You may have read elsewhere that we here at The Smith Manoeuvre contend that there is no ‘leverage’ involved in the strategy. The reason for this is that the leverage has already occurred prior to the Canadian homeowner implementing the strategy. Think about it – the homeowner already borrowed when they bought the house. The mortgage they took out to buy the home is where all the leverage lies. When implementing The Smith Manoeuvre, yes, there is technically ‘borrowing to invest’ but one can not get at any new money to borrow to invest unless they first pay down the non-deductible mortgage loan. For example, they must first pay down the mortgage balance by $1,000 before they can borrow back that $1,000 to invest for their future. Total debt stays the same, and if there is no increase in debt, there is no leverage. But let’s talk about it a little anyways…
Who is Talbot Stevens?
Talbot is a Canadian author and speaker who believes strongly in improving the financial literacy of Canadians. Among his writings is “Dispelling the Myths of Borrowing to Invest” – a small booklet which looks at conservative leverage in a light which is readable and understandable. Talbot, after much past research, describes a number of investment strategies revolving around borrowing and clearly explains the advantages of borrowing to invest which have escaped many others. Here I will quickly go through some of the myths he lists in his booklet.
Myth One – Leverage is only for the wealthy
With a basic understanding, any Canadian can use the benefit of borrowing to invest to their advantage. If one spends the time to educate themselves on the pros and cons, there are leverage strategies anyone can implement.
Myth Two – All debts are bad
Yes, some debt is bad – personal loans, credit cards, store loyalty cards…When you load up on this debt, you are quite likely paying high, non-deductible interest charges on money that was used to buy depreciating assets. However, if you borrow to invest, chances are very high that your asset will increase in value over time, thus improving your net worth. And to top it off, you can also deduct the interest on that loan, if done right.
Myth Three – Leverage is too risky for me
Can you control your emotion? Can you borrow just enough rather than too much for your given situation? If so, you may be in a position to greatly benefit. In any event chances are very good that you’ve already engaged in leverage – if you bought your house with a mortgage, you leveraged. And I’m betting that worked out well for you…
Myth Four – Returns must exceed cost to be profitable
The breakeven point is lower than the nominal rate of interest you are paying on the borrowed money. If you borrowed to invest in a non-registered account, for example, then because you are able to deduct the interest from your income, the real rate you are paying is lower than the nominal rate. For example, if I am at the 40% tax bracket and my nominal rate of interest is 6%, then the breakeven rate of return on the investment is only 3.6%.
Myth Five – Returns must exceed cost to be better
If you are investing in assets which produce generally capital gains, then we must remember that these are taxed in the future (you can deduct the interest annually but you are only taxed when you realize the gain – once and I in the future) and taxed less (while interest is 100% deductible, only a portion of the gains are taxed).
If you are looking to improve your family’s net worth, then check out Talbot’s booklet, and read up more on The Smith Manoeuvre.