December ignites the spirit of giving and most affluent Canadians are continuing to spread the wealth, despite the current economic climate.
A survey conducted by Pollara Strategic Insights on behalf of IG Private Wealth Management found that 96 per cent of high-net-worth Canadians (those with at least $1 million in investible assets) give to charities, with more than half (57 per cent) stating that the volatile economy will not impact their philanthropic priorities. However, only 26 per cent have a charitable giving strategy.
There’s good reason to give, particularly at year’s end, as many can pair supporting the causes they care about with financial incentives. However, with increased capital comes complexity – it’s important that wealthy Canadians speak with a financial advisor to understand when, and how, to give to maximize the benefits for themselves and the causes they champion.
A carefully constructed giving strategy can enhance tax efficiency and optimize the impact of donations. Below are three key considerations to keep in mind when making a charitable donation:
Tax benefits
Prior to making a gift, it’s helpful to understand the tax benefits associated with your donation. An organization can issue a tax receipt following a donation if it meets the criteria under the Income Tax Act.
A charitable donation claimed personally on your tax return generates non-refundable donation tax credits. The value of these credits reduces the taxes you owe.
When claiming donation tax credits on your tax return, the credit rate you receive and amount of tax savings for each dollar donated will depend on your specific circumstances. The value of the donation tax credit is determined by the amount of donations you wish to claim, your taxable income level, and your province or territory of residence.
If this is a high-income year, it may be beneficial to increase donations in the year to take advantage of the potentially higher donation tax credit rates available to you.
Deciding what to give
Your donation decision should align with your overall financial plan – when deciding on the amount to give, consider your short- and longer-term goals, retirement and estate plan. Continue Reading…
Most posts about legacy, wills, and estate planning focus on how to settle your estate afteryou pass: ensuring your intentions are met, your family is cared for, charitable gifts are fulfilled, taxes are minimized, and so on.
Estate planning is important; we help clients with it all the time. But today, I’d like to offer a valuable twist on the theme of estate, life, and legacy planning:
Instead of your excess wealth being distributed after you die, you may find even greater value in giving some of it away while you’re still around.
Properly managed, making gifts and charitable donations while you’re alive can offer solid tax-saving benefits to you and your estate financial planning. In particular, targeted charitable giving can be a powerful tool for business owners and similar professionals who are approaching retirement and facing high-tax events, such as selling their business, or exercising highly appreciated stock options.
As importantly, it can be incredibly rewarding to witness the results of your generosity. Don’t underestimate the value this intangible benefit can add to your life and legacy planning.
Legacy Planning for Quality Living
First, what is “excess wealth?” Is there such a thing as too much money??? Not really.
This is where legacy planning is essential. If you’re thinking about spending, gifting, or donating significant wealth, don’t just guess at the dollar amounts. Instead, you and your financial advisor should periodically crunch the numbers to determine how much you and your loved ones conservatively need to remain well-positioned, even under worst-case scenarios (such as, say, a global pandemic).
After that — if you and your loved ones are indeed set for life — any extra resources become the financial equivalent of gravy on your entrée. How will you use your excess wealth to add flavour to your life and to the lives of others so that you are leaving a legacy you can be proud of?
An anecdote about Lifetime Charitable Giving
To envision what it would be like to make one or more significant charitable donations during your lifetime, consider the story of “John and Jane,” an earnest couple in their 60s who came to me for advice a few years ago. John came from meager roots, but he was determined to make his own way. With a boost from some financial aid, he put himself through college, where he met Jane. Together, they worked hard, scrimped and saved, and raised two kids. Along the way, John started his own business, which prospered.
Fast forward to 2020, when John was able to sell his business for a substantial sum of money. After we ran all the numbers, it was clear he, Jane, and even their kids would be able to live comfortably for their remaining days. Both personally and in a holding company, the couple also owned some taxable investments that had appreciated nicely.
So far, so good. However, there was one challenge (even if it was a nice “problem” to have): even with extensive planning in the anticipation of an eventual sale (purified operating company, multiplying the lifetime capital gain exemption, etc.), the business buy-out would generate hundreds of thousands of dollars in taxes in the year of the sale. As the saying goes, when you’ve incurred taxable gains, you can choose who’s going to benefit the most from the taxable portion: the government, or your favorite charities. I suggested to John and Jane, they could reduce their taxes owed in the year of the sale by instead fulfilling some of their existing charitable intents that same year.
To manage the significant donation they had in mind, we established a Donor-Advised Fund (DAF) in their name. They then donated into their DAF an equal amount to the taxes incurred from the sale of John’s business. This helped them accomplish several goals:
They were able to fully offset the taxable buy-out gains with their charitable contribution.
John was able to fulfill a lifelong dream by using some of the DAF assets to establish a scholarship at his alma mater. By doing so during his lifetime, he has been able to see others benefiting from a solid education, just as he had when he was young. On a personal level, he and Jane have found the experience highly rewarding.
Moving forward, they can donate highly appreciated assets to their DAF to wash away those gains as well.
A DAF offers a few other benefits as well. For example, you can direct how to invest undistributed DAF dollars in the market, potentially increasing your giving power over time. You can also keep your charitable giving anonymous if you’re so inclined. Continue Reading…
According to Warren Buffett, “Price is what you pay. Value is what you get.”
The cyclically adjusted price-to-earnings ratio, commonly known as CAPE, is a valuation measure invented by Nobel Prize recipient Robert Shiller. It is calculated by taking the price of an index and dividing it by its average earnings over the past 10 years, adjusted for inflation. The ratio’s use of average earnings over the last decade helps to smooth out the impact of business cycles and other events and thus provides a better picture of a market’s sustainable earnings power.
The CAPE ratio is commonly used to gauge future returns over medium to long-term horizons. In theory, higher than average CAPE levels imply lower than average future returns, while their lower counterparts suggest that future returns will be relatively high.
In the following piece, I analyze historical data to determine if the CAPE ratio has been a useful predictor of future real (i.e., after inflation) returns. In my view, including real rather than nominal returns is appropriate given the recent resurgence of inflation. Investors must be mindful of inflation’s potential to erode a substantial portion of their portfolios’ purchasing power. Lastly, I comment on what investors can expect going forward given the current CAPE level.
The following table presents average real future returns following various CAPE ranges.
S&P 500 Index: Average Real Returns Sorted by CAPE Ratio (Jan. 1970 – Nov. 2022)
There has been an inverse relationship between CAPE ratios and future returns. When the CAPE ratio has been near the high end of its historical range, future returns have tended to be relatively low. Conversely, low CAPE ratios have tended to foreshadow higher returns. Whereas this relationship has not been statistically significant over shorter holding periods, it has been strong over the medium to long-term.
When CAPE ratios have been below their historical average of 21, annualized real returns over the subsequent five years have averaged 8.3%, as compared to only 3.3% when CAPE ratios have stood above this level. The corresponding numbers for 10 year holding periods have been 8.8% vs. 4.2%.
The difference in average returns cannot be understated. On a $10 million investment over 5 years, the difference in return equates to a real value of $14,922,900 vs. $11,754,768. Adding in the average inflation rate since 1970 of 4.04%, the corresponding nominal values have averaged $17,920,804 vs. $14,240,696.
Over ten-year holding periods, the average real values of a $10 million investment made when CAPE levels were below vs. above average were $23,290,712 and $15,137,096, respectively. After adding back the post-1970 average inflation levels of 4.04%, these figures rise to $33,533,809 and $22,140,747.
These differences, although significant, represent the divergence in average returns during times when CAPE ratios have been merely above or below average. As the table above demonstrates, the difference in returns following investments made in very low vs. very high CAPE environments has been far greater.
Explaining the Anomalous “Bump”: Where Behavior Confounds Theory
Although low CAPE levels have been associated with higher future returns, and vice versa, the relationship is far from perfect across different CAPE ranges. Specifically, there is an anomalous “bump” whereby future returns for the 20-25 CAPE range have been nearly as high or higher than those that have followed any other CAPE level.
My best guess is that this peculiarity relates to human psychology and behavior. Historically, when stocks have risen for an extended period following a bear market, investors have been increasingly willing to believe that “it’s different this time” and that the good times will continue indefinitely. At these times, FOMO (fear of missing out), greed, and momentum have taken center stage until valuations reached levels which all but guaranteed a catastrophe.
Greed, Fear, & Where we Stand Today
The above relationships are a powerful representation of investor psychology. Historically, when the crowd’s greed manifests in lofty stock valuations, future returns have tended to be anemic. On the other hand, when widespread skepticism and despondency have caused earnings to go on sale, above average returns have tended to ensue. Alternately stated, investors would be well-served to follow Buffett’s advice to be “fearful when others are greedy, and greedy when others are fearful.”
Recent market malaise notwithstanding, stocks remain overvalued by historical standards. Taking the most recent data available, the CAPE ratio currently stands at 27.42, which is 30% higher than its historical average since 1970. This CAPE level implies real annualized returns over the next five years of 3.6%, which is approximately 50% lower than the 6.9% average that has prevailed since 1970. Over the next ten years, the implied real rate of return is 4.3% as compared to a historical average of 6.6%.
When the Going Gets Tough, the Tough get Tactical and Seek Dividends
Over five decades spanning January 1970 to December 2019, the two worst periods for the S&P 500 Index were the 1970s and the 2000s. Continue Reading…
Investors may see key improvements in conditions in the capital markets and the wider economy in 2023 and beyond, according to the Capital Market Expectations (CMEs) from Franklin Templeton Canada. We presented our CMEs at Franklin Templeton’sGlobal Investment Outlook in Toronto on December 6.
We develop a proprietary set of CMEs annually, using top-down fundamental and quantitative research. Using an outlook for the next seven to 10 years, we review the expected returns and risk of investable asset classes: equities, fixed income, alternatives and currencies. Our economic outlook and 10-year asset class forecasts are driven by macro expectations, current valuations and various asset class assumptions. The CMEs are annualized 10-year return expectations, and they are intended to coincide with the average length of a business cycle and are aligned with the strategic planning horizon of many institutional investors.
Our process also considers long-term macroeconomic themes to complement the objectivity of our quantitative analysis. This year, we factored in three major themes:
Growth: We expect to see moderate growth in the next phase of the economic cycle, driven by advances in technology and increasing productivity. Demographics will likely be a slight headwind to growth as populations in developed markets age.
Inflation: Inflation is expected to remain slightly higher than the targets established by central banks over the medium term. Rising wages and energy prices are sticky aspects of inflation.
Fiscal and monetary policy: Central banks, including the Bank of Canada, will keep up their aggressive fight against high inflation. Not surprisingly, this will hamper economic growth. On the other hand, we expect fiscal policy by governments to remain accommodative. Fiscal policy can result in higher government debt, which can be inflationary. But if government stimulus targets, say, capital projects such as infrastructure, then it can be beneficial to long-term growth. Policymakers are walking a tightrope now.
Capital Market Expectations
With that background, here is a concise summary of our expectations over the next several years:
The expected returns for fixed income assets, like bonds, have become more attractive. We also expect the recent volatility in fixed income markets to subside.
The returns of global equities are expected to revert to their longer-term averages and outperform bonds.
Stocks in Emerging Markets are expected to outperform developed market equities over the next seven to 10 years.
A diversified and dynamic approach to investing is the most likely path to achieving stable returns over the long run.
The chart below sets out our range of expectations for key assets compared to historical averages:
Note that these return projections are higher than our 2022 outlook and are closer to their long-term averages.
Franklin Templeton Canada uses its CMEs to shape strategic asset allocation for our portfolios. However, we do not just “set it and forget it”. We employ a dynamic asset allocation process over the shorter-term, taking into account market conditions. While we are optimistic over the next decade that returns will favour risk assets, our short-term preference (next 12 months) is to be cautious as recession risks rise. Continue Reading…
Rising interest rates are causing a lot of unhappiness among bond investors, heavily-indebted homeowners, real estate agents, and others who make their livings from home sales. The exact nature of what is happening now was unpredictable, but the fact that interest rates would eventually rise was inevitable.
Long-Term Bonds
On the bond investing side, I was disappointed that so few prominent financial advisors saw the danger in long-term bonds back in 2020. If all you do is follow historical bond returns, then the recent crash in long-term bonds looks like a black swan, a nasty surprise. However, when 30-year Canadian government bond yields got down to 1.2%, it was obvious that they were a terrible investment if held to maturity. This made it inevitable that whoever was holding these hot potatoes when interest rates rose would get burned. Owning long-term bonds at that time was crazy.
One might ask whether we could say the same thing about holding stocks in 2020 when interest rates were so low. The answer is no. Bond returns are very different from stock returns in terms of unpredictability. We use bond prices to calculate bond yields; one is completely determined by the other. The situation is very different with stocks. Even when conditions don’t look good for stocks, they may still give better returns than the interest you’d get if you sold them to hold cash. All the evidence says that most investors are better off not trying to time the stock market.
Most of the time, investors are better off not trying to time the bond market either. However, the conditions in 2020 were extraordinary. Long-term bonds were guaranteed to give unacceptably low returns if held to maturity. This was a perfectly sensible time to shift long-term bonds to short-term bonds or cash savings.
Houses
The only way house prices could rise to the crazy heights they reached was with interest rates so low that mortgage payments remained barely affordable. Fortunately, the government imposed a stress test that forced buyers to qualify for a mortgage based on payments higher than their actual payments. This reduced the damage we’re starting to see now. Unfortunately, there is evidence that some homeowners faked their income (with industry help) so they could qualify for a mortgage. This offset some of the good the stress test did. Continue Reading…
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