(Photo courtesy of Pexels) I am always delighted to get emails from readers and reviews on Amazon or Chapters. I thought I would share a few recent comments as they mirror my objectives with the book and newsletter. The first is on Amazon.com. Most reviews […]
(Photo courtesy of Pexels) Success through simplicity entails buying the right companies and holding them a long time. This significantly reduces stress and workload managing investments, and leads to better outcomes. But do I follow my own advice? My first decade of stock investing had […]
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There has recently been a lot of negativity directed towards the mutual fund and financial advisory industries around performance and fees, partly because of the emergence of Exchange Traded Funds (ETFs) with lower fees. Advisors however rely on mutual fund fees. Clearly my bias is towards taking full control with direct stock ownership. This virtually eliminates fees and if done correctly can enhance performance. It isn’t nearly as difficult as it’s made out to be. However, this isn’t the solution for everyone and many will continue to rely on advisors.
A friend contacted me wondering if I would give him a second opinion on his mutual fund portfolio. He too was concerned about performance and fees. I was hesitant as I am not licensed to provide advice catered to an individual. My work is categorized as “Advising Generally,” which allows writing and speaking to a broad audience. I suggested however comparing his performance to ours to help him evaluate.
My friend’s portfolio performance chart included annual results from 2010 to 2018. Canadian and International balanced funds, which contain both equities and bonds, represented the bulk of the assets. He was thus widely diversified with slightly more equity than bonds. His compound annual growth rate (CAGR) was 5.4% for the nine years. From what I understand, this would be average performance amongst investors. (All calculations were done to present as simple and fair a picture as possible)
To get a broad comparison, I averaged four personal accounts, our two RRSPs and two TFSAs. The CAGR of these accounts calculated to 9.9%. The average of the Canadian and US equity (S&P 500) indexes CAGR was 8.5%. One would certainly expect lower performance from a balanced portfolio than an all equity portfolio, as in theory a balanced portfolio gives up performance but protects the downside in weak years. Did this happen?
The comparison was illuminating to me. I previously believed the theory, but argued that an all equity portfolio performed so much better long-term, especially at today’s interest rates, that it is best to go all equity. This is dependent on a person’s situation, needs and time-runway, but most would benefit from all equities while accepting greater volatility. However, in my friend’s case the balanced approach DIDN’T protect the downside.
In three out of the nine years, equity markets were down. In two out of those three down years, our all equity portfolios outperformed his balanced portfolio. On average, over the three down years, my friend was down 3.2%, whereas my wife and I were down just 1.8%. The equity indexes were negative 4.5%. You could argue he did slightly better than the equity indexes but at what cost?
There were six strong equity years during which my friend averaged a gain of 10.0%, but my wife and I gained 16.4%. The equity markets averaged a gain of 15.7%. Giving up six percent on good years was a huge cost for the questionable downside protection achieved during the poor years.
Perhaps none of the three down years were severe enough to show the true value of a balanced approach. I went to the fund websites and found 2008 in their long-term charts. This was the worst equity year in over 75 years, so a true acid test. On average the balanced funds were down 24.6% whereas our personal all equity RRSPs (TFSAs didn’t exist then) were down 22.5%. The markets were off 35.0%. My equity approach has done comparatively well in difficult years, but is not guaranteed.
I used the “Rule of 72” to calculate the effect of the performance differences. In a 35-year time-frame, my friend would turn $1,000 into $6,400, equity market returns would be $17,600 and my results would be $28,800.
Many will continue to buy mutual funds through financial advisors, which may be best for those who appreciate personal advice and financial discipline. My biggest encouragement is to become educated enough to evaluate performance to help you determine value for fees, which could be two percent annually. It doesn’t have to be an all or nothing. You can work with an advisor on some accounts and on your own for others.
During a 35+ year career in agriculture, Herman VanGenderen became an active investor in stocks and real estate. He writes a monthly newsletter and his book “Stocks for Fun and Profit: Adventures of an Amateur Investor” is available at internet book sites. Visit his website at www.you1stenterprises.com, or email comments and questions to email@example.com.
(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 […]
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 […]
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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.
(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 […]
(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:
- 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.
- 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.
- 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 firstname.lastname@example.org.
(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 […]