How To

Smith Manoeuvre – A Tax Deductible Mortgage Strategy

The Smith Manoeuvre is a Canadian strategy that is designed to structure your mortgage so that it is tax deductible.

Since the Real Estate market has gone up in value significantly over the past few years, I’ve decided to use some of that equity sleeping in my house to invest in the stock market.

For Canadians, this means I’m doing the Smith Maneuver (transforming the interest paid on my mortgage into a tax-deductible expense). For all other investors, this article will talk about leverage in general. Should you borrow to invest? What’s the possible outcome? What are the risks? How to start investing with borrowed money? These are the subjects we will discuss today!

Why do a Smith Manoeuvre?

First things first, the Smith Manoeuvre includes leverage. This means borrowing money to invest. This is not for everyone (more on that later), please do your due diligence and make sure you have the right risk profile before using leverage.

All right, now that we have the disclaimer out of the way, here’s some background information from yours truly. In 2003, I completed my bachelor’s degree with a double major (finance & marketing). I started a job at National bank in the credit department for partnerships with Power Corporation. My goal was to help financial advisors build credit applications for their clients who wished to use leverage to provide capital for investments. In other words, I was the architect behind millions of dollars of investment loans.

I also used the Smith Manoeuvre for several years back then with great success. I saw the best and the worst of this strategy throughout those five years. I’ve seen investors build enormous wealth and others have burned down tens of thousands of dollars on a margin call. I can’t stress this enough; leverage can bring the best out of the stock market and can also destroy your wealth. Please use this strategy with caution.

Wealth generation

Why did I decide to use such a “dangerous” strategy? Because I have time, knowledge and an incredibly high-risk tolerance on my side. The math behind leverage is quite simple. If you can borrow money at a 3-4% interest rate and then invest it at a 6-7% return, you can create wealth out of thin air.

With conservative numbers and $333.33 per month ($4,000 / 12), you can create more than half a million dollars in 30 years.

Imagine borrowing $100K at 4% for the next 30 years. The cost out of pocket would be $4,000 per year, or $120,000 for the entire duration of this loan. Keep in mind that the $4,000 doesn’t move (unless your interest rate changes). This means that $4,000 in 20-30 years from now isn’t that much if you factor inflation.

Now if you take that $100K loan and you invest it at a 6.5% average annual return, 30 years later your investment would have grown to $661K. You could then pay off your loan and end-up with more than half a million dollars. Over 30 years, you turned $120K into $561K (more than 4.5 times your investment). With leverage, the advantage is that you turned a 6.5% return into 9.1% (you must achieve a 9.1% investment return on a yearly investment of $4,000 to reach $566K in 30 years.

Using a 6.5% expected return is quite conservative (see the chart of the S&P 500 and the TSX on the following page). I could potentially talk about 8.5% return and how you could transform the same $120K in interest payment into more than $1M net of debt.

But that’s daydreaming and you must also consider taxes applicable to this strategy. Now that you understand the wealth generation ability, let’s talk a little bit more about the dangers inherent in this strategy.

The danger of leverage – This is not for everyone

While I used conservative numbers (a 100% equity position should generate an annualized return of 6.5% over a 30-year period), this is still a positive scenario. If you borrow $100K today and your investment goes down by 30%, you then have $70K invested and you are still paying interest on a debt of $100K. You could also get sick or need additional money for many reasons. These perspectives are enough to make a lot of investors sick. At best, leverage should be a complement, not a “all-in” strategy. It could turn even worse if you have a margin call.

If you use your investment as collateral, there is a good chance that the bank will set a minimum value for your portfolio to maintain the loan. When your portfolio goes down too low too fast, the bank will “call you” and ask you to put more money in the portfolio. If you don’t have liquid assets, the bank would simply sell your investments and use the proceeds to cover the loan (or a part of it).

Because I want to slowly build my leveraged portfolio and I don’t want to get squeezed by a margin call, I’ve decided to use my house as collateral for my leverage strategy. Here comes the Smith Manoeuvre!

What’s the Smith Manoeuvre?

The Smith Manoeuvre is a Canadian strategy that is designed to structure your mortgage so that it is tax deductible. A financial planner named Fraser Smith introduced this concept where you borrow money against the equity in your home, invest it in income-producing entities (dividend paying stocks), and use the tax return to further pay down the mortgage. It’s not that impressive for our fellow Americans since their mortgage interest is already tax deductible. But it’s a big thing for Canadians since we don’t have this advantage!

To set this strategy up, you need a home equity line of credit (a source of revolving credit). Then, each month, you pay off a part of your mortgage (imagine $500 in capital). Right after you pay off that capital on your debt, you use the home equity line of credit (HELOC) and borrow that same $500 and invest it.

Month	Mortgage	HELOC	Interest paid	Investment Account	Net Wealth Creation
0 (start)	-$200,000	$0	$0	$0	0
1	-$199,500	-$500	$1.66	$502.70	$1.04
12	-$194,000	-$6,000	$130.04	$6,215.50	$85.46
360	-$20,000	$180,000	$108,300	$556,084	$267,784

Following this chart, I could transform $180K of debt into a tax-deductible mortgage by simply using $500 a month for my leverage strategy. You could go a lot faster by increasing the amounts. Obviously, if you boost the amount invested or increase the percentage of expected return, the strategy looks even more attractive.

The largest advantage of leverage (on top of the tax deductibility) is the power of compounding interest. While the interest you pay monthly doesn’t compound, the amount invested is compounding. Throughout time, a small difference of 2.5% (4% interest vs 6.5% investment return) creates thousands of dollars even if you start small.

All about long-term

The point here isn’t to make you dream about riches, but rather to show you how even a conservative leverage strategy could create incremental wealth. The plan I’m about to discuss applies to the start of my Smith Manoeuvre (with $500 a month) but could be applied to a larger leverage amount either using a monthly investment or a lump sum payment.

Keep in mind that the basic rules of leverage will apply on a $500 or a $500,000 loan. The way you build your portfolio and how you should approach this strategy remains the same. Numbers are just growing with zeroes, but they react the same to the power of compounding interest.

In the next two parts of this article, I’ll share with you my plan and the portfolio model I wish to build in the coming years. I will show you how to use DSR tools to build your own leverage strategy.

The Smith Manoeuvre Plan

The purpose of this exercise isn’t to make you follow my plan and invest the same way. I want to provide you with a guideline as I am building this wealth creation strategy. As I successfully built my pension portfolio using exclusively Dividend Stocks Rock tools, I’m doing the same thing for the Smith Manoeuvre portfolio. Numbers and details could change depending on your financial situation, your age, and your risk tolerance. Again, do your own due diligence.

Opening a margin account allows options

First things first, which type of account should you use to invest using leverage? Since I’m a bit crazy, I’ll be opening a non-registered margin account. To make your leverage strategy successful, having a non-registered (meaning a taxable account) is mandatory. One of the perks of leveraging is to be able to use the interest you paid on your loan against the investment income you generated. Therefore, using the 4% interest rate and the 6.5% expected returns numbers, the first 4% return of the portfolio is “tax free”.

Margin account

Opening a margin account instead of a regular non-registered account is to give me additional flexibility. My goal isn’t to use margin on top of borrowing money. That’s what we could call a “double-dip”. However, if the market drops drastically, I’d like to have additional liquidity ready to be deployed. Imagine if my pension plan was in a margin account during March of 2020. I could have easily borrowed $50K and boosted my positions into amazing companies like Canadian Banks, Telcos, Utilities and Tech stocks.

My margin account also allows me to trade options. Since the goal of this portfolio is to generate investment income, I would also leave the door open to writing covered calls in the future. This would obviously not happen right away, but I would rather be set with the most flexible investment account upfront. Then, I don’t have to worry about any other paperwork.

Setting a budget

Once I decided to open a margin account allowing option trading, it was time to determine how much money I wanted to borrow each month (or a lumpsum amount if you have lots of equity sleeping in your house). Keep in mind that leveraging should be a complement to your wealth generation plan. Your financial plan should not rely solely on leverage.

The reality of a business owner is that there are always a thousand things going on in my financial life. Therefore, I don’t want to go “all-in” with my Smith Manoeuvre for now. For this reason, I thought of starting with $500 per month. This enables me to keep my financial flexibility (and continue to support my children as they go to college!). I will revisit this amount separately each year.

If you intend to use a larger amount for your leverage strategy, I’d suggest you consider two things. First, the amount of interest that must be paid monthly on that loan. It’s fun to imagine the compounding interest on a $250,000 investment over the next 20 years, but this requires cash flow in the meantime. At $250K, we are talking about a very nice car payment $833.33/month at 4%. To make sure the leverage strategy works, the most important thing is to have time. Therefore, you must ask yourself if you can afford a “BMW payment” for the next 20 years or so.

Investment rules

As you know already, I like to keep things simple. There is no need to have a complex investing strategy because you have borrowed money to invest. However, there are a few more rules to observe for this specific approach.

#1 Follow the DividendStocksRock methodology

When you borrow to invest, you want to reach a balance between generating an interesting total return and making sure you don’t put your portfolio at risk. Taking “bets” would end-up badly in a leveraged portfolio while focusing on dividend growers will achieve this balance. The DSR methodology to pick stocks will apply perfectly to this strategy (but I’ll add rule #4 in my stock selection process).

#2 Invest for the long term (minimum 20 years)

I’m currently 40 and I plan to use this strategy for the next 30-40 years. Since it’s a compliment to my wealth generation plan, I will be able to keep my leverage strategy above 70. The idea with leverage is to use compounding interest to your advantage. You can only do that over a long period of time.

#3 Invest 100% in Canadian stocks

I’m not your tax guy, but if you are Canadian and you want to play around taxes, it would be a good thing to invest in Canadian stocks to benefit from the preferential Canadian dividend tax treatment. Only Canadian corporations will pay eligible dividends. Therefore, I’ll keep my love for U.S. dividend growers in my tax-sheltered pension (LIRA) and retirement (RRSP) accounts exclusively.

#4 Generate a minimum yield of 5.5%

Right now, my HELOC interest rate is set at 5.4%. Therefore, my portfolio must generate at least 5.5% in dividend income. Again, I’m not your tax guy, but if you are Canadian and you wish to deduct the interest you pay against your investment income, it can’t be used against capital gains (e.g., it must be interest or dividend income). Then again, it doesn’t mean that all stocks in your portfolio will offer a 5% yield and above, but the total generated by the portfolio must be in that range.

Smith Manoeuvre Execution – Portfolio Model

To select the companies “worthy” of my leveraged portfolio, I will get inspiration from the Canadian Retirement portfolio and the 100% Canadian portfolio models. I’m looking at stocks offering a decent yield (minimum of 3%) but with some growth opportunities as well. I used the DSR stock screener, the watch list (PRO feature) and the portfolio builder (PRO feature) to build my portfolio model. If you can’t use the DSR stock screener, you can look at the Dividend Rock Stars List here.

Stock selection using DSR stock screener

The first step in finding interesting stocks is to go to the Canadian Retirement portfolio and the 100% Canadian portfolio models’ pages and select companies with a minimum rating of 3 for both the DSR PRO rating and the Dividend Safety Score. I also added a minimum dividend yield of 4% as I want to make sure I can use the full 5%+ interest rate that will be charged on my loan by the end of the year. Right now, I’m at 5.4% on a variable rate. That helped me to select a few stocks, but it wasn’t enough to build a complete portfolio. I wanted to double-check across our entire stock library.

Then I used the same filter with the stock screener. I don’t want to start too narrow. This simple set of filters gave me a list of 75 companies. To build a diversified portfolio, I’d like to have about 20 stocks. The plan is to buy one position each month over the course of almost two years. Having to investigate 75 stocks upfront seems a bit overwhelming.

So, here’s my trick: I kept the filters in place and looked at each sector one by one. After all, there is no point in looking into 10 stocks in the same sector. If this happens, I can always add more minimum metrics or select stocks with a rating of 4 for the PRO rating or the Dividend Safety Score.

I then selected my favorite 3-4 companies per sector to see how many companies I could rack up. Between both techniques, I got to a short list of 22 stocks that might make a good fit for my portfolio.

Deep dive with the watch list

Before I started my research with the stock screener, I emptied my watch list. The watch list enables you to see only the stocks you have selected in the screener. This is great to create a group of companies you like and want to follow going forward.

I selected each stock that looks interesting by clicking on the star button on the left side of the stock screener. Those selections are then automatically reported to the watch list.

Why would I bother to add all those stocks to a watch list? For two reasons:

#1 I will invest in new companies each month for a long time. I want to keep a close eye on my prospects.

#2 I can then look at my favorite stocks and download the excel spreadsheet with all data

While I love our stock screener, when you look at 30 financial metrics, it’s not that easy to see them and sort them as you want. Excel is a better software to use to make an additional triage among the list of your potential stocks. Then, I can read each stock card and start building my portfolio! Will I go ahead and buy the 22 stocks? Let’s build a fake portfolio to see what it looks like, shall we?

Sector allocation verification with the portfolio builder

The last thing to do before pressing the buy button is to check to see if the portfolio makes sense. I won’t have to make ~20 buy decisions today, but it helps to have an idea of where I’m going with my purchases. Therefore, I’ve built a fake portfolio using the portfolio builder. Good news: in a few months, you’ll be able to select which portfolio you want in your consolidated reports. You will select which portfolio(s) you want and generate as many reports as you wish!

Here’s the list of all the potential stocks after the review:

Symbol	Name	Sector	Pro Rating	Dvd Safety	Dvd Yield Fwd
AP.UN.TO	Allied Properties REIT	Real Estate	4	3	6.74%
AQN.TO	Algonquin Power & Utilities	Utilities	4	4	6.81%
ARE.TO	Aecon Group	Industrials	4	3	7.72%
AW.UN.TO	A and W Revenue Royalties Income Fund	Consumer Discretionary	4	3	5.63%
BEP.UN.TO	Brookfield Renewable	Utilities	4	4	4.34%
BEPC.TO	Brookfield Renewable	Utilities	4	4	4.14%
BIP.UN.TO	Brookfield Infrastructure	Utilities	4	4	4.04%
BMO.TO	bmo	Financials	4	4	4.35%
BNS.TO	ScotiaBank	Financials	4	4	6.22%
CM.TO	CIBC	Financials	4	4	5.31%
CNQ.TO	Canadian Natural Resources	Energy	4	4	4.12%
CRT.UN.TO	CT REIT	Real Estate	4	3	5.44%
EIF.TO	Exchange Income	Industrials	4	3	5.47%
EMA.TO	Emera Inc	Utilities	4	3	5.63%
ENB.TO	Enbridge Inc	Energy	4	3	6.39%
FTS.TO	Fortis Inc	Utilities	4	4	4.30%
GRT.UN.TO	Granite REIT	Real Estate	4	4	4.13%
GWO.TO	Great-West Lifeco	Financials	4	4	6.48%
KMP.UN.TO	Killam Apartment REIT	Real Estate	4	3	4.28%
NET.UN.V	Canadian Net REIT	Real Estate	4	4	5.50%
PKI.TO	Parkland Corp	Energy	4	3	5.12%
POW.TO	Power Corp.	Financials	4	4	5.98%
SYZ.TO	Sylogist	Information Technology	4	3	8.74%
T.TO	Telus	Communication Services	4	4	4.92%
TD.TO	TD Bank	Financials	5	4	4.03%
TPZ.TO	Topaz Energy	Energy	4	4	5.13%
TRP.TO	TC Energy	Energy	4	3	5.99%

I’m not saying this will be my final portfolio. However, it’s a great start and it gives me a very strong buying list to look at. Each month, I’ll go deeper in a specific stock and adjust along the way. Remember, investing is like hiking, you don’t get to the summit or get a great view during the first 100 meters.

Why Using Leverage? Should You Do It At Any Age?

I’d like to end this article on a very important topic; at what age leverage becomes irrelevant? I’ve highlighted the point of risk tolerance several times. If you can’t sleep when your portfolio is down 10%+ or because interest rates are rising, leverage isn’t for you. Not now, not at any age. Period.

As a banker, we used a few rules to qualify investors for an investment loan (on top of having a very high-risk tolerance). I’ve modified them a little:

Smith Manoeuvre Rules

#1 Don’t borrow too much. I believe the rule back then was to not borrow more than 50% of your liquid net worth (liquid = investments, no houses or rental property)

#2 Make sure you can afford to make the loan payment. The investment and growth parts are fun, but if you can’t pay the loan from your regular income, don’t go there. You don’t want to squeeze your budget with another loan.

#3 Invest for 20 years or go home. The rule was more to do it at least for 10 years, but it seems a bit short to my taste. The idea is to go through a full economic cycle (recession + expansion). If you can let your investments ride through several economic cycles, you will realize the full power of compounding interest. In other words, it comes down to: Don’t borrow what you cannot afford and let your investment run for a long time.

If you can withstand fluctuations (and you keep your eyes on the long-term horizon), using leverage before 50 is a very smart move. I’ve used leverage several times in the past and it paid off nicely. Using leverage for 20-40 years seems like a no brainer. But is it the case when you are 50 or even 65?

Should you use leverage at 50? Over 65?

Assuming your life expectancy is somewhere between 85 and 95, if you start a leverage operation at 50, this means you have a good 35 to 45 years to make it bloom. This should be enough to generate wealth for the next generation (and hopefully for your grandchildren too!). Therefore, it would make sense (assuming, again, that you have a high-risk tolerance).

Finally, The “last chance” to do a leverage operation is probably when you get close to 65-70. I really focus on that 20-year period to make sure the investment grows and blooms. I don’t think it would be useful to start leverage in your 70’s as it would likely bring on more stress than anything else. Again, some people want to generate additional wealth for generations to come and this strategy provides a vehicle for that incremental growth.

I hope this article has given you some food for thought. I’ll be covering my Smith Manoeuvre in my portfolio newsletter update going forward. You’ll be able to follow my progress.

From CAD to USD With No Fees – A Guide to Norbert’s Gambit

Norbert’s Gambit strategy is the most effective way to convert CAD to USD (Canadian Dollar to U.S. Dollar) or vice versa without paying expensive Canadian banks’ conversion fees. In this article, I’ll show you how I save ~2% on all my conversion fees with Norbert’s Gambit strategy. This currency conversion technique is:

#1 Risk-free, you don’t assume any costs or risk doing it.

#2 Easy to understand and easy to apply. You only need a few minutes and an online brokerage account.

#3 Working all the time. What you do with Norbert’s Gambit is that you cut the middleman. You just save fees you shouldn’t pay in the first place!

How to convert CAD to USD

You may want to convert some of your loonies into U.S. dollars for a trip to California or you think it’s better off to invest a part of your money in the U.S. market (and you are right doing so). In both cases, you will need to convert your CAD into USD at your bank or a currency exchange office.

Once you get to the counter, the agent will wrongly tell you there are no fees in converting money into another currency. The conversion fee is hidden in the rate you get. You don’t believe it? try this trick:

If you pull out your phone and Google “CAD to USD”, you will get a completely different rate than what you are offered at the counter.

CAD to USD rate

It’s only normal that your bank or the currency exchange agent offers you a conversion rate between 1.5% to 3% lower than the real one. This is how they make the transaction profitable for them.

Now I know you are frustrated because you just realize your banker kept money in his pocket each time you bought U.S. dollars (or worst, when you got hit twice if you converted back the money you didn’t use during your trip!). There is good news, someone found a way for you to save fees. His name is Norbert Schlenker.

What’s Norbert’s Gambit Strategy?

A financial advisor named Norbert Schlenker from Libra Investment Management, a B.C. investment firm found a solution for his clients. According to the online “legend”, this creative advisor established a strategy to skip the middleman and not pay conversion fees. Here’s how it works:

Some companies trade on both Canadian and U.S. stock markets. You can think of Canadian Banks for example. Therefore, if you purchase shares of Royal Bank (RY.TO) through your online brokerage account, you can then call your broker and ask him to journal (transfer) the shares over to the same listing in the foreign currency, at the market exchange rate, and then sell the shares in the currency you want to end up with.

This strategy would convert money invested in Canadian dollars in Royal Bank shares into U.S. dollars once you sold the same shares on the U.S. markets. The only fee paid would be the one charged on the buy and sell transactions. Depending on the amount converted, the transaction fee would be minimal.

Now that this strategy has been spread around Canadians, there are cheaper ways to apply Norbert’s Gambit strategy. Here’s how I convert my CAD to USD or vice versa:

How to Use Horizons US Dollar Currency ETF (DLR and DLR.U) to Convert Your Currency

The stock market is filled with great minds ready to make a buck on a good idea! This is how Horizons created two ETFs which sole purpose is to be used to convert CAD and USD.

Horizons US Dollar Currency ETF (DLR.TO)
Horizons US Dollar Currency ETF (DLR.U.TO)

Therefore, whenever you want to convert Canadian dollars into U.S. dollars, you can do it without paying any conversion fees!

First, you must first open two non-registered online brokerage account: One in Canadian dollar and the other one in U.S. dollar. You can open them within literally 15 minutes with Questrade (watch my step-by-step tutorial). You must also have two bank accounts (one in CAD and the other one in USD).

Your CAD bank account must be linked to your online CAD non-registered brokerage account. Same for your USD accounts.

Can I use Norbert’s Gambit with my RRSP?

I’ve received this question many times: “Can I use Norbert’s Gambit to transfer CAD into USD in my RRSP account or does this strategy only works with non-registered accounts?”

You can use Norbert’s Gambit with an RRSP account. The principle is the same: you would need a CAD and a USD account and you follow the steps explained in this article. The only difference is that you don’t withdraw the money from the account at the end (you use your CAD to buy American stocks in your USD account for example). Keep in mind that dividends paid by US-based companies remain tax-free in an RRSP (as opposed to a withholding tax of 15% applied on dividends paid by a US-based company in a TFSA account).

You can also use Canadian Depositary Receipts (CDRs) to buy US stocks with a currency hedge.

Then, follow these steps to convert CAD to USD with no fees

#1 Transfer your money into your non-registered online brokerage account in Canadian dollar.

#2 Buy DLR.TO for the amount you wish to convert. DLR.TO trades like any other ETFs, you simply buy the number of shares times the price. For example, DRL.TO trades at $13.45 and you wish to convert $1,345. You will then buy $1,345 / 13.45 = 100 shares of DLR.TO.

Wait for the transaction to settle. This is the same process for any stock transactions.

#3 Transfer your position from DLR.TO to DLR.U.TO. Many brokerage services allow you to do it online. Some others will request a call or an online message through their contact form. The broker will give you exactly 100 shares of DLR.U.TO at a price in U.S. currency.

#4 Go in your U.S. non-registered account and sell your shares of DLR.U.TO

#5 Transfer your U.S. Dollar into your U.S. bank account.

Voila!

If you want to transfer USD into CAD you simply follow the exact same steps, but start with your U.S. account and buy DLR.U.TO first.

Please note the conversion could take about 5 to 6 business days between the time you send your money to your brokerage account and you receive it back in the other currency.

Norbert’s Gambit Real-Life Example

You may wonder if it’s worth your time to open two brokerage accounts and wait a few days for both transactions to settle right? I ask myself the very same question. Here are real my results using a transaction of transferring $7,003.04 USD into CAD in my business account (my business made sales in U.S. dollars and I needed to convert it into Canadian dollars).

First, I went to my U.S. bank account and tried to convert a small USD amount into CAD to see the rate. As you can see, the rate offered was 1.3003 (while they clearly show the real rate at 1.3254 at the bottom of the page).

Converting CAD to USD

I decided to skip the middleman and applied the Norbert’s Gambit strategy: I then sent my $7,000 USD into my USD online brokerage account on February 12^th 2020 and bought 692 shares of DLR.U.TO and I waited.

DLR Horizon USD ETF

A couple of days later, I called my broker and ask to transfer those 692 shares of DLR.U.TO into 692 shares of DLR.TO in my Canadian dollar brokerage account. That was literally a 2 minutes call.

The same day, my Canadian account shows 692 shares of DLR.TO for the amount of $9,265.88.

I waited again for the transaction to settle and I sold my 692 shares a few days later. I then have the total amount transferred to my Canadian dollar business bank account.

On February 20^th 2020, I had $9,265.88 deposited in my bank account showing a conversion rate of 1.3231 on my money (7,003.04 * 1.3231 = ~$9,265.88). If I had called my bank to convert on February 20^th, they would have given me $1.2996 for each dollar. That’s a difference of 2.35% or $164.73.

Norbert's Gambit

Norbert’s Gambit takes a few days to operate

As you can see in my example, the conversion is not done instantly. This is probably the strategy’s biggest drawback. In times of high volatility, this is not ideal. You could be waiting and the currency you want could increase by 2% in a single day. On the other side, the 2% you save on the conversion rate makes a solid margin of safety.

Final thoughts

As a business owner, you can guess that I have to use Norbert’s Gambit on a regular basis to change my money from USD to CAD.

So far, it has paid off to save roughly 2.3% on each currency conversion.

I haven’t run into any major problems and I’m glad to keep saving so much money in currency conversion! What about you? Did you ever used Norbert’s Gambit?

How to Buy Canadian Stocks

The best way to improve your financial situation and retire stress-free is to invest. But how do you buy Canadian Stocks? Which one should you be buying? Do you need a financial advisor or can you simply buy stocks on your own?

I’ve asked myself all those questions before I made my first trade on the market. At first, I felt overwhelmed by the information about the stock market. I didn’t know where to start, which type to account to choose, and which investing strategy (do you need one?) to pick. Fifteen years after I first bought my first shares of Power Corporation (POW.TO), I take a look back at what I’ve learned to help you start today (and avoid some of the mistakes I’ve made!).

I remember the very first thing I did once I got my first stable job was open an investment account. I was fortunate enough to meet with the right people telling me at a young age that the best way to build wealth was through investing. At the age of 23, I didn’t have much financial responsibility, and this was the perfect timing to start saving and investing. However, before opening a brokerage account and buying stocks of the first company that comes to my mind, I should have take the time to build a real plan.

Here are the steps I should have followed before making my first investment. This is a complete article that will be updated as I add more content to each section. You don’t need to read it in one shot (just bookmark it!). Just take one step at a time and you will learn how to buy stocks.

Step #1 Know yourself and know where you are going

Before you even think to buy stocks, you must first draw the picture of your financial situation and write down why you invest. Do you….

Wish to retire early or comfortably?
Fund your children education?
Buy a rental property or vacation property by the lake?
Or you just want to save money “just in case”?

Answering those questions, looking at your current financial situation and determining your risk tolerance will tell you a lot about the type of investing strategy you should pick (we will cover that later down the road).

The “classic and boring” investor profile questionnaire meets this purpose. Why is it so important to complete such questionnaire before you start investing? Because once you invest and the storm gets in and you lose money, it will be too late to know if you were able to handle it or not. It’s better to know if you are able to look down the cliff before you jump right?

The best questionnaire I found so far isn’t coming from a bank or an investing firm (that adds to the credibility!). In fact, it’s coming from the Financial Market Authority of Quebec (L’autorité des Marchés Financiers). You can give it a try here:

Investor profile questionnaire

Step #2 You need a brokerage account

Now that you know why you invest, it’s time to know how you can buy stocks on the market. Forget about movies where you call some shady brokers at their desk, you can do everything on your own!

A brokerage account is basically a platform enabling you to buy and sell stocks on the market. You can have multiple different accounts (RRSP, TFSA, RESP, etc.) with the same online broker. The money is being transferred from your bank account to your brokerage account as any other electronic fund transfer. Then, you can start buying stocks.

You can open an online brokerage account at your bank or you can go the savvy route and opt for Questrade. Questrade is a safe online broker offering the lowest fees. While most banks will charge you around $9.99 each time you buy or sell stocks, Questrade will do it for a starting price of $4.95. After that, shares are .01 each, to a maximum of $9.95.

For example, if you buy 100 shares of Royal Bank (RY.TO), you will pay $4.95 + $0.01*100 = $5.95. That’s 40% discount vs any other bank. Plus, if you want to buy ETFs (Exchange Traded Funds), you do it for free!

Here’s how I opened a Questrade account in less than 15 minutes:

You can open an account with Questrade today and start with $50 in free trades.

Step #3 Canadians can choose among plenty of account types

When you open a brokerage account, you have the choice of opening multiple types of accounts. Each account is getting taxed differently and has different purposes. In general, all stocks and ETFs can be bought through any account types. Here are the choices will have:

Cash & margin accounts

The cash account is the most straightforward of them. You can trade any type of investments in this account. However, there are no tax deductions when you invest money. Profit, interest or dividend are also subject to taxes.

This type of account can be managed individually (by yourself) or joint (with your spouse for example).

RRSP (Registered Retirement Savings Plan)

This is probably the most classic account type if you plan to retire. The RRSP is well-known by Canadians for its tax advantages. Whenever you invest money in your RRSP, the “contribution” is being deducted from your declared income on that year. Also, all profit, revenue or dividend made inside a RRSP is tax sheltered (you don’t pay taxes on them). On the other side, when you withdraw money from your RRSP account, the amount withdrawn will be added as a revenue in your tax report.

TFSA (Tax Free Savings Account)

Here’s the most flexible and tax optimized investing account for Canadian! The TFSA has been designed to shelter your investment from taxes. When you buy stocks in your TFSA, the “contribution” will not be deducted from your income. In other words; there is no tax return on your contributions. All profit, revenue or dividend made inside the TFSA is tax sheltered (no more taxes!).

The good news is you can withdraw money from this account at any year and never pay taxes on your withdrawals. Even better, you can put that money back the following year without any penalty (or obligations!).

RESP (Registered Education Savings Plan)

This is probably the most complicated account as it is not designed for you, but for your children tuitions. I will cover this account later down the road with a complete article on it. In the meantime, what you need to know is that both Federal and Provincial Governments will grant subsidies according to the amount you invest. Plus, all profit, revenue or dividends earned in this account is tax sheltered. The purpose of the RESP is to help you pay for tuitions.

TFSA or RRSP?

As you can see, chances are you will have to make the decision between having a TFSA or a RRSP. Most investors will end-up with both. If you are starting in the investing world, I think the TFSA would allow you more flexibility than the RRSP.

Step #4 Which type of investment is offered to Canadians?

Now that you have opened a brokerage account and you have selected the right account type, we are now one step closer in learning how to buy stocks. This section covers the type of investment you can buy.

While there are hundred of ways to buy stocks, we’ll focus on a few products that are simple to understand and will get you started. Because time is money and time in the market is everything.

Robo-Advisor

If you are completely new to investing and you don’t want to get your feet too wet at first, Robo-Advisors are probably the best solution. A Robo-Advisor is a proven recipe that has been cooked and assembled for you. All you need to do is to pick your asset allocation according to your taste (risk tolerance) and you invest your money in this “recipe”.

Fees are relatively low for a complete “packaged and managed” solutions and you don’t have to worry about anything. Robo-Advisors create portfolios using specific ETFs to cover all assets classes. In a single transaction, you buy hundred of stocks and get a fully diversified portfolio instantly.

ETF (don’t even think of mutual funds)

We are not going to cover mutual funds here because A) they are expensive and B) they don’t do better than ETFs in most cases.

Exchange Traded Funds (ETFs) are packaged investment products replicating a market, a sector or a strategy. For example, one of the largest Canadian ETFs is the ISHARES S&P TSX 60 INDEX ETF (XIU.TO). This ETFs will mimic a portfolio that would include the 60 stocks included in the … TSX 60 (the 60 largest companies trading on the Toronto Stock Exchange). Therefore, instead of buying individually 60 stocks and make sure that each of them shows the same weight in your portfolio, a single transaction give you access to this “bundle”. If the TSX 60 goes up by 4%, the ETF will follow very close behind (as there is still small fees to pay). In the specific case of the XIU, its management fees are 0.18%. Therefore, the XIU would show a return of 3.82%. Not bad for not having to manage 60 stocks portfolio, huh?

There are plenty of ETFs combinations and strategies possible and we will cover them in the future.

Stocks

If you don’t trust someone else to manage your money because nobody cares more about your portfolio than you do, buying individual stocks is the strategy you must follow. Buying stocks isn’t as overwhelming as it seems. What you need is a clear strategy determining where you will put your focus. There are several thousand stocks on the market, you can’t (and don’t want) to buy them all. Focusing on specific stock market areas will help you saving time and make the right investments for you.

Then, through a straightforward process, you will identify which stocks to buy and how much to invest in each position. I’m sharing key metrics I look at before buying any shares in step 8 of this article. In the upcoming sections, you will learn how to buy stocks and build a strong portfolio.

Other investment products

There are obviously a lot more to cover when you consider investing. If you are reading this article, this means you are at the beginning of your investing journey. You don’t necessarily need to know and master all type of investments. My most important advice at this point is to keep your portfolio simple. You don’t need the latest investment strategy combining options, preferred shares and leveraged ETFs. You just need to learn how to buy stocks and build a solid portfolio. Now let’s get started.

Step #5 Transfer money in [this is exciting]

At the time to open your brokerage account in step #2, you already linked your investment account with your bank account. This is how you will transfer money into your investment account in the first place. You can either transfer a lump sum of money or start by periodic payment plan.

The lump sum transfer will allow you to buy larger amount of stocks in one transaction. However, it could take time to save before you can start investing. If you have a large amount coming from an heritage, the sale of a property or a pension plan transfer, you should transfer it directly to your brokerage account and start investing.

You can start with as low as $25/month

Depending on your brokerage account, you can start a periodic payment plan for as low as $25/month. Now, there is no excuse preventing you to start buying stocks! If you start with less than $100/month, you are better off looking at ETFs instead of stocks. You will gain immediate diversification and you can buy ETFs for free through Questrade.

Periodic payment plan can be done weekly, bi-weekly (to time with your paycheck!) or monthly. It’s a great way to automate your saving habit and not thinking about it anymore. You will learn to live without this amount in your budget. This is another version of “pay yourself first” strategy.

Dollar Cost Averaging (DCA)

Periodic payments also enable you to use a strategy called dollar cost averaging. Since you will be buying more stocks or ETFs periodically, your cost of purchase (the price you pay per share) will be average up when the market is doing well and average down during challenging period.

Throughout time, you will have money invested at peaks, but also at bottom levels. When you buy during down markets, you get more shares for your bucks. When markets rise, you get to enjoy the ride and buy at each level.

The key in both strategy (buying stock with a lump sum vs DCA) is to stick with your strategy and not wait. Time in the market will be the greatest source of your return. Don’t ruin it by waiting.

Step #6 A few key definitions before you start

Now that you have money ready to buy stocks, it’s time to get a few key definitions before you place your first order. Some of them are basic terms, but some may surprise you. Let’s do a quick tour of some common terms used in the financial world.

Common Shares/stock

This is what we refer as a “stock”. When you buy stocks, you buy common shares of a company. This is a small (tiny winy) portion of a business. Holdings common share entitled you to have rights on your part of the company’s value, receive dividend (if any) and go to shareholder meetings.

Preferred Shares

Similar to common shares, preferred shares will usually pay a higher dividend and will entitle shareholders to first right on the company’s assets in case of bankruptcies. Dividends are not only higher, but they are paid first (before common shares dividend). Preferred shares are halfway between common shares and bonds. Shareholders do not have voting rights. They are usually less volatile and less liquid (less stocks bought or sold each day) than common shares. If you start investing, you want to stick with common shares.

Symbol/Ticker

When you place a market order in your brokerage account, you will need the symbol or the ticker of the company. For example, Royal Bank’s ticker is RY. If a website covers both US and Canadian stocks, chances are “RY” will become “RY.TO” or “RY-TO” to identify on which market common shares can be purchased. You can search for the ticker inside your brokerage account or via a free investing site by looking for a “quote” or “stock quote”.

Quote/Stock Quote

In your broker screen, you will read “quote” or “stock quote”. This is where you will get the latest information on the stock you want to purchase. It will give you information such as the ticker, the full company’s name, the latest transaction price, the “bid and ask price” and “bid and ask size” and general information on the stock such as the PE ratio, the dividend yield, market capitalization, etc.

Bid and Ask Price

Remember the stock exchange (the Toronto Stocks Exchange (TSE) or the New-York Stock Exchange (NYSE), etc) is a place to buy or sell stocks. The bid price will refer to the latest order placed from a buyer (an investor is willing to pay $23.66 per company ABC shares) and the ask price refers to the latest order placed from a seller (an investor willing to sell shares of company ABC at $23.74). The transaction will happen once a buyer will meet a seller’s price.

If there is a huge difference between the bid and the ask price, this means there isn’t many buyers and sellers and the stock price will be subject to higher fluctuations. Penny stocks are a good example of this situation.

Bid and Ask Size

Similar to the bid and ask price, the size refers to the amount of shares an investor is willing to purchase or sell. This tells you how “liquid” the stock is. By liquid, I mean how many shares will be exchanged (bought and sold) in the upcoming transactions. The more liquid, the “smoother” the stock price will fluctuate. This is more important when you trade, again, penny stocks and other small capitalization (low value) stocks. Big guys of the TSX 60 don’t have this problem.

Market Order

A market order happens when you enter the number of shares you want to purchase, but you are willing to buy them at market price (the lowest ask price). That’s usually not a problem when there are lots of transaction (liquidity) going on because you will pay a price very close to the latest price shown in your stock quote.

Stop Order

The stop order is when you put a number of shares and a specific price you want to buy or sell. The transaction can be placed for several days until the desired price is reached. The transaction will only trigger if the price is reached.

Investors use that to buy stocks at a better price or to protect their gains. If a stock surged from $22.34 to $37.09, an investor may want to protect his profit by setting a stop sell at $35.00. If shares ever go down to this price, the online broker will automatically sell your shares starting at $35. This means that if shares keep going down, you will continue to sell until you have sold all your shares. Your average price sold will likely be lower than $35.

This doesn’t mean that you will sell the stock at $35/share, just that the market order will be triggered at $35. Same rationale applies for buy stop order.

Limit Order

A limit order is similar to a stop order only that the former will only happens at a specific price. For example, if you put a limit order to buy 400 shares at $56.75 and only 200 are available at that price, you will end-up with 200 shares in your account and a pending order for 200 more at $56.75.

Step #7 Where do you get your information to buy stocks?

Now that you are all set and ready to start investing, it’s time to do some stock research! Unfortunately for us, Canadians, the offer is quite limited when you look for free information on Canadians companies.

The best free stock screener you can find is probably over at the TMX or Yahoo Finance where you can do research on both Canadian and US stocks. This is a good place to start building your watch list.

Then, general sites such as Reuters, Motley Fool, , and Morningstar will provide you with some useful information and quick analysis.

Then, one of the best places to find reliable information is the company’s investor relations site. Simply type “Royal Bank investor relations” and you will get directly to where you can read quarterly reports, investors presentations and annual reports. I’ve listed other free financial resources here.

Step #8 Key metrics to find the best stocks to buy

What is the most important when I look at the company is not the number, but my investment thesis. Before I get there, I must screen stocks with a very specific, yet simple stock screener. I’m looking for company with revenue growth, earnings growth and dividend growth. This is what I call the “Dividend Triangle”.

Growing revenue

My criteria for a positive revenue analysis is:

An increasing revenue trend line for at least the last 5 years;
A revenue growth trend line that is steeper than the company’s closest competitor;
Do I expect that the company has a better than reasonable chance of continuing with the steep revenue trend line in the next five years.

If the company cannot meet these requirements, then my analysis usually stops. However, there may be some cyclical stocks that see up and down periods in revenue growth. If this is a consistent pattern, then that is ok. Another thing I keep in mind is that very large companies (i.e. Royal Bank or Canadian National Railway) can have difficulty growing revenues year after year. I don’t necessarily look for a high revenue growth trend line, only a trend line that is up and growing faster than the competition.

Growing Earnings Per Share (EPS)

Earnings per share (EPS) is a much tougher thing to decipher for a company. Revenue is revenue and is hard for a company to lie about, other than recognizing sales before the product actually ships or something like that. EPS on the other hand can be easily manipulated by a company, and not just in illegal ways. There are a number of very legitimate methods a company can present earnings. During my analysis of earnings, I don’t necessarily concern myself with the exact EPS number, but more importantly the trend line. Just as I do with revenue, I require the following criteria be met:

An increasing EPS trend line for at least the last 5 years;
An EPS trend line that is steeper than the company’s closest competitor;
Do I expect that the company has a better than reasonable chance of continuing with the steep EPS trend line in the next five years?

The last point can be tricky, but further analysis of items such as ROE later on will help to determine how well management is performing in their ability to earn money for the company. I always keep in the back of mind that earnings can be manipulated. Again, I am looking at the trend.

The next step I take when analyzing EPS is to estimate what the EPS number will be 5 years out. This is obviously a very tricky thing to do, but it will be important later on when I start to value the stock. I look at the past 10 years of EPS history and earnings estimates from services such as Value Line to determine a number I am comfortable with. My approach is to be very conservative in my number to help build in a safety net if things get bad. This will ultimately give me a buy price for the stock that I believe has some safety built into it.

Dividend Growth

Once you’ve selected a company from your screener, the next step is to download their financial statements. If you are lucky, you will find an “Investor Fact Sheet” or “Recap” giving you some key ratios such as Earnings per Shares, Sales, Profit, and Dividend Payouts throughout the past years.

If you can’t get a hold of a one pager giving you the information right away, you’ll have to dig inside the financial statements. Take the annual reports as you will have more than one year and the info might have been calculated for you already.

When you look at the dividend growth history, it is preferable to look at the past five years. Instead of simply calculating the dividend growth annualized rate, I suggest you make a quick graph of the past 5 years dividend payout. It will give you a clear idea of which stocks have a strong dividend payout strategy compared to another. The graph can be as simple as the following:

Which looks a lot better than the following:

The first graph is a good indication of a solid company that is looking to increase its dividend year after year. For the record, the first graph is TRP dividend growth and the second graph is Encana dividend growth.

Looking at past dividend history is a good start to know if the company intends to boost its dividend in the future. But there is always a will and a way, right? So the company might have a strong dividend growth history over the past 5 years, it doesn’t mean that it is sustainable.

The relation between sales evolution and earning per shares will tell you 3 things:

How is the company’s main market doing (if sales are growing or not)
If are the company’s profits growing (are they making more profit or not)
How are the company’s margins doing (if the sales and EPS graph don’t head in the same direction, that’s a red flag or very nice news for the companies’ margin)

To ensure stable dividend growth over time, it’s obvious that you need stable sales and earnings growth. Sales growth will ensure future cash flow and earnings growth will ensure that the company makes more money as sales climb. If these two metrics are negative or growing erratically, you will need to dig deeper into the financial statements to explain it or simply pick another stock to analyze.

Royal Bank Example

Royal Bank is as close as a “perfect dividend triangle” you can find:

Source: Ycharts

In an ideal world, RY’s revenue and earnings would grow faster than its dividend, but you can see a steady trend for all three metrics. This is the kind of stock you want to buy for your retirement.

Step #9 Get your plan in motion; how to buy stocks summary

Before you start your investing journey and buy your first shares, remind yourself of the following key points:

#1 Keep things simple; overcomplicated will not necessarily improve your returns.

#2 Know yourself and know where you are going; having a financial plan and an investing strategy will come handy when the market goes crazy. Just stay focused on your plan when this happens.

#3 Write down why you buy stocks; elaborating your investment thesis for each purchase is crucial to build a solid portfolio.

#4 Don’t expect fast results; investing is all about playing the long game. After your purchase some shares, don’t refresh your account every hour. Don’t even look at it daily. Let time works is magic. Patient investors make good investors.

#5 Download this free ebook:
DOWNLOAD the WORKBOOK

I wrote an entire workbook to give you confidence and guide you through the first steps of your investing journey.