All posts by Pat McKeough

How to build the best long-term stock portfolio for retiring in Canada

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Diversification, RRSPs, and compounding interest are important topics for investors building portfolios for retiring in Canada

Long-term stock investment strategies aren’t built to make a fast dollar. They are built to prosper over time, and most important, teach you how to pick the right stocks. Retiring in Canada can be easier if you follow our tips for building a long-term stock portfolio.

Retiring in Canada: Diversify your holdings to create a long-term retirement portfolio

One of our key rules for successful investing is to maintain a diversified stock portfolio. This means spreading your money out across most, if not all, of the five main economic sectors: Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities.

Here are some additional suggestions to prepare investors for retiring in Canada:

  • When it comes to a diversified stock portfolio, stocks in the Resources and Manufacturing & Industry sectors expose you to above-average share price volatility.
  • Stocks in the Utilities and Canadian Finance sectors entail below-average volatility.
  • Consumer stocks fall in the middle, between volatile Resources and Manufacturing companies, and the more stable Canadian Finance and Utilities companies.

Most investors should have investments in most, if not all, of these five sectors. The proper proportions for you depend on your temperament and circumstances.

Conservative or income-seeking investors may want to emphasize utilities and Canadian banks for their high and generally secure dividends.

Long-term value investing is a key part of building a balanced and diversified portfolio

The core of the long-term value investing approach is identifying well-financed companies that are established in their businesses and have a history of earnings and dividends. They are likely to survive any economic setback that comes along, and thrive anew when prosperity returns, as it inevitably does.

When you look for stocks that are undervalued, it’s best to focus on shares of quality companies that have a consistent history of sales and earnings, as well as a strong hold on a growing clientele.

Here are three of the financial ratios we use to spot them:

  • Price-earnings ratios
  • Price-to-sales ratios
  • Price-cash flow ratios

A long-term investment strategy for retiring in Canada maximizes compound interest

Compound interest — earning interest on interest — can have an enormous ballooning effect on the value of an investment over the long-term. It can be considered the mother of all long-term investment strategies. This tip is especially important for young investors to learn. The benefits of this stock trading tip apply to both dividend-paying stocks and fixed-return, interest-paying investments such as 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. 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.

Registered Retirement Savings Plans as an option for retiring in Canada

Registered Retirement Savings Plans, or RRSPs, are a form of tax-deferred savings plan. RRSP account contributions are tax deductible, and the investments grow tax-free. When you begin withdrawing funds from your RRSP, they are taxed as ordinary income. RRSPs are the best-known and most widely used tax shelters in Canada.

Bonus tip: If you’re retiring in Canada soon, you should switch your RRSP to a registered retirement income fund (RRIF)

Why should you switch your RRSP to a registered retirement income fund (RRIF) if you’re retiring soon in Canada: as opposed to other options?

If you have one or more RRSPs, you’ll have to wind them up at the end of the year in which you turn 71. We think converting your RRSP to a RRIF (registered retirement income fund) is the best option for most investors. You have three main retirement investing options:

  • You can cash in your RRSP and withdraw the funds in a lump sum. In most cases, this is a poor retirement investing option, since you’ll be taxed on the entire amount in that year as ordinary income.
  • You can purchase an annuity.
  • Proceed with the RRSP to RRIF conversion.

Converting your RRSP to RRIF is the best retirement investing option for most investors. That’s because RRIFs offer more flexibility and tax savings than annuities or a lump-sum withdrawal.

Like an RRSP, a RRIF can hold a range of investments. One convenient thing to note about the RRSP-to-RRIF conversion process is you don’t need to sell your RRSP holdings when you convert: you simply transfer them to your RRIF.

Retiring in Canada can be easier if long-term strategies are used. Have you employed any short-term investment strategies to prepare for retirement, and if so, how have they performed for you?

If you’ve already retired, what investment tips would you offer to those just planning their retirement finances?

 

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was originally published in 2017 and is regularly updated, most recently on July 10, 2018. It is republished on the Hub with permission. 

Safer investments for Retirees: How to retire with less stress

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Retirement planning is becoming more difficult for Canadians because they’re living longer and need larger retirement nest eggs. This often manifests itself in “pre-retirement financial stress syndrome.” That’s the malady that strikes when it dawns on you that you may not have enough money saved to be able to earn the retirement income stream you were banking on.

To alleviate this worry, we recommend Successful Investors base their retirement planning on a sound financial plan. Here are the four key variables that your plan should address to ensure you have sufficient retirement income:

  1. How much you expect to save prior to retirement;
  2. The return you expect on your savings;
  3. How much of that return you’ll have left after taxes;
  4. How much retirement income you’ll need once you’ve left the workforce.

Note, though, that if you’re heading into retirement and are short of money, you should move your investing in the direction of safer, more conservative investments. That’s a far better option than taking one last gamble.

Moving into “too safe” investments for retirees can sharply cut your long-term returns

This applies as well to “risk-reducing strategies,” of which there are many. One of the most common is the urge to “go into cash” (also known as “taking money off the table”) when you foresee a market downturn. Like all risk-reducing strategies, this one can seemingly work from time to time, by getting you out of the market before a drop. But it’s even more effective at ensuring that you are out of the market when prices are shooting upward.

In the stock market, downturns do come along from time to time. But they are far less common than fears of downturns, which are virtually non-stop.

Safer investments for retirees: How to use RRSPs and RRIFs to add to your long-term investing success

RRSPs (Registered Retirement Savings Plans) are a great way for Successful Investors to cut their tax bills and maximize returns of their retirement investing.

RRSPs are a form of tax-deferred savings plan. RRSP contributions are tax deductible, and the investments grow tax-free. (Note that you can currently contribute up to 18% of your earned income from the previous year. March 1 is the last day you can contribute to an RRSP and deduct your contribution from your previous year’s income.)

When you later begin withdrawing the funds from your RRSP, they are taxed as ordinary income.

If you want to pay less tax on dividends, interest and capital gains while you’re still working, investing in an RRSP is the way to go.

Converting your RRSP to a RRIF is clearly one of the best of three alternatives at age 71. That’s because RRIFs offer more flexibility and tax savings than annuities (see the pros and cons of annuities at TSI Network) or a lump-sum withdrawal (which in most cases is a poor retirement investing option, since you’ll be taxed on the entire amount in that year as ordinary income).

Like an RRSP, a RRIF can hold a range of investments. You don’t need to sell your RRSP holdings when you convert—you just transfer them to your RRIF.

Safer investments for retirees should assume conservative yield estimates to account for unforeseen setbacks

As for the return you expect from investing for retirement, it’s best to aim low. If you invest in bonds, assume you will earn the current yield; don’t assume there will be increases in the value of the bonds.

Over long periods, the total return on a well-diversified portfolio of high-quality stocks runs to as much as 10%, or around 7.5% after inflation. Aim lower in your retirement planning — 5% a year, say— to allow for unforeseeable problems and setbacks.

Above all, it’s important to remember that while finances are important, the happiest retirees are those who stay busy. You can do that with travel, golf or sailing. But volunteering, or working part-time at something you enjoy, can work just as well.

One thing we encourage all Successful Investors to do is perform a detailed study of how you spend your money now. Then, you analyze your findings to see what personal expenses you can cut or eliminate. This too can have fringe benefits, especially if it helps you break unhealthy habits. You may be surprised at how much you’re spending and how much more you could be saving for retirement.

Do you believe in safer investments? What do you consider a type of safe investment?

What kind of investments do you have in place as part of your retirement plan?

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was last published on Sept. 18,  2018 and is republished on the Hub with permission.  

The hidden dangers of online trading

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It doesn’t get as much play in the media as it did a decade ago, but even in the volatile market of 2018, online trading carries hidden dangers that aren’t always evident at first.

The main risk comes from the fact that online trading may seem deceptively easy. The lower costs and higher speeds of online trading can lead otherwise conservative investors to trade too frequently. That can lead you to sell your best picks when they are just getting started.

The apparent ease of online trading may even prompt conservative investors to take up short-term trading or day trading. That’s just another danger of trading stocks online: there’s a large random element in short-term stock-price fluctuations that you just can’t get away from.

Lower costs attractive, but Investment Quality makes money

This random element can be profitable for short periods. But you can’t reliably profit from it over the long term. In fact, most short-term traders wind up losing money. By the time their beginners’ luck fades, many are trading in dangerously large quantities.

Frequent trading can also lead you to buy lower-quality, thinly traded stocks. The danger arises from the fact that the bid and ask spreads of many of these investments can be so wide that the share price will have to go up significantly before you’ll even begin to make money on a sale.

You can make trades quickly in online trading, and that cuts your commission costs. However, for successful investors, this is a bonus, not the object of trading stocks.

It is far more important to focus on high-quality, well-established companies and how they fit in your portfolio. The longer you hold these stocks, the greater the chance that your profits will improve, as well.

Here are two other dangers to avoid in online trading. Both can seriously hurt your long-term returns:

1.) Practice accounts can breed false confidence

Some investors are nervous about trading stocks online. So, instead of jumping right in, they start off by using the “practice accounts” or “demo accounts” that the online brokerage industry initiated several years ago. Practice accounts are supposed to be identical to real accounts in all but one respect: you buy stocks in them with imaginary or “play” money, rather than the real thing.

The brokerage industry says this gives would-be traders a free opportunity to learn how to trade online without risking any money. Using an online broker’s practice account, you can learn online trading essentials, such as how to enter an order to sell or buy stocks; how to double-check your order before submitting it, so you avoid obvious but common mistakes, like buying 10,000 shares when you only meant to buy 1,000; and so on. The big risk with practice accounts is that you’ll try out a risky and ultimately unwinnable investment approach, like day trading or options trading, and hit a lucky streak. This could embolden you to put serious money at risk just when your results are about to regress to the mean. This will deliver losses instead of profits.

2.) Automated stock-picking systems can backfire

Some investors who trade stocks online use automated stock-picking systems to help them make investment decisions. These systems are typically marketed with impressive-looking performance records designed to make investors think they are sure to make guaranteed profits. However, those records are typically derived by “back-testing” the program against past data. In other words, the promoters go back through old trading records and see what would have worked in the past.

Automated stock-picking systems essentially do two things: First, they narrow down the data you use when you make investment decisions. Second, they apply a fixed rule, or rules, to draw a conclusion or an investment decision from that selection of data. Unfortunately, the market’s key concerns continually change. Today’s good investments can turn into tomorrow’s dead ends. For a time, these systems seem to work, but that’s usually coincidental. If the market is going up and the system tells you to buy volatile investments, it automatically generates profitable trades. But they can just as quickly turn around and begin pumping out unprofitable trades. Often this happens just when they can do the most damage to the investor relying on the system.

Bonus Tip: Building a “Buy and watch closely” portfolio

Of course, there are a variety of ways to build an investment portfolio. Some work better than others. But our Buy and watch closely approach has done well for our portfolio management clients over the past few decades. We recommend this approach for our readers as well.

We start by applying our three-part Successful Investor rule for portfolio construction:

  1. Invest mainly in high-quality, well-established companies, with a history of earnings if not dividends;
  2. Diversify across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; Utilities);
  3. Downplay or stay out of stocks that are in the broker/media limelight. This limelight raises investor expectations to dangerous levels. When stocks fail to live up to those heightened expectations, share-price slumps can be swift and brutal.

We advise selling particular stocks when we feel the situation has changed and they no longer qualify as high-quality investments. We also sell if we decide that a stock isn’t as high-quality or well-established as it needs to be, to cope with the challenges it faces. Of course, many of our sales are due to a successful takeover of a company’s stock, which generally results in a major profit for our clients.

Pat McKeough has been one of Canada’s most respected investment advisors for over three decades. He is the founder and senior editor of TSI Network and the founder of Successful Investor Wealth Management. He is also the author of several acclaimed investment books. This article was originally published in 2012 and is regularly updated, most recently on July 9, 2018. It is republished on the Hub with permission. 

 

Using bonds for retirement will hurt your retirement income

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Senior couple trying to figure out tax declaration

As some investors near retirement, their advisors recommend switching to bonds and other fixed-income investments for their retirement investments instead of holding stocks or ETFs.

To some extent, this is an understandable retirement investing strategy, since bonds can provide steady income and a guarantee to repay their principal at maturity.

Bonds will lower the long-term returns that are key to successful retirement investing

Unfortunately, using bonds for retirement may not be the best strategy. Bond prices will likely fall over the next few years because interest rates are likely to rise. Bond prices and interest rates are inversely linked. When interest rates go up, bond prices go down, when interest rates go down, bond prices for up.

Bonds have been in a period of rising prices (a bull market) more or less since 1981. That year, long-term interest rates reached an historic turning point when long-term U.S. Treasury bond yields peaked near 15%. Ever since, interest rates have gone through wide fluctuations, but they have essentially headed downward.

Today, interest rates just don’t have that much further to fall. But under certain conditions, interest rates could go substantially higher. Remember, as mentioned, when interest rates go up, bond prices drop.

Even so, brokers continue to sell bonds to their clients. That’s partly because most of today’s brokers had not yet entered the investment business when the bull market in bonds began in 1980. All they know is that bonds do tend to reduce the volatility of your portfolio, since they tend to rise when stock prices fall. Of course, bonds also generate more commission fees and income for the broker, compared to stocks, especially if you buy them via bond funds and other investment products.

That’s why we continue to recommend that you invest only a small part of your portfolio—if any—in bonds and fixed-income investments. Instead, you should aim for a diversified portfolio of well-established companies with long histories of dividends, or ETFs that hold these stocks. We recommend a number of stocks and ETFs appropriate for retirement investing in our Canadian Wealth Advisornewsletter.

We recommend this retirement investing strategy because equities are bound to be more profitable than bonds for retirement over long periods. That’s because equity returns are related to business profits, while returns on fixed-return investments are related to business interest costs.

Bonds and other fixed-return investments can add stability

Returns on your stocks are sure to be more volatile than what you earn on fixed-return investments (that includes short-term bonds). That’s because returns on stocks are related to the part of gross profit that’s left over after a company pays its interest costs. Continue Reading…

Stock portfolio management and planning for your Heirs

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Our work with stock portfolio management clients sometimes gives us a window into problems that can arise with the death of parents and the distribution of their personal belongings and financial assets.

For instance, siblings may assume they were supposed to get particular items of jewelry or furniture. When they learn that somebody else asked first, they can harbour a grudge that can last for decades.

Planning for your heirs: Head off sibling conflict with frank discussions

The best way to spare your family this problem is to head it off while you’re still alive. Tell your kids that you want to be fair to everybody. Ask them to send you a note or an email to express interest in any particular article. But don’t put too much emphasis on who asked first, and don’t feel you need to rush into making a list of who gets what. Some of your children may be slow to think of what items matter most to them. Or they may feel shy about asking for them.

Everybody should understand that if one child gets valuable household items from the estate, they may wind up receiving less cash.

Unpaid loans from parents can also cause dissension. Sometimes adult children run into money problems and wind up having to sell their home, for instance. Later, they may want to borrow the down payment to buy another home. If you grant that request, don’t simply write a cheque.

Instead, have a lawyer register a mortgage on the new home for the full amount of the loan. Explain to your child that this protects the money from attachment by creditors if new money problems come along, and keeps it in the family. You should also be aware (no need to mention it to your child) that this step also keeps the money in the family in the event of divorce.

Dissension can also arise when a child stays in the family home long after his or her siblings have moved out. Living at home and taking care of a parent can hold a child back from career advancement, and may get in the way of the child’s social or romantic life. But siblings may see it as simply taking advantage of free room and board. If you think it’s appropriate, you may want to add a line or two in your will that acknowledges the personal contribution of the stay-at-home child.

It’s hard to avoid all tension that grows out of these all-too-human conflicts. But if you think about them and talk about them with your children, things will go much more smoothly than if you leave them for the kids to sort out on their own.

Planning for your heirs: Invest based on your heirs’ timelines

If you have substantially more money than you’ll need for the rest of your life, and you plan to leave the excess to your heirs as part of your retirement planning, it makes sense to invest at least part of your legacy on their behalf. That is, invest based on their time horizon, not yours. And above all, choose investments with our Successful Investor philosophy in mind.

For instance, if your heirs are in their 40s, your retirement planning should involve holding at least part of your portfolio in a selection of investments that would suit investors in their 40s, and that follow our Successful Investor approach. Of course, you’d still want to invest conservatively. But you’d want to take advantage of the many years that 40-somethings have till they reach retirement age. Continue Reading…