Still doing tax returns for my adult children & their spouses

Every year I ask myself, should I continue to offer to do tax returns for my adult children and their spouses? All of them have university degrees and are smart enough to file their own tax returns. My daughter was willing to do it one year using tax preparation software with only a little help from me.

Part of my problem is Canadians are not even aware of how much tax they pay. Plus we keep voting for governments that buy votes using our tax dollars. The average Canadian family will pay 42.9% of their income in taxes imposed by all three levels of government in 2016. (Federal, provincial and local) Tax freedom day was June 7, 2016 if Canadians paid their total tax bill up front. Our U.S. neighbours tax freedom day was April 24th and they will only pay 31% of their income in taxes.

There are a number of reasons why I continue to offer to do tax returns for the whole family. Having worked as a financial advisor, tax planning is a key element when putting a financial plan together. My tax knowledge and skill comes from working many years with accountants and tax lawyers ensuring that my whole family pays the least amount of tax.

Plus, the Canadian tax system is very complicated and is constantly changing with every federal and provincial budget. For example: many tax credits that were given by the Conservative government have been taken away completely by a new Liberal government.

For the 2015 tax year, the Liberals cancelled income splitting for families, a maximum tax credit of $2,000 for transferring up to $50,000 of income to a spouse with a lower income if they had a child under 18 years of age.

Some changes for 2017 include the elimination of the following credits:

  1. Education and textbooks credit
  2. Children’s fitness credit
  3. Children’s arts credit
  4. Public transit tax credit

Now, most retired Canadian seniors who don’t have a pension from their former employer are not even aware of a $2,000 pension credit. It requires opening a RRIF account, transferring $2,000 from their RRSP and then taking it out. They don’t have to wait until they reach the age of 71 in order to open a RRIF account. Plus, RRIF income can be split with your spouse if both of you are 65 years of age which could potentially add up to $4,000 of income tax free per year.

The Federal Liberal government will introduce a new budget on March 22 and there are rumors of more tax increases. Three things that Canadians should worry about;

  1. Higher capital gains inclusion rate from 50% to 75%
  2. Reducing the dividend tax credit
  3. Taxing your principal residency 

I will end this post with two well known proverbs. ” In this world nothing can be said to be certain, except death and taxes.” & “A penny saved is a penny earned.”

 

Tips on rebalancing your retirement portfolio

rebalance-moneyunder30

Many investors are in for a rude awakening when they open their year-end retirement plan statements. The bond portion will probably show negative returns. It could even wipeout a good portion of their positive returns from owning equities.

Now, the most common method used in rebalancing your established asset allocation mix would be to reduce the holdings that are up in value (sell stocks) and buy assets that have fallen in price (buy bonds). This practice may have worked very well in the past but interest rates are going up forcing bond prices down.

The chart below compares the S&P 500 with the IShares 20 plus year Treasury bond ETF

tlt

“The decades-long bull market in U.S. Treasuries has finally drawn to a close following Donald Trump’s surprise presidential election victory, according to mutual-fund manager Bill Miller.”

“Miller isn’t the first to call time on the bond bull market. Economist Henry Kaufman, the original “Dr. Doom” who is credited with calling the last bond bear market in the 1970s, told the Financial Times this week that the current bull run is at an end.”

In the past, when the Federal Reserve decided it was time to unwind its easy monetary policies, it would raise the federal funds rate fairly quickly. The Fed believes a neutral stance on monetary policy is reached somewhere above the 4% level. The current Federal Reserve is moving slower than normal. Based on an average of three rate hikes per year, it will take the Fed a little over 4 years to normalize interest rates.

Tip # 1

Short-term, reduce or eliminate investing in target date mutual funds since they automatically rebalance from equities to bonds. Plus they increase your bond exposure the closer you are to retirement.

Tip # 2

During a period of rising interest rates, the prudent strategy is to reduce the duration of your bond portfolio. That could mean using a short-term bond ETF or a ladder of GICs both of which would allow you to benefit from an increase in rates.

Tip # 3

If you’re comfortable with a little credit risk, use short-term investment-grade corporate bonds to get a little more yield.

Tip # 4

Cash is by far the safest asset class. Move some of your equity allocation and some of your fixed income allocation to cash. I have my doubts that President Elect Trump can get congress to pass all his stimulus agenda and even economists are unsure if these policies will actual increase economic growth.

Corrections in the bond market are not as uncommon as you think. Most have been short in duration. See the chart below:

lt-treas-losses

Keep in mind that in the past, rate hikes were implemented  at a much faster pace than what the current Fed has purposed. Losses in the bond market could continue for longer than expected.

Should you bet your portfolio on who will be the next president?

Republican presidential nominee Donald Trump shakes hands with Democratic presidential nominee Hillary Clinton following the second presidential debate at Washington University in St. Louis, Sunday, Oct. 9, 2016. (AP Photo/Patrick Semansky)

Who’s going to be the next president? The betting odds on the election at gaming site Bodog as of Oct. 10 are Clinton -425 and Trump +325, meaning a winning $425 bet on Clinton will pay out $100, while a winning $100 bet on Trump would net you $325.

For investors, the important questions are how the election outcome could affect their investment portfolios and whether they should do anything about it. It’s a legitimate concern, considering the spikes in volatility this year caused by fears of global economic slowdown, dissolution of the European Union and policy reversal by the Federal Reserve.

A November election surprise could trigger renewed volatility in the financial markets.

Conventional wisdom has it that the markets favor Republicans in the White House because they typically fight for lower taxes and less regulation. Donald Trump, however, is not a typical Republican candidate.

Trump has promised tax cuts, but he has also railed against the “rigged” economy and talked of building walls to keep out neighbors. The market does not like uncertainty, and Trump may be as unpredictable a candidate as either party has ever fielded for the White House.

It stands to reason that a Trump victory could hurt more than just the Mexican peso and the stock market. His bravado toward global trading partners and his talk about renegotiating trade deals and global security pacts could also put a chill in financial markets generally.

On the other hand, a President Clinton might also rock some boats. If Clinton wins, energy stocks could arguably take a significant hit. So might health-care stocks. Many believe her support for a financial transactions tax on high-frequency traders could seriously damage sentiment in the markets.

Fear on Wall Street could spark a sell off no matter who wins. It could provide investors with a great buying opportunity. Having some cash in your portfolio may be a prudent option to take advantage of market volatility.

Hidden fees can destroy your retirement dreams

When asked about contributing to a company’s pension plan, my standard answer was always put in enough to receive the company’s matching percentage. Never turn down free money, it’s like receiving a yearly bonus of 2% or 3% of your annual salary.

However be aware of fees that are hidden in the fine print. Make no mistake, these fees do matter. They may seem tiny, barely noticeable but they can eat away your future. A one percent reduction in fees can add an additional 10 years to your retirement income. If two people have the same 7 percent return over time but one pays 1 percent in fees while the other pays 2 percent, the latter will run out of money 10 years earlier.

For nearly 30 years, the pension plan industry wasn’t legally required to explain exactly how much it was charging investors. Sadly, a recent industry survey showed that 67 percent of Americans believe they pay no fees in their 401(k) plan. In a recent survey in Canada, 36% of Canadians claimed that they paid no fees and 11% were unsure.

In a muddy but legal arrangement, a high percentage of plan providers accept payments from the mutual funds they offer in your 401(k) plan. This is called revenue sharing or, more aptly, paying to play. Naturally, the list you have to choose from includes the funds that pay the provider the highest amounts, rarely the best performing and certainly not the lowest in cost.

Additionally, many providers restrict low-cost funds to plans that exceed a certain amount of assets, meaning that employees of smaller companies are forced to invest in funds with higher fees. Since the providers don’t make much of a profit on the lower-cost funds they do offer, they will usually charge a significant markup. For example; you could be paying a 1 percent annual fee for an S&P 500 Index fund when the actual cost is .05 percent. That translates into a 2,000 percent markup.

“Last year the Obama administration announced that hidden fees and backdoor payments were costing Americans $17 billion per year. And that’s not counting the excessive “out-in-the-open” fees that are draining our retirement accounts. The Department of Labor is also sounding the alarm. “The corrosive power of fine print and buried fees can eat away like a chronic illness at a person’s savings,” said Labor Secretary Thomas E. Perez.

A company pension plan is a wonderful savings vehicle when it’s efficient. The problem is that many of these plans are plagued with a variety of additional hidden layers of fees. These added layers have seemingly arbitrary labels, such as “asset-management charges” or “contract asset charges.” They often add up to 1 percent or more and are buried in the fine print of plan disclosures.

New regulations for advisors

Beginning in April 2017, a financial professional who makes investment recommendations to you about your 401(k) or IRA will be legally required to provide advice that is best for your situation, not the funds that provide the most compensation to the advisor. “The advisor will now be required to disclose their conflicts of interest.” This new fiduciary standard will only apply to retirement accounts, and advice provided about other types of taxable investment accounts will not be held to the same standard.

Employers need to wake up and take their role as pension plan sponsors more seriously. It’s in their power to dramatically impact the future quality of life for their employees.

My advice;  put in enough to receive the company’s matching percentage and read the fine print before making any additional contributions to your company’s pension plan.

Is it time to look at alternative investments?

'I have mostly conservative investments in my retirement portfolio, plus a few riskier, short-term performers tossed in as a hedge against inflation.'

Hedged funds are usually reserved for institutional investors and for the very wealthy. Alternative strategies are now available to ordinary investors. These funds must adhere to a higher level of transparency and liquidity than hedge funds or limited partnerships.

Ever since the crisis of 2008–2009, financial advisors and their clients have looked for ways to shield portfolios from potentially devastating losses. Many set their sights on liquid alternatives funds, an emerging investing category that’s sold as both mutual funds and exchange-traded funds.

In 2008, just $44 billion was invested in alternatives through mutual funds and ETFs, according to research firm Morningstar. At the end of 2015, however, assets had exploded to $300 billion, with close to 600 funds.

There are a large selection of alternative strategies available. When the market faltered in 2008, managed futures and interest–rate swaps funds were up in value while stock holdings were down. Other categories include strategies, such as market neutral, commodities, multi-asset, multi-currency and long/short equity.

Some advisors use liquid alternative funds as a way to deal with the current low-interest-rate environment. Bonds are dead money right now and stocks themselves aren’t cheap. Advisors are essentially eliminating bonds and replacing them with something that will serve the same purpose, but also offer some potential return. A very popular choice to protect your equity exposure is a long/short strategy. These fund managers buy stocks that they expect will rise in value (long), while shorting those they expect will fall.

Most advisors use alternative funds as ballast during falling markets because they invest in non-traditional assets that aren’t correlated with stocks or bonds. Investment experts recommend a meaningful allocation of 15 percent to 20 percent; otherwise, the impact won’t be felt. Trying to predict when markets are likely to fall and inserting an alternative fund is very hard to do.

While alternatives might fare better than a mainstream stock/bond portfolio in a downturn, they’ve got their own drawbacks. The big one is fees.

According to Morningstar, the average expense ratio of alternative funds is 1.7 percent, many times that of either equity or bond funds. “The high fees have eaten into returns, which is a concern when it’s generally a lower-return environment,” said Josh Charlson of Morningstar.

However, compared to the fees that such strategies charge in the hedge fund structure, they’re a bargain. Investors in hedge funds normally pay 2 and 20 — a 2 percent fee on assets under management, plus 20 percent of profits.

Now I believe that this low-interest rate environment may continue for another decade so investing in fix income products doesn’t make sense. Sitting on cash that yields nothing or being 100% invested in stocks is overly risky.

I recommend checking the fees that your company’s pension plan provider charges. Switching from fix income to an alternative fund may be more economical than you think.  A word of caution, before you invest in any alternative fund, make sure you understand the strategy, the risk and the fees.

What are your thoughts on alternative funds and ETFs? Are they suitable for your retirement fund?