Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

A sensible RRSP vs. TFSA Comparison

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A Sensible RRSP vs. TFSA Comparison

Should you contribute to your RRSP or your TFSA? It’s one of the most frequently asked questions here and on other financial forums, yet the answers couldn’t be more divided. Furthermore, there is a growing sentiment among Canadians that somehow RRSPs are a government scam because you’ll be forced to pay tax on any withdrawals in retirement. That leads many to (sometimes) incorrectly declare that a TFSA is the better savings vehicle for retirement due to the tax-free treatment of withdrawals.

Let’s start by clearing up one important fact in the RRSP vs TFSA debate: The accounts are mirror images of each other. When you put money in an RRSP and invest the tax refund, you’re using pre-tax dollars. The money grows inside a tax sheltered account and then you pay taxes on your withdrawals years later in retirement.

The opposite is true of a TFSA – you contribute with after-tax dollars but won’t have to pay taxes when you take money out. If you’re in the same tax bracket when you withdraw from your RRSP as you were when you made the contributions, the RRSP and TFSA work out to be exactly the same.

RRSP vs TFSA Comparison

Here’s a simple chart that David Chilton used in The Wealthy Barber Returns to help drive this point home:

TFSA RRSP
Pre-tax income $1,000 $1,000
Tax $400 n/a
Net contribution $600 $1,000
Value in 20 years @ 6% growth $1,924 $3,207
Tax upon withdrawal (40%) n/a $1,283
Net withdrawal $1,924 $1,924

Two important caveats to keep in mind:

  1. You need to invest the tax refund in order for RRSPs to work out as designed. Unfortunately, most Canadians spend their refund and so they don’t end up with as much money in their retirement account.
  2. A TFSA is flexible in that you can take out money at any time without penalty. For Canadians who use a TFSA as their primary retirement savings vehicle that means resisting the temptation to raid the account whenever “something” comes up. You should also replace the ‘S’ in TFSA with an ‘I’ and make sure to invest that money for the long-term. Continue Reading…

The Rear-View Mirror and U.S. stocks: A Contrarian Indicator

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By Noah Solomon

Special to the Financial Independence Hub

As we have written before, sentiment and emotions can have an outsized influence on investor psychology and investment decisions. Relatedly, there is a powerful inclination among investors to perceive markets that have outperformed as being less risky than those that have underperformed.

Interestingly, this tendency exists not just among individual investors, but is also prevalent in the professional investment community. A 2008 study by finance Professors Amit Goyal and Sunil Wahal explored the performance of investment managers who had been fired by institutional investors. The analysis compared the managers’ performance in the three years before being fired with their subsequent three-year performance.  The results of the study are summarized in the following graph.

The Selection and Termination of Investment Management Firms by Plan Sponsors

On average, fired managers had poor performance in the three years preceding their termination, with average annual underperformance of 4.1% vs. their benchmarks. This figure should come as no surprise, as you wouldn’t expect that they were fired for knocking the lights out! However, what may be counter-intuitive to many is that these managers tended to subsequently outperform, with average annual outperformance of 4.2% over the three years following their termination.

Clearly, not only does looking in the rear-view mirror fail to prevent you from hitting something that is in front of you but may in fact cause it!

The other takeaway is that even seasoned, institutional investors can be swayed by short-term performance, which in turn can lead to decisions which are both ill-timed and economically perverse.

Beware the Mean Reversion Boogeyman

Last year saw a continuation of a long-established trend of U.S. stock outperformance, with the S&P 500 rising 28.7% as compared to 8.3% for the MSCI All Country World Index (ACWI) Ex-U.S.  From the end of 2008 through the end of last year, the S&P 500 rose at an annualized rate of 16.0%, producing a cumulative return of 587.3%. In comparison, the ACWI Ex-U.S. Index rose at an annual rate of 8.6% and delivered a cumulative return of 190.7%.

The outperformance of U.S. stocks argues for actively reducing U.S. exposure and increasing allocations to other regions, as the mean-reverting, contrarian nature of investment manager performance can also be applied at the country level. The following chart covers the period from 1970-2021 and includes the U.S., U.K., Germany, France, Australia, Japan, Hong Kong, and Canada. Specifically, it illustrates the results of investing every three years in a portfolio of country indexes based on their trailing returns over the previous three years.

3-Year Performance of Countries ranked by Trailing 3-Year Performance

The chart brings fresh perspective to the standard regulatory disclosure language in the marketing materials of investment funds, which states that “Past performance is no guarantee of future returns.”

Outperforming countries tend to become subsequent underperformers : those that have had superior returns over the past three years tend to produce relatively poor results over the next three years. Conversely, underperformers tend to subsequently outperform: those that have lagged over the past three years tend to outperform over the next three years. Continue Reading…

Gen Z is Canada’s most engaged generation for tracking Financial Goals

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Move aside, Boomers: Gen Z is coming through!

According to BMO’s annual Investment Survey, Gen Z is now Canada’s most engaged generation for tracking financial goals.

Younger Canadians are flexing their financial savvy by evaluating their financial goals and plan more frequently than any other cohort: including Boomers!

According to the survey, 62% of Gen Z (aged 18-25) and 54% of Millennials (age 26-41) review their financial goals at least quarterly, with 41% of Gen Z and 29% of Millennials doing so monthly. In comparison, only a third (36%) of Boomers (aged 58-67) review their financial plans at least once a quarter and only 15% of them do so monthly.

“It’s exciting to see the next generation of Canadians building solid financial habits and establishing a foundation early” said Nicole Ow, Head, Retail Investments at BMO, in a  press release, “Real financial progress is a lifelong pursuit as our goals and circumstances change throughout our lifetime. We encourage Canadians of all ages to consider ways not only to grow their wealth and work towards immediate financial goals, but also to ask their advisor how they can align their investments with their values, define their longer-term goals, and protect and share their wealth with their loved ones and the causes that mean the most to them.”

Social media a big influence

While the survey found the majority of young Canadians rely on advice from a professional when making financial decisions, what’s more interesting is the additional sources they are seeking out for guidance. Many are currently working with a financial advisor, and 47% of Gen Z and 32% of Millennials say they were referred to their advisors on the advice of a trusted friend or family member. The impact of social media on the financial habits of young Canadians also mustn’t be overstated. A third of Gen Z and 22% of Millennials refer to financial influencers and social media for their investment decisions. In comparison, only 7% of Canadians over 55 utilize these sources.

Barriers to Entry

Among younger Canadians with savings primarily held in cash, half of Gen Z and close to two fifths of Millennials say the primary reason for this is that they do not know how to invest. Whether it’s not knowing where to begin, or being unsure who to trust with their finances, a lack of basic financial literacy skills being taught in schools may be partly to blame for this. Thankfully, the previously mentioned alternate sources that young Canadians seek out can help to educate those feeling overwhelmed. Continue Reading…

Investing during Wartime: How does the Geopolitical Climate impact your Financial Planning?

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By Steve Lowrie, CFA

Special to the Financial Independence Hub

Don’t let Geopolitical Strife destroy your Investment Resolve.

This month, I was planning to write about financial planning for small- to mid-size business owners, including ways to optimize your personal and corporate tax planning. I believe many of you will find the information useful, so I promise to publish that soon.

But not now. Not after Putin invaded Ukraine. It feels wrong to go about business as usual while most of us are asking important questions about this geopolitical crisis.

By no means do our financial concerns detract from the greater, human toll. That said, if I can help you remain resolute as the world justifiably severs Russia’s access to capital markets and the global economy, perhaps we can both do our part to restore justice in Ukraine.

So, let’s talk about geopolitics and investing during wartime. Here are my key takeaways:

Big picture, geopolitical events’ impact on financial markets are usually short-lived

To help you keep your financial wits about you, consider Vanguard’s historical perspective on how the U.S. stock market has responded to other geopolitical crises over the past six decades. As Vanguard’s chart depicts in the article Ukraine and the Changing market environment, the turmoil has typically translated into initial sell-offs. But markets have also exhibited remarkable resilience, delivering returns in line with long-term averages as soon as six months later. That’s not to predict the same outcome this time, but it reinforces the wisdom of betting for vs. against the market’s staying powers.

Credit: Vanguard – Ukraine and the changing market environment

In Vanguard Canada’s recent article, When the markets seem to turn against you, Greg Davis, Chief Investment Officer recommends a steadfast approach:

“A new dimension of risk has entered the financial markets with heightened tensions in Ukraine …

We know this, however, about equity markets in the context of geopolitical risks: they’ve been resilient, much as markets have always been resilient in the face of various risks. We expect the markets to work themselves out, reaching new heights over time and at varying paces …

So now is not the time to give up your fortitude. Now is the time to take it all in with a deep breath, knowing that this day would come — and knowing that it will pass.”

Speaking of predictions, ignore those who claim to know what’s going to happen next

In their landmark studies on political forecasts documented in their book, Superforecasting: The Art and Science of Prediction, Wharton professor Philip Tetlock (a Canadian, by the way) and co-author Dan Gardner found that we’re unlikely to do our net worth any favors by depending on the “expert” predictions you may be seeing on the daily news:

“People who generate better sound bites generate better media ratings, and that is what gets people promoted in the media business. So, there is a bit of a perverse inverse relationship between having the skills that go into being a good forecaster and having the skills that go into being an effective media presence.”

In other words, those forecasts you’re hearing are more likely to sound like sure (often scary) bets, and less likely to be reasoned reflections on the many ways any given event might play out. In fact, evidence suggests, the more certain an expert seems about their forecast, the more skeptical you should be about its worth.

Continue Reading…

In volatile times, look for Quality

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By Paul MacDonald, CIO, Harvest ETFs

(Sponsor Content)

After nearly two years of a global pandemic, capped by surging inflation, the past month has been dominated by Russia’s invasion of Ukraine and a wave of geopolitical uncertainty unleashed by the largest European conflict since 1945.

“What a crazy decade these past two years have been,” is a line making the rounds on social media at the moment.

In the midst of all this volatility, uncertainty, and tension, we believe it’s important to focus on quality investments. We should begin by understanding and defining quality within our unique philosophy at Harvest ETFs. We can then outline some of the strategies at work in our Harvest ETFs that protect against volatile times and how today’s shocks fit in a longer-term macro-outlook.

Be diversified and own quality

To begin, our view remains that you want to be diversified and you want to own quality. How do you measure quality though? At Harvest, we do it through financial metrics like variability of earnings, visibility into earnings, return on invested capital and others. What those metrics tell us is that large-cap companies have the ability to navigate tail risks.

While risks related to geopolitical tension are top of mind now, we should emphasize that supply chain issues, inflation, and interest rate transitions are arguably the biggest volatility risks now. In this uncertain environment, it’s important to prepare for volatility from a wide range of sources. The expectations for how much and how quickly interest rates will rise is also going to be volatile and will likely result in some sectors doing better at different times, more so than what we have seen in recent history. Volatility shouldn’t come as a surprise if we’re adequately prepared for it with an investment approach that focuses on quality & diversity.

Our focus on quality is a core element of the Harvest investment philosophy. That philosophy focuses on leading companies in specific sectors or mega trends as the best place for investors to be if they want long-term capital appreciation prospects and income across market cycles.

Income Generation and Covered Calls

Income generation is another core element of the philosophy at work in Harvest’s equity income ETFs. That is achieved through a covered call strategy, generating a premium by agreeing to sell up to 33% of a holding at a set price. Using an active covered call strategy, Harvest’s team of portfolio managers generate consistent and high yields on their ETFs. As well, the value of call options tends to increase when volatility and uncertainty increase. The premiums generated by the covered call strategy act as some downside protection by the premium received. Continue Reading…