Last updated on March 10th, 2023 at 10:48 am
Last month I shared that I received a sizable home equity line of credit (HELOC) of $400,000 from TD. Since the new year, I planned on applying for a HELOC so I could use it to invest. So now that I have a HELOC, what’s my plan for this money? How will I use it to build wealth and reach financial independence?
Now, it should be said outright: the Smith Maneuver is an advanced strategy.
Sure, it’s not too hard to wrap one’s head around the potential benefits (and drawbacks) of leveraged investing. But that’s not what I’m talking about here. What I mean is that the Smith Maneuver is mechanically complicated, confusing, and down-right tedious.
From capitalizing interest, to adjusted cost base, return of capital and (gasp!) phanton distributions, there’s a lot to learn about and stay on top of. Much of these topics I’ll cover in more depth in future articles.
For now, let’s get into strategy.
What’s the Best Investment for the Smith Maneuver?
There are two trains of thought when it comes to picking a Smith Maneuver investment.
Many people prefer to invest in some great Canadian dividend stocks. Doing so allows them to receive tax-advantaged cash flow that can help offset their interest expenses or pay down their mortgage even quicker. The other added benefit, avoiding that annoying “return of capital,” makes tax season less headache.
Others prefer to invest in a basket of ETFs, or a single all-in-one ETF, for simplicity and maximum diversification—cash flow be damned.
I fall into the second category in that I prefer the simplicity and diversification that ETFs (and especially all-in-one ETFs) have to offer. Also, with the size of the HELOC I have at my disposal, I am not too enthusiastic about being far overweight Canadian equities in my portfolio.
In considering the low-MER all-in-one ETFs that offer a reasonable expectation of earning income (a requirement for the investment loan being tax-deductible), VEQT (Vanguard All-Equity ETF Portfolio) is the obvious choice. It’s inexpensive, with great diversification, and backed by a reputable ETF provider.
VEQT also has the added benefit of only paying dividends once per year, which makes keeping track of my adjusted cost base easier and less tedious than it would be had I chosen its competitor, XEQT (iShares Core Equity ETF Portfolio).
To Capitalize or Not To Capitalize?
Many people who first consider the Smith Maneuver grow worried about cash flow: how do you pay your mortgage AND your HELOC’s interest without impacting your day-to-day finances?
Well, as you may know, one of the sleek benefits of the Smith Maneuver is that you can set it up so that it does not impact your daily cash flow at all. This is accomplished by capitalizing the interest.
Capitalizing the interest of your HELOC is essentially using your HELOC to pay its own interest. And as long as your HELOC was used for investing, capitalizing its interest wouldn’t negatively impact the tax-deductibility of your loan. Win-win!
So I plan to capitalize my HELOC’s interest. This will allow my wife and I to do the Smith Maneuver while still using our regular employment income to contribute to our registered accounts.
Smith Maneuver Contribution Strategy
Onto my contribution strategy.
With a $400,000 HELOC, one might be tempted to go all-in and invest it all immediately in the market. While this may be a good strategy on average, I’m a little too cautious, especially with rates climbing ever higher.
Instead, I plan to take a more balanced approach. Between now and the end of 2022, I plan to dollar-cost-average $10,000 per month into VEQT. I’ll re-evaluate at the end of this year and make any adjustments as needed.
However, there’s a wrinkle to this strategy. I also plan to up my contribution beyond $10,000 should the market take a sizable dip.
If VEQT falls 10% from its price when I started, I’ll invest another $50,000 on top of my regular contribution. A 20% fall will inspire an additional $100 to 200k contribution. And if we see anything above a 30% decline, I’ll contribute the remainder of my available HELOC funds.
What about Margin?
It’s a good question. Those of you familiar with my leveraged investing strategy so far know that I employ margin in my Interactive Brokers (referral link) account. Doing so allowed me to buy over $40,000 of VEQT with my $25,000 Tangerine line of credit (sign up using my Orange Code 46870461S1!).
However, I am not considering using margin as part of my Smith Maneuver strategy. Mainly because the benefit is quite small for the amount of leverage I’d be comfortable using with this amount of money.
As of writing, margin rates at Interactive Brokers are 2.34%, while my HELOC is at 3.5%. This may seem like a big difference, but I would only be comfortable using something like a 1.2 leverage ratio. At this ratio, I’m only saving 0.22% by using margin to supplement my HELOC—even less after taxes.
Plus, with so much liquidity at my disposal, I don’t need to tap margin to increase my investible assets: if I wanted to buy more VEQT, I could just withdraw more from my HELOC.
Thanks for Reading
I recently wrote a few articles that you may be interested in. This includes my post on Canada’s housing market in 2022 and my post on the 10 best Canadian dividend stocks. Consider giving those a read if you think they’ll help you on your financial journey!
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