In 2017 house prices climbed once again in many parts of Canada. Of course the hot spots were Vancouver, the Lower Mainland and Fraser Valley, and Toronto condos. Even Montreal is getting warm.
Chances are if you bought in these areas even a few years ago, you have gained substantial equity in your home.
The Smith Manoeuvre is a great way to access this equity and use it to fuel your investment portfolio and set yourself up for a nice retirement. Executed properly with a disciplined investment strategy, the Smith Manoeuvre can make you quite wealthy over time.
With enormous amounts of dead equity sitting in homes after this colossal price run-up, this year is a great year to begin the strategy. According to the Bank of Canada (that's the bank for banks), nearly half of all outstanding mortgages will be renewed this year! If you are one of the 47% of Canadian homeowners who will be walking into your bank sometime in the near future, you should seriously examine if the Smith Manoeuvre is right for your financial situation.
This way you can set up the proper mortgage/HELOC structure and shop around for a good rate while avoiding any cancellation penalties that might occur if you were breaking a mortgage mid-term.
Factors to Consider
Meeting the Equity Requirements
To begin the Smith Manoeuvre, you must have at least 35% equity in your house. While there are ways around this, I think it begins to get risky if you're reaching for more money.
Maintaining at least 35% equity gives you a nice cushion to withstand stock market movements, especially when starting the strategy. This could prevent you from being in a negative net worth situation.
It's easy to calculate your equity percentage. Simply take your outstanding mortgage balance and divide by a reasonable house valuation. If the resulting number is lower than 0.65 (or 65%), you have at least 35% equity in your home. It's time to put this equity to work!
Being Financially Stable
If you're living paycheque to paycheque, hitting the line of credit every now and then for surprise expenses, are unable to pay off your credit card, or can't seem to save any money, the Smith Manoeuvre is not for you.
The Smith Manoeuvre is a form of leveraged investing. That means taking on risk. It would be absolutely reckless to start a Smith Manoeuvre if you are not in complete control of your finances.
While over time the strategy should make you a lot of money, there are periods when stock markets drop 50% in a matter of months. The Smith Manoeuvre could wipe you out.
I believe the best candidates for the Smith Manoeuvre strategy are people who are financially stable and are already investing. This might be in a TFSA, RRSP, or some other account. It also works well if you are working a job that promises a secure pension – like a government defined benefit plan.
No Near-term Income Shocks
The Smith Manoeuvre is based on stock market investing. If you are able to put $100,000 of home equity to work using the Smith Manoeuvre HELOC account, you would buy about $100,000 worth of stocks or ETFs in your Smith Manoeuvre investment account.
However, we know that stock markets carry risk. It's entirely possible that a year after starting your strategy, your investment account could have dropped to just $50,000. If this happens, it's a nice time to try pump as much money as possible into your strategy and buy stocks or ETFs at a discount.
For this reason I think it's best to make sure you don't start the Smith Manoeuvre just before an income shock. Income shocks happen when you are pregnant and will be going on a reduced pay maternity leave. Or if your company is laying off and employment prospects are shaky at the moment. You get the idea.
When these events happen, people are often not prepared financially and can find themselves running into short-term debt situations. While accumulating debt is never a good thing, it's even worse if your investments are also tanking.
You might be tempted to access your Smith Manoeuvre HELOC for money when it's needed most for investment purchases and this is a bad idea. It also means you are complicating your accounting situation for tax calculations every year for a long, long time.
Before implementing the Smith Manoeuvre it is very advantageous to have some familiarity with investing – particularly self-directed investing via stocks or ETFs.
You should have a self-directed TFSA going (I use Questrade which has free ETF purchasing), or maybe a RRSP. If you haven't invested yourself yet, but are using an investment advisor, it is easy to get started. Questrade has great tutorial videos to show you how to purchase stocks/ETFs in a step-by-step manner. Use Limit Orders and enjoy the learning curve!
It's also important to understand the nature of investing. After several years of comfortable to high investment returns, it's easy to be numb to loss. You must realize that you can lose a substantial amount of your investment account during market downturns. Despite this, you must be invested in something that generates income at all times! If not, you will run into tax problems.
You can pair Smith Manoeuvre investing with a momentum strategy. For example, you may buy XIC.TO if it is positive over the past 12 months but switch to XBB.TO if it's not. This could shield you from some downside risk but will potentially reduce your returns, especially after accounting for taxes on capital gains.
Understanding Personal Finance
You should also have a basic understanding of personal finance. This means managing your bank accounts, paying your bills on time, avoiding unnecessary interest costs, and doing your own taxes (if you don't own a business).
The Smith Manoeuvre requires detailed accounting and tracking of money movement. A huge benefit of the Smith Manoeuvre is saving tens of thousand of dollars in tax over your lifetime.
It also requires moving money between a number of accounts. Your regular bank account, your Smith Manoeuvre chequing account, your Smith Manoeuvre investment account, and your HELOC. These need to be done in a timely manner every two weeks or month (depending on your mortgage payment cycle).
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