Smith Manoeuvre

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..

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.

never mind...

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.

SirloinofBeef wrote: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

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.

fraser wrote: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.

Paksis wrote: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"?

str wrote: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

rain111 wrote: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".

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?

gnunn wrote: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?

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.

Cake wrote: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.

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.

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.

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.

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.

AGF has a investment loan service (http://www.agf.com/static/en/products_s ... /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.