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).

Motley Fool: How to move from Saving to Investing

Posted By Jonathan Chevreau | June 29, 2019

What’s the difference between Saving and Investing and how do you move smoothly from the one to the other? Motley Fool Canada has just published the second in a new series of articles by me about the basic steps towards Financial Independence, or what I call “Findependence.” You can find the first one, which ran early in June, here; and the new one by clicking on the highlighted text here: 2 critical steps toward Financial Independence.

The first article discussed how the journey to Findependence hasn’t even begun while you’re still in debt. To paraphrase one of the characters in my book Findependence Day, you can’t even begin to climb the tower of Wealth until you get out of the basement of debt.

It’s nice to be free of debt, whether high-interest credit card debt, student loans or even a mortgage. It’s a big step moving from negative net worth to being merely broke, where your assets and liabilities cancel themselves out. Being free of all debt is certainly a nice place to be if you’ve been anxious over being hounded by creditors. But it’s not financial independence either, which is the stage of life when all sources of income more than meet your monthly financial needs.

As the followup article summarizes, you want to move from Debt elimination to the intermediate step of Saving, and then from Saving to true investing. Saving is being a loaner — you lend money to a bank or other institution and receive a small amount of interest back as well as your principal upon maturity. But to be an investor you want to be an owner: a business owner, through stocks or equities, or more broadly through a diversified basket of equity ETFs.

The end of the piece references a piece by Investopedia about the difference between investing and saving. You can find their explanation here. It says saving is for emergencies and purchases, by which they mean immediate needs. Investing is about a longer-term horizon (defined as seven or more years) and entails more risk than saving. That’s why they refer to the “risk free” return of investing in cash, treasury bills and the like.

Investing is about Money begetting Money

The beauty about saving is that, once the process is begun, it sets the stage for when money begins to beget still more money, a process that will ultimately happen even while you’re sleeping. So does investing: the difference is that saving is a kind of junior partner to investing: it works a bit for you, but nothing so hard as true investing for the long term. Saving begets small amounts of money; ultimately, investing begets huge amounts of money: eventually enough to live on whether or not you choose to work another day in your life. Continue Reading…

Using Canadian Dividend ETFs as your core Canadian holding

Posted By Financial Independence Hub | June 25, 2019

By Dale Roberts

Special to the Financial Independence Hub

As warm and cuddly and comforting as are dividends, the subject or investment approach can lead to some lively debates. Many will write (or build podcasts on the subject) that dividends simply don’t matter.

On that, here’s a measured response from Mike at The Dividend Guy blog. Please have a read of Should I Go With Dividend Growth Investing or ETFs. An Answer To Ben Felix. Of course many dividend and dividend growth investors will simply reference or pull out the Ned Davis research on S&P 500 constituents.

I like the evidence from the Dividend Aristocrats (NOBL) in the US and Canada (CDZ) that both have greater total returns compared to broad market funds through the last market cycle. There is a longer history of outperformance to observe in the US market with those Aristocrats that insist on at least 25 years of annual dividend increases. The threshold for a Canadian Aristocrat is 5 years of dividend increases.

All said, I will leave it to you to decide if dividends matter: to you. Given that nothing is more important than investor behaviour, if watching the dividends is a very useful distraction and those dividend payments allow you to stick to your plan, then they are more than worth the dollar value that shows up in your discount brokerage account.

And for the record I do think or know that the benefits of dividend growth investing do move beyond the emotional and behavioural and into the math and the types of companies that can be found by way of a meaningful dividend growth history. Even Ben Felix will admit that it can help us find certain types of companies and investment factors.

Canadian investors need help!

Let’s face it, the Canadian market is not well diversified. I would often state to clients that Canada makes for a terrible investment. The Canadian market is concentrated in financials and energy and commodity related sectors.

From iShares XIC, TSX capped composite.

TSX Composite Sector Breakdown The Canadian investor needs the sector and geographic diversification offered by the US and perhaps International markets. Here’s the sector breakdown of the S&P 500, by way of iShares IVV.

S&P 500 Sector Breakdown The basic principle of the need for added diversification holds true whether a Canadian investor embraces core index funds or dividend focused funds. How much you add by way of International exposure is certainly a personal decision. I am of the opinion that you might go light on that front given that the large and mega cap US companies earn a considerable percentage of their profits overseas. That said, in a recent CTCI investing post I suggested you might also look to developing markets where there is greater growth and growth potential.

Canadian Dividend ETFs

For my Canadian allocation in my personal RRSP account I hold a concentrated portfolio of individual bank stocks, plus pipelines and telcos. I do not expose my wife’s personal RRSP account to that concentration risk: we hold Vanguard’s High Dividend Yield ETF, ticker VDY. That is the core holding. Here is the sector breakdown for the VDY fund. Continue Reading…

Building your financial stop-doing list: Stop chasing dividends

Posted By Financial Independence Hub | June 24, 2019

By Steve Lowrie, CFA

Special to the Financial Independence Hub

During the 20+ years I’ve been a financial advisor, I’ve noticed how often the market keeps playing the same devilish tricks, each time in a guise that differs just enough to fool us all over again.

Today’s “Stop Doing” post exposes one of these more common tricks of the trade: Investors who are seeking a reliable income stream for retirement should STOP building their investment strategy around dividend-paying stocks (or higher-interest-yielding bonds) in isolation, without considering them in the context of their total wealth management.

Speaking of devilish acts, let’s revisit The Wall Street Journal columnist Jason Zweig’s “The Devil’s Financial Dictionary” (emphasis is ours):

DIVIDEND YIELD, n. A company’s annual DIVIDEND divided by its current share price. “You buy a cow for its milk and a stock for its yield,” says an old Wall Street proverb. But when a company gets into financial trouble and has to cut its dividend to hoard cash for its own survival, the yield will shrink or disappear. Investors who buy a stock only for its yield may suddenly find themselves owning a cow that gives no milk and is too scrawny to butcher for the meat.

Clearly, I am not alone in my skepticism when I see investors investing in a stock because “it pays a good dividend.”

What is a Dividend?

Sweep away all the complexities about corporate profits, and you’re left with this truth: When a public corporation makes a profit, it has two choices on what to do with that cash:

Re-invest it back into the business, or
Return it to shareholders through cash dividends or share repurchase plans.

These concepts aren’t new. Nobel laureate Merton Miller and Franco Modigliani published a paper back in the 1960s, explaining why profits are profits, whether they’re “packaged” as dividends or share value. So, let’s take a look at why chasing dividend-paying stocks may not be all it’s cracked up to be. Continue Reading…

Retired Money: Time for retail investors to STANDUP to the financial services industry?

Posted By Jonathan Chevreau | June 20, 2019

My latest MoneySense Retired Money column is a review of advisor John De Goey’s new book: STANDUP to the Financial Services Industry. Click on the highlighted headline for the full column: Fight for your right to low fees.

Obviously a retrofitted acronym, STANDUP stands for Scientific Testing and Necessary Disintermediation Underpin Professionalism. STANDUP was an undercurrent in the four editions of De Goey’s previous book, The Professional Financial Advisor. There he argued that while most advisors hold themselves out to be professionals like doctors, lawyers or accountants, the primary function of most advisors is “to sell products.” STANDUP Advisors are the good guys and gals: the “self-aware and knowledgeable advisors” his new book aims to help readers find. His personal website is www.STANDUP.today.

Bad advice they believe is good

Right from the get-go, De Goey is pretty harsh on many members of his profession. Much of what advisors believe is “demonstrably wrong” he declares right on page 2 of his introduction: “People who give advice for a living routinely give bad advice while honestly believing that the advice they are giving is, in fact, good. That’s a huge problem.”

He puts much of the blame on the managers of retail advisors, chiefly the senior members of Canadian mutual fund companies. He hauls out the old Upton Sinclair quote to illustrate the gap between doing what’s good for investors and what’s profitable for the financial industry itself: “It is difficult to get a man to understand something when his salary depends upon his not understanding it.” Continue Reading…

The ABCs of Retirement Compensation Arrangements (RCAs)

Posted By Financial Independence Hub | June 19, 2019

Tax Minimization Strategy for High Income Individuals

By Spencer Tilley, CFP, RFP, CFA

Special to the Financial Independence Hub

There is a common theme among high net worth and high-income earners: “How can I save on tax?,” and “What are the most tax efficient ways to save for retirement?”

No question that focusing on tax savings is the most crucial component to some of the most successful individuals in the world.

In Canada, RRSPs, TFSAs and pension plans are commonly utilized retirement vehicles, but what happens when you max out your available room? Unfortunately, as a salaried employee, your additional options for tax-efficient retirement savings are limited, or non-existent.

Retirement Compensation Arrangements (RCAs) are one strategy that not many know but may be available to you as a high-income earner.

What is an RCA?

RCAs are a tool for a high-income earner to save additional funds on a tax-deferred basis, over and above the RRSP/pension limits, for their retirement. It is funded by an employer for the employee’s long-term benefit. It was created to help supplement and overcome the income gap in retirement that occurs because of the relatively low annual prescribed RRSP/pension limits.

Basically, RRSP room has not kept pace with wage growth and there is essentially a cap on the amount that can be saved tax-deferred for retirement. RCAs help make up the difference between what can be saved for retirement and what is needed in retirement, on a tax-deferred basis.

Here’s what you need to know:

Today, top personal tax rates are over 50% in 7 out of 10 provinces, with the other 3 provinces clipping north of 47.5%. With these high personal tax rates combined with the recent changes in the Federal Government Small Business Tax regime, RCAs, along with the Individual Pension Plan (covered here), are making a comeback as a strong player in the retirement game for highly compensated executives and can provide a huge tax benefit for those who may qualify to use it.

How it works:

The employer contributes 100% of the amount, of which 50% is sent to the CRA, held in a non-interest bearing, refundable tax account and 50% is deposited to your RCA Investment account, held with a custodian where it can be invested on a tax-deferred basis. Withdrawals are taxed as regular income. Giving the CRA 50% of your money today may seem like a bad deal, but let’s examine the benefits a little closer:

The Benefits

Employee benefits (assuming top marginal tax rate):

In 7 out of 10 provinces, you would otherwise be paying the CRA 51.3%-53.53%, upfront and permanently. You are already ahead of the game in these provinces
In the other 3 provinces, you would pay 47.5%-49.8% to the CRA, so at most a 2.5% disadvantage. But …
The real advantage lies in your ability to withdraw the funds over time and at your discretion, rather than receive them personally all at once, thus (hopefully) reducing your income in any given year enough to drop you into a lower tax bracket and ultimately pay less tax
Contribution limits are not based on RRSP room and can exceed pension contribution limits by significant amounts
50% is contributed to the RCA investment account and invested for your retirement.
When you withdraw funds in retirement, 50% of your withdrawal is added back to the RCA investment account via a refund from the CRA refundable tax account (the 50% that went to the CRA at the beginning)
Funds are the employee’s in the end, whether the company is around or not

Employer benefits:

100% of the employer contributions are tax-deductible for the business
Key employee retention

The Downside/Risks

An actuary needs to be hired to implement and keep track of everything incurring an annual cost for administration” approximately $1,000/year
50% of the contribution is sent to the CRA in the form of a refundable tax
- Money in the CRA account is held in a non-interest bearing account
Investment risk is taken on by you and not your employer (unless the RCA is funding for a defined benefit supplemental pension guaranteed by your employer)
Employment income needs to be high over the last 15 years to qualify
This is only for those who have maximized their pension benefits and cannot achieve 70% of their current income as retirement income with existing retirement plans
A company cannot ‘bonus down’ to keep income lower than the small business limit

Who this is best suited for:

High-income earners: groups of managers or executives, successful business owners, or other highly compensated individuals where income is tied to special employment incentives, such as a professional athlete.

Let’s review a simplified example:

Assume you have earned a $1,000,000 incentive paid above your usual salary of $314,928/year in Alberta, which you have received for the last 10-15 years. If you were to pre-plan with your employer and utilize an RCA, the benefit could be upwards of approximately $200,000 using the RCA strategy vs straight T4 income: that’s like an extra $10,000/year for 20 years of your retirement!

Some technical details:

If this $1,000,000 incentive were paid as T4 income, in Alberta you would pay $480,000 (48%) tax and you would keep $520,000 (52%). Continue Reading…