Book Review: The Smith Manoeuvre

The author, Fraser Smith, is a Vancouver-based financial planner, who devised the eponymous strategy to take advantage of the fact that while the interest paid on a mortgage for a personal residence is not tax-deductible, any interest on a loan taken out to make investments (in mutual funds or stocks or a private business) is deductible. The key to the Smith Manoeuvre (SM) is a readvanceable mortgage in which the lender is willing to advance a loan equal to the mortgage principal that is repaid with every payment.

The biggest problem with the book is that Mr. Smith never really explains the risks involved with his strategy. He claims that the manoeuvre is no more risky than a mortgage on a personal residence because the leverage involved is the same. True enough, but there are two key pitfalls to his strategy:

1. A mortgage is a loan that is amortized over many years (25 years is the standard). Over this period of time, the principal balance will decline steadily. In the SM the principal balance remains the same.
2. People are irrational. They will be willing to buy a home with a huge loan and even if housing prices decline, they probably won’t sell and rent immediately and will do their best to meet the mortgage payments. Taking out a huge loan and investing in the market is a completely different cup of tea. In a market correction or worse-yet, a bear market, they are going to panic and sell not having the stomach to take further losses.

Incredibly, Mr. Smith suggests the opposite. He suggests that people might be better off capitalizing the interest on their investment loans, which is really a fancy term for adding the interest due on a loan to the principal owing. Great, now we have compounding working against us!

I also found the book difficult to follow and the author has the tendency to rant instead of sticking to the topic. It doesn’t help that every few pages he wants the reader to purchase the $mithman Calculator (retails for $39.95), a software program to evaluate his strategy under various assumptions.

The vast majority of Canadians can safely skip the book and the fancy calculator and simply max out their RRSPs (remember, interest on loans to fund your RRSP is not deductible) and pay down their mortgage as fast as they can. Once their personal balance sheet shows very little debt, they can take out a secured loan (if they have the patience and stomach to make leveraging work) to make taxable investments.

That said, people who are lucky enough to have very stable jobs (and a predictable cash flow) and are willing and able to stomach the risks involved in a leveraged investment strategy might find the book useful.