E Point Perfect

Should you borrow to invest with the Smith Manoeuvre?

I am not familiar with any Smith Manoeuvre calculators, Warren, but I can try to simplify the math a bit. First, what is the Smith Manoeuvre? It was developed by Fraser Smith in the 1980s as a method to make mortgage interest tax-deductible while building investment assets.

Lenders will typically allow you to have a home equity line of credit (HELOC) for up to 80% of the value of your home minus your mortgage balance. (If you are refinancing, your HELOC may be limited to 65% of the home’s value.) 

As an example, say you have a $750,000 home and a $600,000 mortgage with an interest rate of 4%. Your HELOC would be $600,000 less your mortgage. As you pay down your mortgage, the equivalent amount of room is added to your HELOC limit. Assuming a 25-year amortization, the first monthly payment for your mortgage pays down $1,173 of principal. After 12 months, you will have repaid $14,330 of principal and added the equivalent amount of room to your HELOC.

The Smith Manoeuvre involves borrowing the new room available on your line of credit to invest each month. The interest is tax-deductible if the funds are invested in a taxable non-registered account, and you end up with more investment assets growing over time. If you use all the new room, your mortgage debt level stays the same, because you’re borrowing back every dollar of principal you repay—but more of your debt becomes tax-deductible. 

How inflation affects your borrowing costs

You mention a few variables that you are having trouble addressing in your calculations, Warren, including inflation. Inflation will have an indirect impact on the numbers.

If inflation is high, interest rates will also typically be high to fight inflation. According to the Bank of Canada, it aims “to keep inflation at the 2 per cent midpoint of an inflation-control target range of 1 to 3 per cent.” Right now, inflation is over 6%, so inflation is on everyone’s mind. But over time, inflation will return to the target, hopefully by 2023, based on the Bank’s assessment.

If high inflation were to persist, not only would interest rates stay high, but investment returns would also likely be higher. Interest rates would be higher for bonds and guaranteed investment certificates (GICs). Persistent high inflation as represented by increasing prices for goods and services would generally lead to higher corporate profits and stock returns as well. (More on interest rates below.)

Warren, I’m inclined to assume that your calculations are over a long enough period that inflation is back under control and not a factor in deciding whether to borrow to invest. I would not recommend borrowing to invest as a short-term strategy. Market timing is very difficult, and leverage increases investment risk. So, if an investor decides to borrow to invest, it should be over a long time horizon.

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