First it was the subprime mortgages in the US. Now the latest news is margin calls in the US. Margin calls occur when people borrow money and put up stock as security for the loan. I could do this through my broker account but I never have to date. It sounds like the Bank of Montreal is being hit by the margin call problem. I wonder about the other Canadian Banks.
The thing is-when a margin call is made people have to come up with more cash or sell some of their holdings. This can translate into a wide stock market sell off taking the good companies down with the bad. And, I guess...if it is large enough - the sales reduce the values of the equities even more, the ones being used for collateral and this in turn can lead to additional more margin calls...and the cycle feeds on it self.
I wonder...could the reduction in equity values lead to margin calls or something equivalent for those doing the Smith Manoeuvre?
I see the sell off today has brought some Canadian Banks to the brink of making new lows...TD, RY and BNS.
Showing posts with label Smith Manoeuvre. Show all posts
Showing posts with label Smith Manoeuvre. Show all posts
Monday, March 10, 2008
Thursday, September 6, 2007
Reading Other Blogs - September 6, 2007
I continue to be impressed with the quality of information available on the web. In the workplace, I always believed that if you encouraged people to think and communicate in a group environment, that everyone would learn together. The web is the ultimate communication tool for this type of thing. When I read the different blogs it is almost like being back at work and discussing investments over coffee break. In fact, it's much much better... since the quality of discussion is 1000 times better.
For Example
Canadian Dream posted his recent interview with Derrick Foster about his new book. Just yesterday I read on another blog that DF had written a new book. I expect to read both of DF books this winter. However, because of the information I found on the web about dividend stock investing and the tax breaks available, I have already invested some money in a dividend stock mutual fund.
Four Pillars posted an overview of his investment plan. One point I liked is that he has limited his leveraging to a level he is comfortable with, currently about 10% of his investments. I strongly encourage anyone with a mortgage to take a hard look at the SM opportunities in conjunction with a financial planner. It is normal to be wary of leverage, but rather than do nothing and let the years slip by, one can follow FPs lead and start with a percentage limit on the leveraged portion of one's portfolio. I recall having trouble sleeping when I took out larger mortgages years ago but I quickly forgot about it. After a short while the extra debt "was normal" and I never gave it much thought. In the final analysis we all leverage our investment in real estate when we take on a mortgage.
The Financial Blogger is posting his real time experience with the SM. I look forward to following his progress. It is a good blog to read if your afraid of the SM. It doesn't sound very scary because the numbers start out quite small. It gives one a chance to "grow into it" over time.
Million Dollar Journey's blog has a great guest post by Melanie McLister that summarizes the SM and provides a link to a table of comparison for Canadian sources of special mortgages needed for this strategy.
For Example
Canadian Dream posted his recent interview with Derrick Foster about his new book. Just yesterday I read on another blog that DF had written a new book. I expect to read both of DF books this winter. However, because of the information I found on the web about dividend stock investing and the tax breaks available, I have already invested some money in a dividend stock mutual fund.
Four Pillars posted an overview of his investment plan. One point I liked is that he has limited his leveraging to a level he is comfortable with, currently about 10% of his investments. I strongly encourage anyone with a mortgage to take a hard look at the SM opportunities in conjunction with a financial planner. It is normal to be wary of leverage, but rather than do nothing and let the years slip by, one can follow FPs lead and start with a percentage limit on the leveraged portion of one's portfolio. I recall having trouble sleeping when I took out larger mortgages years ago but I quickly forgot about it. After a short while the extra debt "was normal" and I never gave it much thought. In the final analysis we all leverage our investment in real estate when we take on a mortgage.
The Financial Blogger is posting his real time experience with the SM. I look forward to following his progress. It is a good blog to read if your afraid of the SM. It doesn't sound very scary because the numbers start out quite small. It gives one a chance to "grow into it" over time.
Million Dollar Journey's blog has a great guest post by Melanie McLister that summarizes the SM and provides a link to a table of comparison for Canadian sources of special mortgages needed for this strategy.
Sunday, September 2, 2007
Smith Manoeuvre Review...September 2, 2007
I'm still reading the book and reviewing some comments on other blogs. It took me awhile to understand the basics. Not because I am older, and not because I am new to this kind of financial stuff, my resistance goes much deeper. It is contrary to my basic emotional programming. I guess I also thought that this sounds too good to be true.
I must admit that I am still trying to "get use to the idea". It makes a lot of sense logically and mathematically but like most everyone else I have been brain-washed with the working-class belief that debt is bad and that we should run away from it as fast as we can. Our beliefs come from our parents, friends, relatives, books and the media. Were all driven by fear. When I read other posts on the SM I know I am not alone on this issue.
Smith makes some excellent points beyond just using leveraging. That when it comes to investing in things that go up in value such as equities or real estate, "time is our friend". That is not a new concept, I have "know it" for many years. But Smith has found a way around the "big rock" in the stream, he shows us a way that we can overcome an imaginary obstacle, like the migrating salmon, we can jump over it. He gives us a solution that we never had before. It is positively brilliant.
It then follows that to wait "to invest", until the mortgage is paid off is not the best course of action. It is a "missed opportunity".
The reality of it all is that in order to become financially independent and retire at an early age, we need to own our own home and own other investments as well.
The SM is much more than just leveraging to buy investments. Smith also demonstrates the benefits of selling current investments like CSBs, Term Deposits or equities, using that money to pay down the mortgage, then borrow it back to re-invest. Many of us have a mortgage and money invested in other things at the same time. I was in that position for a couple of decades.
By simply re-arranging our financial house to take advantage of the tax benefit, we can keep our total debt the same, own all the same stuff, and get a big tax refund on top of it all. The tax refund can be used to pay off the mortgage sooner or to buy more investments. One's dollar level of debt never goes higher than the original size of the mortgage. And, with inflation, that debt actually reduces over time. A debt of $100,000 today is really less than a debt of $100,000 ten years ago. So one's debt level and amount of leverage actually reduces over time using the SM.
What about our fears...what if a bear market occurs? What if interest rates rise? These are excellent questions and I think one needs to go into the SM with eyes wide open and with "an emergency plan". Having an emergency plan reduces stress.
I don't know if my emergency plan ideas for the SM are the best ones, but here are a few initial thoughts.
Emergency Plan Ideas
If interest rates go crazy, like they did back in the early 1980s - and mortgages go above 20 percent, what can one do with leveraged investments? I can think of several options.
Owning equity investments, in addition to one's home, is not the same thing as owning a more expensive house. You can't sell half of your home quickly, easily or conveniently. In comparison, with the SM you have more control. Equity investments can be easily sold to reduce the amount of leverage.
Using the SM one owns the equity investments free and clear. They are not "bought on margin"(the old scary method) so you will never see a margin call that forces you to sell anything during a market crash. You won't be tempted to jump off a 10 storey building. You will therefore always have total control on the degree to which you are leveraged.
When and if it happens, you will have to weigh the pros and cons of selling equities and losing the tax refund. Higher interest rates will also bring higher tax refunds to your door to mitigate the situation. It may come down to whether or not one can meet higher monthly payments. Keep in mind that interest rates don't go from 6% to 20% overnight. You will have some time to consider your options.
During a long bear market one could sell some equities in the SM leveraged portfolio and replace them with interest paying things like Term Deposits, GICs or CSBs. During periods of high mortgage rates, these things would also be paying much higher interest rates. I can recall getting in-the-order of 18% on term deposits back when mortgage rates went above 20 %.
Another option may be to lock into a fixed interest rate loan for the investment account.
Smith also discusses the option of capitalizing interest. CI means borrowing more to pay the interest. Doing some of this would also be a way to control monthly payments.
I must admit that I am still trying to "get use to the idea". It makes a lot of sense logically and mathematically but like most everyone else I have been brain-washed with the working-class belief that debt is bad and that we should run away from it as fast as we can. Our beliefs come from our parents, friends, relatives, books and the media. Were all driven by fear. When I read other posts on the SM I know I am not alone on this issue.
Smith makes some excellent points beyond just using leveraging. That when it comes to investing in things that go up in value such as equities or real estate, "time is our friend". That is not a new concept, I have "know it" for many years. But Smith has found a way around the "big rock" in the stream, he shows us a way that we can overcome an imaginary obstacle, like the migrating salmon, we can jump over it. He gives us a solution that we never had before. It is positively brilliant.
It then follows that to wait "to invest", until the mortgage is paid off is not the best course of action. It is a "missed opportunity".
The reality of it all is that in order to become financially independent and retire at an early age, we need to own our own home and own other investments as well.
The SM is much more than just leveraging to buy investments. Smith also demonstrates the benefits of selling current investments like CSBs, Term Deposits or equities, using that money to pay down the mortgage, then borrow it back to re-invest. Many of us have a mortgage and money invested in other things at the same time. I was in that position for a couple of decades.
By simply re-arranging our financial house to take advantage of the tax benefit, we can keep our total debt the same, own all the same stuff, and get a big tax refund on top of it all. The tax refund can be used to pay off the mortgage sooner or to buy more investments. One's dollar level of debt never goes higher than the original size of the mortgage. And, with inflation, that debt actually reduces over time. A debt of $100,000 today is really less than a debt of $100,000 ten years ago. So one's debt level and amount of leverage actually reduces over time using the SM.
What about our fears...what if a bear market occurs? What if interest rates rise? These are excellent questions and I think one needs to go into the SM with eyes wide open and with "an emergency plan". Having an emergency plan reduces stress.
I don't know if my emergency plan ideas for the SM are the best ones, but here are a few initial thoughts.
Emergency Plan Ideas
If interest rates go crazy, like they did back in the early 1980s - and mortgages go above 20 percent, what can one do with leveraged investments? I can think of several options.
Owning equity investments, in addition to one's home, is not the same thing as owning a more expensive house. You can't sell half of your home quickly, easily or conveniently. In comparison, with the SM you have more control. Equity investments can be easily sold to reduce the amount of leverage.
Using the SM one owns the equity investments free and clear. They are not "bought on margin"(the old scary method) so you will never see a margin call that forces you to sell anything during a market crash. You won't be tempted to jump off a 10 storey building. You will therefore always have total control on the degree to which you are leveraged.
When and if it happens, you will have to weigh the pros and cons of selling equities and losing the tax refund. Higher interest rates will also bring higher tax refunds to your door to mitigate the situation. It may come down to whether or not one can meet higher monthly payments. Keep in mind that interest rates don't go from 6% to 20% overnight. You will have some time to consider your options.
During a long bear market one could sell some equities in the SM leveraged portfolio and replace them with interest paying things like Term Deposits, GICs or CSBs. During periods of high mortgage rates, these things would also be paying much higher interest rates. I can recall getting in-the-order of 18% on term deposits back when mortgage rates went above 20 %.
Another option may be to lock into a fixed interest rate loan for the investment account.
Smith also discusses the option of capitalizing interest. CI means borrowing more to pay the interest. Doing some of this would also be a way to control monthly payments.
Saturday, September 1, 2007
The Smith Manoeuvre Review...September 1, 2007
I'm currently reading "The Smith Manoeuvre" by Fraser Smith, 2002. ISBN 1-55369-641-7.So far I'm finding the book quite good and easy to understand. It is a quick and easy read if you don't stop to check the math. Theoretically, in hindsight, had I discovered the SM back in the mid 1980s, when the author first invented it, and had I implemented it on my mortgage, and had I understood the market, as much as I do today... back then... then I would be a lot richer than I am now. Hindsight is 20/20 and there are a lot of "ifs" in this statement!
One of my initial concerns was that the SM required one to take on additional debt. This doesn't seem to be the case. As I understand it, for the Plain Jane version, one's total debt never exceeds the initial amount of the mortgage for the life of the mortgage. That is less scary than taking on a mortgage plus additional debt for investments.
I also like the fact, that for young people, the investments grow slowly over time, giving one time to adjust to the reality of market volatility. It forces one to "dollar cost average" into the market. Even if one understands very little about the market, dollar cost averaging builds in a safety factor against really dumb moves. But be very careful here....dollar cost averaging alone is not enough to save one from big stock market mistakes.
The SM depends upon using financial leverage to help one grow their net worth over time. However, financial leverage can also make a bad move much worse. In general, the SM alone does not guarantee success and it could make things much worse.
When applying the SM one should have a solid understanding of how the stock market works and the historical pitfalls. "The Four Pillars..." book is a good primer on this issue. In particular, learn about the historical mistakes that keep repeating themselves with each generation. Each and every time market participants think "this time is different".
A worse case scenario for the SM would be where one invests a very large "lump sum" into the market, in the wrong (high risk) investments, at the worst possible point in time. This could happen with a mature SM account, where the owner gets caught up in a buying mania, sells and buys a large sum of investments within the portfolio, or where one begins the SM with a large lump sum borrowed on a home that had been owned free and clear before the SM.
For example, if an investor (gambler) made a lump sum purchase of dot.com stocks such as Nortel (NT)or Cisco (CSCO) or even the entire Nasdaq Index near the peak of ~5000 in late 1999 or early 2000. This was a classic case of "irrational exuberance" when many people treated the market like a gambling casino. Then, during the subsequent severe bear market, the investor/gambler "lost heart", gave up on the "buy and hold" philosophy because the pain was too great, and sold it all at a large loss. That loss would then be in the form of debt, debt that the investor/gambler must pay interest on until it is paid off.
One redeeming fact is that the interest on that debt is all income tax deductible. Also, if the SM had been in place for a number of years with significant profits accumulated, prior to the dumb mistake, these profits would help offset the big error.
Monday, May 14, 2007
The Smith Manoeuvre
I have requested Smith’s book from the library for further research into this concept. Although I own my home mortgage free I’m curious to see what I might have done.
If I understand it correctly…the basic premise is that the house title in one’s name gives one the power to make a big loan. Rather than just pay down the mortgage, the Smith Manoeuvre goes one step further.
As the principle is paid off each month, use this increment in growing home equity as collateral for a second loan and use the loan for investment. The mortgage payment and original loan amount remains the same and your equity in the home continues to grow as under the normal approach.
The interest on the "new loan" amount is then income tax deductible. I guess, in general terms…if one makes 10% on investment, pays 7 % on the "new loan" and has a marginal tax rate of 50%, then the after tax cost of the new loan is 3.5 %. The net increase in net worth is 10-3.5 = 6.5 %.
One of the main benefits is that rather than waiting 25 years, while paying off the mortgage, then start investing, one starts investing much earlier in life. This time factor is one of the biggest obstacles to becoming financially independent.
If I understand it correctly…the basic premise is that the house title in one’s name gives one the power to make a big loan. Rather than just pay down the mortgage, the Smith Manoeuvre goes one step further.
As the principle is paid off each month, use this increment in growing home equity as collateral for a second loan and use the loan for investment. The mortgage payment and original loan amount remains the same and your equity in the home continues to grow as under the normal approach.
The interest on the "new loan" amount is then income tax deductible. I guess, in general terms…if one makes 10% on investment, pays 7 % on the "new loan" and has a marginal tax rate of 50%, then the after tax cost of the new loan is 3.5 %. The net increase in net worth is 10-3.5 = 6.5 %.
One of the main benefits is that rather than waiting 25 years, while paying off the mortgage, then start investing, one starts investing much earlier in life. This time factor is one of the biggest obstacles to becoming financially independent.
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