Stocks for Fun and Profit

Stocks for Fun and Profit

Adventures of an Amateur Investor

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Three More Articles to Enjoy with Your Coffee

Three More Articles to Enjoy with Your Coffee

(photo courtesy of Pexels) I have been a Grainews columnist for a year with my first article having appeared on March 13th, 2018. The articles are generally coordinated with my blogs but not always. This series of articles will catch up blog readers with my […]

The Folly of Market Predictions

The Folly of Market Predictions

In the column, “Re-Think What You Thought,” I mentioned less than half of predictions are accurate. This phenomenon has been well documented, yet market predictions continue to abound. I began making market predictions in my newsletter in January of 2016, mostly to poke fun at […]

In Defense of the Much Maligned RRSP

In Defense of the Much Maligned RRSP

(Photo courtesy of Pexels)

We are approaching the Registered Retirement Savings Plan (RRSP) deadline but deadline or not, I suspect most readers will have contribution room available, which can be found on your annual income tax “Notice of Assessment.” Many Canadians have tossed the RRSP into the trash bin, favouring the TFSA. I certainly agree with favouring the TFSA, especially for lower income Canadians, but wanted to make a case for also supporting the RRSP.

There are three key advantages of the RRSP over the TFSA. Firstly, contributions are tax-deductible the year they are made, creating an immediate tax benefit. Contributions can be made the first two months of the current year and applied back to the previous year, which is why the deadline is usually February 28th or March 1st. Secondly, there are no dividend withholding taxes on US stocks. Thirdly, and a much less know benefit, is that retirement funds might be secure from creditors in the case of bankruptcy. There are some caveats around this benefit which vary from province to province, so please check with your accountant on its pertinence in your individual case. One caveat is that if a large lump sum payment is made into an RRSP just prior to declaration of bankruptcy, it is unlikely to be protected for obvious reasons.

This third reason is why entrepreneurs should seriously consider an RRSP, especially starting out when finances of a business are less stable. Nobody starts a business with the intent of going broke but it frequently occurs.

The key disadvantage of the RRSP is that when it’s collapsed, the money withdrawn is taxable. This is why so many have turned negative on the program even though many will be in a lower or equal tax bracket upon retirement than when working. Entrepreneurs, who tend to pay themselves poorly while operating their business but may retire wealthy when they sell, could be in a higher tax bracket upon retirement. Let me demonstrate, using the “Rule of 72,” how even if paying higher taxes upon retirement, an RRSP could still be financially beneficial.

Compounding builds faster when tax-free

For this scenario, let’s use a 40-year career length time period, nine percent annual returns which is very doable with stocks, a 33.33% marginal tax rate when the contribution is made, and a 50% tax rate upon retirement.  The money would double every eight years, leading to five doubles. A $1000 contribution would compound to $32,000, and applying a 50% tax rate upon withdrawal would leave $16,000 after tax. However, you also get a $333.33 tax refund. Investing this at the same rate of return would yield six percent after tax, doubling every 12 years or 3.33 times in the 40 years. Therefore the $333.33 refund becomes $3,547, added to $16,000 becomes $19,547.

Simply investing $1000 outside an RRSP, achieving nine percent before tax or six percent after-tax would yield $10,640, which is considerably less than $19,547.

Dividend or capital gains investment income is generally taxed at a lower rate than straight income or interest income. If we used a marginal tax rate on investment income of half the 33.33% for 40 years, the money outside an RRSP would become $18,720.  The $1,000 inside an RRSP taxed at 50% upon withdrawal, with a $333.33 tax refund invested outside the RRSP would total $22,240, still considerably more than investing entirely outside an RRSP.  Please keep in mind this advantage exists despite the unlikely scenario of paying considerably more tax upon retirement than when working.

A more likely scenario would be that the tax rate is the same going in and coming out. Let’s see how it works out with a 50% marginal tax rate when the contribution is made and when withdrawn, with a 25% tax rate on investment returns outside an RRSP. The money outside the RRSP yielding 9% with a 25% tax rate would effectively yield 6.75%, taking 10.7 years to double and doubling 3.7 times in the 40 years. Therefore the $1000 outside an RRSP would become $13,600.The $1000 deposited inside the RRSP would still become $32,000, getting cut in half upon withdrawal to $16,000.The $500 tax refund would become $6,800 for a total of $22,800. Way more than $13,600! These examples are simplifications but should clearly demonstrate the advantage of compounding inside a tax-advantage RRSP account.

In conclusion the advantages of investing inside an RRSP are better:

  • The longer the time horizon.
  • The higher the rates of returns.
  • The higher your current marginal tax rate.
  • The lower your retirement marginal tax rate.
  • In the unfortunate event of bankruptcy.

I hope this article equips you to use the “Rule of 72” to think through scenarios for your own specific circumstances, keeping in mind it is an approximation calculation. It was not my intent to get into all the RRSP details, but simply paint a picture of why RRSPs should be considered as part of a financial plan.

 

The Real Estate Chapter

The Real Estate Chapter

I hope everyone had a very Happy New Year. My apologies for not sending anything yet this year, and hope everyone took advantage of the market downdraft late in 2018 to add to your TFSA with the new $6,000 contribution room for 2019. I added […]

2019 SMART Investing Goals

2019 SMART Investing Goals

(Photo courtesy of Pexels) 2018 has been a challenging year for stock and bond investors around the world. Virtually every asset class, in every country is down year-to-date. Perhaps things will change in the last two weeks of the year, but at time of writing […]

Three Recent Articles

Three Recent Articles

(Photo courtesy of Pexels) With the excitement of having articles in the Globe and Mail and MoneySense, I have fallen behind communicating recent articles written for Grainews, one of Canada’s leading agricultural publications. Following are links to three recent articles, all including a key investing message:

  1. Investing In Speculations is an Oxymoron: This article appeared November 2nd and is a updated version of a blog posted on my website last January. It might be very topical as bitcoin and cannabis continue their decline, while high flying tech stocks also lose altitude.
  2. Is Market Level Relevant?: Appeared October 15th an reiterates my position that trying to predict short term market fluctuations is futile. It is also an updated version of a blog posted this past March.
  3. Cash Flow is King: Appeared Sept 17th. I view cash flow as the most important and consistent financial metric.

All of these articles emphasize my approach of building wealth over time and avoid stressing out over short term volatility, as we are currently experiencing. My book continues to receive excellent reviews on Amazon and Chapters. Please share your comments. Thanks Very Much.

We are now approaching year-end, and the beginning of a new year. If you are interested in my paid newsletter for up-to-date information on portfolios and more intensive commentary, please e-mail me at you1st.stocks@gmail.com

Re-Think What You Thought: Part 2

Re-Think What You Thought: Part 2

(Photo courtesy of Pexels) Please share with others on your social media if you find it informative, and if you have read my book please write a review on the site it was purchased. Please have a look at current reviews on Amazon.  Much Appreciated.  This article […]

MoneySense Article

MoneySense Article

I continued the journey of helping build better financial literacy by contributing my first guest column to MoneySense. Please click on the link to read the article and if you like it please share on your social media. The “Rule of 72” is critical in […]

THE GLOBE AND MAIL

THE GLOBE AND MAIL

LARRY MACDONALD

Herman VanGenderen published an investment book, Stocks for Fun and Profit: Adventures of an Amateur Investor.

Herman VanGenderen, 60, is currently pursuing a semi-retired lifestyle of travel, hiking and managing a seed business in Calgary. He also enjoys stock-market investing as “a great and productive pastime to help keep one’s mind active” – not only managing the family’s portfolios but also writing a monthly newsletter on stocks and publishing an investment book, Stocks for Fun and Profit: Adventures of an Amateur Investor. The book chronicles his investment journey of the past 35 years in the hope investors still in the early stages of their journeys might learn from some of his experiences and mistakes.

The Globe and Mail recently interviewed Mr. VanGenderen.

How are your investments performing?

At the end of 2017, my RRSP [registered retirement savings plan] had an 11.7-per-cent compound annual growth rate over the last 25 years and my TFSA [tax-free savings account] had a track record of 17.4-per-cent annual compound growth over the last nine years. My wife’s registered plans, which I manage, are not far behind.

 

But when you first began investing in the 1980s, things didn’t go well?

Correct. Back then, it was common to open an account with a stock broker and rely on their advice. This was not a good experience for me.

The first broker made a lot of recommendations that I acted on without any research on my part. It didn’t go well. My second broker said my portfolio was full of junk and dumped most of it. The junk then promptly rallied.

This broker subsequently had to leave his firm because he wasn’t bringing in enough business. My third broker got promoted and my fourth changed firms so that by the late 1990s, I was with a fifth broker. By this time, I was no longer accepting stock tips unquestioningly and had my own self-directed accounts.

What accounts for your outperformance since the 1990s?

I am 100-per-cent invested in stocks. Stocks of well-selected companies have performed far better than interest-bearing investments over the long term. I expect that outperformance to continue, especially in light of today’s very low interest rates.

 When it comes to selecting stocks, I like those that pay dividends, especially if they are well supported by earnings and are raised regularly. Research studies show that dividends represent a big part of overall stock market returns over the long term.

I also prefer companies with solid track records that I can hold for a long time. This reduces the workload and the stress of managing investments, which leaves me in a better frame of mind and seems to also enhance my performance.

I try to buy my dividend stocks when they are value priced. I like dividends but if the stock has a high price-to-earnings ratio, over 20, and a price-to-cash-flow yield over 12, I hesitate to buy.

Many investors fail at stocks because they are continually attempting to time the market but I just keep plugging away trying to find decent companies at decent valuations. I may also be a little more aggressive after big market drops and a little more cautious after big increases.

A big reason why my RRSP has done well is the shift I made into U.S. stocks in the years before 2014, when the Canadian dollar was trading close to par with the U.S. dollar and Canadian companies were selling at premium valuations to U.S. companies due to the resource boom. The weighting toward U.S stocks in our portfolios went to about 70 per cent, which served us well as the U.S. dollar and stock valuations recovered in recent years. I am now inching back toward Canada, despite all of the negativity in Canada.

Diversification is important. In sectors where I don’t feel confident about picking stocks, like gold and emerging markets, I use exchange-traded funds.

Tax efficiency is important, too. I like to minimize withholding taxes on U.S. dividends – I am willing to sacrifice some dividend yield for growth. I also hold U.S. stocks in our RRSPs, which are exempt from the U.S. withholding tax.

 

What was your best move?

One good move was not panicking during bear markets. For example, our TFSA performances are largely due to putting the contributions into the stock market during the bear market in 2009 and over the ensuing years when valuations were depressed.

What was your worst move?

I purchased Seadrill, an ocean driller, after it had declined significantly in 2014. It was making lots of money at the time but had lots of debt and ended up declaring bankruptcy. The enduring lesson was to really watch debt levels of companies in cyclical industries. Seadrill was in my wife’s TFSA, and without it, her performance may have been as good as mine.

This interview has been edited and condensed.

Larry MacDonald is an economist, author and financial writer.

Re-Think What You Thought

Re-Think What You Thought

(Photo courtesy of Pexels) Please share with others on your social media if you find it informative, and if you have read my book please write a review on the site it was purchased. Please have a look at current reviews on Amazon.  Much Appreciated.  The theme […]