Out of many investing topics written about on Million Dollar Journey, the Smith Manoeuvre was one of the first and among the most popular investment strategies discussed.
What is the Smith Manoeuvre?
But, what is the Smith Manoeuvre and why is it so popular? This investment strategy was named after Frasier Smith, a financial advisor who popularized this strategy through his book. The Smith Manoeuvre, in its simplest form, is a leverage investment strategy that uses your home as collateral. It’s popular because borrowing to invest makes the interest eligible for a tax deduction. So to frame it in an enticing way, Canadians, it enables Canadians to convert their regular mortgage into a tax-deductible mortgage.
How does it work? If you have a home with some equity, the simplest way is to obtain a Home Equity Line of Credit (HELOC) and invest in the stock market with the balance. To make it the true Smith Manoeuvre, you would need to obtain a readvanceable mortgage that increases your HELOC balance as you pay down your instalment mortgage. Using your HELOC balance to invest within a taxable investment account, over time, your regular mortgage shrinks while your HELOC balance (and hopefully your taxable investment account) grows. In the end, you have a fully tax-deductible HELOC that has replaced your regular mortgage.
Sounds risky right? Well, leveraged investing is definitely risky so you’ll definitely need to have a high-risk tolerance to implement this strategy. You can read much more detail about the nuts and bolts of the Smith Manoeuvre Strategy here.
My Implementation of the Smith Manoeuvre
As many readers know, I implemented the Smith Manoeuvre many moons ago in 2007/2008. I obtained a readvanceable mortgage from BMO, withdrew $50,000 and invested in Canadian Dividend stocks. Yes, right before the financial crisis! While the timing wasn’t great, I knew that I was in it for the long haul, with the goal to generate dividend income to one day fund early retirement.
We eliminated the regular instalment mortgage in our early 30’s but never really maxed out the HELOC. In total, we borrowed over $100k, and used the HELOC to pay for itself (we capitalized the interest) and let the balance and tax-deductible interest grow.
Fast forward to today, the strategy is still alive and well, but it looks a little bit different than in 2007/2008. While we capitalized the interest (used the HELOC available credit to cover the monthly payment) for many years, the balance also grew over time. That is until over the past year where we are now using the dividends to slowly pay down the HELOC balance.
In my last update, I reported that my leveraged investment accounts pays out about $7.8k in dividends per year from a 3.68% yield – which equates to a portfolio size of approximately $212k. Based on the underlying investment loan (my HELOC), I pay about $3,600/year in interest, with the difference (about $4k) to slowly pay down the investment loan balance. At this rate, based on my projection and assuming that I do not borrow more, the HELOC should be paid off between 25-30 years. While the spread between dividends and interest paid is wide right now, it may start to close in as interest rates rise. If this ever gets inverted, I may need to revise my plan and start aggressively paying down the loan.
Why the shift from capitalizing the interest to paying down the HELOC? Basically, we are reducing a little risk/liability in preparation for semi/early retirement! After hitting the million dollar net worth milestone in 2014, we turned our focus on building our passive income to the point where it would cover our recurring expenses. We basically doubled down and put pure focus on building our dividend and indexed portfolios.
By mid-2020, we managed to hit a big financial milestone – we reached financial independence by growing our dividend income enough to cover our family’s expenses. At the time, it just felt like another day. What I didn’t realize was that it started a subtle shift in the way I thought about my day-to-day life. It might have been party because of the COVID pandemic restrictions, or partly due to working from home full time – but my taste and underlying wanting for more freedom was growing stronger.
So I have taken the leap in phasing out of full-time work and moving into a phase of working on new projects and hobbies. While these projects and hobbies aren’t very lucrative, we have been making the shift from accumulation of assets, to finally spending some of those dividends that have been growing over the past 13+ years. I’ve also noticed that the accumulation of assets is pretty straightforward compared to the puzzle of efficiently decumulating your assets!
Have I Given up on the Smith Manoeuvre Strategy?
So have I given up on the Smith Manoeuvre strategy? Not a chance! The portfolio predominantly holds companies that pay a growing dividend. Over the long-term, the dividends should continue to increase (and theoretically the portfolio size), and the investment loan balance should decrease. In 25 years, the portfolio should be over twice the current size, with a HELOC balance of almost $0. On the other hand, looking at it from another perspective, when the investment loan gets paid off in the future, it’s no longer the Smith Manoeuvre! So maybe my future self will give up on the Smith Manoeuvre after all.
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