Decumulate & Downsize

Most of your investing life you and your adviser (if you have one) are focused on wealth accumulation. But, we tend to forget, eventually the whole idea of this long process of delayed gratification is to actually spend this money! That’s decumulation as opposed to wealth accumulation. This stage may also involve downsizing from larger homes to smaller ones or condos, moving to the country or otherwise simplifying your life and jettisoning possessions that may tie you down.

Retirement Case Study: Marcus and Lee

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by Patricia Campbell, Cascades Financial Solutions

(Sponsor Content)

Ages: 60 & 55

Province: Ontario
Professions: Capital and Facilities Planning Director & Senior Data Analysist

Primary Goal: Determine annual retirement income, save taxes, and plan for travel.

Marcus and Lee were on track for retirement in 5 years, but an early retirement offer from Marcus’ company prompted them to consider retirement earlier than originally planned. We investigate their concerns in this retirement planning case study using Cascades Financial Solutions.

The Issues

Unexpectedly, Marcus was forced into retirement by his company due to a severe downturn in business. The couple thought they had at least five more years before they would need to make a decision regarding retirement.

Over their careers, Marcus and Lee prioritized saving money each year in their Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA). In addition, they both had a joint savings account, and Marcus had a defined benefit pan but, was it enough?

Their Concerns

How much retirement income will they have? Did they have enough money for Marcus to retire early? Lee will continue working until she is 60 but was depending on Marcus to have 5 more years of income and savings. 

How could they minimize the taxes on their retirement? The couple would like to explore tax efficient strategies and are unsure how to approach this.

Will they be able to travel? By retiring early Marcus is concerned about their future travel plans.

The Plan

Marcus and Lee realized that this was a critical time and needed help from someone with extensive experience in retirement income planning.

Marcus and Nicole decided to seek financial planning advice. The financial planner they found uses Cascades Financial Solutions.

The Cascades financial planning process included the below steps:

Gather fact find data. This included the details of each RRSP, TFSAs, defined benefit plan and any joint savings, their investments large purchases they plan on making in the future.

Consider ages for CPP and OAS options. The next step was to run a few retirement income scenarios which included adjusting the start age to receive CPP and OAS.

Choose a winning strategy. After running a few scenarios which included receiving CPP at 60 vs. receiving at 70 they were able to determine a sustainable withdrawal plan and maximize taxes savings over the course of their retirement.

Execute the plan. Finally, it was time to start putting the new retirement income strategy in place. Seeing the plan on paper, gave the couple the confidence and financial security they needed to be at ease.

The Results

Marcus was delighted retiring early knowing their hard work and saving for a rainy day paid off. While Lee wasn’t quite ready to retire, she was happy Marcus can enjoy a few years of retirement before she did. When they are both retired, they plan to take two international trips each year and spend plenty of time with family.

The financial planning process helped Marcus and Lee in several ways: Continue Reading…

The Lure of Dividends

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A super juicy yield can be a warning sign

By Anita Bruinsma, CFA, 

Clarity Personal Finance

Special to the Financial Independence Hub

Earning income from dividends is an attractive proposition that’s available to anyone with money to invest in the stock market. In a prior blog post, I highlighted two ways to get dividends from your investments: by investing in high dividend-paying ETFs and by investing in individual stocks. When choosing an ETF, I suggested three qualities to look for, one of which was choosing a fund with a high yield, with the note that “higher is better.”

“Higher is better” is a pretty safe bet with ETFs but when it comes to dividend-paying stocks, you need to be a little careful. Although higher is generally better, a very high dividend yield can be a warning sign.

Understanding dividends

As a reminder, a dividend is a payment made by a company to its shareholders and a dividend yield is the dividend per share divided by the stock price. (For a dividend primer, read my blog posts here and here.) The primary reason why a company pays a dividend is because it has extra cash. After paying expenses to run the business and invest for future growth, some companies still have money sitting around. They could put that money in the bank, or they could distribute it to shareholders. The thinking is that a shareholder might have better things to do with the cash than having the money sitting in the corporation’s bank account, causing shareholders to say, “Hey, I’m a part owner in this company – send me that cash that’s sitting around doing nothing for you.”

Another reason companies might pay dividends is to entice shareholders to buy their stock. If demand for a company’s stock is high, the price (generally) goes up. Companies like this a lot. The big drivers of demand for stocks are the large buyers: the companies that run mutual funds, pension funds and exchange-traded funds. (They are called institutional investors.) Dividend-focussed funds often have a requirement to invest only in companies that pay a dividend. Sometimes a fund’s portfolio manager likes a company but can’t own it in the mutual fund because it doesn’t pay a dividend. If the company wants these funds to buy its stock, it might choose to pay a dividend, even if it’s a small one. Is this the right motive for initiating a dividend? Not really, since the purpose of dividends is to distribute excess cash to shareholders – and unless there really is enough cash available, a dividend is simply window dressing.

When higher is not better

What kind of company makes the best dividend-payer? One that has stable profits and steady cash flow. Why? Because as an investor, you might come to rely on the dividends you are being paid – the last thing you want is for the company to stop paying the dividend. Not only does this mean you will have less income, but it can also be a signal that the business isn’t generating cash the way it used to. A company that reduces or eliminates its dividend is often punished by the market, sending the stock down. Companies most likely to face this situation are those that have volatile earnings – if profits are down, they may not have enough cash in the bank and cutting the dividend is inevitable. In fact, once a company sees that business is weakening, eliminating the dividends is one of the first and easiest ways to save money. Pay employees? Yes. Pay the bank loan? Absolutely. Pay the dividend? Nope.

This explains why a high dividend yield can be a warning sign. If a company’s stock price is falling, its dividend yield is going to move higher and higher so long as it doesn’t reduce the dividend. (Recall that the yield is calculated as dividend/stock price.) Does a 14% dividend yield sound great? Heck. yeah! That’s way better than a 4% GIC. But the expression “If it’s too good to be true, it probably is” applies here. A declining stock price probably means the business isn’t doing well – and that means the dividend is seriously at risk of being cut. If you’re interested in getting in the weeds a little (and now I’m regressing to my stock analyst days), have a look at this prime example. Just Energy had a 14% dividend yield in 2012 – it was way too high. Dividend cuts soon followed, and the company now pays no dividend. (The stock has been decimated.)

When higher is better

The recent stock market decline has resulted in some really nice dividend yields: BCE at 6.2%, CIBC at 5.6%, and Manulife Financial at 6%. But this is different: the whole market is going down. In this case, a higher yield isn’t a sign that the company is necessarily failing or that the dividend is at risk. This presents a nice opportunity to buy some of these stocks. Continue Reading…

BMO ETFs: Tax Loss Harvesting

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By Sa’ad Rana, Senior Associate – ETF Online Distribution, BMO ETFs

(Sponsor Content)

With volatile markets, rising inflation and a potential economic slowdown, 2022 has proven to be a challenging year for investors. Exchange traded funds (ETFs) are effective tools for investors to help navigate these uncertain markets and can be used to help crystallize losses from a tax perspective. As 2022-year end approaches, this article provides trade ideas to help you harvest tax savings from under-performing securities.

What is Tax-Loss Harvesting?

By disposing of securities with accrued capital losses, investors can help offset taxes otherwise payable from securities that were sold at a capital gain. The proceeds from the sale of these securities can then be reinvested in different securities with similar exposures to the securities that were sold, in order to maintain market exposure.

  • Realized capital gains from previous transactions can be offset by selling securities, which are trading at a lower price than their adjusted cost base.
  • Investors can then use the proceeds from the security that is sold to invest in a different security, i.e. BMO Exchange Traded Funds (ETF).
  • In addition to common shares, tax-loss harvesting can also be applied in respect of other financial instruments that are on capital account, such as bonds, preferred shares, ETFs, mutual funds, etc.

Considerations:

If capital gains are not available in the current year, the realized losses may be carried back for three years to shelter gains realized in those years or carried forward to reduce capital gains in upcoming years.

Continue Reading…

Why a focus on ‘leaders’ works in Call Option ETFs

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By Paul MacDonald, CFA

(Sponsor Content)

Harvest ETFs Chief Investment Officer explains why the independent ETF firm focuses on 20-30 ‘leaders’ in its call option ETFs.

Harvest’s call options ETFs are built through a structured process. Portfolio managers begin by identifying an industry, sector or theme with long-term growth prospects such as healthcare, technology, or utilities. They then identify and select between 20 and 30 leaders: large-cap companies with significant financial reserves and market share. The portfolio managers then apply Harvest ETFs’ active & flexible call option strategy to the ETF holdings to generate consistent monthly income for unitholders.

But why do they only select between 20 and 30 companies for their call option ETFs? Diversity is a key to any investment strategy, so shouldn’t Harvest ETFs focus on the widest variety of holdings as possible?

In our experience, the focused approach taken in many Harvest ETFs is tied directly to the execution of Harvest’s active and flexible Covered Call Option strategy.

20-30 stocks is not a random number. When we select the stocks we want an ETF to hold, our goal is to create concentrated portfolios, but with large enough capitalization and a wide enough diversity of business styles and operations that we can give investors broadly diversified exposure to a single sector or industry.

We like diversity, and in a one-stop solution for market exposure, having a huge array of companies can make a lot of sense. But for a targeted strategy like a call option ETF, focusing on the leaders of a particular industry or sector means the managers making decisions have a deep familiarity with the companies they hold.

Why familiarity matters in Call Option ETFs?

Call Option trading in an actively managed ETF requires constant engagement with options premiums available on specific stocks. One of the key value adds of an active call option strategy is the flexibility portfolio managers can have, both to generate their consistent monthly distribution and capture higher options premiums when available to expose more of the portfolio to potential market upside.

Continue Reading…

Retired Money: What Asset Class charts can teach about risk and volatility

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My latest MoneySense Retired Money column addresses a topic I have regularly revisited over the years: annual charts that help investors visualize the top-performing (and bottom-performing!) asset classes. You can find the full column by clicking on the highlighted headline here: Reading the “Annual Returns of Key Asset Classes”—what it means for Canadian investors. 

As the column notes, I always enjoyed perusing the annual asset classes rotate chart that investment giant Franklin Templeton used to distribute to financial advisors and media influencers. I still have the 2015 chart on my office wall, even though it’s years out of date.

Curious about the chart’s fate, I asked the company what had become of it, and learned it’s still available but now it’s only in digital format online. As always I find it enormously instructive. It’s still titled Why diversify? Asset classes rotate. As it goes on to explain, “one year’s best performer might be the next year’s worst. A diverse portfolio can protect your from downturns and give you access to the best performing asset classes this year – every year.”

The chart lists annual returns in Canadian dollars, based on various indexes.

Right off the top, you see that U.S. equities [the S&P500 index] are as often as not the top-producing single asset class. It topped the list five of the last nine years: from 2013 to 2015, then again in 2019 and 2021.

On the flip side, bonds tend to be the worst asset class. Over the 15 years between 2007 and 2021, at least one bond fund was at the bottom seven of those years: global bonds [as measured by the Bloomberg Global Aggregate Bond Index] in 2010, 2019 and 2021, US bonds [Bloomberg US. Aggregate Bond Index] in 2019, 2012 and 2017, and Canadian bonds [FTSE Canada Universe Bond index] in 2013. And consider that all those years were considered (in retrospect) a multi-decade bull market for bonds. You can imagine how bonds will look going forward now that interest rates have clearly bottomed and are slowly marching higher.

As you might expect, volatile asset classes like Emerging Markets [measured by the MSCI Emerging Markets index] tend to generate both outsized gains and outsized losses. EM topped the chart in five of the last 15 years (2007, 2009, 2012, 2017 and 2020) but were also at the bottom in 2008 and 2011. EM’s largest gain in that period was 52% in 2009, immediately following the 41% loss in 2008. Therein lies a tale!

The latest Templeton online charts also include a second version titled “Risk is more predictable than returns.” It notes that “Higher returns often come with higher risks. That’s why it’s important to look beyond returns when choosing a potential investment.” It ranks the asset classes from lower risk to higher risk and here the results are remarkably consistent across almost the entire 15-year time span between 2005 and 2021.

The missing alternative asset classes

This is all valuable information but alas, these charts seem to focus almost exclusively on the big two asset classes of stocks and bonds, precisely the two that are the focus of all those popular All-in-one Asset Allocation ETFs pioneered by Vanguard and soon matched by BMO, iShares, Horizons and a few others. Continue Reading…