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MONEY
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M A G A Z I N E
Table of Contents
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M A G A Z I N E WI NT ER
A personal view of Financial Planning by Ian R. Whiting ~ pg. 4
Gold, Silver and Common Sense Investing
by Darren V. Long ~ pg. 6
The Canadian Dollar by James Dean ~ pg. 9
Confessions of a CFP: You may need a second mortgage by Tahnya Kristina ~ pg. 10
Family Savings You Don’t Want To Miss
Market Myths
by Guy Conger ~ pg. 20
The Canadian Real Estate Market is Hot Right Now, But How Long Will it last? by Larry Weltman ~ pg. 21
Tax Free Profit Extraction using Life Insurance by Ryan Wall ~ pg. 22
Money Illusion - “A Dollar Today > A Dollar Tomorrow”. by Alan Fustey ~ pg. 24
by Dean Paley ~ pg. 12
Be It Resolved
Good news for interest rates…
by Robert M. Gignac ~ pg. 25
by Guy Ward ~ pg. 13
by Becky Wong ~ pg. 26
Save to invest
How to Tell the Difference Between Investing and Gambling!
Tablets vs. Laptops
When will the economic turnaround be here?
by Heather Phillips ~ pg. 27
by Malvin Spooner ~ pg. 14
by Mark Borkowski ~ pg. 17
The Advantages and Disadvantages of Online Legal Document Preparation Companies by Bert Griffin ~ pg. 18
An Important Aspect of Risk Tolerance: Ensuring that a Client Can Financially Sustain the Risk
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by Gerald Trites ~ pg. 27
5 Retirement Mistakes and How to Avoid Them Tax Policy 2014: The Feds Continue to Squeeze Corporations. by Trevor Parry ~ pg. 28
The ‘Perfect” Canada Pension Plan Client
You Need to Answer These Estate Planning Questions by Ed Olkovich ~ pg. 32
Do Index Funds Always Beat Managed Funds? by Don Shaughnessy ~ pg. 33
How is Canadian credit score calculated? by Art Smith ~ pg. 35
Mindset
by Laurie Lee ~ pg. 37
5 Money Tips to implement for 2014 by Lise Andreana ~ pg. 38
The Value of Time Value of Money Concepts by Camillo Lento ~ pg. 39
Pay Attention to your Pension – A Retirement Strategy for Small Business Owners by Ian Burns ~ pg. 40
A Time for Reflection
Contact: James Dean, Editor & President Kennon S. Vaughan, Artistic Director Ian R. Whiting CD, CFP, CLU, CH.F.C., FLMI(FS), ACS, AIAA, AALU, LSSWB Senior Editor/Writer Enquiries: +1 416 360 0000 james@money.ca Mailing Address: Head Office 7181 Woodbine Ave., Suite 226 Markham, ON L3R 1A3 Regular Features Best Rate Around Mutual Fund Review Media Release The MONEY® Book The Social Currency The Advisors Channel
pg. 8 pg. 34 pg. 16 pg. 43 pg. 45 pg. 47
by Cynthia J. Kett ~ pg. 41
Balance is the Key
by Tammy Johnston ~ pg. 41
Diworsification by David Atwood ~ pg. 44
by Gordon Brock ~ pg. 29
Three Major Meltdowns... Next? by Steve Selengut ~ pg. 31
by Jack Comeau ~ pg. 19
3 - MONEY® Magazine - Winter 2014
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Advertisers Index Mercedes-Benz pg. 2 Back Office Canada pg. 5 GIC Wealth Management pg. 11 Ruth’s Chris pg. 23 Retirement101 pg. 30 Reputation.ca pg. 36 The MONEY® School pg. 42 The Mortgage Centre pg. 46 Penthouses.com pg. 48
FINANCIAL PLANNING MONEY
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A personal view of Financial Planning Written by Ian R. Whiting, Senior Editor
Financial planning is a wonderful tool – but often misunderstood and is now being further confused by the addition of the word “holistic” to the front of the phrase. The word “holistic”, in my opinion, adds nothing but confusion to both the concept and process. I believe it is nothing except a marketing ploy to somehow ennoble the perception that a planner using this word is somehow better than just a plain financial planner. Holistic is generally defined as “being whole”, “dealing with the whole person” – well, that is what I do and have done. The “financial” part is just a bunch of numbers that unless they are tied to some specific life and personal goals, remain nothing but a bunch of meaningless numbers. It is the process – the entire process that is in fact “whole”. Any PROFESSIONAL financial planner already knows this – it is taught and reinforced everywhere – so the mere act of adding this word to the process certainly doesn’t improve the skills of the planner nor does it improve the value or effectiveness of the plan. I don’t pretend to be a “text-book” person, nor will I ever achieve that standing, so for whatever it may be worth, here are the 7 aspects or areas of a complete financial plan. With the exception of the LIFE PLANNING segment which I believe must always be done first and very thoroughly, the sequence of steps is very much controlled by my client. I have my own biases however they are meaningless unless they match those of my client. Life Planning What gets you up in the morning? For what are you striving in life? What excites you about your future plans? How do you see your personal or business legacy? What is important in your life today?
4 - MONEY® Magazine - Winter 2014
Cash Flow Management Sources, reliability and expected duration of current and future income Taxation of current and future income Expenses review and analysis Includes any Education funding requirements Income tax planning – personal, investment and business sources of income Debt Management and Net Worth Enhancement Good Debt versus Bad Debt Analysis of Debt amounts, repayments, interest rates and purpose Restructuring opportunities for enhancing Net Worth growth Net Worth targets Non-retirement financial goals and objectives (education, asset acquisition, travel, etc.) Funding of goals from surplus or designated cash flow Includes all assets other than personal effects and non-realisable collectibles, antiques and jewelry Investment Management Individual Risk Tolerance Profiles Full investment analysis and review including purpose, goals and priority Targeted holdings and transition plans as appropriate
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Tax efficiency and effectiveness Includes business review from investment perspective including eventual disposition plans Risk Management Lifestyle protection Asset protection Cash-flow protection Retirement protection Estate Planning Legacy planning
Expected sources of income, duration, taxation and indexing Lifestyle objectives – 3 stages of retirement – lifetime income requirement Tax efficiency and effectiveness of income Protection of lifetime income from erosion by inflation So if someone approaches you about doing financial planning, you are welcome to use this as a quick “checklist” to test them on their professionalism and thoroughness. I haven’t listed the entire myriad of sub-steps and detailed analysis and review that takes place under each category, but rather just high-level points for your consideration.
Survivor income and bequest planning Tax planning for your estate and legacy Charitable bequests (if applicable) Special needs bequests (if applicable) Retirement Planning
Does everyone benefit from having a financial plan – the answer is a resounding YES. However not everyone is willing to take the time and put in the effort with a professional planner. It is not a simple, easy process. Like most things in life that have value – that are worthwhile – effort and commitment are needed. Every plan is different. I hope this brief summary will help you make a sensible and sound decision regarding your own future!
Current sources of income, duration, taxation and indexing
Total
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Gold, Silver and Common Sense Investing By Darren V. Long Guildhallwealth.com
There are many pieces to the investment puzzle. Some we know, but the most important pieces are unknown to the great majority. All one can do is to continually monitor events and adjust accordingly. The best predictor of the future has always been past monetary cycles. For over 3000 years, the most reliable asset for wealth protection has been physical gold and silver bullion. Mainstream news does not usually present this message hence the bit of humour. None of us want to be sheeple.
generous return on investment despite what appears to be manipulation at times. There is no evidence to suggest that it will be any different in the coming months or years either. Four Fundamentals to Drive Bullion Prices Higher There are four major fundamentals at work that can explain the precious metals markets and in particular silver the best. Each has had an unequivocal impact on pricing thus far in this secular bull market for precious metals and each fundamental can be argued alone or as a group. US Dollar and World Currency Depreciation The first fundamental is US long-term fiat dollar depreciation and fiat currency depreciation all over the world. It is happening folks. The purchasing power of the US dollar, both domestically and abroad has dropped ominously since the last century.
Image Courtesy Of TopYaps Dot Com
Since 2002, there have been at least four major rallies and subsequent peaks in both gold and silver. Throughout that time the markets have still managed to yield an overall 6 - MONEY® Magazine - Winter 2014
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Central banks and the world’s largest institutions of power know it. For this reason gold and silver can act as an insurance policy as they are store of value. Remember the lower the value of the currency the easier the time a country will have paying its debt. In the long term gold and silver increase in value against declining currencies.
One large investor could literally turn the market on its head. (Store this little tidbit and recall it when you have already purchased bullion and you are trying to convince others to do the same.)
Long Term Inflation The second fundamental is a wave of inflation that I expect to hit markets with a vengeance because of the fiat paper being recklessly printed during this unprecedented phase of currency depreciation. (Please see John Williams of www.Shadowstats.com for more on the subject of inflation and the true rate of inflation at street level). Leading up to an inflationary event bullion has historically performed extremely well. Look back at the 1970’s when each precious metal rose dramatically as the fear of inflation also rose. Gold during that decade managed a climb of 2300 percent while Silver fared even better gaining 3200 percent by January of 1980. Geo-Political Instability The third fundamental is a repetitive wave of geo-political instability in the form of regime overthrow, regional instability from economic fallout, poorly diversified countries, and yes even war. I suggest repetitive because this particular fundamental rears its ugly head time and time again. Simply look back to the 1970’s Russia and Afghanistan war and the Iran Hostage situation to name a couple. Today we have Syria, Iran and North Korea as both new and potentially larger threats. In the past several years Geo-Political Instability has expanded to include Geo-Political Positioning and a crisis of confidence. Entire nations and geographical regions have come to identify with assets such as gold and silver, and their central banks change policy to acquire in a net sense as much as they can. This has generally been the case now with many central bank buyers of gold since at least 2009. China has been the brazen in their acquisition of Gold. So too has Russia and India. Look to countries like Iran, Germany, Venezuela and many others for more insight on the topic of central bank buying and the repatriation of gold by countries. Supply and Demand Supply is tight and physical demand is high for both metals. However, in this category silver really shines. Some of the greatest writers in the bullion field have already laid the foundation for understanding how much above ground silver there really is. Look no further than Ted Butler or Eric Sprott. In short silver has been used and abused at very low prices for more than three decades. In the case of Butler, his arguments have been so compelling that he makes a case for there actually being less above ground silver than gold at present time. There were billions of ounces in January of 1980 when silver reached its all-time historical high of $52 per ounce. Fast forward to 2014 and it is said that there is now less than 900 million above ground ounces available not just for the thousands of applications and critical industrial uses but for all of the world’s total demand. At today’s price of approximately $20.00 per ounce, 900 million ounces would be valued at about $18 billion dollars.
Conclusion We are arguably in the worst period of economic experimentation/upheaval we have seen in our lifetimes. Look around and see the unemployed or underemployed, the droves of foreclosed homes and the bankrupt cities like Detroit. Go view how many people are on food stamps in the US and the amount of debt owed by each man, woman and child (Now approaching $55,000 per person in the US and $35,000 in Canada at last check). Participation rates continue to drop for those in the US job force and the number of those on social assistance is increasing rapidly. The sobering conclusion is that things are far from rosy. Since 2008 alone the US has increased its monetary base faster than in any other time in history. There will be more “bail-ins”, more lending, failure and white collar crime to come. It is only a matter of time. Physical bullion gold and silver demand is not only growing in places we already know about but it is also burgeoning faster than ever before in places like India, China, Russia, Brazil and other countries where there is a growing population that is becoming more and more inured to the potential of a long term financial disaster. When you recognize these facts it quickly becomes overwhelmingly apparent that one should run, not walk, to their nearest bullion dealer to add some physical bullion to your portfolio today. Be it for protection or insurance, for gain or simply for speculation, all of these reasons will seem so obvious when the fireworks take gold and silver prices higher than ever before. Yours to the penny, Darren V. Long Darren V. Long is Senior Analyst with Guildhall Wealth Management Inc. Darren is a speaker, writer and financial commentator on gold, silver and the economy. He can be heard weekly on “The Real Money Show” on 640 am radio in Toronto discussing all facets of the precious metals markets. Listen to replays of all shows on iTunes. 1.866.274.9570 www. guildhallwealth.com and www.guildhalldepository.com or email at: investing@guildhallwealth.com
MONEY® Magazine - Winter 2014 - 7
BEST RATE AROUND®
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BEST RATE AROUND® refers to exactly that - the highest interest rates paid, the lowest mortgage rates offered and the best rates, ranking and returns overall on all core financial products, services and investment schemes.”
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Mortgage Rates - Canadian-Mortgage.com 1-Year 2-Year 3-Year 4-Year 5-Year 7-Year 10-Year
GUARANTEEDINVESTMENTCERTIFICATES.CA
The Mortgage Centre The Mortgage Centre The Mortgage Centre The Mortgage Centre The Mortgage Centre The Mortgage Centre The Mortgage Centre
2.89% 2.69% 2.89% 3.39% 3.49% 3.99% 4.49%
Precious Metals Gold
$1,395.04 - CAN PER OZ
Silver $21.76 - CAN PER OZ
Platinum
$1567.54 - OZ CDN
Crude Prices
Prime Rate
Exchange Rates
US $95.72
3%
Canadian $ 1 ------------------> 0.8964 USD www.thecanadiandollar.ca www.theamericandollar.ca
Stock Update
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THE CANADIAN DOLLAR MONEY
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Written by James Dean, Publisher
It’s been a long, cold, lonely winter and Canadian’s were hard hit with some of the biggest and worst ice storms across the nation that alternately paralyzed half the country. The damage is enormous, the cost is in the billions and still we hope, pray and plan for the worst and hope for the best.
And sometimes the rest of us fans should re-think about the competition both here and abroad. How hard is it to be competitive to win locally, nationally, internationally and for your country? How tough can it be to lose at home or abroad?
The Front Cover of Money Magazine is a beautiful reminder of the true North brave and free. The brilliant photographic image captures the essence of a window on any street in any city on one the coldest of days of the New Year and without heat or electricity.
This is the competitive nature of the beast and this is the optimum time for incredible human athletic achievement in the coldest of environments and amidst the toughest of challengers in the strangest of locales. The thrill of winning and the pain and agony of defeat are all on the other side of the coin.
It’s cold but this country works best under pressure, extremely well in low temperatures, negative double digit integers in fact with wind chills that will turn your head around.
Do we really know how hard it is to be an athlete and worse to compete? Against all odds and verse the best in the world in the most frigid of environments.
These darkest of months seem bleak and tragic with almost nothing to do and not much left to look forward to. Now is a good time to break in to song, perhaps a chorus of “A Few of My Favorite Things”.
How much harder is it to beat all of your local friends, competitors and fellow countrymen and women? What are the stakes for the few winners nationally in the wake of many competitors and those who tried they’re best. How hard is it to be an Olympian to work and train hard for months and years for only a moment of ecstasy or a lifetime of disappointment.
We all have something to celebrate, something good to look forward to if not our own wealth, health, success or good fortune; maybe that of others. A Silver Dollar portrays “The Lucky Loonie” a Canadian Mint ‘Special Edition’ coin commemorating the 2014 Winter Olympics.
No gold, silver nor bronze. What happens if you don’t win on the greatest of world stages?
GO TEAM CANADA!
For the average Canadian MONEY creates The these professionally Good Luck – Bon Chance Money Magazine – ‘Special trained, dedicated and Edition’ Top quality full 4 color process publication with *48 loyal bunch of Canucks represent their country to the best of Pages. their ability and no one will doubt they wear their hearts on Government of Canada announces Minimum Wage Hike with higher amount and faster deployment than U.S. MONEY contemplates the move toward CanadianMoney.mobi with Monthly Budget App and Money Magazine Download. Enter Olympics: It’s hard to believe 4 years have melted away and a new Winter Olympic season is upon us in Sochi, Russia. The essence of Canadians and winter sports is to play to win.
their sleeves.
How easy is it to be a fan, a fan of sports, a fan of winter sports, a fan of the Olympics or a fan of the 2014 Winter Sochi Olympics. How easy is it to be a Canadian, a Canadian fanatic, a bandwagon jumper or a loyalist when your entire dominion is getting ready to rumble? On behalf of MONEY, a country, a currency and an entire economy along with a competitive spirit. ‘MAKE THE FINALS’ and if you don’t just say sorry after all you are only human, polite and a Canadian after all. MONEY® Magazine - Winter 2014 - 9
MORTGAGES MONEY
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CONFESSIONS OF A CFP:
You may need a second mortgage Written by Tahnya Kristina, CFP
As a financial planner, clients come to see me for a variety of reasons from investment advice to debt consolidation. On a good day clients bring me a big lump sum of money to invest and on a bad day clients can be in my office with tears in their eyes because they can no longer provide for their families due to the fact that they have accumulated thousands of dollars in debt that they can’t afford to pay. A second mortgage gives you access to cash There are many reasons why people accumulate debt from over spending and poor budgeting to experiencing a job loss or making a bad investment. When clients are experiencing financial difficulties or need a large amount of money they often turn to their home as a way to free up some extra money because their home is most likely their most valuable asset. A second mortgage is a new loan in second position on your property title. In simple terms it means that you will have two mortgage loans on one property. If you can no longer afford to make your monthly mortgage payments, the second lender will be paid in second priority if your home is forced into default and needs to be sold at auction. Second mortgages are offered by credit unions, trust and finance companies but are not regularly offered by the big banks. The first position bank would be (i.e. your original mortgage loan) would be paid first and if there is money left over after your home is sold, your second position lender (i.e. your second mortgage loan) would be paid from the remaining proceeds of the sale. Depending on how much money is leftover from the sale of the home, the second mortgage lender may not be repaid in full. Therefore in exchange for their added risk, companies charge higher interest rates on second mortgages than on first mortgage loans.
10 - MONEY® Magazine - Winter 2014
Consider your options with a second mortgage According to Cait Flanders of RateHub.ca, a mortgage rate comparison website that helps Canadians access the best mortgage rates in the country, second mortgages are most often used as a solution to help clients consolidate high interest debt; but she says that a second mortgage should be a second option for homeowners. “Most of the big banks (initially offer) homeowners a home equity line of credit (HELOC) for debt consolidation.” A HELOC is generally more advantageous than a second mortgage since interest rates are usually lower and the product offers more flexibility, but if your credit is less than ideal a second mortgage may be your only option. Flanders confirms that “someone with a lower credit score may not be approved for a HELOC and could then consider a second mortgage loan.” My best advice to clients considering a second mortgage is to make sure you fully understand the financial implications involved when taking out a second lien on your home because that’s exactly what a second mortgage is. It’s a completely different mortgage contract than the original loan, with a new mortgage term, a new interest rate and a new amortization. A second mortgage loan also means a second monthly mortgage payment. Shop for the best interest rate on your second mortgage How do you find the best interest rate available? By shopping around and comparing rates between companies. Consumers should visit RateHub.ca to find a local mortgage broker in your area who can help compare second mortgage interest rates. Rate comparison websites such as RateHub. ca exist – to provide Canadians with a different perspective on mortgages and also provides some financial calculators so they can make informed decisions. Flanders hopes that with the help of their website “more Canadians will feel comfortable with the decisions they make regarding their mortgages.”
Proud Members of the RDBA GIC Wealth Management Inc. is a member of the Registered Deposit Brokers Association. The RDBA is the professional standards Self-Regulatory Organization (SRO) for the Canadian Deposit Broker Industry. Membership in the organization includes Financial Institutions, Deposit Brokers and their representatives. The organization is a strong supporter of a regulated industry and strives to work closely with federal and provincial governments and other regulators to insure investor safety and compliance with regulatory mandates. With every deposit we make on your behalf, a Client Consent and Information Form issued by the RDBA and signed by the client is required. If you have any questions about the RDBA, or the required form, please contact us.
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“I use GIC Wealth Management Inc.’s services because Brandon listens to my investment needs and offers great advice at every meeting. Brandon has provided a dependable, exceptional service to me and my late husband over the years. I highly recommend using GIC Wealth Management Inc.” – L.L.,Toronto
PERSONAL FINANCE MONEY
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FAMILY SAVINGS
You Don’t Want To Miss Written by Dean Paley
My wife and I had some friends over for dinner recently and the conversation turned to family. Our friends were telling us how well their youngest daughter was doing in gymnastics and the progress their oldest boy was making in hockey. To keep the conversation going, we boasted about our two kids in university. The conversation got me thinking about income taxes (again!) and how many families miss a number of tax saving opportunities. Child Fitness Tax Credit You can claim up to $500 per child of the cost for registration in fitness programs. To qualify, the child must be under 16 years and the program must be eight consecutive weeks (or 5 consecutive days for a day camp), be supervised and require physical activity. Children’s Arts Tax Credit The children’s arts program is another credit that you can claim up to $500 per child of the cost of a program that contributed to artistic or creative skills, has a focus on wilderness or is structured or enriches academic studies. Now might be a good opportunity to search the house for those receipts or contact the provider for the fitness or arts credit receipts. Tuition & Education If you or your spouse attended a post-secondary institution, you may be able to claim the tuition and education amounts. The institution will issue tax slips allowing you to claim these credits. If your child attended a post-secondary institution, they are entitled to claim these credits. However, they may also transfer a portion of the amount to a parent which may be used to offset your own tax bill! 12 - MONEY® Magazine - Winter 2014
Medical Expenses Many of us have access to private health insurance through our employers. But did you know that more and more employers are downloading the direct cost to their employees and scaling back the amount the plan covers? Medical expenses will include those premiums you pay for non-government health insurance and will be reported on your T4 as well as any amounts you pay out-of-pocket. If you travel during the year and purchased travel medical insurance those costs can also be claimed. A couple of strategies that you may use when claiming medical expenses include grouping family expenses together (i.e. spouse and dependent children) and claiming the expense on the lower income spouse. Medical expenses can be claimed for any 12 month period ending in the tax year. This may be helpful when you had high expenses at the end of 2013 and the beginning of 2014 but would not have otherwise have been able to use the credit. Disability Credit The disability tax credit is another credit that is often missed. This credit must be applied for and does require your doctor to complete a form. The credit is generous as it is worth about $1,500 is tax savings. Caregiver Amount The last credit is the family caregiver tax credit. The person must be dependent on you due to mental or physical impairment or be a parent or grandparent born before 1948. Their income must also be below $19,824. As you start receiving those T3s, T4s and T5s, start thinking about some of the above items to see if you might qualify for some additional tax benefits.
INTEREST RATES MONEY
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GOOD NEWS for interest rates… Written by Guy Ward
There’s good news on the interest rate front. In the Bank of Canada’s (BoC) most recent announcement it maintained its prime rate at 1%, however with one slight difference. Since 2012, the BoC’s report has included a tightening bias, warning Canadians that rates would soon rise. That bias was removed from BoC Governor Stephen Poloz’s recent report. Instead he is planning to hold the interest rate at these low levels at least into 2015. The reason? Low inflation and a slow economy. Inflation is sitting just above 1% (the BoC likes it near 2%) and annual economic growth is limping along at 1.6%. Also, softer-than-expected economic growth in the U.S. contributed to the decision. The BoC likely won’t move its rate until the U.S. Fed moves its rate, which is not expected until 2015. Over time, that tightening bias became irrelevant to borrowers who just ignored the warnings and carried on business as usual. That’s when the Minister of Finance Jim Flaherty stepped in and started making changes to the mortgage rules by reducing amortization periods, eliminating insured Home Equity of Lines of credit, changing qualifying ratios, etc. It looks as if we might get some mortgage rule changes again. Since the BoC has not been able to raise rates nor curb spending in the housing market – sales in many markets continue to grow and house prices continue to rise — the only way the Government can control the housing
market is by making changes to the mortgage guidelines. Finance Minister Flaherty recently said he was looking at the housing market and talking to industry insiders but will not interfere just yet. What we have learned over the past five years is that “just yet” certainly means “it may be coming sooner than you think.” If, and that’s a BIG IF, they believe that home prices are continuing to escalate out of control and the housing market is overheating, they may act. But for now, lets’ look at what’s happening. Earlier this year, when it seemed that the end of our low-rate environment was near, bond yields spiked, which led to an increase in fixed rates but over the past few weeks, those yields began to taper off. If yields continue to fall, or even if they stay stable for a period of time, we may see some reductions in fixed rates yet again. This is welcome news for many. Variable rates are near prime-0.50% and the trend is towards bigger discounting. Now that the BoC has said there won’t be an increase until 2015, then variable-rate mortgages will likely become more popular. Over the next few weeks I will be watching the housing market activity in Canada to see if it is indeed tapering and also to watch the impact if fixed interest rates do drop. As always, if you have any mortgage questions and/or concerns, feel free to contact me.
Guy Ward is a Mortgage Broker in Calgary, Alberta with TMG (The Mortgage Group Alberta). WWW.GUYTHEMORTGAGEGUY.COM
MONEY® Magazine - Winter 2014 - 13
MONEY
®
How to Tell the Difference Between
Investing and Gambling! Written by Malvin Spooner
I recently saw a question posted on a popular social network. The question was: ‘What is the difference between gambling and investing?” I’m inspired to reproduce (edited with permission) the following excerpt from A Maverick Investor’s Guidebook (Insomniac Press, 2011) which I believe provides as good an answer as one might find. “How do you develop ‘smart thinking’ and when do you know you’ve got ‘avarice’?” My instinctive response would be: “You always know when you’re being greedy. You just want someone else to say that your greed is okay.” Well, I’ll say it then: greed is okay. The proviso is that you fully understand when greed is motivating your decision and live with the consequences. Avarice is driven by desire, which is not a trait of an investor. Remember, it’s best if investment decisions are rational and stripped of emotion. Greed is associated with elation on the one hand and anger (usually directed at oneself) on the other hand. When decisions are motivated by greed, I call it gambling. In my mind, there are different sorts of gamblers. Some gamblers place modest bets and if they win, they move along to another game. For me this might be roulette. There are 14 - MONEY® Magazine - Winter 2014
those who enjoy playing one game they’re good at, such as blackjack or craps, hoping for a big score. Finally, there are those who are addicts. I can’t help those folks, so let’s assume we’re just discussing the first two types. It’s okay to do a bit of gambling with a modest part of your disposable income. In fact, investors can apply some of what they know and have fun too. Unlike the casinos, financial markets have no limits or games stacked in favour of the house. It’s the Wild West, and if an investor understands herd behaviour, the merits of contrarian thinking and does some research, the results can be quite lucrative. Whether using stocks, bonds, options, hedge funds, domestic mutual funds, foreign equity, debt funds or commodity exchange-traded funds (if you don’t know what these things are and want to know, buy a book that introduces investment theory and the various types of securities), applying investment principles will help you be more successful. To put it plainly: counting cards may not be allowed in a casino, but anything goes when it comes to markets. Just don’t forget that most of the financial industry is trying to
MONEY
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make your money their money. There’s a reason why a cowboy sleeps with his boots on and his gun within reach. The fine line between gambling and investing is hard even for old cowhands to pinpoint. Investing also involves bets, but the bets are calculated. Every decision an investor makes involves a calculated bet—whether it’s to be in the market or not at all, biasing a portfolio in favour of stocks versus bonds, skewing stock selection in favour of one or several industry groups, or picking individual stocks or other types of securities. I met a lady once in line at a convenience store. She bought a handful of lottery tickets, and I asked her, “Aren’t the odds of winning pretty remote for those lotteries?” Her reply was, “The odds are good. There’s a fifty/fifty chance of me winning.” Confused, I asked, “How do you figure?” I laughed aloud when she said, “Either I win or I lose; that’s fifty/fifty, isn’t it?” A maverick investor knows there’s always a probability that any decision to buy or sell or hold can prove to be incorrect. The objective is to minimize that probability as much as is feasible. It’s impossible to make it zero. This is why financial firms have sold so many “guaranteed” funds lately. People love the idea, however impossible, of being allowed to gamble with no chance of losing. Whenever there’s a promise that you won’t lose or some other similar guarantee, my senses fire up a warning flare. There’s usually a promise of significant upside potential and a guarantee that at worst you’ll get all (or a portion) of your original investment back. Many investors a few years ago bought so-called guaranteed funds only to find that the best they ever did receive was the guaranteed amount (extremely disappointing) or much less after the fees were paid to the company offering the product. If you think this stuff is new, trust me, it’s not. A fancy formula-based strategy back in the ‘80s called “portfolio insurance” was popular for a brief period. An estimated $60 billion of institutional money was invested in this form of “dynamic hedging.” It isn’t important to know in detail how the math works. Basically, if a particular asset class (stocks, bonds or short-term securities) goes up, then you could “afford” to take more risk because
you are richer on paper anyway, so the program would then buy more of a good thing. If this better-performing asset class suddenly stopped performing, you simply sold it quickly to lock in your profits. The problem was that all these programs wanted to sell stocks on the same day, and when everyone decides they want to sell and there are no buyers, you get a stalemate. The “insurance” might have worked if you actually could sell the securities just because you wanted to, but if you can’t sell you suffer along with everyone else. The notional guarantee isn’t worth the paper on which it’s printed. Remember these are markets, and even though you see a price in the newspaper or your computer screen for a stock, there’s no trade unless someone will step up to buy stock from you. The market crash that began on Black Monday— October 19, 1987—was, in my opinion, fueled by portfolio insurance programs. The market was going down, so the programs began selling stocks all at once. There weren’t nearly enough buyers to trade with. By the end of October ’87, stock markets in Hong Kong had fallen 45.5%, and others had fallen as follows: Australia 41.8%, Spain 31%, the U.K. 26.4%, the U.S. 22.7%, and Canada 22.5%. Minimizing the Probability of Stupidity If you’re gambling, follow the same steps you would as if you were investing. If it’s a particular stock you are anxious to own, do some homework, or at least look at someone else’s research available through your broker or on the Internet. When I was a younger portfolio manager, there were limited means to learn about a company. I would have to call the company and ask for a hard-copy annual report to be sent to me. When it arrived after several days, I’d study it a bit so I didn’t sound too ignorant, then I’d call and try to get an executive (controller, VP finance, or investor relations manager) to talk to me. If asking questions didn’t satisfy my need to know, then I’d ask to come and meet with them in the flesh. Nowadays, you have all the information you need at your fingertips. Money.ca is a PRIME example of just one such source of valuable information available to investors today! MONEY® Magazine - Winter 2014 - 15
MEDIA RELEASE
MONEY®
M A G A Z I N E
For Immediate Release
Guildhall Diamonds Attracts Discerning Investors with Expanded Website www.guildhalldiamonds.com Toronto, Ontario – February 4, 2014 - Guildhall Diamonds Inc. has launched their new website guildhalldiamonds.com showcasing the high quality of their natural fancy color diamonds for collectors and investors. Nicole Snitman, Vice-President and GIA D.G., A.J.P., Guildhall Diamond Grading Expert was instrumental in ensuring the website has a greater focus on education for the new buyer. “Appreciation for the quality of these color diamonds is important, as it is the quality that allows investors to realize returns on their purchase.” says Snitman. The website now features expanded information and analysis of the fundamentals of color diamond investing, focusing on how to select an investment-grade color diamond and case studies. A very important factor is the brand new high-end original photography that has been added, enabling visitors to visually appreciate the beauty of each diamond available on the site before purchasing.
“A Guildhall Colored Diamond must meet a strict set of criteria before it is even considered for acquisition. Our unwavering pursuit of excellence means every diamond must be of the absolute highest quality available, and above all else possess unmistakable allure.” says Paul Wiseman, President of Guildhall Diamonds Inc. Guildhall Diamonds Inc. offers premium investment-grade natural fancy color diamonds for collectors and new buyers looking for an alternative asset class. Each diamond is of the finest color, cut, and clarity grade. The collection features a wide variety of Yellow, Pink and Blue-Green diamonds. All diamonds have been independently appraised and the pricing and GIA Grading Reports are available online with each diamond.
About Guildhall Diamonds Inc. Guildhall Diamonds Inc. specializes in catering to the needs of both the diamond investor as well as the discerning individual looking for the unique beauty of color diamonds. With access to unparalleled resources and expertise, Guildhall Diamonds is a trusted partner to global investors and collectors. Guildhall Diamonds source and supply exclusive and beautiful investment-grade natural fancy color diamonds available worldwide. Customers, collectors and enthusiasts may purchase diamonds loose or have them set in original jewelry pieces known as “Wealth To Wear©”. For more information please visit: www.guildhalldiamonds.com
Media Contact: Robert Para, VP Marketing – Guildhall Wealth Management Inc. Tel: 905-305-8422 || Email: robertp@guildhalldiamonds.com
www.MediaRelease.ca
MONEY
®
WHEN WILL THE
“ECONOMIC TURNAROUND”
BE HERE?
? Written by Mark Borkowski
A great deal has been written on the status of the economic turnaround in the US and Canada. Many more skilled and prominent economic analysts than I ever could be are foreseeing the sky falling. Falling it may not – yet, but the prospect of a sudden rift to our North American economy and also that of the world now seems to me to be a real one. Who are these people and what are they saying? In his book, The End of the Line, Andrew Leonard believes that globalisation has made the United States and Canada too dependent on foreign companies – dangerously so – and sees “imminent disaster looming.” While he pronounces his opinions on China’s involvement and the mess created by former President Bill Clinton, the real value of his book lies in his coherent and fascinating explanation of how the “flexibility and interconnectedness” that are “fundamental building blocks of the global economy” are instead producing rigidness and vulnerability that forms the actual “Achilles’ heel” that will finally bring down the current economical apparatus. Interestingly, there are a wide variety of supporting opinions ranging from the BBC to Internet news blogs. One details the five major reasons why the economy will crash again and stay crashed and not recover for decades! Those five reasons are the weak U.S. dollar, the coming commercial real-estate bubble and the lingering and the continuing of the U.S. housing bubble, terrorism, long term prospects for accessible cheaper and available sources of energy and the so-called generational problem that has a disproportionate old population increasingly being supported by a shrinking younger, shrinking working population. These all result in “decades of high inflation, high taxes and high political turmoil.” Credit is still very difficult to obtain for even stable and profitable companies.
But, what scares me were the confessions of a renowned former member of the international banking community who once wrote an eye-opening book called Confessions of an Economic Hit Man. John Perkins advances a U.S.-led international conspiracy by claiming that through his job as chief economist of Boston’s Chas. T. Main, he helped to engineer multi-billion dollar loans to third world countries like an Indonesia or an Ecuador. These deals were designed to benefit a few large U.S. companies like a Halliburton or a Bechtel, to build that country’s infrastructure that would tend to benefit only a few of that nation’s very wealthiest families. At the same, the financial cost saddled the borrowing nations
with “amazing debt that the country couldn’t possibly repay.” He claims that the U.S. government is still pursuing this same philosophy. Since our last crash of two years ago, not a single piece of legislation has been passed to change Financial Regulation in the US. To more fully understand the dire results when the markets crash, Maury Klein, professor history at the University of Rhode Island, notes that the combined collapses of the stock market and economy of 1929-1932 fed on each other and turned American citizens’ “first feverish love affair with the stock market into a lasting aversion” that only eased when trading volumes reached 1929 levels again in 1952. She contends that crash destroyed a promising Herbert Hoover Presidency and facilitated the fall from power of the Republican Party, which became the minority party for the first time since the 1850’s and did not regain the White House until 1952. The crash also encouraged a monetary policy that may have been the single most important factor in prolonging the depression, says Ms. Klein. As government continued to make war on inflation, its traditional enemy, Ms. Klein asserts that deflation had emerged as the biggest threat. Banks failed. Jobs disappeared. Companies closed. Overseas, this collapse led to the coming to power in Germany of Adolf Hitler as well as other extremists. President Franklin D. Roosevelt’s presidency’s imposing legacy was the rise of big government – which still dominates today – and far-reaching federal intervention in the national economy. This intervention led to the creation of original federal social programs and federal regulation of Wall Street institutions. Does this all sound familiar today? With the world’s poor nations clamoring for structural reforms, both Canadian and U.S. jobs being transferred to third world countries, increased government interventions in social policies and programs and with more street violence involving youth, can we safely say that we are comfortable living in our economic “glass houses”? Should we anticipate another massive transfer of wealth in the next year or two? Mark Borkowski is president of Toronto based Mercantile Mergers & Acquisitions Corp. Mercantile is a mid-market M&A brokerage firm. Contact Mark in confidence at www. mercantilemergersacquisitions.com.
MONEY® Magazine - Winter 2014 - 17
BUSINESS MONEY
®
The Advantages and Disadvantages of
Online Legal Document Preparation Companies Written by Bert Griffin As a financial planner, I regularly advise my clients on a range of financial planning matters from retirement planning to investment planning to tax and estate planning. In order to create a truly solid financial footing, I urge my clients to consider and discuss every one of these financial topics. However, for the purpose of this article, I would like to speak to the latter on the list – namely, estate planning.
important question: should we recommend that our clients use these online companies as a way to create and execute their legal documents?
You may already know what estate planning is, but, for the purposes of clarity, I’ll provide a basic definition. I believe that estate planning is the development of “… a plan for the efficient handling of [one’s] estate in the event of death”. And as an added note, typically this plan involves the execution of estate documents, such as Living Wills, Enduring Powers of Attorney, Trusts and arguably the most common estate document, the Last Will & Testament.
First, it has to be said that the biggest advantage to using an online source to prepare a legal document has to be the cost to the customer. Having a document prepared by an online business comes at a fraction of the cost as compared to having an attorney prepare a document. And if a client is looking to have several estate planning documents prepared at once, the savings online companies offer can be truly significant. Besides savings, these online businesses also offer convenience. Let’s face it – most people would rather be doing something else other than creating and drafting legal documents. So, the convenience of being able to create an estate document from the comfort of one’s home really goes a long way to motivating people to actually have their estate documents drafted and executed.
When I discuss this topic with clients, I’ve noticed in recent years that an increasing number will respond by asking my opinion of online legal document preparation companies and whether or not I recommend their use. If you are unfamiliar with the concept of online document preparation companies, in the past ten years or so – or essentially since the inception of the digital marketplace – online businesses have sprung up that fill the need of providing legal documents to consumers through a website. Essentially what happens is when a customer wants to have a legal document prepared, say for example a living will, rather than going to a lawyer, they will go to the website of an online legal document preparation company. The customer then enters their personal information in addition to any legal information particular to the document they want prepared (say, for example, if the customer would like to have a living well prepared, they will enter in whether they want to have life support or not). Once the customer has provided all needed information, the online company then prepares the personalised forms and mails it to the customer for his or her signing and proper execution. So, what to make of these online document companies? Well, foremost, I can confidently predict that with the everincreasing influence of the digital marketplace, the influence of these online companies in the legal world will only grow. But, that still leaves financial planners, like me, with a very 18 - MONEY® Magazine - Winter 2014
Well, at the risk of sounding on the fence, rather than answering this question with a yes or no, I’d like to highlight a few of the positive aspects of these companies, as well as some of their drawbacks.
But, not everything comes down to savings and customer convenience. After all, having a legal document prepared conveniently won’t matter much if the document turns out to be legally invalid. So, as a counterpoint, I think it’s important to mention that when working with online document preparation companies, the legal accuracy and quality of their documents must be carefully considered. Background research on whichever online firm is chosen is very important. And if the research reveals that the company has a track record of providing legally invalid documents or documents that have not been updated to reflect the most current provincial or national laws, then this may be a serious red flag. In the end, I would recommend that prior to deciding to do business with an online legal document company research should be done on their track record; and for those individuals who have particularly complex estates or complex legal matters relating to their estates, it may be best to stick with a good old, traditional attorney.
RISK TOLERANCE MONEY
®
An Important Aspect of Risk Tolerance:
Ensuring that a Client Can Financially Sustain the Risk Written by Jack Comeau
As a financial advisor, I’ve been working for over twenty years in helping my clients build and preserve their wealth. In my career, I’ve seen the financial market enjoy its highs and suffer its lows. I’ve seen both bull and bear markets and I’ve seen the financial sector absorb and withstand one of its largest downturns – namely, the financial meltdown of 2008 and the recession that’s followed it. Having experienced and worked in all these varying financial climates, I’d like to think that I’ve gained a strong understanding in how to advise clients in a way that best suits their financial well-being. More specifically, I’d like to think that my experience as an advisor has enabled me to be even more adroit in accurately discerning my client’s willingness to take on financial risk. Those of us who work in the financial and investment sector, and undoubtedly plenty of people outside the industry, know that financial risk is at the heart of making an investment. Simply put, regardless of what type of financial investment one is making or what type of economic environment the investment is being made in, an investment can never lead to a financial gain without the assumption of a certain amount of risk. The concept stands fundamentally at what it means to “invest” one’s assets. Of course, it’s our duty as financial advisors to have a full understanding of the risks associated with each type of investment on which we advise. More to the point of this article, in advising a client and helping build their financial portfolio its part of a financial advisor’s duty to understand how much risk that client is willing to take on, or, to use industry language, it’s critical to understand that client’s “risk tolerance”. The capacity for an advisor to determine a client’s risk tolerance is indeed so crucial that I would argue that whether or not the advisor is skilled in this ability largely determines whether that financial advisor is good or not. For this reason, I thought it would be worthwhile to discuss
the subject of a client’s risk tolerance more extensively. Specifically, one aspect of it that I feel sometimes gets overlooked – namely, the client’s financial ability to withstand a risk, if indeed market environments turn negative and that risk turns into a reality. In my years as a financial advisor, I’ve come to find that there’s a large and common difference between perceived risks versus risk capacity. When I approach a client with a new investment idea and I explain to them the risks associated with it, it’s common for the client to absorb what I’m telling them through the admittedly narrow framework of their own financial goals and their own portfolio. This is the client’s perceived risk and I’ve found that in many ways this can be dangerous and can lead to a myopic point of view on the part of the client. Obviously, if a client understands an investment only from the perspective of how it will affect them and doesn’t understand, more broadly, how the investment interacts with the greater financial world, this is not a good thing. It’s for this reason that I take pains to explain to the client two additional elements of any investment: one, the greater or required risk associated with the investment and, second, the client’s real financial ability to withstand the risk if the market happens to face a downturn. Of course, there’s always the danger of information overload. Most clients do not work on a daily basis with investments and finances and may not be very well-versed in all the terms of the industry. So in describing an investment, it’s important not to overwhelm clients with too much technical detail. However, that is no excuse for not providing clients with enough information so they can understand the required risk that goes along with an investment, as well as how it relates to their risk capacity. That’s a fundamental part of being an honest and fair advisor. MONEY® Magazine - Winter 2014 - 19
MONEY
®
MARKET
MYTHS
Written by Guy Conger
There are three common Market Myths many would-be investors bring up to explain their inability to invest. Market Myth #1: Buy and Hold doesn’t work. Market trackers love to say “buy and hold” doesn’t work in volatile markets. Traditionally, you would hear this from brokerage firms that needed their clients to trade in and out of positions in order to make their nut in commissions. But even in today’s world of low-cost brokerage accounts, there are still plenty of experts telling investors that long-term investing is a stupid move. Now, I agree that a buy-andhold approach isn’t ideal for some investors however, the idea that you can’t make very good money by sticking with big companies and holding them for years on end is patently false. For example, take a look at Merck, a firm that is often cited as “dead money” by so called experts. I recommended this giant drug company for my own clients back in January of 2011. Through yesterday, the shares have handed us an open total return of 46.7% … or roughly 17% A YEAR. If only all our money could be that dead! Or how about Pfizer, another big, boring drug company that I recommended for my clients exactly three years ago. Including all dividend payments, Pfizer has handed us a realworld return of 91.1% so far … or about 30% annually for three years straight. I could cite plenty of other examples, but my point is that you can make LOTS of money by simply buying solid stocks at fair prices and then doing nothing more for years at a time. Of course, a lot of folks will say that’s impossible now that the market has run up so much … Market Myth #2: Buying stocks right now is a sucker’s move. The chorus of stock market naysayers grows with every new all-time high in the S&P 500. And to be sure, we are no longer seeing a huge smörgåsbord of undervalued companies. At the same time, you CAN still find good bargains. In fact, I just alerted my clients to a brand-new opportunity in an oil and gas driller … one that I will be adding to my own portfolio tomorrow. What you have to remember is that generalizations like 20 - MONEY® Magazine - Winter 2014
“stocks are now overvalued” don’t tell the full story. There are many thousands of individual companies trading out there — each of which needs to be evaluated on a case-by-case basis. Just because the market is sitting at some particular P/E ratio doesn’t mean there isn’t a small tech firm experiencing tremendous growth or a large retailer being unfairly punished because of its latest earnings report. My point is that there are many valid approaches to the stock market — from buying and holding to aggressively trading a handful of companies you know very well. The key is determining your goals right up front and then sticking with the plan you’ve made. Which brings me to one last major market myth … Market Myth #3: You can’t make money if stocks aren’t moving up. Nothing could be further from the truth. As I’ve already explained a million times, you can easily collect solid dividend cheques month in and month out no matter what the underlying stock is doing (or not doing). In addition, the market is always moving at least a little bit every day. Plus, there are two more ways to make money from stocks during sideways — or even down — markets: 1. for starters, you can sell options to generate additional income from stocks you already own or even on stocks you’d LIKE to own. This is exactly what I’ve been helping my clients do for years. The end result so far? I’m tracking 26 straight profits and not one booked loss. That’s right. Just by using options very conservatively, I figure my clients have already had the chance to collect as much as $3,630 in additional income out of the stock market in less than six months! 2. meanwhile, you can also aim to profit as individual stocks — or the broad market — falls. And you can do this by buying put options … short selling … or simply using inverse ETFs. So the bottom line is that there are countless ways to make money from the stock market, especially if you choose to employ a combination of the ideas I touched on in today’s article.
MONEY
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The Canadian Real Estate Market is
Hot Right Now... But How Long Will it Last? Written by Larry Weltman I work as a representative at AccessEasyFunds or AEF for short, which is a business that provides advances to Canadian real estate agents on the commissions they earn. I’ve been with the company since its inception and as a result I have had the good fortune over the years of being able to watch the trends that pass through the real estate market. If you’ve been keeping up with real estate news recently, you may have noticed the growing chatter in many media channels about the Canadian real estate market and, specifically, about the rising prices across the country. Perhaps adding fuel to the fire, the Canadian Real Estate Association announced another surging home sale month for October - up 8% from October 2012. Indeed, with this rise in home sales and, more importantly, with the increase of real estate values now outstripping affordability for the average Canadian, many analysts are predicting that the market is reaching a tipping point and that we are in the middle of watching a real estate bubble form. The media repeats the doom and gloom predictions; and the Government has done its best to control surging real estate prices by implementing new mortgage restrictions in the past two years. No one wants a big meltdown like we witnessed in the US and parts of Europe! The murmurs of an impending real estate bubble in the media were indeed loud enough for the Governor of the Bank of Canada to try to assuage the increasingly anxious market by publicly stating on November 20th that, unless the global economy is hit by another financial meltdown similar to the one circa 2008, Canadians should neither be concerned about the possibility of a real estate bubble nor should they be concerned about the likelihood of some sudden correction in real estate prices. Of course, the hope is that the Governor is not only accurate in his positive assessment, but also that his attempt to appease nervous skeptics succeeds. After all, we all know that in many respects, economic bubbles tend to be selffulfilling phenomena. We all witnessed increasing prices for almost a 10-year period; with one small dip in the fall of 2008 with the world market crashes. That dip seemed to only last about 6 months, with prices in sales surging again in the spring of 2009. Personally, I’m also cautious about starting in on the drum beat of doom and gloom when it comes to the current real estate environment. Looking five, ten years out, I’m optimistically hopeful that rather than the market blowing out in a quick devaluation, it will gradually level off and eventually reach a point of increasing affordability as perhaps the economy starts to rebound and create more employment and better-paying jobs.
With that said, there is one trend in the current economic sector that is more than mildly dampening my cautious optimism, and that’s the trend of Canadians taking on an ever increasing amount of debt. As point of illustration, in an article dated November 13th, 2013, The Globe and Mail cited that “… the average Canadian consumer’s total debt in the third quarter rose $225 to $27,355, or 0.83 per cent, from the previous quarter”. The willingness of Canadians to assume a greater amount of debt is cause of alarm in and of itself. It’s also cause for concern when considering the future outlook of the real estate market. Simply put, if the current trend of increasing personal debt continues its upward momentum, Canadians on average will find it far more difficult to afford mortgages in the coming the years; especially if mortgage rates rise. So key to a price leveling off market without a crash is that mortgage rates remain in the low. Of course we must look at the affects of immigration and foreign investment in Canadian property. Canada remains very appealing from an immigration perspective and many foreigners view Canada as stable and secure from a property investment perspective. So I feel this all bodes well. I’d also like to point out that there could be some sort of coupling affect with the growing amount of student loan debt that our younger generation is acquiring. As mentioned in a recent Financial Post article, across the board, Canadian tuition fees are increasing faster than the rate of inflation. Furthermore, the same article mentions that “… 60% of undergraduate students go into the working world with an average debt of $27,000, and that is likely larger if private debt is included.” Unlike our American neighbors, high student tuition, along with high student debt, is relatively new and unprecedented in this country. The question is – how will this affect the younger generation’s ability to afford homes that are increasing in value at an ever quicker pace? Although, once again, I don’t want to pound the drumbeat of doom and gloom, these two trends – higher home prices matched with higher consumer and student debt – are fundamentally opposed to each other and if the two continue in their same respective trajectories, it could lead to a far different Canadian real estate environment in the future. Disclaimer This article strictly reflects my opinion, thoughts and perception of the real estate market. I strongly recommend that anyone consults with an experienced professional before making a decision to sell or buy a property or to hold onto a property; and should not rely on this article. Moreover I assume no responsibility whatsoever for any decisions made by any reader of this article. MONEY® Magazine - Winter 2014 - 21
INSURANCE MONEY
ÂŽ
Tax Free Profit Extraction Using Life Insurance Written by Ryan Wall
A tax avoidance strategy has been growing in popularity in recent years. Although CRA has been aware of the strategy for over ten years, its increase in popularity and the Federal government’s current focus on reforming the taxation of insurance means that the life of the strategy may be coming to an end.
minimized, making corporate ownership an attractive option.
There are several good reasons for life insurance to be owned corporately rather than personally. A business owner is typically a key person of the business, and any buy-sell agreements or business interruption applications may require that the policy be owned corporately. Corporate ownership also allows for the payment of premiums with corporate dollars, which for small businesses generally have a lower tax rate than if the policy is owned personally.
The sale of a policy from personal ownership to corporate ownership introduces a little used, until recently, tax savings opportunity. In exchange for the policy the corporation pays the individual the fair market value of the policy. The gain reportable to the individual is based on the cash surrender value of the policy rather than the fair market value, the two of which may differ substantially.
There are of course also downsides. The loss of creditor protection, a potential impact to the capital gains exemption, additional complexity and accounting requirements, and the potential taxation of the death benefit are among the impacts to consider. Properly planned, these issues can be 22 - MONEYÂŽ Magazine - Winter 2014
The corporately owned policy can be a newly issued policy, or could be a personally owned policy that is sold to the corporation. The latter may be the only option if health concerns make it costly, or even impossible, to obtain a new policy.
In many cases the taxable gain to the individual is zero, effectively resulting in a tax free disbursal of earnings from the corporation. Overview of the transfer A shareholder transferring a policy to his or her corporation
MONEY
®
is making a non-arm’s length transfer and therefore subject to Section 148(7) of the Income Tax Act. In exchange for the policy the company pays the shareholder the fair market value of the policy. The tax consequences consist of four parts: Deemed Disposition – The shareholder who owns the policy is deemed to have disposed of the policy for the cash surrender value (CSV). The taxable income to the shareholder will be the CSV minus the Adjusted Cost Basis (ACB). New Adjusted Cost Basis – Section 148(7) also deems the new ACB after the transfer to be equal to the CSV. The corporation has acquired an interest in the policy at the new ACB. Payment for the fair market value – The corporation pays or provides a note to the shareholder for the fair market value of the insurance policy. There is no tax to the shareholder and the company has a reduction in retained earnings. Payment of the Death Benefit – Upon the death of the life insured, the death benefit is paid into the Capital Dividend Account (CDA) to the extent that the benefit exceeds the ACB. The ACB will typically have enough time to decrease to $0, so the entire death benefit is paid into the CDA, which can then be distributed tax free. Best Policies to Value An actuary specializing in fair market valuation can provide
advice on the potential value of a policy. The best policies to transfer will result in little or no taxable income upon disposition, and have fair market value that is greater than the cash value. There are several factors which contribute to a policy having a fair market value that is greater than the cash surrender value. Deterioration in health – Any health problems that reduce life expectancy will increase the value of a life insurance policy. Policies with guaranteed costs – Policies with guaranteed level premiums build up value over time, as the initial premiums exceed the cost of insurance in order to keep the premiums lower at higher ages when the cost of insurance exceeds the premiums. The reduction in interest rates has further increased the value of such policies, as they premiums were set assuming higher interest rates, and the premiums are guaranteed. Examples of these policies are Universal Life with level cost of insurance, term to 100, and whole life non-participating policies. Government Position Although the CRA has stated that they agree with the tax treatment described above, they also feel it is an anomaly and referred the matter to the department of Finance. This position has been confirmed several times in the past ten years. While Finance has yet to take any action, the issue does now appear to be on their radar. The next budget may very well put an end to this opportunity.
If it doesn’t sizzle SEND IT BACK.
Prime corn-fed beef, broiled to perfection at 1800 degrees and served sizzling.
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23 - MONEY® Magazine - Winter 2014
MONEY
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MONEY ILLUSION: “A Dollar Today – A Dollar Tomorrow”. Written by Alan Fustey Money illusion refers to the tendency of individual investors to think of investment returns only in terms of nominal value. The term was coined by the economist John Maynard Keynes in his early writings. Nominal value only uses current market value without taking into account the past and future effects that inflation has on purchasing power. The alternative is to use real value, which is the value after accounting for the effects of inflation.
believe that the 4% quoted interest rate has to be more attractive because it appears to be greater.
Imagine you purchase a bond for $100 that pays an annual 5% rate of interest (we wish!). You begin the year with $100 and will finish the year with $105. However, the $5 you receive is the nominal interest rate and does not account for the effects of inflation. Whenever interest rates are quoted, they refer to the nominal rate of interest, unless it is stated otherwise. If the inflation rate was 3% for that year, then a $100 item that you could purchase at the beginning of the year would cost $103 by the end of the year. If you take into account the effects of inflation, then the $100 bond has earned a real return of only 2%.
One accepted proxy for the rate of inflation in Canada is shown by the monthly price change in the consumer price index (CPI) even though the CPI is NOT exactly equal to inflation. This index calculates changes in the cost of a fixed basket of consumer items that includes food, shelter, furniture, clothing, transportation and recreation.
Money illusion can influence your perception of which outcome is most beneficial to select. You will tend to choose a 4% nominal investment return in an environment of 2% inflation, over a 2% real investment return, even though the real returns of the two alternatives are equivalent. You 24 - MONEY® Magazine - Winter 2014
A dollar today is worth more than a dollar tomorrow and they are both worth much more than the value of a dollar in forty years. Inflation erodes the future purchasing power of your investments. This erosion is deceiving to most investors because it occurs slowly and compounds over time.
In the forty year period from 1970 to 2010 the average annual inflation rate was 4.45%. A $100 investment in 1970 had to increase to $570 by 2010 just to maintain the same real value. You need to overcome the effects of money illusion in order to understand how inflation affects the real purchasing power of your investments over long time horizons. Bank of Canada http://www.bankofcanada.ca/en/rates/ inflation_calc.html
MONEY
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BE IT RESOLVED Written by Robert M. Gignac
Date: January 1, 2014 Time: 9:37 a.m. (well, it was a late night after all…) Ok, now what? As the clock ticked over to start 2014 we are once again on the verge a new period – a new year. I’d like to drag your thoughts back to January 1, 2013 for a moment, if I may. I suspect many of us started last year off with a laundry list of resolutions about things we were going to: a) do more of, or b) do less of. Many of us refer to them as our “New Year’s Resolutions” but I am always surprised when we do not refer to them as our “New Year’s Goals”. I suspect I know why. With resolutions, when we do not achieve them, we have simply “broken” our resolutions. If we call them goals and we do not achieve them, then we have “failed”. It is easier to tell ourselves “it was just a resolution, no big deal”. Since “resolutions” do not carry the emotional baggage of “goals”, it is easier to live with ourselves when we don’t accomplish them. That said, how did you do for 2013? Crossed some off your list? Worked on others? Added some new ones? Tossed your list in the recycle bin so it can’t torment you anymore? A new year is a special time – a clean 12 month slate to plan our future. While resolutions tend to focus only on the year at hand, what I am suggesting for the start of 2014 is that we develop a series of short-, mid- and long-term goals and by writing them down, we’ve already taken the first step toward accomplishing them. Many people fear that once they write a goal down they are stuck with it, as if they had chiseled it into stone. Somehow it eludes us that goals are flexible and can change with the passage of time or with the completion of other goals on the list. Sometimes we change them; sometimes life changes them for us. I know what you’re thinking. Short-term? Mid-term? Longterm? Schmong-term? Why all these terms? Can’t you just have some goals and leave it at that? The goal (sorry, bad pun…) is to make the process manageable and easier on which to focus. Short-term goals are the present, perhaps a 3-12 month window. Mid-term goals move your horizon out a little further, focusing on a 2-5 year time-frame. Finally, your long-term goals can go out as far as 10, 15 even 20 years or more. It’s ok to dream a little bit at this level, so be creative. The pictures will become
clearer as the process starts and as our time frame changes. Remember, there are no limitations on setting goals at any stage in your life. The process is a flow; the first step is to set goals. Second, we pursue them, doing whatever activities need to be done to accomplish them. Then at some predefined point – perhaps the first day of every month or quarterly – we review what we have accomplished and map it against our goals. What did we learn? How are we doing? Once we know where we are, we can cross off the accomplished or make adjustments if required. We then generate new goals to replace the completed goals and the cycle continues. Why don’t more people do this? My personal belief is that people don’t understand that there is no such thing as a right or wrong goal. The fear of failure keeps us from writing them down. Resolutions, after all, are things we verbally tell our friends. When it comes to goals, if we write them down, we share them and then don’t attain them, somehow we have failed. It’s not a failure to attempt to do something and not achieve it. The failure comes in not making the attempt in the first place. Just because you create goals on paper doesn’t mean you’ll accomplish them all. Don’t kid yourself – it does take work. Far too many people associate the word ‘work’ with the word ‘hard’ and, to be frank, that might just be what stops people from beginning the process! We have a brand new year ahead of us – and when we look back at it ten years from now a decade will have passed by, regardless of our decision to set goals and to navigate a path of our own design. As the clock rolls over on December 31st my goal is to clink a glass and say “Be it resolved that this is the start of another great year!” I wish the same for all of you.’ Robert Gignac is the owner of “Rich is a State of Mind” providing keynote presentations, client seminars and workshops on personal financial development and motivation. He is the author of the Canadian best seller “Rich is a State of Mind” and the author of the US edition of the same title. Sample chapter and reviews at: www. richisastateofmind.com. To book Robert to speak at your next corporate or organization event, please contact him at: robert@richisastateofmind.com Copyright 2013 – Rich is a State of Mind MONEY® Magazine - Winter 2014 - 25
INVESTMENTS MONEY
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Save to Invest Written by Becky Wong, CFP
A popular exercise at this time of year is the infamous New Year’s Resolution. What will be yours? We’ve heard it from dozens of pundits. Financial gurus constantly preach to us on its merits. Even our parents lectured us on it. We’ve all heard it before, but how many of us actually do it? Saving 10% or 15% of your gross annual income is called “paying yourself first.” A part of all that you earn is yours to keep. As such, cut a cheque for yourself at a minimum of 10% from each pay cheque that you earn before doing anything else with it. If you wait until all of your other expenses are paid (i.e.: groceries, entertainment, travel, etc.) the likelihood of having anything left to save at the end of the month is slim to none at all. I recall reading an article in the Financial Post in early 2010 titled “How to profit from China’s transition.” It had struck a chord with me when I read a sentence in the article as follow “… the Chinese tend to save much more of their income than people in Western countries because they have less of a social safety net.” Given how little we save in Canada, an industrial nation with a highly developed science and technology sector, even in light of the credit crisis lessons of 2008, there is perhaps some truth to that statement. Personal savings rates did rise sharply in 2009, especially in the U.S. and U.K. The fear was heightened with the real estate correction in combination with the fall in the equity markets. Everyone feared that more losses were to come and thus tightened their spending. This resulted in increased savings to 4.8% in 2009 versus an average rate of 3.7% in 2008. (BMO Capital Markets Economics). According to Statistics Canada’s reported 2013 third quarter report, our household savings rate is close to a 16 year high at 5.4%. Though less than ideal, it is a positive trend in the right direction as shown here: 2005 Q1 0.9 % 2008 average 3.7 % 2009 average 4.8 % 2013 Q3 5.4 % China’s savings rate in 2006 was 50%, and was anticipated to be a bit less today as people are getting accustomed to 26 - MONEY® Magazine - Winter 2014
a higher standard of living. However, according to a recent study done by the People’s Bank of China, household savings rate in China continues to stand at 50% versus the global average of 20%. Why is there such a spread between Canada’s 5.4% versus China’s 50% savings rate? Could the reason really be due to the fact there is an under-developed social security system in China? Therefore, these folks must save for retirement, healthcare and education. In Canada, however, could it be our belief that our social network, which includes our Old Age Security (OAS) and associated benefits (Guaranteed Income Supplement and Allowance) will take care of our retirement needs if we fail to do so ourselves? At age 65 and/or age 67 given the recent changes to the OAS qualification, assuming residency requirements are satisfied in Canada, we will qualify for $551.54 full OAS each month indexed quarterly starting January 2014. The GIS cheque offers $495.89 per month (assuming a married couple both receiving full OAS). And if eligible, an Allowance cheque for $1,047.43 per month is also available to those between ages 60-65. Aside from the government transfers, there are a number of other publicly funded services and social programs that benefit those with low-incomes like Medicare, public education for grade school, subsidized post-secondary education and subsidized housing. Do Canadians need to save 50%? No, nor is this is not necessarily good for the overall economy. It is important to spend in order to spur growth in one’s economy. Let’s just use the international savings rate of 20% — this still is nearly four times higher than Canada’s 5.4%. This is an indicator that we simply enjoy spending money rather than saving money. Let’s make one of our 2014 New Year resolutions to increase our savings by just 5%. Once you make a commitment to take this important step, you can then move on to the next step of investing. Yes, there is a difference — saving is concentrating on the amount saved and investing is maximizing the rate of return. The two are not mutually exclusive. Financial security is achieved by optimizing both.
MONEY
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Tablets vs. Laptops Written by Gerald Trites, FCA, CPA Tablets, smart-phones and other highly mobile devices have become a standard part of the technological landscape. And such devices have been creating a good deal of change and hype. The concept of BYOD (Bring Your Own Device) has been causing organizations around the world to develop and adopt new strategies that work in integrating mobile devices of various kinds into their IT systems. Given the variety of devices, this is not an easy task. One of the major aspects of BYOD is security. Many of the devices do not have sufficient security features to meet the demands of most businesses. This is a serious issue and if Blackberry survives, this may be the reason, because Blackberries are the exception – they do have a reasonable level of security. Tablets vary too in their level of security and often do not measure up. Therefore, companies adopting a BYOD policy need to identify the uses to which the devices will be put so they can control the data that will be available on and to those devices and minimize the risk in this way. The idea of determining the uses to which the devices will be put extends beyond the BYOD policies of businesses and other organizations. That’s because laptops and tablets are useful in different ways. The functionality of laptops is much stronger than that of tablets, therefore making them useful for more complex computing tasks as well as more complex word and spreadsheet documents. On the other hand, tablets are very good for obtaining information from the Internet and given their portability, are more useful for people in the field who just need to obtain some basic information and perhaps do some quick input and then move on. It is possible to structure a system such that if employees are required to use tablets to obtain information in the field, then the information they can access would be restricted to that which is necessary. That is the basic general principle for security in any event. There has been some debate as to whether tablets will eventually replace laptops. The answer is a resounding “NO”. A recent survey carried out by Dell, supported this conclusion. When asked whether tablets would become the primary computing device at their organization, 54.1% of the respondents said no. We know that most organizations are introducing tablets into their computing environment, either through purchases or BYOD policies (or both), therefore they need to co-exist and their functions need to be allocated appropriately. The same applies in the daily use of laptops and tablets outside of the business. Most people would prefer to avoid carrying both devices when they are on the move. So it takes some planning as to what they will be doing while away from their desk. It’s an issue we all are trying to deal with.
5 Retirement Mistakes and How to Avoid Them Written by Heather Phillips Have you ever wondered if you are ready to retire? I was speaking to a researcher not long ago who told me that people don’t panic about retirement until age 50. I met him when I was 48 and I knew I was close to the panic button!! Since that time, I have been thinking about what my retirement would look like, what things I should do, and what retirement mistakes to avoid. While I’m sure that there are more than 5 retirement mistakes, here are the ones I have uncovered: Mistake #1 - Procrastination People think about retirement and ask questions like “Am I going to be ok?” And they don’t take action. They are either afraid of the answer or don’t know where to start. Mistake #2 – Not knowing the difference between a Retirement Plan and a Financial Plan People use a financial plan as a retirement plan and the two are very different. The retirement plan answers the question: “What will I do when my pay cheque stops?” Mistake #3 – Thinking that Retirement is a destination People may think retirement is the “end game” and once you retire, that’s the end. The truth is retirement is a transition you create in your pre-retirement years with a plan. Mistake #4 – Not being emotionally prepared. There are a lot of changes that happen when you retire. Know what those changes are so you can be prepared. Mistake #5 - Expecting your Investment Advisor to create your Retirement Plan You are in charge of your destiny. You are in charge of what your future looks like. No one else can create it for you. You can download a free audio and worksheet of the “5 Retirement Mistakes…” from our website: www.r101. ca/free-audio-–-5-retirement-mistakes-and-how-avoidthem-0 . I know these are pretty hard hitting statements, but I feel they move us to take action. If you are already retired and would like to share your retirement story, please feel free to contact me at: www.r101.ca/contact-us. Use the subject line: “I have a story”.
MONEY® Magazine - Winter 2014 - 27
TAX MONEY
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Tax Policy 2014:
The Feds Continue to Squeeze Corporations. Written by Trevor Parry All G7 countries have struggled with managing their fiscal houses and a variety of policies tools have been employed with varying degrees of success. Europe and the UK have adopted a program of austerity which is starting to show results, the Americans have opted for monetary alchemy and tax increases which have seen both burgeoning national debt and political dysfunction be the rule of the day. Canada has opted for a middle strategy. While some cuts have been made, largely through attrition rather than program rollbacks, tax policy has become a central element of the Harper government’s action plan. It has been a central tenet of both Conservative and Liberal tax policies that low corporate tax rates encourage business. While this seems a straight forward approach it has generated unintended consequences. Those on the left argue that preferential tax rates for small business merely perpetuate small businesses. I am begrudgingly inclined to agree with them. Companies will adopt byzantine structures and jump through accounting hoops to avoid paying higher rate tax. In addition to these inefficiencies, low corporate taxation has resulted in the growth in corporate savings at almost every level. The investment and insurance industries are well aware of the growth in saving within corporations, for indeed almost all new products and associated strategies for the last twenty years have been aimed at enhancing deferral through the elimination of distributions which would attract punitive tax rates on passive income or through the re-characterization of that income into more tax friendly streams, such as capital gains. The exempt life insurance policy, the corporate class mutual fund, and the pre-paid forward contract are all examples of this strategy made manifest in product form. The Harper government has decided to begin a methodical and pronounced assault on these strategies and products. This is smart political calculus. They have not severed their ties to the business community, but gently applied pressure to eliminate some of the more egregious deferrals. They thus avoid the protests that would be associated with more bold policy actions such as reforming civil servants pensions and the politically motivated claims by the press that they were in the pockets of the rich if they embarked on tax reform which would flatten rates and broaden the tax base. 28 - MONEY® Magazine - Winter 2014
The last three federal budgets have seen further evidence of this squeeze on the use of corporations. The 2011 budget proposed changes to past service funding for Individual Pension Plans (although this was not passed into law), the 2012 budget announced the intention to rewrite the “exempt” test that governs permanent life insurance policies and the 2013 budget saw several actions all directed at forcing corporations to disgorge savings. The recharacterization rules are no doubt the first step in a policy that will effectively end the use of corporate class funds, the prohibition of the 10/8 strategy is a shot across the bow of aggressive insurance based planning and most notably the change to the taxation of non-eligible dividends will effectively end the “all dividend” compensation strategy that was taking hold across the country. Dividends were becoming for many the preferred means of compensation, for in addition to avoiding the requirement to contribute to the Canada Pension Plan, sizable tax savings were possible. It is my contention that very few people actually saved money, but instead rapacious personal spending was further encouraged. Mr. Flaherty, no doubt seeing the drop in both tax revenue and CPP contributions, realised that too many were gaming the system. He thus reduced the gross up associated with these dividends. The result is that $2.2 billion in tax revenue will be generated in 2014. Only in Ontario, Newfoundland and Nova Scotia is there a small benefit to preferring dividends to income and the governments of those provinces will no doubt move to end that preference. Planning will therefore have to change to meet this more aggressive policy environment. Clearly this will go beyond simple corporate tax planning as promises to tax testamentary trusts at the highest marginal rates can be seen as nothing more than a bald faced assault on the middle class. Planners must therefore be cognizant of these trends in tax policy and seek to minimize exposure of client assets to peril. Perhaps an expansion in the use of registered plans, such as the IPP will go some of the way to both protecting retirement plans and maintaining deferral. Nonetheless the days of the indefinite deferral of taxation by using a corporate structure are coming to an end. Entrepreneurs must seek new options or be prepared to pay considerably higher tax bills.
CANADA PENSION PLAN MONEY
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The ‘Perfect’ Canada Pension Plan Client Written by Gordon Brock
What would you think of the Financial Advisor who sets you up in a financial product that works like this? • You invest $4,700/year into this plan-up to your age 65. Contributions are mandatory. And while the contributions are tax deductible all benefits received are fully taxable. • These contributions must be made beginning the year you start working full time (you might be age 19 right out of high school or perhaps older after University). • If you die as a single person (non-married, no children) say, 5 or 10 or 20 years later, there is a taxable death benefit of $2,500 (maximum) payable to your estate. Nothing else is payable from your contributions. • If you die and you are married and you do have one or more children, the $2,500 death benefit is payable and there is also a maximum (it could be less or much less) monthly pension of about $555/month payable to your surviving spouse and additional $228 per month (maximum) for each of the dependent children while they are dependent. • If you become severely disabled you might qualify for a disability benefit. In order to qualify the disability must be both ‘severe’ and ‘prolonged’. The definitions are: Severe means that you have a mental or physical disability that regularly stops you from doing any type of substantially gainful work. Prolonged means that your disability is long-term and of indefinite duration or is likely to result in death. The maximum disability benefit is about $1,213/month to age 65. • At retirement (age 65) you will receive a monthly pension of about $1,012/month from this product—and you will receive it as long as you live. • But there is a catch—if you and your spouse are both retired each receiving the maximum pension (keeping in mind you have each contributed over the past 40+ years while working) and one of you dies—even if this is just a few days after retirement—the benefit payable to your surviving spouse is limited to the Death Benefit of $2,500 (maximum) – which is taxable. In other words you have contributed $4,700/year for over 40 years, you die one month into retirement and your contributions of over $188,000 will provide a benefit to your surviving spouse of only $2,500.
Is this a good deal? I would suggest you would be quite concerned (or even upset) about an Advisor who put you into such a plan. What I have just described above is a simplified version of the Canada Pension Plan. Some will note that the individual’s annual maximum contribution is only one half of the $4,700 I quoted above—this is because your employer must make a contribution equal to your contribution—so there is, in fact, $4,700/year going into the CPP on your behalf. Some will also argue that you must allocate some cost for the premature death and disability benefits that are payable under the CPP. This is a valid argument but even after you take these costs into account—is it a ‘good deal’ for the surviving retired spouse to receive absolutely nothing (other than the $2,500 taxable death benefit) from his/her deceased’s pension? And others may point out that the CPP benefits are indexed—but then, so are the contributions each year. The title of this article is the ‘PERFECT’ Canada Pension Plan client. The ‘perfect’ Canada Pension Plan client (from the government’s point of view) is the person who is working and contributing to the CPP beginning in their 20’s, never has a CPP disability claim and lives to ‘retirement age’ (early pension available as early as age 60) and then dies after receiving one monthly CPP pension cheque. Total contributions over, say, 40 years would be almost $190,000 (ignoring inflationary increases) and the total benefits paid would be one month of pension ($1,012) plus the $2,500 death benefit. Is this a good deal? For whom? At the time of this writing (November 2013) there are ongoing discussions and political posturing to ‘enhance’ the Canada Pension Plan by increasing contribution levels (and the so called ‘benefits’). Would this be a ‘good deal’ in the eyes of most Canadian taxpayers? I suspect that most people do not fully understand the workings of the Canada Pension Plan. And I would suggest many (most?) politicians don’t understand either-but it makes for good political noise. As a professional I cannot imagine how I could possibly justify recommending a financial product that works like this—that would require thousands and thousands of dollars contributions for a pension benefit that may end up being worth less than the first year’s contributions. MONEY® Magazine - Winter 2014 - 29
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Three Major Meltdowns...
NEXT? Written by Steve Selengut
The market was breezing along that year, enjoying one of the broadest rallies ever experienced. From the very start, equity prices seemed incapable of moving lower; only interest rate sensitive investments had that ability. One major barrier yielded to the next; new all time highs became a weekly occurrence at first, a daily expectation later. Higher and higher the averages soared. Institutions minted glitzy new products, IPOs flourished, investors “morphed” into passively transfixed speculators. Surely, the markets were “safe” once again... they could relax and look ahead to a secure retirement. But what if the Fed changes direction, or peace breaks out in the Middle East, or planes do what! What then? Sound familiar? Is this a description of the road to the ‘87 computer loop, the turn of the century “dot.com bubble” or the 2008 “financial fiasco”? All three, you might say. Each major meltdown was different: different economics, different excesses, different excuses, different durations, different politics, different finger pointing and different band-aids applied. All three rallies were the same: each nurtured institutionally; fueled by the media and accepted much-too-late by individual investors; each terminated abruptly and painfully, with no bonuses returned... AND, each correction proved to be a “best buying opportunity ever”. All three were part of the normal market cycle that we have been failing to deal with sensibly since the securities markets began. Market cycles are old news, unavoidable, unpredictable and, perhaps, scary. Unfortunately, most people only think of them as scary when the direction is downward. Is “up” the only good; are corrections always bad? What do you think? Growing up in Northwest Jersey, the most popular entertainment around was the rickety old roller coaster at Bertrand Island. The excitement mounted as you ascended the first peak, anticipating the breathtaking plunge; eyes wide open, screaming from the thrill with a white-knuckled grip on your date’s hand as you navigated the ensuing bumps and turns together, but, also, alone. The “shock” market is the grown up version of childhood thrill rides, but with no predictable beginning or end, and no way of knowing either the amplitude or duration of the peaks and valleys... only our experience can teach us what to expect
and when, what signals to look for and how reliable they may be. Millions of words are squandered as rallies and corrections grow older. Most gurus guess when the direction will change but few focus on what to do in anticipation and, more importantly, when... The secret is to operate investment programs within the actual market environment, where volatility and unpredictability are standard... and certainty does not exist. There are four essential rules to follow, and the chart you find here should help you understand why. Quality: Select equities from a universe of Investment Grade Value Stocks (google IGVSI). These are B+ and higher rated, NYSE, profitable dividend payers... you probably know most of the names. The IGVSI “line” generally falls less than the S & P during corrections and rebounds to new highs sooner. It usually will weaken before the S & P 500 (signaling?). Don’t buy until a stock is down 20% from its 52-week high; don’t sell IGVSI stocks at losses in down markets. Diversification: No more than 5% of portfolio “cost basis” (Working Capital) is ever invested in any one security. Diversification minimizes risk, as does Income, Quality and Profit Taking. Cost basis is also used for asset allocation decisions. Income: Own no security that does not have a history of paying regular dividends or interest. Asset allocations must include at least 30% income-purpose securities. Tradeable Closed End Funds (CEFs) should be researched to create a selection universe of five-year-old-plus, consistent paying, prospects. Profit Taking: Establish reasonable profit taking targets for all securities and enforce them religiously. It is significantly more likely that you will realize a 10% gain in a short period of time than it is a 20% gain. Set your target at 10% or lower and you will see the impact of the compounding. One year’s interest in advance or 10% is a reasonable CEF target. Income CEFs generally move lower months before bubbles burst, rarely fall as far during corrections; and continue to pay income to fuel buying activities throughout. Now back to the chart for the “what ifs”. If you have the patience/discipline to operate this way, your Wall Street roller coaster ride will become more productive and enjoyable... all the time and without either ETFs or mutual funds. MONEY® Magazine - Winter 2014 - 31
ESTATE PLANNING MONEY
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You Need to Answer These
Estate Planning Questions Written by Ed Olkovich
Why do you invest your money? My guess is so you don’t have to stay up at night worrying about it. Money makes a difference in your life. You need it to protect yourself and your loved ones. But who will protect your family and your money when you are gone? Everyone can remember when an uncle or aunt died without a will. You saw what happened to your relatives. It was a costly learning experience that may still have painful memories. Your money and your family may also be at risk. All it takes is a bad estate plan. Sure, you may think a bad estate plan is better than no plan. A bad estate plan is good for the tax department and court lawyers. It is never good for your family. It is a bad investment that too many people make. Only your family really suffers and regrets your failure to make a proper estate plan.
6. Is your will up to date with the right executors and backups? 7. Have you set up a trust in your will for minor children? 8. Did you set up a trust for beneficiaries with special needs? 9. Have you provided for ex-spouses and your common-law spouses? 10. Is your cohabitation or prenuptial agreement still valid? 11. Have you got the right kind of life insurance? 12. Is your will up to date and can you find the original?
You work hard for your money. So invest in professional estate advice to create a proper plan. If you think you don’t need help, see if you can answer these 12 estate planning questions.
If this were a game, 7/10 correct answers may be a good score. In real life, however, one mistake can be a tragedy for your family. It’s never too early to write your will. Get a professionally prepared will and help avoid real tragedies for your loved ones.
Estate Planning Quiz
Keep Your Promises
Answer either Yes or No to each question. Count the “Yes” answers. Are you sure you don’t need professional advice to get the right answers?
Didn’t you promise this was the year you would get around to:
12 Estate Planning Questions You Need to Answer 1. Do you know who should be the beneficiary of your RRSP, RRIF, annuities, life insurance policies and taxfree savings accounts? 2. Is putting assets into joint ownership with your relatives a good idea? 3. Should you make bank accounts or your family home jointly-owned? 4. Do you have a simple probate tax saving plan you can follow? 5. Are you sure you have the best succession plan for your business?
32 - MONEY® Magazine - Winter 2014
•
making a will;
•
getting powers of attorney; and
•
figuring out what happens to your business when you are gone?
Learn more about estate planning by reading my free e-book, Estate Planning: 7 Keys to Success. Visit www.EstateTherapy. com. Edward Olkovich (BA, LLB, TEP, and C.S.) is an Ontario lawyer, nationally recognized author and estate expert. He is a Toronto based Certified Specialist in Estates and Trusts. Edward has practiced law since 1978 and is the author of Executor Kung Fu: Master Any Estates in Three Easy Steps. Visit www.ExecutorSchool.com. © 2013
MONEY
®
Do Index Funds Always Beat Managed Funds? Written by Don Shaughnessy Maybe not. It will behoove you to notice the parameters. It is a tenet of my life belief system that it is better to know nothing than it is to know something that I believe to be true but which is in fact untrue. When I know nothing, I could be right by accident. For some time I have made the argument that index funds do not always beat managed funds, or even most of the time. Management fees, therefore, may be worth their price. Many disagree. There are several points to my belief: 1. Index numbers do not mean the same thing as they used to mean. It is possible that losing to the index means nothing. At one time, say pre-1995, the index numbers represented the value of the businesses in the index and changes measured how the underlying fundamentals of the businesses changed and how the expectations of the buyers of the securities saw things into the future. That is not the case any longer. High velocity trading is different. At one time much of the trading in large corporations was of the buy and hold variety. As late as 2006 high frequency trading was about 9% of the trading, but by 2010 it was over 60%. The index value to volume correlation was once strongly positive, it is now random. The “meaning” of a trade that is fully cycled within 10 milliseconds is different than one that cycles over 10 years. No one invests for the dividend return in a millisecond world. Dividends are an important part of the definition of a business. Therefore a large percentage of the trades do not relate to the business aspects of the index. 2. The existence of index funds alters the value of the index. As index funds grow in popularity there is greater demand and thus price increase for the securities that make up the index. That demand has exactly zero to do with the business expectations of the companies in the index and exactly zero to do with the buyer’s expectations for their future success, but it does depress the comparative results for managed funds. 3. There is empirical evidence to dispute the idea that index funds beat managed funds. Capital Group, the proprietor of the “American Funds” family is pretty obscure but large. By December 2007 they ran 7 of the 10 largest funds in the United States but were nearly invisible. They issued three press releases after 1925. They recently compiled information based on rolling monthly periods from December 1933 to December 2012, a period of 80 years. (I am aware of the value of end point biases and checked December 1933. It was low but not as low as 1932. It may affect some of their results, but the index itself covers the same periods.)
· They compared their funds to indices over several rolling month-end hold periods, 1-yr, 3-yr, 5-yr, 10-yr, 20-yr and 30-yr. There are over 30,000 results in the study. For instance, there are 600 month-end results for 30-year holds for each of their funds. They found that the funds beat indices as follows: o 1-year period – 57% o 5-year period – 67% o 20-year period – 83% The Capital Group information conflicts with a comparison provided by S&P in June 2013. An example of its result is that over 5-year periods, the index beat managed equity funds 72.14% of the time. Quite a difference. How come? The average fund as used by S&P includes both the best and the worst managers. You can deal with whoever you want but you cannot deal with “average manager.” Averages then are not meaningful to you if you can choose to deal with particular managers. Saying that Index funds beat the average managed fund is not equivalent to saying that Index funds beat all managed funds. It pays to notice how particular managers do what they do. Some can approach index return values after fees while holding 20% or more of the assets of the fund in cash. While not producing the highest yields year over year, they tend to be more stable and more tax efficient. Fund management fees include custodial, trading and tax reporting costs. More importantly they used to include amounts paid to advisors. It is probable that advisors add nothing to fund returns but despite that, people who use advisors tend to end up with more money. You can spend money, you cannot spend percentage gains. A large portfolio is only partly the result of investment returns. Capital value arises from disciplined capital investment, tax sensitivity and from choosing the better managers. Advisors add great value to those parameters. A competent advisor will spend time organizing a plan and a portfolio, but even more time managing you. That is where the real money turns out to be. You should not expect to get the service for free. As always, pay attention. The world, fundamentally, is just organized common sense. Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.
MONEY® Magazine - Winter 2014 - 33
MONEY®
MUTUAL FUND REVIEW
December 2013
Starting assets (November 30, 2013) + Net sales +/- Estimated market effect = Ending assets (December 31, 2013)
M A G A Z I N E
Asset Growth ($)
Asset Growth (as a % of starting assets) Net Sales ($)
Net Sales (as a % of starting assets) Performance (Fund Category Averages)
$799.5 billion $12.6 billion -$2.6 billion (-0.3%) $809.5 billion
Top 3 Categories
Bottom 3 Categories
Global Neutral Balanced: $2.982 billion Cdn. Div. & Income Equity: $1.712 billion Canadian Focused Equity: $1.293 billion Preferred Share Fixed Income: 42.4% Misc. – Geographic Equity: 20.3% Cdn. Focused Small/Mid Cap Equity: 16.3% Global Neutral Balanced: $2.963 billion Canadian Neutral Balanced: $1.522 billion Canadian Focused Equity: $1.212 billion Miscellaneous – Other: 71.5% Canadian Focused Equity: 3.8% Canadian Small/Mid Cap Equity: 3.3% Cdn. Focused Small/Mid Cap Equity: 2.6% European Equity: 2.6% Natural Resources Equity: 2.5%
Canadian Equity: -$836 million Canadian Fixed Income: -$809 million Cdn. Short Term Fixed Income: -$441 million Misc. – Undisclosed Holdings: -46.8% Cdn. Synthetic Money Market: -16.6% Cdn. Inflation Protected Fixed Income: -6.3% Cdn. Short Term Fixed Income: -$99 million International Equity: -$97 million Natural Resources Equity: -$61 million Misc. – Undisclosed Holdings: -40.6% Cdn. Synthetic Money Market: -2.8% Commodity: -2.3% Retail Venture Cap: -4.8% Greater China Equity: -2.3% Precious Metals Equity: -1.9%
ALL THE INFORMATION AND SERVICES YOU NEED CANADIAN INVESTMENT AWARD WINNERS Advisors’ Choice Fund Company of the Year Winner: Fidelity Investments Canada ULC Best Canadian Balanced Fund Winner: Steadyhand Income, Steadyhand Investment Funds Inc. Best Canadian Dividend & Income Equity Fund Winner: Sentry Canadian Income, Sentry Investments Best Canadian Equity Fund Winner: Mawer Canadian Equity, Mawer Investment Management Ltd. Best Canadian Fixed-Income Fund Winner: TD Canadian Core Plus, TD Asset Management Inc. Best Canadian Small-/Mid-Cap Equity Fund Winner: Sentry Small/Mid Cap Income, Sentry Investments Best Emerging Markets Equity Fund Winner: Brandes Emerging Markets Equity, Bridgehouse Asset Managers Best Fund of Funds Winner: CI Portfolio Select Series, CI Investments Inc. Best Global Balanced Fund Winner: Mawer Balanced, Mawer Investment Management Ltd.
Best Global Equity Fund Winner: EdgePoint Global Portfolio, EdgePoint Wealth Management Inc. Best Global Fixed-Income Fund Winner: Templeton Global Bond, Franklin Templeton Investments Corp. Best Global Small-/Mid-Cap Equity Fund Winner: Mawer Global Small Cap, Mawer Investment Management Ltd. Best High Yield Fixed-Income Fund Winner: Fidelity American High Yield, Fidelity Investments Canada ULC Best International Equity Fund Winner: CI Black Creek International Equity, CI Investments Inc. Best Specialty Equity Fund Winner: CI Global Health Science, CI Investments Inc. Best U.S. Equity Fund Winner: Beutel Goodman American Equity, Beutel, Goodman & Company Ltd. Best U.S. Small-/Mid-Cap Equity Fund Winner: Trimark U.S. Small Companies, Invesco Canada Ltd. IFIC Investor Education Award
www.MutualFundReview.ca
MONEY
®
HOW IS CANADIAN CREDIT SCORE CALCULATED? Written by Art Smith
Your score is the calculated based on a number of issues; the most important is your credit history. If you apply for credit with different lenders within short period they will check your credit history and this alone decreases your score (and might decline your application). If on the other hand, check/ request your score/history on your own it does not affect your score. While the credit score formula (Beacon score) is kept secret, the score is based on (roughly): •
35% is based on repayment history meaning how good you are with repayment of your debt.
•
30% is based on existing debts, how much you owe.
•
15% is based on age of accounts, the longer credit accounts have been opened the better. It is a good idea to have 3 different accounts (such as a loan, credit card, line of credit) each over 1 year old.
•
10% is based on the type of debt: bank loans or credit cards impact credit history differently.
•
10% is based on credit inquiries, how often you apply for credit in the last 12 months.
Factors such as late payments over 30 days, collections, judgments and bankruptcies have very negative impacts on your credit score. A single 30-day late payment can easily
drop credit score by 20 points. Besides the obvious reasons (bankruptcies, collections, late payments etc.) other reasons that can reduce your score are: •
Payments over 30/60/90-days late
•
Seeking too much credit in a short period of time (e.g. applying for 4 credit products in one or two months). Numerous applications in the past 6-12 months reduce your score significantly.
•
Maxing out credit cards/lines of credit, the utilization ratio should not exceed 30% to 40% (the utilization ratio is the ratio between the limit of the credit and the balance). If you reduce the utilization ratio from 80% to 30% your score will improve within a relatively short period (several weeks). It is better to have 3 credit cards with $330 balance and $1,000 limit on each card rather than 1 card with $990 balance and $1,000 limit.
You can request your history report for free but in order to get your score you will have to pay, Equifax and TransUnion are not obliged to provide the score for free. To get your free history reports go to http://www. equifax.com/ecm/canada/EFXCreditReportRequestForm.pdf and http://www.transunion.ca/docs/personal/Consumer_ Disclosure_Request_Form_en.pdf. MONEY® Magazine - Winter 2014 - 35
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MONEY
®
MINDSET Definition of “mindset”: A fixed mental attitude or disposition that predetermines a person’s responses to and interpretations of situations. What is your mindset around money? Here are five quick questions, answer them truthfully. Then ask yourself: “is my debt a result of circumstances or poor decision making?” •
Are you honest with yourself and/or your spouse about your financial purchases?
•
Are you hiding on-line shopping purchases?
•
Do you have a secret account?
•
Are you justifying purchases that are really not necessary?
•
Are you using shopping as an outlet to make yourself feel better?
The emotions that are tied to money can be very overwhelming. Before you tackle your financial situation, take a deeper look at why you are in the financial position you currently find yourself. I am a firm believer that most debt occurs for one of two reasons: 1. circumstances; or 2. poor decision making. Bad Luck Sometimes, really bad stuff happens to really good people and it does not matter how financially savvy you may be or how great the communication is between spouses or how fantastic you are at managing your finances, you can still end up in trouble. The people who are in financial trouble due to an unforeseen circumstance (for example the loss of an income because of an ill child) just need some clear, helpful support, an advocate and a plan and they will be back on their feet financially in a short period of time. Bad Planning Poor decision making however, is repeated over and over until you learn new habits and change your mind set when it comes to finances. The current financial trend is to adopt an attitude of: •
“I deserve”
•
“Debt is the new norm”
•
“I will pay off my student loans later, for now check out my new iPhone!”
Having a credit limit is not your money, having a student loan is not your money, a credit card is not your money. Until the mindset changes, whether it is coming from, I deserve or I will always be in debt, it is very difficult to change one’s spending habits.
Look at Money Differently If you truly want to be put yourself on the path to financial freedom then treat the money you have earned from your paycheque as your income, that’s it. Treat all forms of credit as the banks’ money, which you will HAVE to pay back with interest and interest and more interest, until you are very old, leave the country, or file for bankruptcy, (remember, student loans are not eliminated if you choose bankruptcy). OR you can start right from the beginning with a success mindset and do not carry this debt to begin with. Success Story Yes, with a little discipline, the right mindset and a clear picture of what you want, you can set the tone for a life of financial success. Take my client “John.” I started working with him when he was only 19. He was attending university and had two large student loans. He had a clear (albeit ambitious) financial goal: no debt when he graduated from university. We worked together to develop a plan to give him the best chance to achieve his goal. We divided up his student loan into needs, books/rent, and travel expenses to and from school, food etc… The plan included $40 spending money per week for all other events/activities and the remainder was never used. After three years of university, he took one year off and worked his #@# off, following the same plan, $40 per week for entertainment and following the budget for food etc… Four years later, after implementing the plan, he had graduated and he continued to follow the same plan while working in his field. Only six months after graduating we celebrated that he was debt free, all student loans paid in full. What a success story! He has an amazing well-paying job in his field and no debt. Why did he succeed? He had the right mindset and a clear goal! Money is such a personal issue and we all carry our history when it comes to financial successes and failures. You cannot change your past but with the right mindset around money, your future can be a financial success. Always wanting more and never feeling that you have enough has everything to do with changing your mindset not your finances. Having a grateful heart and being thankful can change your outlook on your finances and your future. Take control of your money, don’t let money control you! Written by Laurie Lee, Goodcents Co. MONEY® Magazine - Winter 2014 - 37
5
MONEY
®
MONEY TIPS
TO IMPLEMENT FOR 2014
Written by Lise Andreana, CFP, CPCA, Financial Planner and Partner, Continuum II Inc.
1
RRSP - This year’s (2013) maximum contribution room is 18% of earned income up to $23,800. Review your RRSP contributions – now is the time to plan for how you will fill your remaining contribution room in time for the March 3rd, 2014 deadline. If your employer offers a matching retirement savings plan, check to make sure you are taking full advantage of your employer’s generosity! Oh go on, show your spouse some love – contribute to a spousal RRSP, the benefit is the opportunity of income splitting at any age. If you are expecting a year-end bonus, consider allocating it to your RRSP. Your “Gift” will arrive in April in the form of tax savings!
2
RESP – If you already own an RESP, it is too late for your 2013 contribution but start thinking of 2014. If you are a Grandparent planning to purchase birthday or Christmas gifts, just imagine how much more you will be remembered and appreciated for a gift of an education, over another toy. Most children tire of their toys within a few weeks while an education is a gift that lasts a lifetime. Your “Gift” is that the RESP can receive the Canada Education Savings Grant equal to 20% of the contributions up to a maximum of $2,500 each year.
3
Charitable Contribution – Make a charitable contribution before year end and receive a tax credit for that same tax year. Contributions to your favorite charity are a great way to help those in need. Plan a family dinner around the topic of community service and giving back to your community. What a great way 38 - MONEY® Magazine - Winter 2014
to educate your children about gratitude, while teaching them not everyone is so lucky. There are many worthwhile charities – just check the CRA website to be sure it is properly registered so you get your receipt and your donation reaches your desired destination! Your “Gift” is that you will receive a 15% federal tax credit on the first $200 donated and a 29% credit on any amount above $200. Spouses can pool their donation receipts to maximize tax credits!
4
Get Organized – Gather up all of your receipts for your tax deductible expenses or creditable such as medical bills, allowable business or work costs, children’s fitness and art programs, tuition and text books. By organizing now you may find that some slips are missing and you will have time to get duplicates before the tax deadline arrives. Your “Gift” is increased tax savings.
5
TFSA – The Tax Free Savings Account 2013 limit is $5,500 and it is the same for 2014. Many people plan carefully all year to maximise your RRSP and RESP contributions. However TFSAs don’t always stay top-of-mind and there is no 60-day grace period. TFSA contributions are done on the calendar year but if you haven’t maximised past contributions, your missed amounts can be added in 2014. Your “Gift” is tax sheltered investment growth for as long as your money is in the TFSA! P.S. Watch for “Financial Care for Your Aging Parent” soon to be published by Self Counsel Press, by Lise Andreana.
MONEY
®
Written by Camillo Lento
The Value of
TIME VALUE OF MONEY CONCEPTS Knowledge is Power. Time is Money. These are two old adages that carry much weight. In this article, I will describe how knowledge of time value of money concepts can lead to more money in your pocket. Time Value of Money Concepts
savings account, and makes monthly contributions of $250 over a 25-year period. Further, assume that the entire portfolio is invested in a mutual fund that earns a return of 6.5% annually before the MER. The following is the future value of the portfolio assuming different MERs.
The results from Table 1 reveal that an individual can Time value of money (TVM) concepts deal with the principle increase their investment returns by approximately $18,000 that, under times of normal economic conditions, a dollar ($33,990 - $15,829) by choosing lower MER funds, such as today is worth more than a dollar in the future. TVM exchange traded funds. concepts are the Investors with a solid Table 1 – Mutual fund values with various MERs fundamental building understanding of TVM blocks of many models 1 concepts will understand MER Retirement Value Total Fees Opportunity Cost that underlie capital the impacts of MERs on markets and the banking 1.00% $160,852 $15,829 $11,494 portfolio returns in order industry. For example, 1.50% $149,569 $22,554 $16,603 to maximize their wealth. TVM concepts are used 2.00% $139,186 $28,586 $21,381 Without understanding to determine compound TVM concepts, it may be 2.50% $129,62 $33,990 $25,833 interest, mortgage hard for an investor to payments, bond values, appreciate the impacts and even option prices. of MERs when selecting between investments. TVM are a cornerstone of many business and economics A second common example that can display the power of undergraduate programs, and are also covered in elective TVM concepts is in regards to home mortgages. Mortgage courses for many other majors. Students also learn some of payments and amortization schedules are all grounded in the basic TVM concepts in high school. You can also learn TVM concepts. Currently, about TVM concepts Table 2 – Interest paid on Mortgage at various interest rates fixed mortgage rates vary through free open from approximately 3% to courses and websites. Interest Rate Monthly Payment Interest Paid Over Mortgage 6.75%, depending on the Currently, the average maturity. Table 2 presents 3% $1,419 $125,853 cost of a four-year the total interest paid on 4% $1,578 $173,305 undergraduate degree a 25-year mortgage of 5% $1,744 $223,265 is estimated to be $300,000 at various interest 6% $1,919 $275,550 approximately $33,500 rates. for students living at 7% $2,101 $329,963 Table 2 reveals that even 1% home and $57,225 for difference in the mortgage students away from rate can lead to significant differences in the amount of home. These costs are already large, and forecasted to interest paid over the course of a 25-year mortgage. Those increase into the foreseeable future. Is the cost of education with a sound understanding of TVM will already understand really worth it? Well, this is definitely open to debate. that small differences in interest rates can lead to significant However, there definite is value to understanding TVM differences in interest paid. By reducing your mortgage rate concepts. In fact, obtaining a solid understanding of TVM from 5% to 4%, an individual can save $49,960 ($223,265 concepts during an undergraduate degree can pay for the $173,395) over the course of a 25-year mortgage. cost of education itself without considering the employment income increases that can materialize from holding an Concluding Thoughts undergraduate degree. With just two examples (MERs and mortgages), we can The Value of Understanding TVM Concepts Let’s look at a few examples to display the value of understanding TVM concepts. The first example deals with investing in mutual funds or exchange traded funds. A solid understanding of TVM concepts will help an investor understand the impacts of the management expense ratio (MER) on retirement savings. For example, assume that an individual contributes $1,000 to a registered retirement
see how understanding and using TVM concepts to your advantage can lead to significant increase in wealth. With the two examples covered in this article, an individual hypothetically saved $67,960 ($49,960 + $18,000), which is greater than the cost of a 4-year degree in Canada. The TVM concepts have paid for the cost of the education alone with only two applications. There are many other possible applications of TVM that are not explored in this article which would lead to further increases in one’s wealth. MONEY® Magazine - Winter 2014 - 39
SMALL BUSINESS MONEY
®
Pay Attention to your Pension
– A Retirement Strategy for Small Business Owners Written by Ian Burns, CLU, CH.F.C., EPC & Shelley Johnston, CFP, EPC As a successful professional or entrepreneur – you have spent a good portion of your life building your business and made many sacrifices– both financially and personally. After all, taking care of your business and your financial obligations is a huge responsibility and leaves little time for retirement planning. Many owners rely solely on the value of their business as a primary source for retirement funding. For most middleincome workers, a Registered Retirement Savings Plan (RRSP) is an effective method of saving for retirement. However, as a successful business owner, if you make over $125,000 a year, your RRSP contributions are limited and your RRSP will probably not generate enough income to allow you to maintain your current lifestyle in retirement. Fortunately, there is another way to build a retirement income that will more likely live up to your expectations: an Individual Pension Plan (IPP). IPPs were allowed beginning in 1991 and are designed to put business owners on an equal footing with public sector pension plans. Like many of these plans, IPPs are “definedbenefit plans”, registered with Canada Revenue Agency and subject to federal or provincial pension benefit regulations. The IPP must be sponsored by an incorporated company who makes contributions on behalf of the business owner(s). IPPs have many advantages: •
they are an excellent tool for removing cash from your business in a tax-efficient manner;
•
the corporation has 120 days after its year-end to make a contribution, rather than 60 days as with RSP contributions;
40 - MONEY® Magazine - Winter 2014
•
contribution limits are higher than RRSPs levels;
•
they may be used as part of a succession plan;
•
any pension surplus belongs to the member;
•
they allow for a one-time contribution for past service and possibly an additional lump sum for terminal funding at retirement;
•
they provide creditor protection; and
•
they have very conservative investment guidelines and the ability to top up due to market drop or weak performance.
IPPs also have their disadvantages: •
setting up and maintaining an IPP is quite complex and can be costly;
•
you cannot skip contributions in any given year; and
•
your personal RRSP contribution room is reduced.
Like corporate pension plans, when you are ready to retire, the assets accumulated in your IPP can be used to: 1. fund a monthly pension; 2. purchase an annuity in a prescribed manner; or 3. be terminated with a lump sum disbursement. Setting up an IPP requires an investment of your time, and the continued involvement of professionals that specialize in IPPs. So take control of your retirement, speak with a professional to determine if an IPP is the right fit for you.
MONEY
®
A Time for Reflection Written by Cynthia J. Kett
It’s traditional at this time of year to review past events and to anticipate new ones. The floods in Calgary and Toronto and the recent ice storms that crippled parts of eastern Canada provided many of us with the opportunity to reassess what’s important. There have been many natural disasters internationally, but the ones here hit home and allowed us to experience first-hand what it’s like to go without the things that we take for granted. Was your first thought, “I should have bought that larger home, spent more on renovations or purchased that more expensive car”? No, more likely it was, “Are my family and friends alright? Have I the financial resources to withstand the losses that I will face?” Knowing that, might you make different time and financial choices in 2014? You may not think that time and money are interrelated, but they are in many circumstances. For example, let’s assume that you have a choice between buying a home that will require a $300,000 mortgage or one that will require a $500,000 mortgage. Assume that you’re diligent – you’ll make weekly payments for 20 years – and that your average mortgage rate over that period will be 5%. Your mortgage payments would be $456.47/week ($23,736.29/ year) or $760.78/week ($39,560.48/year) for the two mortgages, respectively. That’s a difference of $15,824.19/ year or $316,483.86 over 20 years. If you opted for the less expensive home (thus reducing your fixed expenses), what could you do with the extra $15,824.19/year? Many things, but two possibilities might be: 1. spend it on something that’s important to you – perhaps involving family or friends; or 2. work less (if your marginal tax rate is about 40%, you could earn $26,373.65 less than if you had the higher mortgage to pay). Both choices would enable you to allocate more time and money towards goals other than your home. Furthermore, a less expensive home will likely mean lower property taxes, utilities, maintenance and furnishing costs. As you enter the New Year, be strategic about your household spending. Is it a “want” or a “need”? With all the beautiful homes that you see on TV programs, it’s easy to confuse the two. Cynthia J. Kett is a partner with Stewart & Kett Financial Advisors Inc.
Balance is the Key Written by Tammy Johnston
Life is all about maintaining a healthy balance. We need to eat, exercise, work, rest and play. Since money is an important aspect of life, we need to balance this aspect as well. Financial balance means being conscious of how we spend our money each day. If you put all your focus on one area of your monetary existence, you will quickly put your life off kilter. Too many people put all their energies onto debt. Either racking it up or fretting about how to eliminate it. Others concentrate on sacrificing for a “rainy day” or retirement or their children’s education. Neither of these approaches work. Successful and happy people have found a way to bridge both the desire for security and fun. Three vital components are included in their budgets: Financial Freedom, Debt Reduction and Play. If you are fortunate and are without debt then fabulous, you can focus on the other two! Financial Freedom is money that you put aside and DO NOT TOUCH. These are seeds that grow and grow. These are your long-term investments. These funds start small and grow through compound interest and growing knowledge. Debt Reduction is another form of investing. By eliminating credit card and vehicle debt, lines of credit, loans and mortgages we free ourselves for bigger and better things. By putting together a reasonable plan to reduce and eliminate debt, we free our minds to learn about creating more money. Play money is what allows us to stick with our plans. We can’t be serious and hard working all the time. Without the ability to relax, laugh and just enjoy things, what is the point of life? By putting a portion of our income aside for pure fun we are motivated to stick to our plan. This money is our reward for doing the right things with our money. I recommend that you spend this money monthly. Small, regular rewards are proven to be more effective than one big reward in the future. You can still a big reward (like a tropical vacation), but it should not be the only reward. By taking a balanced approach to money management you get to eat your cake and have it too. Balance is the Key Written by Tammy Johnston “You have a divine right to abundance, and if you are anything less than a millionaire, you haven’t had your fair share.” Stuart Wilde
MONEY® Magazine - Winter 2014 - 41
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Diworsification Written by David Atwood
“Diversification is what fools do to hide their mistakes.” ~ Warren Buffett According to the world’s greatest investor, Warren Buffett, and his best friend and business partner, Charlie Munger, there are really big flaws in what is being taught about investing in many finance schools. In 2005 at the annual general meeting for Berkshire Hathaway, Munger commented, “modern investment theories are a crock”. The next year Munger described Modern Portfolio Theory (MPT) as “asinine”, and a year later he asserted that, “At least 50% of everything taught in finance schools is pure twaddle”. Finance school students and investment advisors all over the world are still tested on their knowledge of MPT. Modern Portfolio Theory was developed back in the 1950s and one of the early collaborators was awarded a Nobel Prize for Economic Sciences – Dr. Harold Markowitz. Expert witnesses echo the findings of the academics. Regulators use the legal precedents to assess investment suitability, so MPT and investment suitability are a bit like the difference between reading a Harlequin romance novel and actually having sex. Two of the most successful investors in the world admit to being totally out of step with this “crock of asinine twaddle”. You may find investment theories are something you want to look at a little more closely. “Don’t put all your eggs in one basket”, is one of those home baked, apple pie clichés in which we take comfort. In the Buffett-Munger kitchen you would find that the eggs are all in one basket which is watched very closely. The difference in the number of baskets is the understanding of value. Buffett uses the term “deworsification” to describe the foolish behaviour of loading up on sub-par businesses to hide mistakes. Rather than experiencing a single toe dipping in the waters of failure, many are inclined to stand knee deep in a potpourri of certain mediocrity. I am a better investor because I am a businessman and a better businessman because I am an investor. If you were to be asked, “Who is the wealthiest person you know?” chances are good that the person you name will be a business owner. The wealth of most business owners is largely attributed to one business, although there may be multiple facets to that single enterprise including other businesses within the business. The point is that much of the serious wealth with which we are familiar is derived from the ownership of a single business. There are many examples to choose from by looking at the Forbes list of the wealthiest people in the world. An obvious example is Bill Gates and Microsoft, but did you know that 44 - MONEY® Magazine - Winter 2014
Warren Buffett eats his own cooking with about 98% of his wealth tied up in Berkshire Hathaway? Berkshire includes an $87 billion portfolio of publicly traded stocks where just 4 stocks account for over 60% of the basket. Buffett is known to say, “The only thing better than owning a good business is owning more of a good business”. Buffett has managed to accumulate 100% ownership of about 80 other outstanding businesses within Berkshire simply by focusing on value. So what are the implications for investors? If we don’t know what we’re doing, we are well advised to get diversified. The best way to diversify is through an index because the guidance of a helper is going to cost you something. A dollar saved is a dollar earned, so any savings will compound along with the returns of the market. On the other hand, an index investor may be considered penny wise and pound foolish when compared to those who understand value and focus on a small basket of great businesses. We don’t single out a lemming jumping off a cliff from all the others. Diversification reduces the risk of being singled out and for some advisers and their clients, preservation is about blending in. Independence is a state of mind, a willingness to think and behave apart from the others. If we are going to hire someone to assist with investing, we want someone with the courage to stand-alone; we don’t need help to roll the dice on mediocrity. When the names of the businesses in an investment portfolio are different than those of an index and when the amounts held within those names differ from the index, those portfolios are considered to be “Active Share”. Simple intuition gives us the understanding that the investment managers who do outperform their indexes are most certainly doing so because their portfolios are different from an index. Active Share Research proves what the greatest investors in the world have known intuitively. In conclusion, the single greatest investment you will ever make is in yourself! It takes only a little more intelligence than average and the temperament of a business owner to be a successful investor. Between the humorous distractions, the clichés and the academic theory we need to know one thing; how to assess value. Well decorated individuals “helping” with asset allocation solutions from their ivory towers are not the answer. Judging a book by its cover or an asset by its name, does not determine value any more than a beauty contest. We will find the best opportunities are a little hairy, not as well polished as others and the unassuming appearance is likely contributing to the underlying value.
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