A few suggestions on how to invest a $300,000 inheritance

Last week’s post contained a real life Canadian couple’s financial dilemma on how to invest a surprised inheritance. I asked writers and readers of financial blogs to email me their suggestions. This couple is in their mid-fifties and are hoping to retire in 8 to 10 years. They are debt free, have poor paying jobs and only managed to save $55,000 for retirement. Unfortunately, my bullet point list of Canadian tax info wasn’t very clear.

Additional clarification of  the Canadian Tax system

Canadians have three choices for saving for retirement if they don’t have a company pension.

Registered Retirement Saving Plan (RRSP)

  • Contributions are limited to 18% of working income (max. $25,370 investment income not included)
  • Tax deductible, refund based on your tax rate (lowest 20%, highest is 53%)
  • Tax free compounding, withdrawals are 100% taxable at your personal tax rate (lowest 20%, highest is 53%)
  • Government requires you to make withdrawals at age 72
  • Not usually recommended for low income families

Tax free Savings Account (TFSA began in 2009), geared to low income families

  • Personal contributions are limited to $5,500 per year, not tax deductible
  • Unused contributions are carried forward indefinitely
  • Tax free compounding, withdrawals are not taxable
  • No restrictions on withdrawals, money can be taken out and put back in the following year.

Taxable investment account

  • Interest income, foreign interest and foreign dividends are 100% taxable at your current tax rate (lowest 20%, highest is 53%) Plus there is 15% foreign tax withheld. If personal your tax rate 30%, foreign dividends of $100 minus  $30 personal tax – $15 of foreign tax = $65
  • Canadian Dividends have an eligible tax credit that increases the after tax yield. In theory, a Canadian could earn $40,000 in dividends tax free if they had no other income.
  • Capital gains has the lowest tax rate because only 50% of the gain is included in income, so only $50 of a $100 gain would be included. High income earners (53% tax bracket) would only pay 26.5%  in income tax.

I only received two suggestions and didn’t receive any input from any Canadian bloggers or readers.  So, I asked a financial planner who works at one of my local bank branches to weight in.

From the United States, Bear with the Bull offered the following:

I am not sure I am most qualified to be a financial adviser and I really do not know Canadian tax laws. I would think they might want a mix of income, bond, possibly cash, and growth stocks.  For my 401, I have about a 60/40 split of stocks and income/bond allocation. So if they are looking for more cash / income, maybe they would be more comfortable with something more 40/60 instead. 

They probably would look to a portion to be cash or bond fund that could be used to maximize yearly retirement contributions and or have readily available should they need it.  Since the Canadian real-estate market is seemingly doing well, how about investing in some Canadian REITs?  It would have a short term growth opportunity and dividends as well.  ETF’s also seem to be the latest investing vehicle and generally have lower fees than mutual funds.

  • The 40% equities ($120,000) 50% Canada 40% U.S 10% Emerging markets
  • The 60% fix income ($180,000) Perhaps a 1/3 split.  $60,000 Bonds, $60,000 Reits, $60,000 Cash

Realize that this response and $5.00 will get you a good cup of Starbucks so take it for what it is worth.

From Belgian, Amber Tree Leaves offered the following:

Here is a potential solution, as I am not sure to fully understand the Canadian system, I will skip that part.

General comment: As they have not yet accumulated a lot of assets, it might be tough to retire in the next 8-10 years. It is reasonable to expect a severe correction in that period. As it seems that they have little investing experience, it might be better to go for an approach that generates cash from dividend stocks. The assumption here is that it generates higher yields than ETFs. 

  • allocation: 70 % stock and 20 % bonds and 10 % gold.
  • The 70% equities 20% in Canadian dividend stocks, 50% world wide in dividend paying stocks

The gold is there as a hedge against the really bad times. It should be managed in a way that it needs to be sold and converted into stock/bonds when the price rises a lot. Timing this is hard, it is not the goal to get the absolute top.

Bank Financial Planner

First of all, I believe that money has different weights or “gravity” depending on how you acquire it.  Inheritance money seems to have the most weight as often people feel they “owe” a higher degree of care of duty to it and are less likely to deal with it the way they would a lottery win or an insurance settlement.

Obviously, the first thing I would need to do is get a better understanding of their situation and their time horizon and risk tolerances.  Let’s assume they are comfortable with a balanced approach. I would recommend 60% equity/40% fixed income.  ($180,000 in equity and $120,000 in fixed income.)

I would recommend they start by contributing fully to TFSAs, which would account for $102,000 between the two of them.  In the TFSA, I would use a ladder of market linked GICs to give them diversification, security of capital and the potential for higher returns than offered by traditional GICs.  This allows them their only chance to earn interest without paying tax on every penny of it.  It also means there are no fees to pay on almost one third of their investments. 

For the non-registered account, I would recommend a core holding of a growth ETF portfolio ($100,000 with additional positions in our Canadian ($30,000), US ($15,000 and International ETF funds $25,000), with a portion in our US Dollar ETF $15,000) for additional diversification on currency. 

After the initial investment occurred, I would want to have an annual strategy to move the maximum TFSA contribution for each of the clients.  This would involve selling a position of the non-registered investments (unless there are additional savings available) and reinvesting in the same fund inside the TFSA to maintain the balance in the overall account.   This would allow the gradual transition into the TFSA accounts, helping with taxes and probate fees down the road.  A portion of capital gains (or losses) would be triggered each year, smoothing the tax impact on the clients.

I am not sure if this inheritance is big enough to bail out this couple’s retirement plan. A key element is understanding after tax returns when investing.

 

 

 

Warning signs that oil prices are range bound for many years

The future price of crude oil is very important to the Canadian economy and to investors in the Toronto stock market (TSX). The Canadian oil patch represents a 25% weighting in the overall index. Over the past few months, we have seen a massive sell-off of oil sands assets by foreigners.

In March, Royal Dutch Shell and Marathon Oil sold stakes in the Alberta oil sands project to Canadian Natural Resources for $12.7 billion. Marathon sold its 20% stake in the project for $2.5 billion. Later in March, Conoco Phillips sold their partnership in the oil sands to Cenovus Energy for $17.7 billion.

Reuters reported last week that BP is considering the sale of its stakes in three Canadian oil sands projects.

“BP’s 50 per cent stake in the Sunrise project near Fort McMurray in Alberta, where Husky Energy Inc owns the rest and is the operator, is the most valuable of the three assets. It also owns a 50 percent stake in Pike, operated by Devon Energy Corp, which is still awaiting a final investment decision, and is majority-owner of the Terre de Grace oil sands pilot project.”

Also in the news is Chevron was exploring the sale of its 20% stake in Canada’s Athabasca oil sands project which could fetch $2.5 billion.

“Faced with a lower oil price environment and challenging economics, which include high cost operations and carbon taxes, global players are increasingly put off by the oil sands.”

Extracting oil from the vast majority of Canada’s oil sands is a very labor and capital intensive process. It requires much higher crude oil prices to justify the more expensive extraction method. Global players exiting their oil sands positions could be a warning sign that the price of oil getting above the $60 level is overly optimistic.

The upcoming IPO of Saudi Arabia’s state own oil company (Saudi Aramco) is another warning sign that the price of oil could be range bound. The company’s oil assets are valued around 2 trillion dollars. It begs the question; why would Saudi Arabia sell part of its state own oil assets to investors?

The simple answer is the Saudi’s need more revenue to pay for their government spending programs. I believe that this is another warning sign that the price of oil will stay lower for much longer. OPEC’s current production cuts are aimed at stabilizing the oil market so that the Saudi Aramco IPO will be successful in raising much need cash for Saudi Arabia.

The key question for the future of the oil market is for how long can a surge in U.S. shale supplies make up for the slow pace of growth elsewhere in the oil sector. The 5 year chart below illustrates the returns on owning two different oil ETFs. You would have lost money owning the Canadian oil ETF (XEG) and you would have broken even on the Spider ETF (XLE). 

In my humble opinion, long term buy and hold investors should avoid oil stocks. I have been bearish on Canadian oil companies for a long time because our oil and gas is land lock. Our only customer is the United States and they have already put a 20% tariff on softwood lumber. There are growing tensions around renegotiating NAFTA which could lead to a tariff on Canadian oil. Oil stocks are still trade-able but you need to be very nibble.

 

Do you agree or disagree? All comments are welcomed.

 

Disclaimer: This post is for discussion purposes only, do your own research before you invest.

 

 

Canadian Marijuana bill gives a new meaning to Happy Easter

On Thursday, Liberal Prime Minister Justin Trudeau introduced a bill that would legalize marijuana for recreational purposes. It would be the first developed country in the world to fully legalize pot since the international war on drugs began in the 1970s. The government hopes to clear the parliamentary and procedural hurdles to make pot legal by July 1, 2018.

The bill would allow people to own up to 30 grams of dried or fresh cannabis and sets the minimum at 18 years of age, though provinces and territories can set a higher legal age. Consumers can grow up to four plants at home or buy from a licensed retailer. The federal government will handle licensing producers while provincial governments will manage distribution and retail sales.

Speculators have dived into Canadian marijuana stocks raising concerns of a green bubble. Only two marijuana producers are showing any profits. Most companies are spending money to increase their production facilities in anticipation of increase recreational use. None of the players know the exact size of the recreational market, with sales estimates ranging from nearly $5 billion to roughly $10 billion.

The Canadian marijuana index which contains 12 stocks already has a market cap of over 5 billion.

Marijuana Index Ticker Market Cap
Canopy Growth Corporation WEED 1.61b
Aurora Cannabis Inc. ACB 903.73m
Aphria Inc. APH 898.84m
Cronos Group Inc. MJN 411.54m
Supreme Pharmaceuticals Inc SL 293.17m
OrganiGram Holdings Inc OGI 285.50m
CanniMed Therapeutics Inc. CMED 274.54m
Emblem Corp EMC 205.47m
Hydropothecary Corporation THCX 174.94m
Emerald Health Therapeutics I EMH 126.65m
THC Biomed Intl Ltd THC 77.32m
Naturally Splendid Enterprises NSP 20.90m

Beware that insiders have been selling according to Bloomberg!

“Since March 1, five directors, officers and board members with Canopy Growth Corp. sold 3.2 million shares worth at least $7.5 million, including Chief Executive Officer Bruce Linton, who sold $3.7 million worth of his holdings, according to data compiled by Bloomberg. Between March 1 and April 10, eight executives and the chief cultivator for Aurora Cannabis Inc. sold a total of 4.9 million shares worth $11.8 million, data show.”

A found two companies listed on U.S. exchanges that are in the medicinal marijuana field that look interesting.

 

AbbVie (ABBV) is ahead of the field in medicinal marijuana because its cannabis-based drug Marinol has already been approved by the Food and Drug Administration and is currently being marketed. Marinol relieves nausea and vomiting in patients undergoing chemotherapy. It is also used for AIDS patients who have lost their appetites.

GW Pharmaceuticals (GWPH) could be a growth play in the medicinal marijuana field. With a market cap of $2.16 billion, the company has researched marijuana-based medicines since 1990 and has a promising drug called Epidiolex. The drug has not been approved by the Food and Drug Administration, but it is showing effectiveness in treating epileptic seizures. It is cannabis-based and could gain wide acceptance quickly if approved.

On a personal note, my 84 year old mother suffers from high levels of anxiety. Her doctor prescribed a number of different anxiety drugs but she couldn’t tolerate the side effects. Out of desperation, I convinced her reluctant doctor to refer her to a cannabis clinic for assessment. She has been approved and is currently ingesting small quantities of cannabis oil. It is still too early to tell but I have noticed some improvement.

Happy Easter

Disclaimer: I do not own any of the above mentioned stocks. This post is for educational purposes.

Active or passive investing? Why I now use both approaches

There is perhaps no controversy in the investing world more contentious than active versus passive equity investment management. Members of both camps constantly argue that their way is unequivocally the best, despite real-world results that support one side’s argument one year and the other’s the next.

Blackrock, the world’s largest money manager, is overhauling its actively managed equities business. They are cutting jobs, dropping fees and relying more on computers to pick stocks. This is a clear indication how difficult it has become for humans to beat the market.

“BlackRock  CEO Larry Fink has sometimes expressed disappointment in the performance of the company’s actively managed stock funds, and he has pivoted increasingly to focusing on the company’s data-driven “Scientific” equity teams.”

Most investors seem to be in either the active or passive camp, few use both methods. For years, I have been in the active camp because I use options to make money during up and down markets. However, providers of exchange traded funds (ETF’s) have evolved beyond just offering low cost sector and index funds.

The growing popularity of ETFs have increased competition among providers to attract investors to purchase their products. I have notice an increase in the number of products that include covered call and also some put right options.

                               A Partial list of Covered Call ETFs

Advisor Shares STAR Global Buy-Write ETF (VEGA)
CBOE S&P 500 Buy Write Index ETN (BWV)
Credit Suisse Gold Shares Covered Call ETN (GLDI)
Credit Suisse Silver Shares Covered Call ETN (SLVO)
First Trust High Income ETF (FTHI)
First Trust Low Beta Income ETF (FTLB)
Horizons S&P 500 Covered Calls ETF (HSPX)
Recon Capital NASDAQ 100 Covered Call ETF (QYLD)
S&P 500 BuyWrite Portfolio ETF (PBP)
BMO Covered Call Canadian Banks ETF (ZWB-TSX)listed on the Canadian TSX stock exchange
BMO Covered Call Dow Jones Industrial Average Hedged to CAD ETF (ZWA-TSX)listed on the Canadian TSX stock exchange
BMO Covered Call Utilities ETF (ZWU-TSX)listed on the Canadian TSX stock exchange
BMO US High Dividend Covered Call ETF (ZWH-TSX)listed on the Canadian TSX stock exchange
First Asset Can-60 Covered Call ETF (LXF-TSX)listed on the Canadian TSX stock exchange
First Asset Can-Energy Covered Call ETF (OXF-TSX)listed on the Canadian TSX stock exchange
First Asset Can-Financials Covered Call ETF (FXF-TSX)listed on the Canadian TSX stock exchange
First Asset Can-Materials Covered Call ETF (MXF-TSX)listed on the Canadian TSX stock exchange
First Asset Tech Giants Covered Call ETF (CAD Hedged) (TXF-TSX)listed on the Canadian TSX stock exchange

A key advantage of ETFs with covered call option writing is investors have some downward protection during these uncertain times. Plus you don’t have to be approved by your financial institution to trade options. Keep in mind that the management expensive ratios are going to be higher than index funds and these ETFs are also fairly new so it may be difficult to evaluate their past returns.

 

Disclaimer: These are not recommendations, do you own research before investing.

 

 

 

 

A reality check on Trump’s tax reform agenda

Still etched in my brain was the great income trust debacle that took place on Halloween of 2005. The Canadian conservative government won re-election promising not to change the tax preferred treatment of income trusts. That promise was broken and Canadian investors lost billions of dollars overnight. The value of my income trust holdings fell by 40% instantaneously.

Needless to say, as an investor in U.S. stocks, failure to appeal and replace Obamacare (ACA) makes me very nervous. Trump’s promise of massive tax cuts and infrastructure spending will need support from the Freedom Caucus (tea  party) who want a border adjustment tax to offset some of the loss revenue.

There is also a complicated Senate rule that would prevent Democrats from blocking the tax bill. Under the rule, the bill cannot add to long-term budget deficits. That means every tax cut has to be offset by a similar tax increase or a spending cut.

‘‘Yes this does make tax reform more difficult,’’ said Ryan. ‘‘But it does not in any way make it impossible.’’

Nevertheless, Treasury Secretary Steven Mnuchin said Friday the administration plans to turn quickly to tax reform with the goal of getting an overhaul approved by Congress by August.

House Republicans have released a blueprint that outlines their goals for a tax overhaul. It would lower the top individual income tax rate from 39.6 percent to 33 percent, and reduce the number of tax brackets from seven to three. The House plan retains the mortgage interest deduction but repeals the deduction for state and local taxes.

However, nearly 34 million families claimed the mortgage interest deduction in 2016, reducing their tax bills by $65 billion. Also, more than 43 million families deducted their state and local income plus personal property taxes from their federal taxable income last year. The deduction reduced their federal tax bills by nearly $70 billion.

On the corporate side, the plan would repeal the 35 percent corporate income tax and replace it with a 20 percent tax on profits from selling imports and domestically produced goods and services consumed in the US. Exports would be exempt from the new tax. (border adjustment tax)

The general goal for Republicans is to lower income tax rates for individuals and corporations and make up the lost revenue by reducing exemptions, deductions and credits. Overhauling the tax code is actually hard because every tax break has a constituency and the biggest tax breaks are among the most popular.

Over the past week, some investors are starting to doubt that the tax cuts will get passed. The value of the U.S. dollar has weaken and ten year bond yields have fallen  from 2.62% to 2.4%. Eight of the ten sectors that make up the S&P 500 were negative for the week. The biggest losers were U.S. financials (-3.72%), energy (-1.78%) industrials (-1.75%) and materials (-1.3%).

There is a lot of money on the sidelines that missed the Trump rally and are waiting for a stock market correction. I took some profits before the Canadian federal budget that hinted at tax increases so I also have some money to re-invest. The Canadian conservative government taught me a valuable lesson back in 2005. What government promises to do and what they actually do can have a negative affect on your investments.

 

10 Reasons to be cautious on equity markets

Image result for david rosenberg

David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

Here are my 10 reasons to be cautious on equity markets right now.

Valuations are stretched

Trailing and forward price-to-earnings multiples are now in the top quintiles historically and the most expensive in 15 years.

Only in 1929 and the “Dotcom” bubble has the cyclically-adjusted multiple (CAPE) been as high as the case today.

We are heading into the ninth year in the cycle and have logged an epic 250-per-cent surge in the process. As retail investors now plow in to this market in the late innings, one could legitimately ask what it is they could possibly know that corporate insiders do not, considering the latter have been selling their company’s stock this year at a pace not seen since the data began to be published in 1988.

Extended leverage

U.S. margin debt has surged at a 27-per-cent annual rate since immediately prior to the election to stand at $513-billion, the highest level on record (eclipsing the high from April 2015).

Retail inflows

After an eight-year hiatus ($200-billion of net outflows), private clients have thrown in the towel and plowed nearly $80-billion into mutual funds and ETFs since the November election.

Remember Bob Farrell’s Rule No. 5: “The public buys the most at the top and the least at the bottom”.

Narrowing leadership

For the past four sessions, we have seen more new 52-week lows than new highs (the longest streak since Nov. 4) — a technical sign of a toppy market.

Moreover, the Russell 2000 index is now flat for the year and off 4 per cent from the high — again, we know from history that the generals tend to follow the privates.

Tack on the fact that the S&P 500 recently traded as much as 10 per cent above the 200-day moving average, and we have a market ripe for a near-term correction.

Complacency abounds

From a VIX of 11.9 to nearly 60-per-cent Bulls in the Investors Intelligence poll — though this has begun to roll off its highs in a sign of the “smart money” beginning to take profits.

The S&P 500 has gone 57 days without so much as a 1-per-cent intraday swing, something we have not seen in at least 35 years. The proverbial calm before the storm.

The Fed is in play

The front-end Treasury yields are rising discernibly — the two-year T-note yield has gapped up to nearly 1.4 per cent and futures market is in the process of pricing in an extra two rate hikes after the likely March tightening (the overnight index swaps market currently has priced in 70 basis points of tightening by year end).

The Fed has met its twin objectives and the fed funds rate consistent with that is 3 per cent, not the 0.75 per cent currently.

By the time the Fed reaches that level, the yield curve will likely have inverted long before and that’s when the clouds will come rolling in.

This could be next year’s story, which means a forward-looking market begins to discount this prospect sometime later this year.

Inflation pickup

Cyclical price pressures are showing through, with the core PCE inflation rate at a 30-month high of 1.738 per cent year over year.

As was the case in 1990, 2000 or 2007, this likely is not sustainable, but is a classic late-game signpost nonetheless.

All one needs to see is the latest blow-off in the commodity complex, which is now on pause, to notice how late cycle we are. Remember what oil did, for example, in 2008?

Lofty expectations

The survey data are at extremely high levels at a time when actual economic growth is running barely above a 1% annual rate.

Gaps like this, once again, are classic near-end-of-cycle developments.

The prospect of there being huge disappointment over the pace of policy change in Washington is also very high.

Over-ownership

While households were not net buyers of equities until very recently, the near-quadrupling in the stock market has still boosted their exposure to a 21.1-per-cent share of total assets. Only five times in the past 16 years has the share been this high or higher — this is 42% above the norm.

Frothy credit markets

Bonds lead stocks, just know that. And the risk-premium on U.S. high-yield corporate bonds very recently approached lows for the cycle at a super-tight 335 basis points.

However, they now are widening again, and with the overall narrowing path of the Treasury curve, this is well worth monitoring for those equity investors who are still long this market.

Nobody ever lost money by booking a profit, especially for a cycle that is now heading into year number nine.

Do you think that David is right?

Being Canadian, I am worried about the Federal Budget scheduled for March 22 because there are rumours of an increase in the capital gains tax. I have been taking some profits in my taxable accounts and for investment club just in case. I do believe it is impossible to time the market so I am still fully invested in my tax sheltered accounts.