How Does The Smith Manoeuvre Work And Why Is It Crucial For Your Dividend Investing Strategy?

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Author: John Adams

 

We all deserve a dignified retirement. However, the Canadian Pension Plan and Old Age Security don’t have the buying power they once had. If you’re in your 30s or older, you’re likely feeling the heat. The cost of living keeps rising, leaving less money for RRSP contributions.

Tough times call for creative measures, If you own your home, you can tap your most significant asset to supercharge your retirement savings. By employing the Smith Manoeuvre, you can use your home equity to invest in dividend-bearing stocks.

In this post, we’ll fill you in on the basics on this cheeky bit of financial jiu-jitsu.

 

What Is The Smith Manoeuvre?

The Smith Manoeuvre is an investment strategy crafted by financial planner Fraser Smith. Decades ago, his clients lamented the fact that mortgage interest in America was tax-deductible, but not in Canada. So, he did some digging into Canadian tax law to see if he could find a way around this roadblock.

After months of study, he succeeded. While interest on mortgage payment wasn’t tax-deductible in Canada, interest on investment loans was. After using this strategy to significant effect with his clients, he released a book on the subject in 2002.

It was a niche success, selling 55,000 copies. But even more importantly, it influenced a generation of mortgage brokers and financial planners. They adopted the Smith Manoeuvre en masse, and convinced their clients to redistribute roughly 20% of Canadian mortgage debt onto lines of credit.

 

How Can I Use The Smith Manoeuvre To Invest In Dividend Stocks?

So, you can convert your mortgage debt into line-of-credit debt. But, how does that make your mortgage debt tax-deductible? As briefly as we can put it, here’s the Cole’s Notes version of the Smith Manoeuvre.

Start by making an appointment with your bank. In it, ask to convert your mortgage loan into a re-advanceable mortgage. In a re-advanceable mortgage, a home equity line of credit accompanies the primary mortgage loan. As you pay down your mortgage, the amount of credit available increases.

Use your line of credit to purchase income-bearing investments like dividend stocks. As you pay down your mortgage, you gain more room to invest in these equities. As you borrow more using your line of credit, your interest payments will increase.

However, Canadian tax law allows you to deduct interest from investment loans from your taxable income. Done right, this will result in a bigger tax refund. Use the proceeds to make a sizable extra payment on your mortgage. Repeat the cycle, and you’ll significantly reduce the life cycle of your home loan. At the same time, you’ll dramatically increase the funds available within your line of credit.

From there, it snowballs. Before you know it, you’ll have paid off your mortgage early. At the same time, you’ll also have a significant portfolio of income-bearing dividend stocks.

Clear as mud? If you’re still not 100% clear on how it works, check out the Smith Manoeuvre bible for dividend stock investing. This guide explains this investment strategy in a way that even financial laypeople can understand.

 

Employing The Smith Manoeuvre Is Crucial To Your Investing Success

If you invest in an RRSP, chances are good you’re a buy-and-hold investor. For years, this method has been held up as the “One True Path To Wealth” by followers of gurus like Warren Buffett.

However, this methodology has a serious flaw – it relies on hope and time. Unlike day traders, who profit immediately from their efforts, buy-and-holders must wait decades to reap the fruit of their labours.

But isn’t day trading risky? It sure is. But buy-and-hold investing also comes with risk. If you aren’t aware of them, ask those who were ready to retire in 2008. The stock market collapse that year erased decades of gains, forcing millions to extend their working careers.

So, what other options are there? In a word, dividend stocks. Dividend stocks pay their holders a set amount per share quarterly. The more you own of a dividend-bearing stock, the more you earn.

Best of all, dividend payments are mostly inelastic. When market corrections hit, they are usually unaffected. In bad crashes, the stock issuer may cut back their rate, but only rarely is it suspended. In all but the worst of times, you get paid.

Sounds good, right? Sadly, the average Canadian investor struggles to invest enough to make dividend stocks pay a worthwhile return. This is where the Smith Manoeuvre comes in. By leveraging the biggest asset you own, you can increase the size of your dividend portfolio at an unprecedented rate.

In this way, the Smith Manoeuvre allows you to build a passive income machine. Together with a 100% paid-off home, it offers you the rarest of all birds: true financial freedom.

 

What Are The Risks Of The Smith Manoeuvre?

Nothing worth doing is easy. While the Smith Manoeuvre has proven itself to be an effective creator of wealth, we mustn’t ignore its reliance on leverage.

No market goes up in a straight line forever. Countless housing and market downturns have occurred in modern history. When booms go bust, your home equity can evaporate. In bad recessions, dividend income can drop.

And then, there’s your primary source of income. In a downturn, you risk losing your job. If this  happens, your ability to service loan payments required by the Smith Manoeuvre may be compromised. Home equity loans are secured – to gain access to funds, you put up your house as security.

Miss enough payments and the bank could seize your property. It’s this scary reality that dissuades many from adopting the Smith Manoeuvre. However, if you plan for worst-case scenarios (saving up emergency funds) and are realistic about the long-term performance of stocks, you can significantly reduce these risks.

 

Leverage Your Home To Create Real Wealth

For most, our home is the biggest asset we own. Why not leverage it to build something even bigger? Thanks to the Smith Manoeuvre, countless Canadians have achieved the financial freedom offered by dividend-bearing investments.

By following this strategy responsibly, you can achieve the same.

 

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