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Discussion Starter #1
I've been reading about SM and wondering what's the real difference between a SM and a good ol' HELOC leveraged investing.

One difference I can see is that in a SM deal with your bank, the funds available for investing increase with every mortgage principal payment i.e. re-advanced as an investment loan rather than a mortgage, thus making the interest tax-deductible.
So other than this automatic ever-increasing investment amount, is there any difference between SM and HELOC investing?

Thanks

-HC
 

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The only difference I know is with a HELOC, you actually need to have some equity to get one. With the SM, when you are fully mortgaged to the hilt, you kind of just swear an oath, that for evermore you will always be mortgaged to the hilt, so help you god.

That's about the only difference. A SM is for people who have no equity and never really want any, but just do not know why.
 

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A SM is for people who have no equity and never really want any, but just do not know why.
There's no need to be judgemental!

We have lots of equity in multiple properites. We use the SM because it is one of the few true deductions left in our tax system (besides RRSP contributions). We are in the highest tax bracket and every deduction helps. Investment income covers the interest payments, so we aren't out of pocket for interest costs. That being said, if there was a sudden upheaval in the markets and our investment income was affected we can afford to carry the interest costs if we have to.

Off and on, we have SM'd for over 15 years and it has worked out well for us. When we first started, only a couple of financial institutions offered re-advanceable mortgages, but now it appears that most of them do.
 

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The way I see it, is originally, financial advisors looked for people who had a lot of equity in their homes and said, hey, would you like to take some of that out for investment purposes and enjoy some tax benefits at the same time.

Then came along a few more greedy financial advisors that got tired of walking away from people who had debt up to their eyeballs and said, hey, I have this neat little idea we call the smith manoevre, where I can still make money from you.

Hey, tax wise, it works just as well as the former, but I personally think it best to wait until you build up a little more equity than what you end up with after making one months mortgage payment. That is my opinion. Good luck to you.
 

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The way I see it, is originally, financial advisors looked for people who had a lot of equity in their homes and said, hey, would you like to take some of that out for investment purposes and enjoy some tax benefits at the same time.

Then came along a few more greedy financial advisors that got tired of walking away from people who had debt up to their eyeballs and said, hey, I have this neat little idea we call the smith manoevre, where I can still make money from you.

Hey, tax wise, it works just as well as the former, but I personally think it best to wait until you build up a little more equity than what you end up with after making one months mortgage payment. That is my opinion. Good luck to you.
OptsyEagle has a point. You have to wonder if there isn't an element of self interest in many advisors pushing SM. After all, all that leveraged investing generates extra fees.

Having said that, implementing a SM doesn't mean you have no equity. You take out equity from the home and use it to buy stocks. Instead of home equity, you have a stock portfolio and are willing to ride the ups and downs of the market.
 

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Dana, if your investments are paying the carrying charges then you are not doing a SM, but rather plain old leverage.
A key feature of the SM is not using your own cash flow to fund the investment loan.
Personally I am beginning to doubt the validity of the SM, specifically the deductibility of compound interest.
Doesnt it seem "to good to be true"? Never pay out of pocket interest costs, and receive an ever increasing deduction?
IT533 is commonly bounced around because it states compound interest is deductible "pursuant to section 20(1)(C). Has anyone read the specific section?
"Cashdamming" is also said to be allowed in regards to rental property, but IT533's reference to cash damming simply means to segregate your credit lines.
 

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TFSA killed the true SM for me

I've decided to put money straight into TFSA rather than implementing SM

It's still leveraged investing in a way, but much simpler and beats SM when you make decent yield. SM only beats TFSA in very low yield/very high MTR situation

This doesn't apply to people who already paid off their mortgage or TFSA limit is too far behind
 

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I think the biggest difference between traditional forms of leveraging and SM is really about the time frame. The SM gradually and slowly transitions your nondeductible debt to deductible debt in its most common application.

The leveraged investing typically increases your debt load in a quantum leap. Certainly you could adopt this method within an SM structure ( this is what I did) but I'm trying to compare typical examples.

The argument for SM is that you were willing to sign up for a highly leveraged debt instrument for a very specific "investment". Why wouldn't you be willing to gradually diversify your debt and investments by adopting the SM?

I think if one chose a Couch Potato Portfolio and readjusted annually then there is a high likelihood that 20 years down the road they would be significantly better off.
 

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TFSA killed the true SM for me

I've decided to put money straight into TFSA rather than implementing SM

It's still leveraged investing in a way, but much simpler and beats SM when you make decent yield. SM only beats TFSA in very low yield/very high MTR situation

This doesn't apply to people who already paid off their mortgage or TFSA limit is too far behind
Have you compare the interests rate between the LOC and HELOC?
I am not leveraged (yet), however, from my readings, the HELOC rate seems to be lower than you could get with a LOC, making investing with a HELOC a little more attractive.

I could be wrong though!
 

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By leveraging, I mean putting money straight into TFSA rather than on my mortgage and borrowing it back

The SM is supposed to be a way to start investing young by paying off your mortgage asap and borrowing it back

As long as I have $5000 TFSA per year, I don't see myself needing SM for the tax benefit

When my house is 50% paid off I will prob use a HELOC to diversify my portfolio, but this is just good 'ol HELOC investing as Harold says
 

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I think the biggest difference between traditional forms of leveraging and SM is really about the time frame. The SM gradually and slowly transitions your nondeductible debt to deductible debt in its most common application.

The leveraged investing typically increases your debt load in a quantum leap. Certainly you could adopt this method within an SM structure ( this is what I did) but I'm trying to compare typical examples.

The argument for SM is that you were willing to sign up for a highly leveraged debt instrument for a very specific "investment". Why wouldn't you be willing to gradually diversify your debt and investments by adopting the SM?

I think if one chose a Couch Potato Portfolio and readjusted annually then there is a high likelihood that 20 years down the road they would be significantly better off.
Cannon are you saying a couch potato would qualify for a SM?
Very little income produced by these funds.
I was thinking about index funds with a pure leverage or SM. Nice difersification, and you will the benchmarks with low fees.
 

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I don't think that the SM and leveraged investing are two distinct strategies.

Leveraged investing applies to any situation where you are borrowing money for investment purposes. This normally results in deductible interest but not always (ie rrsp loan).

The Smith Man. is just a specific strategy where you use leveraged investing but in a fairly defined manner. So it's just a type of leveraged investing.

My complaint about the SM is that it maximizes your debt load thereby maximizing your risk level. Financial advisors love this because you will have more assets invested with them.

While I'm sure that this fits some people I suspect that most people (like myself) are far better off using leveraged investing but only to the amount they are comfortable.

When I did leveraged investments, I had about 50% equity in my house and I only used about 15% of the house equity for investments. I'm not saying that is the optimum amount for myself or anyone else but my point is that I chose the amount that I borrowed.
 

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SM and leverage are similar, but the main feature of the SM is you do not use any of your own cash-flow to do it.
I was pro SM, BUT I do have doubts about "capitalizing" the interest, and staying onboard with CRA. I still await a tax opinion on the matter from CRA.
The accountant who is doing my taxes this year worked for CRA as an auditor, so i will run it by him and see what he says. He would have been "the guy" who allows or denies the compound interest claim.
I have a lot of equity in my home just sitting there doing nothing so I may utilize leverage as follows:

1. Borrow to invest in CDN dividend growth companies. (little at a time when I can buy at a reasonable price.
2. Initial yield will be enough to cover the interest payment, with a bit left over. Over the next 20+ years hopefully this income will be much higher, giving me a nice cash-flow.
3. Since I will be paying the interest out of pocket, the amount I borrow will be an amount that I can comfortably cover the interest payment should the dividend income be cut or eliminated completely. Plan for worst case, so i wont be forced to sell at the wrong time. So far i have the "stomach" for investing in bad times, BUT leverage changes the ball game.

Alternatively:

Simply borrow an initial larger amount and dump it all into a tax efficient basket of ETF's i.e couch potato. Low fees and I will hit the benchmarks without the guidance of someone who stands to make thousands off of me in commission and trailers.
Not sure if I could hold some cash in the portfolio and stay on board with CRA.
 

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Discussion Starter #15
Not sure if I could hold some cash in the portfolio and stay on board with CRA.
Yeah, how does that work with the tax-deductibility of the interest (for regular leverage as well as SM)?
The investment account is bound to have cash at some point or the other, and sometimes the cash holding could be significant, such as when you've sold a large position and waiting to re-deploy.
Is the interest you are paying on your loan still tax deductible or do you have to keep track of %?
 

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Harold cash that is generated by the investments is fine, I was refering to cash as a % of assets in the total portfolio, say 10% cash to start.
 

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Discussion Starter #17
Harold cash that is generated by the investments is fine, I was refering to cash as a % of assets in the total portfolio, say 10% cash to start.
Right, and that's what I meant.
Say I take out $1,000 loan from the HELOC and transfer to my investment account.
Then invest only $400.
Month later another $300
6 months later another $300.
In the meantime, I'm paying interest on the full $1,000.
Is the full interest deductible?
 

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Harold I am talking about something completely different. It is my fault for not being clear. When I mean cash I mean cash that will never be invested. For example (can't remember exactly where I got this) a capital preservation portfolio will hold 20% cash. So on a 100K portfolio 20K will always sit as cash. I am not sure CRA would be on board with this although you will be earning interest. CRA requires any income, not net income.
 

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I think the biggest difference between traditional forms of leveraging and SM is really about the time frame. The SM gradually and slowly transitions your nondeductible debt to deductible debt in its most common application.

The leveraged investing typically increases your debt load in a quantum leap. Certainly you could adopt this method within an SM structure ( this is what I did) but I'm trying to compare typical examples.

The argument for SM is that you were willing to sign up for a highly leveraged debt instrument for a very specific "investment". Why wouldn't you be willing to gradually diversify your debt and investments by adopting the SM?

I think if one chose a Couch Potato Portfolio and readjusted annually then there is a high likelihood that 20 years down the road they would be significantly better off.
Well said, cannon fodder. I've been thinking about this a lot lately, but decided against leveraged investing for other reasons (mostly relating to what bean pointed out about leverage magnifying losses and emotions, and not just gains -- it helped to receive a gentle spanking on this issue over in the Retirement section). For me, the biggest incentive to participate in leveraged investing (whether it is all at once or through the SM) is because the government is willing to cut you a break on the amount that risk, to the tune of your marginal tax rate. Thirty-nine cents on the dollar is a lot of money.

Another difference between the SM and an investment in a primary residence also should be pointed out here. The regular mortgage is used to purchase something very functional: a roof over your head that you would need to pay for, at least in part, no matter what. This is not the case with the SM. With the SM there is no guarantee of gains ... even with the tax deduction lowering your hurdle rate.

The big downside of the SM is that a mortgage is a heavy burden indeed. Doing the SM would double the time it would take to kill your debt (so, yes, it is in fact using your cash flow -- it's just your future cash flow that you are impacting), and the new debt would still be putting your house at risk. If the market crashes, you could risk killing two birds (the house and the portfolio) with one stone.

Not sure if I could hold some cash in the portfolio and stay on board with CRA.
I have never heard of this being an issue at all. The principle behind the Smith Maneuver (and its fatcat cousin, the Singleton Shuffle), allows the deduction because there is a direct link between the borrowed money and the (deduction-eligible) use you put it towards. The focus is therefore on making sure that 100% of the money is used for investing... and only for investing. If you "invest" it by letting it stagnate at first earning 0.1% in a RSP, well, that's your concern. Are you thinking of waiting longer than a year to invest the money?

Interesting thread. Very topical for my life right now, so I appreciate it.



Edited to add: Oops, I think I conflated this thread with this one: http://www.canadianmoneyforum.com/showthread.php?t=1990
 

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I am new here so please bear with me but I have a (long) question. :confused:

I have been reading this thread with great interest. I don't like the ever-advancing debt load that seems to be part-and-parcel of the Smith Man but would I be violating any CRA rules by skipping the constant conversion of equity into debt?

I like the idea of having a tax deduction for interest paid to finance an investment (house or otherwise) so I guess what I'm hoping to end up with is a 'tax deductible mortgage' of sorts.

For instance, say you have 80% equity in your home (therefore 20% of the home value remains on your mortgage). For examples sake lets use a $1M home (this is the West Coast after all :) ) meaning you have a $200K mortgage.

Let also say you have a sum of money ready to invest, say 50% of the existing mortgage value. For this example, $100K.

Wouldn't it make sense to:
1) take the $100K and pay off 1/2 of the Mortgage.
2) take a HELOC (lower interest rate than a plain LOC) for $100K
3) invest the $100K as you normally would
4) still allocate the same sum for your normal mortgage payment (paying on 1/2 the mortgage value).

You could now structure your payments in a few ways (assuming your original mortgage payment was $1500):

- pay $1500 minus (HELOC interest cost) into the mortgage, paying the mortgage down faster

or

- pay $1500 minus new mortgage payment into the HELOC, paying both down at the same time

or

etc...

Isn't this a simple but reasonable plan? No special mortgage types, just transfering some non-deductible debt into deductible debt.

Also, would this strategy change in anyone's eyes if you were able to pay off the entire mortgage? You could then HELOC the entire value back and make use the value of your original mortgage payments to pay the HELOC down...

Your feedback is greatly appreciated.

I would even assume that as long as the HELOC $ was transferred to an exisiting standard investment account (the one I already have) I would be within the CRA rules.

Sorry for all the questions.
 
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