In the previous post, I outlined the main risks associated to dealing with your accountant and your banker while setting up the Smith Manoeuvre. But I didn’t attack the core of the risks. The main issues may arise from a bad financial planning done by your financial planner. In fact, the entire success of this strategy is linked to the ability of creating wealth over your mortgage.
There are several risks related to leveraging. One of them is the timing risk. You investment horizon should be at the very least ten years. Over this lapse of time, you will go through recessions and economic surges. Economic cycles use to be over seven to height years. Economists noticed a change in the economic cycles that length only four to five years in the new economy. Therefore, you will benefit from two full economic cycles over the span of ten years. If you plan on cashing your investments at a certain point in time, you must change your investment portfolio accordingly.
Another risk is the interest risk. As the Smith Manoeuvre is based on the creation of wealth over the interest charged on the money borrowed, you must cover all kind of scenarios. What if you borrowing interest rate go up by 3%? What if you investments go down by 20%? All these questions need to be answered by your financial planner and the consequences accepted by yourself and your spouse.
A lack of diversification or an over diversified portfolio could represent a huge risk for your investments. Both cases will affect your overall yield in a bad way. Your financial planner should invest according to your investor’s profile and objectives. He must also invest funds in several types of investments in order to decrease the risk of fluctuation, also called portfolio’s volatility.
We definitely don’t setup a Smith Manoeuvre in order to lose money. However, it might be the case if bad investments are made or if your borrowing cost surges. You must be aware of all possibilities and ready to take those risks. Set up semi annual appointment with your financial planner to see how the strategy works out in a real environment. Be aware of all transactions and reserve yourself the right to approve or decline any purchase of sell of an investment.
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