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Cash Alternatives: Bond ETFs and other Vehicles

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By Alizay Fatema, CFA 

(Sponsor Content)

Central banks across the globe are likely to continue with their attempts to tame inflation by hiking interest rates, crushing the hope that markets will return to normality any time soon.

With the unemployment rate at a historically low level, inflation remains a top concern for the Bank of Canada (BoC) and the Federal Reserve (Fed), who are also dealing with looming risk of a recession and uncertainty regarding the impacts of the recent bank turbulence. The BoC and the Fed appear to be ahead of global peers in their attempt to slowdown inflation – raising the question around whether we have seen the peak in rates in North America.

The rapid tightening cycles by policy makers are reinforcing the appeal of owning high-
quality ultra-short bond, and money market ETFs. A series of recent rate hikes by the Bank of Canada and the Federal Reserve gave a boost to yields for these products, making the saying “cash is king” true to a certain extent, as investors who are worried about higher inflation and slowing growth prefer investing in these cash alternatives to ride out the market volatility. In today’s market, you can earn an attractive yield while taking less risk – earning while you wait for volatility to subside.

Yield curve[1], are we in love with the shape of you?

Normally, the yield curve is upward sloping, meaning longer-term bonds yield more than shorter-term bonds as investors often demand higher yields for locking their money up for a longer period. However, at present, the shape of the yield curve is inverted, which means shorter-term securities are yielding more than longer-term ones. This inversion is largely owing to the Central Bank’s quest to reduce inflation by hiking the interest rates.

Due to historically low interest rates in the last few years, investors were compelled to take more duration[2] risk by adding exposure to longer-term bonds and higher credit risk[3] by investing in lower credit quality segments such as high-yield or emerging markets bonds. However, due to the current yield curve inversion, the tables have turned now, offering a unique opportunity for fixed-income investors looking to earn higher yields.

Source: Bloomberg USYC3M10 Index (Sell 3 Month US T-bill & Buy 10 Year US Bond Yield Spread) Sep 1992 to April 2023

Why stash cash in money market & ultra-short-term bond ETFs?

The front-end of the yield curve (0-1yr) offers an attractive asymmetry and opportunity to capture yield between 4-5% + with limited duration and credit risk. This allows investors to earn the highest yields we’ve seen in more than a decade on fixed income and build a more stable high-quality fixed-income portfolio by adding exposure to ultra-short investment grade bonds and money market securities. Based on the current interest-rate volatility, hugging the front-end of the curve seems a more prudent and consistent way to preserve capital in a fixed-income allocation. BMO ETFs offers solutions such as BMO Money Market Fund ETF Series (ZMMK), BMO Ultra Short-Term Bond ETF (ZST) and BMO Ultra Short-Term US Bond ETF (ZUS), which are a great way to get exposure to the front end of the curve.

These money market & ultra short-term bond ETFs invest in high credit-quality instruments that provide a great degree of safety and capital preservation. Firstly, by investing in securities that mature in less than one year, the duration risk is minimal, which results in lower interest rate sensitivity in your portfolio. Secondly, these ETFs offer high liquidity[4] due to the nature of their underlying securities, which means they can be bought and sold easily with minimal market impact. Continue Reading…

Retired Money: Americans cashing out of employer Retirement plans could benefit from Canadian approach

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My latest MoneySense Retired Money column, which has just been published, looks at an interesting study on trends in cashing out Retirement savings when American workers leave their jobs. You can find the full column by clicking on the highlighted text here: Should you cash out your workplace pension when you leave a job?

The paper, titled Cashing Out Retirement Savings at Job Separation, is co-written by a Canadian, Yanwen Wang, associate professor at the University of British Columbia’s Sauder School of Business. The study, which is fairly technical, is also featured in a more accessible version in the Harvard Business Review. The article that ran on March 7, 2023 is titled Too many employees cash out their 401(k)s when leaving a job.

Canada and the United States differ in how retirement plans are treated on leaving jobs, so most of the column applies mainly to the United States. But there may be lessons for the US retirement system that can be drawn from the Canadian treatment.

Average American has more than a dozen jobs over a career

In the US, the average American worker will have 12.4 jobs over a career, prompting the report’s authors to write that “Employers should recognize that most people working for them will change jobs before retirement.” Unfortunately, it’s all too easy for their workers to cash out of their 401(k)s when leaving a job, instead of rolling them over and letting the money continue to grow in a tax-deferred manner.

A UBC press release issued early in April carries the alarming headline that “Americans are cashing out the retirement savings at an alarming rate.”  The study identifies a “key” problem: when they switch jobs, 41.4% of employees are cashing out of those funds — even though the U.S. Internal Revenue Service (IRS) imposes a 10% per cent penalty on anyone younger than 59.5 years old.

Here’s what Wang said via email about the implications for Canadian retirement: “Canada has some different fundamental rules around retirement savings withdrawal. It is hard or probably impossible to speak to the Canadian RRSP withdrawal based on our US-based study.”
Canadian plans have locked-in feature

In particular,  many Canadian RRSPs have a locked-in feature, Wang added: “which means that even at job changing cash withdrawals are not allowed unless the individual becomes non tax resident. The locked-in feature is a key feature not present in most US retirement savings accounts. I don’t have data but I believe the illiquidity feature substantially reduces 401(k) leakage. I think the U.S. can learn from the Canadian retirement system and consider something similar — a locked-in 401(k) on top of an emergency savings plan — to satisfy the long-term retirement needs as well as short-term liquidity emergency.”

Unlike Canada, American employees can cash out at any time whether they’re working or leaving a job: the only developed economy that does. As the article points out, “other countries require many months of unemployment and evidence of clear hardship before allowing someone to tap defined contribution retirement savings.”

 Researchers also found an interesting phenomenon whereby the more a generous employer “matches” employee contributions, the more the departing employee is tempted to cash out and spend what it regards as “house money” or “free money.” Thus, the authors write, “Right now, cashing out is the path of least resistance. People choose what is easy, not what is wise.”

The column closes with some findings from a recent H&R Block Canada survey released on April 3, 2023. It  found nearly half of Canadians are unprepared for retirement and more than a third (36%) between ages 18 and 54 believe they won’t ever retire.

New tax-free Questrade FHSA helps Canadians save, invest & realize their dream of homeownership

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Image courtesy Questrade/iStock

By Rob Shields, Questrade 

Special to Financial Independence Hub

On April 1, 2023, Questrade became the first in Canada to offer the new First Home Savings Account (FHSA). For us, this was a major accomplishment in our continued mission to help Canadians on their journey to financial independence. Our goal has always been to challenge the status quo, transforming financial, investing and mortgage services for the good of Canadians. Knowing the Government of Canada was introducing the new FHSA on April 1, the team at Questrade began planning months ago. Our goal was to offer Canadians this account on day one, so they can start saving, investing and growing their money for their first home. Mission accomplished.

Save for a home faster

Saving for a home is a big challenge for many Canadians. With housing prices as they are — especially in major cities — maximizing your down payment is critical. By opening an FHSA account at Questrade, Canadians can invest up to $8,000 annually, deduct their investment contributions from their taxable income and give it the opportunity to grow in the market. They can contribute up to $40,000 in this account, with no limits to how much it can grow, making it a powerful savings tool. Ultimately, they can withdraw it tax-free to use it for a home purchase: with no requirement to repay. The only requirements to open an FHSA are: being a verified resident of Canada, being at least 18 years of age, and being a first-time home buyer.

Imagine a scenario where you open an FHSA account with a goal to buy a house in 10 years. If you maximize your annual contribution limit of $8,000 per year for the first 5 years, you’ll reach the lifetime contribution limit of $40,000 in 5 years. If you invest your account with a Questwealth Aggressive Growth Portfolio, which had an average return of 7.18% per year, your account could grow to $69,993 after 10 years*. That’s $69,993 you can withdraw tax-free to put towards your home, with $29,993 coming just from investment gains. Continue Reading…

How to build a portfolio of Fine Wines: for Fun & Profit

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It’s been two years since former Vanguard Canada CEO Atul Tiwari launched Cult Wines Americas. Late in April, Tiwari celebrated the milestone with a small media gathering at Fine Wine Reserve, a premium wine storage facility in Toronto.

Atul Tiwari

For a refresher, see this Hub blog written by Tiwari late in 2021: A New Asset Class for Affluent Investors. It explains that the Cult Wine Investment story began in London, England in 2007, and in 2021 expanded into North America with offices in Toronto and New York.  See also these articles written by two Globe & Mail writers who were at this month’s event along with myself: How profitable is investing in fine wine? and Former Vanguard Canada CEO to head wine investing venture in the U.S. 

The idea behind Cult Wine Investment is to let you invest in leading global wines (mostly French) for ultimate profit, and to safely store it off-site while still having title to and access to the actual product, should you wish to consume a portion. As Tiwari told the G&M’s John Daly last year, “Cult Wines is not securities regulated, because you actually own the wine.” Below are some pointers on building a collection. Cult currently allows Canadian investors with as little as $12,500 (or US$10,000 for U.S. investors) to access a customized wine portfolio, with management fees ranging from 2.25%t to 2.95%, depending on portfolio size.

Marc Russell: www.finewinereserve.com

In addition to sampling the mostly-French wines, we had a quick tour of the Toronto storage facility, courtesy of Marc Russell, Founder and CEO of The Fine Wine Reserve Inc. (shown on the right).

The chart above shows a portfolio of Cult Fine Wines [CWI is the orange bars] has performed against its benchmark, the EP40 index (Green bars) as of March 31, 2023. EP40  is a fixed basket of 40 Bordeaux En Primeur wines.

“Fine wine as an asset class has performed as it should over the last two years,” Tiwari told me, “In a volatile market setting, Cult Wines has returned on average 16% in 2021 and 12.77% in 2022, in addition to providing the portfolio diversification  benefits of low correlations to equities, low volatility and acting as an inflation hedge.”

As we learned at the briefing, investing in fine wines for profit primarily means investing in French wines, mostly from the French districts of Bordeaux, Burgundy and Champagne. Those three districts account for roughly 80% of Cult Wine portfolios. At the briefing, the tasting focus was on the first two: after all,  Tiwari is a member of the Confrérie des Chevaliers du Tastevin, a global society of Burgundy aficionados.

A handout says Bordeaux wines are “the bedrock of fine wine” portfolios, adding that after a period of recent underperformance, “Bordeaux wines now offer more attractive relative values when compared to other French regions.” In addition, “the end of zero-COVID policies in China fuelled a surge in fine wine trading in early 2023.”

How to store fine wines

While most folk merely buy wines from the LCBO or nearby Vineyard and consume it within days, it turns out that storing multiple cases of wines for profit is considerably more complex. This was evident at the four of the Fine Wine Reserve, where temperature control, humidity and other variables are all far more complex than you might imagine. And yes, if you do hire them to store your wines, you are able to visit and even withdraw a few bottles or cases for actual use, should you desire to enjoy your investment as well as profit from it down the road.

Here are a few interesting talking points provided at the tour:

• Everyone overestimates the importance of cool temperatures when storing and aging fine wines, and underestimates the importance of temperature stability and high humidity.

• This explains why wines age best in the cool damp natural cellars located far below ground, as in Europe.

(Here I dare to add a personal note, since I once visited a white wine vineyard in France’s Loire Valley that bears the illustrious name Chevreau.)

• Wines are like kids. If you neglect them when young, they grow up unbalanced. Don’t put off proper storage. Stored improperly, wines will be irreversibly damaged within a year. And 1 hour in a hot car! Continue Reading…

3 things that make me want to pull my hair out

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Pexels: Mikhail Nilov

By Bob Lai, Tawcan

Special to Financial Independence Hub

I have been writing on this blog for almost nine years. Over that time, I have learned and gained a lot of personal finance and investing-related knowledge. Whenever I gain new knowledge, I try to share it on this blog with the hope that readers can gain the same understanding as well.

As much as I love sharing new knowledge with other people, there seem to be some deep-rooted misunderstandings, myths, or misconceptions on certain topics. I really don’t understand why some people have these misconceptions and I will try my best to debunk some of the common misconceptions I have encountered, just so I don’t have to keep ripping my hair out.

#1 Don’t want a raise to avoid the next tax bracket

Our tax system is extremely complicated, so I understand there are some misunderstandings here and there. The biggest misunderstanding is that all your income is taxed at your tax marginal rate.

Due to this misunderstanding, people often make such statements like…

“I don’t want a raise just to get taxed more.”

“I am not working overtime to get bumped to the next bracket and lose my income to taxes.”

And so on…

But that’s a very very wrong understanding. Your income is taxed on a tiered bracket system. Below are the 2022 federal tax brackets.

Taxable Income – 2022 Brackets Tax Rate
$0 to $43,070 5.06%
$43,070.01 to $86,141 7.70%
$86,141.01 to $98,901 10.50%
$98,901.01 to $120,094 12.29%
$120,094.01 to $162,832 14.70%
$162,832.01 to $227,091 16.80%
Over $227,091 20.50%

So if you happen to make $90,000 a year, the entire amount does not get taxed at 12.29% tax rate. The first $43,070 is taxed at 5.06%, then the next $43,070.99 is taxed at 7.7%, then the rest is taxed at 10.50%.

Essentially your $90,000 annual income is taxed like below:

Income Tax Rate Tax amount
$43,070.00 5.06% $2,179.34
$43,070.99 7.70% $3,316.47
$3,859.01 10.50% $405.20

You’d be paying a total of $5,901.00 of federal tax on your $90,000 income, or an effective average tax rate of $6.56%. The same tiered tax bracket system is applicable to provincial taxes as well, albeit with different specific percentages for each province.

So no, the $90,000 you received isn’t all taxed at 10.50%. The amount is divided up and taxed at different tax rates.

What if you had an income of $90,000 and your employer decided to give you a $35,000 raise? Should you say no because you’ll move up two tax brackets federally from 10.5% to 14.7% and get taxed way more than your $35k raise?

It’s mind-boggling that some people actually believe this is the case and therefore would say no to any raises!!! Let’s do some quick and easy math to sort this out.

I ran the numbers using Wealthsimple’s 2022 income tax calculator and set BC as the province. Here’s the summary:

Income Federal Tax Provincial Tax (BC) CPP/EI Net
$90,000 $12,643 $5,079 $4,453 $67,825
$125,000 $21,146 $9,320 $4,453 $90,091
Delta $35,000 $8,503 $4,241 $0 $22,266

So, an increase of $35k a year raised your total taxes by $12,744 a year. More importantly, you will be netting $22,266 more than you’d have at the lower income of $90,000 a year.

So ask yourself, would you rather pay almost $13k more in taxes while pocketing over $22k more each year? Or would you rather not get the extra money at all? I think 99.9% of the population – if not more – would want the former.

All things equal, you will always come out ahead with a raise regardless of what tax bracket you end up with.

Fortunately, people that have this misconception are a very small percentage of the population.

#2 “Invest” in RRSP

Every February I hear statements in the line of… “I’m investing in my RRSP.” But when I ask for more clarification, I learn that people are simply transferring money into their RRSPs and letting that money sit in cash. They’re moving money into RRSP simply for the RRSP income tax deduction.

I get the idea of getting the RRSP tax deduction to reduce your overall taxes. But don’t you want your money to compound and grow? Why do you have your money sit inside a tax-deferred account and earn a measly 1% interest rate when you can invest in things like ETFs and stocks?

Some people argue that GICs are way safer than other investment vehicles like mutual funds, ETFs, and stocks because GICs have a guaranteed earning rate and you can’t lose money. Continue Reading…