The Smith Maneouvre during a Market Crash

There has been much concern over the viability of the Smith Manoeuvre or a leveraged investment strategy during this recent bear market.  The main concerns are due to a couple of reasons, first, sinking equities, second, the increase of variable rates due to the credit crunch. In addition to this, one of the more popular readvanceable mortgages, The Firstline Matrix Mortgage, has stopped offering the product altogether (source: Canadian Mortgage Trends).

The truth of the matter is that leveraged investing is risky.  The investment account is facing the relatively risky equity market along with building interest on the capital that supports it.  The opportunity for the account to grow at an accelerated rate is great, but so is the opportunity for values to drop.

With current market conditions, it’s a gut check to see who can really take the leveraged investing heat.  With the possibility of HELOC (home equity line of credit) rates, which are traditionally at prime, to increase above prime, it will make this strategy even more expensive.  However, with a slow economy, the prime lending rates will most likely decrease even further, which will hopefully even out any increases.  With that said, The Smith Manoeuvre strategy is still a valid option, just with one less readvanceable mortgage available along with the potential with higher HELOC rates.  For those of you looking for alternative readvanceable mortgages, here are some of my other favorites.

What am I doing with my leveraged portfolio during this correction?  Even with the extreme fear in the streets, I have my eye on the big picture and my long investment time line.  Therefore, I’m sticking to the plan, watching my favorite dividend paying stocks and waiting to deploy some cash when they appear cheap.  I’ve said this before, and I’ll say it again, these market corrections are temporary and should be viewed as an opporunity to buy cheap equities for the long term.  It may take a while (even years) for the markets to bounce back, but if you buy cheap, you’ll take full advantage of the upcoming recovery.

For those of you with leveraged portfolios at this time, have you made any changes?

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FT

FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.
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Ed Rempel
9 years ago

With hindsight, we can see that starting the Smith Manoeuvre after a market crash is usually the best time.There was “Irrational Pessimism” ( https://milliondollarjourney.com/irrational-pessimism.htm ) at the end of 2008 and early 2009, so anyone that started then has probably done very well.

The Smith Manoeuvre is a risky strategy because it involves borrowing to invest, so it must be a long term strategy. If you do it long term, your chance of success is high, but you will go through market crashes. There are usually a couple of major market crashes every decade, but the market always recovers if you stay invested.

To be a successful investor, you cannot view market crashes as fearful times to avoid being invested. You need to see market crashes as buying opportunities with stocks on sale.

We have found that faith in the stock market long term is the key to making the Smith Manoeuvre successful.

Ed

Duncan
12 years ago

Jatinder,
Given your current situation I’d definitely hold off for now. While there are many attractive dividend yields out there, there’s still a great deal of downside risk in equities in the short to medium term. In this economic climate, a sure thing is a good thing(ergo your 4.55 fixed mortgage)! SM is a great long term strategy under normal circumstances. Given the current state of the world economy, fundamentals can not be trusted in the near term. Most of the wisest investors are currently sitting on the side lines. Better to risk losing some gains than catch a falling knife (with borrowed money from an LOC)
Good luck to you!

Jatinder
12 years ago

Is this a good time to start SM, I haven’t even secured the LOC yet and have about 2.5 yrs left on current mortgage at 4.55 fixed. Any ideas?

Thx

moneygardener
12 years ago

Just to add to this discussion with another data point:

I was able to obtain a prime + 1% secured LOC against my existing investments with BMO.

DAvid
12 years ago

Duncan,
This possibility has been suggested on the Manulife One Mortgage entry, https://milliondollarjourney.com/manulife-one-mortgage-review.htm Look for answers, comments, suggestions and ideas there.

DAvid

Duncan
12 years ago

Wonder if someone can offer their 2 cents?
I’ve a fixed mortgage at 5.69%, 4 yrs remaining
I’ve a LOC at prime. It’s the Firstline Matrix product.
Should I take funds out of my LOC to pay down the fixed rate mortgage?
If I do, the entire mortgage will be paid off before renewal and converted over to the LOC at prime.
Would this make sense? Seems like prime is going to stay low for the next while right?
Thx

Scott
12 years ago

A semi-off-topic post:

I’ve got a funny mortgage story (bet ya didn’t think there were any!). Few years ago one of my friends bought a house at the end of a cul-de-sac, beside a park. His neighbour across the street had bought his house in the 80’s and had locked in the total amortization period of his whole mortgage at 18%! When he finally paid it off, the city wanted to re-claim more park land, so they bought his house from him. Very shortly after his house was bulldozed! Ha! Wow, was that guy ever pi$$ed! “I spent all that money and time paying off that house and they just rip it down!”.

Unfortunately my friend sold his house too or he could have been living across from a very scenic park view.

Scott
12 years ago

Ed,

I looked up the data a LONG time ago so I’m not too sure where I found it. Specifically, I was referring to a 5-yr fixed. Here’s a crappy little chart (how do you link?) to hopefully give a bit of an idea:

http://www.mortgagehotline.ca/images/chart_5yr_prime.gif

THe majority of the chart lies above 9%. Roughly eye-balling/ball-parking, there’s almost a 30-year span between 1967-1995 where rates dipped below 9% ONCE and went as high as 21%. I’m not a rate expert or historian so maybe I’m way off. Am I?

Brendan
12 years ago

Hi Ed,

I think the CT will work, but not in the way the product was intended to be used. With the account you get a variable LOC, as well as optional fixed portions. So the only way to make it work for the SM, as I understand it, is to use the variable LOC for your investments, and create fixed portions for your mortgage, your car loan, renovation loan, etc. The fixed portions require you to pay interest+principal monthly, while the variable portion will allow you to pay interest only (and will auto-capitalize the interest too).

The way the account is marketed, all of your deposits and withdrawals are supposed to go through the variable portion. If you want to use this account for the SM, however, you necessarily have to do your day-to-day banking elsewhere since you can’t mix everything in the variable account.

This diagram helped me understand:

Variable LOC (use for investing)
——-
Fixed portion 001 (your mortgage)
Fixed portion 002 (your car payment)
Fixed portion 003 (renovations)

As you pay down the fixed portions, you get more room in the variable portion. CT has a sample statement on the left nav bar of this page: https://www.mortgageinyourway.com/#/stepTwoMenu

I would much rather have the LOC and my mortgage at prime, but I can’t find a lender at the present time who will offer this and pay the appraisal+legal costs. (CT does cover these costs.) This business down south has everyone panicked.

I actually filled out your questionnaire, Ed, and had been working with a BMO contact of yours. Today she informed me BMO doesn’t even offer the three-year open variable for the ReadiLine anymore. The best they can do is prime+1 on a five-year closed.

Yuck.

If anyone knows any BMO reps still offering the ReadiLine at prime on a three-year open variable, please drop me a line: brendan at letterwhiz dot com.

I’d be more than happy to speak to other lenders offering prime as well. (Provided they cover legal+appraisal costs, or offer some kind of value that makes up for having to pay a portion of these costs.)

All the best,

Brendan

Ed Rempel
12 years ago

Hi Brendan,

Mortgage rates and discounts are changing every day lately, but we still have access to several at prime. The last time we looked at Canadian Tire, their mortgage did not allow for a sub-account, so it is not usable for the Smith Manoeuvre.

We are tracking the best rates daily. If you want a referral to the best SM mortgage, we have a free referral service on this blog if you email us with answers to 10 questions.

Ed