Back in February, I have made a few changes in order to get a better diversification in my Smith Manoeuvre investment strategy. Therefore, I decided to add US, Canadian and International index funds. Unfortunately, I noticed in March that all my transactions have not been done according to my instruction (it is apparently quite a feat to write down 4 transactions!).

Nonetheless, I have made some great picks since my new investments really picked up during the March Rally. It is good to see that my Smith Manoeuvre account is showing a positive year to date return or 4.2%. Overall (since February 2007), my Smith Manoeuvre account shows a negative return of -25%. It is obviously quite tough to compensate for 2008 in a single quarter! It will actually going to take years to come back to a decent level.

So here’s what my portfolio look like as of March 31^st:

- National Bank Divided Funds: $4,942

- Sprott Canadian Equity: $3,163

- Omega preffered shares: $101

- Omega American consensus: $183

- Altamira Canadian index: $0

- Altamira American index : $177

Total in my Smith Manœuvre : $8,566

I am still not convinced from the March rally that the stock market is back on track and that everything will come back to normal in 2009. While I believe we will see our money back (for those who are still invested in the market!) and that it is currently an opportunity of a lifetime, what happened in March just seems unreal. On the other side, what happened back in September and October 2008 seemed unreal as well! This is why I stick to my investing strategy no matter what I think and I am not trying to sell to make a quick profit and come back into the market after the next correction. I still think that you should not do market timing.

I am now investing $500 per month into my leverage strategy and I don’t plan to make much modification for a while. I will look at what is going on on the markets and look at my investment strategy next quarter but don’t expect many changes. I think I will keep this investment strategy for the upcoming year and keep dollar cost averaging the market!

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I have not been writing much about The Smith Manoeuvre Strategy for the past months because I was simply too lazy to make some modifications to my investment portfolio. I was aware that I had to do some tweaking for my investments strategy.

I am heavily concentrated in financials (National Bank dividend fund) and in oil and other natural resources (Sprott Canadian Equity Fund). But the most important part: I am 100% in the Canadian market.

Now that the market is down and that everybody is selling the stocks cheap, it is the perfect timing to buy more shares of good mutual funds. I would rather go by trading indexes but since I am injecting money on a monthly basis into my portfolio (and it doesn’t show much these days ), I have no other choice but to pick funds instead of indexes.

So I cancelled my $400 periodic investment into the National Bank dividend fund and decided to split this amount among 4 funds. On top of that, since I am paying a very low interest rate and that I have enough cash flow to afford it, I decided to increase my monthly investment to $500.

$100 in Altamira Canadian Index Fund

I wanted to keep of my monthly investment into Canadian equity as I think that the Canadian market will go up over the long run. There are several good undervalued companies that will pick up on the next economic boom. On top of that, the Altamira MER’s is only 0.53%. So I will be almost on the target to follow the index.

$150 in Altamira US index fund

Based on the same reasoning regarding the MER’s, Altamira indexes funds are pretty cheap and the US fund is hedged against currency risks. I wanted to start diversifying my risk with another country. As the American market took at good kick in the teeth in 2008, I think it’s a perfect timing to buy an American index fund.

$150 in Omega preferred shares

Canadian preferred shares are mostly issued by financials, insurance companies and resources companies. Since they took a major hit in 2008, we have great chances to see this type of class coming back with great strength. In addition to that, the Omega preferred shares (managed by ING) is the first Canadian fund of being 100% invested in preferred shares.

$100 in Omega American consensus

Why am I putting more money into the American market? Because I love the way the Omega American consensus picks its stocks. To learn more about the trading model developed by Validea capital, you can click here and read about my review of their Omega funds. Their trading method is based on mathematical models and, therefore, gets rid of all kind of emotions in the trading equation.

I decided to pick American consensus instead of international for 2 reasons. I truly believe in the American market capacity of coming back stronger than international equity. The second reason is based on the fact that many great American companies make a lot of their revenue outside the United States. Therefore, I am still expanding my diversification a little bit to the international market.

Disclaimer: I am buying those funds but this post should not be considered as any kind of recommendation of buying or selling any of the above. Please trade carefully …and at your own risk!

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I have made monthly investment in the National Bank Dividend mutual funds and the Sprott Canadian Equity funds. Over the past 2 years, I have made a total investment of $10,100. This money was taken out of a separate HELOC to make sure that interest is tax deductible. Borrowing cost for 2008 has been $198.73. Therefore, I should receive a tax return of $83. Barely enough to buy 2 good bottles of wine

I have encountered difficulties when asking for additional credit at my bank. The main reason was that they didn’t understand the strategy and therefore thought that I had been paying interest only on my mortgage without making any capital reimbursements. They didn’t want to understand the link between my brokerage account and the borrowed amount on my second HELOC account.

I was able to get what I wanted but it wasn’t without pain, a lot of documentation and explanation! Considering the current economy, I can’t blame them; all they were seeing is a young kid with a big line of credit maxed out for 2 years.

I was supposed to invest into international funds in order to diversify my risk and optimize my long term yield. While I am still wondering if I’m better with ETF’s or specialized funds, I decided to not budge. The Problem with ETF’s is that I can’t buy them on a monthly basis. I would have to wait until I have sufficient money to buy at least 100 shares. The thing is that I don’t want to put my SM monthly contribution into a money market fund. I should probably go with index funds in the meantime then.

I was a bit disappointed with the annualized return that my account shows after almost 2 years of investment. I actually have a negative annualized return of -27% since February 2007.

Hopefully 2009 will be a better year for all of us in regards to the stock market!

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This will give me the opportunity to discuss about more things and not only write a few lines about how much I made or I lost during that month. I was quite surprised to find out my annualized return at the beginning of this month: a big fat – 40%.

I can’t say that I am smiling but I am not panicking as well. Huge fluctuations are yet to come for the next 6 months and there is actually no reason to open your investment statement since mid 2009! You simply have to make sure that you have a solid investment strategy and that you keep going.

One of the biggest advantages of the Smith Manoeuvre is that you benefit from the systematic investment strategy. By buying every month, you have the possibility to average down your costs and get more shares.

Because of huge market fluctuation, I decided to not change anything in my strategy for now. I am still buying $400 a month of National Bank Dividend Fund. Once the market settled, I will consider other options.

I was recently looking for preferred share issued by Canadian bank, they offer a 5 to 6% return and their value don’t fluctuate much since the main reason of acquiring such shares is the dividend. Since I pay below prime as a bank employee, this almost looks like an arbitrage option.

Hopefully my next update in January will be showing better numbers

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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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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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“Hi, I’ve read with great interest your Smith Maneuver progress, especially since I was thinking of doing it when my current mortgage comes due with an All-in-One as well. However, I’m still confused about how it works in this situation (with made up numbers). Perhaps you could explain it to me? Say a home is valued at $400K, so the bank would give an All-In-One (Ai1) up to $300K. Now, assume the property has a current mortgage of $200K. Then I could split the Ai1 into a $200K mortgage portion and an immediate $100K investment LOC. Would I then have to pay my regular mortgage payment plus the interest on my investment LOC each month? I understand that I could “capitalize the interest” but, doesn’t that make some of the LOC not invested in investments, hence, not being eligible for the tax deduction? Sorry for the question if you’ve answered it before! Best of luck to you in your endeavours”.

Hello Jeff,

In your example, you will have 2 accounts linked to your property:

#1 200k regular mortgage (which you will pay capital + interest payment)

#2 100k HELOC (all-in-one) (which you have to pay at least the interest every month)

If you withdraw the 100K from your all-in-one and invest it, you will have to pay the interest on the 100K (so roughly $4,750 if prime rate doesn’t change). That makes payment of almost $400 every month.

In addition to this $400, you still have your mortgage to pay. At 4.25% (let’s say that you selected a variable rate as well and you got Prime – 0.50) over 25 years, that makes payment of $1,079 a month.

In total, you will have to pay at least $1,479 per month to have #1 a 200k mortgage + #2 the all-in-one account fully invested. Please keep in mind that the $4,750 in interest paid on your all-in-one is fully tax deductible.

A few suggestions

#1 If you have enough room in your budget, I would definitely go with a variable rate on the 200K mortgage. You can easily get Prime – 0.50% with such amount (especially that you will be doing a 100K HELOC at the same time!).

#2 If you like to have fixed payment in order to follow your budget, you can always go for the variable rate but with a fixed payment. The bank will calculate a fixed payment at the 5 years rate (around 7%) and the extra money will be applied as a capital payment.

#3 An investment of 100K is big enough to have access to great financial products. I strongly suggest that you deal with a Financial Planner or a recommended broker. They will be able to guide you as of which investment products are the best in your situation. Keep in mind that if you really want to benefit from this leverage strategy, you need to show an aggressive investment profile and will occur several fluctuations.

#4 If you want your mortgage to fully become tax deductible, I suggest you seek for a product that enables the HELOC to increase as you are doing your mortgage payment. I know for a fact that BMO and National Bank are offering this product. As for the other institutions, you will have to ask them.

#5 You are technically not allowed to capitalize the interest. If you leave a few thousand in your line of credit for this goal, the bank system will detect that you are not paying the interest as no new money is going into the account. Unless you find a product that gives you the opportunity, I strongly suggest that you make your interest payment.

#6 Banks are now going at 80% of a property value for a HELOC without charging any premium. Therefore, you can have a 320K mortgage split 200K mtg and 120K line of credit.

#7 If you have any other questions about the SM or any other leverage strategies, don’t hesitate to send me an email at thefinancialblogger @ gmail.com.

If anyone has any other ideas, please feel free to comment!

Best of luck with your investments!!!

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