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).

The hidden costs of DIY Financial Planning: Bad Investments cost more than you think

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Today’s Simple Investing Take-Away: Simple investing mistakes can result in bad investments that can derail your long-term financial goals and erode your emotional well-being. One of the biggest missteps, amplified by our behavioural tendencies, is to ignore the many hidden costs of DIY investing. Even if the price paid isn’t obvious, it still takes a toll on your results.

 

Lowrie Financial

 

By Steve Lowrie, CFA

Special to the Financial Independence Hub

Eager to embrace DIY investing? Or have you at least wondered whether you’ve got what it takes to succeed on your own?

I understand the appeal. When you engage a personal financial advisor, you’ll see their advisor fees, loud and clear. The financial regulators require us to disclose them. Plus, at least here at Lowrie Financial, we want you to see them. How else can you tell if you’re getting a fair shake?

But therein lies a dilemma. Thanks to behavioural finance, we know about a multitude of murky costs that can slip in when investors allow their rational resolve and simple investing strategies to be hijacked by their complex instincts and emotions. Some of these self-inflicted costs include:

  • The cost of chasing past returns by getting caught in a “fad” during up markets; or by panicking and selling out during scary times
  • The cost of ignoring tax ramifications of frequent trading in taxable accounts
  • The cost of investing as a form of entertainment, or experimenting with your financial future while learning the ropes

Once you factor in the bad investments and other prices paid by so many DIY investors, financial advisor fees start to seem well worth it. A reputable advisor should help you focus on your personal financial goals while avoiding these and other DIY investing pitfalls.

The cost of chasing Past Returns

Have you heard of “FOMO” or “Fear of Missing Out”? It’s that itchy feeling you get when you long to get in on a red-hot popularity contest, regardless of whether it fits into your financial plan.

Most recently, others seem to be making millions on all sorts of “silly season” exotica: from SPACs and Reddit-fueled stock runs, to cryptocurrency and NFTs. In real time, these may seem like simple investing decisions; jump on the bandwagon and make a ton of money, fast. Unfortunately, by the time you’re aware of a trend on a tear, you’ll be hard-pressed to buy in low enough, sell out high enough, and do both consistently enough to come out ahead in the long run. This means odds are heavily stacked against FOMO-driven investors who try to come out ahead (but usually fail) by chasing after winning streaks.

There are reams of academic inquiries pointing to the merits of more patient simple investing strategies for capturing expected long-term market growth. Recently, a University of British Columbia/Emory University study found (once again) that individual investors in Canada and around the globe tend to underperform the same stocks and markets in which they’re invested. Digging into why, the study’s co-authors found investors created extra self-inflicted investment volatility (nearly 50% higher) by piling into the market “after superior stock returns and before inferior returns.”

These findings only add to a volume of past studies into similar return-chasing adventures. By succumbing to FOMO investing and similar bad investment habits, DIY investors unnecessarily sacrifice available market returns.

The cost of ignoring Tax Ramifications

These days, many people are working from home, with more time to spend consuming financial media or social media forums. A simple look at these investing forums would lead you to believe that everyone from your co-worker, to your favorite sports hero, to popular financial gurus like Canada’s own Chamath Palihapitiya are supposedly seizing big profits and cutting losses in rapid-fire trades day after day. It seems so easy.

Again, if we look at the evidence, the after-cost, after-tax results usually fall short of a simple buy-and-hold approach. In a recent extreme example, a U.S. day-trader used $30,000 in cash, placing 10–50 trades daily, to come out $45,000 ahead in 2020. Not bad. Unfortunately, by failing to understand U.S. tax regulations, like the wash-sale rule, he also generated an $800,000 tax bill on the realized gains. Continue Reading…

MoneySense Retired Money: How safe are REITs and REIT ETFs during the Covid recovery period?

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MoneySense.ca: Photo by energepic.com from Pexels

My latest MoneySense Retired Money column has just been published: it looks at how much real estate should make up of an investment portfolio, either through direct ownership in physical real estate, or through more diversified REITs or REIT ETFs. Click on the highlighted headline for the full column: How much real estate should you have in a balanced portfolio? 

How much should real estate comprise in a balanced portfolio? While a principal residence certainly will be a big part of most people’s net worth, personally I don’t “count” it as part of my investment portfolio, even though it can ultimately serve as a retirement asset of last resort, via Home Equity Line of Credits (HELOCs), reverse mortgages or simply an outright sale when it’s time to enter a retirement or nursing home.

If you take that approach, and many of my advisor sources do, then the question becomes how much real estate should you have in your investment portfolio, above and beyond the roof over your head?

Certainly, if you are happy being a landlord and handy about home maintenance, direct ownership of rental apartments, duplexes or triplexes and the like is a time-honored route to building wealth. That’s the focus of organizations like the Real Estate Investment Network (REIN).

However, if you don’t want the hassle of being a landlord, you may want to try Real Estate Investment Trusts (REITs), which are far more diversified both geographically and by housing type. Some REITs focus on baskets in particular real estate sectors, such as residential apartments or retirement homes.

A still more diversified approach is to buy ETFs providing exposure to multiple major REIT categories, whether Canadian, US or international.

Adrian Mastracci, portfolio manager with Vancouver-based Lycos Wealth Management, says the REIT idea “makes sense” but suggests they should not make up more than 5 or 10% of an investor’s total wealth or not more than 7% of an equity portfolio. “I consider it part of the equity bucket. Publicly traded REITS trade more like equities than real estate.” He advises buying top-quality REITs (or ETFs holding them), diversified across Canada but avoids foreign ETFs because “you want the dividends taxed as Canadian dividends.”

Most of the major ETF suppliers with a Canadian presence have broad-based passively managed REITs although there is at least one actively managed one.

Major passive and active Canadian REIT ETFs

The Vanguard FTSE Canadian Capped REIT Index ETF (ticker VRE/TSX) was launched in 2012 and has a modest MER of 0.39%.  As the name implies, any one holding is capped at 25% of the total portfolio [typically this is RioCan.] Its mix is 22% retail REITs, 19.8% office REITs, 18.5% real estate services, 18.5% residential REITs, 8.5% industrial REITs, 8.1% diversified REITs and 4.6% real estate holding and development.

An alternative is XRE, the iShares S&P/TSX Capped REIT Index ETF, trading on the launched in 2020, which holds roughly 16 Canadian REITs, with weightings almost identical to VRE. The iShares product (from BlackRock Canada) has a slightly higher MER of 0.61%. Continue Reading…

Asset bubbles and where to find them

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Vanguard Group

Commentary by Joseph H. Davis, PhD, Vanguard global chief economist

Republished with permission of Vanguard Canada

There’s only one sure way to identify an asset bubble, and that’s after the bubble has burst. Until then, a fast-appreciating asset may seem overvalued, only for its price to keep rising. Anyone who has tried to breathe one last breath into a balloon and finds it can accommodate two or three more breaths can relate.

Yale University’s William Goetzmann learned just how hard it can be to pinpoint a bubble. He found that assets whose prices more than double over one to three years are twice as likely to double again in the same time frame as they are to lose more than half their value.1

Vanguard believes that a bubble is an instance of prices far exceeding an asset’s fundamental value, to the point that no plausible future income scenario can justify the price, which ultimately corrects. Our view is informed by academic research dating from the start of this century, before the dot-com bubble burst.

Are there asset bubbles out there now? We at Vanguard have great respect for the uncertainty of the future, so the best we can say is “maybe.” Some specific markets, such as U.S. housing and cryptocurrencies, seem particularly frothy. U.S. home prices rose 10.4% year-over-year in December 2020, their biggest jump since recovering from the global financial crisis.2 But pandemic-era supply-and-demand dynamics, rather than speculative excess, are likely driving the rise.

Cryptocurrencies, on the other hand, have soared more than 500% in the last year.3 It’s a curious rise for an asset that is not designed to produce cash flows and whose price trajectory seems like that of large-capitalization growth stocks: the opposite of what one would expect from an asset meant to hedge against inflation and currency depreciation. Rational people can disagree over cryptocurrencies’ inherent value, but such discussions today might have to include talk of bubbles.

What about U.S. stocks? The broad market may be overvalued, though not severely. Yet forthcoming Vanguard research highlights one part of the U.S. equity market that gives us pause: growth stocks. Low-quality growth stocks especially test our “plausible future income” scenario. For some high-profile companies, valuation metrics imply that their worth will exceed the size of their industry’s contribution to U.S. GDP. Conversely, our research will show that U.S. value stocks are similarly undervalued.

 

Low-quality Growth has outperformed the market

 

Notes: Data as of December 31, 2020. Portfolios are indexed to 100 as of December 31, 2010. Low-quality growth and high-quality value portfolios are constructed based on data from Kenneth R. French’s website, using New York Stock Exchange-listed companies sorted in quintiles by operating profit and the ratio of book value to market value (B/P). The low-quality growth portfolio is represented by the lowest quintile operating profit (quality) and B/P companies. The high-quality value portfolio is represented by the highest quintile operating profit and B/P companies. The broad U.S. stock market is represented by the Dow Jones U.S. Total Stock Market Index (formerly known as the Dow Jones Wilshire 5000) through April 22, 2005; the MSCI US Broad Market Index through June 2, 2013; and the CRSP US Total Market Index thereafter.
Source: Vanguard calculations, based on data from Ken French’s website at Dartmouth College, mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html; MSCI; CRSP; and Dow Jones.
Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Low-quality growth stocks — companies with little to no operating profits — have outperformed the broad market by 5.5 percentage points per year over the last decade. Of course, there are reasons why growth stocks may be richly valued compared with the broad market. Growth stocks, by definition, are those anticipated to grow more quickly than the overall market. Their appeal is in their potential. But the more that their share prices rise, the less probable that they can justify those higher prices. A small handful of these “low-quality growth” companies may become the Next Big Thing. But many more may fade into obscurity, as occurred after the dot-com bubble. Continue Reading…

Gold still trusted over Bitcoin, but gap is closing

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A report by LendEDU finds Bitcoin is making a lot of headway with investors over Gold. 56% said Bitcoin is a better investment to maximize profits, versus just 33% for gold. However, they still see gold as a better store of value against inflation, with 50% answering gold  (including 67% over the age of 54), and 39% saying bitcoin.

On behalf of New Jersey-based LendEDU, research firm Pollfish surveyed 1,000 Americans on April 21st to see how they would deploy an initial US$50,000 to build a retirement nest egg, and found gold only had a slight edge: 45% versus 42% for bitcoin. However, if the goal of the $50,000 investment is strictly to maximize profits, 49% specified bitcoin, versus just 37% for gold.

LendEDU Director of Communications Mike Brown says Bitcoin is up roughly 68,189,500% since its start in 2009, while gold is up 105% over the same period.

“Gold is proven as a reliable investment and safe haven against market volatility and inflation, which is especially relevant in 2021. Bitcoin is becoming a competitor for just the same thing, although its wild price fluctuations are not for the faint-hearted and attract a younger, more aggressive investor … We found gold is still trusted for more cautious investing, especially amongst older Americans, but bitcoin is closing that gap and is preferred for speculative investing, especially with the younger crowd.”

LendEDU’s Mike Brown

Brown says the survey results were “none too surprising; bitcoin has periods of monumental gain that make it a salivating buy for aggressive investors trying to make a profit. But it also has periods of monumental loss and faces constant regulatory and institutional scrutiny that make it a questionable buy if your first investment priority is protecting the money you already have.”

Gold, on the other hand, doesn’t have eye-popping surges like bitcoin but is safe and has historically delivered steady profits to the patient investor looking for a financial safe haven.

The survey reveals a younger bias towards bitcoin and an older population favoring gold. Thus, 56% of those between the ages of 18 and 24 thought bitcoin was the better speculative asset, while 29% thought gold was. The percentages were 29% and 55%, respectively, for poll participants over 54.

Similarly, 42% of the 18 – 24 cohort thought bitcoin was a better store of value to protect against inflation, while 44% said gold. For the over 54 cohort, those percentages were 16% and 67%, respectively.

Brown found the 35-44 age group surprising as they were quite bullish on bitcoin in all four questions and broke with the normal trend that had older respondents favoring gold and younger ones opting for bitcoin. “This could be due to this demographic getting in on bitcoin in the extremely early stages, around 2010 when they were in their mid-twenties or early-thirties.”

When asked if they have invested in bitcoin or gold recently amid concerns about inflation, 15% had invested in gold, 31% in bitcoin, 15% in both, and 36% in neither.

For retirement investing, gold still holds a dwindling edge

In another part of the survey, poll participants were given four increasing monetary values and asked if they would rather invest each value in either bitcoin or gold to build a retirement nest egg that they couldn’t touch until retirement. In nearly every scenario, gold was the preferred retirement investment choice over bitcoin. Only when $1,000 was the starting amount did more respondents (47%) want to invest in bitcoin over gold (43%).

But as the starting amount went up, so too did the risk, which is likely why respondents switched over to the less-risky, less-volatile gold to start building their retirement nest eggs as the questions progressed. As Brown notes, “Retirement accounts should be stable, and you’ll lose a lot less sleep investing $50,000 in gold instead of $50,000 in bitcoin.”

Even so, no matter the initial investment amount, most age groups preferred building their retirement nest egg through bitcoin rather than gold. For example, 46% of the 45-54 cohort wanted to invest $50,000 in bitcoin compared to 41% who said gold. Continue Reading…

Death and Taxes, Cross-border Style

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Dollar Printing: Global Macro Shifts; Franklin Templeton Investments Licensed from Gettyimages

By David Cieslowski, CPA, CA, CFP, CIMA

(Sponsor Content)

As Benjamin Franklin famously wrote, “… in this world, nothing is certain except death and taxes.”  For US citizens, as well as some Canadians who own US assets, the first may be swiftly followed by the second.

In the United States, an estate tax is applied to the transfer of the taxable estate of every deceased  American citizen, resident or non-resident, including green card holders or others with dual US-Canadian citizenship. Even Canadian citizens who have never stepped foot in the United States, but hold US securities or other US assets, could find their estates subject to a tax on situs assets, which are defined as assets with a tangible or intangible direct US connection or location.

The low-down on US estate tax

Estate tax falls into the category of transfer taxes, as opposed to income tax. It can be substantial; those in the top marginal tax bracket may pay up to 40% on estates with assets of more than US$1 million. Moreover, for US citizens and residents this tax applies to assets held worldwide. Real estate ownership alone can easily exceed those limits.

Fortunately, the reality is somewhat more encouraging. Only around 2% of the US population actually pays estate tax, largely because of exclusions that effectively spare all but the largest estates.

The two most common exclusions are:

  • Annual exclusion of US$15,000 per person
  • Lifetime credit of US$11.7 million for 2021 and indexed annually. Something of a political football, this credit can rise or fall along with changes in government[1]. The current credit limit is set to expire at the end of January, 2025.

These annual exclusions are portable, meaning they can be used by any descendant of the deceased.

The gift that keeps on giving: to the IRS

In the battle of wills between those determined to transfer all of their wealth to succeeding generations and those determined to “tax to the max,” many strategies have been tried and failed. Gifting assets to relatives while the owner is still alive has been one of the more popular tactics. Not surprisingly, the IRS employs two additional taxes to thwart such attempts at tax-free wealth transfer.

The first is a garden-variety gift tax. For non-spouses, annual exclusions are the same as for estate taxes. For spouses they are more generous: unlimited for spouses who are US citizens and $159,000 for 2021 (indexed annually) for spouses who are not. Continue Reading…