All posts by Pat McKeough

How Real-Return Bonds compare to Regular Bonds

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ultimate guide to bonds

Real-return bonds pay a return adjusted for inflation. But when you buy a real-return bond, you are only protecting yourself against unanticipated rises in inflation.

Real-return bonds pay you a rate of return that’s adjusted for inflation, but that’s not always as promising as it seems.

When a real-return bond is issued, the level of the consumer price index (CPI) on that date is applied to the bond. After that, both the principal and interest payments are typically adjusted every six months, upwards or downwards from that base level, to compensate for a rise or fall in the CPI.

Look at this theoretical example to understand how a real-return bond works

The Bank of Canada issues $400 million of 30-year bonds maturing on December 1, 2049. The bonds have a coupon, or interest rate, of 2%.

If after six months from the date of issue, the new CPI level is, say, 1% above the level of the CPI on the issue date, then each $1,000 of bond principal is adjusted to $1,010 of bond principal ($1,000 x 1.01). The semi-annual interest payment is then $10.10 ($1,010 x 2% / 2).

If after 12 months, the level is 2% higher, then the bond principal is adjusted to $1,020 ($1,000 x 1.02), and the interest payment rises to $10.20 ($1,020 x 2% / 2).

Consider these three important factors to realize benefits with real-return bonds

  1. The price you pay for real-return bonds reflects the anticipated rate of inflation. In other words, if investors feel that inflation will rise 2% over the long term, the price of the bond will reflect that future inflation increase and its effect on the bond’s principal and interest payments. So, when you buy a real-return bond, you are only protecting yourself against unanticipated rises in inflation.
  2. When the inflation rate falls over a six-month period, the principal and interest payments of a real-return bond fall. In times of deflation, the inflation rate turns negative. In a prolonged period of deflation, the principal of a real-return bond could fall below the purchase price. Interest payments would fall, as well.
  3. As with regular bonds, holders of real-return bonds must pay tax on interest payments at the same rate as ordinary income. That income gets taxed at the investor’s marginal rate. In addition, holders of real-return bonds must also report the amount by which the inflation-adjusted principal rises each year, as interest income, even though you won’t receive that amount until the bond matures. That amount is added to the bond’s adjusted cost base.

If the CPI level falls, that reduces the inflation-adjusted principal. You deduct the amount of that reduction from your taxable interest income that year, and also subtract it from the adjusted cost base.

Download this free report to learn more about how to profit from stock investing.

Find out how real-return bonds compare to regular bonds and if they make better additions to your portfolio

In simple terms, a bond is a form of lending whereby you lend money to a corporation or government. In return, a bond pays a fixed rate of interest during its life. Eventually, a bond matures, and holders get the bond’s face value—but nothing more. Receiving the fixed interest and face value at maturity is the best that can happen. Note, though, that in some cases, corporate bonds can go into default. As well, inflation can devastate the purchasing power of bonds and other fixed-return investments.

Furthermore, bonds also generate more commission fees and income for your broker, compared to stocks, especially if you buy them via bond funds and other investment products. Continue Reading…

Short-term Investment Decisions can hurt your Long-Term Portfolio Returns

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While short-term investment decisions can look like the best way to profit in the stock market, we feel that a better strategy by far is to buy top-quality stocks: stocks that will gradually accumulate stock market profits over decades.

And because you’re investing for a long period of time, short market fluctuations will have very little effect on long-term gains. That makes for a less stressful term 30 (not to mention successful) investment strategy.

Short-term investment decisions can lead to premature selling

There is no denying the immediate appeal of taking a fast profit. However, most successful investors find over long periods that much of their profit comes from a handful of their best investments: stocks that went up much more than they ever expected. If you are too quick to take profits, you’ll wind up selling your best picks when they are just beginning to rise.

Even the best short-term investment decisions will cause you to miss out on the benefits of compounding

Compound interest — earning interest on interest — can have an enormous ballooning effect on the value of an investment over the long term, and lift the overall returns on your portfolio.

This compounding principle applies to equity investments like stocks, not just to fixed-return, interest-paying investments like bonds. When you earn a return on past returns (including reinvested dividends), the value of your investment will grow more quickly. Instead of rising at a steady rate, the number of dollars in your portfolio will grow at an accelerating rate.

Additionally, you can’t expect to earn an outsized return on a risky investment in your portfolio indefinitely. Instead, focus on making steady gains over time with mostly conservative, dividend-paying stocks.

Making short-term investment decisions that cause you to miss out on big gains

To succeed as an investor, you need to get used to the idea that short-term declines come along unpredictably. And just as important, you need to be careful that those short-term fluctuations don’t prompt you to make ill-advised short-term investment decisions—decisions like getting out of the market in anticipation of a further decline and then missing out on a big rebound.

Before making short-term investment decisions, remember that the highest long-term returns will come from following our three-part Successful Investor approach

  1. Invest mainly in well-established, dividend-paying companies;
  2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities);
  3. Downplay or avoid stocks in the broker/media limelight.

Bonus tip: Short selling is one of the short-term investment decisions that we think will cost you money

Short selling stocks involves selling borrowed shares in hopes of a drop in price. We advise against this strategy, mainly because of the perennial drawbacks of short selling. Continue Reading…

5 powerful long-term investment strategies for higher returns

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Here are five long-term investment strategies that we are certain will enhance your long-term investment results. They’ve long been part of the advice we give in our investment services and newsletters, including Canadian Wealth Advisor, our advisory for conservative investing.

1.) No stock can ever be so undervalued or desirable that it overcomes a lack of integrity on the part of company insiders

We’ve always believed that investors should sell a stock if they have any doubts about the integrity of the people who are in charge of the company. In other words, if you think a company is run by crooks, you should sell the stock right away, no matter how attractive it seems as an investment.

However, to enhance your long-term returns, not just avoid loss, you need to apply this tip in a moderate fashion. You need to distinguish between lack of integrity on the one hand, and naivete or poor judgment on the other. Many public companies unintentionally run afoul of tax rules or regulatory decisions, for instance. If you take that as a sign of low integrity, you can wind up selling sound investments at market lows.

2.) Compound interest — earning interest on interest — can have an enormous ballooning effect on the value of an investment over the long-term

Compound interest can be considered the mother of all long-term investment strategies. This tip is especially important for young investors to learn. This stock trading tip’s benefits apply to both stock and fixed-return, interest-paying investments like bonds. When you earn a return on past returns, the value of your investment can multiply. Instead of rising at a steady rate, the number of dollars in your portfolio will grow at an accelerating rate.

To profit from this tip, you need to pay attention to steady drains on your capital, even seemingly small ones: like high brokerage commissions, say. If you’re losing (or missing out on a profit of) even 1% a year, it can have an enormous draining effect on your investments over a decade or two.

3.) As a group, investment long shots are overpriced

If you have nothing but long shots in your portfolio, you are likely to make meagre returns or lose money over long periods, rather than making the high returns you seek. That’s why you need to be particularly cautious and selective when adding anything to your portfolio that offers the potential of high returns. Continue Reading…

11 tips successful investors use to find TSX Blue-chip stocks

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TSX blue-chip stocks are well-established companies with attractive business prospects on the Toronto Stock Exchange, like Bank of Montreal (TSE: BMO), RioCan Real Estate Investment Trust (TSX: REI.UN), and Enbridge (TSE: ENB).

Well-established firms have the asset size and the financial clout — including solid balance sheets and strong earnings and cash flow — to weather market downturns or changing industry conditions.

The best TSX blue-chip stocks have strong positions in healthy industries. They also have strong management that will make the right moves to remain competitive in ever-changing marketplaces. Blue-chip investments should always be prominent, if not dominant firms, in their industry.

True Blue Chips pay off

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Because of this, blue-chip companies can give investors an additional measure of safety in today’s volatile markets. And the best ones offer an attractive combination of moderate p/e’s (the ratio of a stock’s price to its per-share earnings), steady or rising dividend yields (annual dividend divided by the share price) and promising growth prospects.

We feel most investors should hold the bulk of their investment portfolios in TSX blue-chip stock investments. All these stocks should offer good “value”: that is, they should trade at reasonable multiples of earnings, cash flow, book value and so on. Ideally, they should also have above average-growth prospects, compared to alternative investments.

11 tips for picking the best TSX blue chip stocks:

1.) Review the company’s finances going back 5 to 10 years. The types of blue-chip investments we recommend have a history of profits going back for at least that long. Companies that make money regularly are safer than chronic or even occasional money losers. Continue Reading…

How to cut your tax on capital gains — and keep more of your money working for you

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In Canada, tax on capital gains is at a lower rate than tax on interest. You can take advantage of that — and substantially cut your tax bill — by structuring your investments so that more of your income is in the form of capital gains.

(Our free report, “Capital Gains Canada: 7 Secrets for Managing Your Canadian Capital Gains Tax Liabilities,” is packed with simple strategies you can use to shift more of your income to capital gains.)

You have to pay tax on capital gains, specifically on the profit you make from the sale of an asset. An asset can be a security, such as a stock or a bond, or a fixed asset, such as land, buildings, equipment or other possessions. However, you only pay tax on capital gains on a portion of your profit. The “capital gains inclusion rate” determines the size of this portion.

About 20 years ago, the Canadian government cut the capital gains inclusion rate from 75% to 66.6% and, within a few months, to 50%. This cuts tax on capital gains, and had the effect of lowering the overall rate you pay on capital gains to one-half of what you would pay on income or interest.

By The Numbers: Tax On Capital Gains

For example, if you buy stock for $1,000 and then sell that stock for $2,000, you have a $1,000 capital gain (not including brokerage commissions). Continue Reading…