There are many different ways to diversify:

By industry

• The different industries will perform uniquely in different market conditions and business cycles – putting all your money in one sector can greatly increase volatility, as well as overall risk.
• Hold securities from a variety of industries/sectors.

By management style

• Hold some securities in an actively managed portfolio/mutual fund, and some in a passive portfolio such as an ETF portfolio/mutual fund or index mutual fund.

By geography

• Geographic diversification is critical as only 3% of the world’s market capitalization is found in Canada – if Canada’s economy is slowing down, you want to have exposure to securities from other countries to offset any potential losses

By security

• Asset allocation is important because if you don’t include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal. Many financial planners agree that you will likely need to include at least some stock or stock mutual funds in your portfolio. On the other hand, if you include too much risk in your portfolio, the money for your goal may not be there when you need it.
• A well-diversified portfolio should be comprised of securities from different asset classes – cash/cash equivalents, fixed income, and equities.
• Determining your asset allocation is likely the most important decision that you’ll make with respect to your investments – in fact, it’s more important than the individual investments you buy. It is said that the asset allocation of a portfolio can account for 80% to 90% of your return over the long term.
• You’ll need at least a dozen carefully selected individual stocks to be truly diversified. A mutual fund portfolio may provide you with a cost-effective way to ensure you have a wide-range of holdings in your investment portfolio, as they allow for investors to own a small portion of many investments.

Have questions? Drop me a comment!

If you are able to spread income among family members who are taxed at lower marginal rates, you may be able to lower your family’s overall tax bill. While there are significant restrictions, you may want to explore these tax-saving, income splitting options futher:

Use a spousal loan at the prescribed rate

If you transfer or gift funds to your spouse or common law partner, any interest, dividends or capital gains earned on those funds will continue to be taxed in your hands. An interest-bearing loan made from the spouse in the higher marginal tax bracket to a spouse in a lower tax bracket for the purpose of investing provides an income-splitting opportunity. It is important to note that interest must be charged at the Canada Revenue Agency’s (CRA) prescribed rate in effect at the time the loan is made and interest must be paid by January 30 of each year. The CRA sets the prescribed interest rates quarterly, based on prevailing market rates. Periods, like now, of low prescribed interest rates are generally the best time to establish a loan since the low rate can be locked for the duration of the loan.

Income splitting with a spouse or common-law partner before retirement

This is possible by arranging for the spouse earning the higher income, paying as much of the family’s living expenses as possible. This allows the lower-income spouse to save and invest his or her income. The earnings on those invested funds will be taxed at a lower marginal rate and the overall family tax burden will be reduced. Income splitting in retirement can be achieved by making spousal Registered Retirement Savings Plan (RRSP) contributions while working, through pension income splitting and by splitting Canadian Pension Plan (CPP) benefits.

Pension income splitting

If you are receiving payments from a defined benefit pension plan or are 65 or older (your spouse does not need to be 65) and have pension income, you may be able to split that income with your spouse or common law partner.

Pension income splitting allows a transfer of up to 50% of eligible pension income to a spouse, which provides a significant opportunity to split income where retirement incomes are disproportionate. The allocation of this income is done by each spouse making a joint election annually in their respective tax returns. For income tax purposes, the amount allocated will be deducted from the income of the person who actually received the eligible pension income and this amount will be reported by the other (lower income) spouse.

If you allocate pension income to your spouse and they have no pension income, they may be able to claim the pension income tax credit.

According to the CRA, eligible pension income includes:
Canadians Who are 65 and Over and Receive:

1. registered pension plan payments;
2. Registered Retirement Income Fund (RRIF) payments (includes Life Income Fund (LIF) and Locked-in Retirement Income Fund (LRIF) payments);
3. lifetime annuities from registered plans; or
4. prescribed and non-prescribed annuities (interest component only)

Canadians Who are Under 65 and Receive:

1. registered pension plan payments; or
2. items (2) to (4) above only if received as a result of the death of a spouse.

Income splitting with adult children or grandchildren

Providing a gift to an adult child may allow them to make an RRSP or TFSA contribution or give them an opportunity to earn investment income at their lower marginal tax rate. In addition to adult children or adult grandchildren, you may want to consider this strategy for parents whom you otherwise support in after-tax dollars. The attribution rules do not generally apply to an adult relative (other than a spouse) if a gift is made. However, these rules may apply in a situation where a loan is made to a related adult where no interest (or interest below the prescribed rates) is charged on the loan.

Income splitting with children under age 18

Income splitting can be achieved by making a gift to a minor child, either directly or through a trust, to acquire investments which generate only capital gains. In most cases, capital gains earned after the transfer on a gift is taxed in the minor’s hands. However, interest or dividend income will attribute back to the transferor parent unless fair market consideration (such as a prescribed rate loan) is received. However, second generation income such as income earned on income from the original gift, does not attribute back to the giftor.

As with any tax-reducing strategy, I recommend a visit to an accountant or tax specialist, as rules change with CRA, and your tax specialist will be able to guide you further with these strategies.

Have a question? Drop me a comment!

Just when it started getting to me I made this discovery:   My home was essentially paying me more than $1,000 a month.   I don’t mean simply that I was paying it down.  I mean in addition to the equity gained from my mortgage payments, it was appreciating by about $1000 a month.

That helped me chill about the much-diminished holidays and the fewer non-existent dinners out.

Being cash poor is tough, but watching your net worth increase is a feel-good that can hardly be beat.  And somehow, I managed to have a lot of frugal fun.

So if you’re worried that purchasing an asset of any kind will cramp your style, it might.  But do it anyways.  One way or another you’ll manage just like I did, and down the road you’ll be so glad you did.

Quick. Name five of your possessions that are the most valuable and/or meaningful to you, without stopping to think about it.

We usually associate Wills with death, which I suppose is why we’re not so great at keeping them up to date (if at all). Why not think of them differently? Think of them as bestowing the people you love with items of value.

If you do nothing else right now, take 10 minutes just doing a mental scan of some of your most valued possessions – jewelry, art, piano, furniture, book, music collection – and consider who you would want to receive them.

The term leverage means to borrow money to invest – the multiplying effect from investing this debt is called “leverage”. But, as with anything that increases your ability to earn gains, there’s a potential opposite effect… It can amplify losses, too.

Two primary ways to use leverage are:

Investment loans: You use borrowed funds to invest in the market. In Canada, you can deduct the interest paid on loans for certain investments, which make this strategy much more appealing, and reduce the effect of interest rates eating into your returns.

RRSP loans: Borrowing to invest in your RRSP has advantages – you receive a larger tax deduction for the larger RRSP contribution. Also, the growth of your investment is tax-sheltered within the RRSP which will enhance your returns.

Why would I want to leverage to invest?

Basically, you are borrowing someone else’s money, and reaping the benefits. This works well as long as your principal investment is making more than the interest you are paying on  your debt obligation.  The bottom line is, borrowing to invest can be an effective way to reach your financial goals faster.

That sounds good, so what’s the risk?

As I mentioned, there is more risk with leveraged investing than with traditional investing. What happens if the market goes down? Not only does your investment go down, but you also still owe your debt obligation. Just as gains are magnified, so are losses.

There are some things you can do to minimize your risk:

• Plan to invest for the long-term. Investments are subject to fluctuations but tend to grow over the longer term. Holding your investment for over ten years will greatly reduce the risk due to normal fluctuation of the market.
• Diversify your investments. Market volatility can be reduced by investing in equity-based mutual funds that are diversified.
• Borrow smart — make sure you can afford to make the monthly loan payments and income tax obligations. You wouldn’t want to have to sell your investment to make a loan payment, or pay tax on your gains.
• Invest your tax savings. In most cases, borrowing to invest gives you a tax deduction of interest on your investment loan – so if you re-invest the savings, you will be combining the benefits of leveraging with the benefits of dollar-cost averaging.
• Reduce your debt obligation by making lump sum principal payments on your investment loan.

Is leveraging for me?

Leveraging strategies can be very basic, or very advanced, and involve varying degrees of risk. Whether or not you could benefit depends on your financial situation, goals and comfort level with taking on risk. It’s definitely not for everybody. Talk to your financial professional to determine if this type of investment strategy is right for you.

It’s hard to respond to a ginormous goal like, “I want to become effective with my money”.

We need to break it into concrete, do-able actions.  So answer this question: What one habit, if done repeatedly over time, would have a positive impact on my finances?

Now go schedule time to enact your answer.

This week we move on to a second way our mindset sabotages our ability to get involved with our money.

#2: We go all the way from A – Z in our minds before we even get started. By that I mean, our internal voice goes something like this:

• OMG! I really should be better with my money
• How am I going to do that?
• OK, I need to get out of debt and make a budget and increase my RRSPs so I have $500,000 ($500,000?  How can I possibly?!)  and stop impulse spending and … <fatigue starts to set in>
• To accomplish this I should buy some kind of accounting software and I should get a second job and I’m never going into Banana Republic again!  And I should probably have a Staycation this year.  <This is starting to suck but I know I really should do this.>

And next thing you know a process that should be empowering and engaging has become a grim thing.

STOP IT!

Counter Strategy #2: Ask yourself this simple question.  What one small habit could I start that, as I act on it repeatedly, will result in significant change over time? For me, it was 15 minutes a day tracking my spending.  That may not be the right habit for you.  Choose something that you are confident is truly doable, and sustainable.

If you are feeling especially bold, leave a comment below with your one-habit commitment so I can cheer you on!

Every fund has what’s called a Management Expense Ratio (MER). This is the fee charged by the mutual fund managers themselves, and is generally a percentage of the invested assets — it’s the built-in and necessary cost for the work they do. These fees can range from a little a 0.5% to as high as 3% or more depending on the management company, the type of fund and the investments held within it.

While every fund has an MER, there are additional fees that can be charged when you purchase or sell a mutual fund. If you buy a Front End Load (FEL) fund, your advisor can negotiate a fee of up to 6% to purchase the investment. This comes off the top, and the remainder will be invested. Once this fund has been purchased, there is generally no cost to sell or move the money out of the fund.

If you purchase a Deferred Sales Charge (DSC) fund, it will not cost anything to make the purchase up front, however, if you decide to sell any of the units or move your money to a different fund company you can be charged a fee. This fee can be as much as 6% or even higher, sliding down to 0% depending on how long the money has been inside the fund. The time frame is usually 6 or 7 years before all your funds are deemed “free money”.

The third type of mutual fund is a “no load” fund which has no up front or deferred fees attached to the purchase or sale. These are most often offered by chartered banks.

Be sure to ask your advisor about any fees associated to the fund you are buying long before you sign on the dotted line.

Have a question about loads? Drop me a comment!

To know the exact right time to buy and sell, even a MAJORITY of the time, let along MOST or ALL of the time is a statistical impossibility. Anyone who tells you otherwise is selling you.

This doesn’t mean it can’t be done – in fact you can get extremely rich if you do it well and get more than a little lucky. It’s just not something I would ever recommend to my own clients. In my experience, for the average investor who doesn’t want to put all their money on “red” and let it roll, the far superior method of long term risk-adjusted investing has proven to be creating a disciplined plan, doing plenty of homework on each choice, monitoring it diligently and rebalancing your portfolio as necessary. This may be boring but it’s very effective.

Individual events, including the global meltdown of financial markets in 2008 and 2009, can easily be survived with this approach of discipline and patience. If you are investing today for your retirement 20 years from now, the events of tomorrow, next week or next month will have much less of an impact on your overall returns if you stay true to your investment plan. If you’ve ever seen a chart of worldwide market returns, you would know that betting on those markets as a whole pays off over time virtually every time. Conversely, the more often you try to pick the “next big thing”, the more likely you are to finish with less than you started.

Enlisting a competent advisor to walk you through the process is a good way to get started.

Here’s how they work:

• Resident Canadians, 18 and over, are allowed to contribute up to a maximum of $5,000 every year, and the maximum contribution levels will be indexed to inflation, and rounded to the nearest $500.
• Your investment income can grow tax-free for as long as you keep your money within the TFSA
• Contributions to your TFSA, unlike a RRSP, are not tax deductible.  (But, remember, RRSPs allow you only to defer taxes on the initial contribution and any growth, whereas TFSAs can grow tax-free — You don’t pay taxes on that growth, no matter when you withdraw your funds and growth!)
• There is no need to open a TFSA account to generate TFSA contribution room
• You can withdraw your money at any time with no penalties. Remember though, that you have to wait for the next tax year to deposit any monies withdrawn from your account, after you deposit your maximum contributions for that year (and any contribution room available from previous years).
• You don’t need to open your account with the full $5000 deposit
• You can contribute to a spouse’s or common-law partner’s TFSA
• TFSA assets are transferable to a spouse or common-law partner upon death

Have questions about TFSAs?  Drop me a comment!