The Smith Manoeuvre: Steps 6 & 7

Step 6: Borrow Back Money to Invest

Within the re-advanceable HELOC structure, as regular mortgage payments reduce the principal of the mortgage loan, the available credit in Portion 2 of the HELOC increases automatically. Remember, we can borrow up to 65% of the home value using a HELOC.

Always leaving a small amount of available credit in Portion 2 to cover interest costs (more about that in Step 10), transfer the newly available money on a regular basis from Portion 2 of the HELOC to your SM investment account.

Make these transfers shortly after your regular payments to Portion 1 of the HELOC. Don't worry about the stock price on any given day or month, markets go up 70% of the time—make the most of it with regular investing. Quick investing helps ensure all your interest on borrowed investment money remains tax deductible.

Step 7: Buy Income Generating Stocks

Investments purchased within the Smith Manoeuvre strategy are not in tax-advantaged accounts. Tax efficiency is important when choosing your investments, but always put balance and global diversification first.

To be eligible for tax-deductible interest expenses, you must invest in assets that generate some form of income: interest, dividends, or other income. Capital gains and return of capital are not considered "income"  by the CRA for this purpose. Don't invest in swap-based ETFs or T-series mutual funds.

From a tax efficiency perspective, this leaves Canadian-listed stocks as the best investment choice for your Smith Manoeuvre investment account.

Set up the Smith Manoeuvre investment account so that all dividend income and distributions from your investments are directly deposited in your Smith Manoeuvre chequing account. You can do this in your account settings online.

Smith Manoeuvre income and expenses will normally be claimed by the higher income partner in a relationship. If the higher income partner is in high tax brackets, you will need to choose low yielding stocks. If the higher income partner is in a lower or moderate tax bracket—or if the incomes are relatively even and the income and expenses from the strategy will be split between both partners—you may choose higher yielding stocks.

Don't worry about having the dividends cover your interest expenses (here's why it doesn't matter). You don't want to have a large tax bill on dividend income as a result of the Smith Manoeuvre. Less tax is almost always better.

Some Investment Options for Higher Earning Individuals

Individuals in higher tax brackets will normally want lower dividend yields. Where yield control is important, a diversified basket of low-yield stocks should be used. Invest in a portfolio of larger, global companies.

ZCN.TO or XIC.TO:  Index ETFs tracking Canadian stocks, low cost, moderate yield
BAM-A.TO:  Global asset manager, value purchaser, low yield
FFH.TO:  Global insurance and investments, known for excellent hedging, low yield
CSU.TO or OTEX.TO:  Large, global, diversified IT and software companies, low yield
IMO.TO:  Large, diversified oil company, refining and chemical assets, low yield
STN.TO:  Larger engineering and design firm, US exposure, low yield
ATD-B.TO:  Large, global convenience store operator, rapid expansion, low yield

Some Investment Options for Lower Earning Individuals

Lower earning individuals may choose higher-yielding investments to help pay down the mortgage faster. Generally speaking, ETFs provide good results, promote decent diversification, and are managed at a low cost making them a good option.

You may also choose high-yielding individual stocks to have better control over yield. However, be very mindful of diversification. Invest across different business sectors and choose companies that generate revenue outside of Canada.

ZCN.TO or XIC.TO:  Index ETFs tracking Canadian stocks, low cost, moderate yield
ZDV.TO:  Diversified dividend ETF, moderate cost, higher yield
XDIV.TO:  Moderately diversified dividend ETF, low cost, higher yield
VDY.TO:  Less diversified dividend ETF, lower cost, higher yield
ZPR.TO:  Preferred share ETF, moderate cost, high yield, better near retirement

Disclaimer:  The listed securities are presented simply as educational example and should not be read in an advisory context. I invest in securities which may from time to time include the securities listed here. I do not own, nor do I anticipate owning, a controlling or influential stake in any of the companies listed. I do not derive any meaningful financial benefit nor do I collect any revenue should you invest in the securities listed.

Comments & Questions

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6 Replies to “The Smith Manoeuvre: Steps 6 & 7”

  1. Hi, I just wondered if you could perhaps go into a bit more detail about the implications of investing in one of the ETF’s that includ foreign companies? I understand that it is more tax efficient to focus on Canadian companies but I want to ensure diversification in global markets as well. Any explanation you can give on how these etf’s effect th smith manuvure would be appreciated!

    Thanks
    Andrew

  2. Daren (Editor) says:

    Sure, I’ll do another post on this topic as there are a few things to think about with ETFs holding foreign stocks.

  3. I’ve been considering starting the SM for some time (already have HELOC/etc) but I still don’t feel this is a good time to enter the market with high leverage so I’m waiting for the next downturn. Perhaps a mistake but I’ll continue to invest regularly regardless in the mean time.

    I’ve been trying to finalize my investing strategy when the time comes. I’m a big believer in passive investing in my other accounts but question if that’s the best approach here. I’m also not looking to get max dividends as I have a high marginal rate and would prefer to defer the tax implications. I’m also wary of limiting myself to Canadian stocks to benefit from the tax credit as I would like to focus on growth.

    Overall I think the Dual Momentum approach may be a good contender here because downside protection would be a major asset here I feel. It makes little sense for me to hold bonds with a SM setup though as its very unlikely it would cover the interest cost. Do you see any significant concerns/challanges I may be overlooking with repaying the LOC when the signal is bonds? I’ve read a lot of your blog but I didn’t notice much about the strategy(s) you utilize with your SM portfolio specifically.

    Thanks,
    Alan

  4. Daren (Editor) says:

    I think Dual Momentum is a pretty good approach, even with the bonds. Due to the front rate controls and QE that have been implemented in the past few market cycles, bonds have tended to outperform when stocks fall. This is especially true for long-term bonds. It would be common for bonds to outperform your net (after-tax) HELOC rate during this time as your HELOC rate will likely drop.
    If you pay off your HELOC, you will lose your tax deduction.

  5. Thanks for the guide!

    I have a question about this particular instruction:

    Set up the Smith Manoeuvre investment account so that all dividend income and distributions from your investments are directly deposited in your Smith Manoeuvre chequing account. You can do this in your account settings online.

    Questrade does not seem to offer this option — I couldn’t find it on my own, and the agent I chatted with confirmed as much.

    Is this step a critical one for tracking purposes, or merely a convenience/time-saving measure?

  6. Daren (Editor) says:

    It is not critical, but it does make it easier. Most brokerages allow dividend deposits directly to your chequing account for non-registered accounts only.

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