Investing is a difficult task, and similarly any degree of involvement in the decision process relating to managing one's portfolio (that starts with selecting or not an adviser) is a tedious endeavor considering, in the end, your lifestyle will be directly impacted by the overall performance. Thereafter is a summary of different thought processes involved in assessing one's annual financial strategy in view of one's financial plan. It could serve as a starting point for any further discussion with one's competent counsel in the matter of money management during annual reviews, as well as an objective evaluation of oneself when self-managing one's portfolio (for retail investors). The thought process I will present relates to the following 3 questions:
  1. - How much should I invest?
  2. - Can I follow the strategy I have defined, eventually supported by competent counsel in the matter of money management, or was the strategy properly executed?
  3. - Can my portfolio beat the market, or some index I define as being my benchmark? 

How Much To Invest? ... is not the right question ! 


As a retail investor there are 2 questions to be addressed, and common wisdom is most probably not the appropriate answer: (1) How much excess cash flow do I have throughout the year, taking into account living, utilities and any maintenance expenses as well as required costs of insurances ? and (2) How much of that excess cash should I invest in a particular investment strategy in view of my current financial plan that may/should have more than 1 strategy?  .. which should trigger a third question relating to the relevancy of different strategies in view of one's financial objective(s).

Once the previous 2 or 3 elements have been addressed, the next step is to ground the notion of Investment, as defined by Benjamin Graham:
"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative." — Ben Graham
Thus, the allocation of one's excess cash flow to an investment strategy shall be thought as being better off managed through one's portfolio investment strategy, rather than the following conception: "as soon as I have made enough profits, I will withdraw my original contribution and keep playing with the house money". The later has to be speculation, as apparently either the strategy involved carried too much risks for one's tolerance, or the contributed cash is actually required for your everyday expenses.

Finally, as one will investigate a strategy for potential investment, it may be relevant to ground the notion of price as a function of the previous statements such as:

At that point, retail investors should be ready to objectively evaluate different strategies to participate in reaching one's financial plan, and start investing by following (=executing) the trading signals of selected strategies.

Following a Strategy


Once your strategy is defined (quite a subject in itself, and not to be discussed here) .... a very simple step remains: Following the strategy's investment signals (Buy, Hold, Sell) and start trading. Consequently, one could argue that the most important aspects of successful trading are discipline, consistency, and confidence, where discipline has very much to do with understanding the Role of behavioral finance in investment decisions, consistency relates to adjusting one's strategy and financial objective to one's time to manage such or partner with a competent counsel in the matter of money management, and confidence relates to understanding the rationals for the strategy that could partially be gained from strategy backtesting analysis.

Discipline: behavioral biases affecting you, and your performance

Many investors biases have been identified since the domain of behavioral finance was investigated as a scientific field, since late 1960 and initially by Daniel Kahneman and Amos Tversky. It is represented as the combination of behavioral and cognitive psychological theories with conventional economics and finance to provide explanations for how people make financial decisions, and most specifically those irrational ones. From my point of view, the early motivation, that still prevails, is the investigation of irrational and illogical investors behaviors that disrupt the efficient market theory of modern finance. Nonetheless, Eugene Fama, the founder of market efficiency theory, noted that many of the anomalies found in conventional theories could be considered shorter-term chance events that are eventually corrected over time. But a question remains: over what time frame, and are you, as a trader, negatively impacted by such during your decision ? 

My intuition is that retail investors are subject to these anomalies which have a statistically significant impact on their performance, principally due to the fact that their portfolio does not "represent", size-wise, the market, thus capturing part of these anomalies but without the benefit of long-term "market efficiency".

Behavioral Finance

A great introduction to Behavioral Finance and related investor biases is provided by Behavioral Finance [Vanguard] and Investopedia. There are lots of biases to be aware of but the following are the one I periodically remember myself of:

Representative Heuristic, my favorite when identified during introspection; From Efficient Markets Theory to Behavioral Finance [R.Shiller,2003]. This relates to judgments that tend to be made whereby people try to predict by seeking the closest match to past patterns, without attention to the observed probability of matching the pattern. Furthermore, this condition is usually enhanced by a biased self-attribution, a pattern of human behavior whereby individuals attribute events that confirm the validity of their actions to their own high ability and attribute events that discount their actions to bad luck or sabotage.
Disposition Effect and related Inertia; Are investors reluctant to realize their losses? [T.Odean,1998] ; This represents the tendency of investors to hold losing investments too long, and sell winning investments too soon. Investors' reluctance to realize losses is at odds with optimal tax-loss selling for taxable investments, which leads to Inertia, that is at play when people know they should be doing certain things that are in their best interests but find it hard to do today (saving for retirement, dieting ...). One negative aspect of the Disposition Effect is that it prevents investors from capturing tax losses by selling their losing investments whereas sophisticated investors reconcile tax-loss selling with the aversion to realize losses through a tax-swap, selling the losing position and purchasing a stock with similar risk characteristics, effectively maintaining a similar risk exposure.

Herding; Memoirs of Extraordinary Popular Delusions [C.MacKay,1841]; This illustrates a "price-to-price feedback theory", amongst which the famous tulipmania ! word of mouth leads to extreme upward or downward price movements as one individual envies the success of another (or vice-versa). Interestingly enough, findings in Predicting financial markets with Google Trends demonstrate that historical search volume interest for keywords applied on suitable assets carries highly predictive information on future trend, that is yet another illustration that word of mouth is a driver for generating investment interest, unless at any given time non-biased investors have uncorrelated similar trend.

Dunning-Kruger Effect; Unskilled and Unaware of It: How Difficulties in Recognizing One's Own Incompetence Lead to Inflated Self-Assessments [J.Kruger, 1999]. "People tend to hold overly favorable views of their abilities in many social and intellectual domains [...] in part, because people who are unskilled in these domains suffer a dual burden: Not only do these people reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the metacognitive ability to realize it." [...] Fortunately for the willing retail investor, there is also evidence that "paradoxically, improving the skills of participants, and thus increasing their metacognitive competence, helped them recognize the limitations of their abilities." [...] Thus periodic objective self-assessment should prevent "overestimating oneself, being satisfied by a minimal threshold of knowledge, theory, or experience that suggests one can generate correct answers", although without falling into the reverse condition that "without even an intuition of how to respond, people do not overestimate their ability, instead if people show any bias at all, it is to rate themselves as worse than their peers".

The previous biases may illustrate why the true cost of shorting stocks is probably much higher than the explicit interest cost of borrowing the shares, and why only sophisticated investors should use them; there are additional psychological costs that inhibits short selling : unlimited loss potential that short sales entail. When an investor buys a stock, the potential loss is no greater than the original investment. But when an investor shorts a stock, the potential losses can greatly exceed the original investment The effects of this pain of regret have been shown to result in a tendency of investors in stocks to avoid selling losers, but the same pain of regret ought to cause short sellers to want to avoid covering their shorts in a losing situation. People prefer to avoid putting themselves in situations that might confront them with psychologically difficult decisions in the future

To conclude on behavioral biases, I believe periodic objective self-assessment should lead to the following thought: Do Financial Experts Make Better Investment Decisions? [A.Bodnaruk and A.Simonov,2014]; "Private investments of fund managers perform on par with investments of investors similar to them in terms of age, sex, education level, income, and wealth. Even more striking, mutual funds managers’ investments perform more poorly than the private investments of the wealthiest 1% of investors. [...] Our results can be best summarized in the following way: financial expertise is of little value for investors in the top decile by investable wealth. It is plausible that marginal effect of financial expertise on investment decisions is trivial for these investors (note: the 1%), but is of larger importance for less well-off individuals." Although interesting for anyone partnering with competent counsel in the matter of money management, there remains a fundamental question to address: what type of retail investor can identify him/her- self to the 1% ? Considering these 1% are highly dependent on the country under consideration, there must some generic behavior attributable to the 1% for our specific interest of money management. My intuition is that it may be a direct correlation to ownership and education; ownership as making decision for your personal financial situation and eventually being responsible for poor decisions and correcting them, and education as a mean to objectively determine if one is able to self-manage one's wealth, either partially or entirely, or not at all but educated enough to select appropriate competent counsel in the matter of money management with the underlying understanding that involvement will nonetheless be required annually for financial plan review.

As a side note, and being a believer in diversification (although proportionally to one's wealth), I do believe this applies to who is managing one's funds. Thus even if self-managing, its always a good thing to partner with a third-party adviser with partially allocated funds as part of the overall portfolio strategy.



It is most probable that a strategy was selected as part of a financial plan from the analysis of past performances. A strong hypothesis is that future performances should be similar to past ones, but there is yet a similarly strong assumption that, unless the analysis was carried out by randomly taking into account part of a strategy trading signals, following each trading signal will be performed blindly, consistently, in other words mechanically. The later assumption carries quite some risks for retail investors, but hopefully, being better equipped with the understanding of behavioral biases and their impact on financial performance, such an issue may be mitigated by increasing self-control.

High Self-Control Predicts Good Adjustment, Less Pathology, Better Grades, and Interpersonal Success. [J.P. Tangney,2004] Anecdotal impressions and assorted research findings suggest that substantial individual differences exist in people’s capacity for self-control. Some people are much better able than others to manage their lives, hold their tempers, keep their diets, fulfill their promises, stop after a couple of drinks, save money, persevere at work, keep secrets, and so forth. These differences seemingly ought to be associated with greater success and well-being in life. [...] Regulating the stream of thought (e.g., forcing oneself to concentrate), altering moods or emotions, restraining undesirable impulses, and achieving optimal performance (e.g., by making oneself persist) all constitute important instances of the self overriding its responses and altering its states or behaviors. More generally, breaking habits, resisting temptation, and keeping good self-discipline all reflect the ability of the self to control itself, and we sought to build our scale around them. [...] Central to our concept of self-control is the ability to override or change one’s inner responses, as well as to interrupt undesired behavioral tendencies and refrain from acting on them. 

This notion of self-control and consistency can be enhanced by sufficient confidence in a given strategy, as a grounded rational when doubt arises ... and it will. This partially explains why I keep saying "Maths talk, people mumbles", that Jack Bogle (founder of Vanguard) would apparently tend to agree with:
"Confidence in the mathematics — the relentless rules of humble arithmetic — enables you to get through"



It is no surprise, at this stage, that I'm a proponent of Mechanical Trading Systems (MTS) to automate the entire decision process of trading, and ideally Automated Trading Systems (ATS) to automate both the entire decision process and the entire management of trading orders. ATS would prevent most of behavioral biases besides few selected ones (being better than your system, shutting down for whatever reason), but requires a relatively sophisticated approach to financial investment. Thus most retail investors would rely on MTS during which all of the previously stated biases may occur. To that end, I recommend 2 easy and short reads that gives a practical illustration of a group of participants following the same MTS: The original turtle trading rules, and the story of pre-retirees shifting their strategy from absolute value return, to Dividend Growth Investment.

Before we go any further, remember the following from the Mathematical Investor: The Renaissance Fund, an ATS fund founded by brilliant mathematician James Simons, has produced an average annual return of 35%, after fees, over a period of 25 years. Yet other quantitative funds have failed, sometimes miserably. Solid, mathematically-driven investment methods are as profitable as they are scarce!

There is a need to build confidence in a MTS and that is achieved by backtesting and understanding fundamental economical rationals enabling the formulation of said strategy. To backtest strategies in a proper way, the following 5 steps should be involved:
  1. - Look-ahead bias: Preventing the use of data that would not have been known during the simulation period. This could be easily avoided if using an event-driven backtesting framework such as Quantopian, PyAlgotrade for python savvy investors on their way to building ATS, or ETFreplay (and similar) for non-coders evaluating MTS.
  2. - Survivorship bias: Preventing the tendency to exclude from the data (=universe of financial instruments carrying a potential of investment) failed or delisted companies during a simulation. This could inflate your results or simply show as profitable a non profitable strategy.
  3. - Liquidity bias: Preventing non-realistic investment in illiquid stocks, that would not have been able to be purchased in such quantity, or at all.
  4. - Investigating performances before and after broker commissions.
  5. - Using in- and out- of-sample data for development and validation respectively to prevent over-optimization (curve fitting). 
Again, at this stage, a retail investor is well equipped to perform backtesting investigations on different strategies for inclusion in the overall financial plan. But remember, the underlying objective of these actions is to provide support when doubting a strategy endangers Consistency (following trading signals). To deliver the required and expected support, backtesting should also be investigated objectively, that is understanding its inherent limitations.

Past Performance is No Guarantee of Future Results 

Although to this stage the discussion may provide a high level of confidence for a given backtested strategy, keep in mind that "past performance is no guarantee of future results", that is future returns. A great example of MTS shortcomings is the Google flu trend system detailed in "Detecting influenza epidemics using search engine query data ; Nature 457, feb. 2009". Although it carried great potential and demonstrate strong performance during backtest and some level of forward testing, occasionally the Google flu trend got confounded by previously unseen events that negatively impact performances; As stated by John Brownstein, an epidemiologist at Harvard Medical School in Boston, Massachusetts: 
"You need to be constantly adapting these models, they don’t work in a vacuum. You need to recalibrate them every year."
This assertion is perfectly suited for MTS and ATS. Consequently, during periodic objective self-assessment, one should carry a review of the selected strategies for assumptions confirmation, in view of supporting backtest, as a grounding effort to support Consistency in following future trading signals. Eventually, this might explain why long-term successful retail investors say "the fewer parameters in a model, the stronger your confidence could be", that similarly illustrates the following concept that the fewer the number of parameters involved in a MTS thus required to adapt to unforeseen (future) events, the better.

Finally, disregard the concept that confidence arises from data, or stated differently the more data does not mean the better. Indeed the more data, the better insight, but only for the statistically savvy strategy designers that do understand big data pitfalls, and seek for causation rather than correlation; "If you have no idea what is behind a correlation, you have no idea what might cause that correlation to break down."

So we are getting there, but one aspect remains while defining, and following, decisions relating to investment. What rational should be involved in assessing the performance of investment strategies in view of one's financial plan: does your decision effectively provide you with a market edge, compared to buying'n'holding market-like indexes as suggested by Warren Buffett:
Although setting performance rationals is part of one's decision, and no generic answers could be provided as it should be a direct relation with one's financial situation and objective, it is important to understand the notion, and extend of, Beating the market.

Beating the market


The long-term dynamic of beating the market, is very well analyzed in "Mission Impossible: Beating the market forever". It basically concludes that:
  1. - Earning 25% — or more — compound annual returns over long horizons is virtually impossible, as one would end up owning the entire stock market.
  2.  A “doable” 20% a year implies that an investor will own 0.026% of the market at the end of 2013. With a $25.6 trillion total market value as of 31 December 2013, this implies a personal stock portfolio worth $6.6 billion — not a bad retirement plan. Proof is: Warren Buffett and a selected few others represent some of the richest people on the planet.
In essence, the previous analysis can be illustrated by the following excerpt:
If value-weight market returns reflect a binding constraint on the collective investor experience, how long can an individual investor “beat the market” before he actually becomes the market? As it turns out, compound growth prevents skilled investors from beating the market forever. This result is counter intuitive but follows the established behavioral bias that humans have a hard time understanding the implications of compound growth. Al Bartlett, professor emeritus in nuclear physics at the University of Colorado at Boulder, states this bias succinctly: “The greatest shortcoming of the human race is our inability to understand the exponential function.”
Consequently, when defining financial objectives, and related strategy benchmarks and threshold performances, a first step toward building Confidence as support for Consistency to further prevent behavioral biases negatively impacting your performances, is to define realistic objectives (subject for another blog post).



It is my personal opinion that knowing who you are in terms of investor (Goetzmann and Massa, 1999) is fundamental, and it may be very different than who you are in your professional and personal life. This explains why I'm a firm advocate for periodic objective self-assessment in view of your financial plan. You may very well conclude that at some point in your life your ability is adequate to self-manage part of your wealth, while not adequate at all at another point in time as a direct result of past life events, or by objectively assessing one's ability to take responsibility for future considerations (ownership of potential failures in planing for retirement). Nonetheless, periodic reviews should provide a rational decision that is comfortable, although it may oscillate between the two.

There exists lots of literature to support the notion of objectively assessing oneself. I personally use the following non-directly related literature, to both educate myself and question my past decisions and rationals for investments:
  1. Cognition, creativity, and entrepreneurship [T.Ward,2004]
  2. Warren Buffet's Berkshire Hathaway Inc. shareholder letters.
  3. The Intelligent Investor, by Benjamin Graham

On average though, do remember the following from the Dalbar reports:
Every year the conclusion [of the DALBAR report] is the same: On average, investors earn less than mutual fund performance figures imply. Sometimes they earn much less. … One conclusion: No matter whether the market is booming or busting, “Investor results are more dependent on investor behavior than on fund performance.” Investors who buy and hang on are consistently more successful than those who move in and out of the markets

Over the past 20 years, “equity fund” investors achieved an average 5.02% annualized return, which is 4.2% less than the 9.22% that he/she could have achieved by simply investing funds in an S&P500 index-tracking fund. This gap expanded in 2013, for only the third time in ten years.

Nonetheless, I will leave you with the following personal intuition as a positive end note: At relatively similar investment competences and abilities, self-managing your investment portfolio will statistically carry higher chances to beat the market, as a direct relation to its value compared to the overall market size; Similarly, the larger a portfolio value, the more market-like it becomes, and thus the more skilled one has to be to beat the market, which illustrates the inherent limitation to be aware of when investing in large funds.

NOTICE if some material/information is lacking reasonable references to the original author, kindly email me of such with appropriate information and I'll make the necessary changes.

We've already detailed the principle of the Smith Manoeuvre 'SM' in a previous post. So, should you have elected that this strategy fit your own financial situation with competent counsel in the matter of money management, the next step is implementing the SM. In case you've followed the cash flows presented previously, few questions come to mind:
  1. - How to relate the SM theory to the actual mortgage schedule sent by my bank ?
  2. - How to automate Guerrilla Capitalization 'GC' (considering manually handling cash flows would drain way to much energy to be efficient) ?
  3. ... what happened if I want to stop the SM ?
Thereafter, I will present a set-up (and I'm not claiming any mind blowing concept here! It's very simple.) enabling the semi-automatic management of the SM, including GC cash flow; by semi-automatic I mean that, once every mortgage term (and only once), one will need to manually create a cash flow schedule in form of post-dated bank transfers. Such semi-automatic process has a downside that is a sub-optimal payment of interest versus {market investment opportunity & (Broker fees vs Contribution) }. Nonetheless, it provides much benefits in terms of time-efficiency/cost-effectiveness compared to alternatives I've investigated. For that reason I call this set-up the lazy SM.

KEEP IN MIND THAT ONCE YOU'VE STARTED RE-ADVANCING CAPITAL, THAT VERY FIRST DAY, INTERESTS START RUNNING UNTIL SUCH RE-ADV. CAP. IS PAID BACK .... AND THAT IS THE ONLY WAY TO STOP THE SM !!! (that is selling as much as portfolio value as required, and eventually putting additional cash to clear the full amount of re-advanced principal invested).

    Implementing the SM from a bank mortgage schedule

    Recalling Figure 4 from the previous post, and as illustrated below, there are 2 parts that needs to be scheduled, namely (1) Re-advancing the reimbursed principal and (2) GC.

    In the Lazy SM, the objective are (1) to easily track the cah flow, for potential CRA audits as well as for one's benefit in managing the expected cash flows, (2) to automate the Guerrilla Capitalization component, and (3) to know exactly what could be invested, but without doing the math. It appears that if post-dated transfers are timely defined, (2) & (3) can be achieved at once. The required set-up for the Lazy SM is represented much like before (information, details and motivation will be represented thereafter):
    Figure 1: Lazy SM set-up. Bank & Broker names are for illustration purposes.

    Defining Schedule 1

    The re-advanced capital derives from the 'reimbursed principal' section of your bank mortgage schedule which becomes available in the Home Equity Line of Credit ('HELOC'). For the lazy SM to operate, a sub-account line of credit 'S/A' should be created from the original HELOC. It is illustrated in Figure 1 as 'SM HELOC sub-account'. Its mechanic is such that it can access any capital available in the HELOC (= reimbursed principal originating from mortgage, not yet withdrawn). Its purpose is 2 folds: track the amount of re-advanced principal from the HELOC, and most importantly automate Schedule 1 as presented thereafter. This step most probably carries extra fees such as $2.5/month at National Bank (see the relating open question at the end), but should a tax audit happen, this provides a clean state for any tax claim refund for 'interest expenses on money borrowed to purchase investments', which is part of the SM strategy. There is a more important motivation for that cost but we'll come to that later.

    Automating GC ... sounds like something the bank back-end system should be doing. Indeed, this is precisely where we do not want to interact manually to make sure numbers do add up and no surprise arises from miscalculated due interests. There are 2 objectives here: (1) make the most of the bank back-end system to automate the capitalization of interests, and (2) to be left only with the remaining portion of the re-advanced capital for SM portfolio investment. Such automation requires a dedicated checking account 'SM/Check'. It is illustrated in Figure 1 as 'SM Checking Account' and will be used to track both (1) the amount of 'interests expenses on money borrowed for investment', further used for tax deduction, and (2) contribute to the SM portfolio as well as receive further dividends from that portfolio (used to attack the main mortgage).

    Almost there ... so how to set-up the checking account so that GC schedules are inferred by the bank back-end system ? Well kind of straightforward from that point. Talk to your bank adviser, and simply state that the monthly minimum interest to be paid for using the S/A should be debited from the SM/Check, and define Schedule 1 to represent at most the transfer from S/A to the SM/Check, of the available principal reimbursed in the HELOC in a given 30-days period, BEFORE INTERESTS ARE DUE IN THE HELOC (similarly S/A as it is the same date). Then, at the monthly HELOC interests payment day, interests for using S/A will be charged to SM/Check, that is taken from the re-advanced capital, from which point the remaining will be what's left for contributing to the SM portfolio.   

    At this point, one should understand that GC periodicity corresponds to that of HELOC interest charges (monthly), not that of mortgage payments (monthly, bi-weekly, bi-monthly, weekly). So one can still benefit from bi-weekly payments, doubling mortgage payments without fees (straight to principal), and the lazy SM.

    As well, kindly remember that following IT-533 (paragraph 30), interests may be deducted only when the money borrowed is invested for the following purpose: "Normally, CCRA considers interest costs in respect of funds borrowed to purchase common shares to be deductible on the basis that there is a reasonable expectation, at the time the shares are acquired, that the common shareholder will receive dividends. Nonetheless, each situation must be dealt with on the basis of the particular facts involved.")! In other words, once GC occurred, the more you wait to invest, the less interests you may deduct (but the bank will charge them anyways) ... Nonetheless current year interests are not as relevant as the interests deriving from aggregating previous years of contributions to SM portfolio .... so invest as you see fit with support from competent counsel in the matter of money management. Mind you, interests starts the day the capital is re-advanced from HELOC, and kindly note that said capital does not work for you until invested, that is after GC interest payment + few days to transfer remaining funds to the SM portfolio, which is the price to pay for the lazy SM to happen

    At this point, the said schedule needs to be define. This will translate into determining post-dated transfers from the 30-days period scheduled principal reimbursement available in the HELOC prior S/A interests are charged. There are different ways to determine the post-dated transfers (a) monthly by transferring the 'rounded to the closest minimum integer' capital value available from HELOC prior S/A interets payment day, (b) periodically by transferring bulks of capital (say upon each aggregation of $5,000) although S/A interets must be paid every month or (c) when market conditions are met and enough available capital is available although S/A interets must be paid every month. The lazy SM involves (a).

    When determining the schedule, keep the following in mind (obvious but hey!):
    1. - Avoid post-dated transfers during the week-ends.
    2. - Verify that the cumulative sum of post-dated transfers, at any given time, is less than the cumulative sum of the capital reimbursed illustrated in your bank amortization schedule.

    Note: Why not using the HELOC directly and save the S/A costs ? For the lazy SM to operate, S/A and SM/Check need to be tied together for automatic interests payments. There are different ways to use a HELOC to repay one's mortgage faster (subject of another post), and to prevent other transactions and transfers to polute the SM, paying this extra cost is a definite requirement, unless the HELOC is 100% used for the SM ... ever !!!

    Economic Drawbacks for Performing the Lazy SM

    The drawbacks (=cost) of performing the lazy SM is as follows:
    1. - One will have to invest the remaining of the re-advanced capital as soon as GC occurs in order to benefit from further tax deduction, ALTHOUGH (and most probably) that might not be the best investment timing.
    ... nothing comes for free!

    A Practical Scenario

    Let's assume the following bank amortization schedule received in the mail: a 1-yr closed term for bi-weekly payment on a $110,750 mortgage at 2.64% interest amortized over 259 months.

    Figure 2

    To practically implement the lazy SM 2 elements are important:
    1. - the monthly recurrent HELOC interest payment day,
    2. - the scheduled Principal. We said that Principal shall be rounded to the nearest minimum (I can't explain why the digits forecast in my simulation differ by few cents from that of my bank schedule, and although this frustrates me, I'll live with it considering integers do match. As usual, considering my code is Open Source, any insight are appreciated considering the math should perfectly match that of the bank schedule.), which leads to the following:

    For the sake of example, let's assume the HELOC interests are to be paid on the 25th of each month. That is, the S/A interests are to be paid on the 25th as well, as this is simpy a HELOC sub-account. In addition, let's define that we need 2 days of buffers for transfering funds into the SM/Check. And finally, let's assumer this is the very first round of SM contributions. Therefore, the following schedule is to be obtained:
    Transfers should not be initiated during week-ends (this was not cross-checked in this illustration)
    As it can be seen, the very first payment (2014-03-23) is not contributed to the 2014-03 month as it violates the 2 days of buffer 'rule' defined for re-advancing capital into the SM/Check prior the 25th of current month. It is thus contributed in the 2014-04 month.

    Although I did not performed an agenda check on that schedule, one should always validate that transfers do not occur during week-ends. Nonetheless, this was the very motivation for the 2-days buffer that wuld take care of such misalignement.

    From Theory to Evidence: Understanding Costs

    We have detailed the theory of the set-up required for a Do-It-Yourself Smith Manoeuvre with Guerrilla Capitalization, while explaining the mechanic for automating the GC component. The interesting element is now to have an understanding of the lazy SM cost on a complete SM w/ GC. For that purpose, I will reuse the example of the previous post.

    From what has been presented so far, one may have the following intuition about such costs:
    1. - Small portfolio contributions have to be weighted against broker fees, one of the cheapest in Canada being Questrade (trade stocks for 1¢ per share, $4.95 min / $9.95 max)
    2. - Delaying contribution of principal to the SM portfolio will have 2 impacts: (1) a limited impact on yearly distribution through dividends , and (2) a limited impact on the overall capital appreciation. This intuition is motivated by the fact that most dividends and capital appreciation originate from the 'aggregated' principal of previous years (versus current).
    3. - Delaying contribution of principal to 'an investment vehicle' will decrease the 'amount of interest claimable as tax deduction under CRA expenses on money borrowed for investment'. This could be eye-balled defining a worse case scenario, assuming rightfully that monthly reimbursed capital increases only slightly during a given year, such that: the 'loss' of deduction can be approximated by aggregating the monthly cost of borrowing half of the last annual contribution (the largest principal reimbursement of a given year); for example, reimbursing 1000$ in December, one could over-estimate that 500$ would be carried over to the next month contribution due to the 2-days buffer rule, and this for every month, representing a 'relative loss' of 500*rate_of_HELOC=500*3%=15$/year.
    In my Open Source Code repository,  I have modified 'SmithManoeuvre.R' to account for the cost of a lazy SM set-up (although I've taken a full month of contribution, not half). This is exposed in HouseMortgageStructure.R under LoanStructure$LazySM <- FALSE/TRUE.

    To investigate the impact of performing a lazy SM on cash flow, I've re-run the simulated financial situation investigated in the previous post.

    SM (non-lazy) Cash Flow

    Lazy SM Cash Flow

    From these simulation results, it can be seen that the impact of the lazy SM costs on a SM set-up are negligible in view of the overall process, accounting for (1) time to reimburse the home mortgage, (2) building the SM portfolio and (3) repaying the HELOC.


    The lazy SM is a simple way for automating the Guerrilla Capitalization component of the variation of the Smith Manoeuvre I have presented in a previous post, for a very limited cost that does not impact the objective of said strategy.

    It is my non-financial expert opinion that individuals willing to self-managed their SM portfolio, eventually with competent counsel in the matter of money management, would not really benefit from third-party companies providing, for a fee (>40$/month + 1 time $3,000 set-up), the automatic management of the GC component.

    Open Questions

    1. - I'm wondering if sub-account line of credit fees ($2.5/month) are tax deductible under the CRA policy as 'fees to manage or take care of your investments', considering this is paid only to manage the SM process (the GC component to be exact) and get a clean track records for CRA?

    The Smith Manoeuvre 'SM' is about transforming a nondeductible debt (bad debt) into a deductible debt ("good" debt), while potentially increasing your assets (in form of a stock portfolio) and paying off that nondeductible debt faster, using leverage with a home value as collateral. 

    [this post is accompanied with R codes allowing investigations of the strategy under different financial situations]

    In Canada, F.Smith originally applied this financial process on home mortgages, slowly restructuring such to increase individuals' Net Assets, leveraging the tax opportunity to "deduct interest expenses on money borrowed to purchase investments with the purpose of earning income" [CRA IT-533]. There are many variations of the SM, and I have elected to present one in this post that is of interest to me.

    The overall objectives of the present SM variation are to (1) Accelerate the repayment of a home mortgage and (2)  Create additional financial assets in form of a dividend-growth portfolio (another interesting link for dividend portfolio), (3) without introducing additional financial burden other than the monthly contribution associated to the original home mortgage. First things first, let's review the mechanic of the SM process, then draw a clear picture of the risks.


    Home mortgages are the combination of (a) a principal representing the required amount to purchase a home (what the bank lends), and (b) the interests representing the costs associated to borrowing from the bank (why the bank lends). The full amount of such a mortgage is repaid through monthly (or bi-monthly) contributions (and lump sum contribution to the principal) where part of the amount goes toward the interests, while the remaining goes toward the principal, and where the initial agreement is to secure (repay) a significant part of the overall interests, but with the understanding that gradually such proportion shifts toward repaying most of the principal.

    '101 mortgage' statements apart, the SM will aim at borrowing back the progressively contributed amount toward the principal, to invest in a dividend-growth portfolio to benefit from the cumulative effect of (a) annual dividend distribution and (b) tax returns originating from the "interests on borrowed money to purchase investments" principle, to increase either the monthly contribution (limited to twice the minimum) or the lump sum contribution to the principal thus effectively attacking the mortgage while reducing interests (interests = function of remaining principal); effectively, there are 2 kinds of lump sum contributions, an annual contribution usually limited to 10% of principal, and a punctual but unlimited contribution at the end of a mortgage term (during rollover prior mortgage renewal).

    NOTE  the "interests on borrowed money to purchase investments" principle applies providing that investments are carried in non-registered accounts, that is outside RRSP,TFSA and the like, and only if with the objective to try to earn investment income, including interest and dividends.

    The financial instrument to borrow back the principal involves structuring a mortgage value (the principal) in a Home Equity Line Of Credit 'HELOC' (also referred to as a revolving line of credit), where the principal can be re-advanced (borrowed) for investment, yet subject to repayment of the amount drawn plus interest (at variable rate), with a HELOC minimum monthly payment requirement. To prevent the introduction of additional financial burden other than the original monthly contribution of the home mortgage, while re-advancing the principal, part of the amount will be invested in the dividend-growth portfolio while the remaining will be put aside to satisfy the HELOC minimum payment requirement, in other words capitalizing interests referred to as Guerrilla Capitalization in SM terminology (interests on interest being tax deductible, the tax return from "interests on borrowed money to purchase investments" principle remained effective).

    At this point, one may wonder why is the Guerrilla Capitalization process tax deductible under CRA IT-533 #30; It is my understanding (please validate this with competent counsel in the matter of money management and tax deduction) that as the very first contribution has been fully dedicated to SM portfolio investment, then further interests, and interests on interests, are tax deductible. In other words, make sure to get your accounting right, and do not capitalize interests to do anything else but the Guerrilla Capitalization for supporting SM portfolio contribution from re-advanced capital .... or else things would go south from a tax deduction perspective !!!

    NOTE since 2013, provided a minimum down payment of 20% of the value of the property is deposited, a maximum amount equivalent to 65% of the value of the property may be available in the form of a HELOC (the remaining has to be in the form of a mortgage loan). For example, $65,000 can be re-advanced in the HELOC with a property value of $100,000 as collateral.

    Finally, this variation of the SM will be completed once a debt free status is reached, that is when the HELOC is paid up in full from the ongoing cumulative effect of monthly contributions, dividends and tax returns, being applied toward the re-advanced principal. (see final notes for other SM variations)

    EV1D3NCE = F(ThE0RY)

    Thereafter is presented a full SM, for a Quebec resident (tax implications detailed in source code ; Ontario is implemented as well), on a $360,000 mortgage, with an annual percentage rate 'APR' of 3% compounded semi-annually requiring a minimum monthly contribution of $1,704, further structured in a HELOC with an APR of 3% compounded daily, and where assumptions for the dividend-growth portfolio are 3% annual capital appreciation and 4% annual dividend distribution.

    The complete source code is available in my GitHub under WealthManagement/StandaloneTesting/ as SmithManoeuver.R. SM Simulations can be performed by modifying information relating to a specific Personal Financial Situation (income, rates, mortgage amount ...) in the 2 scripts contained in the directory WealthManagement/StandaloneTesting/FictionalFinancialSituation.

    Figure 1
    A primary read on assets reveals that the home mortgage repayment is anticipated by 8 years (2953 days), and an additional 5 years (1795 days) on top of the traditional home mortgage plan provides a dividend-growth portfolio of $537,000.

    > max(Mtg$Schedule)-max(MtgSmith$Schedule)
    Time difference of 2953 days
    > max(SmithGConv$Schedule)-max(Mtg$Schedule)
    Time difference of 1795 days

    A secondary read on costs reveals that the total interests paid for a SM is significantly greater than than those paid for a traditional home mortgage. But in reality, a meaningful review of costs should be from the perspective of the debtor, and this cannot be evaluated by looking at interests considering these are 'attacked' by sources of revenue other than one's cash flow (dividends, tax returns) and thus only represent what's in for the bank as a creditor.

    Thereafter is presented a summary view of the additional costs for carrying on a complete SM from the debtor pocket perspective, along with the net resulting assets (taking out the additional costs from the portfolio value).

    Figure 2
    Describing this figure is rather straightforward. we've mentioned previously that (1) in takes 5 additional years to perform a complete SM, and (2) no additional financial burden is introduced other than the monthly contribution originating from the initial home mortgage. Consequently, the additional costs from a debtor perspective is these 5 years of additional monthly contribution, or $103,000 represented by the green line that leads to a net asset dividend-growth portfolio value of $450,000 that should keep on generating value on a yearly basis.

    Food for thoughts: consider the following statement from the Globe and Mail in view of retirement (I will update some R code for this later on):

    it’s possible for an individual with no other sources of income to earn nearly $50,000 in dividends without paying any tax at all.

    > max(NetBenefits)
    [1] 450020.5
    > max(cumsum(SMCost))
    [1] 102221

    THE QUEBEC PROVINCE LIMITATION (comments driven by evidences)

    The amount of investment expenses deductible (understand the interests) in Quebec is upper bounded by the maximum of the distribution received (understand the dividends) originating from the amount borrowed to invest  during same year, unlike other provinces in Canada without such limitations. It is thus often said that SM is of lesser interests in Quebec, if interesting at all.

    In the R code provided for the SM, this is materialized in IncomeStructure.R, under the function InterestTaxRefund() at
    ProvEffectiveRefund = max(QcRates[QcBrackets<Income$GrossSalary]) * min(Amount, EarnedDividends)

    Thereafter is the comparison of performing a complete SM in Quebec and in Ontario, under similar hypothesis. There is indeed an additional cost for performing such in Qc to the order of $12,000, representing  2.3% of the final dividend-growth portfolio value, stemming from an additional 7 months of contribution to complete the SM, but overall dividend-growth portfolio values are almost equivalent.

    Figure 3

    This scenario illustrates the fact that the limitation of the "deductible interests on money borrowed to invest" principle affecting Quebec residents only impact part of the SM processes for the first 15 years, at which point the capital appreciation of the portfolio value offset this Qc specific constraint. THIS RESULT IS A GOOD ILLUSTRATION OF GOING FROM THEORY TO GETTING EVIDENCES !


    In this scenario, a complete Smith Manoeuvre sginificantly accelerates the repayment of a home mortgage loan while potentially creating an additional dividend-growth portfolio at reasonable costs from the debtor perspective, without introducing additional financial burden other than the monthly contribution deriving from the original home mortgage.


    The Smith Manoeuvre is all about using leverage ... on your home ... which means part of the risks are driven by your appetite for profits while building a portfolio. To mitigate part of the risks associated with different variations of SM, I have chosen one SM variation that focuses on accelerating the repayment of the home mortgage, supported by the definition and the management of a dividend-growth portfolio.

    Indeed, the portfolio's objective is to generate increased cash flow to contribute to lump sum payments toward the home mortgage and later on onto the HELOC. Thus, a meaningful exercise while investigating this strategy is to define portfolio characteristics that satisfy (1) the debtor investment profile, (2) cash flow effectively attacking outstanding debt and (3) variability in value that the debtor can stomach. Such exercise should be performed in collaboration with competent counsel in the matter of money management.

    NOTE as illustrated in the previous section, Quebec residents have to factor in capital appreciation with more weight when designing their portfolio in view of tax return constraints, although appreciation similar to that of inflation (3%) deliver SM performances similar to that obtained in Ontario.

    Once the definition of such portfolio characteristics is done, the lack of consistency in keeping your objective in line with the original plan is yet another risk, as the portfolio value may increase over time, providing extra cash flow that should be used for nothing else but repaying debts, and portfolio value may decrease over time, providing a temporary lack of extra cash flow for which re-evaluation is required with potential action (other than panic!).

    Yet another inherent risk of the SM is the HELOC variable rate, a double edge sword, which upon increase reduces the contribution to the portfolio and increases the required additional interests to be paid. Same applies with the renewal of home mortgage rates throughout the mortgage life, with same implications. Managing the mechanics of the different debts' structures involved in the SM should be performed in collaboration with competent counsels in the matter of money management, and legal & tax accounting.

    Finally, to prevent additional burden on you cash flow other than the monthly contribution deriving from the original home mortgage loan, the consistency with which the capitalization of interests intervene is crucial. Poor management at this level will drag on further interests to be paid, and might lead to draining additional cash flow. Although of lesser contribution to a risk of ruin, this may significantly increases behavioral stress on the debtor should this process be not fully understood and applied.


    Figure 1 allows to define risks measures, one of them being the sell off portfolio equity value after the home mortgage loan is fully repaid, and when sufficient to fully repay the HELOC: this is exactly when the blue & pink curves intersect. As well, the standard deviation between these 2 curves represents the profits that would derive from selling off the portfolio equity to terminate the SM and minimize the risk of ruins due to the remaining HELOC debt.


    The eligibility to the Smith Manoeuvre structure requires a 20% down payment of the home value, for the bank to grant you access to the instrument enabling a home mortgage loan (at fixed rate) to reside inside a HELOC (at variable rate). This is commonly referred to as All-in-One banking 'AIO'. Practically, the HELOC can represent up 80% of the home value, from which a maximum of 65% can be re-advanced toward the dividend-growth portfolio, the remaining being automatically in a mortgage loan.

    In such scenario, interest to both HELOC and the mortgage loan can be directly withdraw from the AIO provided that paychecks are automatically deposited in that account. This efficiently use free cash flow to consistently reduce interests from the variable interest rate of the HELOC which are compounded daily.

    Although this is sufficient to start a SM, creating a SM-specific sub-HELOC account associated to a SM-specific checking account, will enable easy track recording of SM cash flow for tax purposes should there be an audit (specifically the amount of dividends and "interests on money borrowed to invest" principle).

    Below is an illustration of such AIO with National Bank of Canada. NBC advertises the AIO as a financial process where

    Figure 4

    In this scenario, fess and interests arise during cash outflows. Thus transfers from the main HELOC to the SM sub-HELOC account are immediately subject to interests, even if funds are not withdrawn from the SM sub-HELOC account. In other words, it might be more efficient to aggregate enough 'free principal' in the main HELOC to transfer a bulk amount in the SM sub-account synchronously with the purchase of equity in the trading account while growing the divided-growth portfolio. Furthermore, and for illustrative purposes at NBC, the SM checking account is subject to a 1$/transaction fee and the SM sub-HELOC account is subject to a flat 2,5$/month 'maintenance fee'. No additional fee exists besides the HELOC & mortgage loan interest (on top of the home value!).

    It is my personal opinion (as a non financial adviser), that the most difficult part of maintaining the SM is cash flow transfers enabling the capitalization of interest in the SM checking account. Again, it is my personal opinion that, with support from competent counsel in the matter of money management and accounting, these transfers should be predetermined and automated based on the loan schedule received from the bank upon loan subscription, detailing the periodic amount of principal reimbursed upon each monthly contribution. I will update this post with R codes for that matter.


    It is my personal opinion that variable interest rate should be monitored monthly, along with the dividend-growth portfolio performance, specifically in terms of anticipated $-figures from the dividends distribution. Indeed, it is the $-amount of dividends that directly contribute to the repayment of loans, not the capital appreciation (or depreciation) of the portfolio (yes they are related through the dividend yield but in the end, what matters is $-amount despite what goes up/down).

    Furthermore, with support from competent counsel in the matter of financial advises, the loan interest rate should be monitored to strategically determine the length of the home mortgage loan, evaluated against the benefit of unlimited repayment of principal during roll over during loan renewal (which may drastically reduce the overall interest of the loan).

    Should there be a good soul to design a SM dashboard, let me know !


    There has been presented a variation of the Smith Manoeuvre with Guerrilla Capitalization for the creation of a dividend-growth portfolio. However, different variations of the SM can be thought of:
    1. - To reduce the overall risk exposure of the manoeuvre, part of the portfolio could be used to increase the repayment of the home mortgage (the capital appreciation), or upon full repayment of the loan, to contribute to attacking the remaining HELOC (if not totally closing the HELOC by selling out most of the portfolio equity).
    2. - Instead of investing in a dividend-growth portfolio, some argue that it would be desirable to invest in an aggressive equity-value growth portfolio. I remember reading some of Warren-Buffet thoughts on the subject in his 2012 annual letter to Berkshire-Hathaway investors (see page 19). Nonetheless, the main risk associated to designing such  portfolio is that very ability of management considering the overall objective of the SM is to repay a home mortgage by leveraging additional findings otherwise not available to you. If no dividends, extra-contributions should be brought in form of selling equity with relevant capital appreciation every year, effectively thinking you can beat or at least equate Wall Street. It is my personal opinion that this require well educated competent counsel in the matter of money management to perform as such without putting your home at additional risk.
    3. - To accelerate the reimbursement of the HELOC, the portion of the portfolio that derives from capital appreciation could be sold off the significantly contribute to repaying that debt.
    4. - To Increase the leverage used during the Manoeuvre by using a portion of the re-advanced principal not for direct investment in a portfolio, but as a collateral for another loan used to create a portfolio but with more capital. There are risks associated with leverage, and although I would personally consider such in some situation, I believe that is not the case when a principal residence, someone's home, is used as a collateral.  
    5. - Not to repay the HELOC and maintain the interests deduction (..for ever..), with the assumption that the portfolio will always balance out [the due interests + HELOC] in the end (this assumes interests are paid monthly out of one's pocket, or from some monthly distribution, or from selling some stocks).
    Copyright © 2012 Theory (n) Evidence