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:
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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