Time for the Smith Manoeuvre?

Interest in investing in stocks is low right now, and interest in using leverage (borrowing money to invest) is even lower. This also applies to the Smith Manoeuvre, which is a leveraging technique for borrowing against your home’s equity to invest.

I’ve never been a big fan of leverage because it magnifies losses. If your investments do well, then leverage will make them perform even better, but if stock prices have big declines, you can be left with a lot of debt and a shrunken portfolio that won’t cover those debts.

Having said all that, using leverage now is far less risky than it was when stock prices were higher. Paradoxically, the average investor is less interested in using leverage right now. Let me reiterate that I’m not a fan of leverage, but if there ever is an appropriate time for it, now is probably that time.

I give FrugalTrader at Million Dollar Journey credit for continuing his series on his Smith Manoeuvre portfolio after the big stock price declines. It would be easy to just write about other things and return to the Smith Manoeuvre again when stocks have recovered and the subject is more popular. However, it is precisely when stocks are peaking that this topic is most popular and the use of leverage is most dangerous.

Comments

  1. AnonymousNovember 11, 2008 at 8:56 AM

    Thanks for the mention! It is indeed difficult to post about losses in net worth and portfolio value, but financial results aren't always rosy. As you mentioned, if looking for the long term, this may a great opportunity to deploy some cash.

    ReplyDelete
  2. Jim TurnbullNovember 11, 2008 at 12:21 PM

    I'm not a big fan of leverage too. However, I think most of us would have to admit that we are leveraged in the stock market, if you, like me, both own stocks through your RRSP and also have a mortgage.

    I am a big fan of not making any bold moves. So if you think stock are cheap and you want to take advantage of that, maybe make some small moves. For example, if you subscribe to an asset allocation formula between stocks and bonds, maybe now is as good a time as any to rebalance by selling some bonds and buying some stocks.

    If you have an all-stock portfolio and a mortgage, maybe now is a good time to maximize that RRSP contribution to buy stocks, versus making a lump-sum payment to your mortgage.

    You could also look at lowering your mortgage payments, if possible, so you could direct more cash to the market through registered or non-registered accounts.

    The Smith manouvre takes this even further, by borrowing as much as possible from the equity in your home. This seems too risky to me - I would rather just try to strike some kind of balance between paying off debt and having exposure to the market.

    One rule of thumb is to try and pay off all your debt methodically by the time to retire.

    ReplyDelete

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