Allocation with some SM

[Loon]

320K total, about 1/3 in Smith Manoeuvre (SM) and needing yield.
36 years old, Double income total 170K, 2 kids under 3.
Was working with advisor for the last 10 years.

Asset Class	%	Registered CDN$	Registered US$	CDN$ (All SM)
CDN	25	HXT	-	PPS, stocks?
US	20	HXS	VTI	-
Global	10	-	VEA	-
Emerging	10	-	VWO	-
Real Estate	10	-	-	ZRE
US Junk	10	-	-	CHB
CDN Bond	10	-	-	XHB
Cash	5	-	-	-

I see rebalancing being an issue given upwards of 12 accounts (rrsp-$CDN, rrsp-$US, tfsa, resp, lira, non-reg)x2. Is this too many asset classes? I left out small and mid for this reason but kind of want to add them. Feedback please!! And ideas to get yield for SM please!

[Soils4Peace]

Borrowed money is a negative cash allocation, so I don't get the 5% cash allocation. Why not just let dividends sit around until you need to rebalance (~0 to 3%).

I think you are ok with 15% REITs: that will help with interest payments.

[Loon]

Borrowed money is a negative cash allocation, so I don't get the 5% cash allocation. Why not just let dividends sit around until you need to rebalance (~0 to 3%).

Interesting point. I was not really getting the cash allocation to begin with. Just trying to fit in It was making more sense to me to hold back some of the home equity credit for the next rainy day, or a market crash. If there are any threads or other reading on the rationale of the cash allocation please share.

I think you are ok with 15% REITs: that will help with interest payments.

This makes sense to me, thanks.

[andrewf]

XHB and CHB are both US high yield. The Canadian high yield market is vanishingly small compared to the US market.

[Loon]

XHB and CHB are both US high yield. The Canadian high yield market is vanishingly small compared to the US market.

Ok, I didn't notice that. How do I diversify my bond holdings, or do I need to? Is it ok to shift most of my bonds to CHB for their value in SM? Is it really just a function of how much risk I want to take on? How about 15% CHB for SM and 5% something of higher quality in RRSP?

[Loon]

Borrowed money is a negative cash allocation, so I don't get the 5% cash allocation. Why not just let dividends sit around until you need to rebalance (~0 to 3%).

Perhaps instead of a 5% cash allocation I can balance to having room in my home equity LOC equal to 5% of total assets. That would have me buying faster in a bear market and slowing down in bull. It seems like that would serve the same purpose as a cash allocation in a non SM portfolio.

[andrewf]

There are some tricky rules around SM that would make me discourage using CHB (it distributes only ROC and capital gains) and any other bond fund (some issues around borrowing at a higher rate than bonds you purchase). It seems safer (you're likelier to stay on the right side of the rules) if you borrow to invest in equities/REITs. You can consult a good tax accountant, but they are likely to advise you to err on the side of caution. It seems to me that CRA doesn't like these kinds of structures, but is hampered by law/SC rulings in cracking down. So don't leave any flanks uncovered.

Are you doing a real SM, or just leveraged investing? If you intend to use all the cash flow from the 'SM' assets to pay interest and principle on the investment loan (or reinvest in the same account), that also makes things simpler. I would also caution against using the Horizon ETF for a SM account, as it holds swaps rather than equity, and may have clauses in the prospectus preventing it from distributing income.

[Loon]

Are you doing a real SM, or just leveraged investing?

I was doing leveraged investing with an advisor who also did my taxes. At the time I had a mortgage but no Home Equity LOC. I've since bought a house and converted the investment loan into a mortgage chunk. HELOC is now growing and I'll start to buy from it in due course. This year for the first time I borrowed back last years interest based on the 'capitalization of interest' principle and used it and my tax return to pay down the mortgage. I ran that by my new tax guy and he was all for it. That leaves all the dividends free to pay down the mortgage, which is my intention. So long story short I'm converging on the classic SM.

I'm not working with the advisor any more and am in the process of selling his high MER products. I would very much like to avoid ROC and the fancy calculations but it seems like all ETFs pay ROC. I'd go all stock but the wife is leary about the lack of diversity. I'm not done with her yet so she may come around.

If she doesn't come around, it sounds like I'm ok to simply take only dividend income out of the account to pay down the mortgage and leave the ROC portion in the account as cash and reinvest at rebalancing time?

I would also caution against using the Horizon ETF for a SM account, as it holds swaps rather than equity, and may have clauses in the prospectus preventing it from distributing income.

The horizon products are intended for the RRSP to make up the difference in CDN Equity and help me balance the accounts. The low MER seems good. But still, could you elaborate on the this swap issue?

[Four Pillars]

Borrowing to invest means you are increasing your investment risk. Before doing any borrowing, it makes sense to increase your portfolio investment risk and then borrow on top of that.

In other words, you should convert any cash and fixed income to equity.

[Loon]

Borrowing to invest means you are increasing your investment risk. Before doing any borrowing, it makes sense to increase your portfolio investment risk and then borrow on top of that.

In other words, you should convert any cash and fixed income to equity.

Is that a challenge? That's a very interesting POV and I think I follow you, but I don't see this as purely leveraged investing for two reasons. First, the tax savings on the interest provide a margin of safety, which is true for anyone in a sufficiently high tax bracket. Second, by paying to down the mortgage to generate credit I'm eliminating a bad debt, which would not be true if I simply took out an investment loan.

For these reasons I don't completely do away with fixed income but I will keep it as an asset class and limit the amount and tend to keep it in higher yield products.

I'm not a mathematician but I'd bet that a case could be made for SM providing higher returns with less risk, assuming of course you will have a high income for the life of your mortgage.