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How To Assess If The Smith Manoeuvre Is Good For You

Smith ManoeuvreI have been wanting to write about the Smith Manoeuvre for a long time now since I believe many think they are doing it but aren’t really. In fact, they are simply borrowing to invest. I am not sure why the Smith Manoeuvre term are so often referenced loosely because it has a really high level of risks as you will read. Lets find out if you are in fact doing the Smith Manoeuvre and if you want the level of risks it has to offer.

Related: Smith Manoeuvre – When Should You Consider It

What is the Smith Manoeuvre?

In the true sense as explained by Fraser Smith, the Smith Manoeuvre has the following principle: “After every payment you make, you borrow the principle amount and re-invest it”. In essence, it means that you use the equity in your home to invest (in the qualified investments) and the interest can now be tax deductible. What this means is that for every payment, you would borrow hundreds of dollars and buy investments. Unfortunately, using stocks for this purpose is too expensive and that’s why Fraser Smith recommends mutual funds (MER anyone?). The result is that 20+ years later your $300K mortgage is now a $300K investment loan and you need to hope the investments have appreciated with it as well. Make sure to read the article snippet from Jonathan Chevreau (after you finish reading of course :) ).

Here is a graph showing how the Smith Manoeuvre looks like in terms of debt. Can you see that between your mortgage and the HELOC setup to invest with your borrowed equity stays constant at $300K? That’s the principle outlined by Fraser Smith. I find that quite risky because your debt level never decreases. The interest does become tax deductible since you are not investing with money borrowed from your HELOC but you need to be highly confident in your ability to pay the monthly interest in your HELOC.

Smith Manoeuvre Mortgage

Below is a graph showing the potential cost of servicing your Smith Manoeuvre. Your mortgage payments are fixed for 25 years generally speaking and when you start borrowing from your HELOC to invest, the interests are on top of your mortgage. In the case below, the monthly mortgage payments are of $1,400 for a $300K mortgage at 3.5%. As your HELOC increases, so does your monthly payments. I used 4% for the interest of the HELOC below which is relatively conservative. If you can negotiate, you should be able to have your HELOC at prime.

Smith Manoeuvre Monthly Cost

The major benefit, as outlined by Fraser Smith is that over time your investments should have grown and depending on your investment skills, your assets should grow larger than your loan. At some point, the monthly income from your investment should be able to cover your interests. Based on your ability to service your extra debt, you could re-invest your dividends (or other income) which would definitely accelerate your growth. I won’t outline potential scenarios for an investment growth as there are way too many variables. The easy part is understanding the cost of the process – the benefits really depends on your investment plans.

Note that the setup isn’t all that simple and not all banks or financial planners can set you up properly. Be sure to research your Smith Manoeuvre provider to make sure the setup will allow you to deduct the interest on the loan. Be careful on the mutual funds provided if that’s what you choose – today’s 5 star mutual fund is often tomorrow’s bottom performer.

What is NOT the Smith Manoeuvre?

In simple terms, borrowing money from a HELOC isn’t considered a Smith Manoeuvre. It’s simply using leverage to invest which is perfectly acceptable and will still allow any investors to deduct the interest from the loan from their taxes. Whether the loan comes from a bank or from yourself through any of your line of credit, the government still allows you to receive a tax deduction from the interest on the loan as long as the investments qualifies.

You can also repay it if it pleases you to reduce your debt or you can keep it at the same level if you continue to generate more income than it costs you. Borrowing to invest, I find, is much more manageable and you can pick your investment options based on the overall amount you borrow. For example, if you decide to borrow $20K, than you could put $4,000 in 5 dividend paying companies (REITs will complicate your taxes but they are also an option).

Can You Stomach The Smith Manoeuvre?

I have read about it many years ago after purchasing my first place but I could never pull the trigger because the debt level isn’t supposed to be reduced. As Fraser Smith explains, you always borrow the equity paid from your mortgage. That means your debt servicing level never goes down and it requires any investors to be extremely diligent about their finances to manage the debt servicing. More so if you use a line of credit with a variable rate since the payments will fluctuates over time.

There are 2 things you need to do a Smith Manoeuvre:

  1. The ability to service a higher debt over time until your mortgage is paid
  2. A solid investment plan for ensuring growth
It’s also worth noting that the bank (or lending financial institution) will get all the money it expected through the mortgage payments. There are no substitutions there and the only way to reduce the interests the bank earns from you is to accelerate your payments, manage your mortgage rate or make lump sum payments. In short, the Smith Manoeuvre is just a fancy name for accessing all the available equity in your home and investing it as you make your payments.

Readers: Are you doing the Smith Manoeuvre as outlined by Fraser Smith? Are you contemplating it? What do you think of the risk level?

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29 Responses to "How To Assess If The Smith Manoeuvre Is Good For You"

  1. Ed Rempel says:

    Hi PIE,

    That’s a well-written article.

    There is one part of the Smith Manoeuvre process that you don’t quite have right. The monthly cost from your cash flow is normally only your mortgage. Therefore, your payments stay the same.

    The credit line interest is best capitalized, which means that the credit line pays it’s own interest. There is a tax reason for this. If the interest on a credit line is tax deductible, than the interest on the interest is also tax deductible. So, why would you use your cash flow to pay the tax deductible interest when you could use that cash flow to pay your non-deductible mortgage.

    If you have a readvanceable mortgage, then you automatically gain credit available with each mortgage payment. This extra credit available is what you can use to reborrow both to invest with the Smith Manoeuvre and to pay the interest on the tax deductible credit line.

    There is zero income from the investments necessary for the Smith Manoeuvre. When we set it up, we normally try to have little or no tax on the investments, so that we can get the maximum tax refund (to reinvest).

    Since you like dividend investing, you can use the dividends to increase your mortgage payment, which would pay your mortgage more quickly. Then you would also have more credit become available with each mortgage payment, which means you can reborrow that much more to reinvest as well.

    Just so you know, we modeled it. If you compare using dividends vs. tax-efficient investments with no tax, the dividends will pay the mortgage off more quickly but have a lower long term benefit. That is because of the “tax bleed” of lower tax refunds.

    The Smith Manoeuvre should only be done as part of a long term plan, such as your retirement plan. It should not be done just to pay your mortgage off more quickly.

    I hope that is helpful, PIE. Otherwise, that was a well-written article.

    Ed

    • The Passive Income Earner says:

      @Ed

      Thanks for sharing the details of the loan setup. I found very little on the setup of the loan and therefore I assumed the payments would increase since you are borrowing more. With keeping the payments fixed, it does make it less risky from a cash flow perspective.

      I actually looked at your site :) and I could not see any details about the overall debt servicing. I would have signed up for a seminar but I am too far west. I am glad you stopped by.

      The 2 key points about the setup are:
      - A capitalized line of credit since the interest on the interest is also tax deductible
      - A readvanceable mortgage to efficiently access your credit. (This one I assumed but not the prior point)

      On that note, I need to update the graphs with the capitalized line of credit since it does change how money flows.

  2. Dan says:

    Hi PIE,

    My two cents; you’ve used 4% interest rate which you state is conservative. This isn’t really the case, historically prime has been much higher than 3%. Over the 25 year loan, this will likely average more than 4%.

    Other than that it’s a well written article. I’ve never heard of this investment strategy. My concern would be the nerves, most investors twitch at the first major slump in any asset. If you had your mortgage pinned to these same investments, you’d need ice water in the veins.

    Dan

    • The Passive Income Earner says:

      @Dan

      Thanks for your comments. I agree about the interest rates being on the low. I wander what the average is over the past 25 years? 7% is probably a better one. I have to do one update with a capitalized HELOC to show the difference and I may just update it.

  3. Great article and well done.

    I too, have read about this many years ago after purchasing my last house, but couldn’t get the nerve to do it.

    I’m not comfortable with servicing debt, I figure I have enough with my mortgage and I enjoy seeing the numbers tick down.

    I guess I’m a pretty conservative investor at the heart.

    Mark

  4. Bill says:

    Nice article, with the clarifications Ed R. mentioned.

    I started this about 18 months ago. My mortgage is well under control after 18 years, and I have not leveraged my house to the max. My total is set based on what my house was worth 7 years ago, and then I have split off a reserve for true emergencies on the LOC (furnace, roof, etc.). I then use the rest for the SM (separate accts keeps accounting simpler too).

    I am capitalizing the interest monthly, and using the dividends received to accelerate the mortgage repayment; re-borrow the difference; repeat for many years …

    So far I am pleased. My total debt has not changed, and my stocks today are worth pretty darned close (1-2% less) what I have borrowed plus the interest. If I had to sell today for some reason, I would be on the hook for that difference. At times they have been worth more than what I owe.

    A big risk is dividend cuts, though I have not had any personally.

    Once the mortgage is paid off (in about 7 years for me, maybe 6), then I will direct all the dividends to mortgage repayment.

    • The Passive Income Earner says:

      @Bill

      Thanks so much for sharing your experience! I really appreciate that. I think the one key aspect when planning is that everyone estimate the value of the investment and it’s nice to see a concrete example.

  5. LJ says:

    A lot of useful info, much appreciated. Anyone heard of the smith maneuvre juiced up? I was approached with a proposal to use the smith m and on top to borrow a significant amount of money to be invested with a guaranteed 8% return paid in monthly dividends, to be applied towards my mortgage payments. This is in a nutshell, once the mortgage is paid off the payments made toward the mortgage would go into an rrsp account and the remaining monthly dividend would got towards paying back this larger ampunt of borrowed money that is invested. If all goes well i could be mortgage free and have a large rrsp plus a large amount of cash available at my disposal in about 20 years. Any thoughts?

    • The Passive Income Earner says:

      @LJ
      I am going to have to think about this a little. Any mention of a “guaranteed 8% return” is over selling in my book. There are no guarantee of return on investments.

      Did you model the scenario on how your money would move with proper interest calculations? I started model the scenario with a capitalized line of credits and in the end, the interest chew up a fair chunk of your potential invested capital so you never end up investing the entire amount of the mortgage but your load is still constant and you have to be good at investing to ensure your capital invested grows.

      There must have been some sad people in 2009 …

    • 8% in monthly dividends is a dream IMO. Don’t drink that Kool-Aid. 3-4% is realistic given this strategy usually means you don’t take on a lot of risk.

    • RAMU says:

      You should run as fast as possible if someone mentions about 8% garunteed income. Dont even wait for him to complete his sentence :)

  6. I’ve though of the Smith Manoeuver years back but it doesn’t fit with my strategy of paying off the mortgage asap. So I’m sticking with using leverage to invest, for now.

    Great article!

  7. Ed Rempel says:

    Hi LJ,

    The strategy you are referring to is called the Smith/Snyder. You were not told the whole story. It is not a guaranteed return of 8%. The guarantee to take 8% out of the PRINCIPAL of your investment each year and give it to you.

    The strategy normally works something like this. You take an investment loan of $150,000. You invest in a mutual fund that has a fixed monthly distribution of 8%, that is normally paid out of the principal. This is called “return of capital (ROC)”, since they are giving you back your own money.

    The investment gives you $1,000/month which you pay down on your mortgage. Then you reborrow from a credit line and reinvest the $1,000.

    The result? You paid your mortgage down by $1,000, but now $1,000 of your investment loan is now non-deductible (because you cashed in $1,000 of the investment).

    You pay your mortgage down more quickly, but replace it with an investment credit loan that is NON-DEDUCTIBLE. Normally, after about 12 years, the entire $150,000 investment loan is not deductible.

    That is one of the strategies we sometimes use for clients doing the Smith Manoeuvre retire and need to start taking retirement income. It is an income strategy – not a growth strategy. It also does not reduce non-deductible debt.

    If you still have a mortgage and are not needing income today, I think this strategy is a huge sales pitch with no benefits.

    In fact, the Smith/Snyder usually means you are limiting your investments to those that have a big monthly distribution, instead of being able to choose the best investments based on risk and return.

    If you do the Smith Manoeuvre with a similar amount of leverage, you should expect to be better off long term than with the Smith/Snyder.

    Ed

    • The Passive Income Earner says:

      @Ed

      Thanks for sharing Ed. I had not heard of the Smith/Snyder strategy. As you say, I don’t see any benefits from it. The Smith Manoeuvre has more benefit potentials. I starting modelling a scenario with a capitalized line of credits and there are many cash flows to take into account – including the tax credit one would get. I just want to get it right so it will be the topic of a future post.

    • LJ says:

      Ed, thank you for the feedback, very valuable information. Since I am not very familiar with investing and tax rules I truly appreciate all the replies.

  8. scrouge says:

    PIE ditch the CAPTCHA Code…. its a real pain…it seems to not be able to read its own code.

  9. Ed Rempel says:

    Hi PIE,

    Wow, you have Rob Carrick quoting you??? That’s cool!

    We purchased a Smith Manoeuvre calculator from a guy that goes by Cannon Fodder. It is quite good. He apparently just retired in his mid-40s, so I’m not sure if he still sells his calculator, but you may be able to find him in the blog world, especially the Million Dollar Journey site.

    If you have strategies or simulations you would like to try, you could also post the variables and I can run them for you. The calculator produces results, but also has a nice graph. I’m not sure how I could post the graph, but let me know if you want to try something, PIE.

    I need to help you, since you have Rob Carrick’s ear… :)

    Ed

    • The Passive Income Earner says:

      @Ed

      Thanks for the info on the calculator. Do you plan on having the calculator on your site?
      As for Rob Carrick’s ear, I just got lucky there :) but it’s definitely nice.

      Cheers!

  10. Ed Rempel says:

    Hi PIE,

    It is not my calculator. Cannon Fodder wrote it and then he created a special version for us with some of our unique strategies.

    We have it, though, so if any of your readers want us to run a scenario, we can post the results.

    Ed

  11. JL says:

    Hi PIE, great article and comments. I’ve been looking into the Smith Maneuver for a while now and want to make sure that I know the specifics before I start anything. Can you provide any detail about the steps required for using the room in your re-advancable mortgage to purchase investments? The borrowing from yourself part is a little unclear to me as I’m not seeing how this is identified on your taxes.
    Thank you

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  13. Mark Huber says:

    Hi all

    I found that for my clients the SM was hard for them to understand and harder to implement and maintain…

    So I revised the strategy and presented the system that simplified things 100%.

    I wrote about this in “The UnCanadian Way To Get Rid Of Your Mortgage And Create Wealth”…

    Now, in my opinion, because of following conventional Canadian “financial advice”, all to many Canadians may be forced to fund their retirement with their home equity – assuming the real estate market holds…

    To combat this scenario, I’ve written a new report entitled,

    “The 10 Top Myths Of Canadian Home Ownership – Exposed”

    and was wondering if I missed anything…

    You can pick up your free copy at: HowToGetRidOfYourMortgage.com

    I would welcome your thoughts and comments.

    Cheers!

    Mark Huber, CFP
    HowToGetRidOfYourMortgage.com

  14. LifeChanges says:

    Hi, I have been doing the true SM for 4 years now. In my 40s I found myself single again and starting a brand new career. As a result I am lacking in the retirement security department. I felt that the SM was the best way to find that security.

    I pay my mortgage weekly, remortgaged at a lower rate but kept the payments the same, use the monthly dividends and tax return to pay down the mortgage and as much as possible pay an extra lump sum down on the mortgage every month.

    The LOC pays the interest on the LOC.

    I am diligent in my application of the SM and I truly believe that it is a good strategy provided that you can view it in the long term. Whilst at the moment the fact that selling my investments wouldn’t cover the full amount of the investment loan makes my blood run cold, I put it aside. No point worrying about it until I come to retire. Hopefully between now and then there will come the ideal time to sell and pay the LOC debt so that I enter retirement mortgage/LOC free with a tidy amount of funds supporting me.

    Everything in life is a risk, we no longer have the security of a “job for life” which ends with a good pension and stocks. Those days were lost in the 80s!

  15. DocW says:

    I’m debating using the smith maneuver for my primary residence. I’d appreciate anyone’s critique of my strategy.

    Professional, self employed 2 years out of dental school.

    Home value 150K mortgage left 94K no other personal debt.

    Monthly revenue between 15-20K before tax.

    Currently my professional corp is paying 15% tax on the income and what I take as personal dividends I pay varying rates on between 0-26% depending on the income level.

    My investment idea would be to put the money in either a REIT or a MIC and use a dividend reinvesting plan. Though many here make valid points about using the dividend to pay down debt.

    I don’t really have a cash flow problem, though I’d like to pay less in tax (who wouldn’t) but my main concern is I currently have a low net worth of between 65-70K due to aggressively paying off education debts.

    • @DocW

      From a cash flow and loan servicing perspective, it looks like you are in the clear. How long do you have on your mortgage? How long do you want to have it for? If you want to pay less interest (which is what you end up managing with the tax deductible interest) than you can also accelerate paying your mortgage. You may essentially only have 5 or so years left compared with someone that has a 25 year mortgage.

  16. DocW says:

    I’ve got a 15 yr mortgage – and only about 9 months in thus far. My main motive for the smith maneuver is to get low risk interest on the capital I’ve got tied up in the property. I will continue to pay it off at a fast rate, however would like to start investing soon.

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