Today I’m reaching into the mail bag for a new feature I’m calling the Money Bag. I’ll answer questions and address comments from readers on a wide range of money topics, myths, and perceptions about money. No question is off limits, so hit me up in the comments section or send me an email about all the money things you’re dying to know.
To start, we’ve got two questions from reader Kevin, who asked about expected future investment returns and also why I haven’t done the Smith Manoeuvre. Take it away, Kevin:
Expected Investment Returns
“I read an article in your weekly reading that spoke about how good stock market returns have been over the last few years and that we shouldn’t expect the same results going forward. The author said we should expect 4-5 percent returns going forward.
I was wondering if that is the case, why not pay off your mortgage faster instead of putting that money into an ETF portfolio.
The money put into your home would be a safer short term investment, plus the added “mortgage freedom” benefit. Then if you REALLY wanted you could borrow against the equity later when expected investment returns are higher?”
Hi Kevin, thanks for your email. I believe the best long-term investment is in the stock market, but with mortgage interest rates creeping up it certainly makes that decision more complicated.
Expected future returns are just that…projections. Nobody knows where the stock market is headed tomorrow or next week, let alone for the next two decades or more.
There’s an opportunity cost with every decision. The risk you take by putting all your extra cashflow against your mortgage is that you could miss out on better returns if markets rise higher than expected. That’s why I think it’s best to stick with a regular contribution schedule for your investments and balance that with responsible debt pay down (including mortgage).
Kevin, without knowing your age, employment situation, family situation, debt situation, and investment goals it’s impossible to say what you should do. All I know is if you base your investment strategy on market timing and looking at crystal balls, you’ll end up disappointed more often than not.
Perhaps a blended approach of additional mortgage payments along with your regular investment contributions will scratch both of those itches for the time being until something changes in your personal situation that warrants a new approach?
Here’s Kevin again with a follow up reply:
“Have you looked into doing the Smith Manoeuvre yourself? Why did you decide to do it or not do it?
I’m young professional with a 100k plus salary and wife that stays at home with our new baby. I have been researching [the Smith Manoeuvre] and I’m considering doing it with index ETFs, or borrowing to buy another home.
I’d like to know why you did it or not, and hopefully gain some understanding from your experience.”
Ahh, the Smith Manoeuvre. This was all the rage back in 2007 when I started following financial blogs. It was made famous in that circle by Frugal Trader at Million Dollar Journey, among others.
The Smith Manoeuvre is a leveraged investment strategy where an investor obtains a readvanceable mortgage to borrow against their home and invest in the stock market. While turning your mortgage into a tax-deductible loan sounds appealing, it’s not without risk.
Unfortunately, I know of several bloggers and blog readers who didn’t stick with the strategy through the financial crisis in 2008/09. Looking back it was the worst time to be setting up a leveraged investment portfolio. That’s because it’s hard to stomach watching your portfolio get cut in half in just a few months. And sure, many companies kept their dividends intact, but that’s little solace for some investors who were staring at a $200,000 loan balance and a $120,000 investment portfolio.
Okay, so let’s fast forward 10 years and now we’re in an unprecedented bull market for stocks, while home valuations are also sky high in many areas. While I never advocate market timing, it just doesn’t feel like a good time to be setting up a leveraged portfolio if you’ve never lived through a crash of that magnitude and know for certain how you’d react…or how your significant other would react for that matter.
Personally, we have many competing financial priorities and I believe maxing out our RRSPs and TFSAs, plus RESPs for the kids and a little bit extra on the mortgage is good enough to meet our financial goals. If I get to the point where our mortgage is paid off and all other accounts are maxed out AND there’s still money left over, then I’d consider opening a non-registered account and looking at some different investment strategies (including the Smith Manoeuvre). But at this point I have no plans to consider this strategy anytime soon.
Finally, you mentioned indexing, which of course I’m all for, but the Smith Manoeuvre likely* works best with Canadian dividend stocks. Not only is the loan tax-deductible but there’s also the dividend tax credit to consider. The point is to have the dividends pay the interest, and while index funds pay distributions they are likely too small to cover the loan interest.
*Note: I’m not a Smith Manoeuvre expert at all
I hope you enjoyed the first edition of the Money Bag. Please feel free to share your thoughts on expected returns or the Smith Manoeuvre with me and Kevin in the comments section. We’d love to hear a different perspective.
And send me an email with your money questions and I might include it in a future Money Bag segment.