Even thought a part of my mortgage is tax deductible, the market fluctuations make the strategy useless on a short term basis. Some months I am making money and others, like now, I am losing money. I am telling you, investing is not for the soft hearted

So in my Smith Manoeuvre account I have:

178.278 shares of National Bank Dividend Fund for $2879.19

116.444 shares of Sprott Canadian Equity Fund for $5065.31

Total portfolio worth $7,946.87 as of August 4th.

In my previous update, I said that I would purchase the Omega International Consensus fund. I feel ashamed to say that it’s not done yet. What is the reason? Simply lazyness. In fact, I just have to pick up the phone as changed my periodic investment strategy. The overall operation with the brokerage firm would take about 5 minutes. Too often, we let our financial sins take over our investment strategy.

Committing to your investment plan is tough but rewarding. This is why writing it down and have it on a piece of paper is relevant. Every trimester, you should look at your plan and determine if you are following it. It will also help you out seeing if you reach certain stage where modification in your portfolio is requested.

I am not talking about changing your investment strategy every time you get your investment statement and make stupid moves according to the market. I am talking about following the strategy you already designed for the next few years.

I think you should review your investment strategy on a yearly basis and make your decision according to your need and your financial situation; not according to what is going on the market!

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The purpose of setting up a SM is to get your mortgage tax deductible. In order to achieve the strategy, you need to leave your mortgage as high as possible and flip the non tax deductible debt (i.e. your original mortgage) to a line of credit account that will be used to invest (leverage principles). Therefore, you will need a Home Equity Line of Credit (HELOC).

About a year ago (maybe it’s two, I am not too sure about the time frame), Canadian financial institutions decided to report mortgages and HELOC to the credit bureau agencies such as Equifax or Transunion. It was previously a regular practice to not declare such information in order to protect your clients from competitors.

However, with the financial crimes increasing, banks had no choice but to report any credit activities in their branch. Therefore, we started to see mortgages and HELOC account our credit bureau. In regards to mortgages, there is not much impact on your credit score as long as you pay on time. On the other side, it is a different story for home based lines of credit.

Actually, making your required payment on time is not enough when it comes down to revolving credit (i.e. credit cards and lines of credit). The amount used compared to the amount granted is important also. Since your HELOC is probably your biggest revolving credit, its weight on your debt to available credit ratio is huge.

If you are using more than 80% of your revolving credit, you start to get seriously penalized. For example, I have my whole mortgage on a line of credit that is maxed out since I do the Smith Manoeuvre. I recently checked my Beacon Score and it dropped about 50 points since last time I checked. Nothing had changed in my situation beside the fact that my HELOC is now reported. Fortunately for me, I used to have a Beacon near 800 points. Therefore, it didn’t change much my financial situation.

I thought you may want to check your credit bureau before doing such strategy or even before transferring your mortgage into a HELOC if you had credit issues in the past. Home line of credits are the most flexible and useful type of mortgage. However, that will surely not help your credit score!

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I don’t want to become one of those financial prophets who tell whoever wants to listen to them that the apocalypse is near. However, I must open my eyes and look at Canadian stocks the way it should be. The commodity stocks are dominating the market and are the only reason why the S&P/TSX was beating the American and other international markets since the beginning of 2008. We are at a stage where those sectors (oil, metals and other resources) are representing about 50% of the TSX. If anything goes bad on that side, needless to say that the whole market is going to plunge.

My portfolio is still showing positive returns with a 5.9% annualized rate since Feb 2007. I am quite far away than my 14% from last month! Sprott Canadian Equity is the part of my portfolio that took the biggest hit from a price of $50.03 to a price of $47.32 as of July 5^th.

However, I am quite happy to realize that I have now $8,100 of my mortgage that is tax deductible! At the same time that I increase my liquid assets, I am paying fewer taxes. That is giving me more flexibility in my overall finance which is always good news.

In order to avoid getting cut with all my money invested in a bear market, I am opening up my horizon for next month. In fact, I divided my systematic investments in order to get $200 in the National Bank dividend bond and another $200 in the Omega International Consensus managed by Validea Capital. It won’t make a big different right away, but I don’t want to get rid of what I bought so far. I still think that the dividend fund and the Sprott Canadian Equity will do well in the long run.

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So my annualized return rate is now 14.5% while I did paid between 3.5% and 2.75% (a big thanks to the Bank of Canada on this one!) in interest charges. In dollars, I am making a paper profit of $753 minus $189 in interest, so it makes $564. So my net annualized return is therefore 10.8%. Not too bad after a little bit more than a year.

So here are my positions so far:

National Bank Div. fund: 129.639 par at $17.17 for a total of $2225.90.

Sprott Cdn Equity fund: 116.444 par at $50.03 for a total of $5825.69.

I am still making my $400 a month investment even though interest rate went down big time since 2007. There is a part of me wanting to increase my leveraged strategy by at least $200 a month and there is another part saying that I have other debts coming due in less than 3 years and I should leave my Smith Manoeuvre the way it is.

When you are borrowing to invest, it is important to stick with your investment plan. If you start playing with your periodic investments or borrowed money, you might go off track at one point. The temptation is always great when you are actually making money. Everybody wants a piece of the market, right?

I recently read an interesting point of view on the smith manoeuvre strategy written by Frugal Trader at milliondollarourney.com. He is also making his mortgage tax deductible through the SM strategy but he decided to pick his own stocks. The interesting part is that he is using high paying dividend stock in order to cover for his interest charges on the leverage loan (a home equity line of credit – HELOC).

With this strategy, he doesn’t have to take any money from its pocket. Therefore, he is applying leverage at its best: using other people money to make money!

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This guest post was written by Mike from Quest For Four Pillars, a blog about personal finance and more. Feel free to visit his site and subscribe to his feed.

There is a popular financial strategy known as the Smith Manoeuvre which basically involves borrowing money to buy investments and then using the proceeds of the investments to pay down your mortgage. You don’t pay down your total debt but rather you slowly convert it from non-deductible to deductible debt in order to get a tax rebate on the interest.

I am a fan of borrowing money to buy investments, however I don’t bother with the true Smith Manoeuvre since it is designed to maximize the financial benefits of your advisor. I put together an investment plan a while ago which uses leverage and it has been quite successful so far. The plan is very basic – borrow money from my home equity line of credit and buy blue chip Canadian dividend stocks. One of the key differences between my plan and the Smith Manoeuvre is that I limit how much I can borrow according to a simple risk analysis exercise. Most SM advisors want their clients to borrow the maximum 80% of the appraised value of their home in order to maximize the advisor’s profits. The problem with this “strategy” is that it might leave the client over-exposed to interest rate risk.
Basically what I did to determine how much I was willing to borrow for my leveraged investment strategy was the following:

1. Calculate the maximum monthly payment I was willing to pay for my mortgage and leveraged loan.
2. Assume that in a worst case scenario I can increase the amortization of my mortgage and HELOC to 25 years.
3. Calculate the amount of total debt which if set to a 25 year amortization, gives me the monthly payment amount from #1.
4. Subtract the mortgage from the total debt calculated in #3.

You can see my proper analysis in this post for a detailed example.
This particular exercise only looks at interest rate risk which is one of the biggest problems with borrowing to invest. You always have to consider that if interest rates go up a lot then you will have to come up with more money to pay the interest payments.

If you liked this post then please check out Quest For Four Pillars or subscribe to his feed for plenty more just like it!

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