A TMWTFS reader, Keith, asks the following question,
“My wife and I have been considering using the smith/snyder strategy to convert our current mortgage to tax deductible. The Smith Strategy in principle makes sense to me. However the proposal made to us also includes leveraging equity in our home; adding an investment loan component, using these funds to buy a DSC charge mutual fund with a ROC option, using the payments from the ROC to pay down the mortgage and re-borrow under the investment line of credit side. Have you had any experience with this and I would appreciate your thoughts? The proposal almost sounds too good to be true so in my experience it means I must be missing something of the risks associated.”
I’ll be honest with you Keith that there are a few things I don’t like about the proposed situation; specifically the plan to buy any mutual funds let alone a DSC mutual fund. I can actually say quite confidently that this is likely a strategy proposed to you by a financial advisor who does not have your best interests at heart. DSC mutual funds, for many reasons, are not good investments. When you compared them based on cost and/or performance the advisor and Fund Company often do better than you will over the short-term. Also many index funds perform just as well as a managed mutual fund and on a cost basis are much cheaper over the long-term. A savings of 1.5% on the MER (management expense ratio) each year results in a savings of 15% over 10 years if both mutual funds provide the identical return over that time period.
If a Smith Manoeuvre is what you’re interested in than you want to read the series by Million Dollar Journey written on this strategy (Read Part 1 & Part 2). MDJ probably writes the best and simplest explanation of the overall process including the benefits, costs and examples of how the strategy can work. I agree with him that this strategy should only be used for portfolios that focus on income paying investments (dividends specifically) or investment property that produces income.
With any leverage strategy you want to focus on being able to pay most of the interest with income produced from your investments. With the proposed strategy from your advisor I find it difficult to understand where that sufficient income would come from considering the fees that are likely involved in all the products he/she are proposing you develop in the strategy.
I would certainly advise doing a lot more research on the specifics of the strategy and examples so see how the strategy can work for you. Ultimately you have to make sure you’re comfortable with the strategy, the leverage and the repayment of the loan/interest without extending yourself too far financially.