Debt & Frugality

As Didi says in the novel (Findependence Day), “There’s no point climbing the Tower of Wealth when you’re still mired in the basement of debt.” If you owe credit-card debt still charging an usurous 20% per annum, forget about building wealth: focus on eliminating that debt. And once done, focus on paying off your mortgage. As Theo says in the novel, “The foundation of financial independence is a paid-for house.”

Tax Strategies to Boost your Financial Savings

Posted By Financial Independence Hub | September 3, 2021

By Steve Lowrie, CFA

Special to the Financial Independence Hub

Today’s Simple Investing Take-Away: Your tax planning strategy should take a holistic, tax-efficient investing stance in both tax-sheltered and taxable investment vehicles to optimize saving for the future.

Does it bug you to pay more taxes than you need to? I don’t think I’ve ever met anyone eager to shell out extra money, just in case the government could use more. But practically speaking, that’s exactly what you end up doing if you don’t build tax-efficient investing and other tailored tax strategies into your ongoing financial planning.

Are you:

A young professional, aggressively saving for a distant future?
A seasoned business owner, managing substantial financial savings
Starting to spend down your assets in retirement?
Planning for how to pass your wealth on to your heirs?

Regardless, there are many best practices for maximizing your after-tax returns—i.e., the ones you get to keep. Today, let’s cover what some of those sensible tax strategies look like.

Fill up your Tax-Sheltered Accounts

The government offers a number of “registered” investment accounts to provide various types of tax-efficient investing incentives. They want you to save for retirement and other life goals, so why not take them up on the offer? Two of the big ones are the Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA).

Saving for Retirement with Your RRSP

As the name suggests, your RRSP is meant to provide tax-efficient investing for retirement. In the years you contribute to your RRSP, you receive a deduction on your tax return in equal measure. Then the proceeds grow tax-free. Once you withdraw RRSP assets in retirement, you pay income tax on them.

In theory, your tax rate is often lower once you retire, so you should ultimately pay fewer taxes on taxable income. Even if there are some retirement years when your tax rates are higher, you’ve still benefited from years of tax-free capital growth in an RRSP. And you still have more flexibility to plan your RRSP withdrawals to synchronize with the rest of your tax planning.

Bonus tips: If you’re a couple, you may also consider using a spousal RRSP to minimize your household’s overall tax burden. This works especially well if one of you generates a lot more income than the other. There also are specialized guidelines to be aware of if you’re a business owner considering how to most tax-efficiently draw a salary and participate in the Canada Pension Plan (CPP).

Saving for the Future with Your TFSA

TFSAs are meant to be used for tax-efficient investing toward any mid- to long-term financial goals. So, at any age, most taxpayers are well-advised to fill up their TFSA space to the extent permitted. You fund your TFSA with after-tax dollars, which means there’s no immediate “reward” or deduction on your tax return in the year you make a contribution. But after that, the assets grow tax-free while they’re in your TFSA, and you pay no additional taxes when you withdraw them, which you can do at any time.

Bonus tip: Too often, people leave their TFSA accounts sitting in cash, using it like an ATM machine. Unfortunately, this defeats the purpose, since you lose out on the tax-free gains you could expect to earn by investing that cash in the market. How much is tax-efficient investing worth? In “Cash is not king: A better investment strategy for your TFSA,” I offer some specific illustrations.

Manage your personal Tax Planning like a Boss

Once you’ve filled your tax-sheltered accounts, you can invest any additional assets in your taxable accounts.

Like hard-working “employees,” these assets can thrive or dive depending on their management. Think of it this way: As a business owner, you wouldn’t hire a promising team of talented individuals, only to assign them random roles and responsibilities. Likewise, your various investments and investment accounts have unique qualities worth tending to within your overall tax-efficient investing. Let’s cover a few of them here.

Capital Gains Reign

In your taxable accounts, your best source of tax-efficient investing income comes in the form of capital gains or even better, deferred/unrealized capital gains. This is super important, but often forgotten in the pursuit of sexier trading tactics, like chasing hot stocks or big dividends. (It’s popular to think of dividends as a great source of dependable income in retirement, but in “Building your financial stop list: Stop chasing dividends,” I explained why that’s mostly a myth.)

Don’t believe me? Consider these 2021 combined tax rates for Ontario on various sources of investment income:

Taxable Income Source

2021 Combined Tax Rate

Interest and other income

53.53%

Eligible dividends (mostly Cdn. companies)

39.34%

Capital gains

26.76%

Source: CI Global Asset Management

This illustration assumes a top marginal tax rate in Ontario, or taxable income greater than $220,000. But the point remains the same at other rates: You can usually lower your taxes by favouring capital gains over other sources of taxable income.

Also remember, you don’t pay taxes on a capital gain until you actually “realize” it, by selling an investment for more than you paid for it. Combine this point with the rates just presented, and your ideal investment strategy seems obvious: Tax-efficient investing translates to a low-cost, low turn-over, buy-and-hold approach.

Since minimizing the impact of taxes is a huge way to improve on your overall rate of returns, this happens to be exactly what I advise for any of your investments, whether you’re holding them in a taxable or tax-sheltered account.

Bonus tip: Once you’ve embraced low-cost, low-trade investing, be sure to also use funds from fund managers who are doing the same. It defeats the purpose if you are being disciplined about your tax-efficient investing, but the underlying funds in which you’re invested are not.

Asset Location Is where it’s at

As your wealth accumulates, you’re likely to end up with a mixture of registered and taxable accounts. You can reduce your overall tax burden by managing these accounts as a single, tax-efficient portfolio, instead of treating each as an investment “island.” Asset location means locating each kind of investment, or asset, in the right type of account, given its tax efficiency:

Hold your relatively tax-inefficient assets in tax-favoured accounts, where the inefficiencies don’t matter as much. Examples include bonds, which generate interest and other non-capital-gain income; and investments that have higher than average yields such as REITs.
Hold your relatively tax-efficient assets in taxable accounts; examples include broad domestic or global stock funds that generate most of their returns as capital gains.

An Easy Rebalancing Strategy

As I covered in “Rebalancing in Down Markets, Scary But Important,” it’s essential to periodically rebalance your investment portfolio. It’s like tending to your garden by thinning out (selling) some of the overgrowth, and planting (buying) where you need more. This keeps your productive portfolio growing as hoped for, with a buy low, sell high strategy.

But as usual, there’s a catch: When you “sell high” in a taxable account, you’ll realize taxable gains. So, whenever possible, try using cash you’d be investing anyway to do your rebalancing for you. Instead of just plopping any new investable cash into haphazard holdings, invest it wherever your portfolio is underweight relative to your goals. In so doing, you can improve on your tax-efficient investing. (PS: Here’s another post I’ve published, with additional ideas on “What to Do with Excess Cash.”)

Tax-Loss Harvesting

Again, one of the best ways for your assets to grow tax-efficiently is within your registered, tax-sheltered accounts. That said, tax-loss harvesting is one tax-efficient investing strategy you can only do in a taxable account. Without diving too deep, when one or more of your holdings is worth less than you paid for it — but over the long run you expect the position to grow — you can use tax-loss harvesting to:

Sell the depreciated position to generate a capital loss, which you can then use to offset current or future taxable gains.
Promptly buy a similar (but not identical!) position so you remain invested in the market as planned.
Eventually (optionally), reinvest in the original position to restore your portfolio to its original mix.

Again, all this only works within a taxable account. Also, the CRA has strict rules on what qualifies as a true capital loss, and may disallow it if you violate those rules. This makes it one smart strategy best completed in alliance with your personal financial advisor.

Advanced Tax Strategies for Families and Business Owners

We’ve barely scratched the surface on the myriad tax-planning strategies you can deploy in your quest to pay no more than their fair share of income taxes. Depending on your particular circumstances, you can take advantage of some of these tax strategies: Continue Reading…

6 ways to protect your Business from Credit Card Fraud

Posted By Financial Independence Hub | September 1, 2021

By Martha Pierson

Special to the Financial Independence Hub

We all want to do our best to provide our customers with the utmost convenience. Isn’t this the whole point of eCommerce, POS financing, and other recent developments in sales?

Unfortunately, with these conveniences also come increased risk. In fact, this article is going to discuss one of the dangers brought about by technology and its added convenience. That is credit card fraud.

Recent statistics point out that 47% of Americans experienced some form of financial identity theft in 2020. More importantly, credit card fraud, especially those related to new accounts, was reported as the second-worst reported following scams related to government benefits.

It is, indeed, very troubling. Fortunately, there are ways to prevent and minimize such malicious attacks. Here are six tips that both business owners and lenders (such as POS finance providers) can put into action:

Tip #1: Invest in Technology

There are numerous technologies that can help minimize credit card fraud. We simply need to take advantage of them.

For instance, declining cards without an EMV chip is a good first step. Not only does EMV provide another level of encryption, but chipped cards also generate unique codes after every transaction. These features make it impossibly difficult for thieves to create counterfeits.

You can also invest in incorporating a fraud prevention system into your eCommerce website. These platforms are easy to integrate and provide real-time protection for every transaction. Most of these programs can help you screen and authenticate customers, prevent fraud, and even identify vulnerable accounts.

You might also want to look into any advanced payment security feature that your eCommerce platform offers as an add-on.

Tip #2: Beware of Red Flags

Speaking of identifying vulnerable accounts, the next best step to prevent credit card fraud is to simply be aware of the red flags. For example, a person reaching for a credit card from his pocket rather than from his wallet is certainly suspicious. The same can be said for an online customer with multiple failed attempts to purchase due to incorrect information.

Of course, we’re not saying that these red flags automatically point out that one is committing fraud for sure. For all we know, that online customer simply had his caps lock on the whole time. Or maybe the previous customer just shoved his credit card into his pocket for no particular reason.

In the end, the skill to discern fraud can simply be achieved over time through the practice of vigilance and experience.

Tip #3: Increase the Quality of Employee Training

So you now have an idea on how to catch credit card fraud. The question is, are your employees equally equipped as well? Unless you manage every aspect of your business on your own, it is imperative for any business owner to make credit card fraud a part of their training.

We also recommend developing a clear procedure that your employees can follow. Here’s an example for in-person transactions.

Check the customer’s ID for every credit card transaction.
Make sure that the credit card doesn’t look tampered with in any way.
Use an Address Verification Service to confirm the cardholder’s billing address.
Finally, compare the receipt with the actual card. Check for any errors and inaccuracies. Continue Reading…

GICs with an equity twist: RBC’s latest solution for Canadians looking to grow their savings

Posted By Financial Independence Hub | August 27, 2021

By Flora Do

Vice-President,

Term Investments & Savings, RBC

(Sponsor Content)

Remember piggy banks? I sure do. Piggy banks stuffed with loonies, quarters, dimes, nickels and pennies (remember pennies?) My piggy bank helped me save for so many precious purchases when I was growing up.

During those childhood years, my piggy bank was the equivalent of a low-risk savings vehicle (I’d say ‘no-risk’ but it did shatter if dropped). I knew exactly where my money was and how much I had. The only thing the savings in my piggy bank could not do was grow on their own.

I wasn’t yet an investor; I was a saver. Today I lead a team which helps Canadians to be both, through a solution we’ve just reinvented: the humble GIC (Guaranteed Investment Certificate).

For decades, GICs have been the preferred choice for Canadians looking to invest savings, with the guarantee that their initial investment (principal) would be fully protected.

The market stepped things up by giving some GICs an equity twist – tying GIC returns to the equities markets – for Canadians seeking the security of GICs but looking for opportunities to increase their return potential. As with traditional GICs, an investor’s initial investment is 100% guaranteed. Unlike traditional GICs, equity-linked GICs are connected to stock market performance, linked either to various indexes or a basket of stocks, offering investors potential gains from market returns.

New GIC linked to ESG

Specifically at RBC, this summer we introduced our first GIC based on ESG (Environmental, Social and Governance) factors – the RBC ESG Market-Linked GIC – and our first GIC to track the performance of a customized basket of 20 North American companies – the RBC North American MarketSmart GIC.

Our ESG GIC is a direct response to the growing interest we’ve been seeing among Canadians in looking beyond a company’s balance sheet when making investment choices. If you’re an investor who wants to help make a difference in the world by including ESG considerations in your investment decisions, our ESG GIC is purpose-built for you. It’s linked to a global index of environmentally and socially responsible organizations, all of which must first pass a set of rigorous ESG standards. To be included in the index, each company must demonstrate positive ESG metrics, low carbon impact and strong financial health. Continue Reading…

Getting your Fixed Income Fix with BMO ETFs

Posted By Robb Engen | August 11, 2021

This article has been sponsored by BMO Canada. All opinions are my own.

Fixed income doesn’t get enough attention on this blog, mostly because I’m still in my accumulation years and invest in 100% equities across all my accounts. But most investors should hold bonds in their portfolio to reduce volatility and so they can rebalance (selling bonds to buy more stocks) whenever stocks fall.

In this post we’re going to take a deep dive into BMO’s line-up of fixed income ETFs. We’ll see that there isn’t a one-size-fits-all approach to investing in fixed income, and that investors can capture yield using a wide array of products and strategies.

DIY investors should be familiar with BMO’s suite of fixed income ETFs. It’s the largest in Canada with more than $23 billion in assets. At the top of the list is BMO’s Aggregate Bond Index ETF (ZAG) with total assets of $5.86 billion.

Robo-advised clients also have BMO fixed income ETFs in their model portfolios:

Nest Wealth clients hold BMO Aggregate Bond Index ETF – (ZAG)
Wealthsimple clients hold BMO Long Federal Bond Index ETF – (ZFL)
Questwealth clients hold BMO High Yield US Corp Bond Hedged to CAD Index ETF – (ZHY)
ModernAdvisor clients hold BMO Emerging Markets Bond Hedged to CAD Index ETF – (ZEF)

BMO Fixed Income ETFs

Investors are nervous about holding bonds today. Interest rates are at historic lows, and when rates eventually rise, we’ll see bond prices fall – especially longer duration bonds. We’re also seeing higher inflation, which causes interest rates to go up (and bond values to go down).

I reached out to Erika Toth, Director at BMO ETFs to talk about fixed income ETFs and how investors should think about bonds and fixed income today and into the future.

Q: Erika, investors are concerned about low bond returns, particularly from long-term government bonds. How should they think about the fixed income side of their portfolio?

A: Investors should think of fixed income as a ballast in their portfolio. It helps reduce overall volatility (chart below). Correlations between US Treasuries and stocks (represented by the MSCI USA index) have been negative over the last two decades. All that to say, when stocks fall, bonds tend to do well.

From an investor perspective, there are two things at play – FOMO, and fear of volatility. Fixed income still has its traditional value in a portfolio; to offset equity risk.

What we are seeing from some clients is the willingness to take on more equity risk – shifting from a 60/40 balanced portfolio to 70/30 portfolio, as an example.

But you can see the payoff from fixed income using a simple example of Canadian equities (represented by ZCN) and ZAG. Volatility drops materially without costing investors too much return.

ETF	10-year annualized return	Standard deviation
ZCN	6.21%	11.8%
ZAG	3.69%	4.0%
60/40 (ZCN/ZAG)	5.38%	7.4%
70/30 (ZCN/ZAG)	5.61%	8.5%

The bottom line: Fixed income keeps investors in the markets during times of distress.

Q: What about a retired investor who typically holds a 60/40 or 50/50 portfolio but is concerned about generating income in a low-yield environment?

A: Such an investor may wish to include ETFs that harness option-writing strategies such as covered call writing, put writing, or a combination of the two, to generate a high level of tax efficient monthly cash flow (option premiums are taxed as capital gains and/or return of capital).

With fixed income generating lower yield today, the equity portion of a portfolio needs to make up for the yield shortfall. Covered call strategies are an efficient way to do so and ETFs are a convenient way that allow investors to attain access.

Here are a few examples of these types of strategies. I would include these on the equity side of the portfolio to increase overall level of yield:

ZWC BMO Canadian High Dividend Covered Call ETF, yields 7.3%
ZWB BMO Covered Call Canadian Banks ETF, yields 5.84%
ZWS BMO US High Dividend Covered Call Hedged to CAD ETF, yields 5.94%

Q: I’m a big fan of asset allocation ETFs to make DIY investing as simple as possible. But is it wise to unbundle ZGRO or ZBAL and hold multiple ETFs with the intention of avoiding long-term bonds in favour of shorter duration government bonds or corporate bonds?

A: Part of the appeal of the all-in-one asset allocation ETFs is their simplicity; and they tend to appeal to investors who do not want to get granular in their investment process. The other benefit of a one-line holding is that you are less likely to overthink the underlying components and make reactive decisions when you see something go into the red.

The 0.18 % management fee (0.20% MER) for ZGRO and ZBAL are all-in, there’s no double-dipping on fees. That is basically the cost of underlying ETFs with almost nothing more for the rebalancing. Keep in mind that there is often a trading cost for rebalancing multiple ETFs on your own. For investors with small portfolios, the cost of selling and buying stocks and bonds every year can become proportionally expensive.

Portfolio rebalancing is the maintenance involved in sticking with your asset allocation plan. Your asset allocation plan is what is going to help you meet your goals. One of the biggest pros to portfolio rebalancing is that it keeps risk under control, and sometimes just maintaining a level of risk takes some action.

There is tremendous value to having the rebalancing done systematically. Conservatively, experts say it can add between 0.30% to 0.40% annually over the long term.

For an investor who does not mind doing a handful of trades and rebalancing once or twice a year, the “unbundling” strategy could work. However, if the concern is rising rates, corporate bonds would tend to do better than government bonds. Continue Reading…

What the new Higher Stress Test means for Homebuyers

Posted By Financial Independence Hub | August 10, 2021

By Sean Cooper

Special to the Financial Independence Hub

Ever since the start of COVID, the real estate market has been on fire. To help deal with the record level of activity in the real estate market and also keep things balanced, a new mortgage stress test was introduced June 1^st. In this article we’ll look at the new mortgage stress test and how it affects you.

What’s the Stress Test?

The stress test is a measure that anyone buying a home, refinancing their mortgage or switching mortgage lenders must pass. Pretty much the only time you don’t have to pass the stress test is when you’re renewing your mortgage with your existing lender. Whether you’re buying a home with less or more than 20 per cent, it doesn’t matter. You’re affected by the stress test.

The stress test was introduced several years back to help protect homebuyers from becoming overleveraged and taking on too much mortgage debt. Prior to the stress test, you only had to prove that you could afford mortgage payments based on the mortgage rate when you first sign up for your mortgage. However, with Canadians spending more and more on homes and the threat of higher interest rates looming, the Canadian government decided to introduce the stress test in early 2018 out of precaution.

To pass the stress test, you need to show that you can qualify at the greater of your mortgage rate plus two per cent and the stress test rate (currently at 5.25 per cent). With mortgage rates currently somewhere in between the mid one percent’s and the mid two per cent’s for both fixed and variable rate mortgages, you’ll almost always have to qualify at 5.25 per cent as things stand today.

How has the Stress Test changed?

The new stress test rules came into effect June 1^st. Prior to the introduction of the new stress test rules, the mortgage stress test rate was 4.79 per cent. That’s because it was based on the average of the big banks’ posted mortgage rates. However, the government decided to change how the stress test was calculated. Continue Reading…