The Smith Manoeuvre is a Moose-approved financial strategy which, over time, converts your regular old mortgage into a productive, tax-deductible investment loan. You use the loan money to buy Canadian stocks which pay dividends--like XIC.TO for example. The investment contributions, tax savings, and dividends are applied to your mortgage to help pay it down quickly.
The best part about the strategy: it should substantially increase your wealth over time when compared to traditional mortgage pay-off and investing.
In Step 1, we looked at establishing the correct HELOC loan structure for the SM.
Step 2: Setting Up Your SM Chequing Account
The Hub of Activity
The chequing account is the hub of your Smith Manoeuvre money flow. For this reason, you need an online account that is completely separate from your personal account. A clean paper trail is important--do not ever use this account to pay your Mastercard bill or buy groceries!
Your chequing account is crucial to keeping track of money movement for the SM strategy. All dividends from your Smith Manoeuvre investments will go directly into this chequing account. You will also transfer money for your regular mortgage payments to this account from your main day-to-day chequing account. The extra money for investing will also go into this account.
From the chequing account, you will make your mortgage payments (Portion 1 of your HELOC that we discussed in Step 1). Make sure to top up your regular mortgage payments to the maximum possible. Most banks should allow doubled-up payments penalty free.
Use the dividend income and all extra money available for investing (after filling the TFSA/RRSP) to pay down Portion 1 of your HELOC as fast as possible. For annual lump-sum payments you may need to physically attend a branch of the bank that holds your HELOC and pay with a cheque.
You will also use the chequing account to guerilla "capitalize"--or pay at no extra cost to you--the monthly interest owing on your investment loan (Portion 2 of your HELOC). Basically we borrow the interest owing from the loan and pay it back right away.
As Fraser Smith put it: when the interest on your investment loan is tax-deductible, the interest on the interest is also tax-deductible. Capitalizing the interest on your loan ensures Portion 2 of your loan is always 100% tax-deductible.
However, for this reason do not max out the investment loan every month. Always leave enough available credit to, at the very least, pay the monthly interest bill on your investment loan by doing the double transfer I described.
Use A Cheap, Online Account
The best account for our purpose is a free online chequing account. I recommend either of the two most popular options: the Tangerine Daily Chequing Account or the PC Financial No Fee Chequing Account.
You will only be making online transfers and payments with this account. You do not need overdraft insurance or any other frills. You may need cheques to make annual lump-sum payments to your mortgage. You can open these accounts online with a small deposit.
If you are married or CL create a joint account. Joint accounts are better for estate purposes when in a relationship. Trust your partner, give them access, show them how this works. As a Moose reader you live for the best, but you also prepare for the worst case scenario. Don't leave your partner in the dark.
Despite using a joint account, all income and expenses related to this strategy will be claimed by the higher income spouse. If both of your incomes are in the same tax bracket and are likely to remain that way over time, you will split the income/expenses evenly. We will discuss this more in a future post.
In Step 3, for our next SM post, we will discuss the application of your existing Cash/Margin investments to this strategy.