March 26, 2020

Episode 91: Robinson Smith: Tax Efficiency & Leverage: The Smith Maneuver

March 26, 2020

The Smith Maneuver was developed by Fraser Smith as a smart way for Canadians to convert a traditional, non-deductible mortgage into a deductible mortgage by systematically re-borrowing to invest. Today we are joined by Fraser's son, Robinson, to talk about the maneuver, his father's legacy and explain how you can use it to your financial advantage. In his book, The Smith Maneuver, Fraser laid out a plan for working the mortgage and debt system to your advantage, by deducting the interest on a mortgage, while still being able to claim exceptions on the sale of a house. Robinson does a great job of explaining the procedure for implementing the strategy and all the possible ways to use it. He talks about risk, different kinds of debt and investor diligence, giving everything you need on the subject! Robinson believes in his father's vision of bringing the practices of the wealthy to the average Canadian and allowing wealth creation through leveraging possibilities instead of the inertia and fear that most people choose. For the last part of our conversation, Robinson gives us some examples from the Smithman Calculator, illustrating just how effective the system can be! Join us on the Rational Reminder Podcast today, to get it all!

Key Points From This Episode:

• An explanation of the Smith Maneuver and its usefulness to Canadians. [0:03:40.6]

• A step by step walk-through of the implementation of the Smith Maneuver. [0:07:15.1]

• The possibility of refinancing a credit line for lower mortgage rates. [0:10:18.0]

• How to think about maintaining more leverage with mortgage payments. [0:13:04.9]

• The risks of debt, minimizing withdrawal amounts and reversing the maneuver. [0:16:48.6]

• Robinson and his father's investor experiences around the 2008 market crash. [0:18:35.3]

• Why leveraging smart debt is so much better than gambling on a startup! [0:20:24.2]

• The regulatory risk that is present when performing a Smith Maneuver. [0:22:04.1]

• Risks that accompany not applying these strategies that Robinson is espousing. [0:24:47.6]

• The influence of your tax rate on the efficacy of the Smith Maneuver. [0:27:23.2]

• The diligence that is needed in the implementation of the Smith Maneuver. [0:29:15.0]

• How the Smith Maneuver can address poverty issues that plague Canada. [0:33:39.8]

• Running through the input process and rewards on the Smithman Calculator! [0:34:51.8]

• Net-worth improvements and cash-flow dams from re-borrowing. [0:38:41.7]

• How Robinson defines success in his mission to help Canadians. [0:41:26.3]

Read the Transcript:

I figure there's no one better to do this than you. Can you describe the Smith Maneuver?

Yeah. Well, basically, as we all know, Canadians pay extremely high taxes. When we look at all taxes combined, we're paying typically over 50% of our income. And consistently, we're in the five highest tax-paying citizenry on the planet, so taxation is an issue. Canadians have pension insecurity. We've got insufficient personal savings, just simply because of the cost of life. And corporate pension plans, if we're fortunate enough to have corporate pension plans, we just have to look to Sears to see what can happen there.

And, of course, as you guys know, we've got inflation. And especially as it regards Canadian homeowners, we've got the high cost of mortgages. It takes a big chunk of our paycheck each and every month or two weeks. And typically, we, as Canadians, we've got this sequential approach to personal finances, meaning we've got these two big goals. We want to get rid of our mortgage, and we want to save for our retirement. But this decision of which to do first is typically made for us, not by us, because of all of these expenses and taxes.

If we don't save for our retirement with our personal cash, no one is going to knock on our door. But if we don't make our mortgage payment, it's a contractual obligation. Someone will knock on our door. So we attack the mortgage first at the expense of getting invested. We lose the power of compound growth, etc.

Now, as you guys know, in Canada, if we borrow to invest with the reasonable expectation of generating income, we can deduct the interest from that income, and that's what the Smith Maneuver takes advantage of. In a general sense, what it does is it allows us to re-borrow any equity that we create in our home via our regular mortgage payment or any prepayments, and we can get that money invested.

What this does is three important things, very valuable things simultaneously. We're starting to generate tax deductions. These tax deductions typically lead to a tax refund, which is cash that otherwise we wouldn't have, and we can now prepay that mortgage and get rid of it faster. But we're also saving for our retirement, and so we're getting all these three benefits simultaneously. We're starting now. We're attacking that non-deductible debt now. We're getting invested now. We're reducing our tax bill now. We're doing it all immediately, and it doesn't cost the homeowner anything out of pocket to implement the strategy on an ongoing basis.

The big difference between Canadians and Americans, as we know, in the US, they can deduct most of their mortgage interest from their income. But they're subject to capital gains tax when they sell their home. In Canada, it's the reverse. We do not get to deduct any income from our mortgage interest, but we do get capital gains exemption when we sell our homes.

What the Smith Maneuver does is it levels the playing ... Well, it actually brings the playing field to our advantage because now we can deduct the interest on our mortgage, and we still get to claim exemptions on the sale of the house.

The way you explain it makes a ton of sense as a planning decision.

Yeah. Well, there are an increasing number of financial professionals across Canada who are becoming aware of the strategy, reading up on it, reading my book. It just came out November 20th, Master Your Mortgage for Financial Freedom. And a lot of Canadians are becoming more and more aware of this as well. Canadians are getting tired of getting hammered at the pump, tax time, everywhere they look, in the grocery store, so they're starting to look for answers. They're starting to look for solutions. They're doing their reading, they're looking up and looking things up, and they're coming across the Smith Maneuver, so there's a great amount of increasing interest in this strategy.

I agree with you. The Smith Maneuver comes up more and more all the time in client meetings. Our audience is pretty technical, Robinson. I was wondering if you could walk us through step-by-step the actual specifics in implementing a Smith Maneuver.

Sure. The first thing is the appropriate financing. You're going to want to talk to a Smith Maneuver certified professional mortgage broker who can determine if you have the appropriate mortgage already or not. Generally, people need to refinance into what's called the readvanceable mortgage. Now a lot of mortgage lenders out there have this type of mortgage. It's different than a typical mortgage when we think of the word mortgage in that a typical mortgage is simply one big lump sum, 400, 800, $1,000.00 that we owe the bank. We borrowed that in order to buy the house. We pay that off over 25, 30 years, what have you.

A readvanceable mortgage has ... there are a number of different variations on the theme, but generally, there's a line of credit, which is also secured by the house. So it's one mortgage, but there's an amortizing, non-deductible loan side and an interest-only line of credit side. And so, as I mentioned earlier, when we make a mortgage payment, let's call it $3,000.00, if $1,000.00 goes to the bank in interest, $2,000.00 reduced principal. The secured line of credit, if it starts off with a zero limit, it's going to increase by the exact same amount that was just reduced on the other side of the mortgage, so it increases by $2,000.00. I can pull that out, and I can invest.

Now, what I actually do with that available borrowing on a monthly basis is very important because a lot of Canadians have a readvanceable mortgage. They aren't really using it to their best financial advantage. They're taking this $2,000.00 out, and they're making a Lexus payment with it, or they're going on vacation. And so, all they're doing is trading non-deductible debt for more non-deductible debt. Now, if we borrow this out to invest, we get all these good benefits I mentioned earlier, tax deductions, we can take the refund, we can prepay that mortgage, and we're saving for our retirement immediately.

What I also mentioned earlier is that it required no new cash from the homeowner to implement the strategy, and that's going to be ... Some of the more astute people listening are going to say, "Well, hold on a second. I've got a cost of monthly payment at $3,000.00. Now, if I implement the Smith Maneuver, I've also got an increasing balance on the line of credit. So if that $3,000.00 stays constant, but I've got interest on the line of credit, where is the line of money to service that coming from?" And the answer will astound and amaze you, men.

It lies in the increasing efficiency of the regular mortgage payment. We know that if I have a $3,000.00 mortgage payment, month one, $1,000.00 goes to interest, $2,000.00 to principal. Well, month two, $998.00 goes to interest, and $2,002.00 goes to reduce the principal. So, as per the readvanceable mortgage, month two, instead of $2,000.00 to re-borrow to invest, I can re-borrow $2,002.00. I only invest $2,000.00, and I leave $2.00 behind, which goes to service the interest from the month previous on that $2,000.00. The next month, it's $2,004.00, the next it's $2,006.00. So this increasing efficiency of the regular mortgage payment allows us to service the interest on that line of credit without anything coming from our pockets.

Would you ever want to refinance at some point, the line of credit side, to take advantage of lower mortgage rates?

That is a fantastic question. My dad, Fraser, came up with what he called the Fraser Finagle. He liked alliteration. Either he thought too long about what to name it or not long enough, but that's what he came up with, essentially, Cameron. Back after the financial crisis, we know that we saw rates swap on an amortizing loan versus a line of credit. And so, what we did is ... I was an investment advisor at the time. For the clients that had converted their mortgage, and there were many, they now were paying, let's say, five or five-and-a-half, or whatever the rate was at the time, four-and-a-half. But on the loan side, they could get a lower rate, so we swapped them over. We swapped that 400, $500,000.00 of interest-only line of credit over to an amortizing PNI section.

Now the rate was lower, but the problem was, you'd think, well, now I'm paying down deductible debt when I want to maintain my deductible debt. But because they were still in that readvanceable mortgage, all we did was a balance transfer with the same lender. They could re-access the principal component and get that borrowed out as well, so the effect was the same. You're maintaining the principal. You're essentially servicing interest-only but at a lower rate going forward. So that's a great question, and that is definitely a method that could be used to reduce actual out of pocket.

And I bring that up in the Smith Maneuver certified professional accreditation course and instruct professionals how to implement that. But basically, what I've just described there as regards to processes, the plain Jane Smith Maneuver, I'm simply using my existing mortgage payment to my advantage. I'm paying it anyways instead of accruing hundreds of thousands of dollars in nonproductive equity, I'm getting that money out. I'm displacing that equity. I'm taking it out of the house at less than 0% due to inflation into something that's going to earn me a rate of return investment grade.

So that's the plain Jane, but there's also accelerators. Go through in the book in detail, the debt swap, cash flow diversion, cash flow dam, the drip accelerator, and prime the pump. It's a relatively simple strategy. You don't want to do it on your own. After all, we are dealing with the CRA. You want to stay onside, so you want to use professionals. We're dealing with investing and mortgages. But there's a lot of ways to really speed up the conversion process for your mortgage.

You just mentioned debt-equity in the home, and that brings up a really interesting point in this discussion. There's two things that we're talking about. There's leverage, and there's tax efficiency. And I think given the decision to employ leverage, the tax efficiency piece makes a ton of sense. That's dead obvious. But the leverage piece, that's a real asset allocation decision, and it's a big decision, and it's a big decision. How do you think, on that side of the Smith Maneuver, how do you think people should think about this decision to maintain more leverage than they would have had they just paid down their mortgage over time?

Yeah. Well, the tax deductions which I mentioned are about one-third of the total value of the Smith Maneuver. The other is getting invested sooner rather than later. But still, one-third is a pretty big chunk. The whole tax efficiency piece, I mean, we've all heard the rumors that CRA has been listening to homeowners that the tax returns are a little too complex, and they've been working on a new return. And apparently, it's only two lines. How much did you make last year? Send it in.

It's a big benefit on the tax side, but we have to face the fact that generally, as we've grown up from children to young adults to adults, we've been surrounding ourselves with people who have been telling us all our lives that debt is bad. Do not get any debt. If you have to, pay it off as soon as you can. And that's very powerful, this inertia. And so that's what we have to deal with on a daily basis with people who are considering this. "You want me to maintain my debt? You want me to ... I got $400,000.00 mortgage. Do you want me to keep $400,000.00 til the day I die?"

Well, yes, because there's two types of debt. There's good debt, and there's bad debt. Bad debt destroys wealth, good debt creates wealth. And this is what the wealthy know. We need to start, as Canadians, thinking like the wealthy. The wealthy are wealthy for a very good reason. They understand debt. I mean, the top 10% of Canada's wealthiest population owns over half of Canada's wealth. There's a reason that they're there. Right? They know things that the general population doesn't.

We can look at Jimmy Pattison as an example. How did he do it? Did he get his first job delivering newspapers for working at KFC, save up enough money to go and buy a car dealership, and then sit in a corner office waiting for a car to sell? No. He got enough money for a down payment for that dealership. He went out, he borrowed. He got good debt, deductible debt, and he bought his first dealership. And then he took the equity out of that one and bought another dealership. Took the equity out of that, bought a radio station.

Jimmy Pattison owns over 20 car dealerships, representing 12 automotive brands, Canada's largest outdoor advertising network, 40 radio stations. He owns Save-On-Foods, Ripley's Believe it or Not, Guinness World Records. There's a reason that the wealthy are up there, and being able to distinguish between good debt and bad debt is a very big reason of why they're there. They embrace debt, the right type of debt.

And Canadians, whoever bought a house out there in Canada, they behaved exactly like the wealthy when they bought their first house. They went out and put a down payment together. They went out and borrowed money from someone else, and they bought this asset. Which, in most cases, 99.9% of the time, it's going to increase in value over the course of time. It increases their wealth, increases their net worth. But as soon as we went and borrowed that money and bought that house, we stopped behaving like the wealthy because we insisted on paying that debt down and insisted that all debt was bad. And then we let this equity in our house that we're creating on a monthly basis, it's increasing, we let it molder, and 0%, less than 0% due to inflation.

What do you think about the risk, though? How should people think about maintaining that leveraged position over the long-term? I totally agree with you, increases expected returns. And if we think about it from the corporate finance perspective, which maybe is another way of talking about the wealthy, you'll never find a corporation that doesn't have any debt in their balance sheet because it doesn't make any sense. And there's even good academic research suggesting that people should be using debt when they're young, but it's not risk-free.

For every Jimmy Pattison, there's somebody who borrowed money to start a car dealership and then lost everything. How do you think people should approach thinking about that portion of the decision?

Well, when I'm talking to people, firstly with the Smith Maneuver, you don't have to take out everything dollar for dollar that you pay down. You don't have to pull all that back. There's a decelerator called the Smith Maneuver Lite. Now if I've got $1,000.00 that I can pull out on a monthly basis to invest, I can only pull out $500.00 if I want. So I start off with a $800,000.00 mortgage. I end up with $400,000.00 of 100% deductible debt by the end of the conversion period.

Plus, the Smith Maneuver is reversible. If there's anything that happens in my life, say I start the Smith Maneuver as a single man, and I get married. My wife is uncomfortable. Right? Would I divorce her? Probably. But would everyone? Maybe not. Right? They've got to solve this problem some other way. And what they can do is they can redeem the assets that they have accrued over time to pay down that line of credit.

Of course, the biggest risk, I think, for a lot of people is emotional risk. We all know that markets go up and down. Some people can't handle that, and this is a big part of the discussion that a financial professional needs to have with their client who's considering this. If you're invested, what happens when you lose a whole bunch of money on the markets? And what happens when there's a big down day? How do you feel about that?

There are risks, rate risks, for example. If we have a mortgage, we're already susceptible to rate risk. We're paying a rate on that mortgage. But now we've got increased rate risk because we've also got a line of credit with a rate of interest on it. But again, that interest rate is serviced without coming out of pocket by myself. If I'm investing 1,000 bucks a month and all of a sudden, rates rise, maybe I can only invest 980 bucks a month because I have to leave some back to service the interest.

Can you talk about the experience you and your father had with investors that went through the 2008 crisis, for example?

That was fun. It was fun times. Wasn't it, boys? The experience we had was, most of our clients were invested '05, '06, '07, and certainly, the market crisis got us up early, out of bed early. The majority of clients who stood by, listened to us, stayed invested, sucked it up, came through with returns after '09 when the market started turning around. Their portfolios came back up, and they are thanking us for being a little strict with regards to how we felt that they should approach their finances, which is stay in, this will turn around. It always has. If it doesn't, it doesn't matter if you're invested or not. We're all hunting for a cave to live in anyways.

There were certainly clients who ... I talked about the emotional aspect earlier. Either they felt pressured, they pressured themselves to get out. They were worried about the end of the world, or their spouses, or what have you. And certainly, there were people who punched out. But when you run the numbers, it's clear that if they had stayed in, if they stuck to it, which all the financial gurus say, when you're invested, if you've got a long-term plan, stick with it. They would have come out ahead.

I totally agree with everything you're saying. And it's funny because leverage is almost like taboo in investing. Cameron and I have talked about this in the podcast a few times recently because there is really good, not just anecdotal like the stories we're talking about, but there's really good academic research suggesting that people should be using leverage. And the only reason they're not is because maybe it's not common. It's not even just risky. It's just not common. It's socially risky almost.

It's not common. I mean, you're a typical Canadian. You're a school teacher, or you're a manager at an oil company, or whatever you are, you hear people talking about margin accounts, and you turn off. Right? You stop listening because you don't know anything about it. It's not common, but there's a reason borrowing to invest exists. And that's because if you're wise about it, if you don't get greedy, it works. Margin accounts exist because it works. Investment loans exists because it works. Investment loans exist because it works.

You have to be smart about what you're going into. I mean, we always tell people, 2,000 bucks a month, okay, you've agreed to invest it, or 1,000, whatever it is. You've agreed to invest it. Great. What do you want to invest in? Well, my buddy just told me about this internet startup. No! Don't go to Vegas with this. We're talking about financial well-being of you, and your family, your loved ones, 15, 20, 25 years from now. Be relatively conservative. Don't gamble with this. If you've got other money and it fills you with happiness and adrenaline to gamble, fine. Right? We can't stop you. But with this program, be responsible.

Yeah, the way that I would describe that is that if you're borrowing to invest, you better be investing in something with a positive expected return.

Mm-hmm (affirmative).

On the decision to employ the Smith Maneuver, we've talked about leverage. You mentioned the psychological risk. You mentioned a rate risk. Other than those that we've already talked about, are there any other unique risks that putting this in place results in?

There's regulatory risk.

Okay.

Basically, the powers that be in Ottawa, or wherever they are, they make the rules, and we have to follow them. Now, one of the fundamental principles that the Smith Maneuver operates on is the fact that for over 100 years it's been written in the tax act that we can deduct interest on money we borrow to invest with the expectation of generating income. The government could theoretically come out tomorrow and say, "No more tax-deductible borrowing. We don't care what you borrow for, no more tax deductions."

Now that, as I mentioned earlier, would reduce the effectiveness of the Smith Maneuver by one-third, so we're still two-thirds ahead. But really, what is the likelihood that any government is going to come out and say you cannot deduct interest on money you borrowed to invest. While it's extremely unlikely, I'd just like to bring up the fact that there is regulatory risk. I mean, the powers that be, they make the rules, and we have to abide by them.

And there have been changes in the past. There was the 65% HELOC rule. Used to be, like on a readvanceable mortgage, you need at least 20% down. So now I got an 80% loan to value, and I could re-borrow all of that so that on my line of credit, I still have that 80%. Now the maximum is 65%. That reduces the effectiveness of the Smith Maneuver, but marginally. And again, if something happens, the regulations go the wrong way, the maneuver is reversible.

And from a tax perspective, there's nothing aggressive here from a CRA perspective, I would assume.

No. This is back a long time ago. My dad, Fraser, used to love to tell this story. He was sitting in his office, and he'd been putting clients into the Smith Maneuver for a while and been getting traction. And two CRA agents showed up unannounced and asked the receptionist, "Can we sit down and talk to Fraser, please?" So Fraser brought them into the office. "Yeah, we want to hear about the Smith Maneuver you're putting out there in the world."

He put pencil to paper and drew a schematic, and went through the process as he always did. And about three-quarters of the way through, the little guy from the CRA leans forward and says, "Would this work with a $75,000.00 mortgage?" The other guy gives him a nudge. So they walked away, and he never heard from them, which is as much the biggest endorsement you're going to get from the CRA.

As far as legality is concerned, as far as staying onside with everybody, it's 100% entirely legal. The wealthy have been employing these tactics for years and years and years because they've been able to afford to pay the high-powered accountants and tax preparers for their taxes. What the Smith Maneuver does is it opens up these same principles everyday Canadian homeowners.

Do you see any risks in not doing the Smith Maneuver?

Well, complacency is a big one, and it's not just with not doing the Smith Maneuver. But complacency, putting your head in the sand, not entirely comfortable where I am financially, but it's too big and scary a financial world out there. I'm just going to try to get by as I am. That's a big one. As far as specifically with the Smith Maneuver, cash flow risk actually decreases when you employ the Smith Maneuver.

Back in the financial crisis, we had a lot of clients from Alberta and subsequently the oil, when the oil went down. And a lot of these people lost their jobs, but because they had this pool of acquired assets, they were able to draw investment income from their holdings which help go towards the mortgage payment, which wasn't coming from the employment check anymore.

Or even if they were investing 1,000 bucks a month, we could drop that to 500 bucks a month, and they'd have 500 extra cash flow. Without this program, they wouldn't have had that ability to generate the extra cash flow. But really, the big risk here is, if I'm not utilizing the equity that I'm creating on a monthly basis, then I'm losing the power of compound growth.

I mean, if I've got 100, 200, 300, 400, 500, $600,000.00 of available equity in my home, that's a lot of earning power I have sitting right in front of me. And again, it comes back to inertia. People are so thrilled that they're paying off their mortgage and have finally paid it off. Well, we all know someone who's 65, 75, 80 years old, living in a fully paid off house on a fixed income, or they have to work part-time. I mean, next time you walk into Costco or Walmart, take a look around. There's a lot of mature people there who are greeting you or directing you to the aisle. They're not there because they want to be there. They'd be rather playing with the grandkids or golfing in Tucson, but they have to be there.

Yeah. It's crazy stuff to talk about because that's a true statement. And it's almost funny to say that the solution would have been or could have been they should have borrowed more money to invest when they were younger. But the reason it's crazy and the reason I'm laughing about it is because there's a whole body of academic research that says the exact same thing, so we shouldn't be surprised.

We shouldn't be surprised.

I'm not surprised. Yeah, it's funny. It's not funny, but it's interesting.

It's interesting.

You mentioned that one-third, roughly, of the benefit of doing the Smith Maneuver comes from tax efficiency. Just for that piece, forget about the benefits of leverage for a second, just for that tax efficiency piece, is there a tax rate cutoff? If your tax rate is too low, can there be a situation where this can actually detrimental just because the line of credit interest potentially could be higher after-tax that affects mortgage?

Well, yeah. One way to think of this, and I do have an answer for this, but one way to think of this is if I'm at a low tax rate and I have a mortgage, I've got non-deductible debt. Regardless of what my tax rate is, would I rather have non-deductible debt or deductible debt? So that's one part-answer to this.

But on the Smith Man calculator eCourse, I play around with it a lot. And if someone is earning $35,000.00 a year tax rate and margin tax rate 20%, if they've got a $250,00.00 mortgage at current rates, we're still able to take over seven years off their mortgage and see a net worth improvement of over $230,000.00 over a 25-year amortization period. Obviously, those improvements are much greater the higher the tax rate, but there's a few things at play here.

Firstly, we're reducing our tax bill. Secondly, we're paying much less non-deductible interest to the bank over the course of the payment of this non-deductible loan. Yeah, the lower your tax rate, the less effective it is, but things have to be terribly awry before we start getting into the negatives. And that's the nice thing about the Smith Man calculator. We can play around with, okay, I want to see what a very low rate of return on my investments is along with high rates on my mortgage and see where the break-even is on that. On the calculator, you can plug your own numbers in and run scenarios all day long.

Yeah. Let's do that in a sec, but I think we just have a couple of more questions before we get into looking at some numbers.

Yeah, so I get it, and I think our listeners get it, Robinson. I have a question on the implementation because it sounds like there's a bit of machinery that has to go on here. What are some of the typical errors or screw-ups in the implementation of the Smith Maneuver?

Yeah. Basically, on a monthly basis ... It depends on which readvanceable mortgage you have, but in some cases, if you're prepaying your mortgage on a monthly basis, you can do that online or your phone. And then again, online, you can typically withdraw that monthly amount which will go to investment. So there is client actions that have to occur on a monthly basis, either one or two. That's pretty much it on an ongoing basis for the homeowner.

It's not difficult to execute, but you got to be diligent. I mean, obviously, when I was an advisor, I had over 500 families in the Smith Maneuver. And frequently, we would have someone say, "Oh, I just got back from vacation, I forgot to do my prepayment," or whatever the case may be. You got to be diligent. You dot to be firm in your commitment that you're undertaking this strategy for all the benefits that it provides, and do what you're told by your professional, by your advisor.

But you can go back. Let's say you prepaid $2,000.00, and let's say you miss pulling the money out and pushing it to your brokerage account for two or three months. I assume you can go back to the line of credit side and grab that amount of money and invest it, right?

Yes. Yeah. I mean, if that loan portion, non-deductible portion, were coming down on a monthly basis and I was prepaying it 500 bucks a month cash flow diversion, 2500 bucks a month cash flow down, whatever it is, if I forget to pull that out for any given month, that credit is still available to me when I remember it's there. And plus, we always recommend that instead of having as close to zero, $3.00 or $4.00 ongoing balance at month-end in that account where you re-borrow the funds, have one month's buffer. Maybe there's a technical glitch with the website or the lender, or you're on vacation, whatever the case may be.

One of the things that I hear about as being a potential hiccup in some cases is, if people advance their line of credit for other stuff, like they start borrowing for other non-deductible purposes, that can muddy things up.

Yes. And I devote a good portion of my book to this. It is a temptation. Again, it goes back to diligence and education on the part of the financial professional. Basically, I would look my clients in the eye and say, "If you're going to do anything other than what I've told you to do, you call me first. I don't want to see you doing anything with that line of credit other than what I've told you."

But again, when you get clients or people who are doing this for years, it becomes practice. They kind of forget they're doing it. It's part of their monthly routine. And then, an emergency comes up. And maybe they have this ongoing available limit of 10K on their line of credit. Well, I can solve this emergency, my car blew up, by taking that 10K out and buying a car. Now, they'll come back to us and say, "I did a boo-boo." We slap them on the wrist, but it's fixable. All we do is we do a balance transfer of the proportion of debt that is now non-deductible on that formerly 100% line of credit. We transfer that with a phone call, back over to the loan portion of the mortgage.

All the mistakes that I've seen are fixable. Some are more complex than others because someone took it upon themselves to start borrowing on a monthly basis for something that is not deductible, And then, at an annual review, we'll discover this. And they're like, "Oh, wow. Well, I've been doing this for eight months." Okay. Well, now we got to go back, and we got to unwind this, how much total and then figure out the numbers. Generally, as long as the client is educated, as long as the client understands and is diligent, there's no problem from any aspect.

Interesting. I pulled up the academic paper that I keep referring to. I just want to read a paragraph from it because it pertains so well to the discussion we're having. This is a paper that Cameron and I have talked about by a guy who's named Ian Ayres and Barry Nalebuff, all about investment leverage.

So they say, "The point of this paper is to overturn the standard orthodoxy that cancels against buying stock on margin. Most people, including ourselves, mis-invested their retirement portfolio when young. The cost of this mistake is not small. Our estimate suggests that if people had followed this advice historically, the advice to use leverage, they would have retired with portfolios worth 21% more on average compared to had they invested in a 100% equity portfolio with no leverage, and 93% more when compared to life cycle strategy," which is like increasing your weight on bonds over your lifetime.

And then, to your point, Robinson, they say, "These gains could be socially significant." It's the commentary about the older people working in Costco. It's just-

Well, exactly.

Yeah. It's fascinating.

One of the reasons that I feel so strongly about this is, it doesn't take much. You don't have to read much news to hear about people dying in clothing donation bins in Calgary over the winter. Why are they there? It's because they're trying to get a coat out. Canada spends, I don't know how many billions of dollars on social welfare programs, all related to poverty, to lack of resources. And if people were able to better take care of themselves by being better educated, by being better informed by financial professionals, and I'm not just talking about the Smith Maneuver here. But if only half of that money that the government spends on social programs had to go there, we could put the other half in environment, or education, hospitals, you name it. For me, it's about increasing the level of financial wellbeing for Canadians across the country.

Right. Just to finish off, before we started recording, we threw some assumptions into your calculator, the Smith Man calculator you have on your website that people have to pay to access. Right?

Yes.

Okay. We threw some numbers in there just to get an idea of the expected impact from using the Smith Maneuver as opposed to not. Can we just run through that example real quick?

Yeah, sure. The Smith Man calculator, basically it starts off, you input some personal information. We've got annual employment income. We set that at 150, but there's options for investment, pension, rental income, proprietorship income. There's a section you can input assets that you have, liabilities. We put a $10,000.00 emergency fund in cash. And it'll automatically pump out your marginal tax rate based on British Columbia for now. That'll be changing Canada-wide. But you can also input your own actual marginal tax rate.

Then we move to mortgage information. We've got a million-dollar house with an $800,000.00 mortgage balance at 3% amortized over 25 years. That monthly payment is going to come to $3,786. And on the secured line of credit side of the readvanceable, we've got prime plus a half a 4.45%.

Now, the last sheet here for the accelerators, this is where we throw in our assumed portfolio growth rate. And you guys have asked for 7%. Now with that rate, our mortgage payment amount that I just stated, we've got 1,798 of that to invest. I can choose to invest 50% of it, 75%, or 100%. Obviously, 100% is the full Smith Maneuver here. Then I've got a tab where I can apply my tax refunds against my mortgage's prepayments and then get that amount re-borrowed and invested as well.

And the results we see here, as regards to taxation, we've got 442,700 in deductions over the amortization period, which leads to $202,000.00 in refunds. Instead of 25 years of non-deductible debt, we'll be out of that mortgage debt in 21.5 years, saving 3.5 years. And we'll have an investment portfolio based on your assumptions, Ben, of $1,521.00 offset but the fact that we've got an $800,000.00 investment loan, which means a net improvement in family net worth of $721,000.00 over the amortization period.

This $721,000.00 improvement occurs because I decide to go out and switch my mortgage from one that doesn't work to a readvanceable. That takes about a month. Yes, I have to assemble some paper for the mortgage broker and go to the notary and get it signed. And it's not fun. But it takes maybe a month, and for that effort, I end up $720,000.00 to the better.

Now the scary news that the calculator also calculates is what is required to pay off my $800,000.00 mortgage if I do not implement the Smith Maneuver. And what I have to do there is, well, I borrow 800, I have to obviously, repay 800. But I also have to pay $335,000.00 in non-deductible interest to the bank for the privilege of borrowing that money. But not only that, before I can pay the principal, before I can pay the interest, I have to pay tax. And so, I have to earn, over the course of my life, two million dollars to pay off an $800,000.00 investment loan. We're looking at that versus a net benefit of $720,000.00 if I do implement the Smith Maneuver.

Yeah. The two million number is scary. I think the most interesting number to me is the net benefit from doing the Smith Maneuver. And that is coming from, like you mentioned earlier, roughly one-third in tax savings and roughly one-third from the benefits of using leverage. Correct?

Right. And let's see. I haven't done this in advance, and I hope it doesn't prove me wrong, but I'm going to de-click "apply the tax refund," so it's going to pretend that the tax benefits don't exist.

Okay.

So, net improvement is right now 720. Without the tax benefit, it's 416.

Interesting. So that's taking the tax refund and putting it back down on the mortgage, and then borrowing on the other-

Exactly.

... side to invest.

Exactly. Now-

So in this scenario, you're just spending that tax savings in your lifestyle.

That's right. If I don't apply the refund, I'm assuming that ... I'm still bet 416 to the good. But I'm assuming I'm taking that refund, and I'm going to Vegas. And I'm going on a holiday, or I'm doing whatever. Right? I'm rewarding myself. But if you're sticking purely to the plan, you want to apply that against your mortgage.

And then, here is ... there's the opportunity to implement the debt swap. We inputted $10,000.00 in emergency fund in cash. If I apply all of that as a debt swap, so I take that cash, I prepay my mortgage, and I borrow I back, and I invest. Now my net worth improvement is 782,000, up from 721. Plus, I'm out of that mortgage in 21 years versus 21.5 years.

Now obviously, I'd want to go out and source an emergency fund elsewhere, a personal line of credit I don't touch for emergencies. But that's just an example of one of the accelerators in cash flow diversion, cash flow dam.

Cash flow dam is a big one for people who own rental property. Typically, what people do is they will take the rental receipts from their investment property from the renters, 2,000 bucks let's say, and they'll turn around and pay the mortgage on that rental property. What they should be doing or what they could be doing is take that $2,000.00 in proprietorship rental receipts and prepay their mortgage each month by that $2,000.00. They are able to re-borrow that $2,000.00 and service the mortgage on their rental because they're investing in their business, so they can deduct the interest.

If I have $24,000.00 and year in rental revenue and $20,000.00 in rental expenses, if I want to employ the cash flow dam, I just click a button here. And now, my mortgage at 25 years originally is gone in 12.58. The value of my investment portfolio is 1.9 million offset by that $800,000.00 investment loan for a net improvement of 1.1 million. Because 2,000 bucks a month is being re-borrowed, but only 1667 is going towards expenses, so the difference I can get invested in securities, that's where the net worth improvement comes from.

Yeah. The calculator is cool. It's a good model to figure out more efficient ways to use money than people are probably used to thinking about.

Right, right. And there's the ability in case you want to print off the report and put it by your computer. It tells you the results, your assumptions, the results, and actually what your process is on a monthly go-forward basis.

Oh, that is-

What to do and what-

... really useful. Cool.

And soon, we'll be having graphs coming with that to make it all nice and pretty.

So, Robinson, our last question is always the say. Clearly, the Smith family has been on a multi-generational mission here to improve financial lives of Canadians. How will you define success in this mission?

I will define success ... oh, that's a good question ... on putting together the Smith Maneuver certified professional accreditation program. And the idea there is, realtors, mortgage brokers, investment advisors, mortgage condensers, insurance agents, and accountants, all of these financial professionals that should be involved in your daily life, financial life, to guide you, they will be accredited under the Smith Maneuver program.

It's going to be limited to a certain number per city, so it's not like you everyone is going to become accredited. But when I have this built out, it's going to roll out in a couple of weeks now here in Victoria. But when I have this rolled out across Canada, when I've got these teams of all of these different types from financial and service providers in all the major cities, Victoria, Nanaimo, Vancouver, Kelowna, Calgary, Ottowa. And there are financial professionals who have been trained, who these Canadian homeowners can go to across the country to be assisted properly. That's when I'm going to consider this a success.

Right now, there are a lot of people across Canada who are financial professionals who claim to know the Smith Maneuver. Maybe they think they do, but they don't, and they're getting some things wrong. It's a problem. We've got Canadian homeowners who are going to someone in, say, Manitoba, who is claiming to be a professional in the Smith Maneuver, an investment advisor. And the homeowner thinks they're going and getting a Big Mac, and it ends up, they're served a Whopper. Right? It's not being done correctly. Certainly, it is by a few out there, but I need to get out there, and I need to train these professionals and make sure that they're doing 100% right by their clients.

It's a good mission. I just find it fascinating. I know we've come back to this, or I've come back to this a few times. But just the concept of using leverage is so taboo, and so to be someone championing this takes a ton of conviction. Even that paper that I mentioned, they did the research, and it was a good paper, and it made sense. But when it came out, it got slammed by economists and stuff saying, "Yeah, this looks good on paper, but nobody should actually do it."

Inertia, all debt is bad. Right? That's a big one. And even financial professionals are not immune to inertia because they grew up as well, with people around them telling them debt was bad. And one thing I'd like to say here, Ben, is Fraser and I will contest that this is actually a leveraged program. It's a debt conversion program. Because if we think about it, our debt is staying constant.

If I have a mortgage against my house and it's an interest-only line of credit, and I'm paying 1,000 bucks a month to that non-deductible debt forever, I maintain this $400,000.00 in non-deductible debt forever. If I go out and I say, "I'm worried about my retirement," I'm going to ask my mortgage broker buddy, "If I was making a P&I payment on this, how much would that be?" He says, "2500 bucks." Okay, so I'm paying 1,000 for that interest only. I'm going to add 1500 from my personal cash flow and invest that each and every month.

Month one, 1500 invested, 3,000 invested, $4,500.00 invested. My debt hasn't changed. If this person is implementing the Smith Maneuver, the same mortgage payment, 2500 bucks a month, the same investing, 1500 bucks a month, and the debt stays constant. So-

That's a good point.

We're borrowing to invest. I will fully agree with you there. But typically, when you think of leverage, you're increasing your debt. And here, we're not increasing our debt, not one penny. So where is the leverage? That's the question that I pose to people who contend this is a leveraging strategy.

I guess it's a decision to not deleverage it more than it is a decision to leverage.

I love it. Can I use that in the next book?

Oh, yeah. That all made a lot of sense, and you gave us a lot of clarity on the mechanisms behind the Smith Maneuver. It's just fascinating to hear you talk about it because clearly, you, yourself, and your dad before you thought about this presumably more than anyone in Canada because it's what you're thinking about. Hearing it right from you, it was awesome.

Yeah, yeah. It's not just a 9:00 to 5:00, right? It's everything but a few hours sleep for us.

Yeah. All right. Well, Robinson, we really appreciate you coming on the podcast. It was great.

It was great to be here, guys. Appreciate it.