Almost 3 years ago I started up a Smith Maneuver leveraged investing plan which involved borrowing money using an investment loan (home equity line of credit) to invest in dividend stocks. I wrote extensively about this process (see list at the bottom of page). Over time I have seen this account go through some unbelievable volatility, have almost no dividend increases and watched interest rates plummet which meant that the account was quite profitable on a net cash flow basis.
Last week I decided to sell all the stocks in the leveraged investment account and pay off the line of credit loan. I had been debating for a while if I should continue the leveraged plan and since it was at a point where there was a small capital gain, it made the decision very easy from a psychological point of view.
Why did I end the Smith Maneuver plan?
A lot of things had changed for me in the 3 years since I started the plan. My opinion of leveraged investing hasn’t really changed but I didn’t feel that it was a good fit for my situation anymore.
Extra risk. When I started the plan I wanted some extra risk. The problem is that as time went on and it became apparent that we were going to be a single income family and my company had several rounds of layoffs in the past year – my appetite for that extra risk diminished.
Another issue concerning risk is that when I started the plan, my portfolio was 80% equities and 20% bonds. It didn’t occur to me until much later that adding leverage to a portfolio that isn’t 100% equities doensn’t make any sense. All I had to do to increase risk was to decrease the percentage of bonds in my portfolio. If your portfolio is 100% equities and you still want to add some risk then using leverage is a good tool for that.
Hassle - Having a leveraged investment account means doing a bit of work. You have to open the account, buy stocks, transfer money, keep track of purchases for ACB values. Transfer dividends out of the account to help pay the interest. You also have to account for the earned dividends and interest payments when you file your taxes. This isn’t a huge amount of work but again, my life has changed in the last few years – one more child plus a home business which takes time means that I’m a lot less inclined to want to do extra financial activities unless there is a clear benefit.
Motivation - Another thing that changed was my motivation – at this point in time we have a decent standard of living. It’s likely that I’ll be able to retire at a reasonable age with an adequate income so the question is – why bother with extra risk? Extra money is nice but if there is a downside then it’s not worth it for me.
Would I recommend doing or not doing leveraged investing?
My opinion on borrowing to invest hasn’t changed much – I think it is a valid tool to increase your portfolio risk as well as make extra purchases when the market is down. Just be prepared for a bit of extra work. Handling volatility is something that I have no problem with but if you have a hard time watching your unleveraged portfolio go down in value then be prepared for the fact that watching a leveraged portfolio go down is much more difficult.
The original leveraged investing plan
This post lays out the grand plan for leveraged investing. I had a chuckle seeing Frugal Trader’s comment about my projected borrowing costs of 6% – he suggested increasing that estimate a bit. As it turned out the borrowing costs were much lower than both of us anticipated.
The risks of leveraged investing were discussed in great detail.
Here is one risk which I found amusing
Future growth rate of dividends: If this doesn’t happen then the plan will fail. Not much I can do here other than to try to pick good companies with proven histories of both paying dividends and increasing them. Based on the last 10 years this looks like a slam dunk. But as William Bernstein wrote in Four Pillars of Investing “Ignore the last ten years” when looking at trends. I’ll have to ignore William on this one.
Lesson learned – Don’t ever ignore William Bernstein!
Interest rate exposure. This is the risk I was most worried about and ironically it was a non-factor since interest went down and stayed down. This is still a risk factor for the future however.
I’m glad I did the leveraged investing plan, it was quite interesting and I learned a lot. My advice to anyone thinking about it is to start small and make sure you are comfortable with all the different aspects of leveraged investing before you go in deeper.