems like nobody brought it up yet), which is the following scenrio:

At a particular moment, our portfolio is dropped to 50% of the original investment becasue of market investment. We know that we can then hold on to it becasue we are rational investors.


If your portfolio has lost 50% of its value, then I think you have to sit down and determine the root causes, *before* you even entertain the idea of doing the SM. Especially since financial markets of almost all types have had exceptional performance in the past 5 years.

You might be invested in high-fee funds. You might not be diversified. You might be paying your managers or brokers too much in expenses, etc.

Figure out why your portfolio is severely underperforming before you even think of doing the SM.



However, let say if I die at that point, which means my wife would suffer that 50% capital loss. Even worst, this 50% loss will not be able to offset her future captial gain.


Actually, a few things could happen:

1) The ACB of your investments could be rolled over to your wife on a tax-free basis, for future use against her gains;

2) The investments could be liquidated by your estate, and used against other gains in your estate. In death, unused capital losses, once capital gains have been exhausted, can be applied directly against other forms of income.

I would presume that your RRSP would be transferred to your wife on a tax-free basis.

It is very unlikely that the value of the capital losses would be destroyed through your death.



Am I right about the above scenrio or I am missing something here?

Thanks.

I don't think the SM is appropriate for people who do not have their own financial 'houses' perfectly in order, and it is clear to me, by your statement of portfolio performance, that you have some issues that you need to clarify and resolve first.

[sstackho]

I don't think he is saying that his portfolio is currently down 50%. I think he is discussing a potential scenario.

[pitz]

I don't think he is saying that his portfolio is currently down 50%. I think he is discussing a potential scenario.

Oh yeah, I guess its under the heading 'scenario'.

That would be...painful...to say the least, but, I guess, could happen either on the housing, or the investment side if history is any indication.

Its definitely something that can't be overlooked, as both housing, and stocks, have gone down that much at various times throughout history.

[notanexpert]

Oh yeah, I guess its under the heading 'scenario'.

That would be...painful...to say the least, but, I guess, could happen either on the housing, or the investment side if history is any indication.

Its definitely something that can't be overlooked, as both housing, and stocks, have gone down that much at various times throughout history.

To actually see that kind of a loss in your portfolio, you'd have to time two things perfectly:
1. Buy all your investments at the very peak of the market
2. Look at your statement at the very bottom of the market

#2 is fairly easy to do if you look at your portfolio every day (which I'd recommend against)
#1 would require a lot of skill to accomplish!

[florch]

Seems to me that a lot of this worry of massive downturns is unfounded if a) you're properly diversified in each market and globally (conceding that markets are becoming ever more tied together), b) since we're mostly wage slaves around here you buy regularly with some dollar cost averaging or value averaging strategy and c) take the long view - the worst bottom in the market won't feel as bad a year down the road especially if you continued buying during your pain.

Read "The Four Pillars of Investing" by William Bernstein, do what he says and what Pitz and others here say, and relax with a smoke and a Valium if that's what your doctor prescribes.

[pitz]

Read "The Four Pillars of Investing" by William Bernstein, do what he says and what Pitz and others here say, and relax with a smoke and a Valium if that's what your doctor prescribes.

Yeah, basically, you need to stack the odds in your favour. Control what you can control. If you don't understand something, ask questions.

Its even possible that the SM might you let you keep your house when otherwise it would have been foreclosed upon, because when you do the SM, you are building a broader portfolio of assets that can, when times get tough, provide some income to make the mortgage payments.

Someone who is just paying on a mortgage and loses their job has nothing else really to fall back upon, no other sources of income, and would default on a traditional mortgage (or require refinancing on not-so-favourable terms).

Someone who has been doing the SM for a while has assets, investments that can go a long ways towards making the mortgage payments.

And, if the SM works as advertised, its very likely that a mortgage would be paid off earlier, which means, if you collapse the plan, that you can live mortgage free much sooner than you would if you did a traditional 25-year amortization and made a few prepayments.

Plus you're not entirely at the mercy of a mortgage lender when you're on the SM; if you select your investments properly, you can shop around for financing and find the lowest rate on either investment financing, and/*or* mortgage financing, whichever gets you the best rate. If there is a big housing bust, investment-backed borrowing might very well be much more favourable than mortgage borrowing.

[xerox_x]

Hi! Folks..

Have been following this thread from page 1.. and here is my scenario..

Primary Home : Valued @ 400K
Primary Mortgage : 281000 @ 4.99
Monthly : 1634
HELOC : 8K

Every month my principal part of the mortgage installment gets
credited into my HELOC a/c.

Planning to Buy investment property.. banker says wanna do SM.
I read a lot about it but when I put numbers I am not convinced
unless I am going wrong some place..

Option 1 .

Investment Property Values : 202,000
Down Payment : 42K
Mortgage Amount : 160K @ 5.5 % = 935 p.m
Total : 935 Per month. ( P & I )
Assuming put 42 @ 5 % in
Bank : 250 Approx.

Option 2 with SM.

Put 42K down towards Primary Mortgage
HELOC value now : 8K + 42K = 50K

Take 42K from that HELOC and put as down payment for Investment Property.
So my calculation would look like : -

Investment Property Values : 202,000
Down Payment : 42K
Mortgage Amount : 160K @ 5.5 % = 935 p.m
In addition now
42K HELOC INT @ 6.25 % : 277 ( Aprox )
@ 40 % tax bracket
would yield a refund of : 111
Actual INT Paid on 42K : 166

Total Monthly exp : 935 + 166 = 1101.

I am paying 166 $ more p.m.

Am I going wrong some place ?? the numbers show that I should not take SM,

Would appreciate if fellow readers could pour in their comments / inputs.

thanks :confused:

[FrugalTrader]

Hi! Folks..

Have been following this thread from page 1.. and here is my scenario..

Primary Home : Valued @ 400K
Primary Mortgage : 281000 @ 4.99
Monthly : 1634
HELOC : 8K

Every month my principal part of the mortgage installment gets
credited into my HELOC a/c.

Planning to Buy investment property.. banker says wanna do SM.
I read a lot about it but when I put numbers I am not convinced
unless I am going wrong some place..

Option 1 .

Investment Property Values : 202,000
Down Payment : 42K
Mortgage Amount : 160K @ 5.5 % = 935 p.m
Total : 935 Per month. ( P & I )
Assuming put 42 @ 5 % in
Bank : 250 Approx.

Option 2 with SM.

Put 42K down towards Primary Mortgage
HELOC value now : 8K + 42K = 50K

Take 42K from that HELOC and put as down payment for Investment Property.
So my calculation would look like : -

Investment Property Values : 202,000
Down Payment : 42K
Mortgage Amount : 160K @ 5.5 % = 935 p.m
In addition now
42K HELOC INT @ 6.25 % : 277 ( Aprox )
@ 40 % tax bracket
would yield a refund of : 111
Actual INT Paid on 42K : 166

Total Monthly exp : 935 + 166 = 1101.

I am paying 166 $ more p.m.

Am I going wrong some place ?? the numbers show that I should not take SM,

Would appreciate if fellow readers could pour in their comments / inputs.

thanks :confused:

Xerox,

When you borrow to pay down an investment loan, that new loan is also tax deductible. That's why some people advise to "capitalize the interest". This means that you make your HELOC payment from your chequing account, but withdraw the exact amount from your HELOC back to your chequing. This will result in HELOC payments that will not affect your cash flow.

Hope this helps,
FT

[pitz]

Am I going wrong some place ?? the numbers show that I should not take SM,

Would appreciate if fellow readers could pour in their comments / inputs.



The issue is far more complex than your analysis, especially for a rental property.

The first question you need to ask yourself is whether the rent you receive will not only cover the cost of borrowing $200k in the market, but also provide some profit and reserves for longer-term items such as repairs. If the answer is not in the affirmative, then its a bad investment and you should walk away. On a $200k house, you probably need to collect at least $1500/month in rent to make it worthwhile, IMHO. 1:100 is the ratio that typical property income investors use as the ratio between monthly rents and the price they will pay for a property, so that would imply you needing $2k/month in rent to make the venture worthwhile.

The second question you need to ask yourself is how wise is it really to put all your eggs into one basket, ie: real estate, at one time, in an undiversified manner.

The third question to ask yourself is whether or not you really want to be a landlord. Lots of people just aren't cut out for it.

Typically the SM involves:

1) Dollar-cost averaging into small investments (typically stocks/bonds/mutual funds);

2) Diversifying away from property in order to reduce overall portfolio risk.

[cannon_fodder]

Am I going wrong some place ?? the numbers show that I should not take SM,

Would appreciate if fellow readers could pour in their comments / inputs.

thanks :confused:


I don't know anything about tax treatment of owning investment properties so this question is sincere - is it only possible to write off the interest on the downpayment for the investment property as opposed to the entire mortgage you hold on the investment property?

Secondly, can you not use the cash flow dam http://www.smithman.net/cashflowdam.html
to more quickly convert your principle residence mortgage to a tax deductible mortgage by having the expenses of owning the investment property flow through your SM?

The SM also tends to be structured so that you use the tax refund not to help cash flow but to be applied against the non-tax deductible mortgage, paying it down faster, which then allows you to borrow back more money to go to investments (or in your case I guess it would be to pay down the investment mortgage) which then increases the speed at which you convert non-deductible debt to deductible debt.

[notanexpert]

Mortgage on investment property is fully tax deductible. No need to hurry paying it off if you have non-deductible debt.

[ProStor]

just came across this article, would like to share in the forum.
http://www.thestar.com/Special/article/265155

Using property's equity to invest can be risky

Approach favoured by large corporations, wealthy individuals not for faint of heart
Oct 11, 2007 04:30 AM
Terrence Belford
special to the star



Ever hear of the Smith Manoeuvre? How about the Singleton Shuffle? No, they're not fancy dance steps; they are strategies devised by accountants to take advantage of low mortgage rates coupled with high investment returns.

In essence, they are a way to take equity out of a family home, invest it in the stock market, pay off that mortgage loan and take a hefty tax deduction, all at the same time. But do they make sense for the average homeowner? It depends on whom you ask.

"Absolutely not, unless you are a very sophisticated, very long-term investor," says Tracy Broeze, a financial planner with Cumming & Cumming Wealth Management in Oakville. "Unless you can make payments on the mortgage and have the patience to last through losses for those three years, moves like that can spell disaster."

David Phipps, a financial adviser with Assante Capital Management Ltd. in Ottawa, backs Broeze.

"This is precisely the wrong time to consider any of those moves," he says.

Peter Majthenyi, a mortgage planner with Mortgage Architects, argues the opposite case. "It is a great way to make the best use of mortgages," he says. "All you are doing is taking the same approach used by corporations and high-wealth individuals for years. It is my core business."

The Smith, Singleton and similar strategies argue that rising prices have left many people with great chunks of unused equity in their homes. Many are paying interest on mortgages in the 5.5 per cent range. At the same time, dividends from blue-chip shares are paying 7 per cent or more a year.

Stir in the fact that mortgage interest is not tax deductible, while loans taken out to purchase interest or dividend bearing investments are, and the double whammy of that spread between cost of money and investment returns plus an interest payment tax write-off can translate into significant money.



Majthenyi offers an example. A homeowner with a paid-up principal residence takes out $200,000 in a first mortgage at 5.5 per cent interest and uses that money to invest in blue-chip stocks paying 7 per cent a year. The income from the dividends is then used to make mortgage payments. Because the loan was used for investment purposes, the interest is deductible against annual income, which in the highest marginal rates could mean annual savings of $10,000.

The 1.5 per cent spread between the cost of the loan and dividend income could mean another $3,000 gain. And as the price of those shares rise over time, the investor can also count on a gain on equity.

Phipps admit to being on the conservative side.

"It may not be a bad idea for some investors under certain conditions," Phipps says.

"But do you really want to play the stock market with borrowed money?"

[pitz]

just came across this article, would like to share in the forum.
http://www.thestar.com/Special/article/265155

Using property's equity to invest can be risky


Its thinking like this that causes good quality Canadian assets (ie: oilsands, mines, etc.) to remain perpetually and chronically undervalued, just waiting to be scooped up by foreign interests.

Its your *patriotic* duty to use a strategy like the SM to place solid bids underneath good Canadian names in the energy, mining, and banking sectors. Otherwise, given enough time, foreigners will own all of the profits of Canadian businesses, and Canadians will just receive table scraps.

Canada has very few very rich people, and theres a good reason for this -- we have a very risk adverse investing population. Canadians invest less, earn less, spend less, and have a lower level of prosperity than a country (the United States) with a mere fraction of the natural and human resources available in Canada on a per capita basis.

[Spazmogen]

Phipps admit to being on the conservative side.

"It may not be a bad idea for some investors under certain conditions," Phipps says.

"But do you really want to play the stock market with borrowed money?"

Yes. Yes I do. And its tax deductible too.
In the 5 or 6 months I've been doing the SM, I'm up 2.5% so far (net of fee's) in the investments alone. Considering the US mortgage crises hit right after I set it up, that's not too bad. My target is 8% per year anyway.

[foxdog]

Very interested in smith manoeuvre and read through a couple of articles. My case is I started my 5 year variable mortgage this July through a broker and the lender is CIBC. Am I still qualified to get a HELOC? from CIBC or other lenders?

[FrugalTrader]

Very interested in smith manoeuvre and read through a couple of articles. My case is I started my 5 year variable mortgage this July through a broker and the lender is CIBC. Am I still qualified to get a HELOC? from CIBC or other lenders?

Did you get the firstline matrix mortgage? Otherwise, it will be difficult to do the SM with any other cibc mortgage.

In order to do a real SM, you need a readvancable mortgage (http://www.milliondollarjourney.com/smith-manoeuvre-maneuver-mortgage-comparison.htm).

[foxdog]

Did you get the firstline matrix mortgage? Otherwise, it will be difficult to do the SM with any other cibc mortgage.

In order to do a real SM, you need a readvancable mortgage (http://www.milliondollarjourney.com/smith-manoeuvre-maneuver-mortgage-comparison.htm).

I don't think I get the firstline matrix mortgage since it only applies to fixed rate. Seems it won't for me within 5 years :(

[miserguy]

so is anyone just starting this strategy? or are a lot of others waiting for the supreme court ruling on the Lipson's case to move on this

[telix]

Hello,

This is a great thread and I got a lot of new information I never really understood. I was looking at Fodder's spreadsheet and was wondering what would be the formula to calculate the monthly dollar value out put I would need to work out ?

I used this formula on the bi-monthly one : =B6-C6+G6

I'm just not sure if that is correct.

Also, how would one go about paying off the LOC ? At the end of the mortgage, Let's say the portfolio is 310 and the LOC is 290. You can't just take all the 310 to pay off the 290 cuz the capital gains tax will be so high and put you back under again.

Thank you.

[pitz]

so is anyone just starting this strategy? or are a lot of others waiting for the supreme court ruling on the Lipson's case to move on this

I've not heard of anyone even really concerned with the Lipson's. If you read one of my previous posts, basically the circumstances of the Lipsons are significantly different than the run-of-the-mill SM, in that, the Lipsons did not engage in anything other than a simple restructuring of affairs to attempt to achieve deductibility. The Lipsons, through their moves, did not invest even so much as an extra dime into the Canadian economy, unlike SM'ers who are investing each and every month.

The risks to the SM, IMHO, are quite low. Two things I guess could happen in the worst case scenarios, and both would require amendments to the Income Tax Act:

1) Interest expense can only be written off against investment income. ie: no deduction against other (employment) income.

2) Gains made on borrowed money would be taxed as 'income' (ie: non-capital gains).

Both moves would significantly reduce the profitability of the SM.

[HoTiCE_]

I've not heard of anyone even really concerned with the Lipson's. If you read one of my previous posts, basically the circumstances of the Lipsons are significantly different than the run-of-the-mill SM, in that, the Lipsons did not engage in anything other than a simple restructuring of affairs to attempt to achieve deductibility. The Lipsons, through their moves, did not invest even so much as an extra dime into the Canadian economy, unlike SM'ers who are investing each and every month.

The risks to the SM, IMHO, are quite low. Two things I guess could happen in the worst case scenarios, and both would require amendments to the Income Tax Act:

1) Interest expense can only be written off against investment income. ie: no deduction against other (employment) income.

2) Gains made on borrowed money would be taxed as 'income' (ie: non-capital gains).

Both moves would significantly reduce the profitability of the SM.

Well, the Quebec provincial government has already instated the 1st point here.

Sucks to be us.

[Bullseye]

Finally read every post in this thread! I actually read most of it while on vacation for the month of September at a cottage. My wife laughed at the 'nice light reading material' I brought with me. :cheesygri

Here's my list of questions;

1. An administrative question, but how do people here work out what amount to borrow every month? Do they just take annual interest divided by 12, or do they set up some continously evolving amortization schedule to account for added paydowns like refunds, dividends, etc.? Or is it not that important to be precise about it?

2. Would there be any benefit to using something like a second mortgage to get a better rate on borrowed investment funds? Meaning, once you build up a sizable sum in your HELOC or Readvanceable tranche, flip it over to a proper separate mortgage. Obviously, this violates the 'proper' SM, as you'll be paying principal as well as interest, and it will also affect cash flow (not even sure if you could guerilla capitalize that one?), but wondering if anyone has ran the numbers on it.

3. I read an old, first edition copy if Smith's book, and in it he mentions that he suspects collapsing an RRSP and paying down the mortgage with it, then borrowing back, would be an effective strategy. He said he would examine further in future editions, does anyone know if he did so? Or did anyone here run the numbers on such a strategy?

4. How does inflation play into all of this? Wouldn't we need to factor the inflation rate into our break-even rate of return calculation as well?

Thanks

[pitz]

1. An administrative question, but how do people here work out what amount to borrow every month? Do they just take annual interest divided by 12, or do they set up some continously evolving amortization schedule to account for added paydowns like refunds, dividends, etc.? Or is it not that important to be precise about it?


Not that important. In reality, you really don't want to be living that close to the edge. Nonetheless, with a re-advanceable mortgage, the credit limit quoted on your account statement would go up every time you make a mortgage payment that includes some principal repayment, hence, you get a decent idea of the maximum you could draw.




2. Would there be any benefit to using something like a second mortgage to get a better rate on borrowed investment funds? Meaning, once you build up a sizable sum in your HELOC or Readvanceable tranche, flip it over to a proper separate mortgage. Obviously, this violates the 'proper' SM, as you'll be paying principal as well as interest, and it will also affect cash flow (not even sure if you could guerilla capitalize that one?), but wondering if anyone has ran the numbers on it.


My personal suggestion has been to work towards not using your house at all to secure the loans, but rather, just use a cheap margin facility against your investments. You'll need to do this to invest in the United States anyways (unless you want US dollar risk in your portfolio).




3. I read an old, first edition copy if Smith's book, and in it he mentions that he suspects collapsing an RRSP and paying down the mortgage with it, then borrowing back, would be an effective strategy. He said he would examine further in future editions, does anyone know if he did so? Or did anyone here run the numbers on such a strategy?


Investors Group sells this strategy heavily, the so-called "RRSP meltdown", to its clients. Its *very* sensitive to assumptions, let me tell you that (its also hugely profitable for Investors Group to sign clients up).



4. How does inflation play into all of this? Wouldn't we need to factor the inflation rate into our break-even rate of return calculation as well?


Inflation occurs both on the debt, as well as the asset side. The SM performs the best when there is significant inflation.

[Bullseye]

Thanks, Pitz. I should have known the answer to the inflation question, in hindsight, that's an obvious one.

My other question has been touched on here, but I still don't have a good feel for it...how can we be sure that the SM is a better option than using RRSP's? Is there maybe an optimum point where both are used, that achieves maximum effect?

I was thinking something like a straight reborrow for all mortgage principal paydown amounts, capitalizing interest payments on the borrowed moneyto make it cash flow neutral, but then using all available monthly cash flow for RRSP's, instead of additional mortgage paydown.

Any merit to this approach?

[pitz]

Thanks, Pitz. I should have known the answer to the inflation question, in hindsight, that's an obvious one.


Yes, the best thing to do during inflationary times is to go heavily into debt. The flipside of this is that during deflationary times, debts kill you. The Japanese experience isn't very fun, to wit: there are people who have been paying on their mortgages for close to 20 years, who bought at the top, and haven't accumulated much more than a dime of equity because their property values keep declining just as fast as the mortgage is paid off.




My other question has been touched on here, but I still don't have a good feel for it...how can we be sure that the SM is a better option than using RRSP's? Is there maybe an optimum point where both are used, that achieves maximum effect?


Well you can leverage a RRSP as well using options. Again, you are, in essence, dealing with a problem that is extremely highly sensitive to the variables.

Personally I use the RRSP to invest exclusively in the US, because there's no withholding, and no income tax to pay on the dividends paid by US companies.



I was thinking something like a straight reborrow for all mortgage principal paydown amounts, capitalizing interest payments on the borrowed moneyto make it cash flow neutral, but then using all available monthly cash flow for RRSP's, instead of additional mortgage paydown.


Whatever works. My own studies show that one should probably not contribute to their RRSPs early in their working life (do the SM instead), nor should they late in their working life. So essentially you have a period of time, between roughly the ages of maybe 35 and 55 when RRSP contributions are optimal.

Contribute to RRSPs too early, and you are sacrificing leveraged growth and tax deductible interest outside the RRSP. Contribute to RRSPs too late in your working life, and you won't achieve the tax savings that you expected.

Personally, here's my rule of thumb: figure out the present-value RRSP income you want in retirement.

a) Every dollar you have in your 20s in a RRSP equals a dollar of yearly, inflation indexxed income in retirement.

b) Every two dollars you have in your RRSP in 30s equals $1 in yearly, inflation indexxed income in retirement.

c) Every four dollars you have in your RRSP in your 40s equals $1 in yearly, inflation indexxed income in retirement.

d) Every 8 dollars you have in your RRSP in your 50s equals $1 in yearly, inflation indexxed income in retirement.

e) Every $16 you have in your RRSP in your 60s equals $1 in yearly, inflation indexxed income in retirement.

Assuming a 70/30 equity/fixed income split.

So basically find you age, and using the above rules of thumb, determine whether you have too much in the RRSP already for your age and your future requirements.

Its attractive to put aside $60k when you're in your 20s into the RRSP, but you're really forgoing a lot of the tax advantage because when you're in your 20s, your income probably isn't at the maximum tax rates. But as you can see, if you're in your 50s or 60s with little retirement savings, trying to build a substantial retirement nestegg is pretty futile as you need $16 or more for every dollar of income you want.

[cannon_fodder]

Hello,

This is a great thread and I got a lot of new information I never really understood. I was looking at Fodder's spreadsheet and was wondering what would be the formula to calculate the monthly dollar value out put I would need to work out ?

I used this formula on the bi-monthly one : =B6-C6+G6

I'm just not sure if that is correct.

Also, how would one go about paying off the LOC ? At the end of the mortgage, Let's say the portfolio is 310 and the LOC is 290. You can't just take all the 310 to pay off the 290 cuz the capital gains tax will be so high and put you back under again.

Thank you.

Do you mean, what would be the periodic cash flow required to support this? It is typically structured so that their is no additional cash flow required. If, on the other hand, you borrow a sum against the existing equity in the house, it is possible that you can run into situations where you need to provide additional out of pocket cash to cover the LOC interest. I did add a cash flow calculator to a later version of the calculator but I can't remember all of the factors involved.

As for paying off the LOC, there is a popular school of thought where you don't ever pay off the LOC. You can continue to make those 'mortgage payments' which will pay the LOC interest with the remainder going to investing and keep reinvesting the tax refunds, or you could simply cover just the LOC interest and use the residual cash and tax refunds to enjoy a better lifestyle. In either scenario you will continue to let the investments grow until you need to liquidate them. Depending on what you invest in and how they've grown, it might be possible to receive enough income from their growth and/or dividend/interest income to fund your retirement without touching the capital.

The hope is that you will have a wealth of choices.

[grant]

..is it only possible to write off the interest on the downpayment for the investment property as opposed to the entire mortgage you hold on the investment property?
Only interest is an expense. The amount you repay against principal is not an expense and therefore not deductible.


"But do you really want to play the stock market with borrowed money?"
It's sad that someone as simple as Phipps is a "financial planner".

Smith Maneuvre/Singleton shuffle does not increase total debt and it does not increase purchased investments.

According to his logic, people should not have ANY non-rrsp investments while holding a mortgage.

[Spazmogen]

Only interest is an expense. The amount you repay against principal is not an expense and therefore not deductible.


It's sad that someone as simple as Phipps is a "financial planner".

Smith Maneuvre/Singleton shuffle does not increase total debt and it does not increase purchased investments.

According to his logic, people should not have ANY non-rrsp investments while holding a mortgage.

That article is a fine example of why you should NOT take media headlines into account for your financial planning. Everybody's situation is different. I am doing the SM. I have a mortgage, RRSPs & pension plan through work. It works just fine for my timetable in life.

Hire an expert to handle your investments. Its their job to sift through the information streams for the beneficial tidbits. I am not a D.I.Y. investment type of guy. I have too many hobbies and young kids for that.

In my case, getting an RBC Dominion Securities adviser was the best move I made. That was 11 years ago. I'm 39 now, and I'm far better off as a result. I pay for sound advice, and that is what I get. example: I wanted to buy strip bonds in $USD about 3 years ago. He talked me out of it. "Stay with the equities in CDN $ and you'll be just fine." He saw the dollar's potential long before I did. That is why I pay him.

[Enraged]

how much does a financial advisor charge? I'm just starting a new career, and I'm not sure where/what to start investing.

[GimmeGear]

Its your *patriotic* duty to use a strategy like the SM to place solid bids underneath good Canadian names in the energy, mining, and banking sectors. Otherwise, given enough time, foreigners will own all of the profits of Canadian businesses, and Canadians will just receive table scraps.


:lol: I love the way you think pitz - yes sir! I'll invest sir!


Its thinking like this that causes good quality Canadian assets (ie: oilsands, mines, etc.) to remain perpetually and chronically undervalued, just waiting to be scooped up by foreign interests.


I'm am slowly studying valuation methods. How are you determining these undervaluations?




Canada has very few very rich people, and theres a good reason for this -- we have a very risk adverse investing population. Canadians invest less, earn less, spend less, and have a lower level of prosperity than a country (the United States) with a mere fraction of the natural and human resources available in Canada on a per
capita basis.

I strongly agree with you here. This is one trend this Canadian will NOT follow.
I've heard this same sentiment repeatedly in the news. Most notably from professionals in the business when they're on Squeeze Play.

[pitz]

:lol: I love the way you think pitz - yes sir! I'll invest sir!


Hehe. Well seriously, you look at Inco and Falconbridge, the payback period for the foreigners that bought those companies out was like 2 or 3 years. If those stock prices reflected the resource base they had available, a takeover would have been much more expensive.




I'm am slowly studying valuation methods. How are you determining these undervaluations?


Well in the energy sector, you have Encana, at the bottom of a natural gas slump, still trading at 8X earnings. The resource that is available to the oilsands firms is valued at barely even $2/barrel.

The market is just weird; buyers worldwide are willing to value gold companies based not on earnings, but rather their reserves, but they aren't willing to value oil companies based on reserves, but rather, they look to earnings.




I strongly agree with you here. This is one trend this Canadian will NOT follow.
I've heard this same sentiment repeatedly in the news. Most notably from professionals in the business when they're on Squeeze Play.

Can't say I like the show because Kevin O'Leary doesn't have a lot of credibility anymore with his 'reccomendations'. I remember a show a year ago or so, when he stated that people should dump their commodities, and buy Citigroup :(.

[str8jkt]

Does anyone have any referrals or suggestions for financial advisors in Calgary that are familiar with the Smith Manoeuvre?

Also how do financial advisors that work with clients charge them? Is it a comission basis or a flat fee?

Does it make sense to talk to an advisor at first setup who can setup a plan for you, or is it a service you should be utlizing on an ongoing basis?


Thanks to all in advance for their answers. Looks like the official site smithman.net has removed the list of financial advisors from their site (as advertised in their book).

- Casey

[We'reGonnaWin]

My own studies show that one should probably not contribute to their RRSPs early in their working life (do the SM instead), nor should they late in their working life. So essentially you have a period of time, between roughly the ages of maybe 35 and 55 when RRSP contributions are optimal. ...
I just crunched some numbers for fun and that does make sense given the right variables. any thoughts on the RRSP HBP being used by people younger than 35 though?


Its thinking like this that causes good quality Canadian assets (ie: oilsands, mines, etc.) to remain perpetually and chronically undervalued, just waiting to be scooped up by foreign interests.

Its your *patriotic* duty to use a strategy like the SM to place solid bids underneath good Canadian names in the energy, mining, and banking sectors. Otherwise, given enough time, foreigners will own all of the profits of Canadian businesses, and Canadians will just receive table scraps.

Canada has very few very rich people, and theres a good reason for this -- we have a very risk adverse investing population. Canadians invest less, earn less, spend less, and have a lower level of prosperity than a country (the United States) with a mere fraction of the natural and human resources available in Canada on a per capita basis.
Never thought of it that way. Brill-yant. Got a blog?

[pitz]

I just crunched some numbers for fun and that does make sense given the right variables. any thoughts on the RRSP HBP being used by people younger than 35 though?


Sure, use it. But don't obsess about not using the HBP because you don't have 50 grand in your RRSP by the time you're 30-35 -- the money probably would be better off outside, in tax efficient equity investments.




Never thought of it that way. Brill-yant. Got a blog?

www.financialwebring.org/forum is about the closest thing ;). I post a lot there.

[Jero]

I used the Manulife One account previously 3 years ago, but found it hard to be able to remember to move a certain amount over to the investment portion of my LOC and then write a cheque to my financial planner to invest.

Earlier this year, I started the transition to M-Link which sets up everything under PAC (Pre-authorized cheques) and everything is automatic and improves the efficiency of this system. They charge a fee of $1500 to set up and you are aresponsible for paying for the appraisal and lawyer fees as well. They set me up with Merix Financial for the HELOC and my financial planner used the extra equity for a 2 for 1 loan, which accelerates the process. The interest costs on the extra leveraged loan is covered by the cash distributions by the income fund that it was invested in.

Does anybody know of any other 'automatic system' where the fees are a little lower? I want to let other friends know about it, but it's good to know if M-Link has competition.

[Bullseye]

I used the Manulife One account previously 3 years ago, but found it hard to be able to remember to move a certain amount over to the investment portion of my LOC and then write a cheque to my financial planner to invest.

Earlier this year, I started the transition to M-Link which sets up everything under PAC (Pre-authorized cheques) and everything is automatic and improves the efficiency of this system. They charge a fee of $1500 to set up and you are aresponsible for paying for the appraisal and lawyer fees as well. They set me up with Merix Financial for the HELOC and my financial planner used the extra equity for a 2 for 1 loan, which accelerates the process. The interest costs on the extra leveraged loan is covered by the cash distributions by the income fund that it was invested in.

Does anybody know of any other 'automatic system' where the fees are a little lower? I want to let other friends know about it, but it's good to know if M-Link has competition.

M-Link seemed like a rip off to me, the set up fee, having to pay legal and appraisal, and I thought you were restricted as to what products you can invest in with them?

As has been said here before, extra costs and fees will make it harder for the SM to make financial sense. You need low borrowing costs and low investing costs for the maximum effect. High set up costs and the ongoing financial advisor buried fees will eat into your effectiveness.

[frankal101]

i am trying to implement "cash flow dam" by funding inventory (or COGS) with the equity from my home to accelerate the build-up of tax-deductible debt. I know that my business must have an expectation to realize income. Can my business be selling precious metals - buy local and sell on ebay? Does selling precious metals (bullion) qulify for a business whose loans are tax deductible?

Thanks for your help


Has anyone found creative ways with implementing SM in Quebec? I know that the extent of deductible tax for the year limited by income (or cap gains i guess) that is generated by the investment that the borrowed money was used for... It seems if my investments dont generate return over some period of time (whether an investemnt portfolio or personal business as above), the whole benefit of SM is wiped out and i end up holding the bag on the interest...

Thanks

[Bick Financial Toronto]

Earlier this year, I started the transition to M-Link which sets up everything under PAC (Pre-authorized cheques) and everything is automatic and improves the efficiency of this system. They charge a fee of $1500 to set up and you are aresponsible for paying for the appraisal and lawyer fees as well. They set me up with Merix Financial for the HELOC and my financial planner used the extra equity for a 2 for 1 loan, which accelerates the process. The interest costs on the extra leveraged loan is covered by the cash distributions by the income fund that it was invested in.

Does anybody know of any other 'automatic system' where the fees are a little lower? I want to let other friends know about it, but it's good to know if M-Link has competition.

The $1,500 set up fee seems high. My clients don't pay any fees and the system is very streamlined and easy to manage.

[Bick Financial Toronto]

how much does a financial advisor charge? I'm just starting a new career, and I'm not sure where/what to start investing.

It depends on your asset size. If you have $500,000 or more cash or securities to invest then you will pay the investment manager on an equity portfolio about 0.80% annually plus you will also pay a financial advisor an annual fee that is negotiable and ranges between 0.5% to 1%. In absense of half a million your choices will be more limited and you can count on a total MER (management expense ratio) of about 2.3% to 2.5% that also includes that advisor's 1% annual fee. The investment returns that are published for most investment companies are NET of MERS, so that's the money in your pocket.

[pitz]

Has anyone found creative ways with implementing SM in Quebec? I know that the extent of deductible tax for the year limited by income (or cap gains i guess) that is generated by the investment that the borrowed money was used for... It seems if my investments dont generate return over some period of time (whether an investemnt portfolio or personal business as above), the whole benefit of SM is wiped out and i end up holding the bag on the interest...


Why on earth would you deliberately invest in investments that will not generate a return over a period of time? That just doesn't make sense. The Quebec rules aren't a big hinderance -- they just strongly 'encourage' you to invest in businesses that have very reasonable prospects of paying dividends in the future.

Also, the Quebec rules only apply to the provincial portion of the tax return -- all of the traditional SM rules still apply to the federal tax return.

[Bick Financial Toronto]

Looks like the official site smithman.net has removed the list of financial advisors from their site (as advertised in their book).

Indeed. Fraser Smith have a plan of his own to harvest his popularity. Not that you can blame him: he has worked hard for it. Since the contacts were pulled from the site it is now more difficult to find financial advisors who actually undestand the concept in depth AND are able to execute it at a low cost to the client.

[Bick Financial Toronto]

I don't think I get the firstline matrix mortgage since it only applies to fixed rate. Seems it won't for me within 5 years :(

You are right. Your mortgage is not a Matrix. But all is not lost. You could refinance your mortgage into a Matrix and your only cost will be your legals.

[florch]

I used the Manulife One account previously 3 years ago, but found it hard to be able to remember to move a certain amount over to the investment portion of my LOC and then write a cheque to my financial planner to invest.

Earlier this year, I started the transition to M-Link which sets up everything under PAC (Pre-authorized cheques) and everything is automatic and improves the efficiency of this system. They charge a fee of $1500 to set up and you are aresponsible for paying for the appraisal and lawyer fees as well. They set me up with Merix Financial for the HELOC and my financial planner used the extra equity for a 2 for 1 loan, which accelerates the process. The interest costs on the extra leveraged loan is covered by the cash distributions by the income fund that it was invested in.

Does anybody know of any other 'automatic system' where the fees are a little lower? I want to let other friends know about it, but it's good to know if M-Link has competition.

You are probably gonna be sick, it was so easy. Using M1, I paid into my TDW Non-RRSP account like an online bill payment. It's set up to pay recurring every pay day. Just use the account number. I also do this to repay my HBP into my TDW RRSP. And I can change payments or pay extra any time I want without going in to see someone or setting up an inflexible PAC. I hate going in to see them. They just don't understand DIY investing, and I don't want to edumacate them.

[cgjedi]

Is there a complete list of investment types for the SM? For example, Canadian Royalty Trusts - are they ok? How about Forex? Any other fringe types allowed?

Thanks.

[BillyParadise]

Anything that can be invested with the expectation of profits. Not land, not commodities. Dont know about forex, but the idea here is to make long term investments, not gamble it all away. Then you've still got your mortgage, and major investment losses.


Read through this entire thread - it will take a while, but will be worth it - literally hundreds of thousands of dollars. (This thread is worth about 6x the value of my mortgage, based on SM+RM. )

[Bick Financial Toronto]

Is there a complete list of investment types for the SM? For example, Canadian Royalty Trusts - are they ok? How about Forex?

Investments that are expected to generate interest and/or dividend income are allowed. This is it - it will not get any simpler than that. Furthermore, just because the investment is expected to produce dividend or interest income, CRA may not accept it if they can reasonably assume that the investment was made to avoid income taxes.

For example, let's assume that someone has a $100,000 HELOC at Prime (5.75) and also has $100,000 investment in GICs earning 4%. If this person would use the proceeds from the $100,000 in GICs and pay down the HELOC, then re-borrow from the HELOC the $100,000 and reinvest into the GIC, CRA will probable have two objections:

1. Based on the specifics above it is obvious that this was done to avoid paying income taxes

2. The investment structure was not set up in order to earn a "profit" because the GIC rate is below the borrowing rate.

[dark169]

Investments that are expected to generate interest and/or dividend income are allowed. This is it - it will not get any simpler than that. Furthermore, just because the investment is expected to produce dividend or interest income, CRA may not accept it if they can reasonably assume that the investment was made to avoid income taxes.

For example, let's assume that someone has a $100,000 HELOC at Prime (5.75) and also has $100,000 investment in GICs earning 4%. If this person would use the proceeds from the $100,000 in GICs and pay down the HELOC, then re-borrow from the HELOC the $100,000 and reinvest into the GIC, CRA will probable have two objections:

1. Based on the specifics above it is obvious that this was done to avoid paying income taxes

2. The investment structure was not set up in order to earn a "profit" because the GIC rate is below the borrowing rate.

be careful , the courts of told the CRA that they are not to be the judge of profitability and good business sense, rather all one needs to do is reasonably expect income at the time.

And with the tax break one is making a profit if your tax rate is >32% (with the rates you used) as your cost of borrowing is offset by your tax advantage. Which is the justification of the tax break on investment loans.

[pitz]

be careful , the courts of told the CRA that they are not to be the judge of profitability and good business sense, rather all one needs to do is reasonably expect income at the time.


Yeah no kidding, the Income Tax Act does not protect investors from their own stupidity, and nor does the CRA.

If you were stupid enough to borrow a gazillion dollars and throw it into GICs, bonds, or whatever -- you deserve exactly what you'll get :(.

[bonzo]

Just had a quick question about the investment account. Is it better to set up the equities using drip or will that complicate tax filing?

[pitz]

Just had a quick question about the investment account. Is it better to set up the equities using drip or will that complicate tax filing?

By "DRIP", I think you are referring to automatic dividend re-investment, a service offered by some issuers, and some brokers.

Its a less efficient way of doing things, because the idea of the SM is to take the cashflow from the investments (ie: the dividends), and to apply them to the non-deductible mortgage balance, in addition to your normal mortgage payments.

Plus DRIP's are a nightmare when it comes to calculating ACB's.

[BCNeil]

Great read.
I have been thinking about doing the SM for awhile.
Just have a couple questions that I couldn't find answers for.

It seems people are using a combination of a fixed mortgage and an LOC.
Is it possible to do this with a completely open mortgage.

Currently I have a citizens bank creditline mortgage at prime.

The home was $400,000, had $200,000 as down payment.
leaving me with a $300,000 LOC at prime, (75% value of home) with available credit of $100,000 that could be used for investing.

Each month my pay goes into this same account, and bills and spending money are taken out. However the $100,000 available credit keeps increases, as my cash in is greater than cash out.

Can I use an account like this for the SM. Like use the $100,000 I have now to invest right away (or a smaller portion to not be at the edge) , and when my available credit keeps going back up, transfer that to my investment account. Like every month, income minus monthly income is about $1500, so I could keep taking the available credit of $1500 out out month.

Or do you have to have a LOC that is strictly for investing only.

[cannon_fodder]

If your goal is to be able to deduct the interest costs on the borrowing to invest portion then it will be more challenging, especially with constant reborrowing, to get CRA to see it your way.

It is much cleaner, and therefore less worrisome when it comes tax time, to have a separate account for borrowing to invest.

[AllWheelDrift]

Great read.
I have been thinking about doing the SM for awhile.
Just have a couple questions that I couldn't find answers for.

It seems people are using a combination of a fixed mortgage and an LOC.
Is it possible to do this with a completely open mortgage.

Currently I have a citizens bank creditline mortgage at prime.

The home was $400,000, had $200,000 as down payment.
leaving me with a $300,000 LOC at prime, (75% value of home) with available credit of $100,000 that could be used for investing.

Each month my pay goes into this same account, and bills and spending money are taken out. However the $100,000 available credit keeps increases, as my cash in is greater than cash out.

Can I use an account like this for the SM. Like use the $100,000 I have now to invest right away (or a smaller portion to not be at the edge) , and when my available credit keeps going back up, transfer that to my investment account. Like every month, income minus monthly income is about $1500, so I could keep taking the available credit of $1500 out out month.

Or do you have to have a LOC that is strictly for investing only.
The important thing is not to co-mingle the funds. I.e. if you use the same account, part of the loan is for investment and part is your mortgage and because of that you wouldn't be able to deduct the interest. You may be able to get a separate sub account on your existing LOC and use that sub account purely for SM investing.

[sharp21]

1. If you wanted to do the SM but didnt want the burden of a large "good debt" loan, could you borrow to invest up to say $50k, then just pay down the rest of your mortgage? I realize it wouldnt be optimizing the manouvre but staying in your comfort zone is important too.

2. What if a person was in the position of making a substantial extra payment on his mortgage? The mortgage I have allows 15% of the monthly payment every month & 15% of the borrowed principle annually. Saying I could pay the max on both of those, would it be more beneficial to just pay off the mortgage quickly? Or to convert the debt, then pay down the investment loan?
I know the idea is to keep that debt rolling on, but there is great peace of mind from being debt free
S.

[BillyParadise]

Hi Sharp,


1. If you wanted to do the SM but didnt want the burden of a large "good debt" loan, could you borrow to invest up to say $50k, then just pay down the rest of your mortgage? I realize it wouldnt be optimizing the manouvre but staying in your comfort zone is important too.

People can have a tendency to split hairs around here, but the classic definition of the SM is

1. Change your mortgage to a readvanceable product.
2. Leverage your mortage back up to 80%. Your monthly mortgage costs will not change. This new money is called "freeboard equity". Invest it. (prudently)
3. Invest monthly using the increase in equity generated by mortgage paydown.
4. Take the tax refunds generated by the SM carrying costs and apply it to your mortgage
5. Reinvest. Rinse. Repeat.

SM is a process which makes it easy to understand what you're doing. It's essentially leveraged investing, made accessible to the masses.


2. What if a person was in the position of making a substantial extra payment on his mortgage? The mortgage I have allows 15% of the monthly payment every month & 15% of the borrowed principle annually. Saying I could pay the max on both of those, would it be more beneficial to just pay off the mortgage quickly? Or to convert the debt, then pay down the investment loan?


The beauty of the SM is that you're doing two things at once - paying down the mortgage (bad debt), while investing (good debt). I am also paying down my mortgage faster than required. Good "SM Mortgages" are completely open - you can pay off as much as you want whenever. As you pay off the mortgage, you can transfer the equity to investments that much more quickly.
Remember - the money you've invested is yours. You can always pull it out of the investments and apply it to your home in case of emergency. In the short term, the investments may lose a little value, but assuming it's invested prudently, the long term gain should outweigh the carrying costs.


I know the idea is to keep that debt rolling on, but there is great peace of mind from being debt free
S.


Debt Free sounds good at first glance. But Bad Debt Free is where you want to be. It's all but impossible to get ahead without leverage.

Everyone should invest according to their own personal risk profile. I suggest talking to a CFP to help you through the process. Not only will this ensure you're investing prudently, but it will ensure you're doing the SM properly.

BP

[sharp21]

Billy
Appreciate the response.
I bought the book years ago when I had my first house, but never had enough equity to do it.
Now with my second house I am much closer to the 20% needed (yay legislation change!) so want to start planning it out.
However, a 250k outstanding loan still makes me uncomfortable. Perhaps once the mortgage is fully converted I could work at repaying that, using the dividends from the Canadian dividend paying stocks to help pay it quicker. At the end I should have a nice portfolio in addition to no debts
S.

[cannon_fodder]

If you're going to use freeboard equity (I call it 'Big Bang' SM) or tapping into existing equity to jump start your portfolio, then why not submit the T1213 (?) form to CRA to reduce taxes withheld at source, thus allowing you to put more money towards the mortgage sooner?


Sharp21, you may want to factor in your Marginal Tax Rate into the actual costs of the LOC. When you look at converting a $250k non-deductible mortgage at Prime - 0.75 compounded semi-annually, for example, into a $250k deductible mortgage at prime compounded monthly, there are 3 big factors that make them dissimilar:

1. By the time you have finished converting, inflation will make a $250k LOC worth significantly less in today's dollars.
2. You have the option to only pay the interest on the LOC which helps with the cash flow.
3. The interest may be tax deductible - at least that is the goal, anyway.

For example, if you have


$250k mortgage
5% interest rate
32% Marginal Tax Rate (and 5.85% for dividends)
Inflation rate of 2.5%
Investments pay out dividends at a rate of 2.5% per month which you use to pay down your mortgage.
HELOC interest rate of 5.75%
Investments grow at 5.5%


You implement the SM and you reborrow principal payments and capitalize the interest. You also take your tax refunds and apply them to the mortgage, too. Your mortgage payments are $1,454.01.

So, perhaps 19 years and 1 month later you are mortgage free. But, you have a $250,000 LOC and over $440k in investments.

Factoring in inflation, that $250k LOC is really worth about $154k in today's dollars. And your interest only payments of $1,198 effectively cost you only $815 per month. But, again, factoring inflation, the payments are, in today's dollars, $739 costing you only $503 per month (if you are still at that MTR of 32%). That is about 1/3 of what you are paying today.

[sharp21]

Must admit, I wasnt thinking of inflation...
Something unique about my situation:
I work out of the country for more than 6 months, so qualify for a tax rebate. After my tax return is said & done I end up paying approximately 9-12%. So I suppose doing the SM would just increase the size of my return? I also make a good wage so am able to make extra payments.
S.

[Jungle]

Without reading all these pages, can anyone recall what the approximate rate of return is for the taxes?

[BillyParadise]

a) please rephrase the question - there is no rate of return for taxes (unless I misread)

b) don't be lazy. Read this whole thread. It could be worth several hundred thousand dollars to you.

BP

[Bick Financial Toronto]

Must admit, I wasnt thinking of inflation...
Something unique about my situation:
I work out of the country for more than 6 months, so qualify for a tax rebate. After my tax return is said & done I end up paying approximately 9-12%. So I suppose doing the SM would just increase the size of my return? I also make a good wage so am able to make extra payments.
S.

I believe you indicated your average tax rate. Your marginal tax rate is what matters. Higher your marginal tax rate, the better the potential financial benefit of the tax deductible mortgage strategy. This leveraged strategy rests on the notion that you borrow at a net after tax cost that is lower than your net after tax return. Your costs of borrowing is lowered by a higher marginal tax rate. On the other side of the equation you want to defer paying income taxes on your gains for as long as possible, and then pay it at the lowest possible rate. One way to do it is investing in corporate class with certain investment institutions.

Given the combined provincial and federal income tax rates in Ontario, anyone making less than $40,000 will possibly lack the marginal tax rate and the financial stability to take on the tax deductible mortgage strategy, or any other variations of the Smith Manoeuvre.

[big_canuck]

Bump on this topic...

Great info all - just trying to determine how to best introduce either this implementation or a similar one to benefit us. Great spreadsheet cannon_fodder.

Our situation - any advice? All numbers estimates.

Current mortgage - $170k @ 4.5% (2 years left on term)
Current house value - $550k
Current avail HELOC on house - $260k (no balance) - roughly prime + <1% (not sure exact)

Can we 'mimic' the SM by utilizing the funds available from our HELOC for investments by taking out the estimated principal down-payment each month and investing? Or should we accelerate this by taking out a larger portion from the HELOC and investing right away?

Knowing we have enough HELOC available to pay out our mortgage when our term is up in 2 years, is it feasible/advisable to take out $170k from HELOC, invest today (deductible interest) then cash proceeds from investments in 2 years to pay out mortgage?

Since we have the current equity available in our house to do a couple options, are there any recommendations or is it best to follow the SM to the letter?

[grant]

Can we 'mimic' the SM by utilizing the funds available from our HELOC for investments by taking out the estimated principal down-payment each month and investing? Or should we accelerate this by taking out a larger portion from the HELOC and investing right away?
Neither of those ideas have anything to do with SM. They are simply leveraged investing.

It's worthwhile if you expect your investment to return more than your interest %... AND you're ok with the risk.

[houska]

Neither of those ideas have anything to do with SM. They are simply leveraged investing.

It's worthwhile if you expect your investment to return more than your interest %... AND you're ok with the risk.

And don't forget the devil is in the details. The benefit of Smith or of leveraged investing of this comes from the spread between returns and the loan, plus tax benefit. In particular, make sure to consider the fees of your investments - and consider if you could get a HELOC at Prime - or based on the $$$ might even be worth seeing if you could convert it to an open variable at P-0.75 (e.g. if you are in the Scotia STEP plan or something similar).

[cannon_fodder]

big_canuck,

If you are comfortable with leveraging, and understand that it has the potential to magnify losses as well as gains, then you could take out a significant portion of your HELOC available to you and invest that.

I don't think it would be prudent to expect that in 2 years time your investments will definitely have grown to support paying off the mortgage - the longer the time frame, the greater chance you have of being net positive and 2 years is too short a horizon to count on it.

I think the real question, as houska alluded to, is can you borrow at an after tax rate to invest in a portfolio that has a very good chance of producing an after tax performance in excess of that cost over a substantial time frame?

You could forego some tax efficiency by investing at least a portion in dividend producing (not return of capital) investment vehicles which could help offset the interest costs of the HELOC (assuming you intend to cover the interest costs of the HELOC).

Just for kicks, plug your numbers into the calculator starting with a leveraged amount, e.g. $0k, $25k, $50k, whatever. Put that into the Starting LOC amount and the non-registered assets. See how potentially this can reduce the amortization period of the mortgage.

Go through the exercise again, tick the Step 5 box and split the investment growth into a component of investment growth and assets dividend yield (e.g. if you started out with 7% growth, then try 6% growth, 1% yield, %5 and 2%, etc.). Watch again how your amortization period can potentiallybe shortened.

I've run scenarios for longer (e.g. >= 10 years) timeframes where a 4% yield is sufficient to come out ahead of not leveraging within the SM even with 0% growth. I feel confident I can construct a portfolio that will return at least 0% CAGR over 10 years.

[celica00]

Cannon,

I've read about this calculaor of yours :)

Where could I obtain a copy?

Thanks!

[FrugalTrader]

Cannon,

I've read about this calculaor of yours :)

Where could I obtain a copy?

Thanks!

Here you go!
http://www.milliondollarjourney.com/the-smith-manoeuvre-resource.htm

[frankal101]

Has anyone thought of how the SM would look like in a high interest rate environment? Suppose rates on heloc are expected to go to 10% and the yield on your investment portfolio is near the after tax cost of heloc??

are there any products available for the retail investor to hedge borrowing costs? fixed for floating swaps, swaptions, interest rate collars - ideally something that would protect you from upward movements in borrowing costs without having to switch to a mortgage structure (interest only - no principal repayment)... i cant imagine a local BMO branch that would create a custom 10yr interest rate swap for 200-300k?

thanks

[Anonymouse]

I am researching this technique for a friend, who has a high ratio mortgage and only 30k equity. I wonder if SM is appropriate for her?

Also, although I understand that this procedure is professed to be CRA approved, this is not carved in stone. My concern is that CRA will put out a ruling disallowing these strategies, but not until many people are already committed and then there is a large reassessment after the fact.....sort of like what they did with income trusts.

EDIT: "SM" is "Smith Manoevre" and not that other thing, you perverts.

[pitz]

I am researching this technique for a friend, who has a high ratio mortgage and only 30k equity. I wonder if SM is appropriate for her?


NO! One should have at least 30-40% equity in their home before they consider the SM, IMHO. To recommend the SM to anyone with a high ratio mortgage is just irresponsible and wreckless.



Also, although I understand that this procedure is professed to be CRA approved, this is not carved in stone.


Well, the nature of tax deductibility on money borrowed to invest is fairly hard to impugne. It would basically require a complete restructuring of the way that business is financed in Canada.

The probability of the SM, in its most simple form, being attacked in a substantive way, is almost zero. However, it is entirely conceivable that deductibility be limited or deferred such that one can only deduct against investment income, as is the case in the US tax code (and in the Province du Quebec).



My concern is that CRA will put out a ruling disallowing these strategies, but not until many people are already committed and then there is a large reassessment after the fact.....sort of like what they did with income trusts.

Well, the CRA did not have anything to do with the taxation rules concerning income trusts. Those rules were changed as an Act of Parliament, and there was absolutely no 'reassessment after the fact' with income trusts (in fact, there was a 4 year grace period...).

[grant]

I am researching this technique for a friend, who has a high ratio mortgage and only 30k equity. I wonder if SM is appropriate for her?
SM is for anyone who:
1) has a mortgage acruing non-deductible interest
AND
2) owns non-RRSP investments and/or a business which actually earns income.


Also, although I understand that this procedure is professed to be CRA approved, this is not carved in stone.

The CRA challenged the technique and the SUPREME COURT OF CANADA upheld its legality. How do you get more secure than that?


My concern is that CRA will put out a ruling disallowing these strategies, but not until many people are already committed and then there is a large reassessment after the fact.....sort of like what they did with income trusts.
1) the change to income trusts was made by parliament not the CRA
2) there is plenty of advance warning of impending tax changes
3) if by some bizarro legislation the SM is made ineffctive, so what? your friend is no worse off than before.

[pitz]

Has anyone thought of how the SM would look like in a high interest rate environment? Suppose rates on heloc are expected to go to 10% and the yield on your investment portfolio is near the after tax cost of heloc??


Well in a rising interest rate environment, the value of the investments will drop, coincident with declining value of the collateral, and possible restriction of credit on a HELOC. That's why you only want to perform the SM if you have a very healthy equity cushion.

SM funds should be invested in investments that are not particularly interest-rate sensitive. For instance, you shouldn't invest SM funds into additional real estate, or into long-term bonds. You shouldn't invest SM funds into banks in a major way. The best place to put funds is into relatively stable non-cyclical businesses, and into businesses that are relatively anti-cyclical.

Traditionally anti-cyclical businesses have included energy and mining.



are there any products available for the retail investor to hedge borrowing costs? fixed for floating swaps, swaptions, interest rate collars - ideally something that would protect you from upward movements in borrowing costs without having to switch to a mortgage structure (interest only - no principal repayment)... i cant imagine a


Not really.. Basically a SM investor has to look to the underlying investments for characteristics that would be anti-cyclical in the circumstances that you name.



local BMO branch that would create a custom 10yr interest rate swap for 200-300k?


Lol, someday... I doubt you'd even find branch personnel that know what an 'interest rate swap' is.

[Anonymouse]

The CRA challenged the technique and the SUPREME COURT OF CANADA upheld its legality. How do you get more secure than that?


I'm not questioning you, but do you have a link or case name for this? I'd like to read it.

[frankal101]

Pitz - great stuff - to that makes sense. I was thinking of hedging the tail risk of high floating borrowing costs...

Here are some other interest rate hedging alternatives i was thinking about that would be easy for an institutional investor, but seem almost impossible for a retail investor:
- going long a series of FRA's (forward rate agreements)
- going long variable rate instrument (LIBOR based) and short fixed rate instrument (replicating a swap) - but what instruments would one use - munis???
- play long bonds (via options, futures, 2x leverage etfs?) - although this would not seem like the best alternative...

There might be some alternatives like this that exist in US. Theoretically it would be possible to get US denominated margin loans to fund the purchase or maintenance of such (above mentioned) instruments... but then you are stuck hedging another potentially unwated exposure (US Dollar)...

[pitz]

Pitz - great stuff - to that makes sense. I was thinking of hedging the tail risk of high floating borrowing costs...


Well, if the economy goes into heavy asset deflation, pretty much nothing will save you if you are highly leveraged, as the SM would imply.

All the fancy derivative arrangements that you name have serious counterparty problems when you encounter extreme circumstances such as, for instance, 20% interest rates.

I'd suggest that in such circumstances, physical gold or commodities would perform well, historically speaking, as you're basically dealing with the systemic collapse of the banking system.

Unfortunately, I'm of the view that we're not all that far away from such a scenario, especially in the US :(.





Here are some other interest rate hedging alternatives i was thinking about that would be easy for an institutional investor, but seem almost impossible for a retail investor:
- going long a series of FRA's (forward rate agreements)
- going long variable rate instrument (LIBOR based) and short fixed rate instrument (replicating a swap) - but what instruments would one use - munis???
- play long bonds (via options, futures, 2x leverage etfs?) - although this would not seem like the best alternative...


Yeah... counterparty risk is a big issue with all of them... None of your counterparties are going to be solvent and able to perform on the contracts if ever the exogenous conditions that you are trying to hedge against, actually come to fruition.

[Anonymouse]

NO! One should have at least 30-40% equity in their home before they consider the SM, IMHO. To recommend the SM to anyone with a high ratio mortgage is just irresponsible and wreckless.


Why, specifically, though? Is it the potential of poorly performing investments made with leveraged funds?


Well, the CRA did not have anything to do with the taxation rules concerning income trusts. Those rules were changed as an Act of Parliament, and there was absolutely no 'reassessment after the fact' with income trusts (in fact, there was a 4 year grace period...).

I accept that there was no retroactivity in the new income trust taxation rules, but it is not altogether clear to me that the tax refunds made to SM practitioners won't be retroactively disallowed because of some novel theory that some very bright CRA lawyer comes up with. CRA can, and does, reevaluate people's old tax returns and demand more money. If everyone in the country was doing the SM, the country would be insolvent.

Do you really think that the CRA, which was losing billions on income trusts, had nothing to do with rewriting the rules?

[pitz]

Why, specifically, though? Is it the potential of poorly performing investments made with leveraged funds?


Why? Because every 5 years or so, you have to renew that mortgage. At 30% equity, get a 10% drop in prices, and renewal becomes difficult on favourable terms.

That's the simple answer.



I accept that there was no retroactivity in the new income trust taxation rules, but it is not altogether clear to me that the tax refunds made to SM practitioners won't be retroactively disallowed because of some novel theory that some very bright CRA lawyer comes up with.


Well people who are claiming deductibility on so-called 'ROC funds' are playing with fire. This circumstance has been discussed in other parts of this thread.

It is not safe to apply Return of Capital distributions from SM investments against non-deductible debt.




CRA can, and does, reevaluate people's old tax returns and demand more money. If everyone in the country was doing the SM, the country would be insolvent.


Maybe, maybe not. People who borrow to invest create jobs. Nobody will lend you money unless you have savings, so people would accumulate more savings in order to borrow. The underlying investments themselves pay taxes. If everyone did it, then the taxation landscape would certainly change, but it would not render the country 'insolvent'.

[Anonymouse]

People who borrow to invest domestically create jobs.

Fixed. Also, are you from Alberta? I haven't heard a true believer in trickle-down economics for many years. :-)

[pitz]

Fixed. Also, are you from Alberta? I haven't heard a true believer in trickle-down economics for many years. :-)

Well, somebody would have to pay taxes on the interest you pay when you borrow money to execute the SM.

Right? I mean, a SM borrower is essentially borrowing money from a bank, who obtains it from depositors, and depositors pay taxes on the interest received.

[grant]

I'm not questioning you, but do you have a link or case name for this? I'd like to read it.
It's a classic: http://scc.lexum.umontreal.ca/en/2001/2001scc61/2001scc61.pdf

[Bullseye]

SM is for anyone who:
1) has a mortgage acruing non-deductible interest
AND
2) owns non-RRSP investments and/or a business which actually earns income.


You and I have discussed this before...the SM requires no existing investments. Only your first condition is required to begin the SM. Although I agree with Pitz about having siginificant equity first as well.

What your second condition is is simply a swap to make interest tax deductible. The SM was designed purposely for those who DON'T have a non-registered account or business, to achieve the same advantages. Instead of selling an existing portfolio and borrowing back to re-buy it, or building business debt while paying down a mortgage, you are borrowing back in small chunks every principal payment you make on your mortgage.

[grant]

The SM was designed purposely for those who DON'T have a non-registered account or business,
If a person doesn't have investments or a business, they necessarily must purchase investments they wouldn't have purchased otherwise, with borrowed funds.

so it's a matter of semantics: some people call doing that the "smith maneouvre" whereas i call it "leveraged investing".

IMHO a true SM does not alter a person's debt load OR their investments. And for that to be so they MUST have an existing portfolio or cash-flow business.

This difference explains why there's a 47 page thread about the topic; because the 2 concepts get mixed up as if they are the same thing.

[colezy9]

I am about to purchase a house for approx 245k, I have 20% to put down, I am seriously considering the BMO Readiline or Firstline Matrix re-advanceable mortgage to perform the Smith Manoeuvre. I am 25 years old, my yearly salary is 55k, this will be my first house and I may or may not rent out a room. I do realize that you cannot always count on the rental income, however If I lost the renter I could still make my payments.

My questions are:
1) Is the Smith Manoeuvre a good option for me? Why or why not?
2) Can anyone recommend someone with Smith Manoeuvre experience that can help me set out a plan and make recommendations?
3) Would you recommend a variable (currently prime - 0.75%) or fixed rate (approx 5.2%) mortgage.
4)I can afford the payments on a 20 yr ammortization period, but if I went with a 30-35 year ammortization I would have more cash, what would you recommend?
5) Would you recommend BMO Readiline or Firstline Matrix or another option?
6) Can anyone recommend a Financial Analyst to assist with this procedure, I'm in Regina,SK but willing to deal with someone remotely as well.

Any other feedback or comments would also be appreciated.

[BillyParadise]

I am about to purchase a house for approx 245k, I have 20% to put down, I am seriously considering the BMO Readiline or Firstline Matrix re-advanceable mortgage to perform the Smith Manoeuvre. I am 25 years old, my yearly salary is 55k, this will be my first house and I will be renting out a room for $500 per month. I do realize that you cannot always count on the rental income, however If I lost the renter I could still make my payments.

My questions are:
1) Is the Smith Manoeuvre a good option for me? Why or why not?
2) Can anyone recommend someone with Smith Manoeuvre experience that can help me set out a plan and make recommendations?
3) Would you recommend a variable (currently prime - 0.75%) or fixed rate (approx 5.2%) mortgage.
4)I can afford the payments on a 20 yr ammortization period, but if I went with a 30-35 year ammortization I would have more cash, what would you recommend?
5) Would you recommend BMO Readiline or Firstline Matrix or another option?

Any other feedback or comments would also be appreciated.

1) Only you can decide if it's good for you. However, as you have a long time horizon before retirement, you're in an ideal position to make the most of this strategy. I would do it if I were in your position.
2) I used the services of a CFP to set mine up. There's plenty of information online, especially in this thread, so it is possible to set it up correctly without a planner. But doing the SM properly is also about choosing the right investments - something I personally had had difficulty with in the past. (I'm now old enough to know I don't know everything and cant be an expert at everything) I found that going to a financial planner was the best move for me. Also, since you've got rental income in the mix, your SM setup will be slightly more complicated.
3) This is not a question about the SM, but about general mortgage financing. A very prominent survey found that 80% of the time you will win with variable mortgages, as long as you can afford the volatility. I have a variable, but pay more than the minimum, so that if/when rates go up, I won't have to change my payment or extend the amortization.
4) You pay your mortgage interest with after tax money, so everything you can put against that nondeductible debt will get your further ahead. If you set up a second sub-account, you can use it as a line of credit, pulling equity back out of your house as needed, and you won't be mixing up the investment subaccount from your personal spending - very important come tax-time.
5) There are pros and cons to all of them. There's a good SM mortgage comparison at http://www.myvirtualmortgagebroker.com/Smith-Manoeuvre-Mortgages-Smith-Maneuver.html

Hope that helps - remember read this entire thread and it will sort out all of your questions.

BP

[pitz]

1) Is the Smith Manoeuvre a good option for me? Why or why not?


Sure, but you need more than 20% equity. Once you have 30-35% equity in the house, and all your other debts paid off, then you might consider starting the SM.

You should put all your excess cash towards the mortgage at this point. If you can make a bunch of prepayments in the next 5 years, then you'll really build up equity fast.

Only 20% equity, IMHO, isn't really enough to make use of the SM without an extreme amount of risk.



3) Would you recommend a variable (currently prime - 0.75%) or fixed rate (approx 5.2%) mortgage.


If you can get a fixed for 5.2%, I'd take that. You're not going to save anything more than likely over the next 5 years with a variable.



4)I can afford the payments on a 20 yr ammortization period, but if I went with a 30-35 year ammortization I would have more cash, what would you recommend?


Well, if you can do a 20 year amortization, by all means, go for it. As long as you have prepayment priviledges, it really doesn't matter what your amortization is. The key is to minimize the interest rate.



5) Would you recommend BMO Readiline or Firstline Matrix or another option?


Firstline Matrix works well...



6) Can anyone recommend a Financial Analyst to assist with this procedure, I'm in Regina,SK but willing to deal with someone remotely as well.


Hmmm, well at this point, you probably just need to sit down with a mortgage broker (I think the Centum outfit that's by Grekos on Albert Street is the one that a few people I know have used in Regina...) and get yourself set up with the Firstline product.

I don't think, at least for the first 5 years, that you'll have any legitimate reason to actually do the SM because of your minimal equity, *unless* you receive an inheritance or something.

[Bick Financial Toronto]

Why? Because every 5 years or so, you have to renew that mortgage. At 30% equity, get a 10% drop in prices, and renewal becomes difficult on favourable terms.

That's the simple answer.

Renewal will be easy as long as you pay the mortgage as agreed. Even if the mortgage amount is greater than the value of the home, as the lender does not want to foreclose on you as long as you keep paying: they would realize a significant loss. This was the case in the early 1990s in Canada.

It is also true that the renewal rate may not be very pretty: once the lender figures out that you are a captive client (no one would touch the mortgage because the value is lower than the debt owed), they can jack up the rate. The only thing that may hold them back somewhat is if the property owner threatens to walk away from the home and destroying it in the process. But that's kind of last resort as it will mean bankruptcy for the property owner. Most lenders, however, are not predatory as the PR issue would hurt them too much: clients and mortgage brokers will not do business with them going forward.

[pitz]

Renewal will be easy as long as you pay the mortgage as agreed. Even if the mortgage amount is greater than the value of the home, as the lender does not want to foreclose on you as long as you keep paying: they would realize a significant loss. This was the case in the early 1990s in Canada.


...on favourable terms. Banks won't renew on favourable terms (ie: low interest rates) if there is not an equity backstop, because they are becoming prima facie unsecured lenders.

Seriously, when borrowing money, you *never* want to be held captive to one lender when you have to renew. Your original lender might renew the financing, but trust me -- the terms are going to suck, and they're going to fundamentally impair the effectiveness of the SM.



It is also true that the renewal rate may not be very pretty: once the lender figures out that you are a captive client (no one would touch the mortgage because the value is lower than the debt owed), they can jack up the rate. The only thing that may hold them back somewhat is if the property owner threatens to walk away from the home and destroying it in the process. But that's kind of last resort as it will mean bankruptcy for the property owner. Most lenders, however, are not predatory as the PR issue would hurt them too much: clients and mortgage brokers will not do business with them going forward.

Well if a bank has to ration funds because they are weakly capitalized and are having trouble raising money for funding, will they care much about their 'reputation'?

[Bick Financial Toronto]

...on favourable terms. Banks won't renew on favourable terms (ie: low interest rates) if there is not an equity backstop, because they are becoming prima facie unsecured lenders.

Seriously, when borrowing money, you *never* want to be held captive to one lender when you have to renew. Your original lender might renew the financing, but trust me -- the terms are going to suck, and they're going to fundamentally impair the effectiveness of the SM.

Well if a bank has to ration funds because they are weakly capitalized and are having trouble raising money for funding, will they care much about their 'reputation'?

While you do not want to be captive to any lender, one has to consider the historical perspective. In the early 90s many home owners were 'captive' to the banks: the value of their property has declined faster than their mortgage was reduced. Yet the banks did not get ugly with anyone and it was a pretty tough real estate crisis at the time. Given the conservative stance of the Canadian banks I do not expect that it will be different next time, whenever that next time comes.

There is always risk and we can always assume that the worst will happen. I think the safest move is not to do the Smith Manoeuvre or any version of it, or take on any debt whatsoever. The other end of the spectrum is high leverage. Most people find a happy medium between. While a 30%-40% equity cushion in a house is safer than 20%, for me the 20% equity cushion represents acceptable risk. If I do become 'captive' to the banks then worst case scenario I will pay a premium. How much premium? Well, I guess in theory the sky is the limit. In practice, however, I would end up paying about a half a percent more right now: TDCT offers a variable rate of Prime - 0.35% for standard clients and renewals whereas some other lender may offer Prime - 0.75%. If I am 'captive' then I am stuck with TDCT and pay an extra 0.40%.

The after tax impact of a 0.50% cost of capital is not significant, say 0.30%. If it makes or breaks my investment strategy then the whole plan is worthless anyway and no one should go with a strategy with that small margin of error. So I will face a 0.30% increase in my cost of capital IF the real estate market takes a nosedive soon after I levered up? It is a risk that I am willing to take.

[florch]

Within my SM I have a dividend ETF and a real estate investment. Without too many details the RE is starting to produce very good returns but will produce capital gains sooner than later.

On the dividend index front, I'm currently sitting in a loss position. It has a higher MER than I would like and is less diversified than it could be (MER 0.5% with 3.9% yield currently). Would it be a good idea to capture the loss now to set against next years cap. gains by selling and immediately buying another more all-encompassing fund that also starts with X (0.25% with 2.6% or 0.17% with 2.5%). The yield isn't important now but is eventually the objective.

This wouldn't be a superficial loss, would it?

[pitz]

On the dividend index front, I'm currently sitting in a loss position. It has a higher MER than I would like and is less diversified than it could be (MER 0.5% with 3.9% yield currently). Would it be a good idea to capture the loss now to set against next years cap. gains by selling and immediately buying another more all-encompassing fund that also starts with X (0.25% with 2.6% or 0.17% with 2.5%). The yield isn't important now but is eventually the objective.


XDV to XIU/XIC by any chance :) ?

Nothing wrong with that; I never was much of a fan of XDV (too much banking..), and the fees on it are exhorbiant.



This wouldn't be a superficial loss, would it?

No, of course not. The underlying holdings are completely different.

[CDNPatriot]

Been applying the SM for about a year now. I noticed my cash increased in my account thanks to dividends. At the end of the year can I withdraw that cash from my Interactive Brokers account to apply towards a lump sum payment?

Or is there a way to reinvest the dividends with Interactive Brokers automatically into the same company.

[pitz]

Been applying the SM for about a year now. I noticed my cash increased in my account thanks to dividends. At the end of the year can I withdraw that cash from my Interactive Brokers account to apply towards a lump sum payment?


Yes. You should do that, assuming, of course, that the cash was derived from dividends from stocks that were *not* the result of a return of capital.




Or is there a way to reinvest the dividends with Interactive Brokers automatically into the same company.

No. You'd want to implement the optimization as above, and then draw from your HELOC to augment the funding in your IB account to purchase additional shares.

[DrXenon]

I have some RRSP contribution room. Is there any reason why I couldn't deduct the interest I pay on a line of credit to invest within my RRSP?

[pitz]

I have some RRSP contribution room. Is there any reason why I couldn't deduct the interest I pay on a line of credit to invest within my RRSP?

Yes. You are not allowed to deduct the interest on money borrowed to invest in a RRSP (or TFSA).

A basic principal is that if an investment does not/cannot produce taxable income (excluding capital gains) to an investor, you cannot deduct the interest on money you borrowed to buy it.

A RRSP does not generate taxable income to an investor, therefore, you cannot deduct interest on money you borrowed to contribute to one.

[DrXenon]

Hee. Thanks, I thought there'd be a catch.

I bought a pricewaterhousecoopers tax guide from chapters.ca and was excited to read about the fact that I could deduct the interest on a HELOC to buy just about anything. It took me a little while to figure out that it was about the American tax system. :-)

[pitz]

I bought a pricewaterhousecoopers tax guide from chapters.ca and was excited to read about the fact that I could deduct the interest on a HELOC to buy just about anything. It took me a little while to figure out that it was about the American tax system. :-)

I'm pretty sure you can't deduct interest on money used to invest in the US equivilant of RRSPs -- IRA's, and 401(k) accounts.

I'm sure that PwC guide would have pointed that out if it was targetted towards the US personal finance market.

[DrXenon]

I'm pretty sure you can't deduct interest on money used to invest in the US equivilant of RRSPs -- IRA's, and 401(k) accounts.

I'm sure that PwC guide would have pointed that out if it was targetted towards the US personal finance market.

Sorry, the second paragraph was not related to the RRSP issue. I was simply opining that I could have many more deductions if I were American. However, I think you can deduct interest on a HELOC down there, at least that's what I remember reading.

[pitz]

Sorry, the second paragraph was not related to the RRSP issue. I was simply opining that I could have many more deductions if I were American.


Yes, there's more 'stuff' you can deduct on a 1099 return, but the standard exemption is dramatically less, and if you itemize, you don't get a standard deduction at all.

In Canada, the standard deduction is ~$9000. In many provinces you can earn $12-$13k without paying more than a hundred bucks or so in tax. And everyone in Canada gets the standard deduction in addition to any other deductions they are eligible for.



However, I think you can deduct interest on a HELOC down there, at least that's what I remember reading.

Yes, on up to $100k of HELOC debt, as well as a traditional mortgage up to a certain limit. And you only get to deduct if you use itemized deductions (meaning, no standard deduction).

If you are high-income (ie: most dual-income professional families in the US), you get hit with AMT (Alternative Minimum Tax). Under the AMT, most of the mortgage related deductions are null and void.

Canada has its own form of AMT, but it is *rarely* an issue with the Smith Manouevre and is far less onerous than the AMT that exists in the US tax code.

[pluto]

When you borrow to pay down an investment loan, that new loan is also tax deductible. That's why some people advise to "capitalize the interest".

I was thinking of executing the Smith Manoeuvre by purchasing a rental property (actually its the house I currently own, and I would be moving to a new one). I met with a Tax Accountant this afternoon and he seemed to think CRA would not let me deduct the "interest on the interest" for the investment property downpayment (capitalization)

This is described on page 70-76 in The Smith Manoeuvre

Is my tax accountant wrong or is the book?

[pitz]

I was thinking of executing the Smith Manoeuvre by purchasing a rental property (actually its the house I currently own, and I would be moving to a new one).


You'd have to execute some sort of sale and repurchase transaction, such that there is a clear trail between money borrowed, and money invested.

Further, I would advise that your idea is ill-advised; housing not only is one of the most expensive asset classes in the market, but adding more of it to your portfolio reduces portfolio diversity.



I met with a Tax Accountant this afternoon and he seemed to think CRA would not let me deduct the "interest on the interest" for the investment property downpayment (capitalization)


Well basically, you sell your current property. You put the proceeds of that sale into the new property, and then you repurchase the current property, with a mortgage on the current property. If you don't have the 20% downpayment, then you take that out as a loan against the new property.

Structured that way, all the interest should be deductible.



Is my tax accountant wrong or is the book?

As long as you can show a trail between borrowing, and investing in a taxable asset, then you should be able to deduct. Absent the whole series of transactions being a sham, of course.

[pluto]

You'd have to execute some sort of sale and repurchase transaction, such that there is a clear trail between money borrowed, and money invested.

Well basically, you sell your current property. You put the proceeds of that sale into the new property, and then you repurchase the current property, with a mortgage on the current property. If you don't have the 20% downpayment, then you take that out as a loan against the new property.

Structured that way, all the interest should be deductible.

As long as you can show a trail between borrowing, and investing in a taxable asset, then you should be able to deduct. Absent the whole series of transactions being a sham, of course.

Is there anything dictating what the sale/repurchase price of the property needs to be? According to my number crunching, its to my disadvantage to 'sell myself' the existing property for top dollar, even though it reduces the amount of mortgage I need on the new property - the more borrowed to 'purchase' the investment property, the higher a rent I need to charge to generate a reasonable income (which is required for tax deductability). There is a sweet spot somewhere in the middle.... but is there anything stopping me from setting this price artificially below market value?


Further, I would advise that your idea is ill-advised; housing not only is one of the most expensive asset classes in the market, but adding more of it to your portfolio reduces portfolio diversity.

Point taken, however given the alternative of selling my existing property in a down market this doesn't seem like a terrible idea, at least in the short term. I'm fairly well diversified in my other holdings.

[pitz]

Point taken, however given the alternative of selling my existing property in a down market this doesn't seem like a terrible idea, at least in the short term. I'm fairly well diversified in my other holdings.

Well you'd be selling in the down market, and buying in the down market. So, assuming you're moving to a nicer house, you will have somewhat less of a shortfall in equity to make up.

If you're moving to a similar house, you're just essentially swapping your existing house, for one that is similarily depreciated.

[pluto]

Well you'd be selling in the down market, and buying in the down market. So, assuming you're moving to a nicer house, you will have somewhat less of a shortfall in equity to make up.

If you're moving to a similar house, you're just essentially swapping your existing house, for one that is similarily depreciated.

Right, but if I can hold onto the original house until the price recovers (and make a profit in the mean time) isn't this a win-win? Sure it's a bit of a gamble....


I found the following in the CRA guide T4002 (http://www.cra-arc.gc.ca/E/pub/tg/t4002/README.html):


You can choose to capitalize interest on money you borrow:
■ to buy depreciable property;
■ to buy a resource property; or
■ for exploration and development.
When you choose to capitalize interest, add the interest to
the cost of the property or exploration and development
costs instead of deducting the interest as an expense.

Not sure what this means in the real world however - can anyone clarify?

[pitz]

Right, but if I can hold onto the original house until the price recovers (and make a profit in the mean time) isn't this a win-win? Sure it's a bit of a gamble....


But you have to pay interest. And it would appear that house prices bear no connection to any of the fundamentals in terms of valuation, so the risk of loss is extremely high.

Its kind of like doubling down at the casino, essentially. You could make a bit of money, but the odds of a negative outcome are very much stacked against you.



Not sure what this means in the real world however - can anyone clarify?

Basically, if you're claiming depreciation on an asset, you should reduce the debt accordingly -- depreciation, ie: Capital Cost Allowance, is essentially a return of capital. Its fairly commonly accepted that taking a ROC distribution from an income trust bought with borrorwed money reduces the deductibility of the borrowed money.

[pluto]

Basically, if you're claiming depreciation on an asset, you should reduce the debt accordingly -- depreciation, ie: Capital Cost Allowance, is essentially a return of capital. Its fairly commonly accepted that taking a ROC distribution from an income trust bought with borrorwed money reduces the deductibility of the borrowed money.

Sooo, in order to capitalize interest on money used to borrow a property (increase the overall debt), I cannot claim depreciation on it? Does that sound right?

[pitz]

Sooo, in order to capitalize interest on money used to borrow a property (increase the overall debt), I cannot claim depreciation on it? Does that sound right?

No. Its not just a matter of 'claiming' depreciation, its the fact of depreciation. Houses naturally depreciate. The purpose of the rules is to ensure that you aren't left in the position of owing (and deducting interest) on a bunch of money that you borrowed to buy an asset that no longer exists (ie: a completely worn out house).

[pluto]

No. Its not just a matter of 'claiming' depreciation, its the fact of depreciation. Houses naturally depreciate. The purpose of the rules is to ensure that you aren't left in the position of owing (and deducting interest) on a bunch of money that you borrowed to buy an asset that no longer exists (ie: a completely worn out house).

OK, I think I understand.

So if the asset is *appreciating* due to a rising real estate market (I know, I know....) it should be acceptable to increase the amount of debt on the property by capitalizing the interest.... no?

According to MPAC the value of the property is still going up each year so I should be able to increase the deductions year after year as well.

[ibanker]

is it a good time to do this? interest rates are so low

[grant]

is it a good time to do this? interest rates are so low
Are you asking if it's a good time to save money on taxes?

When is it ever a bad time to save money on taxes?

[eelfliw]

is it a good time to do this? interest rates are so low

The Smith Man relies on the assumption that the stock market returns are higher than mortgage interest. Given today's volatile market, that assumption isn't achievable by everyone. So, if you are a stock market guru the Smith Man is for you.

That being said, if you are a stock market guru who can make good money in today's market, you can get FAR FAR richer returns by being mutual fund manager than betting your own house on the stock market.

[Bullseye]

The Smith Man relies on the assumption that the stock market returns are higher than mortgage interest. Given today's volatile market, that assumption isn't achievable by everyone. So, if you are a stock market guru the Smith Man is for you.

That being said, if you are a stock market guru who can make good money in today's market, you can get FAR FAR richer returns by being mutual fund manager than betting your own house on the stock market.

You don't need to be a guru, you just have to have discipline and nerves of steel.

You can buy the TSX index right now with a yield over 4%, of which most is tax advantaged. Most people with HELOC's are at Prime, 3.5%, before the tax deduction. For high income earners, their after tax cost will be more like 2%. So even if all of the companies that collectively make up the TSX cut dividends in HALF, you'd still just be at breakeven, in terms of cashflow. If they don't, you'll be getting paid to wait for the inevitable capital appreciation when the market recovers (as it will, at some point).

The hardest part would just be not panicking, and always keeping a long term view.

[brunes]

You don't need to be a guru, you just have to have discipline and nerves of steel.

You can buy the TSX index right now with a yield over 4%, of which most is tax advantaged. Most people with HELOC's are at Prime, 3.5%, before the tax deduction. For high income earners, their after tax cost will be more like 2%. So even if all of the companies that collectively make up the TSX cut dividends in HALF, you'd still just be at breakeven, in terms of cashflow. If they don't, you'll be getting paid to wait for the inevitable capital appreciation when the market recovers (as it will, at some point).

The hardest part would just be not panicking, and always keeping a long term view.

The second hardest part would be securing a Smith-Manovre capable HELOC at prime nowadays :) The going rate is more like Prime + 1% or higher.

[eelfliw]

You can buy the TSX index right now with a yield over 4%, of which most is tax advantaged. Most people with HELOC's are at Prime, 3.5%, before the tax deduction. For high income earners, their after tax cost will be more like 2%.

If those numbers remain constant for a year, then this is a good bet. But since no one can guarantee that it remains constant, the risk is too great. Especially in light of the 4th quarter numbers coming out over the next little while.

The only people who can benefit from this are the ones who doesn't pay transaction fees to buy/sell the index and still get 4% returns in the index.

Otherwise, the gains are quickly gobbled up by the commissions.

[NUTS]

If those numbers remain constant for a year, then this is a good bet. But since no one can guarantee that it remains constant, the risk is too great. Especially in light of the 4th quarter numbers coming out over the next little while.

True


The only people who can benefit from this are the ones who doesn't pay transaction fees to buy/sell the index and still get 4% returns in the index.

Otherwise, the gains are quickly gobbled up by the commissions.

This is really a wild gamble, even if you were to have zero fees to do the in-out.

When Smith started the idea the assumption was that you could get double return on what the interest it was that you were paying

I dont see those kind of guarantees these days

[dark169]

The Smith Man relies on the assumption that the stock market returns are higher than mortgage interest. Given today's volatile market, that assumption isn't achievable by everyone. So, if you are a stock market guru the Smith Man is for you.

That being said, if you are a stock market guru who can make good money in today's market, you can get FAR FAR richer returns by being mutual fund manager than betting your own house on the stock market.

Heres a major and typical misconception of the SM, your not betting your house on the stock market. Betting your house would be leveraging your home to buy stocks, which the SM is NOT.

Also you don't need to have market returns higher then mortgage interest, you need market returns higher then your cost of borrowing after accounting for tax deductions.

A corner stone of the SM is that your going to be purchasing stocks anyway. The idea being rather then buying the stocks with cash, take that cash and paydown a non tax deductable mortgage and take out a tax deductible loan to buy those stocks.

Your risk hasn't gone up. In either case if your stocks tank your still out that value. If anything your still better off with the SM as at least part of the mortgage you needed to pay off anyway is tax deductible now.

Now if you go take out a 100k HELOC and buy 100k worth of stocks your betting your house. But of course if you have the income to support such a loan your not really betting your house either, the bank doesn't want your house, your betting your future earnings/spending power. But thats now what the SM is about.

[budric]

Excuse the possibly silly question. I read roughly 11 pages of this thread only and it wasn't covered. I don't understand why this technique is advertised as "convert your mortgage to tax deductible loan." I don't see how you're converting anything.

Suppose you have 200k home with 100k mortgage left
200 - 100 = 100 owner's equity
Now you take HELOC for the 100k
200 - 100 (mortgage) - 100 (loan) + 100 (cash you got to invest in stock) = 100 owner's equity

It seems arbitrary to cancel out the 100 (mortgage) with 100 (cash) and not the 100 (loan) and claim that you converted it to a tax deductible loan. Addition is associative after all.

The argument from Smith (and others), is to borrow against and invest the equity in your home. Why not just say this in 2 lines, instead of going on and on about the mortgage? Maybe I'm wrong in my interpretation.

*edit*
dark169 "A corner stone of the SM is that your going to be purchasing stocks anyway"
I think that's what I was missing.

[BornRuff]

Just so that I don't have to go through 48 pages, can someone answer a question for me?

Reading that first page, which was written in 2005, all I could think of was "man, they must have gotten killed in this market crash".

Typically, leveraging is great when the market is going up, but terrible when the market goes down. Not only has the value of their house gone down, but all the money they borrowed against their house has shrunk too. Because he seems to be recommending investing as much of the equity in your house as possible, it seems like this plan could easily have left people in the situation where their remaining equity in the house and the value of their investments isn't enough to cover the outstanding balance on their house, i.e. a one way ticket to bankruptcy.

This just seems like an incredibly risky idea.

[BillyParadise]

As long as you're thinking longterm, its not an issue. Yes, I'm down. But I'm not worried, since this is building for retirement - something twenty years down the road for me.

[Germack]

As long as you're thinking longterm, its not an issue. Yes, I'm down. But I'm not worried, since this is building for retirement - something twenty years down the road for me.

Maybe it is maybe it is not. A huge housing bubble bursted 20 years ago in Japan. 20 years later stocks and housing still have not revovered yet.

[Bullseye]

Just so that I don't have to go through 48 pages, can someone answer a question for me?

Reading that first page, which was written in 2005, all I could think of was "man, they must have gotten killed in this market crash".

Typically, leveraging is great when the market is going up, but terrible when the market goes down. Not only has the value of their house gone down, but all the money they borrowed against their house has shrunk too. Because he seems to be recommending investing as much of the equity in your house as possible, it seems like this plan could easily have left people in the situation where their remaining equity in the house and the value of their investments isn't enough to cover the outstanding balance on their house, i.e. a one way ticket to bankruptcy.

This just seems like an incredibly risky idea.

I don't think anyone has ever advocated borrowing up to your limit of equity. A safe level to start, imo, is 25% equity.

A risk-reducing element of the SM is the averaging of your stock purchases, you do it in small chunks over long periods of time. Remember, the TSX now is back to where it was 4 years ago. Someone using the strategy over the past ten years is down, but probably not terribly so. Someone starting it this year is probably down a lot more percentage wise, but their actual amount invested is probably quite small, so the nominal loss is not significant.

I still maintain that a well implemented SM is not very risky. The biggest risk, as always, is human nature, the urge to panic under pressure and sell at a loss. It's NOT different this time, it never is. There are always naysayers and doomsayers during these periods who preach that the end of the world is nigh. When things recover, these people lay low until the next time the cycle brings fresh economic horrors.

[NUTS]

I still maintain that a well implemented SM is not very risky. The biggest risk, as always, is human nature, the urge to panic under pressure and sell at a loss. It's NOT different this time, it never is. There are always naysayers and doomsayers during these periods who preach that the end of the world is nigh. When things recover, these people lay low until the next time the cycle brings fresh economic horrors.

with the SM its all about the arbitrage spread between money borrowed and the net money earned, to pay down debt, all while writing off the interest on the money borrowed.

Can anyone guarantee this in todays market

In the past it assumed investing in Mutfunds or certain dividend paying stocks or royalty trusts that the SM was possible

Is there anyone here & now doing the SM today that can honestly say that it is working for them?

[Bullseye]

Is there anyone here & now doing the SM today that can honestly say that it is working for them?

It's working for me, so far. I have a dividend stream that is more than double my after tax interest cost, and my portfolio is only down slightly (less than 5%).

Feeling pretty good about it at the moment, really. The dividends allow me to accelerate my mortgage paydown, and then I pick up more stocks at very low P/E levels.

[NUTS]

It's working for me, so far. I have a dividend stream that is more than double my after tax interest cost, and my portfolio is only down slightly (less than 5%).

Feeling pretty good about it at the moment, really. The dividends allow me to accelerate my mortgage paydown, and then I pick up more stocks at very low P/E levels.

that is amazing & if you wouldn't mind sharing - please tell us

Where the dividends come from & what source (do not name the equity or its symbol) ... eg: Banks, Royalty trusts, options, mutfunds

[Bullseye]

that is amazing & if you wouldn't mind sharing - please tell us

Where the dividends come from & what source (do not name the equity or its symbol) ... eg: Banks, Royalty trusts, options, mutfunds

One bank, two insurers, one oil, one telecom, one manufacturer, one utility. All equities, no trusts, options, or funds.

It's a little over a 6% yield, with an after tax interest cost of just over 2%. All picked up on market dips. Some have gone down a fair bit more since buying, some are up. Down slightly overall.

[NUTS]

One bank, two insurers, one oil, one telecom, one manufacturer, one utility. All equities, no trusts, options, or funds.

It's a little over a 6% yield, with an after tax interest cost of just over 2%. All picked up on market dips. Some have gone down a fair bit more since buying, some are up. Down slightly overall.

so with the yield (net positive cash flow) are reinvesting into more equities or paying down the debt?

[dark169]

so with the yield (net positive cash flow) are reinvesting into more equities or paying down the debt?

Bullseye said: "The dividends allow me to accelerate my mortgage paydown, and then I pick up more stocks at very low P/E levels."

which is the smart way of doing it. Rather then committing to paying down the mortage or buying stocks when ever the dividend cheques show up, put it on your mortage and should you come across a good deal pick it up with the HELOC. If you don't find good deals pay down the mortgage.

[Bullseye]

Bullseye said: "The dividends allow me to accelerate my mortgage paydown, and then I pick up more stocks at very low P/E levels."

which is the smart way of doing it. Rather then committing to paying down the mortage or buying stocks when ever the dividend cheques show up, put it on your mortage and should you come across a good deal pick it up with the HELOC. If you don't find good deals pay down the mortgage.

That's exactly what I'm doing. And what I will continue to do until a recovery is well under way. At that point, I'll probably be in a position where I've borrowed more than I've paid down, so I'll stop to let the equity catch up. So not a pure SM, but my own slightly altered version of it.

[eelfliw]

Now if you go take out a 100k HELOC and buy 100k worth of stocks your betting your house. But of course if you have the income to support such a loan your not really betting your house either, the bank doesn't want your house, your betting your future earnings/spending power. But thats now what the SM is about.
In today's market, where can you get a loan with interest rate low enough to match the potential stock market returns without using a valuable collateral such as your home (ie. HELOC)??

I can understand, that in the days when the market returned 10%, that one can get even a personal loan and make money off of SM.

But in today's market, aside from a mortgage, the lowest rate I've seen is at prime HELOCs.

But if you have another source of low interest loan, please tell.

[grant]

I can understand, that in the days when the market returned 10%, that one can get even a personal loan and make money off of SM.

But in today's market, aside from a mortgage, the lowest rate I've seen is at prime HELOCs.

But if you have another source of low interest loan, please tell.
Make money off Smith Maneuvre?? huh?? SM is about making your mortgage tax deductible.

If you are getting unsecured loans to invest in the stock market for profit... then you are nowhere NEAR smith maneuvre... that is definitely, unambiguously, without a doubt: LEVERAGED INVESTING.

[Anonymouse]

In case others have not seen this article:

http://www.canada.com/topics/news/national/story.html?id=1155182

The avoidance they are describing sounds an awful lot like the SM.

[Bullseye]

In case others have not seen this article:

http://www.canada.com/topics/news/national/story.html?id=1155182

The avoidance they are describing sounds an awful lot like the SM.

The Lipson case does not change the fundamental issue that interest on funds borrowed to invest is tax deductible. It remains deductible, and likely always will, as removing that deductibility would be bad for business.

The courts issue with the Lipson case was the application, how they went about it. From my reading on this, it is different from the SM.

You can Google 'Lipson' and 'Smith Manouevre' to read some opinions and details on what I'm talking about.

[dark169]

The Lipson case does not change the fundamental issue that interest on funds borrowed to invest is tax deductible. It remains deductible, and likely always will, as removing that deductibility would be bad for business.

The courts issue with the Lipson case was the application, how they went about it. From my reading on this, it is different from the SM.

You can Google 'Lipson' and 'Smith Manouevre' to read some opinions and details on what I'm talking about.


Heres the facts of the case:

The Lipon’s engaged in a series of transactions as follows:

1. Earl and Jordanna Lipson bought a home in Forest Hill in Toronto;
2. Ms. Lipson obtained a $562,500 loan NOT to buy the house but for Ms. Lipson to buy shares in Mr. Lipsons private held corporation;
3. Mr. Lipson then used the $562,500 of funds invested by Ms. Lipson to purchase the home;
4. A mortgage for $562,500 is obtained which is then used to repay Ms. Lipson’s $562,500 loan referenced in step #2.


from: http://www.milliondollarjourney.com/how-exposed-is-the-smith-manoeuvre-to-the-lipson-case.htm

doesn't look like a SM at all. This is clear avoidance, and in my view doesn't apply to what the SM really is.

[Mr CFP]

Heres the facts of the case:

The Lipon’s engaged in a series of transactions as follows:

1. Earl and Jordanna Lipson bought a home in Forest Hill in Toronto;
2. Ms. Lipson obtained a $562,500 loan NOT to buy the house but for Ms. Lipson to buy shares in Mr. Lipsons private held corporation;
3. Mr. Lipson then used the $562,500 of funds invested by Ms. Lipson to purchase the home;
4. A mortgage for $562,500 is obtained which is then used to repay Ms. Lipson’s $562,500 loan referenced in step #2.


from: http://www.milliondollarjourney.com/how-exposed-is-the-smith-manoeuvre-to-the-lipson-case.htm

doesn't look like a SM at all. This is clear avoidance, and in my view doesn't apply to what the SM really is.

The Lipson case was a "variation" of the Singleton shuffle not the SM (one which the CRA didn't look to kindly on). IMO, SM is strictly a debt conversion strategy. The main reason for implementing such a strategy is the long-term deductibility of the interest cost on the SLOC.

[NUTS]

The Lipson case was a "variation" of the Singleton shuffle not the SM (one which the CRA didn't look to kindly on). IMO, SM is strictly a debt conversion strategy. The main reason for implementing such a strategy is the long-term deductibility of the interest cost on the SLOC.

Agree - these are two totally different cases

Similarly - take Joe the CFP - Joe has grown his FA/IA advisor business so that the retained earnings are $500k.

Joe needs an exit strategy

a) Are the retained earnings capital gain -thus qualifying for the lifetime huge business capital gains deduction
b) Should Joe the individual sell his family home to the incorporated business that Joe operates - Joe can then have $500k in his bank account from selling the family home & the business can go out and get a mortgage on the property which is rented to Joe and his family (win-win) -or-
c) Simply dividend out the retained earnings to Joe and his wife - taxes have to be paid now

Many variations are possible - Singleton or Smith with a twist - call it what you want

1. At some point can you pay down the mortgage 100%
2 Can you then take the capital asset and leverage it or invest it to give you a nice ROR to live on - call this the retirement plan
3. Should you invest in the stock market or purchase another real estate property

[flamingo]

Guys, is it a bad time to jump into the market and do a Smith manoeuvre ?

I am not an investment pro and would like to stick to a K.I.S.S principle.

We will use our HELOC (prime + 1%) to buy some dividends-paying stocks (diversified and we will hold them for the long term, unlike Derek Foster, although I bought his books and gave him credits for telling it like it is but that's another topic)

We will then claim the interest on our HELOC on the income tax returns next year to get some tax refund and will use said refund to pay down our mortgage.

This is a very simplified form of Smith manouevre I believe. I don't understand puts and options and other exotic investment methods and I will not touch those.

Is anybody else doing what I described and if so, could you please provide some feedback including pros and cons.

Merci beaucoup.

[pitz]

Guys, is it a bad time to jump into the market and do a Smith manoeuvre ?


Its a better time today than it has been for most of the past 12-14 years.



I am not an investment pro and would like to stick to a K.I.S.S principle.
We will use our HELOC (prime + 1%) to buy some dividends-paying stocks (diversified and we will hold them for the long term, unlike Derek Foster, although I bought his books and gave him credits for telling it like it is but that's another topic)


I think you have to assume that your house will revert to 2000 pricing, or perhaps even less. In some places, this means that house prices are going down 50%. Do you have enough equity? Mortgage more than half paid off? Solid jobs?



We will then claim the interest on our HELOC on the income tax returns next year to get some tax refund and will use said refund to pay down our mortgage.


Just remember that HELOC funds can be 'called' at any time. If your banker wakes up on the wrong side of the bed and wants his money back, under the terms of a HELOC, you're obliged to immediately repay the loan.

[kerdon]

Scotia now has the auto limit increase option on their secured lines of credit under the STEP

[wx_junkie]

Scotia now has the auto limit increase option on their secured lines of credit under the STEP

Kerdon.

This is very significant. What can you tell us to back up this statement? What is your source?

[kerdon]

Kerdon.

This is very significant. What can you tell us to back up this statement? What is your source?

I set this up on my STEP on Monday.

This came into effect on the 16th. You can Auto limit increase(ALI) a LOC, Scotialine Visa, or any other Visa you have under your STEP.

[Swilt]

This is very interesting, after reading in here about the 16th of March deadline from BNS STEP, I applied Saturday night online to get an increase hoping that the wording allows wiggle room to increase it whether it is completed by march 16th or not. I talked to my advisor whom should have known this on the 16th as well.

Ah well, he also let it slip that worst case it would be what mine already is which means of course I was 1% too high lol.

Pitz good to see you coming back to these forums after awhile. I have been spreading your SM wisdom around as I have continued to research my strategies.

PS any thoughts on the TD HY Bond funds? They are touting great returns coming up, around 20% per year or so.

[newbeetle]

I have been thinking about the Smith Manoeuvre strategy for a while and understand that the total debt level won't increase and so on. But one thing I do not quite get is how this strategy can make the interest paid on the MORTGAGE deductible.

For example,
In Month 1, I paid down the principal on my mortgage for $500. And immediately, I invested $500 from my HELOC. Asumming the interest rate and HELOC is the same as 5%, the $25 interest from my HELOC account is tax deductible. But what about the $25 interest which has already been paid on my mortgage? I paid two $25 interest, but only get one $25 interest as tax deductible, right? Isn't the interest I paid to my mortgage still not tax deductible? :confused:

[Asoul]

I have been thinking about the Smith Manoeuvre strategy for a while and understand that the total debt level won't increase and so on. But one thing I do not quite get is how this strategy can make the interest paid on the MORTGAGE deductible.

For example,
In Month 1, I paid down the principal on my mortgage for $500. And immediately, I invested $500 from my HELOC. Asumming the interest rate and HELOC is the same as 5%, the $25 interest from my HELOC account is tax deductible. But what about the $25 interest which has already been paid on my mortgage? I paid two $25 interest, but only get one $25 interest as tax deductible, right? Isn't the interest I paid to my mortgage still not tax deductible? :confused:

That is correct the interest on your mortgage is still not tax deductible but the interest on your HELOC is. The thing is you wouldn't have gotten charged $25 on both loans. You would have been charged $25 interest on your mortgage, you pay $500 on your mortgage and now you don't get charged interest on that amount, but now you use your HELOC for $500 and now you get charged interest on that amount starting on when you withdraw it. I hope that made sense ha!

[newbeetle]

That is correct the interest on your mortgage is still not tax deductible but the interest on your HELOC is. The thing is you wouldn't have gotten charged $25 on both loans. You would have been charged $25 interest on your mortgage, you pay $500 on your mortgage and now you don't get charged interest on that amount, but now you use your HELOC for $500 and now you get charged interest on that amount starting on when you withdraw it. I hope that made sense ha!

Sorry, I just do not get it. Are you saying I am paying only ONE $25 interest? That does not sound right....

[Asoul]

Sorry, I just do not get it. Are you saying I am paying only ONE $25 interest? That does not sound right....

Why doesn't it make sense? You only pay for what you use. For example If you paid $500 on March 1st, you had paid $25 in interest, that would have been the interest charge for February for your mortgage. You wouldn't have had that balance on your HELOC so you wouldn't have been charged interest for it, but you will start getting charged interest on it starting March 1st when you do the withdraw. So if your HELOC payment is April 1st, you will get charged then.

[newbeetle]

Why doesn't it make sense? You only pay for what you use. For example If you paid $500 on March 1st, you had paid $25 in interest, that would have been the interest charge for February for your mortgage. You wouldn't have had that balance on your HELOC so you wouldn't have been charged interest for it, but you will start getting charged interest on it starting March 1st when you do the withdraw. So if your HELOC payment is April 1st, you will get charged then.

Yes, that is fine. The $25 interest paid on the HELOC is tax deductible. No problem at all. What I do not understand is that the whole Smith Manoeuvre thing is to get the interest paid on the MORTGAGE tax deductible. I just do not understand how that is achieved.

I paid two interests, one on the mortgage and the other one on the HELOC. No matter when the interest was charged. I could only get one of them to be tax deductible, right? I paid $25 more interest in order to get $8.75 back? assuming my marginal tax rate is 35%

[Asoul]

Yes, that is fine. The $25 interest paid on the HELOC is tax deductible. No problem at all. What I do not understand is that the whole Smith Manoeuvre thing is to get the interest paid on the MORTGAGE tax deductible. I just do not understand how that is achieved.

I paid two interests, one on the mortgage and the other one on the HELOC. No matter when the interest was charged. I could only get one of them to be tax deductible, right? I paid $25 more interest in order to get $8.75 back? assuming my marginal tax rate is 35%

Your mortgage is not tax deductible, it is a trick to transfer the debt into a loan product that is tax deductible.

[GSRee]

Yes, that is fine. The $25 interest paid on the HELOC is tax deductible. No problem at all. What I do not understand is that the whole Smith Manoeuvre thing is to get the interest paid on the MORTGAGE tax deductible. I just do not understand how that is achieved.

I paid two interests, one on the mortgage and the other one on the HELOC. No matter when the interest was charged. I could only get one of them to be tax deductible, right? I paid $25 more interest in order to get $8.75 back? assuming my marginal tax rate is 35%

You aren't paying twice. Taking the $500 out of the HELOC is the equivalent of not paying your mortgage. So these two situations are the same:

March 1st you make a payment of $500 on your mortgage, and take $500 off your HELOC. So in February that $500 on your mortgage cost you $2 in interest. In March it's gone from your mortgage so you don't pay $2 there, but it's now on your HELOC, so you pay $2 there instead. Total cost for two months: $4

March 1st you don't make a mortgage payment, nor do you take any money out of your HELOC. So in February that $500 on your mortgage cost you $2. And then in March it's still there on your mortgage, so you pay $2 interest again. Since there's no balance on your HELOC, you pay no interest. Total cost for two months: $4

So you see, in both situations you pay $4.

So the problem is you're thinking too literally. The SM does not make your mortgage tax deductible, as that is impossible. But as your mortgage shrinks, the amount you borrow from your HELOC grows. So your outstanding debt never changes. What changes is the fact that your increasing HELOC balance is tax deductible if you invest it. So it has the effect of making your mortgage tax deductible.

[newbeetle]

Your mortgage is not tax deductible, it is a trick to transfer the debt into a loan product that is tax deductible.

OK. I think I totally misunderstand the Smith Manoeuvre by some messages saying "Making your mortgage tax deductible by implementing Smith Manoeuvre". Now it seems to me that it is just a stragtegy to leverage while possibly doing dollar cost averaging at the same time since one will be investing only small number each time.

Gee...then why it is made some complicated to associate it with people's mortgage etc. If one to implement it in a small scale, a regular LOC will do as well. Right?

[newbeetle]

You aren't paying twice. Taking the $500 out of the HELOC is the equivalent of not paying your mortgage. So these two situations are the same:

March 1st you make a payment of $500 on your mortgage, and take $500 off your HELOC. So in February that $500 on your mortgage cost you $2 in interest. In March it's gone from your mortgage so you don't pay $2 there, but it's now on your HELOC, so you pay $2 there instead. Total cost for two months: $4

March 1st you don't make a mortgage payment, nor do you take any money out of your HELOC. So in February that $500 on your mortgage cost you $2. And then in March it's still there on your mortgage, so you pay $2 interest again. Since there's no balance on your HELOC, you pay no interest. Total cost for two months: $4

So you see, in both situations you pay $4.

So the problem is you're thinking too literally. The SM does not make your mortgage tax deductible, as that is impossible. But as your mortgage shrinks, the amount you borrow from your HELOC grows. So your outstanding debt never changes. What changes is the fact that your increasing HELOC balance is tax deductible if you invest it. So it has the effect of making your mortgage tax deductible.

Yes, but if I paid the mortgage for those two months regularly without the Smith thing. In other words, not taking the $500 from HELOC, I will only pay $2 for two months for $500 on my mortgage(In month March, it is gone. Hence no interest charge).
Still, I will be paying $2 extra interest to get maybe $0.70 back.

[Asoul]

OK. I think I totally misunderstand the Smith Manoeuvre by some messages saying "Making your mortgage tax deductible by implementing Smith Manoeuvre". Now it seems to me that it is just a stragtegy to leverage while possibly doing dollar cost averaging at the same time since one will be investing only small number each time.

Gee...then why it is made some complicated to associate it with people's mortgage etc. If one to implement it in a small scale, a regular LOC will do as well. Right?

Bingo!

[Asoul]

Yes, but if I paid the mortgage for those two months regularly without the Smith thing. In other words, not taking the $500 from HELOC, I will only pay $2 for two months for $500 on my mortgage(In month March, it is gone. Hence no interest charge).
Still, I will be paying $2 extra interest to get maybe $0.70 back.

Yes but hopefully you would have made something on your investment aswell. That is the risk you take.

[newbeetle]

Yes but hopefully you would have made something on your investment aswell. That is the risk you take.

Got it now. Thanks!!

[GSRee]

Yes, but if I paid the mortgage for those two months regularly without the Smith thing. In other words, not taking the $500 from HELOC, I will only pay $2 for two months for $500 on my mortgage(In month March, it is gone. Hence no interest charge).
Still, I will be paying $2 extra interest to get maybe $0.70 back.

That's true if you look at it that way, but the assumption is that your investment income will offset (hopefully more than offset) the HELOC interest. If it doesn't, then the SM is a losing strategy, but if it does, that $0.70 is a net gain in your pocket.

Another thing to note: I believe another important point of the SM is that you don't pay the interest due on the HELOC out of your own pocket, you let the HELOC pay it's own interest.

For example, you pay $500 principal on your mortgage, so now you can take $500 out of your HELOC. Next month you pay $502 on your mortgage, and take $502 out of your HELOC. Then you put $2 back in right away to pay the interest for the previous month. So your out of pocket expenses haven't increased at all to implement the SM.

And this keeps going until you have no mortgage left, at which point you can either cash in your investments and pay off your HELOC and be debt free, or if you're feeling safe, you keep your investments as is, and instead of making a monthly mortgage payment, you make a monthly HELOC interest payment (which is still tax deductible).

[newbeetle]

Also, I think people should be really careful about the cash flow when implementing this. There might be a point that the interest payment on HELOC becomes really big and one does not have the money for both the interest payment on HELOC and monthly mortgage payment.

[cannon_fodder]

Also, I think people should be really careful about the cash flow when implementing this. There might be a point that the interest payment on HELOC becomes really big and one does not have the money for both the interest payment on HELOC and monthly mortgage payment.

You can use this calculator to see what happens when the HELOC interest rates are much higher than your mortgage payment. It will also help you understand that as the HELOC balance becomes large (with the mortgage shrinking) that the cash flow is not any more an issue as it was in the beginning. That is because the interest charges on the mortgage are very low as the mortgage winds down. This means there is more principal available to borrow to help pay the HELOC interest. What it does mean is that there is less money to invest each period but, conversely, the tax refunds are higher.

http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls

[cannon_fodder]

For example, you pay $500 principal on your mortgage, so now you can take $500 out of your HELOC. Next month you pay $502 on your mortgage, and take $502 out of your HELOC. Then you put $2 back in right away to pay the interest for the previous month. So your out of pocket expenses haven't increased at all to implement the SM.


Just so people don't get confused, the mortgage payment doesn't change from $500 to $502, it is the principal portion of the payment that changes (i.e. the mortgage payment sees more money going to paying down the principal as the outstanding amount has been lowered, thus leading to a lower interest portion).

[cannon_fodder]

Yes, but if I paid the mortgage for those two months regularly without the Smith thing. In other words, not taking the $500 from HELOC, I will only pay $2 for two months for $500 on my mortgage(In month March, it is gone. Hence no interest charge).
Still, I will be paying $2 extra interest to get maybe $0.70 back.


Yes but hopefully you would have made something on your investment aswell. That is the risk you take.

You can see that, depending on your marginal tax rate, you can achieve significantly less than your mortgage interest rate (let alone the HELOC interest rate which is usually higher) on your investment returns to come out ahead. This is assuming your investments are tax efficient - don't invest in entities that have payouts which are taxed as interest income!

[Swilt]

Any thoughts on hy Bonds? My brother is getting sold a pitch by his advisor on those.

Also do they make sense for SM, are they paying out regularily to qualify with CRA?

[BillyParadise]

High Yield bond funds are all the rage these days, which usually means it's a terrible time to invest in them.

With the SM, you don't want to get a cash distribution at all, unless you go for the "Smith/Snyder" variation, also practised by TDMP. Distributions from funds are usually classified as return of capital. This causes a nasty tax problem as your cost basis declines every year. It's best to stay away from that kind of strategy, IMHO.

[Swilt]

Perfect, thats kinda what I thought.

Basically anything my brother wants to buy, I should stay away from :razz: though his investor did way better than mine last year....

Also thought they were like a ROC, I don't want to make the SM complicated any more than it is.

I should just stick with Pitz's model.

Thanks for your help.

[chinamansteve]

Wouldn't borrowing money on the HELOC to pay off the interest only payment every month increase the HELOC debt? Can anyone enlighten me on this one? The Smith Manoeuvre seems like an excellent idea for someone who has high risk tolerance and is looking for long term investing.

Thanks!


EDIT: Also, what if your mortgage is 60k, and the equity you have is 220k? would you still do the Smith Manoeuvre since the interest paid to the HELOC would be substantially higher than mortgage, therefore risking a higher interest to pay lower interest might not make much sense? :S

[BillyParadise]

Wouldn't borrowing money on the HELOC to pay off the interest only payment every month increase the HELOC debt? Can anyone enlighten me on this one? The Smith Manoeuvre seems like an excellent idea for someone who has high risk tolerance and is looking for long term investing.

Thanks!


EDIT: Also, what if your mortgage is 60k, and the equity you have is 220k? would you still do the Smith Manoeuvre since the interest paid to the HELOC would be substantially higher than mortgage, therefore risking a higher interest to pay lower interest might not make much sense? :S

Steve,

I think you're talking about "capitalizing the interest" - paying the interest on the HELOC with the HELOC. Yes, every month, that amount will increase just a little bit. But the interest you pay on the mortgage will go down by a similar amount. Usually the interest rate on the LOC portion of a mortgage is higher than on the mortgage portion, so it doesn't cancel out exactly. As an example, my mortgage is at Prime - 0.75%, and my associated LOC is at prime. So if I pay down $1000 on my mortgage and invest it, I will pay $1.25 less interest on the mortgage but pay $1.87 more on the LOC (each month).

I generally advise leaving a slush fund of $500 plus one months investment payment to cover the slight differences. Then, when you get your tax refund each year, balance things up. There are usually better ways to invest a tax return than putting it on your mortgage, but as a minimum you should be balancing the slush fund out. You don't want to run out of room on your HELOC - NSF fees can get ugly ;)

[cannon_fodder]

Wouldn't borrowing money on the HELOC to pay off the interest only payment every month increase the HELOC debt? Can anyone enlighten me on this one? The Smith Manoeuvre seems like an excellent idea for someone who has high risk tolerance and is looking for long term investing.

Thanks!


EDIT: Also, what if your mortgage is 60k, and the equity you have is 220k? would you still do the Smith Manoeuvre since the interest paid to the HELOC would be substantially higher than mortgage, therefore risking a higher interest to pay lower interest might not make much sense? :S

The increase in your HELOC debt is exactly equal to your reduction in mortgage debt - hence why they say that your total debt stays the same, you are just converting a non-deductible debt into a deductible one.

And, it is true, that for most people the HELOC interest rate is higher than the mortgage rate. However, once you factor in the tax refunds from ensuring you invest in equities which allow you to deduct your interest charges, the effective rate is actually lower.

For example, if your mortgage rate is 3% and your HELOC is 4%, you would only have to be at a 25% marginal tax rate to even out the two - higher than that and the HELOC effective rate is lower. [4% x (1 - MTR of 25%) = 3%]

[BillyParadise]

EDIT: Also, what if your mortgage is 60k, and the equity you have is 220k? would you still do the Smith Manoeuvre since the interest paid to the HELOC would be substantially higher than mortgage, therefore risking a higher interest to pay lower interest might not make much sense? :S

The goal of the Smith Manoeuvre is to convert that $60k into a tax deductible investment loan. Would you do it? Up to you.

Here's how I would set it up. Your risk tolerance may be different than mine, and these are round numbers based on 3.5%.

On a 280k property, you should be able to get a readvanceable mortgage for 80%, or 224k. The 60k would be the mortgage, and the remainder, or 164k, could be invested. On a 25 year amortization, you would need to pay 300/mo for the home, and about 480/mo for interest on the investment loan, or a total of 780. Of that, about 175/mo is principal reduction on the mortgage, which you would also invest via a pre-authorized debit.

At the end of the year, you would have paid 480*12 or 5760 in interest, plus the small amount of interest on the 175/mo. Let's for the sake of argument call it a total of 6000 interest. If you're in the 42% tax bracket, that should give you about a 2500 tax refund.

[Gotcha]

Still trying to get my head around this strategy, i have a few questions:
I was thinking about doing it on a small scale version, where I will use my existing LOC and take out money to buy investments, example 10K, by next year all the interest accumulated from this LOC (say for example $400) , would I believe be tax deductible.. so in return I will get back (assuming my marginal tax rate of 35%) .35 * 400 = $140… And I can use the $140 to pay back my mortgage.


Also, regarding the LOC, which I've never used, when the bank sends me their monthly statement and shows the monthly interest , Do I have to pay at least the interest portion therefore leaving the 10K balance the same?
I suppose the interest portion I pay each month are the tax deductible portions, right?

In the (year) end , I will have paid the interest portion $400 for the year, the extra $140 in tax return, a debt of 10K and a portfolio of 10K ( hopefully this will increase over time)… Does this sound right?

I think once i get a "feel" of this strategy and also feel comfortable with taking out another loan to buy investment... i'll try the full strategy... its probably me, but I've always had a problem borrowing money to buy things... and associate this like buying things you can't afford...
I'm usually cautious type and always settle a CC on time and will never spend more than i can afford...

but at the same time, im thinking this may be a good time to build a portfolio for retirement, since everything has gone down so much ... and that a limited investments i've had so far is losing more than 35% ( bad investment advice and not cost averaging)



You can see that, depending on your marginal tax rate, you can achieve significantly less than your mortgage interest rate (let alone the HELOC interest rate which is usually higher) on your investment returns to come out ahead. This is assuming your investments are tax efficient - don't invest in entities that have payouts which are taxed as interest income!

What kind of efficient investment or mutual funds can be qualified to get the tax refunds?

Thanks All

[cannon_fodder]

Still trying to get my head around this strategy, i have a few questions:
I was thinking about doing it on a small scale version, where I will use my existing LOC and take out money to buy investments, example 10K, by next year all the interest accumulated from this LOC (say for example $400) , would I believe be tax deductible.. so in return I will get back (assuming my marginal tax rate of 35%) .35 * 400 = $140… And I can use the $140 to pay back my mortgage.


Also, regarding the LOC, which I've never used, when the bank sends me their monthly statement and shows the monthly interest , Do I have to pay at least the interest portion therefore leaving the 10K balance the same?
I suppose the interest portion I pay each month are the tax deductible portions, right?

In the (year) end , I will have paid the interest portion $400 for the year, the extra $140 in tax return, a debt of 10K and a portfolio of 10K ( hopefully this will increase over time)… Does this sound right?

I think once i get a "feel" of this strategy and also feel comfortable with taking out another loan to buy investment... i'll try the full strategy... its probably me, but I've always had a problem borrowing money to buy things... and associate this like buying things you can't afford...
I'm usually cautious type and always settle a CC on time and will never spend more than i can afford...

but at the same time, im thinking this may be a good time to build a portfolio for retirement, since everything has gone down so much ... and that a limited investments i've had so far is losing more than 35% ( bad investment advice and not cost averaging)




What kind of efficient investment or mutual funds can be qualified to get the tax refunds?

Thanks All

I don't want to touch the investment advice since what works for me may not work for you (and I don't know anything about you). Personally, I buy stocks but that is because I have been investing large enough sums to justify the purchases. Interactive Brokers only charges $1 for every 100 shares.

My setup is that my readvanceable mortgage has 2 portions - a LOC and the mortgage. We also have a bank account at the same institution tied to these. When I get notice that a payment is due (and the minimum is always the interest only) I then transfer that exact amount to my bank account. So, my LOC has just increased by the interest payment. Then, when the payment is withdrawn from the bank account, the LOC has now returned to its previous level.

In theory, the withdrawal amount should increase slightly each month - however, since we've been seeing monthly reductions in the prime lending rate, it has actually been going down quite nicely!

Yes, the interest portions are the deductible portions. I don't know if all banks do this, but our bank sent us a letter (not a Tslip or anything official) noting our total interest paid.

I think if you choose solid investments, diversify and hold for the long term you will do very nicely from this point in the market.

[chinamansteve]

thanks for the answers cannon_fodder and BillyParadise,

With regards to the dividends earned from the HELOC investments, do you DRIP the dividends, or do you use the dividends to pay off the mortgage and borrow to reinvest into the stocks? As if you pay off the mortgage and reborrow to invest, you will have to factor in the comission fees charged per month vs no comission fees for DRIP.

thanks!

[cannon_fodder]

thanks for the answers cannon_fodder and BillyParadise,

With regards to the dividends earned from the HELOC investments, do you DRIP the dividends, or do you use the dividends to pay off the mortgage and borrow to reinvest into the stocks? As if you pay off the mortgage and reborrow to invest, you will have to factor in the comission fees charged per month vs no comission fees for DRIP.

thanks!

I use Interactive Brokers which does not offer DRIPs. However, with their low commissions it isn't a great hardship.

So, yes, ultimately I will harness the dividends, pay down the mortgage, reborrow from the HELOC and then reinvest. This way I will actually balance out my portfolio as I go - when certain equities are underweighted, I will funnel the dividend-paid-for purchases to them.

What I do not have are any income trust units in my portfolio - they would be a complication in this setup that I don't need.

[Gotcha]

I don't want to touch the investment advice since what works for me may not work for you (and I don't know anything about you). Personally, I buy stocks but that is because I have been investing large enough sums to justify the purchases. Interactive Brokers only charges $1 for every 100 shares.

My setup is that my readvanceable mortgage has 2 portions - a LOC and the mortgage. We also have a bank account at the same institution tied to these. When I get notice that a payment is due (and the minimum is always the interest only) I then transfer that exact amount to my bank account. So, my LOC has just increased by the interest payment. Then, when the payment is withdrawn from the bank account, the LOC has now returned to its previous level.

In theory, the withdrawal amount should increase slightly each month - however, since we've been seeing monthly reductions in the prime lending rate, it has actually been going down quite nicely!

Yes, the interest portions are the deductible portions. I don't know if all banks do this, but our bank sent us a letter (not a Tslip or anything official) noting our total interest paid.

I think if you choose solid investments, diversify and hold for the long term you will do very nicely from this point in the market.

What I meant what kind of investment... i didnt mean specifically which one to buy but what I meant to ask is that is there certain types of mutual funds/Stocks for example that may not qualify for the Tax Returns...

ps: to give you an idea, until now I've been going through a sunlife financial advisor to advise me funds to buys depending on my risk level... i will need to do my homework and decide for myself the types of investment i'd like to do for myself... and this scenario ( using my existing LOC to build a portfolio) will allow me to get used to investing by myself while at the same time build hopefully a decent portfolio than i currently have. So i wont be risking much ( but my 10K LOC) and until i get more comfortable , i can eventually apply the SM on my whole mortgage.

[Doctor T]

I'm getting more interested in this, but I have a couple of questions:

If I'm using my HELOC for other purposes, how can I easily track the interest paid on the loan amounts for my investments only? Any software tools that can do this?

I have about a 255k mortgage and about 240k available credit on my HELOC. Do I have to invest all the 240k to make this worthwhile? Or can I simply start off small now and just invest the monthly amount that I'm reducing my principal mortgage?

[chinamansteve]

^i have that same concern as well. If any of you read my other thread, I'm also planning to purchase a car with the HELOC, so what would be an easy way to track the interest paid to the investment loan and to the car?

Also, Would it make sense to run the Smith Manoeuvre on a rental property? Becasue the mortgage interest on the rental property is already deductible...if I run the SM, would that make sense?

[max88]

Most banks allow child accounts under one HELOC umbrella. I know TD does that for free, and HSBC does it for a small monthly fee equivalent to that of a chequing account. Check with your bank.

To make tax accounting easier, always keep investment borrowing separate from consumption borrowing.

[nicejam]

The increase in your HELOC debt is exactly equal to your reduction in mortgage debt - hence why they say that your total debt stays the same, you are just converting a non-deductible debt into a deductible one.

And, it is true, that for most people the HELOC interest rate is higher than the mortgage rate. However, once you factor in the tax refunds from ensuring you invest in equities which allow you to deduct your interest charges, the effective rate is actually lower.

For example, if your mortgage rate is 3% and your HELOC is 4%, you would only have to be at a 25% marginal tax rate to even out the two - higher than that and the HELOC effective rate is lower. [4% x (1 - MTR of 25%) = 3%]

cannon_fodder, are you the same poster as on Ed Rempel's Maximum (http://www.milliondollarjourney.com/smith-manoeuvre-strategy-the-rempel-maximum.htm) blog comments?

[grant]

The increase in your HELOC debt is exactly equal to your reduction in mortgage debt - hence why they say that your total debt stays the same, you are just converting a non-deductible debt into a deductible one.
This thread is over 4 years old and still people don't get the message that this is the gist of the smith maneuvre.

[evoviii]

This thread is over 4 years old and still people don't get the message that this is the gist of the smith maneuvre.

I got excited about this 2 years ago. Figured it all out from million dollar journey's blog. Level of financial understanding out there is highly varied. There are those who shouldn't be doing this as they are fixated on the tax deduction and ignoring basic investment principles of risk tolerance.

That and the fact people post before reading or searching the thread which is not isolated to his thread.

[cannon_fodder]

^i have that same concern as well. If any of you read my other thread, I'm also planning to purchase a car with the HELOC, so what would be an easy way to track the interest paid to the investment loan and to the car?

Also, Would it make sense to run the Smith Manoeuvre on a rental property? Becasue the mortgage interest on the rental property is already deductible...if I run the SM, would that make sense?

Do not co-mingle the various purposes for borrowing. Not all readvanceable mortgages make it easy to separate so do some homework before choosing. Look to milliondollarjourney.com for a comparison specific to SM friendly mortgages.

You definitely can run the SM on a rental property. It falls under the cash flow dam proposal that Smith postulated. I don't find this gets as much attention which is probably simply because there aren't nearly as many landlords which are homeowners with readvanceable mortgages and landlords, too. Thus, you may find it difficult to find people with experience to help you out with this endeavour.

[cannon_fodder]

cannon_fodder, are you the same poster as on Ed Rempel's Maximum (http://www.milliondollarjourney.com/smith-manoeuvre-strategy-the-rempel-maximum.htm) blog comments?

The one and the same... if someone else is using my name in vain, I hope at least they are smarter than me.


Reminds me of the Police Squad episode (from the team that brought us "Airplane"). Lt. Frank Debin "Hey, congratulations! I hear your wife is pregnant!" Police Chief "Yeh, when I found out the SOB who did it, I'm gonna kill him."

[nicejam]

The one and the same... if someone else is using my name in vain, I hope at least they are smarter than me.


Reminds me of the Police Squad episode (from the team that brought us "Airplane"). Lt. Frank Debin "Hey, congratulations! I hear your wife is pregnant!" Police Chief "Yeh, when I found out the SOB who did it, I'm gonna kill him."

Thanks. Your information and knowledge sharing there was fantastic, and I did follow your posts a couple of years back. Interesting reading, and even though the SM isn't for me I passed along your words to others who used it to their advantage.

[Gotcha]

Sorry if i sound like a broken record but I didnt get a clear answer to this...

I'm wondering if I can use an existing LOC (10K) at P + 2% and buy INvestments and benefit from the interest tax deductible portion from my LOC at Tax time?

I guess in this case, I would have to pay the interest portion every year and do the calculation of all interest paid for the year and file my taxes with this amount, right?

How about the investment portion... DO I need to prove that the investment i made ?

I'd like to start with this.. and eventually try borrowing the WHOLE equity and apply the principle...

Can anyone answer me those questions... to make sure i got it right about the principle on the investment leverage ... i somehow feel uncomfortable borrowing to buy :P
Thanks

[cannon_fodder]

Sorry if i sound like a broken record but I didnt get a clear answer to this...

I'm wondering if I can use an existing LOC (10K) at P + 2% and buy INvestments and benefit from the interest tax deductible portion from my LOC at Tax time?

I guess in this case, I would have to pay the interest portion every year and do the calculation of all interest paid for the year and file my taxes with this amount, right?

How about the investment portion... DO I need to prove that the investment i made ?

I'd like to start with this.. and eventually try borrowing the WHOLE equity and apply the principle...

Can anyone answer me those questions... to make sure i got it right about the principle on the investment leverage ... i somehow feel uncomfortable borrowing to buy :P
Thanks

Yes, you can do a "lump sum" investment by borrowing against a LOC. It is unfortunate that your interest rate is so high (compared to P). If your LOC allows you to pay interest only then you would total up your interest payments and declare that on your tax return.

You would have to invest in equities which have an expectation of income. If you want to stick with just some ETFs (e.g. XIU) then you would be fine. They will pay out distributions which you would have to declare as income. You could also invest in stocks but with that small amount of money it wouldn't be easy to diversify and avoid relatively hefty commissions. TD e-series of mutual funds are well regarded for their low MERs so that might be an option for you as well.

There will be reports from a brokerage/mutual fund company which lists what you have purchased. I received a T5008 and noted that on my tax return - this was the "proof" that I bought. However, it doesn't note the individual purchases or even what the equities are. That was only noted on my tax return if I sold anything (thus creating a capital gain or loss).

I'm not trying to sell you on borrowing to invest, but think of it this way. If you believe that the market will be higher in a year from now, then you could either put money into it at a periodic rate, let's say $1k per month OR you could borrow $12k now and invest tomorrow. If you paid a little more than $1k/month, your out of pocket costs would be comparable but hopefully your portfolio would be much better off.

If you borrow and only pay the interest costs then you can take a much longer term view.

I'm about to assemble various calculators I've created and put them in one place. You'll be able to run through some scenarios, take a very conservative (dim) view of what you are trying to do and see if you still feel comfortable.

Just a thought - if you are concerned with this approach then consider investing in a dividend mutual fund/ETF/stocks whereby you pick quality companies that are expected to maintain their dividends. It should be relatively straightforward to come up with a portfolio that will cover your interest payments with their income. That way, even if you suffer temporary job loss, it won't impact your cash flow.

[Gotcha]

Yes, you can do a "lump sum" investment by borrowing against a LOC. It is unfortunate that your interest rate is so high (compared to P). If your LOC allows you to pay interest only then you would total up your interest payments and declare that on your tax return.

You would have to invest in equities which have an expectation of income. If you want to stick with just some ETFs (e.g. XIU) then you would be fine. They will pay out distributions which you would have to declare as income. You could also invest in stocks but with that small amount of money it wouldn't be easy to diversify and avoid relatively hefty commissions. TD e-series of mutual funds are well regarded for their low MERs so that might be an option for you as well.

There will be reports from a brokerage/mutual fund company which lists what you have purchased. I received a T5008 and noted that on my tax return - this was the "proof" that I bought. However, it doesn't note the individual purchases or even what the equities are. That was only noted on my tax return if I sold anything (thus creating a capital gain or loss).

I'm not trying to sell you on borrowing to invest, but think of it this way. If you believe that the market will be higher in a year from now, then you could either put money into it at a periodic rate, let's say $1k per month OR you could borrow $12k now and invest tomorrow. If you paid a little more than $1k/month, your out of pocket costs would be comparable but hopefully your portfolio would be much better off.

If you borrow and only pay the interest costs then you can take a much longer term view.

I'm about to assemble various calculators I've created and put them in one place. You'll be able to run through some scenarios, take a very conservative (dim) view of what you are trying to do and see if you still feel comfortable.

Just a thought - if you are concerned with this approach then consider investing in a dividend mutual fund/ETF/stocks whereby you pick quality companies that are expected to maintain their dividends. It should be relatively straightforward to come up with a portfolio that will cover your interest payments with their income. That way, even if you suffer temporary job loss, it won't impact your cash flow.

Thanks for all the valuable info! i guess this is what i wanted to hear to try flying on my own ...so to speak...

[maggieandyaothecats]

I can't find any answer anywhere to these questions, or am finding really complicated answers, but I am REALLY interested in implementing the SM.

1. I would be interested in investing in one and only one ETF (CDZ), but its distributions include interest income, dividends, and ROC. Is the interest income tax deductible (i.e. can I withdraw it along with the dividends). I believe that if I never withdraw the ROC portion, I am fine with CRA???

2. I anticipate the prime rate to go up signficantly, within the next 10 years (it can't get any lower, and best case is that it is flat, right?). So my HELOC is shot and the SM is done? Does this represent a major risk of the SM in a nutshell?

I'd love some feedback

Thanks

[warrexa]

This is what a family member does for the SM:

55% S&P/TSX60 Index
20% S&P500 Index
12.5% MSCI Pacific Index
12.5% MSCI Europe Index
5% MSCI Emerging Markets Index

The reasoning is, because she is a Canadian, she should logically have an overweight on Canadian stocks (esp. to take advantage of the dividend tax credit), and the rest of the foreign content is roughly in balance with worldwide asset allocations by market capitalization.
Pitz,

I'm curious as to how you chose 55% for the Canadian component. I understand that the intention is to overweight -- but considering that the Canadian market is 3% of the global market, even 5% or 10% would be 'overweight'. Is it strictly because of the dividend tax credit? Or to make sure you don't get margin calls on the remaining 45%? Why 55% and not 50% or 60%?

I like this allocation because it's what I do anyway for my RRSP & non-registered investments, except that my Canadian component is in the 10-15% range.

Also I notice that a lot of people seem to like dividend-producing stocks and ETFs. Are the dividends from the above allocation sufficient or would it be worth adding a separate high-dividend allocation?

Thanks for all your great posts, they've been really educational for me.

[pitz]

Pitz,

I'm curious as to how you chose 55% for the Canadian component.


Well ultimately, a stock portfolio for a Canadian will be used to pay for domestic consumption. I personally figure that 2/3rds of the goods and services I consume are produced in Canada, and the other half are produced in the United States or overseas. I would anticipate that a pension or government benefits could fill the gap between 55% and 2/3rds, give or take.

There's really no scientific method behind that particular asset allocation, but the dividend tax credit does give significant incentive to overweight Canada, as well as the dynamics of our economy versus, say, the United States or Europe.



I understand that the intention is to overweight -- but considering that the Canadian market is 3% of the global market, even 5% or 10% would be 'overweight'.


No, because you're trying to hedge your future consumption, not hedge your position against the performance of the world's stock markets. As a Canadian, weighting Canada at its global weighting would be exposing oneself to an enormous amount of risk insofar as living in Canada is concerned. For instance, let's say, in the coming years, because of the stability of Canada's banking system and the economy, that we become a target of large foreign capital inflows -- a portfolio of primarily foreign stocks would seriously underperform.




Is it strictly because of the dividend tax credit? Or to make sure you don't get margin calls on the remaining 45%? Why 55% and not 50% or 60%?


There's no margin issues involved at all; and 50% or 60% or whatever, is completely arbitrary. I'm not going to be a BS'er and claim that there's science behind it, because there isn't, other than to say that its a reasonable mix between exposure to foreign assets, and domestic stability in future purchasing power.



Also I notice that a lot of people seem to like dividend-producing stocks and ETFs. Are the dividends from the above allocation sufficient or would it be worth adding a separate high-dividend allocation?


XIU is mostly dividend payers. The problem with many Canadian dividend payers is that they are asset strippers, and the dividend policy seems to interfere with capital growth and expansion, to wit: the cost of the firm's capital is unnecessarily raised. For instance, Canadian banks should be availing themselves of the excellent investment opportunities right now, rather than paying dividends. Many income trusts are in serious financial doo-doo, or have defaulted, because they were equity-stripped. IMHO, there's very little reason to go outside the TSX60 (ie: the constituents of XIU) to build a portfolio that is very representative of the Canadian stock market.

[pitz]

I can't find any answer anywhere to these questions, or am finding really complicated answers, but I am REALLY interested in implementing the SM.

1. I would be interested in investing in one and only one ETF (CDZ), but its distributions include interest income, dividends, and ROC. Is the interest income tax deductible (i.e. can I withdraw it along with the dividends). I believe that if I never withdraw the ROC portion, I am fine with CRA???


Interest income is taxable in the year that it is earned and paid by a trust. You can safely withdraw the interest income portion and spend it as you please.



2. I anticipate the prime rate to go up signficantly, within the next 10 years (it can't get any lower, and best case is that it is flat, right?). So my HELOC is shot and the SM is done? Does this represent a major risk of the SM in a nutshell?


I think a major risk of the SM right now is that banks are increasingly going to become wary of writing loans secured by *housing*, especially with housing prices crashing right across Canada, and likely to continue getting worse (ie: over time, I'd expect markets like Vancouver, Toronto, Edmonton, Saskatoon, Regina, Calgary and elsewhere to lose half their value from the peak). This is why you want to make sure the securities you buy are liquid, and are marginable -- because you may very well have to use a margin lending facility to gain a competitive interest rate. There is plenty of evidence that HELOCs are already seeing rate escalation (ie: just read the threads on these forums).

For instance, I can borrow on margin right now, Canadian dollars, for ~1.25% (even less if I borrow more). But the cheapest HELOC loan these days is still in the 3% range I understand, because they're being priced at Prime + 1%.

[evoviii]

Interactive brokers offers very attractive margin rates.

[maggieandyaothecats]

Interest income is taxable in the year that it is earned and paid by a trust. You can safely withdraw the interest income portion and spend it as you please.



I think a major risk of the SM right now is that banks are increasingly going to become wary of writing loans secured by *housing*, especially with housing prices crashing right across Canada, and likely to continue getting worse (ie: over time, I'd expect markets like Vancouver, Toronto, Edmonton, Saskatoon, Regina, Calgary and elsewhere to lose half their value from the peak). This is why you want to make sure the securities you buy are liquid, and are marginable -- because you may very well have to use a margin lending facility to gain a competitive interest rate. There is plenty of evidence that HELOCs are already seeing rate escalation (ie: just read the threads on these forums).

For instance, I can borrow on margin right now, Canadian dollars, for ~1.25% (even less if I borrow more). But the cheapest HELOC loan these days is still in the 3% range I understand, because they're being priced at Prime + 1%.

Sorry, I don't understand the concept of "Marginable"...Could you expand a bit for my noobness?

[pitz]

Sorry, I don't understand the concept of "Marginable"...Could you expand a bit for my noobness?

Basically, you want to make sure that you buy investments that, in and of themselves, you could use to secure a loan. For instance, if you buy stocks, you want to make sure that they are such that you could go to a broker and borrow money against.

[warrexa]

Well ultimately, a stock portfolio for a Canadian will be used to pay for domestic consumption.Sure, but consumption is done with cash, not stock, so in the end isn't it irrelevant?


For instance, let's say, in the coming years, because of the stability of Canada's banking system and the economy, that we become a target of large foreign capital inflows -- a portfolio of primarily foreign stocks would seriously underperform.But doesn't this cut both ways? Let's say the stability of Canada's banking system causes its banks to underperform relative to foreign peers, or the price of oil perpetually declines because of electric cars or what not. Or maybe the severity of the 2008/2009 crash elsewhere in the world results in more room for growth here on in.


There's no margin issues involved at all; and 50% or 60% or whatever, is completely arbitrary.Well, the 45% that she borrowed on margin from the IB foreign currency accounts is subject to margin calls, and aren't those stocks are backed by the non-margined securities (non-margined as far as IB is concerned, i.e., the ones purchased with money from the HELOC)?


The problem with many Canadian dividend payers is that they are asset strippers, and the dividend policy seems to interfere with capital growth and expansion, to wit: the cost of the firm's capital is unnecessarily raised. For instance, Canadian banks should be availing themselves of the excellent investment opportunities right now, rather than paying dividends. Many income trusts are in serious financial doo-doo, or have defaulted, because they were equity-stripped. IMHO, there's very little reason to go outside the TSX60 (ie: the constituents of XIU) to build a portfolio that is very representative of the Canadian stock market.I'm not sure I understand what you mean, or what it means with respect to producing dividend income that can be used to accelerate the SM. Also, XIU distributions contains a ROC component. Won't that complicate tax matters unnecessarily?

[mark2000]

Question about the SM from those with experience...

If I have a HELOC with a limit of $180,000 and am carrying a $150,000 mortgage balance on it, and I advance the remaining $30,000 from the HELOC to put in investments for the SM, do I get to deduct interest paid on the portion worth $30,000 only against my taxes, or the interest applied to the whole $180,000 against my taxes?

Also, would just plopping the $30,000 into a bank stock (say, Scotia stock) through an online self-trade system like TD Waterhouse count as an investment?

Thanks.

[digitalsky]

Question about the SM from those with experience...

If I have a HELOC with a limit of $180,000 and am carrying a $150,000 mortgage balance on it, and I advance the remaining $30,000 from the HELOC to put in investments for the SM, do I get to deduct interest paid on the portion worth $30,000 only against my taxes, or the interest applied to the whole $180,000 against my taxes?

Also, would just plopping the $30,000 into a bank stock (say, Scotia stock) through an online self-trade system like TD Waterhouse count as an investment?

Thanks.

I'm interested in the answer to your first question as well. Especially if you pay your mortgage and investments with the SAME LOC, how can you proof how much you borrowed is for investment vs mortgage? When you pay down that LOC, how do you prove if you're payding down your investment loan or mortgage? I don't want to be denied my tax credits because I have them in the same account.

For the 2nd question, I would imagine yes. There is risk and you expect ROI from that stock.

[florch]

I'm interested in the answer to your first question as well. Especially if you pay your mortgage and investments with the SAME LOC, how can you proof how much you borrowed is for investment vs mortgage? When you pay down that LOC, how do you prove if you're payding down your investment loan or mortgage? I don't want to be denied my tax credits because I have them in the same account.

For the 2nd question, I would imagine yes. There is risk and you expect ROI from that stock.

You have to separate the accounts or your going to have trouble. CRA's not stupid and the onus of proof will be on you. So get a HELOC with sub-accounts or else use it for SM ONLY.

Now, no more questions from people who haven't read the first 200 posts of this thread. Did you get other people to do your homework for you in school? Stop being lazy, this is your life savings we're talking about. Reading this will answer many questions and then it will raise more and probably answer them too.

[mark2000]

Now, no more questions from people who haven't read the first 200 posts of this thread. Did you get other people to do your homework for you in school? Stop being lazy, this is your life savings we're talking about. Reading this will answer many questions and then it will raise more and probably answer them too.Oh please get over yourself. :cheesygri I have contributed enough on this board to deserve the odd question answered without digging through 1000 pages of your sorts of rants. While I have got your attention though :) - and I did read many of the threads - it makes sense why people are only going with some of the major banks' HELOCs then.

I believe Scotia and RBC allow you to have sub accounts from what I read in the posts, but do you know if, since the thread was originally started, if the list of big banks offering this feature has expanded?

Thank you!

[cannon_fodder]

I believe Scotia and RBC allow you to have sub accounts from what I read in the posts, but do you know if, since the thread was originally started, if the list of big banks offering this feature has expanded?

Thank you!

Here is a good page that provides a lot of info on SM friendly mortgages

http://www.myvirtualmortgagebroker.com/Smith-Manoeuvre-Mortgages-Smith-Maneuver.html

[evoviii]

Here is a good page that provides a lot of info on SM friendly mortgages

http://www.myvirtualmortgagebroker.com/Smith-Manoeuvre-Mortgages-Smith-Maneuver.html

Not sure if the link is fully up to date. First line matrix was withdrawn last fall though first line still does have a heloc mortgage offering but not sure if the terms are similar.

[Fort McMurray]

I am going to be looking into something like this as my mortgage is up in December and I will have $200K owing on a house worth $550K. Between my wife and I we have $90K in RRSP tax deductible room, which we are planning to max out this year as our bonuses have pushed us up into higher tax brackets, but I am going to hopefully leverage some of the new mortgage into investment opportunities.

I am still stumped as to why I kept getting pressured to max out my RRSPs when I was in the lowest tax bracket only to see how much more I would have got back in tax in the highest tax bracket 5 years later!

Nevertheless, hopefully our financial advisor at RBC that was a mortgage specialist and also was an accountant will be able to advise wisely on this.

[pitz]

I am going to be looking into something like this as my mortgage is up in December and I will have $200K owing on a house worth $550K. Between my wife and I we have $90K in RRSP tax deductible room, which we are planning to max out this year as our bonuses have pushed us up into higher tax brackets, but I am going to hopefully leverage some of the new mortgage into investment opportunities.


If "Fort McMurray" not only means your location, but also your name.... tread cautiously..



I am still stumped as to why I kept getting pressured to max out my RRSPs when I was in the lowest tax bracket only to see how much more I would have got back in tax in the highest tax bracket 5 years later!


Its simple; if you contribute to a RRSP, the investment manager gets to manage 30-40% more money than they otherwise would if you invested in a TFSA or a non-reg vehicle. Therefore, they get to collect 30-40% more management fees. Huge incentive for them to 'favour' the RRSP over the TFSA, regardless of whether it truly makes sense for you.



Nevertheless, hopefully our financial advisor at RBC that was a mortgage specialist and also was an accountant will be able to advise wisely on this.

There's lots of variables involved, but usually its pretty much impossible to beat the return of paying down one's mortgage, by investing in a RRSP, especially with managed mutual funds. Right now may very well be an exception, because the stock market is so abnormally priced compared to mortgage rates, but over the long term, paying down a mortgage aggressively is the best thing you can usually do with any additional incremental money, with the TFSA coming in next.

[brunes]

If "Fort McMurray" not only means your location, but also your name.... tread cautiously..

That's true... think about how confusing his address would be!

:)

[abridgel]

ok despite reading through the first 14 pages of this thread I am still not clear on how the whole process works

I understand that

1. You get some type of readvanceable mortgage or a Heloc
2. As 1 dollar is available in the equity in your house you withdraw that 1 dollar and use it towards investment.
3. The interest on that 1 dollar is now tax deductible

However how are you paying the interest on that 1 dollar?

I understand that there will be dividends from your investment but it is not instantaneous and there is no gurantee that the whole dividend will cover the interest on that 1 dollar - correct?

[pitz]

However how are you paying the interest on that 1 dollar?


Over time, with the 'manouevre' as described, you are transforming the maturity of your investments to the maturity of your debt, and hoping to collect an arbitrage profit on the balance.



I understand that there will be dividends from your investment but it is not instantaneous and there is no gurantee that the whole dividend will cover the interest on that 1 dollar - correct?

Hopefully you would identify investments that eventually will have sufficient dividends available to liquidate the debt, adjusted for compounding, of course.

The huge risk that SM 'users' are understating is the very real risk that they won't be able to renew their debt financing on favourable terms. Ways this can be mitigated:

1) Never use the SM unless you have *at least* 50% of your mortgage paid off (and preferrably 2/3rds).

2) Always and only purchase investments that are such that credit can be readily obtained against them.

3) Arrange for credit lines to be available on a 'standby' basis against the SM investments.

To do anything less, IMHO, really ratchets up the risk dramatically.

[abridgel]

Are there any good mortgage brokers or FP's anyone can recommend for implementing this or at leas having them look at our situation to see if it would be worth while for us

Thanks

[abridgel]

Has anyone tried implemnting this straegy using ING mutual funds?

They don't charge you any fees and you can buy as little or as much as you want.

[hello99]

Hi,

I just completed signing my HELOC at National Bank. They have a special promotion for prime +0 % for engineers.

If you have any questions let me know. I can also send you my reps details if you would like. He's in Mississauga.

[pitz]

Are there any good mortgage brokers or FP's anyone can recommend for implementing this or at leas having them look at our situation to see if it would be worth while for us

Thanks

My suggestion is that you obtain independant, fee-for-service advice (see my other posts in this thread). You really don't want to be getting advice from someone that is conflicted between their own personal goals (of selling investments or mortgages), and your true financial needs.

Basically, if you have your mortgage 2/3rds paid off, you have a steady and stable source of income, and you have no other debt other than your mortgage -- you are a very good candidate. Anything less, and you really ought to tread cautiously.

[cannon_fodder]

ok despite reading through the first 14 pages of this thread I am still not clear on how the whole process works

I understand that

1. You get some type of readvanceable mortgage or a Heloc
2. As 1 dollar is available in the equity in your house you withdraw that 1 dollar and use it towards investment.
3. The interest on that 1 dollar is now tax deductible

However how are you paying the interest on that 1 dollar?

I understand that there will be dividends from your investment but it is not instantaneous and there is no gurantee that the whole dividend will cover the interest on that 1 dollar - correct?

You don't have to invest in dividend producing equities to partake in the SM. You can capitalize the interest, likely in a manual manner, by simply withdrawing the principal paydown each time you make a mortgage payment, siphoning off enough to cover your HELOC interest payments and then investing the remainder.

If all things stay constant, you will see slightly less to invest each period because while the mortgage amount goes down by X, the HELOC also goes up by X and usually the HELOC is at a higher rate of interest.

[cannon_fodder]

Are there any good mortgage brokers or FP's anyone can recommend for implementing this or at leas having them look at our situation to see if it would be worth while for us

Thanks

We got our BMO Readiline with the help of Ed Rempel (www.edrempel.ca) and his team was able to negotiate a better rate off prime than we were able to on our own despite having a lot of business with BMO.

While he is a financial advisor, there was no obligation to invest with him and in fact we have not.

I know that he has made offers in the past to followers at milliondollarjourney.com to offer assistance in getting you an SM-friendly mortgage for free (they of course make a little money from the bank as a finder's fee).

[zzricezz]

How as the recession affected this technique with the falling stocking market?

[pitz]

How as the recession affected this technique with the falling stocking market?

Well, basically house and stock prices have fell (or will fall) 50%. If one were to be in a forced liquidation situation right now, with the SM, and had only done so with <50% of their mortgage paid off, technically, they would be insolvent on a mark-to-market basis.

However, if you have good equity (considering that your house probably will lose 50% or more of its price from the peak) right now -- then hasn't been a better time, in the past 12-15 years, to do the SM.

Just make sure that you buy investments that can have credit granted against them quite easily, because I suspect that loans against anything to do with real estate (ie: HELOCs, mortgages) will become increasingly expensive as time goes on.

[zzricezz]

Well, basically house and stock prices have fell (or will fall) 50%. If one were to be in a forced liquidation situation right now, with the SM, and had only done so with <50% of their mortgage paid off, technically, they would be insolvent on a mark-to-market basis.

However, if you have good equity (considering that your house probably will lose 50% or more of its price from the peak) right now -- then hasn't been a better time, in the past 12-15 years, to do the SM.

Just make sure that you buy investments that can have credit granted against them quite easily, because I suspect that loans against anything to do with real estate (ie: HELOCs, mortgages) will become increasingly expensive as time goes on.

Thanks Pitz,

Can you explain what you mean by credit granted? Don;t I just sell the investments if I need cash?

[pitz]

Thanks Pitz,

Can you explain what you mean by credit granted? Don;t I just sell the investments if I need cash?

You would want to buy, with the SM proceeds, assets that you could get loans against themselves. For instance, marginable stocks.

And no, you don't just 'sell the investments'. The investments may be illiquid, or the market for those investments may be significantly distressed.

[grant]

How as the recession affected this technique with the falling stocking market?
if a person's equity portfolio is smaller, it means they have less ability to perform the maneuvre.

e.g. if you have a $300,000 personal mortgage, and a $400,000 portfolio, then you can do the SM in one big bite.

If you have a $300,000 personal mortgage and a $200,000 portfolio, you can only do 2/3rds of the SM in a big bite, and the rest will have to be done by converting cash flow.

[grant]

ok despite reading through the first 14 pages of this thread I am still not clear on how the whole process works
I'm not surprised. for years people have been throwing all sorts of misinformation into this thread about "accelerated SM" and whatnot.


I understand that

1. You get some type of readvanceable mortgage or a Heloc
2. As 1 dollar is available in the equity in your house you withdraw that 1 dollar and use it towards investment.
3. The interest on that 1 dollar is now tax deductible
close but not quite! You've been lured into this trap where people are encouraging you to increase your leveraged investing which is a totally different subject!

Here is a pure SM technique:

before
1) you earn $10 from your job, investment dividends, etc.
2) you spend $4 paying down your mortgage, $4 on living expenses, and stick $2 in stocks/bonds/other investments (e.g. saving for the future)

after
1) you earn $10 from your job, dividends, etc.
2) you spend $6 ($4 + $2) paying down your mortgage, and $4 on living expenses
3) you borrow $2 from your HELOC and stick it in exactly the same stocks/bonds/other investments that you were planning to buy anyways


However how are you paying the interest on that 1 dollar?
Exactly the same way you were paying interest on your mortgage... because your total debt load hasn't changed!


I understand that there will be dividends from your investment but it is not instantaneous and there is no gurantee that the whole dividend will cover the interest on that 1 dollar - correct?
that is correct, that is why leveraged investing has risk, and that is why SM on its own does absolutely nothing to change your assets or debt load!

Smith Maneuvre on its own makes your existing mortgage interest tax deductible. Nothing more nothing less!

[Jobu]

I understand the SM concept, and it makes sense.

However, I have an intuitive resistance to calling it a conversion of non-deductible interest into deductible interest.

Instead, the way I view this strategy is simply borrowing from a credit facility with an attractive interest rate and investing in relatively safe products that may/will return income and gains over time that exceed the borrowing (prinicipal + deductible interest).

In other words, if one is willing to implement the SM, shouldn't they similarly be borrowing, all things equal, to invest, even if they don't have existing debt?

I have read Smith's book, and he says that the SM presupposes existing non-deductible debt. But why is this a pre-requisite? For a point in time, after one makes a mortgage payment, he has reduced his debt load. Only when he decides to re-borrow to invest does his debt load then return back to where it was.

Am I missing something?

Again, I'm not opposed to borrowing to invest, but I don't think the SM is any more complicated than that, and it's certainly, in my view, misleading to suggest that this is a conversion at all.

[GSRee]

I understand the SM concept, and it makes sense.

However, I have an intuitive resistance to calling it a conversion of non-deductible interest into deductible interest.

Instead, the way I view this strategy is simply borrowing from a credit facility with an attractive interest rate and investing in relatively safe products that may/will return income and gains over time that exceed the borrowing (prinicipal + deductible interest).

In other words, if one is willing to implement the SM, shouldn't they similarly be borrowing, all things equal, to invest, even if they don't have existing debt?

I have read Smith's book, and he says that the SM presupposes existing non-deductible debt. But why is this a pre-requisite? For a point in time, after one makes a mortgage payment, he has reduced his debt load. Only when he decides to re-borrow to invest does his debt load then return back to where it was.

Am I missing something?

Again, I'm not opposed to borrowing to invest, but I don't think the SM is any more complicated than that, and it's certainly, in my view, misleading to suggest that this is a conversion at all.

I think you're missing the marketing. Simply calling it what it is, leveraging, doesn't sound that impressive (if you asked random people on the street, would they even know what that means?).

But when you call it a conversion of bad debt to good debt, people can understand that concept, or at least it'll pique their curiosity, and maybe they'll buy your book.

[Jobu]

I think you're missing the marketing. Simply calling it what it is, leveraging, doesn't sound that impressive (if you asked random people on the street, would they even know what that means?).

But when you call it a conversion of bad debt to good debt, people can understand that concept, or at least it'll pique their curiosity, and maybe they'll buy your book.

Yeah, for sure -- it's a sexy enticement.

However, I think that in the process of framing it in this manner, the concept is unnecessarily complicated and mystified.

Case in point, the hundreds of posts in this thread, which evidence an understandable level of confusion.

I think that Smith and SM proponents would be better served to call a spade a spade; this is a long-standing strategy that involves borrowing to invest, nothing more and nothing less. It doesn't make it a poor strategy, but it's not really new -- even if the available tools to support it make the strategy easier to implement these days.

As I said before, if someone has an existing $50,000 LoC at prime, and its balance is zero, one should be motivated to draw this down to invest -- thereby creating debt where none previously existed -- if he is motivated to use his mortgage in the same way.

At the end of the day, this is the exact same thing: http://www.taxtips.ca/stocksandbonds/borrowtoinvest.htm.

[digitalsky]

I agree with Jobu. I'm still reading the book but as far as I can see, the so called "SM" is just a packaging of doing two things together: 1) pay down mortgage + 2) borrow to invest. If one has no debt, one can still borrow to invest to take advantage of the tax deducatable loan. Maybe the difference is just that when you own a home, you can get a secured LOC at a better rate, whereas if one has no home, he can only get an unsecured LOC at a higher rate?

[pitz]

I agree with Jobu. I'm still reading the book but as far as I can see, the so called "SM" is just a packaging of doing two things together: 1) pay down mortgage + 2) borrow to invest. If one has no debt, one can still borrow to invest to take advantage of the tax deducatable loan. Maybe the difference is just that when you own a home, you can get a secured LOC at a better rate, whereas if one has no home, he can only get an unsecured LOC at a higher rate?

A margin account can be used with similar effectiveness. Margin interest rates, if you shop around, are actually far less than mortgages.

People who don't own house(s) aren't really at any disadvantage.

[grant]

I understand the SM concept, and it makes sense. the rest of of your post proves you totally don't get it.


However, I have an intuitive resistance to calling it a conversion of non-deductible interest into deductible interest.
Of course... because like many other obstinate people, you are trying to stock the "Smith Maneuvre" label on a totally different financial technique called "leveraged investing"


I have read Smith's book, and he says that the SM presupposes existing non-deductible debt. But why is this a pre-requisite?
Because without non-deductible debt, there is nothing to convert to deductible debt!! which is the whole point of SM.


Am I missing something?
Apparently the ability to read even 1 single post above yours, let alone much else in this informative thread.


in my view, misleading to suggest that this is a conversion at all.
In your view, it's "misleading" for someone to acurately label a technique, just because you decide you think the technique should be something totally different?

That's kind of like me saying "I totally understand bicycling. But i have an intuitive resistance to calling it 'riding a 2-wheeled machine'. And this book says it presupposes that a person owns a bike before a person can bicycle somewhere. Why is a a bike a prerequisite? That's misleading because you can just run or walk to go places."

[Jobu]

the rest of of your post proves you totally don't get it. [.quote]
Really?

[quote]
Of course... because like many other obstinate people, you are trying to stock the "Smith Maneuvre" label on a totally different financial technique called "leveraged investing"


How is this different?



Because without non-deductible debt, there is nothing to convert to deductible debt!! which is the whole point of SM.


No, you're wrong. When I re-pay principal of my mortgage, which is a pre-requisite to your so-called "conversion", that is that. Only when I re-borrow against that principal, to invest, have I created deductible interest. After step 1, I no longer have non-deductible interest in connection with the just re-paid principal. So what I am doing is re-borrowing. There is no conversion -- It's just a two-step process.

In other words, you are going from non-deductible debt, to no debt, to deductible debt. Well if I skip the first part, i.e., if I have no non-deductible debt to begin with, it doesn't effect this so-called "manouevre".

It's a marketing ploy, and nothing else. Doesn't make it bad, but it's not unique, nor new, nor innovative.



Apparently the ability to read even 1 single post above yours, let alone much else in this informative thread.


I see that you still haven't done anything to explain how this at all differs from leveraged investing.

Try again, perhaps.

[cannon_fodder]

I think I understand what both Jobu and Grant are saying and why.

The way I look at it is that calling it a Smith Manoeuvre allows Smith to sell books, acquire media attention, be invited as a guest speaker, etc. It helps pad his pocket and there is nothing wrong with that in this entrepreneurial world.

As others have stated, if you broke it down into fundamental components and cast away the powerpoints and marketing speak you will find a great many people will be turned off. This is why Smith goes at great lengths to focus on converting bad debt to good debt and how that is the secret of success for so many wealthy people. (I think there are probably many other authors that speak to this point - IIRC the Rich Man, Poor Man does for example.)

If you tried to talk to the average homeowner I'm guessing that most of them have embarked on a strategy of retiring the mortgage and then getting very serious about putting away money for retirement. Maybe they have contributed to RRSP's but found it difficult to maximize their contributions; they have tried pretty hard to make sure they get the maximum CESG for their RESP's; and don't even get them started about TFSAs - there are too many choices and decisions and I don't have time.

Smith paints a different picture which I'm sure the readers understand the basics. Without any additional cash flow, and without decreasing (or increasing) your debt, you can wind up with a non-registered investment portfolio that, over the long term, should put you closer to financial independence than if you only looked to pay down the mortgage.

That sounds all well and good. But, if you instead took the tact that you are going to borrow money to invest, you are going to 'leverage' to invest, and your total debt obligation doesn't go down ever (if you follow Smith's mantra to die with the HELOC fully maximized) you are going to turn off a lot of people.

Thus, you have to sweeten the medicine with some sugar - how do I come up with a compelling proposition so that the average homeowner puts aside their objections to borrowing as quickly as their paying down debt? How can I find a message that resonates with the majority of people that have always been told, and believed, that any debt is bad?

Well, we Canadians are jealous of the standard of living of the US (maybe a little less now with the hardships facing the US). We are jealous of their access to cheaper and more varied goods, their lower tax rates, their Disney World and their Olive Gardens (well I wish we still had Olive Gardens in this part of Canada).

We are also jealous of their deductible mortgage interest arrangement (let's avoid the whole argument that if that occurred here suddenly, we should expect that house prices would rise to return to an historic affordability level thus at least partially negating the benefit). We can cast the banks and the government as villains - which self-respecting Canadian doesn't have a hate on for at least one of those two, and more likely both?

Ok, the stage is set - on the one hand you have the image of a lazy, wasteful, money grubbing government and an arrogant, greedy, rich beyond its means bank. On the other hand, you have poor little you who works so hard and pays your taxes, and pays your monthly bank service charge and use the ATMs and POS devices and internet banking so as to not bother those tellers or managers who work at the bank doing far more important things than you could ever imagine.

What if we could turn the tables and get the government to give us money so that we could help build a retirement nest egg? What if we could take those tax refunds and pay down our mortgage every year so that the bank doesn't have us locked in for 25 years, paying 2-3 times the cost of the house over the lifetime of that mortgage? What if we could take more control of our financial matters and start NOW towards our goal of financial independence instead of waiting until it may be too late?

What if I could make a dream come true whereby you could have a fully paid off house AND a retirement fund all before 25 years are up? And both the government and the bank were going to help you do it?

The bank will only be too happy to help you out - after all, instead of you being mortgage free in 25 years, you still are on the hook for a massive HELOC. Instead of seeing declining interest payments, they see a healthy, long term profit engine. If they can convince you to invest your principle reborrowings with their mutual funds then they've really hit the jackpot!

And what makes this so much easier to fall in love with, is that this happens gradually over time just like losing your hair (in the right places) and gaining new hair (in the wrong places). It doesn't cost you any more per month than you already have budgeted for your mortgage.

If, on the other hand, you've been diligent about paying down your mortgage, perhaps even putting extra $ towards it in terms of lump sump payments or increasing your payment amount, you may find yourself with a nice bit of equity sitting there. Now, how exactly is that working towards making you more money? What if I could tell you that you could simply borrow that lump sum and invest it? Do you realise that for a lot of people that is a very scary proposition, especially now?

For years I've scrimped and saved and sacrificed, and now you suggest that I take all of those savings and wipe away all of that equity I built into this house and go invest the whole bundle all at once? Heck, I can handle my little $300/month RRSP contributions but investing $50,000 in one shot is way beyond my league. If I did that last summer, I'd probably have lost half of it by now. And it took me years and years to get to this point - I'm not risking it.

So, after this long winded diatribe, I hope it helps you understand that borrowing to invest, even if it is taking a lump sump from mortgage equity, doesn't have the same appeal or even tactics as slowly, but surely, investing in dribs and drabs by just reborrowing what you paid down on your mortgage that month. You are still leveraging - just in a less threatening manner for most people. You also are converting 'bad' debt into 'good' debt with the SM. Borrowing from your home equity in one large amount is simply leveraging - you are actually increasing debt.

Not everyone responds to a message in the same way - sometimes you need compelling stories in order to get people to change their perceptions and behaviours.

[grant]

Really?
yes, really.

The definition of the smith maneuvre is clearly described on Fraser Smith's homepage (http://www.smithman.net/home.html): "make your mortgage tax deductible"!

If you want to get into leveraged investing, great, just accept that that's totally not the point of the smith maneuvre. it is by definition:

converting your non-deductible debt into deductible debt.

[Jobu]

yes, really.

The definition of the smith maneuvre is clearly described on Fraser Smith's homepage (http://www.smithman.net/home.html): "make your mortgage tax deductible"!

If you want to get into leveraged investing, great, just accept that that's totally not the point of the smith maneuvre. it is by definition:

converting your non-deductible debt into deductible debt.

Please explain. You haven't yet.

It is precisely leveraged investing, and nothing else.

Don't be ashamed for buying the marketing. As I've said before, it's not a bad idea, if misleading.

[grant]

Please explain. You haven't yet.

It is precisely leveraged investing, and nothing else.

Don't be ashamed for buying the marketing. As I've said before, it's not a bad idea, if misleading.
1) leveraged investing = increasing debt to purchase investments
2) smith maneuvre = converting non-deductible debt to be deductible.

What else is there to explain? they are different techniques. they have different goals. they have different titles. if you don't get that X != Y then no explanation can help you.

What I find hilarious is even though you claim they are "precisely" the same, you also complain Fraser's book is "misleading" because he doesn't even claim to describe leveraged investing.

(p.s. as for "buying the marketing" i've never purchased a smith product. I had the concept explained to me in 5 minutes by David Ingram and have executed it successfully several times on different mortgages. If you had bothered to actually READ this thread before claiming to be an expert on SM you may have noticed that.

Personally I am amazed that so many people can so thoroughly misunderstand a 5-minute/20 sentence concept, but you take the cake since you actually have the gall to claim the inventor is incorrectly describing his own creation)

[Jobu]

1) leveraged investing = increasing debt to purchase investments
2) smith maneuvre = converting non-deductible debt to be deductible.

What else is there to explain? they are different. they have different titles. if you don't get that X != Y then no explanation can help you.

What I find hilarious is even though you claim they are "precisely" the same, you also complain Fraser's book is "misleading" because he doesn't claim to describe leveraged investing.

(p.s. as for "buying the marketting" i've never purchased a smith product. I had the concept explained to me in 5 minutes by David Ingram and have executed it successfully several times on several mortgages. If you had bothered to actually READ this thread before claiming to be an expert on SM you may have noticed that.

Personally I am amazed that so many people can so thoroughly misunderstand a 5-minute/20 sentence concept, but you take the cake since you actually have the gall to claim the inventor is incorrectly describing his own creation)

Let me see if I can dumb it down for you a little further.

Suppose I have a $100 mortgage. And suppose that my principal payment is $5.

Without employing the SM, I have $95 of debt after my principal payment.

By employing the SM, I have $100 of debt, $5 of which is deductible, and $95 of which remains non-deductible. By virtue of employing the SM, I have increased my debt. Were I not to employ the SM, I'd have less debt.

The same thing can be accomplished with a $0 credit line. I can go from $0 to $5 of deductible debt.

Got it yet, superstar?

[frankal101]

By employing the SM, I have $100 of debt, $5 of which is deductible, and $95 of which remains non-deductible. By virtue of employing the SM, I have increased my debt. Were I not to employ the SM, I'd have less debt.

The same thing can be accomplished with a $0 credit line. I can go from $0 to $5 of deductible debt.

Not true - you start out with $100 debt and no equity... you pay off $5 and reborrow it and invest it... you now have $95 non-deductible debt and $5 deductible debt and $5 in invested assets... so total of 100 debt - 5 equity = 95 net debt... youve just swapped the house equity (long housing market) for some equity investment (hopefully long conservative dividend paying diversified portfolio)...

No leverage in sm - it takes care of the common situation for a family that has a mortgage and non-reg investments at the same time...

[Jobu]

By employing the SM, I have $100 of debt, $5 of which is deductible, and $95 of which remains non-deductible. By virtue of employing the SM, I have increased my debt. Were I not to employ the SM, I'd have less debt.

The same thing can be accomplished with a $0 credit line. I can go from $0 to $5 of deductible debt.

Not true - you start out with $100 debt and no equity... you pay off $5 and reborrow it and invest it... you now have $95 non-deductible debt and $5 deductible debt and $5 in invested assets... so total of 100 debt - 5 equity = 95 net debt... youve just swapped the house equity (long housing market) for some equity investment (hopefully long conservative dividend paying diversified portfolio)...

No leverage in sm - it takes care of the common situation for a family that has a mortgage and non-reg investments at the same time...

What are you talking about?

If I have $95 in debt, no equity, and spend $5 investing in equity, I now have $100 in debt ($5 of which is deductible) and $5 in equity. I agree.

What's the difference between that and having $0 in debt, then investing $5 from a LOC, thereby creating $5 in deductible debt and $5 in equity?

The answer is zero.

The SM is a two-step process which is equivalent to starting from the second step even without a house mortgage or existing debt.

Nothing is being swapped or converted. You are creating deductible debt and equity where no debt or equity existed previously.

[GSRee]

No leverage in sm - it takes care of the common situation for a family that has a mortgage and non-reg investments at the same time...

Your house is the leverage with the SM.

[frankal101]

the sm assumes you start out with two things - a mortgage (non-deductible debt in canada) and a non-reg portfolio...

look - just read the thread or google SM - there is tons of info out there...

[grant]

Let me see if I can dumb it down for you a little further.
even though you come off as too obstinate to learn the basics of Smith Maneuvre, this post might be succinct & clear enough to manage. (http://www.redflagdeals.com/forums/showpost.php?p=8811234&postcount=815)

Follow the bit below "Here is a pure SM technique:" ... if you take a few moments to read & ponder, you might just 'get it'.

[Jobu]

even though you come off as too obstinate to learn the basics of Smith Maneuvre, this post might be succinct & clear enough to manage. (http://www.redflagdeals.com/forums/showpost.php?p=8811234&postcount=815)

Follow the bit below "Here is a pure SM technique:" ... if you take a few moments to read & ponder, you might just 'get it'.

No matter how much you say it, you're still wrong.

I see you deleted your initial reply, which I received in an e-mail notice. Good thing, since it was also completely out to lunch.

Like I said, *you're* the one who doesn't get it. Not sure why it's so hard for you to grasp that the SM requires you to borrow to invest -- you just explained how it works, to some degree, in the link above. Although you have misunderstood the concept rather significantly in that SM presupposes that you do NOT have existing unregistered investments. That's why you have to borrow to invest! It does not assume that you are making unregistered investments already.

Teeheehee.

[cannon_fodder]

No matter how much you say it, you're still wrong.

I see you deleted your initial reply, which I received in an e-mail notice. Good thing, since it was also completely out to lunch.

Like I said, *you're* the one who doesn't get it. Not sure why it's so hard for you to grasp that the SM requires you to borrow to invest -- you just explained how it works, to some degree, in the link above. Although you have misunderstood the concept rather significantly in that SM presupposes that you do NOT have existing unregistered investments. That's why you have to borrow to invest! It does not assume that you are making unregistered investments already.

Teeheehee.

I've not heard it mentioned anywhere that the SM presupposes that you do not have existing nonregistered investments. In fact, in Smith's book, his PPT and in his calculator there is a step one can take to liquidate investments (his examples are usually low interest savings such as GICs), pay down the mortgage, then reborrow the amount in full to invest in equities. It allows you to 'jump start' the process.

From the arguments you and Grant are making I would say that you both are correct to a degree. The SM absolutely requires you to borrow, or leverage. Whether you want to do it in a big lump sum (if that equity is available to you) or just go along slowly by only borrowing your periodic principal payments is a choice each person can make.

I would say that the SM is not strictly leveraging only because you don't need a mortgage to leverage. You only need the facility to borrow money - from a bank, a credit card, a friend - whatever. With SM you specifically use a readvanceable mortgage.

The SM is a form of leveraging, a subset if you will. You were right when you say that by employing the SM you have increased your debt. Grant was also right when he said you don't increase your debt.

How can that be? It is based on your perspective. From Grant's point of you, your total debt load doesn't change. For every principle payment, there is an equal amount borrowed - some portion to pay the interest on the ever growing HELOC, and some to go to investment.

From your point of view (and I'm assuming here, so forgive me if I'm wrong) your debt load is higher because if I just went along normally with my mortgage, my debt would decrease by my principle payment. Thus, by implementing the SM my debt has gotten higher than it would have if I didn't borrow at all.

As an impassioned observer, I think you two are closer than you think - but you are coming at it from two different, and not incorrect, perspectives.

[digitalsky]

Thanks cannon_fodder for your posts, they are very helpful.

I'm not trying to pick a fight here, but I really want to make sure I understand what SM is. Having said that, my view of the SM is more aligned with Jobu's. I think that yes, with the SM you are increasing your debt to invest.

Let me try with an example - please point out where I am wrong with my calculations and/or assumptions and/or logic:


Assume:
Total Debt to begin with: $100 Mortgage
Monthly income: $10

With grant's example: (grant did not say how much of the $4 mortgage payment was interest, I assume $1)


Non-SM Case:
Mortgage payment $3+1
Expenses $4
Investment $2
--------------------
Debt remaining: $100-$3 = $97 (all non-tax deductible)
Investments : $2

SM Case:
Mortgage payment $5+1
Expenses $4
LOC -$2
Investment $2
--------------------
Debt remaining: $100-5+2 = $97 ($2 of which tax deductible)
Investments : $2

So, with grant's example, indeed the debt has not increased, and you get the benefit of $2 in tax deductable loan. There is also "conversion" of bad to good debt.

However, my own understand of the SM is a bit different. In the above example, the original $3 principal paid down was not re-borrowed to invest - which IMO is key to the SM. Imagine if the income was only $8 and you can't afford investments - then you would have no room to borrow in grant's example. I thought that's exactly what the SM is trying to overcome and give you some room to start investing. So really, I do not agree that the above example is "a pure SM technique" as grant said.

Here is another example, given same assumptions, of what *I* think SM is, where mortgage principal paid was immediately reborrowed to invest. The difference will be more striking if I assume income is $8 and everything else the same, but for consistency I stick with the original assumption of $10 income.


Non-SM Case:
Mortgage principal $3
Mortgage Interest $1
Expenses $4
Investment $2
---------------------
Debt remaining: $100-$3 = $97 (all non-tax deductible)
Investments : $2

This is so far unchanged from grant's example, of course.


SM Case:
Mortgage principal $5
Mortgage Interest $1
Expenses $4
Borrow from LOC -$5
Investment $5
---------------------
Debt remaining: $100-$5+$5 = $100 ($5 of which tax-deductible)
Investments : $5

So here, the original $2 that was going to be used for investing was used instead to pay down the principal. The total principal paid down is then $5. This $5 is reborrowed from LOC for investment. The end result is that your debt and investments, as compared to the non-SM case, both increased by $3. This is why I think you are taking on extra debt ($100 vs $97) when you employ the SM. (I think the example will be much more clear with $8 income so the person cannot afford $2 to invest)

And this is also why I wonder about the difference between SM and just borrowing to invest in my earlier post.

Perhaps as cannon_fodder said, it's just a matter of perspective.

[cannon_fodder]

Digitalsky,

When you do the SM the mortgage payments are exactly the same and the cash flow is the same. Your examples show increased payments/cash flow. This is how it looks using your numbers:


SM Case:
Mortgage principal $3
Mortgage Interest $1
Expenses $4
LOC -$3
LOC Interest $0.01
SM Investment $2.99
Investment $2
---------------------
Debt remaining: $100-$3+$3 = $97 (non-tax deductible) + $3 (tax deductible)
Investments : $4.99

This is slightly wrong as the LOC interest won't be due until the following month but you get the idea.

Now, if you want to do a 'more advanced' SM whereby you divert periodic investment contributions to the SM, you would get this:


Advanced SM Case:
Mortgage principal $5
Mortgage Interest $1
Expenses $4
LOC -$5
LOC Interest $0.02
SM Investment $4.98
---------------------
Debt remaining: $100-$5+$5 = $95 (non-tax deductible) + $5 (tax deductible)
Investments : $4.98

One must always realise the 'drag' from the cost of the HELOC. But, what we haven't taken into account is the tax refund generated by borrowing to invest. Let's say it's tax time. Here is what we get in both scenarios (let's imagine 12 months have gone by but we are not going to adjust for the increasing principle paydowns or increasing LOC interest):


SM Case:
Mortgage principal $3 + Tax Refund $0.05
Mortgage Interest $1
Expenses $4
LOC -$3.05
LOC Interest $0.01
SM Investment $3.04
Investment $2
---------------------
Debt remaining: $100-12*$3-$0.05+12*$3+$0.05 = $63.95 (non-tax deductible) + $36.05 (tax deductible)
Investments : $4.99*12+$.05


Advanced SM Case:
Mortgage principal $5 + Tax Refund $0.10
Mortgage Interest $1
Expenses $4
LOC -$5.10
LOC Interest $0.02
SM Investment $5.08
---------------------
Debt remaining: $100-12*$5-$0.10+12*$5+$0.10 = $39.90 (non-tax deductible) + $60.10(tax deductible)
Investments : $4.98*12+$.10

These numbers are for illustration and don't make sense. Real numbers and seeing how all the accounts are affected via each payment is much easier to understand. That is why I created my own spreadsheet so I could see how everything worked and the money flowed.

See what I mean here: http://yfrog.com/11smexample1j and here: http://yfrog.com/11smexample2j

If you can follow the snapshots above, then here is a chance to earn extra credit. Figure out what is different and why the end result is not as favourable comparing the first snapshot with this one: http://yfrog.com/11smexample3j

[digitalsky]

Digitalsky,

When you do the SM the mortgage payments are exactly the same and the cash flow is the same. Your examples show increased payments/cash flow. This is how it looks using your numbers:


SM Case:
Mortgage principal $3
Mortgage Interest $1
Expenses $4
LOC -$3
LOC Interest $0.01
SM Investment $2.99
Investment $2
---------------------
Debt remaining: $100-$3+$3 = $97 (non-tax deductible) + $3 (tax deductible)
Investments : $4.99

This is slightly wrong as the LOC interest won't be due until the following month but you get the idea.

Thanks cannon_fodder. I think the fact that there is the $2 investment makes it a bit more confusing. What I did in my last example was put that $2 too towards the principal, then reborrow that as LOC. So mortgage payment increased only because I used the $2 investement to pay it down, but on the other end I take out $2 more from the LOC. In the end the cash flow is the same ($5+$1+$4-$5+$5 = $10 used up in a month). In your example, your $2 investment haven't gone through the mortgage->LOC cycle, so it doesn't let you convert $2 extra bad debt to good debt. (Remember my example ended up with $5 tax deductible and $95 non-tax deductible debt)

[grant]

However, my own understand of the SM is a bit different. In the above example, the original $3 principal paid down was not re-borrowed to invest - which IMO is key to the SM.
the fact that people build equity in their home with every mortgage payment is not "key to the SM" ... this is something every homeowner does automatically with a standard mortgage.

do you need a "smith maneuvre" to borrow against the equity you are normally building? Of course not. that's why it's simply "leveraged investing"


Imagine if the income was only $8 and you can't afford investments
Then you should think long & hard about whether you want to take on the heavy risk of borrowing to invest. most people don't want to do that.


I thought that's exactly what the SM is trying to overcome and give you some room to start investing.
then you should look again at http://www.smithman.net/ its purpose is pretty darn clear:

GO AHEAD, MAKE YOUR MORTGAGE TAX DEDUCTIBLE


So really, I do not agree that the above example is "a pure SM technique" as grant said.
that's because you are, like Jobu, are confusing SM with Leveraged investing. They can both be done together, or they can be done separately.


Here is another example, given same assumptions, of what *I* think SM is
Instead of co-opting fraser's name for your technique, why dont' you just call it "the digitalsky maneuvre"?


This is why I think you are taking on extra debt ($100 vs $97) when you employ the SM.
no, you are taking on extra debt because you made the concious decision to borrow an extra $3 and invest it. You could have done this without converting any debt to be deductible.

Another example of a "pure" smith maneuvre:

before:
------
1) Mortgage is $100 + $2 interest accrued this month
2) personal business buys $10 worth of widgets & sells them for $18
3) business operator has earned $8
4) business operator uses $4 for living expenses and $4 for mortgage
5) Mortgage is now $98

After:
-----
1) Mortgage is $100 + $2 interest accrued this month
2) business operator borrows $10 to buy widgets
3) business operator sells widgets for $18
4) business operator uses $4 to live on ($14 left over)
5) business operator applies remaining $14 against mortgage
6) Mortgage is now $88 + DEDUCTIBLE loan of $10 = $98

Notice how the business owner has NOT changed his total debt?

of course he could then decide to re-borrow that $2 and invest it (in equities, inventory, whatever). that would be a totally separate business decision.

[ghasita]

After going through posts it seems like I understand the basics of SM. I just have a question about what kind of investment you can do with the money you borrow and if I wish to put money into the Stocks..Can I buy stocks for Royal Bank, Sunlife, Potash, Suncor, RIM, Manulife..?

[evoviii]

After going through posts it seems like I understand the basics of SM. I just have a question about what kind of investment you can do with the money you borrow and if I wish to put money into the Stocks..Can I buy stocks for Royal Bank, Sunlife, Potash, Suncor, RIM, Manulife..?

Yes you can, RIM maybe iffy but the expectation of eventually giving a dividend it should qualify. Though if you really read the posts, you would have known that.

[ghasita]

Thanks evoviii.

I agree I knew that we can buy dividend paying funds but I did not read anywhere saying you can buy Dividend Stocks..Most of the posts talks about buying Dividend Paying Mutual Funds which I am not into it. As I already have some investment in the Banks and Oil Company and very soon moving to a new home so thought can I do these by keeping the same portfolio..

[Hammock]

I have read alot of material over the last couple months, on the web and through forums. How does one get started?

I have already setup a National Bank All in One account with mortgage and sub-accounts, but I don't want to take that next step without some professional guidance.

Do I have to get an accountant to make sure I'm covered? What about a financial planners - are they necessary?

Any advice if I want to DIY?

[cannon_fodder]

I have read alot of material over the last couple months, on the web and through forums. How does one get started?

I have already setup a National Bank All in One account with mortgage and sub-accounts, but I don't want to take that next step without some professional guidance.

Do I have to get an accountant to make sure I'm covered? What about a financial planners - are they necessary?

Any advice if I want to DIY?

Are you going to borrow a lump sum at the beginning or just do it gradually by reborrowing your principal paydowns? Do you have a brokerage account or were you thinking of just buying mutual funds through a bank or accredited representative? Do you currently handle your investments in RRSP/RESP/TFSA by yourself or do you have someone helping you with those decisions?

[Hammock]

Are you going to borrow a lump sum at the beginning or just do it gradually by reborrowing your principal paydowns?

I plan on doing it gradually by reborrowing principal paydowns, except for a lump-sum non-registered paydown of 7-10k at the beginning.

Do you have a brokerage account or were you thinking of just buying mutual funds through a bank or accredited representative?

I prefer brokerage accounts. Have used a few for non-smith type of investments in the past. What do you suggest?

Do you currently handle your investments in RRSP/RESP/TFSA by yourself or do you have someone helping you with those decisions?

I currently handle all my investments, and feel somewhat comfortable picking and selecting the portfolio on my own. My concern is around the tax and book-keeping side of things, to make sure that if I ever run into any scrutiny in the future that I have all the proper documentation I need, and that I haven't mistakenly set something up I shouldn't which could screw me over.

[cannon_fodder]

Are you going to borrow a lump sum at the beginning or just do it gradually by reborrowing your principal paydowns?

I plan on doing it gradually by reborrowing principal paydowns, except for a lump-sum non-registered paydown of 7-10k at the beginning.

Do you have a brokerage account or were you thinking of just buying mutual funds through a bank or accredited representative?

I prefer brokerage accounts. Have used a few for non-smith type of investments in the past. What do you suggest?

Do you currently handle your investments in RRSP/RESP/TFSA by yourself or do you have someone helping you with those decisions?

I currently handle all my investments, and feel somewhat comfortable picking and selecting the portfolio on my own. My concern is around the tax and book-keeping side of things, to make sure that if I ever run into any scrutiny in the future that I have all the proper documentation I need, and that I haven't mistakenly set something up I shouldn't which could screw me over.

If you are going to be investing in stocks, then you need a brokerage with very low fees or else the commissions will be a terrible drag on your performance. I ended up at IB but that's because I wanted to use margin and their margin rates were the best. There is a thread here about people's experience with IB.

To keep the record keeping to a minimum don't choose any stock/mutual fund which returns capital unless you want to make record keeping really challenging.

I use Excel with the help of IB's reporting. You have to be pretty self-reliant on the record keeping. I believe NA readvanceable mortgage is well suited for SM because it allows you to have subaccounts. The way to make it easiest for you is to dedicate a subaccount for your SM Heloc and a brokerage account that is dedicated for your SM investments.

Even with a brokerage like IB that charges $1 for every 100 shares you likely would only be able to invest efficiently once you accumulate a few principal withdrawals.

You can also check out milliondollarjourney.com for more threads on the SM and the site's owners monthly report on his own implementation.

[Bick Financial Toronto]

I have read alot of material over the last couple months, on the web and through forums. How does one get started?

I have already setup a National Bank All in One account with mortgage and sub-accounts, but I don't want to take that next step without some professional guidance.

Do I have to get an accountant to make sure I'm covered? What about a financial planners - are they necessary?

Any advice if I want to DIY?

There are investment corporations that provide you with an annual 6% per year eligible dividends if that's what you are looking for. They also provide you with a superior level of diversification and an ability to change your asset allocation without trigering a taxable event, thus allowing for better compounding. Plus you have a financial advisor, although you may not care about that as you want to DIY. However, you do pay for all these benefits through an MER. If you believe that we are near the bottom in the markets and that this year is a great time to buy, then a solution like this will afford you to get started right away.

[cannon_fodder]

My Readvanceable Mortgage Excel Workbook is up for viewing (http://home.cogeco.ca/~pgannon/investment/Readvanceable_Mortgage.xls). If anyone feels like contributing to make it better, please do.

I've noticed that my calculations don't match exactly with the ones published in the book (when it comes to Steps III and IV, as well as Cash Flow Dam, our investment portfolio amounts aren't identical). They are quite close however.

My longstanding thought is that I have made an error in my formulas or in the spreadsheets. But, after reviewing his book, I have noticed there are errors (e.g. page 100 last paragraph he writes an interest expense of $833.73 for a $200,000 loan at 5% interest, and then correctly reports it in the last sentence on the page). I can't figure out where my logic is wrong, especially since it works for the other situations but perhaps a fresh set of eyes can resolve it.

Whether he is right and I am wrong, or vice versa, or we are both wrong, at least the numbers come out quite close.

My Workbook allows you to specify the following additional parameters which I could not see from the book's screen shots of his calculator (perhaps they are included in a separate screen or a newer version):

- Cash Flow Dam check box and expense amount
- Amortization
- Number of payments per year (although I only have spreadsheets for 12, 24 and 26 - trying to make one spreadsheet cover all scenarios was driving me crazy)
- Starting LOC (for the "Freeboard Equity", "Turbo Smith Maneouvre" or whatever you want to call it. This is when you want to tap into equity built up and draw upon that to a 75% readvanceable mortgage)
- Tax Refund date (I get mine in early March, some people get theirs after April 30th.)

You'll also quickly see what the investment portfolio amount is once the mortgage is retired. The faster you retire it, the smaller the amount is. Taking the full 25 year period (as in his examples) gives more time for the portfolio to grow. I found it helpful as when I was reading the book I mistook the portfolio amount quoted to be when the mortgage was free and clear, not after the full 25 years.

The one thing I haven't allowed for is for you to specify a beginning date for the mortgage. I have placed January 1, 2007 as the starting point so if you look at the spreadsheets themselves you have to go from there. That could affect slightly the calculations because if you start your readvanceable mortgage late in the year, that first year will have a small tax refund but it will be applied before a full 12 months are up.

I hope it is helpful for others.

Look for an updated version at Million Dollar Journey:

http://milliondollarjourney.com/wp-content/uploads/2009/Tax%20Deductible%20Mortgage%20V2_00.zip

I have some other spreadsheets at Canadian Money Forum located at:

http://canadianmoneyforum.com/showthread.php?t=897

[daezd88]

cannon_fodder, if you don't mind me asking, what income tax software do you use or recommend that supports the Smith Manoeuvre, or do you go with an accountant?

[waltereo]

Hi,

I am from Quebec, and looking at this technique.
And I have a couple questions :


Can someone who use Smith Manoeuvre in Quebec can briefly talk about his experience
Who should I contact to have more information to implement that in Montreal ? Any financial planner that you recommend ?
Is SM still worth if we look at the coming years ??



Thanks

[pitz]

Can someone who use Smith Manoeuvre in Quebec can briefly talk about his experience


The tax system is slightly different in Quebec, in that, for the purposes of the provincial portion of your income tax, you can only offset investment expenses (ie: interest) against investment income (ie: dividends). This makes a slight difference to the mathematics of the SM.



Who should I contact to have more information to implement that in Montreal ? Any financial planner that you recommend ?


I would urge you to read the entire thread top to bottom; financial advisors are of extremely limited utility when it comes to the SM, as efficient implementations are, more often than not, too likely to expose them to legal liability for innappropriate investment advice.

The SM is almost like a lunatic fringe concept; yes, it works, yes, its true, but in order to understand it, and in order for it to work, you need to understand it well enough to pretty much implement it yourself. If you rely upon someone to implement it for you, then failure, quite possibly, is very highly probable.



Is SM still worth if we look at the coming years ??
Thanks

I think now is a better time than any in the past 10+ years to do the SM, although losses on housing are quite likely. I am of the view that SM investments should be true diversifiers, and not merely duplicates of the same sort of investment (banks, housing, bonds, RE) that you already have in the house.

[waltereo]

The tax system is slightly different in Quebec, in that, for the purposes of the provincial portion of your income tax, you can only offset investment expenses (ie: interest) against investment income (ie: dividends). This makes a slight difference to the mathematics of the SM.



I would urge you to read the entire thread top to bottom; financial advisors are of extremely limited utility when it comes to the SM, as efficient implementations are, more often than not, too likely to expose them to legal liability for innappropriate investment advice.

The SM is almost like a lunatic fringe concept; yes, it works, yes, its true, but in order to understand it, and in order for it to work, you need to understand it well enough to pretty much implement it yourself. If you rely upon someone to implement it for you, then failure, quite possibly, is very highly probable.



I think now is a better time than any in the past 10+ years to do the SM, although losses on housing are quite likely. I am of the view that SM investments should be true diversifiers, and not merely duplicates of the same sort of investment (banks, housing, bonds, RE) that you already have in the house.

Thanks Pitz for the information.

Yes I still need to do a lot of homework on that.

I understand that the starting point of the SM is to take a HELOC (Home equity Line of Credit) , is that correct ??

Thanks

ps: sorry for my english, I'm trying to do my best with the mortgage terms in english !

[Bick Financial Toronto]

I understand that the starting point of the SM is to take a HELOC (Home equity Line of Credit) , is that correct ??

Waltereo,

Your English is fine and it is certainly better than my French.

Although mechanically getting the mortgage with the HELOC is the first step, the most important step is understanding the concept and finding the right professionals you want to work with who will help you with the process. Implementing this strategy by yourself is overwhelming for most people except if you are numbers oriented and if you are willing to spend considerable time on it. Depending on your preference, you may want to talk to an accountant, a financial advisor and a mortgage broker to get different points of views.

[Bick Financial Toronto]

If you rely upon someone to implement it for you, then failure, quite possibly, is very highly probable.

What do you mean by that?

[brunes]

I would urge you to read the entire thread top to bottom; financial advisors are of extremely limited utility when it comes to the SM, as efficient implementations are, more often than not, too likely to expose them to legal liability for innappropriate investment advice.

The SM is almost like a lunatic fringe concept; yes, it works, yes, its true, but in order to understand it, and in order for it to work, you need to understand it well enough to pretty much implement it yourself. If you rely upon someone to implement it for you, then failure, quite possibly, is very highly probable.

I don't agree with this. Personally, I don't know why people make the SM out to be so complicated.

It is, from my POV, extremely simple.

#1 Get a re-advanceable HELOC. Make sure the HELOC is provably isolated from any other HELOC on the house.
#2 Every month, when you make your mortgage payment, take out the corresponding max you can from the HELOC, and put it into a well-balanced portfolio
#3 Every year when you get your big deduction from #2, Put it back in portfolio
#4 Repeat #3,4 until you have as much in portfolio as your mortgage is worth. Pay off mortgage.

Is that not it? What am I missing? Why do you have to be "so good with the numbers"?

I know you can get into advanced concepts like cash flow damming if you are a contractor or if you own a business, but the avg. person does not have to get into that.

The only aspect of the SM that I see as "complicated" is the "maintain a balanced portfolio" part - but this really has nothing to do with the SM and is just general investment knowledge, and is pretty simple to do with very low MER if you for example stick to a basket of TD eSeries funds for your SM portfolio.

[pitz]

What do you mean by that?

I mean, the SM only makes sense if you are able to do it in a low-cost, low-fee environment. A person can only, realistically speaking, achieve a low-cost, low-fee environment, and achieve supervision of such a scheme, by knowing how to do most of it themselves, as opposed to using a professional.

Why? Because the SM essentially 'compounds' fees and costs, because there is a management fee on both the debt side of things, to issue the debt instruments, and a management cost on the investment side of things, to make the investments.

The long-term return from the SM (ie: the equity risk premium, essentially) may very well only be 3% or so. If a debt broker is taking a 1%/annum spread on the borrowing, and an investment broker is taking a 2%/annum spread on the investing -- poof, there goes all your profit, and the whole exercise is, essentially, a waste of time!

[pitz]

Is that not it? What am I missing? Why do you have to be "so good with the numbers"?


You're not missing anything, but as the past decade or two has shown, the SM isn't as wildly profitable as people would make it out to be, ie: the equity risk premium isn't 6-10% like purveyors of the SM would suggest, but is closer to 3%.

If one is paying a 1% management fee on debt issuance, and 2% management fee on the investments -- where's the profit??

There is also the concept of informed consent, and there is the concept of suitability. An investment advisor may very well advise to buy a portfolio of 50% equities, 50% debt (ie: MBS), with the proceeeds of the issuance of essentially a MBS. How is going simultaneously long a MBS, and short a MBS (through the mortgage) beneficial? Its not. Yet the investment advisor, in many cases, may be professionally obligated, under the 'Know your Client' rules and the risk questionairres, to include a debt allocation.

The SM is just too fraught with risk for a true professional advisor to take it on, in most cases -- and if you're dealing with an amateur, or worse, someone who is just doing cookie cutter, 3% MER mutual funds and 1% MER mortgages sort of guy (ie: you'll find them working at banks, Investors Group, Edward Jones, etc., etc.) -- then the person who pledges their assets and their house to such a scheme is likely to be the loser.



I know you can get into advanced concepts like cash flow damming if you are a contractor or if you own a business, but the avg. person does not have to get into that.


Sure, they can implement the mechanics, but will it work over the long term? The SM, for most people in the past decade, has been a dismal failure for most who have done it, and management fees have made it far worsely so.



The only aspect of the SM that I see as "complicated" is the "maintain a balanced portfolio" part - but this really has nothing to do with the SM and is just general investment knowledge.

Its a lot more complicated than that, and a favourable risk/reward proposition, IMHO, is only possible if the investor eliminates all of the conflict of interest, eliminates all correlated investments, eliminates any situations where negative outcome arbitrage is happening, etc. Also, the aspect of the SM doing maturity transformation is also troubling, especially if there is a run on liabilities such as was experienced last year.

[brunes]

You're not missing anything, but as the past decade or two has shown, the SM isn't as wildly profitable as people would make it out to be, ie: the equity risk premium isn't 6-10% like purveyors of the SM would suggest, but is closer to 3%.


I see it more of a way of hedging my risk.

If all you are doing is paying down a mortgage, then basically, you are putting 100% of that monthly payment into the real estate market for the next 25 years, which historically is a poor performer.

By instead doing the SM with that money, you are instead diversifying your risk over the entire market.

Heck if you are uncomfortable with that and still want to hedge your risk against your house as well, you can just do a de-celerated SM where you take 50% of your payment out and invest it - you will still end up ahead.

[pitz]

I see it more of a way of hedging my risk.
By instead doing the SM with that money, you are instead diversifying your risk over the entire market.


Well, if the cost of debt is not less than the return on investment, than the SM has failed to accomplish its objective. Whether it reduces the mark-to-market volatility of your balance sheet is a matter of correlations between the debt markets, and the equity market (in both RE equity, and in stock equity).

You will only see a reduction in volatility if there is de-correlation. But an extreme increase in volatility if there is tight correlation, unfortunately (as we saw recently...with house prices going down 50%, stock market going down 50%, etc.. although in Canada, if you accept that argument that house prices barely went down -- then such decorrelation reduced the volatility!). (volatility can be strongly upwards as well, although the recent bad example was downwards!)

And of course, management fees, on both debt, and investments, are always drags on returns, no matter which direction the market heads.




Heck if you are uncomfortable with that and still want to hedge your risk against your house as well, you can just do a de-celerated SM where you take 50% of your payment out and invest it - you will still end up ahead.

If the cost of investing, as well as the cost of debt, is kept absolutely to a minimum.. The people who just go to a 'professional', and say, "set me up with the SM" are very likely to have a negative return, no return, or a much less than optimal return. The SM can be an awesome tool for building wealth, but the wealth will be built in the hands of one's 'advisors' unless they educate themselves enough to reap the returns themselves. The expected 'profit' from the SM barely even would cover the typical management fees on 'professional' management these days.

[brunes]

If the cost of investing, as well as the cost of debt, is kept absolutely to a minimum.. The people who just go to a 'professional', and say, "set me up with the SM" are very likely to have a negative return, no return, or a much less than optimal return. The SM can be an awesome tool for building wealth, but the wealth will be built in the hands of one's 'advisors' unless they educate themselves enough to reap the returns themselves. The expected 'profit' from the SM barely even would cover the typical management fees on 'professional' management these days.

Agreed.

[AllWheelDrift]

I see it more of a way of hedging my risk.

If all you are doing is paying down a mortgage, then basically, you are putting 100% of that monthly payment into the real estate market for the next 25 years, which historically is a poor performer.

By instead doing the SM with that money, you are instead diversifying your risk over the entire market.

Heck if you are uncomfortable with that and still want to hedge your risk against your house as well, you can just do a de-celerated SM where you take 50% of your payment out and invest it - you will still end up ahead.
Actually, you're not putting the monthly payment into the RE market, you're putting it against debt. If you're not comfortable with 100% of your SM portfolio in equities then you should simply decelerate as you describe but it's not changing your RE exposure.

Having debt while investing in fixed income is counterproductive because your return on fixed income is going to be lower than your cost of borrowing. Also, in order to maximize the tax arbitrage of the SM you need to avoid interest income.

[brunes]

Actually, you're not putting the monthly payment into the RE market, you're putting it against debt. .

Actually, not really. The debit is secured by an asset, and in this case it is real estate. When you pay your mortgage you are putting 100% of the principal toward an investment in the local real estate market.

If your house had tripled in value, you would be better off putting it all against the mortgage. But that is the whole point - you are dumping all your money into one basket in that case, the real estate market in your town. Historically, real estate under-performs the equity market, the past bubble notwithstanding.

[pitz]

Having debt while investing in fixed income is counterproductive because your return on fixed income is going to be lower than your cost of borrowing.


In the Canadian context -- of course. Yes, mortgages right now are subsidized by the government (because the government is buying up MBS), but since terms are effectively limited to 5 years in Canada -- once those subsidies are withdrawn (which they will be, over time), debt financing against houses will not be artificially cheap compared to business borrowing in the bond market.

There's no denying that in the recent market dislocation/disruption, one could have drawn on a HELOC, and purchased a whole whack of, say, Telus or Suncor bonds for cheap, turned around 6 months later, and flipped them. But the SM really isn't a daytrader or even a traders' strategy, and historically, a diversified business (ie: Telus, Suncor, etc.) will be able to borrow, in the bond market, at a lower rate of interest, than a single, undiversified homeowner.

Don't be blinded by the past decade where real-estate secured loans have been artificially cheap compared to business credit. This isn't sustainable, especially if we want to have a growing economy.



Also, in order to maximize the tax arbitrage of the SM you need to avoid interest income.

I sort of disagree here; for instance, I'd have no problem putting my SM proceeds into something like the Boston Pizza Income Fund* (BPF.UN) (a royalty trust that pays out 14% or so/annum, has virtually no credit exposure, etc.), as opposed to, say, a post income-trust-era, re-constituted BPF.UN that only paid dividends and capital gains.

This won't be an option as these trust flow-through entities are dissappearing due to legislative changes, but investments like those restaurant royalty trusts are awesome investments for something like the SM, even though they pay out straight income.


* not a stock tip, but rather, an example of a security that has a high dividend rate, and pays out 'interest income'. Not a recommendation to buy, sell, trade, etc. *always* keep a diversified portfolio, never more than 5% per asset!

[AllWheelDrift]

Actually, not really. The debit is secured by an asset, and in this case it is real estate. When you pay your mortgage you are putting 100% of the principal toward an investment in the local real estate market.

If your house had tripled in value, you would be better off putting it all against the mortgage. But that is the whole point - you are dumping all your money into one basket in that case, the real estate market in your town. Historically, real estate under-performs the equity market, the past bubble notwithstanding.
That's absurd. Buying RE (using credit or cash) is investing in RE, but paying down a mortgage is not. Paying down a mortgage is reducing debt, and the savings are the interest you'd be paying on the debt. You don't have to share your gains in RE with the bank just because it's value has gone up, after all, you owe the bank a fixed $ amount, not a % of your home.

[brunes]

That's absurd. Buying RE (using credit or cash) is investing in RE, but paying down a mortgage is not. Paying down a mortgage is reducing debt, and the savings are the interest you'd be paying on the debt. You don't have to share your gains in RE with the bank just because it's value has gone up, after all, you owe the bank a fixed $ amount, not a % of your home.

It becomes a lot more clear when you flip it around to what it really is - if you have a mortgage, you don't own your house - the bank does. Rather than looking at it as paying down debit, look at it as buying a house over a period of time. Now do you see that you are in essence investing in real estate? How can you be considered to be doing anything else?

[AllWheelDrift]

It becomes a lot more clear when you flip it around to what it really is - if you have a mortgage, you don't own your house - the bank does. Rather than looking at it as paying down debit, look at it as buying a house over a period of time. Now do you see that you are in essence investing in real estate? How can you be considered to be doing anything else?
But the bank doesn't really own your house, they have a lien on your house for the amount of the mortgage. Again, it's a fixed amount, not percentage and all the upside (and downside) is your's regardless of how much of a mortgage you have. (I.e. your RE exposure remains the same as you pay down the mortgage.) The return of paying down your mortgage isn't related to how much your house does or does not appreciate, it's purely the mortgage interest you save.

What you're saying is that if you have a 200k house with a 100k mortgage, and 100k in the bank, if your house triples you're better off if you'd paid down your mortgage. I fail to see the difference between a 600k house and no mortgage and nothing in the bank and a 600k house with a 100k mortgage and 100k in the bank.

[brunes]

But the bank doesn't really own your house, they have a lien on your house for the amount of the mortgage.

This is just semantics.



What you're saying is that if you have a 200k house with a 100k mortgage, and 100k in the bank, if your house triples you're better off if you'd paid down your mortgage. I fail to see the difference between a 600k house and no mortgage and nothing in the bank and a 600k house with a 100k mortgage and 100k in the bank.

No, what I am saying is if the real estate market in your area tanks and it DOESN'T triple then you would have been better off with that money in the market.

It is all about hedging risk and not putting all your money in the local real state market. It's amazing how some people can see this perfectly when talking about a portfolio but talk around it 8 ways from Sunday when it involves their own home...

The amount you pay towards your mortgage is basically the biggest equity investment the average person will likely ever make - is it better to tie it all up into one piece of equity (1 house), or a basket of equities?

[pitz]

Actually, not really. The debit is secured by an asset, and in this case it is real estate. When you pay your mortgage you are putting 100% of the principal toward an investment in the local real estate market.


I agree with AWD, no, when you retire a debt, you are not 'investing' in RE at all. You are investing in debt retirement. Your exposure to the RE market is independant of the amount of debt you have. If the house burns down, the debt remains, and still has to be repaid.



If your house had tripled in value, you would be better off putting it all against the mortgage.


No, not at all, *unless* mortgage rates rise sufficiently enough, because mortgage lenders are sick and tired of seeing the money they lent losing purchasing power.



But that is the whole point - you are dumping all your money into one basket in that case, the real estate market in your town. Historically, real estate under-performs the equity market, the past bubble notwithstanding.

Indeed. But how much debt you have against real estate, and the repayment of that debt, is completely independant of the actual process, or fact of investment in real estate.


The amount you pay towards your mortgage is basically the biggest equity investment the average person will likely ever make - is it better to tie it all up into one piece of equity (1 house), or a basket of equities?

When times were more normal....buying and paying off a house in 5-10 years was more typical, and the rest of one's investing lifetime would be spent on accumulating ownership of a business that ultimately would provide employment to themselves (and others), and facilitate a retirement.

I know we don't have many businesses even left in North America, but once upon a time....

[brunes]

You are investing in debt retirement. Your exposure to the RE market is independant of the amount of debt you have. If the house burns down, the debt remains, and still has to be repaid.

And if the debit is repaid, and the house is worth nothing, then the debit was completely wasted money. The coin flips both ways.

If you are going to leverage to invest, which is what you are doing when buying a house with a mortgage, you should be investing in a balanced portfolio. A house is not a balanced portfolio.




When times were more normal....buying and paying off a house in 5-10 years was more typical

I don't know what dreamworld this is in in.... but except for a time span during the 20s-50s, this would never have been possible in the past century.
So I would say it is a far cry from being "normal".

Housing prices track actually pretty consistent with inflation when you forget the bubbles and busts.

http://www.investingintelligently.com/wp-content/uploads/2006/08/a_history_of_home_values.png

[pitz]

I don't know what dreamworld this is in in.... but except for a time span during the 40s-50s, this would never have been possible in the past century.


Ummm, there's been lots of times in history when it wasn't hard for a family to save 1/3rd of their income. If they bought a house that was 3X yearly income, then paying it off over a 10-year interval, with a few pay raises inbetween, wasn't too much of a stretch. One working professional (doctor, lawyer, engineer, accountant), or two blue-collar workers (husband = factory, wife = waitressing).



So I would say it is a far cry from being "normal".


This whole nonsense of taking 20-30 years to pay off a mortgage is far from normal. Back in the old days, they had 'mortgage burning' parties. In the 1970s, people on long-term fixed mortgages had strong wage and price inflation at their backs, while their loans were fixed at those low 1960s rates. Of course, this can't happen in Canada again because we don't have those long-term fixed rate loans, but it definitely was very prevalent.



Housing prices track actually pretty consistent with inflation when you forget the bubbles and busts.


Exactly, 1/3rd of one's income, on a house that was 2-3X yearly income = paid off in 10 years. Not too hard of a concept to deal with, mathematically. All those baby boomers who bought in the early 1970s, and had their mortgages heavily paid off by the early 80s are the people who drove the US stock market higher for most of the 80s and 90s -- because they no longer had mortgage payments and could invest crazy amounts of $$$ into the markets. Nowadays, you're seeing loans approved for 40% of income, which is pretty much insane, and ensures that those people won't be participating in the financial markets for many decades to come, barring hyperinflation.

[brunes]

Exactly, 1/3rd of one's income, on a house that was 2-3X yearly income = paid off in 10 years.

..
Nowadays, you're seeing loans approved for 40% of income, which is pretty much insane, and ensures that those people won't be participating in the financial markets for many decades to come, barring hyperinflation.

Ok. So what you are saying is not that housing costs more, but people used to borrow less. This makes sense at least - but does nothing to dissuade my argument. Because in this case, you just end up with less equity in your house anyway.

IE - it makes no difference to pay 50% off on a 200K house over 10 years, or 100% off on a 100K house over 10 years. You have paid the same in principal + interest, and you have the same in equity. It has a psychological difference because you are "mortgage free", but that is it.

It is no argument for or against diversifying away from your house. You are carrying the same risk both ways.

[pitz]

Ok. So what you are saying is not that housing costs more, but people used to borrow less.


Resale housing not only used to be cheaper, but people had lower expectations.

I grew up in an upper middle class (2 professionals) family of 4 in a 1000 square foot house. Today, that same family would have at least 2000 square feet of space. If I was growing up today in that same house, and the kids at school knew...well i'm sure the incest jokes would be going around..lol.



This makes sense at least - but does nothing to dissuade my argument. Because in this case, you just end up with less equity in your house anyway.


There's been a shift from, "let's only buy something we can pay off in 10 years", to "its not a big deal if we take the next 30 years to pay it off, inflation will cover our a*s anyways", in attitude amongst homebuyers. Whether this comes true or not, I don't know. But people who are buying housing today, at such massively inflated prices, are predicting large amounts of inflation, but an environment in which lenders will be unable to recoup losses in their securities because of inflation.

Things are going to end badly for one group, or the other. Just not quite sure which.



IE - it makes no difference to pay 50% off on a 200K house over 10 years, or 100% off on a 100K house over 10 years. You have paid the same in principal + interest, and you have the same in equity. It has a psychological difference because you are "mortgage free", but that is it.


But if the $200k house is the same thing as the $100k house, but 100% overpriced -- then obviously the "mortgage free" person is in a much better position. Don't know where you're trying to go with this argument..



It is no argument for or against diversifying away from your house. You are carrying the same risk both ways.

The mortgage free person doesn't have to worry that the debt issued against his house (or not) appreciates in value, relative to his asset. Whereas, the indebted person must always worry about where the 'liabilities' side of the balance sheet is going, including mark-to-market changes in the liabilities side of the balance sheet. Falling interest rates, without a corresponding increase in assets, could render such a person into a situation of negative equity.

Most people are not conditioned, intuitively, to view both the assets, and the liabilities portion of their balance sheets, as being marked-to-market, but a loan liability has a market value, just as a stock, or a bond, that sits on the asset side of the balance sheet.

The goal of the SM is to minimize volatility in one's networth, ie: the real-time, marked-to-market difference between assets and liabilities. If one invests in uncorrelated assets, then it does a superb job of doing that, and lowers risk. If one doesn't do that, well, then it can have the impact of making the situation far more risky. That's why I suggest that one should put their SM proceeds into 'stuff' that has no correlation with banking, real estate, or mortgages/bonds whatsoever, if they want to keep volatility down and take advantage of the risk diversification (instead of risk concentration) aspects of the SM.

[Germack]

Diversification is for reducing risk. Paying down your mortgage gives you a guaranteed risk free rate of return and therefore you do not need to diversify. If the house market crashes you will be liable for all losses, therefore it does not matter if you paid down your mortgage quicker or used the SM.

[brunes]

But if the $200k house is the same thing as the $100k house, but 100% overpriced


No, it isnt. See above chart. Removing bubbles and busts, a 200K house today is pretty much the exact same as a 200K house 50 years ago when you account for inflation.


Don't know where you're trying to go with this argument..

I don't know either because you apparently agree with me and disagree at the same time.

The *whole point* of not paying down all your money on your motgage is to hedge AGAINST the possibility house being 100% overpriced. If the house ends up being 100% overpriced when you are done paying for it then you basically flushed 50% of your investment down the toilet. If you had instead put half of it in some other vechicle, you would only have lost half.

[brunes]

Diversification is for reducing risk. Paying down your mortgage gives you a guaranteed risk free rate of return and therefore you do not need to diversify..

It's only a guarenteed risk free return if you make the assumption that housing prices in your area will track with inflation or greater. If they don't, then it is not risk free - you end up losing.

There is no such thing as a risk free leveraged investment.

[Germack]

It's only a guarenteed risk free return if you make the assumption that housing prices in your area will track with inflation or greater. If they don't, then it is not risk free - you end up losing.

There is no such thing as a risk free leveraged investment.

Your guaranteed risk free rate of return equals your mortgage interest rate no matter what house prices will do.

Person A) Paid of house. Value of house 300K

Person B) Paid off 50% of house. Invested 150K in equities

House prices crashes by 50%

Person A owns a house valued at 150K. Net-worth 150K
Person B owns a house worth 150K, a mortgage of 150K and investments of 150K. Net-worth 150K.

The networth is in both cases the same.

If you can achieve a higher rate of return after taxes by investing in equities as compared to your mortgage interest rates then go ahead and pay down your mortgage slowly. However, this means you need to take on a lot of risk to achieve this. I would just stick to the risk free approach and just pay down my mortgage as quickly as I can.

[cannon_fodder]

cannon_fodder, if you don't mind me asking, what income tax software do you use or recommend that supports the Smith Manoeuvre, or do you go with an accountant?

I use Taxwiz (because it's free) and use Excel to track all of my various expenses, investments, etc.

[pitz]

The *whole point* of not paying down all your money on your motgage is to hedge AGAINST the possibility house being 100% overpriced. If the house ends up being 100% overpriced when you are done paying for it then you basically flushed 50% of your investment down the toilet. If you had instead put half of it in some other vechicle, you would only have lost half.

You've lost me with this logic, how much you owe (or don't owe) on a house has absolutely no impact on its performance as an investment. The ROA stays the same. If you put $100k down on a $200k house, and it drops by $100k, you've lost $100k. If you put $100k down on a $100k house and it drops by $100k, you've lost $100k. Same loss, either way.

Equity, with respect to individual assets on a balance sheet, is essentially an accounting calculation. But unless the debt is explicitly non-recourse (which mortgages generally are not, especially not the HELOCs used for the SM!), minimizing equity in a particular asset is of no consequence, other than to possibly elevate the cost of borrowing.

An example of this accounting fallacy -- are the people who keep large savings accounts, but have credit card balances. Yes, they have equity (in their savings account!), but they have credit card balances that cost huge amounts to service. This is the premise behind those Manulife One accounts -- they facilitate a consolidation of all debts into one (usually, housing-secured) package, which is at a low interest rate, and eliminates these 'silos' that you claim have an impact on one's finances in a positive way.

[AllWheelDrift]

No, what I am saying is if the real estate market in your area tanks and it DOESN'T triple then you would have been better off with that money in the market.
Only if the market has performed better than the interest rate on your mortgage. Actually, it doesn't matter what happens to the value of your house does, all that matters is the return of your investments in the market vs your interest rate.

It is all about hedging risk and not putting all your money in the local real state market. It's amazing how some people can see this perfectly when talking about a portfolio but talk around it 8 ways from Sunday when it involves their own home...
Well, you're not reducing your real estate exposure, you're simply adding stock exposure as well instead of reducing debt (interest rate) exposure. As Germack pointed out, reducing debt is risk free while investing in the market isn't. Granted, if stock and housing prices are inversely or poorly corelated you may reduce your risk more than by investing in stocks than by investing risk free (repaying debt) but recent trends would suggest housing and stock prices are somewhat corelated.

The amount you pay towards your mortgage is basically the biggest equity investment the average person will likely ever make - is it better to tie it all up into one piece of equity (1 house), or a basket of equities?
Do you reduce your risk of investing in equities by using leverage to invest in a broader portfolio? Basically what you're saying is if you only have enough cash to invest in one asset, you should borrow so you can invest in more assets.

Anyhow, my original claim was you shouldn't invest in fixed income while you still have a mortgage. Even assuming we it is better to diversify via SM you shouldn't diversify into fixed income. For a fixed income component you should simply decelerate the SM instead.

[sjweyman]

I'd like to echo that the future value of your house has nothing to do with this equation whatsoever. You might as well forget about it completely. You still owe the bank X dollars no matter what happens to the value of your house.

The SM is only advantageous because you get to make a loan with tax deductible interest for investing that will hopefully pay more than your mortgage interest in returns. That's all that matters.

In the time being if the value of your house goes up ... great! If it goes down :( But any way you slice it, that has nothing to do with the SM.

[BillyParadise]

Wow, it's been months since I checked this forum, and it looks like the same guys are making the same arguments, getting nitpickier and nitpickier :) I wouldn't want to be a new reader of this thread...

Glad to see you're all still alive and kicking.

[brunes]

Your guaranteed risk free rate of return equals your mortgage interest rate no matter what house prices will do.

Person A) Paid of house. Value of house 300K

Person B) Paid off 50% of house. Invested 150K in equities

House prices crashes by 50%

Person A owns a house valued at 150K. Net-worth 150K
Person B owns a house worth 150K, a mortgage of 150K and investments of 150K. Net-worth 150K.

Wrong - because odds are the equities gained while the house prices crashed. So person B would have a higher net-worth.

That is the whole point of diversifying your portfolio, to mitigate your risk, so that when one sector of the market is losing, the other is gaining.

Yes I know this is not always the case, as in the past year where both equities and RE crashed. But two things - firstly, if your portfolio was TRUELY balanced, and also contained the various commodities that kept value like gold, then you would have come out ahead. Secondly, such an event is not normal historically. Normally either RE is up and equities down, or vice-versa. Third, the equity market recovers faster than the RE market - we are seeing that happen right now even.

[pitz]

I'd like to echo that the future value of your house has nothing to do with this equation whatsoever. You might as well forget about it completely. You still owe the bank X dollars no matter what happens to the value of your house.

Yup. Except that, as long as you have debt, you need to be concerned about receiving a margin call, whether it with debt against stocks, or debt against a house.



In the time being if the value of your house goes up ... great! If it goes down :( But any way you slice it, that has nothing to do with the SM.

If it goes down, and if the stocks go down at the same time, someone doing the SM could be in a huge amount of trouble. And that's the problem I have with people like Smith (and others) marketing it to the unsophisticated -- they try and portray it as being safe as apple pie, but its not.

[slavka012]

Wrong - because odds are the equities gained while the house prices crashed. So person B would have a higher net-worth.

That is the whole point of diversifying your portfolio, to mitigate your risk, so that when one sector of the market is losing, the other is gaining.

You are very confused.

The house is not an asset. It is a place to live.

Unless you add value to YOUR house, any gains/losses in housing market are absolutely irrelevant to majority of people because not only your house gets more expensive, the next house that you are going to buy will also be more expensive. (Or cheaper -- whatever). If anything, you'll have to pay higher commission.

[YYC27]

You are very confused.

The house is not an asset. It is a place to live.

Unless you add value to YOUR house, any gains/losses in housing market are absolutely irrelevant to majority of people because not only your house gets more expensive, the next house that you are going to buy will also be more expensive. (Or cheaper -- whatever). If anything, you'll have to pay higher commission.

The appreciation of your home may be relevant if you intend to use the equity in your home during your retirement years (reverse mortgage, or sell and buy a smaller place, rent, move into a retirement home, etc.).

[slavka012]

The appreciation of your home may be relevant if you intend to use the equity in your home during your retirement years (reverse mortgage, or sell and buy a smaller place, rent, move into a retirement home, etc.).
Yes that is true, but this is just an added benefit. Equity accumulation should never be a consideration during purchasing a house.

[pitz]

The appreciation of your home may be relevant if you intend to use the equity in your home during your retirement years (reverse mortgage, or sell and buy a smaller place, rent, move into a retirement home, etc.).

...but a rate of appreciation greater than that of growth in rents is, in the long run, impossible. And depreciation, relative to that of debt, and to that of prices on productive assets in the economy, is, historically, a more likely scenario.

[AllWheelDrift]

if your portfolio was TRUELY balanced
A balanced portfolio should contain a significant chunk of fixed income, however debt/leverage is the opposite of fixed income, so unless you fixed income portion of your portfolio is larger than your debt, I don't see how you can consider it balanced.

As I said, SM isn't reducing your RE exposure, it's adding equity market exposure at the cost of not reducing your debt (negative fixed income) exposure. With SM your net worth might be something like 80% RE, 100% stocks, -80% fixed income. I know it looks strange that your net worth is composed of both positive and negative percentages, but consider if your stocks went to zero, it would wipe out your net worth. Likewise, if your RE went to zero, you'd only have 20% of your original net worth left. If you tried to balance your portfolio by holding 20% fixed income and 80% stocks in your SM investments, you'd really have your net worth as 80% RE, 80% stocks, -60% fixed income.

Without SM in the same scenario it would be 80% RE and the remaining 20% could be a combination of stocks and FI.

With SM you are really betting on stocks by taking a position against fixed income, not real estate. The real estate may be securing the debt, but that doesn't change the fact that your stock position is funded by debt, not RE. Unless you somehow find a way to share your RE gains/losses you've done nothing to reduce your exposure to RE.

Anyhow, I'm not against the SM, I just think it's important to understand what you're really accomplishing and that fixed income investments have no place in a SM portfolio.

For the same reason, if you have a mortgage, you shouldn't be making fixed income investments unless they are for expenses you expect to have before you are finished paying off your mortgage. Even then, if you have a HELOC/readvanceble mortgage, you should pay down the mortgage and reborrow the money when you need it. Paying down your mortage has the same effect as investing in fixed income, and is always a tax free return. And yes, right now some people (including myself) have absurly low mortgage rates that can cause a temporary exception, but one needs to understand it is a temporary situation and if you take advantage of it, you need to be able to unwind you position and put it towards the mortgage on relatively short notice.

[Germack]

Your guaranteed risk free rate of return equals your mortgage interest rate no matter what house prices will do.

Person A) Paid of house. Value of house 300K

Person B) Paid off 50% of house. Invested 150K in equities

House prices crashes by 50%

Person A owns a house valued at 150K. Net-worth 150K
Person B owns a house worth 150K, a mortgage of 150K and investments of 150K. Net-worth 150K.

The networth is in both cases the same.

If you can achieve a higher rate of return after taxes by investing in equities as compared to your mortgage interest rates then go ahead and pay down your mortgage slowly. However, this means you need to take on a lot of risk to achieve this. I would just stick to the risk free approach and just pay down my mortgage as quickly as I can.


Wrong - because odds are the equities gained while the house prices crashed. So person B would have a higher net-worth.


No. Person A saves 6.75K in interest payments every year as compared to person B. (150K *0.046% (Interest rate) = 6.75K) Only if person B would be able to achieve an after tax rate of return of greater than 4% by investing in equities he would have a higher net-worth as person A.

[brunes]

...but a rate of appreciation greater than that of growth in rents is, in the long run, impossible. And depreciation, relative to that of debt, and to that of prices on productive assets in the economy, is, historically, a more likely scenario.

This depends on where you are looking. Rent has been outpacing housing in NB by 25%+ for as long as I can remember.

[pitz]

Anyhow, I'm not against the SM, I just think it's important to understand what you're really accomplishing and that fixed income investments have no place in a SM portfolio.


One needs to be careful not to include any interest-rate sensitive investments in a SM portfolio (ie: REITs, in particular, but also, certain kinds of banks that derive most of their income from interest rate risk and maturity transformation, as opposed to service fees) as well, going by the same logic. US banks are particularly notorious for being interest-rate sensitive.



For the same reason, if you have a mortgage, you shouldn't be making fixed income investments unless they are for expenses you expect to have before you are finished paying off your mortgage. Even then, if you have a HELOC/readvanceble mortgage, you should pay down the mortgage and reborrow the money when you need it. Paying down your mortage has the same effect as investing in fixed income, and is always a tax free return. And yes, right now some people (including myself) have absurly low mortgage rates that can cause a temporary exception, but one needs to understand it is a temporary situation and if you take advantage of it, you need to be able to unwind you position and put it towards the mortgage on relatively short notice.

The scenario people need to be fearful of right now is that spreads against RE borrowing might very well climb dramatically, even if policy rates do not. That is why it is imperative that a SM be structured so that the investments themselves can be used to secure loans against them, ie: if you buy equity investments with your SM money, make sure you can use those stocks to borrow with a margin account, inexpensively!

If my crystal ball is accurate, we could be seeing Prime + 3% or Prime + 4% HELOCs in the future, but Prime - 1% margin loans won't be a big deal. Once all these government supports for RE lending are removed, and once price drops start picking up steam for houses -- lenders can easily become very negative about lending with HELOCs for cheap.

It is a complete mistake to build a business plan for the SM, or even to assume that HELOCs or mortgage debt will remain 'cheap' relative to business (margin) credit.

[pitz]

This depends on where you are looking. Rent has been outpacing housing in NB by 25%+ for as long as I can remember.

??? Not quite understanding you. You're saying that, while rents have gone up 25%, housing prices have remained flat?

Never been to New Brunswick, but if that's the case, then it sounds like a slam-dunk case for wanting to own there, and that they're totally immune to the bubble that's afflicted the rest of North America.

[Jungle]

How's everyones portfolio doing with the SM? More and more, I am thinking about trying it. Some things I have been thinking about

1. How do you convince your spouse to do this?
2. Dividend stocks paying more than 5% right now ?
3. Rising interest rates???
4. Taxes on dividend income. At what income level do you pay taxes on dividends? (minus all the tax credits)
5. Getting a heloc without paying for the evaluation.
6. House prices crashing

[Jungle]

ie: if you buy equity investments with your SM money, make sure you can use those stocks to borrow with a margin account, inexpensively!

Why would you do this? Does a margin account work differently than a LOC?

[cannon_fodder]

How's everyones portfolio doing with the SM? More and more, I am thinking about trying it. Some things I have been thinking about

1. How do you convince your spouse to do this?
2. Dividend stocks paying more than 5% right now ?
3. Rising interest rates???
4. Taxes on dividend income. At what income level do you pay taxes on dividends? (minus all the tax credits)
5. Getting a heloc without paying for the evaluation.
6. House prices crashing

I got into the SM at almost the worst time - August 2008. And I tapped into about 60% of our equity to buy as the market was going down. Put too much too soon as I didn't anticipate things would get dire so quickly.

My wife has always left the finances to me because she is confident in my ability based on my results. Plus she doesn't really like this area of household management.

Some stocks cut or eliminated their dividends. The only one I own in my portfolio that has eliminated its dividend has ironically been the best performer. It has almost quadrupled in price. My portfolio yield is around 4% - a lot lower than it used to be simply because the prices have risen but the dividends haven't.

In spite of the massive gyrations the portfolio is up about 20% and my mortgage portion is down 66%. In less than a year and a half the net worth improvement as a result of the SM is more than $200k. But part of that is how your Investments do which is irrespective of the SM in reality. The SM gives you an opportunity to have a nonregistered portfolio - you can sink or swim based on how good/lucky your investment strategy is.

I'm in the highest tax bracket so I will be getting a tax refund in spite of over $20k in dividend income and incredibly low borrowing rates.

When rates go up that is likely a signal to an improving economy. Which means the stock prices will trend higher. That will lead to increases in dividend payouts over time. My borrowing costs are around 2% before tax or about 1.1% after taxes. Prime would need to go up around 7% in order for the model to start springing leaks.

We didn't pay any fees but the situation is different now. We have a Prime - 0.75 mortgage and a Prime HELOC.

We bought our house 7 years ago and put some equity into it. It is worth about 30% more now. We are not exactly in a bubble and it frankly is irrelevant to my situation.

[evoviii]

I got into the SM at almmoat the worst time - August 2008. And I tapped into about 60% of our equity to buy as the market was going down. Put too much too soon as I didn't anticipate things would get dire so quickly.

My wife has always left the finances to me because she is confident in my ability based on my results. Plus she doesn't really like this area of household management.

Some stocks cut or eliminated their dividends. The only one I own in my portfolio that has eliminated its dividend has ironically been the best performer. It has almost quadrupled in price. My portfolio yield is around 4% - a lot lower than it used to be simply because the prices have risen but the dividends haven't.

In spite of the massive gyrations the portfolio is up about 20% and my mortgage portion is down 66%. In less than a year and a half the net worth improvement as a result of the SM is more than $200k. But part of that is how your Investments do which is irrespective of the SM in reality. The SM gives you an opportunity to have a nonregistered portfolio - you can sink or swim based on how good/lucky your investment strategy is.

I'm in the highest tax bracket so I will be getting a tax refund in spite of over $20k in dividend income and incredibly low borrowing rates.

When rates go up that is likely a signal to an improving economy. Which means the stock prices will trend higher. That will lead to increases in dividend payouts over time. My borrowing costs are around 2% before tax or about 1.1% after taxes. Prime would need to go up around 7% in order for the model to start springing leaks.

We bought our house 7 years ago and put some equity into it. It is worth about 30% more now. We are not exactly in a bubble and it frankly is irrelevant to my situation.

I was just thinking about the timing yesterday of implementing the SM. The greatest time would have been the near the bottom of the market due to insanely low valuations i.e. super high dividend yields combined with record low interest rates on mortgages. Of course being able to leverage in such a dismal environment at the time certainly requires a stiff character.

I'm assuming you are referring to Teck Cominco possibly as to the dividend cutter that's rebounded amazingly well?

I had similar problem with you in that I was early in purchasing some of my positions before the first crash in fall '08 and then the rest before spring '09. Though my portfolio is up, it could be better but that's just semantics now.

I've noticed some bloggers who've implemented the SM had stopped during the crash i.e. avoiding good value purchases and haven't resumed. Have you kept the SM throughout?

[cannon_fodder]

Yes you were right - Teck was the shining star.

Because I jump started the SM I immediately had a big portfolio - and, for a time, a bigger HELOC. So my case is not typical. My wife would prefer retiring with no debt so even though it may not be the best financial move, paying down the HELOC is the best move for our marriage. That will begin next year as we will have quickly retired the mortgage.

[Jungle]

Yes you were right - Teck was the shining star.

Because I jump started the SM I immediately had a big portfolio - and, for a time, a bigger HELOC. So my case is not typical. My wife would prefer retiring with no debt so even though it may not be the best financial move, paying down the HELOC is the best move for our marriage. That will begin next year as we will have quickly retired the mortgage.

Good for you. I would love to do this, just not sure how to convince the wife. She already thinks I'm obsessed.

Question, since you are in the highest tax bracket, you get the most back from borrowed money. But question, you are the highest tax bracket, so you pay more tax on dividends, even with the provincial and fed credits, right?

I tried doing some divident tax calculations. It's my understading that if you are under 40k imcome (approx), you don't pay dividend tax, and if you are over 40K imcome, you pay dividend tax.

I've been on taxtips.ca and I don't understand how they calculate dividned tax. From my understanding, it's

A= dividend gross up by 45%, times your marginal tax rate.

B= dividned gross up by 45%, subtract fed and provincial credit percentage.

A-B = dividned tax???

[evoviii]

Yes you were right - Teck was the shining star.

Because I jump started the SM I immediately had a big portfolio - and, for a time, a bigger HELOC. So my case is not typical. My wife would prefer retiring with no debt so even though it may not be the best financial move, paying down the HELOC is the best move for our marriage. That will begin next year as we will have quickly retired the mortgage.

I've noticed in my line of work that wives tend to be like the fixed income component of a marriage, they tend to be conservative. Either way, not all success can be measured in dollars.

Paying down mortgage now would allow you a bigger HELOC limit anyways and improve debt/equity ratio. Wife/happiness ratio improves as well.

I've reducing my leverage now instead of making new purchases as valuations aren't as attractive and interest rate on my LOC is increasing.

I'm actually hoping for a correction and want to rebuild LOC room for new purchases.

[Jungle]

my mortgage portion is down 66%. In less than a year and a half the net worth improvement as a result of the SM is more than $200k.



Does this including the saved amortized mortgage interest in this calculation?

[Vednar]

We did the SM before HELOC's were around and before I knew what a Mortgage was. It was funny actually the way it came about. My father is the traditional male head of the house hold and for a few years I tried to rebel against him. We used to live in Downtown T.O and had a crummy little house that was worth maybe 170,180 back in the 90's...

What I didn't know is that my father, had paid off that home in less then 4 years, and only paid 70k for it when he got it. Then went to the bank, leverage'd his arse off and then locked it into a vehicle that was paying 18% per year. (see Indian banks from 1986-1999) I didn't know how he did it at the time, but he was able to secure a second mortgage at the same time from another lender.

All of a sudden in 1999 we buy a McMansion in the burbs, and being a little older my father gives me a few numbers, (Salary, original investments and such) and tells me to figure out how much money he has. I was blown away by the numbers. Then we Got a Heloc on our McMansion and paid off one of the higher interest loans and the 2nd mortgage. And in the 9 years since have even paid off the HELOC. In fact knock on wood, at 30 years old, I hav e never paid a mortgage bill or utility bill or insurance or anything ever. The home is under my name and my brotehrs, I bought my own car cash and blah on and on... the point is..

Due to the SM that my father figured out back in 1986. So if anyone has any doubts...of course there is risk, but he did it with a minimal risk with about a 10% (per year average) return over 2 decades which is what was paid in CD's in India.

OR he would have 3 years left on his 25 year mortgage, assuming we never left the original house that was 70k and slowly built up our cash. But the 18% that was given all those years ago is why it worked.

Sorry, I'm ranting now...

[evoviii]

Good for you. I would love to do this, just not sure how to convince the wife. She already thinks I'm obsessed.

Question, since you are in the highest tax bracket, you get the most back from borrowed money. But question, you are the highest tax bracket, so you pay more tax on dividends, even with the provincial and fed credits, right?

I tried doing some divident tax calculations. It's my understading that if you are under 40k imcome (approx), you don't pay dividend tax, and if you are over 40K imcome, you pay dividend tax.

I've been on taxtips.ca and I don't understand how they calculate dividned tax. From my understanding, it's

A= dividend gross up by 45%, times your marginal tax rate.

B= dividned gross up by 45%, subtract fed and provincial credit percentage.

A-B = dividned tax???

Gross up dividend by 45% and add to taxable income. In Ontario below 40k approx, your combined tax rate is 24.15% for 2010.

Calculate tax credit based on fed and province (17.98% of grossed up dividend for fed and 6.4% of actual dividend for ONT). 24.38% of Grossed up dividend amount


So for example you have $100 dividend.

$145 is added to taxable income. Tax is $145 x 24.15% = $35.0175. You owe $35.02

You div tax credit is $145 x 24.38% (notice this % is higher than your marginal rate) = $35.35

I.E. dividends are tax free or even a minor tax credit.


For the highest tax bracket, dividends are still a tax efficient form of income versus interest which is important for getting most out of the SM. Effectively it's taxed at half the rate of interest income at the highest bracket.

Furthermore dividends grow, interest investments are fixed. It's important to think in after tax dollars as that's what pays the mortgage and interest payments.

[pitz]

Why would you do this? Does a margin account work differently than a LOC?

Fundamentally, no. But its a form of diversification. You want to diversify your investments when you do the SM. You should also want to diversify your borrowing/funding sources when you do the SM. If not, just so one type of collateral can't fall out of favour (ie: stocks, or houses), and you have no ability to use another type of collateral (ie: houses, or stocks) and face essentially a systemic margin call on your entire portfolio (which means that you lose your house).

At any given point of time, one funding source may be cheaper than another. Some collateral may fall so of favour that obtaining a loan against it is impossible or unbearably expensive.

[Jungle]

Fundamentally, no. But its a form of diversification. You want to diversify your investments when you do the SM. You should also want to diversify your borrowing/funding sources when you do the SM. If not, just so one type of collateral can't fall out of favour (ie: stocks, or houses), and you have no ability to use another type of collateral (ie: houses, or stocks) and face essentially a systemic margin call on your entire portfolio (which means that you lose your house).

At any given point of time, one funding source may be cheaper than another. Some collateral may fall so of favour that obtaining a loan against it is impossible or unbearably expensive.

I see what your saying. Use it as a back up. How competitive are the interest rates on borrowed margin?

Margin grows bigger when there is more equity? IE more stock assets.

[pitz]

I see what your saying. Use it as a back up. How competitive are the interest rates on borrowed margin?


My margin account is at Prime - 1% right now. Compared with most HELOCs that are sitting at Prime + 1%. So the difference could be 200bp right off the bat.

If housing prices start going down, the HELOC spreads will likely widen further. Not a trade you want to get caught on the wrong side of without at least some alternatives available.

[Jungle]

Nice rate on the on the margin. That would work excellent right now.

They don't really give you a lot of margin unless you have securties or cash invested in the brokerage anyway, right? With HELOC, you're using the money you have sitting on your house, so you don't have to come up with any cash to use the credit.

[cannon_fodder]

Good for you. I would love to do this, just not sure how to convince the wife. She already thinks I'm obsessed.

Question, since you are in the highest tax bracket, you get the most back from borrowed money. But question, you are the highest tax bracket, so you pay more tax on dividends, even with the provincial and fed credits, right?

I tried doing some divident tax calculations. It's my understading that if you are under 40k imcome (approx), you don't pay dividend tax, and if you are over 40K imcome, you pay dividend tax.

I've been on taxtips.ca and I don't understand how they calculate dividned tax. From my understanding, it's

A= dividend gross up by 45%, times your marginal tax rate.

B= dividned gross up by 45%, subtract fed and provincial credit percentage.

A-B = dividned tax???

It's not quite that simple. If your ONLY income was dividends then (Alternative Minimum Tax aside) you wouldn't pay tax on a significant income. It depends o
in which province you live.

For me even though my dividends exceed my interest costs by about 60% right now I actually pay less tax.

[cannon_fodder]

Does this including the saved amortized mortgage interest in this calculation?

No I'm strictly talking the outstanding principal. With a mortgage at 1.5% almost every dollar is going towards principal. Tax refunds, dividends and principal payments can hammer away at that mortgage.

[pitz]

Nice rate on the on the margin. That would work excellent right now.

They don't really give you a lot of margin unless you have securties or cash invested in the brokerage anyway, right? With HELOC, you're using the money you have sitting on your house, so you don't have to come up with any cash to use the credit.

Well, obviously you'd have to use a combination of margin credit, and HELOC credit, under a SM scenario. But the blended cost of the credit could be lower if you are able to diversify your borrowing sources and collateral.

And there is no "money you have sitting on your house". A house is intrinsically a wasting good. I'm personally amazed that any credit is granted against houses.

[evoviii]

Wouldn't margin be somewhat higher risk form of debt as the collateral fluctuates vs HELOC is based equity built so far in the mortgage.

Is that a closed variable mortgage cannon?

[pitz]

Wouldn't margin be somewhat higher risk form of debt as the collateral fluctuates vs HELOC is based equity built so far in the mortgage.


HELOC collateral fluctuates as well.

And in any case, you don't want to be too leveraged. In this thread, I only advocated considering the SM if you had at least over half the house paid off (if not more), and not withdrawing additional equity.

If you have both credit lines (margin + HELOC) available, then you can move money between them as needed, to meet any margin calls, whether it be a margin call on the HELOC, or a margin call on the stocks. Although, conservatively implemented, that should barely be necessary, except, perhaps, in a situation reminiscent of last year.

[cannon_fodder]

Wouldn't margin be somewhat higher risk form of debt as the collateral fluctuates vs HELOC is based equity built so far in the mortgage.

Is that a closed variable mortgage cannon?

No, the variable mortgage is open. I can pay it off at any time. But, with the current climate I don't know if the bank would use that as an opportunity to unilaterally adjust my HELOC rates higher.

The banks and credit unions have done that (or tried to) with many other people - I don't want to give them an excuse.

I obtained this mortgage about a year and a half ago - that was before subprime variable rates became temporarily extinct.

And as for margin - it was pitz himself who extolled the virtues of IB as the most competitive provider of margin. I investigated and found it suited my liking.

Their trading fees commissions aren't capped. That is definitely a negative.

[evoviii]

HELOC collateral fluctuates as well.

And in any case, you don't want to be too leveraged. In this thread, I only advocated considering the SM if you had at least over half the house paid off (if not more), and not withdrawing additional equity.

If you have both credit lines (margin + HELOC) available, then you can move money between them as needed, to meet any margin calls, whether it be a margin call on the HELOC, or a margin call on the stocks. Although, conservatively implemented, that should barely be necessary, except, perhaps, in a situation reminiscent of last year.

Last year's crash is an example of how being too leveraged at the wrong time hits you from both sides. Currently I'm using 0% BT (1% really due to upfront fee) as leverage with with margin and empty LOC as fall back. It's because of leverage I wasn't willing to buy more in Feb and March.


No, the variable mortgage is open. I can pay it off at any time. But, with the current climate I don't know if the bank would use that as an opportunity to unilaterally adjust my HELOC rates higher.

The banks and credit unions have done that (or tried to) with many other people - I don't want to give them an excuse.

I obtained this mortgage about a year and a half ago - that was before subprime variable rates became temporarily extinct.

And as for margin - it was pitz himself who extolled the virtues of IB as the most competitive provider of margin. I investigated and found it suited my liking.

Their trading fees commissions aren't capped. That is definitely a negative.

Supposedly all HELOC's are supposed to increase across the board for all the major's. Why some have been untouched is beyond me. I orignally wanted to go with IB but at the time my non reg was too small and couldn't keep up with activity fees. I'll go with them later when my BT runs out maybe. Margin discount is fairly significant at 250 bps

[Jungle]

And there is no "money you have sitting on your house". A house is intrinsically a wasting good.

Yes there is, I am refering to equity (if you have it). A house is not a wasting good, you do live in it, you know. And land does not wash away either, unless polar ice cap melts. But I don't think I'll see that in my life time.

[Jungle]

Well, obviously you'd have to use a combination of margin credit, and HELOC credit, under a SM scenario. But the blended cost of the credit could be lower if you are able to diversify your borrowing sources and collateral.

I can see blending it, makes sense, if the loaner calls in the debt. But how often does the bank really call in a HELOC? Assuming you are ok, didn't loose your job or something. Would rising interest costs force it beyond max credit, if fully used?

At what ratio does a brokerage give you margin? At some point, you have to have equity in your brokerage account. I don't think the average person as a lot outside of their registered accounts to use for this strategy. If they did have a large, liquid sum, it should have been put on their mortgage, before trying SM, to save money on interest.

I believe this is what the SM guy is saying "It gives a person an opportunity to have a non-registered portfolio, using HELOC"

So to diversify the risk or margin call, where would the money come from to put in your brokerage account?

Thus taking advantage of your house equity, or as I said, "money sitting on your house", because otherwise most don't have a lot sitting around.

[pitz]

I can see blending it, makes sense, if the loaner calls in the debt. But how often does the bank really call in a HELOC? Assuming you are ok, didn't loose your job or something. Would rising interest costs force it beyond max credit, if fully used?


Well... I already gave an example where using margin for the 'borrowing' side of the SM can save a person 200bp over borrowing on a HELOC. It is possible, at different times in the economic cycle, that certain types of credit will be more expensive, than at other times.

Just using a HELOC, or just using stock margin, is putting all your eggs in one basket.

And its very possible that HELOCs might start getting called or reduced. Very common in the USA.



At what ratio does a brokerage give you margin? At some point, you have to have equity in your brokerage account. I don't think the average person as a lot outside of their registered accounts to use for this strategy. If they did have a large, liquid sum, it should have been put on their mortgage, before trying SM, to save money on interest.


Well, try this example on. Let's say that someone has a $1M house. $700k in equity. They want to SM $200k of that equity. They can borrow $200k from the HELOC at Prime + 1, *or* they can borrow $100k from the HELOC at Prime + 1, and borrow $100k on margin at Prime - 0.5%.

In the first scenario, the cost of borrowing is Prime + 1%. In the second scenario, the cost of borrowing is Prime + 0.25%.

On a $200k loan, the difference is $1500. And the diversification provides for better security, as at least, if the HELOC gets reduced (say the banker gets a little antsy about Vancouver real estate!), there's still plenty of breathing room.



So to diversify the risk or margin call, where would the money come from to put in your brokerage account?


The money to meet a margin call in the stock account would come from the HELOC. The money to meet a margin call on the HELOC would come from the stock account. They diversify each other to some extent, and protect against shifting collateral preferences on the part of lenders.



Thus taking advantage of your house equity, or as I said, "money sitting on your house", because otherwise most don't have a lot sitting around.

I don't like the phraseology of 'money sitting on your house', because it implies that a house is like an ABM, or something dumb like that. Maybe I don't like the phrase either because too many mortgage brokers in the USA convinced people to take actions that led to their financial ruin, and that of the nation. Anyways... Hehe..

[Jungle]

And its very possible that HELOCs might start getting called or reduced. Very common in the USA.

I did noticed that everyone on the forums here was saying how their generous amount of available credit was being reduced on their CC, last year with the "credit crunch." I wonder if that also affected HELOCs.

But in the case of the HELOC being reduced or called, you can sell stocks you bought, to cover the amount. (Just hope it's not Oct 2008)



On a $200k loan, the difference is $1500. And the diversification provides for better security, as at least, if the HELOC gets reduced (say the banker gets a little antsy about Vancouver real estate!), there's still plenty of breathing room.

The savings on interest is beneficial. I get it now. Buy 100K stocks with the HELOC. Then, margin will become available. Buy stocks with the margin. Not sure how much margin they give out, but lets say 100k. 200K is the total in stock equity. Is that leveraging against leverage??



I don't like the phraseology of 'money sitting on your house', because it implies that a house is like an ABM, or something dumb like that. Maybe I don't like the phrase either because too many mortgage brokers in the USA convinced people to take actions that led to their financial ruin, and that of the nation. Anyways... Hehe..

Well, I do agree, for a better term, it's money borrowed using your house's equity, as collateral.

[pitz]

The savings on interest is beneficial. I get it now. Buy 100K stocks with the HELOC. Then, margin will become available. Buy stocks with the margin. Not sure how much margin they give out, but lets say 100k. 200K is the total in stock equity. Is that leveraging against leverage??


Technically, yes, it is. But as long as you don't abuse it... A stock margin lender really doesn't care where you get the money from, because they have the stock as collateral. Of course, you're absolutely correct -- if the economy faces a systemic margin call (or bank run), such as the USA last year -- then you're scr*wed either way to some extent if you didn't keep the leverage down.

[nafrelioob]

Love this site and this thread. First time poster...

I've begun reading through this thread, but haven't got through it all. I have a few questions. I have been hearing various conflicting responces to this Q from the people I talk to. I am currently in an open variable mortgage and am looking to get set up with the SM.

Home: approx. value - $400,000 x 80% = $320,000 total funds available
Owing on the house - $235,000
Maximum amount available to invest - $85,000
Firstline mortgage quote - variable @ prime -.35 (or 5 year @ 3.70%), prime +1 on the HELOC

In setting up the SM, do I:

1. (as the mortgage broker, and an accountant assured me) take 100% ($320,000) out on the mortgage side at 1.9% and use spreadsheets and mortgage documents to prove to CRA that I'm using $85,000 of that for investing, or

2. Take $235,000 out on the mortgage side and $85,000 out of the HELOC at 3.25%. I see examples of this on these forums, stating that it is cleaner and separates the mortgage interest from investment interest for taxation purposes.

If it works for taxes and accounting, obvisouly option 1 is preferred as the cost of borrowing is 1.35% less. But is it doable from CRA's perspective? I know that once mortgage principle gets paid down, $ gets readvanced into the LOC, and will be invested at P+1, but can I get a good jump on things by starting the initial investment loan at the lower rate?

Thanks in advance...

[pitz]

nafrelibob, I'd suggest the you really don't have enough equity to do the SM at the moment. Or, at best, you could get started with $10-$20k. Wouldn't advise any more than that. And definitely not $85k, which puts you at a terrible risk for a margin call on the house itself.

What you're asking is more of a question of interest rates, and requires whomever answers you, to make a prediction on the future of rates and of Prime -- up, or down. Can't really answer that one for you.

[nafrelioob]

nafrelibob, I'd suggest the you really don't have enough equity to do the SM at the moment. Or, at best, you could get started with $10-$20k. Wouldn't advise any more than that. And definitely not $85k, which puts you at a terrible risk for a margin call on the house itself.

What you're asking is more of a question of interest rates, and requires whomever answers you, to make a prediction on the future of rates and of Prime -- up, or down. Can't really answer that one for you.

$165,000 in equity isn't enough to do the SM?

[pitz]

$165,000 in equity isn't enough to do the SM?

Well... Obviously 20% isn't available. And you still need a healthy buffer, to take into account, inevitable housing price corrections. A good rule of thumb is don't consider the SM until you have at least 50% paid off. So that, at best, leaves you with $35k available.

Some irresponsible advisor might tell you that you can do a lot more...but remember...their commission cheques rely upon them telling you that, and they don't bear the consequence of you losing your house if there is a correlated drop in both stocks and real estate.

[Jungle]

do I:

1. (as the mortgage broker, and an accountant assured me) take 100% ($320,000) out on the mortgage side at 1.9% and use spreadsheets and mortgage documents to prove to CRA that I'm using $85,000 of that for investing, or

2. Take $235,000 out on the mortgage side and $85,000 out of the HELOC at 3.25%. I see examples of this on these forums, stating that it is cleaner and separates the mortgage interest from investment interest for taxation purposes.

Thanks in advance...

In option one, your broker said to take out another mortgage??? Stay away from this guy. Better yet, stay away from mortgage brokers and investment advisors, period. Their advice is a conflict of interest. Treat them like used car salesman. Search independently. There is enough information out there to understand this strategy. For example, borrow some books from the library, read up on the CRA website, this thread and million dollar journey.

The short answer is, you need a Home Equity Line of Credit. (I know you get this) Do not borrow from your mortgage. And you need a special HELOC, one where available credit grows bigger, as you put more equity in your house, and one where you can only pay the interest, if you sure wish.

For tax audit reasons, only use this HELOC for the SM, nothing else. Print and save every in-and-out transaction from the HELOC, brokerage account and mortgage, put it on a spread sheet, make the numbers add up. Keep the papers in a file folder and do a self evaluation fairly often.

[Jungle]

Well... Obviously 20% isn't available.

Huh? 20% of $400,000 house= $80,000.

[evoviii]

In option one, your broker said to take out another mortgage??? Stay away from this guy. Better yet, stay away from mortgage brokers and investment advisors, period. Their advice is a conflict of interest. Treat them like used car salesman. Search independently. There is enough information out there to understand this strategy. For example, borrow some books from the library, read up on the CRA website, this thread and million dollar journey.

The short answer is, you need a Home Equity Line of Credit. (I know you get this) Do not borrow from your mortgage. And you need a special HELOC, one where available credit grows bigger, as you put more equity in your house, and one where you can only pay the interest, if you sure wish.

For tax audit reasons, only use this HELOC for the SM, nothing else. Print and save every in-and-out transaction from the HELOC, brokerage account and mortgage, put it on a spread sheet, make the numbers add up. Keep the papers in a file folder and do a self evaluation fairly often.

Isn't HELOC borrowing from your mortgage.

[pitz]

Huh? 20% of $400,000 house= $80,000.

Yeah... The poster in question had equity of 165k. 20% = $80k, which isn't available. Leaving a max of $85k.

Now, if you've ever invested on credit, you know that you can't use the total amount of collateral available, because the price of the underlying collateral varies.

For instance, in the example above...if he took the entire $85k and invested it -- if his house went down just 10% -- he'd have a shortfall of $40k to make up, *just to renew the mortgage*!!!

If the house went down 20%, he'd have an $80k shortfall.

10% decline in house prices is just noise. 20% is a good correction. >20% is what's happening in the United States right now, and likely to spread to Canada.

This is where the SM can be a disaster for people. Some mortgage broker or investment salesman, eager to make a commission, would recommend taking the $85k, and investing it all at once (usually into some front-end-loaded fund....but that's another issue altogether!). House price goes down. Bank wants the HELOC paid down before they renew. Borrower doesn't end up losing the house, but is forced to either sell some of the investments ( = $$commissions$$$), or forced to buy CMHC insurance (=$$$).

SM most appropriate for people who have 60-80% of their house paid off, and want to slowly ease themselves from paying a mortgage, into building investments. Not for people with barely any equity.

[nafrelioob]

In option one, your broker said to take out another mortgage??? Stay away from this guy. Better yet, stay away from mortgage brokers and investment advisors, period. Their advice is a conflict of interest. Treat them like used car salesman. Search independently. There is enough information out there to understand this strategy. For example, borrow some books from the library, read up on the CRA website, this thread and million dollar journey.

The short answer is, you need a Home Equity Line of Credit. (I know you get this) Do not borrow from your mortgage. And you need a special HELOC, one where available credit grows bigger, as you put more equity in your house, and one where you can only pay the interest, if you sure wish.

For tax audit reasons, only use this HELOC for the SM, nothing else. Print and save every in-and-out transaction from the HELOC, brokerage account and mortgage, put it on a spread sheet, make the numbers add up. Keep the papers in a file folder and do a self evaluation fairly often.


No, he didn't say to take out another mortgage, just to take out a both the mortgage and the investment $ from the mortgage side, rather than on the readvanced side (on the initial investment only) - then instead of counting the investment interest from the LOC, you'd invest the same amount at a 1.35% lesser amount..

Thanks for that 3rd part - you don't recommend saving 1.35% in interest so that you can keep the mortgage and the LOC interest separate. I know that is preferred - just wasn't sure if it was doable to invest the initial amount borrowing $ from the mortgage side of the Matrix.

[nafrelioob]

Huh? 20% of $400,000 house= $80,000.

I was confused about Pitz' statement about 20% too. Correct me if I am wrong Pitz, but from your comments you are talking about allowing 20% space for housing values to fall. So I shouldn't invest more than what would account for a downturn in housing prices.

So far in Winnipeg where I live, housing prices have been very solid, even increasing by about 5% in value this past year (according to some RA agents I've dealt with). Winnipeg prices have typically been well below national averages and there has been a recent market correction over the last 5-10years seeing it do some catching up. The economy here is stable, even through turbulent times as it is diverse- we are not relying on oil, the auto industry, etc. to keep us afloat. I'm not saying I am insulated from real estate crashes here, just that I may not be as vulnerable as some other places (unless Pitz knows something I don't!).

[nafrelioob]

Yeah... The poster in question had equity of 165k. 20% = $80k, which isn't available. Leaving a max of $85k.

Now, if you've ever invested on credit, you know that you can't use the total amount of collateral available, because the price of the underlying collateral varies.

For instance, in the example above...if he took the entire $85k and invested it -- if his house went down just 10% -- he'd have a shortfall of $40k to make up, *just to renew the mortgage*!!!

If the house went down 20%, he'd have an $80k shortfall.

10% decline in house prices is just noise. 20% is a good correction. >20% is what's happening in the United States right now, and likely to spread to Canada.

This is where the SM can be a disaster for people. Some mortgage broker or investment salesman, eager to make a commission, would recommend taking the $85k, and investing it all at once (usually into some front-end-loaded fund....but that's another issue altogether!). House price goes down. Bank wants the HELOC paid down before they renew. Borrower doesn't end up losing the house, but is forced to either sell some of the investments ( = $$commissions$$$), or forced to buy CMHC insurance (=$$$).

SM most appropriate for people who have 60-80% of their house paid off, and want to slowly ease themselves from paying a mortgage, into building investments. Not for people with barely any equity.

Thanks for your thoughts Pitz - I value your opinion. I can appreciate your cautions. This is the first I have heard that it is more for people who have most of their home paid off. Both examples in Smith's book show individuals with only 25% equity in their house.

Does anyone here using the SM have less equity than Pitz recommends or think it can be done?

[Lockz]

I started in November with roughly 40% equity, although I've been playing a little too aggressive lately, selling stocks when they're too high so I can get my money back from that stock, pocketing a capital gain which goes against the mortgage while the original cost gets put into a stock which I like (typically one that's priced less than it possibly should, or better dividends).

[nafrelioob]

I started in November with roughly 40% equity, although I've been playing a little too aggressive lately, selling stocks when they're too high so I can get my money back from that stock, pocketing a capital gain which goes against the mortgage while the original cost gets put into a stock which I like (typically one that's priced less than it possibly should, or better dividends).

Okay fair. Do you mind me asking what percentage of your LOC you have used to invest? PM me if you'd prefer...

[cannon_fodder]

I did noticed that everyone on the forums here was saying how their generous amount of available credit was being reduced on their CC, last year with the "credit crunch." I wonder if that also affected HELOCs.



you may have only heard from the vocal minority. I have seen no reduction in credit offered nor any increases to my mortgage or HELOC rates. The fact is the bank is receiving far more interest payments from me because I am borrowing much more money at a higher interest rate than before the SM.

[Lockz]

Okay fair. Do you mind me asking what percentage of your LOC you have used to invest? PM me if you'd prefer...

I gradually moved up so that I've got most of my equity that's allowed for my investments (keeping about 5% back for personal separate HELOC for various things). I just added $4k more last month when I got more room from additional payments.

[cannon_fodder]

When we applied for a readvanceable mortgage the bank only lends you 80% of the estimated value of the home. That is the bank's protection and is not negotiable.

I don't understand the idea of taking a $320,000 mortgage on your $400,000 home and using the money to invest. The bank doesn't hand you a cheque for the equity - they give you no money to spend but instead you receive a payment schedule. I can't even buy a cup of coffee with the money they've lent me.

That is why I need the HELOC portion. That gives me access to money for whatever I want but secured by the equity in my house. They don't know if I'm buying ETFs for the broad based indices or entering into poker tournaments.

I don't share pitz' view of doom and gloom for the housing market. It could happen as he has postulated but your particular situation may make it more or less risky. I've seen my SM portfolio value drop in half and then more than double all within 16 months. My house value has barely moved.

Don't be lured in by dreams of 6% growth of your house value and 10% returns on your SM portfolio while enjoying 2% effective borrowing rates for year after year.

Some people point out the concept of diversification. Do you want all of your assets tied into your home or do you want to borrow money from the bank (it's not borrowing from the house equity - you are borrowing from the bank) to invest in different industries or companies?

[Germack]

Don't be lured in by dreams of 6% growth of your house value and 10% returns on your SM portfolio while enjoying 2% effective borrowing rates for year after year.

Some people point out the concept of diversification. Do you want all of your assets tied into your home or do you want to borrow money from the bank (it's not borrowing from the house equity - you are borrowing from the bank) to invest in different industries or companies?

If you look at long term rates of return (10-40 years) the difference between the return of equities and borrowing rates has been very close to 0. Subtract investing fees and you were often in the negative.

Diversification is important to reduce risk. However by doing the SM you increase your risk. Paying down your mortgage as quickly as you can is risk free (no need for diversification) and gives you a decent after tax rate of return.

[Jungle]

Isn't HELOC borrowing from your mortgage.

No, it uses your house as collateral, giving lower interest rates to borrow money, since some of the risk is removed by having a house to back it up.

[evoviii]

If you look at long term rates of return (10-40 years) the difference between the return of equities and borrowing rates has been very close to 0. Subtract investing fees and you were often in the negative.

Diversification is important to reduce risk. However by doing the SM you increase your risk. Paying down your mortgage as quickly as you can is risk free (no need for diversification) and gives you a decent after tax rate of return.

You have actual figures to back up your statement

[Jungle]

If you look at long term rates of return (10-40 years) the difference between the return of equities and borrowing rates has been very close to 0. Subtract investing fees and you were often in the negative.

Paying down your mortgage as quickly as you can is risk free (no need for diversification) and gives you a decent after tax rate of return.

I've never looked at the long term rates, maybe it doesn't matter, if in the short term, you pay your mortgage off? In your returns above, don't forget to add the tax deductible percentage on the borrowed money, giving you more profit. I believe you can also include commission fees. Since this money comes from a deductible, so it means your paying less income tax and getting it back for this strategy.

But, I do understand what you are saying. I worked out the numbers being realistic, conservative returns, not shooting for the stars.

For my situation, the positive is only like an extra $1000+ish per year. (I'm thinking, big whoop!). I believe that everyone else would get a similar, profit percentage ratio, too.

However, the big savings come from reducing compound interest= 5 years worth. When I add this payment onto my mortgage, every year, for the remaining life, it knocks off like 5 years.

Now, because this didn't really cost you any money out of pocket, (hoping market doesn't crash) you can take your extra payments and use that in addition to the SM, reducing the mortgage faster.

5+ years of no mortgage means a lot of income freed up for retirement plans, investing, new car paid with cash, whatever you want.

[doc50]

You have to have the discipline to put the money where it is to go in the right percentages to the best investments. I've seen a number of people put the money into Uncle Ed's Condo Villa or exotic forex transactions, options, etc. etc. Lose the money and still have the debt. Not a good place to go. Human nature is short term for a lot of people, memory's are short and I just gotta have that wonderfull stock that's going to change the world. Remeber Nortel etc. etc.

For some it is a good idea, for other's not a good idea. Best investment in life is a pd up home. Not a 250,000 perpetual mortgage. Makes you a renter in life, not an owner. The people who think these things up are after the fee income associated with it, because your sure as hell not doing it for free. As soon as Canada Revenue changes the rules everyone disappears leaving the poor sap holding the bag. He/She is faced with financial devastion and the people who advised them into the mess are laughing all the way to the bank. Seen a lot of people take bad advice and then get shafted because of it.

Your Smith Manouvre might be fine, but might not. It depends. Markets can change, for real estate and for investments. If a person does this make sure you CYA, leave a healthy chunk of equity and hope like hell it works.

That's why far too many will "screw it up".

Wise words....I can also see a lot of people cashing out the investments and still having the debt

[nafrelioob]

I'm in the process of setting up the SM. I have an option to set up the dividends with a 2, 4, 6, or 8% return (if I understand correctly). I would use the dividends to further pay down the mortgage. My question for the collective wisdom of the forum:

What percentage should I pick?

The higher dividend return, the quicker I pay down the mortgage (Prime -.31). The lower rate, the more stays accumulating in my investments (LOC @ P+1). (I hope I understand this correctly).

I am investing with the help of a financial advisor. I need assistance to choose and manage the investments as I don't know a whole lot about them. Any idea how much I lose because of the commissions compared to doing it on my own? Is it acceptable/wise/possible to just give him a part of the $ and then use the rest of my initial investment and mirror what he/she does?

[Jungle]

I'm in the process of setting up the SM. I have an option to set up the dividends with a 2, 4, 6, or 8% return (if I understand correctly). I would use the dividends to further pay down the mortgage. My question for the collective wisdom of the forum:

What percentage should I pick?

The higher dividend return, the quicker I pay down the mortgage (Prime -.31). The lower rate, the more stays accumulating in my investments (LOC @ P+1). (I hope I understand this correctly).

I am investing with the help of a financial advisor. I need assistance to choose and manage the investments as I don't know a whole lot about them. Any idea how much I lose because of the commissions compared to doing it on my own? Is it acceptable/wise/possible to just give him a part of the $ and then use the rest of my initial investment and mirror what he/she does?

Ask your advisor how much he charges and exactly what the investments will charge (commission fees, MERs, etc).

[nafrelioob]

Ask your advisor how much he charges and exactly what the investments will charge (commission fees, MERs, etc).

Then what? How do I decide between 2, 4, 6, 8%?

What are reasonable investment fees? I have been investing RRSPs with Edward Jones in the past.

[Germack]

You have actual figures to back up your statement

Of course I can.
Source:
http://www.theglobeandmail.com/globe-investor/investment-ideas/buy-gics-only-gics/article1292666/

Returns of S&P/TSX Composite Total Return Index and GICs for
30 years: S&P/TSX: 10.76 GIC: 7.28 delta: 3.48
40 years: S&P/TSX: 9.77 GIC: 7.71 delta: 2.06
50 years: S&P/TSX: 9.8 GIC: 7.35 delta: 2.45

Equities outperformed GICs over the last 50years by 2.45%. The number is similar vs. Government of Canada bonds. However we cannot borrow money for the SM as cheaply as banks or the government of Canada can. I estimate the borrowing rate for the SM was around 2-2.5% higher as compared to GICs or Government of Canada bonds for the last 50 years. I have not found data for the actual borrowing rates but it should be in this ballpark.

Therfore:

Return of equities (9.8%) - Borrowing rate (7.35% + 2.5%) = ~ 0

Substract investing fees of 0.5 to 2.5% (ETFs; MF) and you are in the minus and lost a lot of money.

[Jungle]

Then what? How do I decide between 2, 4, 6, 8%?

What are reasonable investment fees? I have been investing RRSPs with Edward Jones in the past.

Sorry, I can't really answer your question, because I wouldn't pay an investment advisor one penny to administer my SM portfolio. I might listen to his advice for free, depending if it's convenient for me.

[evoviii]

Of course I can.
Source:
http://www.theglobeandmail.com/globe-investor/investment-ideas/buy-gics-only-gics/article1292666/

Returns of S&P/TSX Composite Total Return Index and GICs for

30 years: S&P/TSX: 10.76 GIC: 7.28 delta: 3.48
40 years: S&P/TSX: 9.77 GIC: 7.71 delta: 2.06
50 years: S&P/TSX: 9.8 GIC: 7.35 delta: 2.45

Equities outperformed GICs over the last 50years by 2.45%. The number is similar vs. Government of Canada bonds. However we cannot borrow money for the SM as cheaply as banks or the government of Canada can. I estimate the borrowing rate for the SM was around 2-2.5% higher as compared to GICs or Government of Canada bonds for the last 50 years. I have not found data for the actual borrowing rates but it should be in this ballpark.

Therfore:

Return of equities (9.8%) - Borrowing rate (7.35% + 2.5%) = ~ 0

Substract investing fees of 0.5 to 2.5% (ETFs; MF) and you are in the minus and lost a lot of money.

Why omit the 10-20 year numbers as that is the interest rate environtment we'll be in for the near future?
10 years: S&P/TSX: 9.41 GIC: 3.35 delta: 6.06
20 years: S&P/TSX: 8.86 GIC: 5.51 delta: 3.35


One of the main premise of SM is to make the interest tax deductible, so rate of borrowing is reduced by marginal tax rate.

Furthermore using numbers from an article from someone obsessed with GIC's is hardly unbiased.

[Germack]

Why omit the 10-20 year numbers as that is the interest rate environtment we'll be in for the near future?
10 years: S&P/TSX: 9.41 GIC: 3.35 delta: 6.06
20 years: S&P/TSX: 8.86 GIC: 5.51 delta: 3.35


One of the main premise of SM is to make the interest tax deductible, so rate of borrowing is reduced by marginal tax rate.

Furthermore using numbers from an article from someone obsessed with GIC's is hardly unbiased.

I did not include the 10 year rate of return because it is very volatile depending on the date you use. Look at the chart and you see what I mean.

Rate of borrowing is reduced because interest is tax deductible, however your rate of return on your equities is also reduced due to taxes payable.

So you say the numbers are incorrect? You have a better source?

[Germack]

Furthermore using numbers from an article from someone obsessed with GIC's is hardly unbiased.

Here is a source showing the numbers for the S&P 500 vs. government bonds for the last 30 years:

Real Return of S&P 500 for the last 30 years: 7.15%
Real Return of 5-yr treasuries for the last 30 years: 4.78%
Difference: 2.37%

Source:
http://thornburginvestments.com/literature/generic_lit/TH1401_realreal.pdf

[pitz]

Return of equities (9.8%) - Borrowing rate (7.35% + 2.5%) = ~ 0

Substract investing fees of 0.5 to 2.5% (ETFs; MF) and you are in the minus and lost a lot of money.

Yup. You're totally right Germack, anyone who uses an 'advisor', and doesn't borrow for the absolute lowest cost possible, is doomed to very poor performance with the SM. This is something that the advisors that push it won't tell you. If one doesnt understand the SM and investing in general, inside and out, then failure is pretty much assured.

[Sanchez]

Here is a source showing the numbers for the S&P 500 vs. government bonds for the last 30 years:

Real Return of S&P 500 for the last 30 years: 7.15%
Real Return of 5-yr treasuries for the last 30 years: 4.78%
Difference: 2.37%

Source:
http://thornburginvestments.com/literature/generic_lit/TH1401_realreal.pdf

Why use the rate of 5-yr treasuries? They are poor proxy for margin or HELOC investing, which use short term interest rates, which are typically always lower than longer term rates (except for rare periods when the yield curve inverts). For example, the 5-yr treasury is currently yielding 2.34% - yet the benchmark rate for margin at something like IB is 0.12%! IB charges a spread of 0.25% to 1.5%, so even with the worst spread (if you borrow less than 100k) you are paying considerably less than the 5-yr rate. HELOCs are also tied to short term rates. Even using the source you noted above, you can see that short term rates (approximated by T-bills) have averaged nearly 3% less than the 5-year rates you quote.

Using the 5-yr rate is also further distorted by the unprecedented long term decline in interest rates to a historic low, which juices returns on medium and long term bonds - evidently this process must eventually reverse itself, as rates have reached "absolute zero" so to speak.

You are also distorting the comparison by ignoring the deductibility of the interest paid. This does not cancel out with the taxes paid on investment gains since these are typically in the form of dividends, whose tax rates range from negative in the best cases to about half that of normal income, or capital gains, which half a rate of half that of normal income and can be deferred for a long period of time - a long deferral can cut the effective rate in half again, or even more.

[cannon_fodder]

Of course I can.
Source:
http://www.theglobeandmail.com/globe-investor/investment-ideas/buy-gics-only-gics/article1292666/

Returns of S&P/TSX Composite Total Return Index and GICs for
30 years: S&P/TSX: 10.76 GIC: 7.28 delta: 3.48
40 years: S&P/TSX: 9.77 GIC: 7.71 delta: 2.06
50 years: S&P/TSX: 9.8 GIC: 7.35 delta: 2.45

Equities outperformed GICs over the last 50years by 2.45%. The number is similar vs. Government of Canada bonds. However we cannot borrow money for the SM as cheaply as banks or the government of Canada can. I estimate the borrowing rate for the SM was around 2-2.5% higher as compared to GICs or Government of Canada bonds for the last 50 years. I have not found data for the actual borrowing rates but it should be in this ballpark.

Therfore:

Return of equities (9.8%) - Borrowing rate (7.35% + 2.5%) = ~ 0

Substract investing fees of 0.5 to 2.5% (ETFs; MF) and you are in the minus and lost a lot of money.

What happens if you use historical Bank of Canada prime rates plus 1.5 to 2% as the borrowing rate?

[pitz]

What happens if you use historical Bank of Canada prime rates plus 1.5 to 2% as the borrowing rate?

And what exactly is the "Bank of Canada prime rate"?

"Prime" has always been something that has been set by the chartered banks, and not by the "Bank of Canada". The BoC sets policy target rates on overnight loans secured with the highest quality collateral (ie: Government of Canada securities), not rates charged by market participants to retail customers.

[evoviii]

And what exactly is the "Bank of Canada prime rate"?

"Prime" has always been something that has been set by the chartered banks, and not by the "Bank of Canada". The BoC sets policy target rates on overnight loans secured with the highest quality collateral (ie: Government of Canada securities), not rates charged by market participants to retail customers.

Well it's not fixed to BoC overnight but the banks seem content to just adjust a person discretionary rate rather than bank prime. The past years LOC adjustments increased. So banks passed on higher cost of borrowing, whether they did it via adjusting prime or just the discretionary part effect is the same.

[pitz]

Well it's not fixed to BoC overnight but the banks seem content to just adjust a person discretionary rate rather than bank prime.

The chartered banks did adjust their spread against the BoC reference target in the past while. It expanded from the 150-175bp that has been seen for most of the past decade, to the current 200bp level (BoC target = 25bp, chartered_prime = 225bp). Plus, of course, they jacked spreads even further above that (just as I predicted).

I suspect spreads will continue to widen on real estate secured debt over time, especially as risk increases and losses increase. Leaving someone who can borrow against investments, as opposed to just strictly real estate, with a competitive advantage over their peers.

[cannon_fodder]

The chartered banks did adjust their spread against the BoC reference target in the past while. It expanded from the 150-175bp that has been seen for most of the past decade, to the current 200bp level (BoC target = 25bp, chartered_prime = 225bp). Plus, of course, they jacked spreads even further above that (just as I predicted).

I suspect spreads will continue to widen on real estate secured debt over time, especially as risk increases and losses increase. Leaving someone who can borrow against investments, as opposed to just strictly real estate, with a competitive advantage over their peers.

Seems you knew exactly what I meant when I asked to use a borrowing rate based on BoC rate with a 1.5 - 2% uplift.

[pitz]

Seems you knew exactly what I meant when I asked to use a borrowing rate based on BoC rate with a 1.5 - 2% uplift.

I know what you mean, but its a complete fantasy to suggest that the BoC controls "prime" rates, or even HELOC rates. As housing, as an asset class, detiorates in quality as collateral -- having diversified sources of borrowing available becomes even more crucial.

That's my only point. Its entirely possible for the BoC to remain at 0.25% target overnight policy, while HELOC rates creep up to 3, 4, even 5-6%/annum. Most people, especially mortgage brokers, don't understand this, and run around using terms like "BoC Prime".

[digitalsky]

Haven't posted here in a while. I bought my place half a year ago, but have yet to implement the SM yet. (I got the LOC but haven't borrowed to invest yet)

RRSP deadline is coming up. I've borrowed 15k from my own RRSP for the down payment half a year ago. Now in 2009, I contributed 5k to RRSP. I now have another 10k cash that I can put into RRSP. I'm wondering what I should do: should I put the 10k in RRSP and immediately repay my 15k loan to myself? (In that case I won't get any tax deduction from RRSP contribution) Should I claim the 15k RRSP to reduce my income tax, and worry about repaying the loan later?

Another thing is I'm wondering if putting money in RRSP is really a good idea if I want to, for example, use the money to purchase investment properties. (AFAIK you can't use RRSP to buy investment property). Your thoughts?

[pitz]

RRSP deadline is coming up. I've borrowed 15k from my own RRSP for the down payment half a year ago. Now in 2009, I contributed 5k to RRSP. I now have another 10k cash that I can put into RRSP. I'm wondering what I should do: should I put the 10k in RRSP and immediately repay my 15k loan to myself? (In that case I won't get any tax deduction from RRSP contribution) Should I claim the 15k RRSP to reduce my income tax, and worry about repaying the loan later?


How is this a SM question??




Another thing is I'm wondering if putting money in RRSP is really a good idea if I want to, for example, use the money to purchase investment properties. (AFAIK you can't use RRSP to buy investment property). Your thoughts?

Ignoring the utter foolishness of over-concentrating oneself in the real estate market, as opposed to diversifying, obviously, if you wanted to buy investment properties, you would need to accumulate assets in a non-registered vehicle such as a TFSA or straight taxable investments.

[digitalsky]

How is this a SM question??


Ah sorry. The other option I forgot to mention would be to use that 10k to pay down the mortgage (and then borrow to invest) instead of repaying the RRSP HBP or buying RRSP to reduce income tax.

I hope this is considered a SM-related question...

[pitz]

Ah sorry. The other option I forgot to mention would be to use that 10k to pay down the mortgage (and then borrow to invest) instead of repaying the RRSP HBP or buying RRSP to reduce income tax.


When I've run the calculations in the past, it seemed that the optimal strategy was to extend the HBP repayment to the maximum allowed time period (without triggering tax), and investing in tax-efficient stuff outside the RRSP.

However, the problem you run into is one of leverage. Since you had to do a HBP withdrawal, you likely have minimal equity in the house, and I personally cannot recommend the SM under such circumstances. And mortgage repayment, generally, is preferrable over RRSP contributions, on an after-tax basis. The problem, of course, is that there are so many assumptions you have to make, especially with respect to present and future income tax rates.



I hope this is considered a SM-related question...

I don't recommend the SM until one's LTV is <50%, or their equity is >50% in their house/mortgage.

[Jungle]

I'm just going through numbers, in Ontario, the dividend tax rates are going up every year it seems. At some point, with a higher tax bracket, I don't see how this strategy will work, with higher dividend tax that increases too.

When I work out the numbers, it appears that the lowest tax bracket, (37K and under) will see the most tax refund, because the dividend tax credit becomes a deductible.

Assuming you invest $75,000 in dividend stocks paying a modest 5% cash=$3750. The cost of the loan is 2.5% or $1875.

20.05% marginal tax rate, -6.23% dividend tax= $609 tax refund
24.15% marginal tax rate, -0.32% dividend tax= $464 tax refund
31.15 marginal tax rate, 9.76% dividend tax= $218 tax refund

Thoughts?

[evoviii]

I'm just going through numbers, in Ontario, the dividend tax rates are going up every year it seems. At some point, with a higher tax bracket, I don't see how this strategy will work, with higher dividend tax that increases too.

When I work out the numbers, it appears that the lowest tax bracket, (37K and under) will see the most tax refund, because the dividend tax credit becomes a deductible.

Assuming you invest $75,000 in dividend stocks paying a modest 5% cash=$3750. The cost of the loan is 2.5% or $1875.

20.05% marginal tax rate, -6.23% dividend tax= $609 tax refund
24.15% marginal tax rate, -0.32% dividend tax= $464 tax refund
31.15 marginal tax rate, 9.76% dividend tax= $218 tax refund

Thoughts?

You are thinking too narrowly, the major point of the SM is mortgage interest that was non deductible is converting the equity you build into a investment loan that is interest deductible.

If assuming your loan rate is after the tax deduction for investment. You are putting still putting 1875 + the refund that you wouldn't have gotten without the SM. Over time you aren't factoring in dividend growth (huge part of dividend investing) nor capital gains which form significant portion of gains. If you think the gains vs risk is too high, you are just simply better paying down your mortgage faster.

[cannon_fodder]

I'm just going through numbers, in Ontario, the dividend tax rates are going up every year it seems. At some point, with a higher tax bracket, I don't see how this strategy will work, with higher dividend tax that increases too.

When I work out the numbers, it appears that the lowest tax bracket, (37K and under) will see the most tax refund, because the dividend tax credit becomes a deductible.

Assuming you invest $75,000 in dividend stocks paying a modest 5% cash=$3750. The cost of the loan is 2.5% or $1875.

20.05% marginal tax rate, -6.23% dividend tax= $609 tax refund
24.15% marginal tax rate, -0.32% dividend tax= $464 tax refund
31.15 marginal tax rate, 9.76% dividend tax= $218 tax refund

Thoughts?

So what one could conclude is that the dividend related tax benefits are better if you stop making so much money. Hmmm. I think I will continue earning as much as I can.

Although it doesn't reverse the conclusion the refund for the interest costs also increase with a higher MTR. That shrinks the gap between the various scenarios you've outlined.

[digitalsky]

When I've run the calculations in the past, it seemed that the optimal strategy was to extend the HBP repayment to the maximum allowed time period (without triggering tax), and investing in tax-efficient stuff outside the RRSP.

However, the problem you run into is one of leverage. Since you had to do a HBP withdrawal, you likely have minimal equity in the house, and I personally cannot recommend the SM under such circumstances. And mortgage repayment, generally, is preferrable over RRSP contributions, on an after-tax basis. The problem, of course, is that there are so many assumptions you have to make, especially with respect to present and future income tax rates.

I don't recommend the SM until one's LTV is <50%, or their equity is >50% in their house/mortgage.

Exactly, there needs to be so much assumptions to make in a calculation to determine buying RRSP vs repaying HBP vs paying mortgage, I wonder what method ppl use to determine things like "mortgage generally is preferrable over RRSP contributions".

One discussion is here:
http://www.four-pillars.ca/2007/07/22/repay-home-buyers-plan-or-contribute-to-rrsp/
http://www.four-pillars.ca/2007/07/25/repay-hbp-or-pay-down-mortgage/

The equity I have in my condo unit is ~40% now. Not sure if this is the right way to go, but at the time I thought it would be good to be able to take out part of my RRSP money to "invest" in my home. Another part of the RRSP was already allocated for funds and stocks.

[pitz]

Exactly, there needs to be so much assumptions to make in a calculation to determine buying RRSP vs repaying HBP vs paying mortgage, I wonder what method ppl use to determine things like "mortgage generally is preferrable over RRSP contributions".


Well, that's not a difficult one to answer; paying down a mortgage is tax avoidance. Paying into a RRSP is tax deferral. You have to invest in some very aggressive stuff in the RRSP in order for the tax deferral to be greater than the tax avoidance.



The equity I have in my condo unit is ~40% now. Not sure if this is the right way to go, but at the time I thought it would be good to be able to take out part of my RRSP money to "invest" in my home. Another part of the RRSP was already allocated for funds and stocks.

I'd suggest that you could start the SM on a very, very limited basis, at best, maybe drawing 5% of your equity down for the SM, and aiming to continue to reduce principal on the amount of the loan outstanding from thereafter.

A good plan might be to devote 1/3rd of your contributed equity to the SM, and 2/3rds to permanent principal reduction. So if you pay $6000/year towards principal, you would draw $2k/year down through the SM.

The 'end-game' in the SM must always be, to be debt-free. I know, Fraser Smith writes that he wants to die being millions of dollars in debt. I disagree with this. Debt accentuates volatility, and quite frankly, who wants to be retired and have more volatility than necessary in their wealth?

[kerdon]

You don't get a deduction for repaying your HBP RRSP. You already got the deduction when you first contributed to the RSP.

[pitz]

You don't get a deduction for repaying your HBP RRSP. You already got the deduction when you first contributed to the RSP.

Yeah, but you lose the deduction, ie: you're assessed the repayment as a withdrawal, if you don't repay the minimum amount as computed in the HBP repayment schedule.

The argument is one of whether accelerated repayment should be undertaken, or not. I would suggest, not.

[hcruhcj]

Noob here...great site btw

Wondering if I am in a good position for the SM.

I have a personal residence. Mortgage of $390K appraisal for $460K. VRate of prime -.6
I have an investment property. Mortgage of $280K appraisal for $330K. VRate of prime -.4

Would I be wise into looking into the SM for either of the properties?

Thanks!

[pitz]

Would we be better off using SM (and how do we do this) or just putting down $470k and getting a mortgage of the difference?


"Would sell" and 'has sold', are unfortunately, two different things these days...

You should be able to structure your new loan to have the attached line of credit, which you could then use for the SM.

I'd suggest keeping things very conservative. Maybe aim to draw $60-$100k out, at the rate of $1-$2k/month, for the next 5 years, to go into SM investments.

In this current real estate market, you don't have a great equity position.

SM investments should never be ones that bear a high correlation to real estate, as either prices, or to the industry more broadly. And never buy additional real estate on the SM!.

[kerdon]

"Would sell" and 'has sold', are unfortunately, two different things these days...

You should be able to structure your new loan to have the attached line of credit, which you could then use for the SM.

I'd suggest keeping things very conservative. Maybe aim to draw $60-$100k out, at the rate of $1-$2k/month, for the next 5 years, to go into SM investments.

In this current real estate market, you don't have a great equity position.

SM investments should never be ones that bear a high correlation to real estate, as either prices, or to the industry more broadly. And never buy additional real estate on the SM!.


I have to agree, and what I find interesting is the amount of people wanting to use all their equity all at once to do the SM. Or have very low rick tolerance and then get out when things get hairy.

[Sanchez]

Well, that's not a difficult one to answer; paying down a mortgage is tax avoidance. Paying into a RRSP is tax deferral. You have to invest in some very aggressive stuff in the RRSP in order for the tax deferral to be greater than the tax avoidance.

That's mis-stating the true nature of the deferral - the tax avoidance on the mortgage is only an avoidance of the tax on the earnings of the after-tax capital (much like a TFSA) - while the RRSP defers not only the tax on the investment earnings, but on the income earned to generate that capital in the first place (you invest with pre-tax dollars).

If your tax rates at withdrawal are equal to those at contribution time, the net effect of these dual deferrals is avoidance. Some people will have lower taxes at withdrawal time, in which case the RRSP is better than avoidance, and some will have higher taxes (more than you might otherwise expect due to claw-backs), in which case the RRSP is worse than avoidance.

Based on historical returns, you don't have to invest in anything more exotic than an equity index to easily outstrip the costs of the SM, especially if you are in a high tax bracket. Future returns may be poorer (but future interest rates may be lower, as well).

[tsuri]

Noob here...great site btw

Wondering if I am in a good position for the SM.

I have a personal residence. Mortgage of $390K appraisal for $460K. VRate of prime -.6
I have an investment property. Mortgage of $280K appraisal for $330K. VRate of prime -.4

Would I be wise into looking into the SM for either of the properties?

Thanks!

You could do a lot with your scenario. Is it good for you? no one can answer that for you. We don't know how you feel about risk, we don't know your time horizon's. I'll give you SM's standard line, talk to a financial advisor.

[Jungle]

Anyone know if you can do the SM inside a TFSA to avoid capital gains if you sell your portfolio?

[evoviii]

Anyone know if you can do the SM inside a TFSA to avoid capital gains if you sell your portfolio?

No, as it's a registered account. You can't claim interest deductibility if funds are used to contribute to a registered account.

[Jungle]

What are you supposed to do when your mortgage is paid off?

I read somewhere that Fraiser Smith says to just die with your massive debt from the SM. I don't really like this idea of servicing this strategy when you are on your death bed. How are you supposed to get up and make deposit/withdraws from the heloc? God knows you could be in a home being spoon fed.

I guess you could suck it up and just pay the capital gains (hopefully if there are any)

[pitz]

What are you supposed to do when your mortgage is paid off?


Use the dividends from the SM investments, along with any other income available, to pay off the loan. Besides, when you're really old, you should be increasing your bond allocation according to traditional logic.



I read somewhere that Fraiser Smith says to just die with your massive debt from the SM. I don't really like this idea of servicing this strategy when you are on your death bed. How are you supposed to get up and make deposit/withdraws from the heloc? God knows you could be in a home being spoon fed.


Theoretically, you'd have a Power of Attorney for that...

[Jungle]

Use the dividends from the SM investments, along with any other income available, to pay off the loan. Besides, when you're really old, you should be increasing your bond allocation according to traditional logic.



Theoretically, you'd have a Power of Attorney for that...

THis is a great idea. If I can pay off the mortgage early, 15-20 years before retirement, I can use the available income and time to pay off the HELOC. In the end, I like the idea of having investments that produce steady income, so I can retire early with cash flow.

Big goals I know, but possible.

[pitz]

THis is a great idea. If I can pay off the mortgage early, 15-20 years before retirement, I can use the available income and time to pay off the HELOC. In the end, I like the idea of having investments that produce steady income, so I can retire early with cash flow.


Yeah, if you're buying investments with your SM money, that don't have dividends, or the near-medium term prospect of having dividends, then you need your head examined anyways.

As has been written extensively earlier in this thread, the people who get into managed mutual fund accounts, where most of the dividends are used to pay management fees, are very unlikely to be successful with the SM.




Big goals I know, but possible.

Well even today, you can borrow for 1.25%, and its not too hard to buy, say, the TSX index, that pays out a dividend of roughly 2.5-3%. So every year that such continues, you are knocking off 2% of your loan, which compounds like an amortizing mortgage. Throw in some dividend growth, and wham, over a 10-15 year period, if history is any indication, you can make a real dent in what you owe.

[Jungle]

Yeah, if you're buying investments with your SM money, that don't have dividends, or the near-medium term prospect of having dividends, then you need your head examined anyways.

As has been written extensively earlier in this thread, the people who get into managed mutual fund accounts, where most of the dividends are used to pay management fees, are very unlikely to be successful with the SM.




Well even today, you can borrow for 1.25%, and its not too hard to buy, say, the TSX index, that pays out a dividend of roughly 2.5-3%. So every year that such continues, you are knocking off 2% of your loan, which compounds like an amortizing mortgage. Throw in some dividend growth, and wham, over a 10-15 year period, if history is any indication, you can make a real dent in what you owe.

1.25% borrowing costs? That's really cheap. Where can I sign up? If I can remember correctly, the margin rate on Questrade was not that great..

[Sanchez]

1.25% borrowing costs? That's really cheap. Where can I sign up? If I can remember correctly, the margin rate on Questrade was not that great..

At IB (http://www.interactivebrokers.ca/en/accounts/fees/interest.php?ib_entity=ca) you can get that about that rate as long as your margin balance is moderate (more than about $100k). If you had a P-1 HELOC, you'd have that rate today, as well.

[evoviii]

At IB (http://www.interactivebrokers.ca/en/accounts/fees/interest.php?ib_entity=ca) you can get that about that rate as long as your margin balance is moderate (more than about $100k). If you had a P-1 HELOC, you'd have that rate today, as well.

Seeing I decided to check for balances less than 125k and it's 1.758%, so it's not bad even if you don't make that threshold.

[chinamansteve]

Would the SM work as good with a couch potato portfolio? With the e-Series and the iShares, the dividend yield isn't that great on the US and international funds.... so anyone have any opinion or tips on a couch potato SM?

[Jungle]

Seeing I decided to check for balances less than 125k and it's 1.758%, so it's not bad even if you don't make that threshold.

That's actually really good. Do you think they will raise it up when prime increases this spring? Anyone know what percentage of available margin they give? Around 50% of cash or stock balances in the account?

[Jungle]

Would the SM work as good with a couch potato portfolio? With the e-Series and the iShares, the dividend yield isn't that great on the US and international funds.... so anyone have any opinion or tips on a couch potato SM?


You could end up loosing. The managment fees, low(er) yeilds and borrowing costs could add up to more than your investment incomes, incuding tax deductions.

[chinamansteve]

You could end up loosing. The managment fees, low(er) yeilds and borrowing costs could add up to more than your investment incomes, incuding tax deductions.

I see, so I suppose the SM is only good with individual stocks.

[evoviii]

That's actually really good. Do you think they will raise it up when prime increases this spring? Anyone know what percentage of available margin they give? Around 50% of cash or stock balances in the account?

It's based on BOC prime + certain amount, so yes if the overnight rate goes up it goes up

[pitz]

It's based on BOC prime + certain amount, so yes if the overnight rate goes up it goes up

Technically...its based on CAD$ LIBOR, and not the BoC target rate. During the credit disruptions a couple years ago, CAD$ LIBOR varied dramatically from the official target rate. Currently CAD$ LIBOR has been running around 0.2%, but goes up and down, depending on the daily supply/demand of funds.

[Jungle]

SO can anyone answer, with IB ( I don't have an account yet), lets say you have $10K in cash, about how much margin do they give?

[pitz]

SO can anyone answer, with IB ( I don't have an account yet), lets say you have $10K in cash, about how much margin do they give?

If you buy LSERM stocks, your $10k in cash could command a position up to $33,333. But, because of SMA limitations, you would only be allowed to buy $20k worth.

[Jungle]

If you buy LSERM stocks, your $10k in cash could command a position up to $33,333. But, because of SMA limitations, you would only be allowed to buy $20k worth.

Is this to prevent going over the margin limit?

[evoviii]

Technically...its based on CAD$ LIBOR, and not the BoC target rate. During the credit disruptions a couple years ago, CAD$ LIBOR varied dramatically from the official target rate. Currently CAD$ LIBOR has been running around 0.2%, but goes up and down, depending on the daily supply/demand of funds.

I stand corrected. So would the overnight rate on finance.google.ca be a good approximate?

[pitz]

Is this to prevent going over the margin limit?

No. Its a SEC rule, which IB applies to Canadians.

[pitz]

I stand corrected. So would the overnight rate on finance.google.ca be a good approximate?

Yeah, reasonably.. LIBOR is the UK-based (London) benchmark for CAD$ funding. I suppose the Canadian and the London markets could become unhinged during a massive market event. I'm really not sure, but without wearing a tinfoil hat and spouting conspiracy theories, you can regard them as being similar.

[evoviii]

Yeah, reasonably.. LIBOR is the UK-based (London) benchmark for CAD$ funding. I suppose the Canadian and the London markets could become unhinged during a massive market event. I'm really not sure, but without wearing a tinfoil hat and spouting conspiracy theories, you can regard them as being similar.

I just looked on the page again and saw it is LIBOR for CAD, so it is based on london as you indicated. Looks like any disparities would minor to negligible and wouldn't close the gap to comparable margin rates at other brokerages which is usually prime +.

[chaoslord]

I read most of the pages and people always talk about HELOC.
What if I refinance my mortgage?

Here's my situation : I own a duplex in quebec and 40% of my loan is already interest-deductible (cause I live on the first floor with a basement and I rent the 2nd floor). I am refinancing and will have 70k$ equity, of that we are taking 40k$ for renos.

Can I take the balance (30k$) to invest and claim that portion to be interest-deductible???

It seems pretty simple, dunno if I misunderstood something.

[Jungle]

I read most of the pages and people always talk about HELOC.
What if I refinance my mortgage?

Here's my situation : I own a duplex in quebec and 40% of my loan is already interest-deductible (cause I live on the first floor with a basement and I rent the 2nd floor). I am refinancing and will have 70k$ equity, of that we are taking 40k$ for renos.

Can I take the balance (30k$) to invest and claim that portion to be interest-deductible???

It seems pretty simple, dunno if I misunderstood something.

You can't deduct both rental interest expenses AND borrowed money used for income producing investments. Pick one of the two.

You can use a certain type of refinanced mortgage. It's called a re-advanceble mortgage. For example:

Re-advanceable mortgage: more credit becomes instantly available form every dollar paid on your principle. The available borrowing amount grows higher and higher. This is the key for the SM. You need to withdraw funds and re-service the loan with it this way. Then you put all other income as an extra payment on the mortgage-which should be done as soon possible. This will decrease compounding time and will pay the mortgage off faster.

Regular mortgage: Get a HELOC. Make sure it does the same above. Some banks' HELOCs are a set maximum amount and won't grow larger automatically.

Anything else is not a SM. It's leveraged investing and you with have to service the loan yourself, somehow.

[zzricezz]

Great thread.

Did a lot of reading and I would love to implement this strategy.

I still got $281k left on my mortage with 17k in my BMO readiline.

Am I a good candidate to start this?

Just not sure how much the investment needs to return to make this worth my while. I read that if my return is not high, it might not be worth it and I'm a bit confuse here, if I'm writing the interest off shouldn't I always be up?

[Germack]

Great thread.

Did a lot of reading and I would love to implement this strategy.

I still got $281k left on my mortage with 17k in my BMO readiline.

Am I a good candidate to start this?

Just not sure how much the investment needs to return to make this worth my while. I read that if my return is not high, it might not be worth it and I'm a bit confuse here, if I'm writing the interest off shouldn't I always be up?

Based on your post I can say that you are definitely not a good candidate for this. SM is dangerous and only people who know what they are doing and can stomach a lot of volatility should maybe do it.

[zzricezz]

I left out that I also got 37k in my non registered account, another 63k in my company investment account, I was incorporated when I was doing consulting for a while. Not sure if I should take all the money out to do this. My original plan was to draw it down when I retired.

The only debt I have is my mortage.

[Germack]

The goal of investing for retirement should not be to maximize the chances of getting rich, but rather to allow for a comfortable retirement and to minimize the odds of dying poor.

Doing the SM is very risky. If you are wrong and it did not work out you might be ruined.

[zzricezz]

Maybe this is a off topic question but if I want to 'borrow' money from my company and invest with it, can I write off the interest I would have to pay back my company? My accountant said there is standard interest rate charge and i can't borrow at 0%.

[Jungle]

Great thread. Did a lot of reading and I would love to implement this strategy. Just not sure how much the investment needs to return to make this worth my while.

In my opinion, the SM needs to have a good positive cash flow (after paying the loan, dividend tax, commissions), otherwise it's not worth it. Long term capital gains will not pay your heloc at the end of this month. On a side note, your BMO readline is an excellent product for making it work.



Doing the SM is very risky.

Building a portfolio right now will be a challenge. Interest rates are raising. Dividend stocks don't seem to be a bargain right now; yields are low. Companies are raising dividends slowly (it seems) Add some asset allocation, corrolation strategies inside to safe guard your portfolio, it could be a challenge.

You could keep your money on the sideline waiting to purchase. We might see a market correction in this housing bubble. HST and higher interest rates are coming fast.