# New to the board...may implement Smith Manoeuvre and looking for input



## yask72 (Mar 11, 2012)

Hey everyone,

I have been searching the net for the better part of the past month looking up information on the Smith Manoeuvre. I have been debating on whether or not to make the move and attempt the SM. I was wondering if i could get some input from those of you who have implemented the SM, or who are familiar with the strategy. Here is my situation:

I am mid 30s and was recently approved for an RBC Heloc totalling 25K. This would give me 25K to start the SM strategy. I only bought my house a couple of years ago and still have about 240K left on my mortgage. My rate on the heloc is 3.5%. I am definitely in this strategy for the long haul and i want to keep it simple for tax purposes as well. As such, i am only looking at Canadian Dividend Stocks. 

Here are the stocks i am looking at as a starting point (looking to start with 4-5):

Bank of Montreal (BMO) and/or Bank of Nova Scotia (BNS)
TELUS (T)
Pembina Pipeline (PPL) 
Husky Energy (HSE)
Encana (ECA)

Other notes:
- I plan on using my heloc to pay the interest so that it will not cost me any additional Cash Flow to pay the interest on the HELOC.
- I will be paying commission from my regular bank account to keep those items separate and a clean papertrail

Now that you know my situation here are some of my questions: 

1 - Should i start my portfolio with 4-5 stocks? Or should i focus on 1 or 2 and worry about diversification as my portfolio grows?
2 - All of the stocks listed above have a dividend yield rate about 4%. Is this enough of a yield? (i've been unable to find a SM calculator that i understand that can help me forecast)
3 - What are your thoughts on the stocks i have identified and are there others that you would recommend.
4 - There are some other stocks i am interested in for growth purposes, but the yield is only 1-2%. Do i bother with these? i guess this ties in to question 2. 

All your feedback would be greatly appreciated. I would consider myself an average investor but i am definitely a newbie to the SM strategy and i am looking forward to having a constructive discussion. 

Thanks a bunch!


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## Soils4Peace (Mar 14, 2010)

You will need an investment policy statement, which will guide you in these decisions. Some general points:

1. Diversify. If this is your only investment, then index ETFs might be better. 
2. If you go with individual securities, avoid those with high debt ratios, otherwise you will get a double hit if interest rates rise.
3. Don't feel particularly tied to dividend yield, as it is a false measure of quality. You can sell for capital gains or losses, or make small redemptions here and there with low cost mutual funds when needed to meet payments.


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## Patience (Mar 8, 2012)

You will want more than 5 stocks, especially since you listed 3 energy companies which puts you at a higher sector risk. In general you should try probably try to find at least 10 stocks across 5 different industries that match your investment criteria. You might even want to consider a dividend-based ETF.

Only you can answer what's enough, although obviously a 1% dividend means you aren't covering your LOC interest payments.


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## doctrine (Sep 30, 2011)

Is your mortgage a RBC Homeline one, i.e. does your HELOC automatically increase as you pay down your mortgage? That is really the point of the Smith Maneuver - every month you can withdraw more once you reach your maximum, and pay down your mortgage faster and faster while DCA'ing at the same time.


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## yask72 (Mar 11, 2012)

Sorry...double post


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## yask72 (Mar 11, 2012)

Yes, its an RBC homeline plan, therefore it increases as i pay down my mortgage.

As for the other advice i appreciate your response. The reason why i am focusing on canadian dividend paying stocks is because that is how best to make the SM strategy work....as i understand it anyway.

As well, i understand i need a diverse portfolio, my question was more along the lines of being as i have 25k to start the SM strategy, is it best just to divide and purchase 4-5 stocks and/or simply chose 1-2 as a starting point and diversify as i go along being as i will be in this for the long haul. 

Thanks again!


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## doctrine (Sep 30, 2011)

Definitely better to have 5 positions with $25k than 1 or 2. 

Much better for SM to start with a stock that yields 4-5% with growth, rather than a 1-2% yielder. Cash flow is important 2% yield at 15% growth will take 5 years to even get to 4%. Meanwhile, the 4% stock at 10% growth will be yielding 6.5% on the purchase price.

You could try Constellation Software to diversify. They are making a lot of money, paying a 4.2% yield and are expected to increase dividends.


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## yask72 (Mar 11, 2012)

doctrine said:


> Definitely better to have 5 positions with $25k than 1 or 2.
> 
> Much better for SM to start with a stock that yields 4-5% with growth, rather than a 1-2% yielder. Cash flow is important 2% yield at 15% growth will take 5 years to even get to 4%. Meanwhile, the 4% stock at 10% growth will be yielding 6.5% on the purchase price.
> 
> You could try Constellation Software to diversify. They are making a lot of money, paying a 4.2% yield and are expected to increase dividends.


Thanks for the input. My only concern with Constellation is that it is trading near its 52 week high and has soared the past 3 months. I will definitely keep an eye and maybe look for a sign of weakness. I definitely like their financials, seem solid with no debt. 

Thanks as well for your rational between chosing the differen yields. I agree with you that i should concentrate on those with higher yields, especially as i am just starting the SM. Maybe as i get further in and my portfolio becomes more established i can look at adding those stocks that i find attractice but that only yield 1-2%.


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## andrewf (Mar 1, 2010)

If you have the cashflow to cover the investment loan (which you should if you are considering SM), I would not focus exclusively on high dividend yield. Attractive companies with low payout ratios and low dividend yields are fine. Yes, you may have to supplement the dividends to cover the loan repayments, but you will be getting tax deferred capital gains, which are better than dividends if you are holding for long periods.


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## Echo (Apr 1, 2011)

Frugal Trader noted some reasons why he doesn't use a dividend ETF for his SM portfolio - http://www.milliondollarjourney.com/why-i-dont-use-a-dividend-etf-for-my-leveraged-portfolio.htm


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## yask72 (Mar 11, 2012)

andrewf said:


> If you have the cashflow to cover the investment loan (which you should if you are considering SM), I would not focus exclusively on high dividend yield. Attractive companies with low payout ratios and low dividend yields are fine. Yes, you may have to supplement the dividends to cover the loan repayments, but you will be getting tax deferred capital gains, which are better than dividends if you are holding for long periods.


Although i do have the cash currently to cover the initial loan, i intend to capitalize the interest so that it does not affect my current cash flow. I want the SM strategy to be completely self sufficient, rather than make a dent in my current cash flow. 



Echo said:


> Frugal Trader noted some reasons why he doesn't use a dividend ETF for his SM portfolio - http://www.milliondollarjourney.com/why-i-dont-use-a-dividend-etf-for-my-leveraged-portfolio.htm


Thanks. I have actually read that site quite thoroughly. What i like in particular is the fact that he divulges his financial situation and he does seem quite objective. It's refreshing to see that instead of people saying "SM sucks" or the "SM rocks" without providing any concrete evidence to support their point.


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## Zeeshan Hamid (Feb 28, 2012)

In general if you're going to carry both mortgage and have investments, it's better to pay off the mortgage and have a loan for investments. In general. Specifically, do you have RRSP and TFSA contribution room? For your income etc. (no idea what tax bracket you're in), maximizing RRSP / TFSA may be a better option. Do you have other savings? How long have you invested? 

I can't tell you how many people I know pulled their money out in early 2009 after the 2008 stock massacre. They missed out on huge appreciation that came afterwards. A lot of these strategies look really good on paper, but if you're new to investing then you should stay as far away from "borrowing to invest" as humanly possible. I also know someone who, when stocks were at the bottom and it seemed like all hell was going to break lose, he maxed out his home equity to put everything in the stock market. 

BTW, I rode out dot-com, post-9/11-crash and the 2008 crash without losing any sleep whatsoever. Unless you've gone through it with your investments, you dont really know how your stomach will handle it. 

Here's a scenario: interest rates rise to 5% and stock market goes through a 20% correction. Suddenly you owe the bank $25,000, paying 5% (albeit tax deductable) interest and you're investments are only worth $20,000. Every new article you read tells you about the impeding crash of stocks. What do you do? 

Honestly, for most people simply maxing out RRSP and TFSA, and paying off mortgage early (guaranteed rate of return) is the best option. I am not saying "SM sucks", I am simply pointing out that it's essentially borrowing money to investing in the stock market (that's inherently risky, especially in the short term). That strategy isn't for novices (dont know if you're a new invester or not btw).


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## FrugalTrader (Oct 13, 2008)

The difference is that he can perform SM *while* maxing out RRSP/TFSA or paying off mortgage. SM does not need to utilize any of his own cash flow as he can capitalize the interest (use the HELOC to pay for itself).

The only comment I have is to make sure that you are looking at the big picture. If you are investing in Canadian stocks for your leveraged portfolio, make sure you that you have exposure to other markets in your RRSP/TFSA. Even though the Canadian market is small, I would diversify by sector, and not just use yield as your investment criteria.


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## yask72 (Mar 11, 2012)

I have been having an internal debate with RRSPs for some time. I have also talked with my financial advisor and he is somewhat of the same mindset as myself. My RRSP crashed to about 50% of their worth back in 2008 but i rode it out and i am back to where i started. I took over control of my RRSPs two years ago and have done better managing them myself then putting them into whatever funds my bank advisor was promoting at the time. I am now back in the black and showing growth. My problem is that i have a very good pension plan. At my current income (75K) i know i will retire on a very, very good pension. I have stopped the contributions to my RRSP for that reason and have focused more on RESP for my daughter who is just over 1 year and will pick up my TFSA contributions shortly. 

I know there is risk with the SM strategy, that being said, i am not looking at this as a 5-10 year plan. My plan is more of the 15-20 year variety. Historically, the market has rebounded from it's major crashes and if you resisted temptation to panick and held your stocks, in the long run you would be ahead, and this is how i am approaching it. Besides...my simplistic view (as flawed as it may be) is as follows: if the market goes belly up and NEVER recovers we will have much bigger problems in the world than my measily mortgage and LOC.


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## andrewf (Mar 1, 2010)

If you capitalize the interest, you don't need to have the investments flow enough cash to cover the investment loan. You need your principle repayments on the mortgage + dividends > capitalized interest. If you have any extra cash flow to save, pay off the mortgage.


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## Zeeshan Hamid (Feb 28, 2012)

FrugalTrader said:


> The difference is that he can perform SM *while* maxing out RRSP/TFSA or paying off mortgage. SM does not need to utilize any of his own cash flow as he can capitalize the interest (use the HELOC to pay for itself).
> 
> The only comment I have is to make sure that you are looking at the big picture. If you are investing in Canadian stocks for your leveraged portfolio, make sure you that you have exposure to other markets in your RRSP/TFSA. Even though the Canadian market is small, I would diversify by sector, and not just use yield as your investment criteria.



I was just pointing out the risk. There's no guarenteed way to capitalize the interest, there's risk involved. Most inexperienced investors under-estimate risks involved and over-estimate their risk tolerance.

Some people get excited thinking they're making their mortgage interest deductable. They're not. They're making a leveraged investment (borrowing money to buy stocks). For instance, I have a huge line of credit at prime (currently 3%) without having to do HELOC or mortgaging my home. I can do the same thing with same result. The whole discussion about "doing this will make your mortgage interest tax deductable" is just a distraction and not entire accurate. Interest on loan used to make investment is deductable as a carrying cost. Nothing to do with mortgages. 

BTW, nothing wrong with that, but I do think people should be experienced investors before they start borrowing to buy stocks. IMO of course.


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## Eclectic12 (Oct 20, 2010)

Zeeshan Hamid said:


> [ ... ]
> 
> Some people get excited thinking they're making their mortgage interest deductable. They're not. They're making a leveraged investment (borrowing money to buy stocks).
> 
> ...


While this is true ... from the response of those I've talked to, the description effectively opens doors to an option a lot of people haven't and usually don't consider.

Then too, my HELOC is tied to the value of my house and is from the mortgage company. Yes, the mortgage interest part is not deductible but the equity portion of the HELOC is available for leveraged investing and stays within the limits of the granted mortgage. It is also not perceived as an added risk as the mortgage used to be that large anyway.


As for qualifying for a LoC at competitive rates - sure, the same can be achieved. 

The question is how many people are lucky enough to qualify for a LoC at a competitive rate at a similar size? Based on the conversations I've had, there don't seem to be a lot.


Finally, is your LoC growing over time? Or would you need to re-qualify for a larger amount? Each mortgage payment I make increases the amount available to me for leveraged investing, with no effort on my part, which IMO is an advantage over a regular LoC.


+1 on being an experienced investor .... or have worked out a "coach potatoe" strategy that takes into account the requirements of leveraged investings.


Cheers


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## Zeeshan Hamid (Feb 28, 2012)

My apologies to OP for hijacking the thread . Back to the original topic.


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## yask72 (Mar 11, 2012)

Zeeshan Hamid said:


> My apologies to OP for hijacking the thread . Back to the original topic.


Haha, no worries, it was a relevant discussion to the topic at hand.

Is there anyone on here aside from FT that has implemented the SM strategy?


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## Eclectic12 (Oct 20, 2010)

yask72 said:


> Haha, no worries, it was a relevant discussion to the topic at hand.
> 
> Is there anyone on here aside from FT that has implemented the SM strategy?


+1 on the sidebar being related to the thread. I've seen other threads wander far worse.


Getting back to topic - it's probably closer to leveraged investing than a SM but yes, I've being doing something similar since 2008. It's not quite a SM because I'm not doing the "roll the equity paid off by each mortgage payment into investments" part. IMO, that is a key identifying feature of the SM.

I dived in for about 16 stocks between Nov 2008 and July 2009 - though in Mar 2009, if I'd checked how little my interest payments were, I would have bought far more.

Since then I've added probably about seven more stocks or added to the existing position, liquidated about three big gainers to maximise my mortgage prepayment ( biggest gainer was the split corporation for +207 CG, which paid 52% of purchase price in distributions in 21 months) and will be mortgage free in Oct this year!

My HELOC is at 3% and most of the shares purchased pay a 5% dividend or better.

Now that the market is moving sideways, I've been month trading POT as well (buy for about $43, sell for just over $47). I figure I like POT anyway so if I have to hold it a while, there are worse things that could happen.


Cheers


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## FrugalTrader (Oct 13, 2008)

Zeeshan Hamid said:


> I was just pointing out the risk. There's no guarenteed way to capitalize the interest, there's risk involved. Most inexperienced investors under-estimate risks involved and over-estimate their risk tolerance.


Agreed, as I've pointed out numerous times on my blog, SM is simply a leveraged investment strategy. With that, gains will be amplified, but more importantly, so will losses. If the investor can't stomach a 40% correction, like 2008/2009, with your home equity on the line, then it may not be the best strategy.


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## Four Pillars (Apr 5, 2009)

yask72 said:


> Is there anyone on here aside from FT that has implemented the SM strategy?


I'm not sure too many people (including FT) are doing a 100% true SM, although at this point I think the term "SM" can also be used for leveraged investing.

I did some leveraged investing for a few years, but I stopped. I wrote way too much about my experience:

http://www.moneysmartsblog.com/smith-maneuver/


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## Eclectic12 (Oct 20, 2010)

Four Pillars said:


> I'm not sure too many people (including FT) are doing a 100% true SM, although at this point I think the term "SM" can also be used for leveraged investing.
> 
> I did some leveraged investing for a few years, but I stopped. I wrote way too much about my experience:
> 
> http://www.moneysmartsblog.com/smith-maneuver/


I suspect the bulk of those doing a true SM are going through some sort of financial advisor or are using a "coach potatoe" strategy.


Cheers


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## yask72 (Mar 11, 2012)

Four Pillars said:


> I did some leveraged investing for a few years, but I stopped. I wrote way too much about my experience:
> 
> http://www.moneysmartsblog.com/smith-maneuver/


Thanks for the link. Read through it and something stood out that i have not read before or maybe i never properly understood it. Can you explain this piece _ "Although the interest rate is tax deductible, when the rates goes up the amount of non-deductible interest goes up as well and this results in a lower profit or higher loss for the investment plan."_

To keep things simple....say this year my initial borrowed amount is 25K @ 5%. As i understand it, on this year's tax return (2012) the total amount of interest 1250 is tax deductible. Say next year (2013) the interest rate increases to 6%, does this mean that not all of the interest is tax deductible on my 2013 taxes? Sorry if this seems like an obvious answer and maybe it's the way i am reading this, but i don't quite understand that statement. 

Thanks for everyone's replies, i am defnitely not jumpin in to anything unless i have a solid understanding and your posts have been very informative and at the very least i have been able to confirm some of my understandings.


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## Four Pillars (Apr 5, 2009)

Eclectic12 said:


> I suspect the bulk of those doing a true SM are going through some sort of financial advisor or are using a "coach potatoe" strategy.
> 
> 
> Cheers


I can believe the financial advisor part, but why would you think the couch potato investing style would be common with the SM? I would tend to think that the majority would use Canadian dividend players.


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## Four Pillars (Apr 5, 2009)

yask72 said:


> Thanks for the link. Read through it and something stood out that i have not read before or maybe i never properly understood it. Can you explain this piece _ "Although the interest rate is tax deductible, when the rates goes up the amount of non-deductible interest goes up as well and this results in a lower profit or higher loss for the investment plan."_
> 
> To keep things simple....say this year my initial borrowed amount is 25K @ 5%. As i understand it, on this year's tax return (2012) the total amount of interest 1250 is tax deductible. Say next year (2013) the interest rate increases to 6%, does this mean that not all of the interest is tax deductible on my 2013 taxes? Sorry if this seems like an obvious answer and maybe it's the way i am reading this, but i don't quite understand that statement.


No. The statement you quoted (from my article) makes no sense at all. I was talking about the net interest payable. There is no 'non-deductible' interest.

Here is the rewrite:



> Although the interest rate is tax deductible, if interest rates increase, the interest amount payable (the interest payment minus the tax deduction) goes up as well and this results in a lower profit or higher loss for the investment plan.


Thanks for pointing that out.


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## dogcom (May 23, 2009)

I think for every investor the way to look at any investment is what can I lose as if losing is a done deal. This is kind of the opposite of the positive thinking most of us are taught to do but I think it is necessary. Leveraged losses can effect your family, your relationships as well as your bottom line and can you deal with this. Answering these questions may stop you from using leverage or will force you to make sure that any leverage you use will be manageable.


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## Eclectic12 (Oct 20, 2010)

Four Pillars said:


> I can believe the financial advisor part, but why would you think the couch potato investing style would be common with the SM? I would tend to think that the majority would use Canadian dividend players.


I probably could have worded this better. 

By "couch potatoe", I was less referring to the asset allocation and more to the "autopilot" purchasing of pre-selected investments on a set schedule.


Cheers


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## Ed Rempel (Apr 4, 2009)

*Thread: New to the board...may implement Smith Manoeuvre and looking for input*

Hi yask72,

I've been doing the SM for more than 10 years and have helped hundreds of families implement it. It sounds like you are doing most of the basics of the SM right. You have a readvanceable mortgage, you have long term time horizon (although 20-30 years would be better than 15-20), you seem to have the risk tolerance to tolerate a steep market crash, and you seem to understand the mechanics such as capitalizing the interest.

Two areas that can help you would be to make the SM part of your written retirement plan (to help you keep a long term focus) and to have a solid investment strategy.

You seem to be relatively new to investing, which is a concern. Borrowing to invest is a riskier strategy, so you need a sound investment strategy. I would definitely recommend wider diversification, including more industries, and US and international investments.

There are a couple of major misperceptions about the SM in the blog world. The 2 main ones are:

- naming ordinary leverage (mostly leverage into dividend investments that pay the interest) as the Smith Manoeuvre.
- thinking that investing in dividend-paying stocks is necessary. 

CRA only requires that a stock market investment not be permanently banned from paying dividends. Almost any stock market investment is acceptable.

The key to investing is earning the highest possible total long term return after tax that is within your risk tolerance. The dividend payout is only one of many factors in evaluating investments - and definitely not in the top 5 factors. In addition, focusing on dividends today may mean that you miss out on many great companies at very cheap prices.

This can be a good time to start the SM, since there is a huge sale on stocks around the world right now. The general mood is very negative, with all types of conservative strategies being popular today - bonds & balanced funds, all kinds of income investments, dividend-paying stocks, etc. 

This type of mood is why stocks are so very cheap. The S&P500 has a P/E of only 11.7%. It is normally only this low when interest rates are very high. Excluding times with high rates, this is the cheapest stock market since 1954. There are also many cheap stocks in Europe and Asia.

Canadian large cap, dividend-paying stocks are the currently popular stocks, so it is hard to find them at good prices. Most have P/Es of 15-20%. You should be able to find lots of great companies with P/Es of 8-12% today.

There are investors that are always going to be dividend investors, such as Frugal Trader, and this is a very solid strategy. However, starting out today with dividends when they have been the "flavour of the month" for the last several years is probably the wrong time to start investing with that strategy. If you want to buy dividend-paying stocks only, I would suggest to wait until they are out of favour.

We prefer to invest in mutual funds managed by the top investors we can find. We call the "All Star Fund Managers". This helps us deal with the risks, allows much wider diversification, and helps give us confidence in the strategy. Most of our investments are global, a significant portion are smaller companies, and we have both value and growth stocks.

Whatever strategy you use, make sure you know what you are doing and that you will be able to stick with your strategy, especially when it is out of favour and through the inevitable bear markets.




Ed


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