Smith Manoeuvre Portfolio – June 2011

Hi Stu,

What is your primary objective:

1. Get the highest possible eligible dividend.
2. Make the most money over time.

It sounds like you are focused entirely on the dividend and not the expected return of the fund or the quality of the fund manager.

We have modeled many different SM strategies. What we found is that receiving a dividend resulted in lower projected money over time (unless your taxable income is less than $39,000). The reason is that, even though you receive dividends at lower tax rates and can pay it down on your mortgage, you still end up paying some tax. If you can invest for growth and have zero distributions of any kind, then you end up with more money over time.

In addition, once you stop focusing only the dividend, you can start focusing on investing in the best possible fund based on risk/return or the best quality fund manager.

In the odd case where we have a client that really needs the cash flow more than anything else, we use a Nexgen fund that has a 9.7% eligible dividend paid monthly. The fund manager is pretty good, although he has been struggling recently because he has a huge, elaborate quant computer model. Like all computer models, there are flaws, but he still has a good long term record and is a very brilliant guy.

When we list the very best fund managers, he would not make the top of the list, but the dividend is quite good.

We can also buy the same fund with a zero distribution, instead of the 9.7% eligible dividend. Any projection shows the zero distribution makes more money. The high dividend pays the mortgage off quicker, but results in a smaller tax refund every year.

Part of the issue is the low interest environment. We can get a mortgage at 2.49% today, while secured credit lines are at 3.5%. You pay the mortgage down at 2.49%, but then reborrow at 3.5%. The credit line interest is tax deductible, but is also 1.01% higher. After tax, it is only slightly lower than the mortgage.

Meanwhile, the dividend is taxed at a lower rate, but still many times higher than deferred capital gains. You can get an eligible dividend today and pay 15-20% tax, or you can invest in a very tax-efficient fund and defer the capital gain, so that you pay 15-20% tax 20 years from now.

I don’t know your situation, but we have worked with hundreds of clients doing the SM. I think the dividend preoccupation today is mostly misguided (except for very low income people that probably should not be doing the SM).

It is normal for people to focus on dividends when the stock markets have a few bad years. Investors have forgotten that the stock markets always grow a lot in the long run. The masses tend to always buy the wrong thing. The cheaper the market is, the more defensive people invest.

These comments may or may not relate to you, but they do apply in general with investors today.

The high dividend helps for people that need income or that are entirely focused on paying down the mortgage. Tax-efficient investments work for people trying to make the most money over time.

My suggestion would be to forget dividends completely and focus on buying the highest quality fund manager in a tax-efficient fund.

Ed

Have you considered integrating this approach with corporate class mutual funds? Many of these return their income as ROC and have little or no distributions for the year. I think by avoiding offsetting your mortgage interest deductions against dividends from your portfolio on an annual basis you could instead offset against employment income which would hopefully give you a tax return to accelerate the conversion from bad debt to good debt. Any thoughts?

FT,

If I’m not mistaken the yield you show is on your original investments, not what someone would get if they invested now. It would be helpful to clarify that if I’m correct in my assumption.

JNK,CDZ,ZWB,XCB,GLD,,VWO,, Reinvest the Dividends through DRIP, this way you are not trying to outguess the market and one bad stock call can erase a lot of gains.

MRK.JNJ,MMM are also quality holds that give a nice dividend and also give you exposure to US $.

I am almost 70, at the point where watching and worrying is taking a back seat to living, at some point the stress of holding individual Stocks loses its’ appeal.

IMO.

A lot of research has shown that you can achieve a well balanced portfolio of stocks with surprisingly few stock selections. If you are focusing just on Canadian dividend yielding stocks, holding 10 or 15 is more than enough to capture what would be mirrored by a more extensive ETF. Again, though, it really only begins to make sense if you are able to purchase in fairly large amounts, $5,000 is my preference, so that the brokerage fees become very low overall. You can rotate out a few losers as you require but for the most part your dividend portfolio is just on autopilot: monitor and reap the rewards. Add a few additional stocks as you have extra funds to add. The key with your basket of 10-15+ stocks is to ensure that you have a good sector coverage within that selection of stocks: financials, energy, consumer goods, etc. It is a bit difficult given the small selection of good yielding Canadian dividend stocks, but you can get the job done with a bit of careful selecting.