This is where your finance takes place

Another great month on the market as my investment are getting higher and higher. It seems that moving a part of my portfolio into Sprott Equity Canadian fund was a great idea Hopefully I will continue to have my lucky touch when I select a more international fund! In the meantime, Sprott went public a few weeks ago and a journalist from the Globe and Mail was thinking that Eric Sprott was making so much money out of its companies (in hundreds of million of dollrs) that the fund was better bet than the stock!

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.

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Yesterday, I had a question on my latest Smith Manoeuvre Update. Since it was a good situation, I decided to write a full post about Jeff’s question. Here’s what he wrote:

“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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