Category Archives: Investing

The Consequences of Debt

The US government is in the process of learning one of the key lessons of the debtor.

The Creditor calls the tune.

The Chinese who hold trillions of dollars in US are not happy, and they are not afraid to let the US know that they need to shape up and fly right. Let’s hope that this credit downgrade is treated as a wake-up call, and the US uses the opportunity to get their fiscal house in order.

But don’t count on it.

The disfunctional houses of congress are too busy stabbing each other in the back in a pointless and self defeating series of internecine battles.

If the US doesn’t sort this out, expect more dire consequences in the future.

In the meantime, use this dip in the Dow to snap up any high quality blue chips while they are on sale. Just make sure you go for quality, look for income in the form of dividends to  tide you over until the markets recover.

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Filed under Dow Jones, Economy, Finance, How It Works, Inflation, Investing, Recession, Stock Market, Uncategorized, US Debt

Changes to Flash Crash Rules

On Thursday Canada’s investment industry regulator, IIROC, proposed new safety measures intended to prevent future flash crashes like the one that happened on May 6.

Existing “circuit breakers” halt trading when the entire market rises or falls extremely quickly within a short period of time, but trading in individual stocks must be reviewed manually. This new proposal would allow trading to automatically be halted for a five minute period on any stock that appears to be subject to a “flash trading” scenario.

The plan is to prevent the extreme investor losses we saw in May, when some stocks lost up to 99% of their value in minutes.

IIROC has invited public comments on the proposal during the next 60 days. Read the press release here.

 

 

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Filed under Investing, Regulation, Securities & Exchange Commision, Stock Market

Computerized Mayhem on the Dow Jones

A thousand point drop in the Dow Jones is stomach wrenching enough to make the toughest investor queasy. A thousand point drop in moments is just mind numbingly inconceivable. How many of us just stood in front of our tv screens like we had just been smacked upside the head with a board?

Although it now seems likely that the excruciating market gyrations we watched today were probably as the result of human error and/or a technical glitch, it really begs the question, How could we not have systems in place to guard against this type of thing?

Our stock markets have become so globalized that any news in any part of the world impacts decisions at trading desks everywhere. We have reached the point where turmoil in Greece impacts the price of oil in Alberta, and the rising price of gold affects the softening Euro.

Then some guy wearing his tie too tight hits the wrong button, and the Dow Jones tanks in moments.

I have to admit it made for great visual theatre, but the whole fiasco does call into question the degree to which we now rely on automated computer algorithms, and how unstuck things can become before real humans can step in to reassert manual control over the system.

Perhaps we need a rethink about the glories of technology and it’s ability to run our lives. Or should that be “ruin our lives.”

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Filed under How It Works, Investing, Stock Market, Uncategorized

Spousal RRSPs, How it Works

If you are not familiar with all the mechanisms of RRSPs, Spousal RRSPs, TFSAs and some of the other types of accounts which are offered at Banks, Investment Dealers and Insurance Companies in Canada, it can be very easy to misunderstand how they work and how they differ. This is very common with Spousal RRSPs.

Often when the account is being set up the advisor gives a quick verbal explanation of how the account works and what the benefit will be to you. Sometimes you get the details in writing, but let’s face it, how many people ever bother to read the fine print?

On more than one occasion I have run across people who misunderstood how their Spousal RRSP works.

To cover the basics – It is a retirement savings account which allows one spouse (husband or wife) to make deposits into the retirement fund of the other spouse. They can be married or common-law. This is most useful in cases where one spouse earns a higher income than the other, or one spouse will have a higher retirement income from a fully funded defined benefit pension plan, and the other will not.

The main things to remember are

  • the account is set up in the name of the receiving spouse
  • the spouse who makes the contribution is the one who gets the tax deduction
  • the receiving spouse, who’s name is on the account, is the owner of the account
  • the owner of the account makes all the decisions about how and where the money is invested
  • the contributor has no say in how the account is operated, or how or when money is withdrawn
  • in the event of marital breakdown the money in this account will be included in the marital assets calculations and apportioned according to the divorce agreement, the contributor does not have a right to ask for the return of the money
  • tax attribution rules mean that if money is deposited by the first spouse and withdrawn within the first three years by the receiving spouse, it will be taxed back to the original contributor
  • exceptions to the three year rule occur in case of marital breakdown or death of the account owner

So are Spousal RRSPs a good idea? Yes. Although new pension splitting rules have reduced the income splitting benefit slightly, it is still good financial planning to equalize income as much as possible and ensure the both spouses have fully funded retirements.

 

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Filed under How It Works, Investing, Pensions, Retirement, Saving, Spousal RRSP, Taxes

RRSP or TFSA?

It’s alphabet soup time out there. Ads everywhere telling you to top up your TFSA overriding the usual February cacophony of RRSP season.

What are you supposed to do? Either ? Both? If you have limited funds which one gets priority?

Many of us are sitting here today looking at RRSP accounts that are still slightly battered from all the recent upheavals, although I think most of us can see the light at the end of the tunnel. But disillusioned by the past year and a half, we ask if we are ready to go down that path again.

At the same time, those near to retirement look at the measly $5,000 annual limit on a TFSA and laugh. There isn’t enough useable space to make a realistic difference in anyone’s immediate plans.

What to choose actually depends on a number of factors; What is your current tax rate? What is the tax rate are you likely to pay in retirement? How old are you? Do you have a pension? What are your current savings? Do you have an emergency fund?

As guidance, I’ll lay out a couple scenarios.

1) 50 year old management type with a good pension and current RRSP holdings, with the house almost paid off.

a) This person is currently in a high tax bracket, and likely to be in a fairly high tax bracket in retirement. Pension income splitting will reduce a couple’s tax burden, and allow them full benefit of their retirement income. Advice – concentrate on the debt, and funnel extra savings to a TFSA which can provide the “fun money” which will make retirement more enjoyable.

b) If you are single or have a spouse who will also have substantial post retirement income, income splitting isn’t likely to help you very much. Advice – forget the RRSPs entirely, they will just create a bigger future tax burden. Pay off the debt, max out TFSAs and if there is still ability to increase savings, investigate unregistered corporate class mutual funds which have a number of tax deferral advantages. Don’t forget the preferential tax status given to Dividend income.

2) 35 years old,with an annual income less than $35,000, no current savings. 20 years left to pay on a 25 year mortgage amortization. A few bucks in an RRSP, no other current savings, no emergency fund.

a) An annual income less than $35,000 is sort of the cut off tax bracket where RRSP contributions are of questionable value. The tax refund you get today, will be pretty well entirely eaten up by the tax you will pay when you start withdrawing the money in retirement. The lower your income the less efficient the RRSP becomes. Advice – get a TFSA to do double duty. Immediate savings can function as an emergency fund because withdrawals will not be penalized. Long term, the TFSA will replace the RRSP for this person, and all income withdrawn from it will be tax free in retirement, which will not affect the person’s eligibility for programs such as OAS. For this person the focus should be on saving, build that nest egg, protect against emergencies. The mortgage, which will pay itself off over time, will be done well before retirement, I wouldn’t worry about it. The trick here is avoiding further debt.

3) Young person, just starting out, lower income, good prospects for the future, no savings, renting. Advice – no question, max out the TFSAs. When the time comes to buy a home, the down payment can be withdrawn from the TFSA without all the headaches of the RSP Homeownership plan. Not only does it not have to be repaid, but you get the available room back the following year, so you are not penalized. During the growing and accumulating years the TFSA can act as an emergency fund, and in the long term will provide tax free income in retirement exactly as above. If this young person does move up in income and tax brackets there may come a day when the tax deduction of an RRSP contribution would be beneficial, however I would continue to advise maxing out the TFSA first.

What to avoid – Tax Free Savings Accounts which are set up like a plain jane savings account, paying pitiful daily or monthly interest. Forget it. At current (and foreseeable likely future) interest rates, these accounts are pointless. The amount of income which could possibly be generated isn’t worth the effort of protecting. We are talking pennies in tax savings here folks. Most of us alive today aren’t likely to live long enough for this to do us any good at all.

What to do – Get a Tax Free Savings Account which is set up like a regular investment account at your local bank, brokerage or investment dealer. Then treat it exactly like you would an RRSP. Same type of investments. GICs, mutual funds, ETFs, stocks, bonds – whatever sets your little heart afire. Think long term, but always keep a little short term money in there on the side in a money market fund or short term GIC, just in case.

 

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Filed under Finance, Investing, Mutual funds, Pensions, Recovery, Saving, Tax Free Savings Accounts

Investing vs Trading

Are you an investor or a trader? Are you in it for the long haul or the quick fix roll of the dice?

Oops. Was that pejorative? Are my true colours showing? Perhaps I can control my personal biases by admitting up front that I consider trading, especially day trading, a form of gambling.

An investor takes the long view. 5+ years is what I normally see. Many are looking at a very long term 20-25 years. These type of time spans will encompass a number of business cycles. Each cycle tends to be focused on a certain sector or two, and often ends when a sector bubble driven by speculation or an overheated economy bursts, or a general correction realigns the overall outlook for the economy as a whole.

Therefore in order to be successful, a long term investor needs to spread his/her monetary investments across a diversified selection of asset classes, sectors, investment styles and geographical regions. Central to this process is an understanding that we cannot predict the next big thing or hot issue, and so must take the high road, and be ready and in place before the action begins in order to take advantage of growth opportunities in the markets. This also means that we understand that we must sacrifice immediate gratification for long term prospects. It is the sit and wait vision of investing.

On the other hand, a good day trader, who is working “The Next Hot Thing”, knows enough to close out his positions at the end of the day, because untold havoc could occur while he/she sleeps, blissfully oblivious to the carnage being wreaked on the Asian or European markets.

The highs and lows that a day trader experiences are not for those who’s sleep patterns may be disrupted by the goings on of some obscure commodities future exchange in some faraway place which no one you know has ever heard of.

I make only one recommendation to those who are serious about trying day trading. Don’t use your real money. This is not someplace to expose your retirement savings, or your kid’s college fund. If you want to try out the roller coaster ride of the FX pits, or lottery winnings of a diamond mine in the Arctic, please only use money you can afford to lose. Use your play money.

For those who believe that they have watched enough business tv, and have become experts in the lingo, and listened the the pundits propound this or that next hot thing, or come up with some quasi rational explanation for the latest jump/dip or hokey/pokey in today’s market, I leave you with one thought.

By the time a news item makes it onto your screen on BNN or MSNBC, it is already 36 hours old, and all the professionals on the street have already acted upon it, and any profit that was encapsulated within that new information has been extracted and wrung dry. You will always be the last person to know.

 

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Filed under Commodities, Day Trading, FX, Investing, Stock Market

Is it over?

Last night I was meeting with clients, and once again I was asked the big question.

Is the recession over yet?

This is one of those questions where the answer depends on where you are standing.

In the world of economics there are leading indicators, lagging indicators, and current statistics and reality. They may all be very different things. We see patterns in the data, and some people try to make predictions based on past experience. Forecasting can be a deadly game, and you are sure to get shot down by someone who is blessed by 20/20 hindsight. Also all forecasts are subject to bias. Are you a cup half full, or a cup half empty type of person?

What I will say at the moment, is that given the current situation, it looks like we might be on the road to a gradual recovery. The Bank of Canada has declared the recession over in Canada, the EU is optimistic, and the US believes that they are beginning to turn around.

But my client’s unspoken question was “when will I see a recovery”. Firstly, remember that during past recoveries, we have progressed in “two steps forward, one step back” fashion. There will be ups and downs as we wander in a generally forward direction.

So we have to ignore the day to day hysteria of the business channels who spend the day trumpeting some piece of useless news as the stock market rises, only to beat their chests and tear their hair out the next day as the market falls 50 points, and they cry crocidile tears over today’s dire statistics which are an obvious indication that the experts were wrong, and the sky is indeed falling. Hog wash. They need to garner ratings. They need the next breathless piece of news to justify the fact that they are taking up valuable airwaves 24 hours a day.

When the markets began to fall last year, I began to talk about the pattern we normally see in these situations. Usually, you can expect the market to fall to a certain (unfortunately unknowable) point. Then we would expect to see a period of time where the market kind of bounces along the bottom. When things begin to look better, the markets will begin to turn upwards in a two steps forward, one step back dance, as we see a gradual return to normalcy.

TSX Oct 27,2009

So far, so good. But the stock markets are not the real world.

Stock markets are generally a device for forcasting the future profits and profitablity of a company. So a stock price is the assumed future value of the income which a company is expect to produce. The markets will usually be 6 to 9 months ahead of the real economy.

Since the markets began to turn around in April, if history repeats itself, this would indicate that somewhere in the next few months we should begin to see the real economy begin to improve. Business should pick up, inventories will need to be replaced, total sales should improve.

Now employment is a different thing. Employment is a lagging indicator. Companies will wait until their business has picked up, and the order books are full before they begin to hire people back. Many companies delay hiring until they are spending too much on overtime, and hiring new staff or recalling old staff from layoff is more economical. Normally this will be 6 to 9 months after the general economy begins to improve.

So for the average person, the recovery will become a reality when everyone is back at work, and everyday life is back to normal. That is going to take a little while yet.

Barring any horrible setbacks, right now we can say that we are headed in the right direction, and so far things are proceeding according to historical norms. Fingers crossed.

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Filed under Economy, Employment, Investing, Recession, Recovery, Stock Market

Cashing out Your Pension

I hear it all the time. A person comes to see me, and tells me how someone (perhaps a friend or a so called investment advisor) suggested they cash in their pension when they retire. Oy vey. Please people, stop it already.

I have heard all the arguments why this is such a terrific idea. And I have seen all the tears when things don’t work out according to somebody’s overly optimistic plan. So lets recap.

Yes, when you leave a job, either quitting or retiring, you are often offered the opportunity to convert (or commute) your pension. This is where the first misunderstandings come into play. Yes, you can commute a pension. You can take the money in your company pension account, and put it into a Locked In Retirement Account (LIRA). A LIRA works similar to a RSP, except (1) it is locked in until you turn 55, (2) there are minimums and maximums that you can withdraw each year.

However, there are pitfalls which these so called friends and advisors neglect to either mention or give proper emphasis. Firstly, like an RRSP, your investments will be subject to market forces. So yes, you get to decide how it is invested, in stocks, mutual funds or GICs as you wish. And if they go down in value, like most investments did in 2008, you alone suffer the consequences.

Secondly, in Alberta, BC, Saskatchewan and Quebec, additional voluntary contributions you might have made in the past are not subject to creditor protection, and could be seized if you were ever sued. In Ontario, Quebec, New Brunswick, Manitoba and Saskatchewan locked in accounts are subject to garnishment for child support.

Thirdly, it is possible that not all of the money in your pension plan account will be eligible to be transferred directly to a LIRA. You may find that there will be a cash portion which will be paid directly to you, and you get walloped by income tax deducted from this amount at your top marginal rate. Peachy eh? Especially if you weren’t warned.

One of the things that really has people excited are rule changes in some provinces which will allow you to take up to 50% of your pension money in cash after January 1, 2010. Hooray! The government will then grab taxes from this amount at your top marginal rate. So if you live in Ontario you could lose up to 46.4% right off the top to the government. Dalton McGuinty  and Jim Flaherty will thank you.

My concerns with this whole process are many.

1. Canadian pension plans are generally well funded and regulated, and unless your company goes bankrupt, you will get all the money you are entitled to.

2. Canadian pension plan managers have shown better long term investment returns than the average RRSP investor. Especially Teachers, HHOOP, Hydro and many of the Union plans. Do you really think that you, as an amateur, can do better than the professionals who work in the business all day every day, who are able to utilize economies of scale and instant preferential access to the most up to date information when making their investment decisions?

3. In a defined benefit pension if there is a shortfall, the employer is on the hook to make up the difference. If your LIRA has a bad year, guess who makes up the difference?

4. If you take out 50% of your pension as a lump sum, what are you planning to live on when you retire?

Now, I know that you can never say never, and there are a few people for whom commuting a pension might actually be a good idea. However, they usually fit into certain limited categories.

A. You have multiple tiny pensions which individually will pay very small amounts every month. In this instance you may not suffer any great penalty by combining them and investing them as a unit.

B. You have a diminished life expectancy, no spouse, and wish your pension assets to go to your heirs. If you can make the argument that you will not live long enough, because of a pre-existing illness, to collect the bulk of your pension, then it might make sense to roll it over into a LIRA so that it can become part of your estate. However – big however – this will expose the entire pension to estate and probate taxes.

So exactly why are some people so quick to advise you to commute your pension?

First, is often the friend who read something someplace, and in whose hands a little knowledge is a dangerous thing.

Secondly, and most egregiously, is the so called advisor who assures you that he can put you into investments that will outperform the “pitiful” returns attained by pension plan managers. This guy is solely driven by commissions. Really, really big commissions. Thousands of dollars in commissions. Big, big, fat, juicy, buy a new Cadillac commissions.

Please don’t listen to these people. By the time you come to see me, I can’t fix it. I can’t correct the mess they have made. I can’t restore the long term value that they destroyed.

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Filed under Estate Planning, Investing, Locked in Retirement Accounts, Mutual funds, Pensions, Saving

Getting Paid to Sit and Wait

Many of you have heard me talk about Dividend funds over the past couple years. I am obviously a fan. I can think of nothing better than getting paid to just sit and wait.

There are a few different types of Dividend funds, the tradition Large Cap fund, and the Dividend Growth fund. These can then be broken down into Canadian, US, Global or sector funds. Although they generally hold different types of investments, they basically operate in the same way.

A Large Cap Dividend fund, formerly known as a “Blue Chip” fund, is made up of the big boys of the stock market. Banks, Insurance Companies, Utilities, Pipelines. These companies have a large enough capitalization (number of stocks outstanding) that their price usually doesn’t move a great deal on a daily basis. Their stock price just grows at a rather slow and steady pace over a longer period of time. Boring! And for a long term investor, boring is fabulous.

A Dividend Growth fund is usually made up of a mix of larger and smaller companies, who may have more potential for year over year corporate growth than the big guys. This can provide more capital apreciation than you might get from a Large Cap fund, but because of this, can introduce more volatility, and the price swings of the individual stocks in the fund can be greater. They still pay a dividend every three months, just like the big guys. Not as boring, but it’s still not exciting enough to be a conversational topic at your next dinner party.

So why is boring good? We are interested in the main underlying feature of any Dividend fund, The Dividend. Every three months these companies pay out their corporate profits in a quarterly dividend of cash to their shareholders. In this case, the fund, and and fund holders, you and me.

This is the good part –

At the end of each year, the fund manager takes all those dividends they have collected during the year, and pays them out to the unit holders of the fund (you) in the form of more shares (units) of the fund. So now, not only have the basic underlying stocks in the fund increased in value, and thereby the fund itself has gone up (we hope), but you now have extra units of the fund. So next year your fund will get dividends on the original units you owned, but also on the new ones you just recieved. Which will in turn be used to buy you more units next year.

And the shares go up, and cash rolls in, and you get more units…

And so on, and so on…..

 

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