With Robb on vacation, I am honoured to have the opportunity to guest post on Boomer and Echo and meet some new readers! For readers here who don’t know me, I’m the blogger behind MillionDollarJourney.com. In the early days (the blog started in 2006), I wrote quite a bit on the Smith Manoeuvre and continue to get questions about the wealth building strategy to this day.
Let’s rewind a little and get back to the basics. What is the Smith Manoeuvre and how can it help build wealth?
What is the Smith Manoeuvre and How Does it Work?
The Smith Manoeuvre is a leveraged investment strategy made popular by Fraser Smith. Leveraged investing is where you borrow to invest in income-producing assets. The long term goal is for the assets to appreciate faster than the interest owed on the loan. A major side benefit is that the interest you pay on the loan is tax deductible – as long as you have invested using a taxable account (ie. not RRSP/TFSA/RESP etc).
Why leveraged investing? For starters, it’s a way to supercharge your gains, but leverage can also supercharge your losses. Needless to say, leveraged investing is only for those with the highest risk tolerance. After all, you’ll be using your home as collateral on the investment loan.
While leveraged investing has been around for eons, the differentiator is that the Smith Manoeuvre uses the equity in your house (usually through a home equity line of credit) towards investments in the stock market.
The Readvanceable Mortgage
To dig a little into the details, the strategy involves using a special type of mortgage called a readvanceable mortgage (offered by most of the big banks).
This type of mortgage is made up of a combination of a regular installment mortgage and a home equity line of credit (HELOC). As the installment mortgage portion is paid down with every payment, the HELOC credit limit increases by the same amount (minus interest).
As money from the HELOC space is made available with every mortgage payment, the new credit is used to invest in the stock market, businesses, and/or real estate.
For homeowners with lots of equity, the HELOC can be used right away in a lump sum to invest. For new home buyers with little equity, you can invest small amounts per month as it’s made available in your HELOC.
So really it’s a two (maybe three) step process:
- Obtain a readvanceable mortgage on your home
- As your HELOC limit increases, use the balance to invest in income-producing assets (ie. the stock market, rental real estate, a business).
- *Bonus: This step is not really the “Smith Manoeuvre”, but more of a Smith Manoeuvre accelerator (maybe the MDJ Manoeuvre?). In this modification, you invest in dividend stocks and use the dividends to further pay down your non-deductible mortgage. The extra mortgage paydown will further increase your HELOC limit, which will allow you to buy more dividend stocks. The snowball will result in paying down your mortgage and building your portfolio faster.
Personal Example
In my own personal example, we built our house in 2008 and obtained a readvancable mortgage on the property for the purpose of investing the HELOC. With a large down payment from selling our starter home and liquidating our non-registered portfolio, we were able to put a large down payment on the house and maximize the starting point for the HELOC.
I used the credit available in the HELOC to invest in Canadian dividend stocks with the plan to use the dividends to help pay down the mortgage faster. It turned out however that with a focus on savings, and selling our rental property, we were able to pay off our installment portion of our mortgage in about three years.
Related: Why Don’t I Pay Off My Mortgage?
Throughout the years, I have continued to invest in dividend stocks (started before the crash of 2008). While investing in my leveraged portfolio has slowed down over the years, it continues to grow and generate dividends every year. In fact, in my most recent financial freedom update, I revealed that my Smith Manoeuvre portfolio generates $7,500 in eligible dividends annually.
Using the Smith Manoeuvre with a Cottage
Having explained the background on the Smith Manoeuvre, one question I get often is if the strategy can be used with a cottage or rental property instead of investing in the stock market.
Before I get into this, let’s talk a little about the tax deductibility of the HELOC, which is one of the big attractions of the Smith Manoeuvre. Who doesn’t want another tax deduction?
The rule with the tax deductibility of interest is that the loan proceeds must be invested in income-producing investments (or the potential to produce income). So that can be equities, business and/or income-producing real estate.
Can this strategy be used with a personal cottage? As the tax rules state, the proceeds to be put towards income-producing investments. So unless the plan is to Airbnb or rent it out via other means, the strategy would not be feasible – at least not in a tax efficient manner (ie. the interest would not be tax deductible).
Using the Smith Manoeuvre with Rental Real Estate
What if you are not a believer in the stock market and would prefer rental real estate instead? This strategy can work, but you may be super leveraged.
As mentioned above, you can use your HELOC towards purchasing rental property and the HELOC interest (along with the rental mortgage interest) will be tax deductible. What some really aggressive real estate investors do is when their rental properties obtain enough equity, they leverage those properties to further grow their real estate empire.
For example, an investor can use a HELOC for a 25% down payment on a rental property and obtain a mortgage for the remaining. Hopefully, the cash flow from the rental is enough to cover the mortgage and HELOC payments. As time passes and the rental property gains value/equity, the property can be re-mortgaged with proceeds invested towards another rental property.
As tenants pay down the mortgage, in the long term, you’ll have large paid off assets that pay a healthy income stream during retirement. Although direct real estate investing is not for me (I own REITs instead), I personally know a number of investors who have funded their retirements through investing in rental real estate.
Final Thoughts
Leveraged investing is a risky strategy and requires the ability to take and have faith in the long term view. If market crashes with 50% corrections (like 2008) scare you, then leveraged investing may not be the best strategy for you. However, if you can tolerate the ups and downs of the market, then a following a proven investment strategy over the long-term can be lucrative.
I have written quite a bit on the Smith Manoeuvre over the years and have compiled all the articles into a resource post. Check it out if you are interested in learning more about the strategy.
https://www.milliondollarjourney.com/the-smith-manoeuvre-resource.htm
FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on MDJ, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. After achieving the big net worth milestone, his focus has shifted to building his passive income sources (up to $45k+) towards achieving financial freedom.
