Scary Financial Facts for Halloween

 

It’s that time of year when scary things come out on Halloween. However, when you open your door on October 31, will you be confronted by anything scarier than these hair-raising financial horror stories?

Will debt destroy your future?

  1. Student loan debt has reached $1.45 trillion dollars in the U.S. and $42.9 billion in Canada. U.S. graduates owe on  average of $37,712 and $27,000 for Canadians.
  2. Credit card debt is increasing in both countries. Americans carry an average of $16,000 and $4,100 for Canadians
  3. 107 million Americans have auto loans for a total outstanding debt of $1.2 trillion. It is estimated that 40% of the 120 billion dollars in auto loans in Canada are financed for 7 years or longer.
  4. Mortgage debt in Canada is a bigger problem than the U.S. because mortgage interest is not tax deductible. Average mortgage in Canada is around $200,000 (much higher in cities like Toronto & Vancouver) and $192,000 in the U.S.

Will someone steal your identity? 

First we find out that the Yahoo hack in 2013 exposed the information of every single one of their 3 billion accounts and then we find out that a data breach at Equifax exposes the personal information of 145.5 million people. Is there a single American who hasn’t been hacked yet?

The odds are great that your personal information is for sale to identity thieves or already in their hands. Can you foil them with credit freezes and other ID protection measures before it’s too late? Is it already too late? Does your VISA card contain mysterious purchases for 10 large screen TVs from Best Buy?

U.S Health Care Nightmare

Who knows what horrors await you if you become sick and your insurance premiums are too high for you to afford? Average out-of-pocket medical costs continue to rise, topping $10,000 in 2016. Meanwhile, premiums continue to rise on the health care exchanges.

Over the past four years, premiums in the individual marketplace have more than doubled. As insurers back out of some markets and political uncertainty reigns, premiums on the state insurance exchanges continue to rise rapidly. For example, rates in Georgia are up by 57%.

Scary lack of retirement savings

According to a report from the Economic Policy Institute (EPI), the mean retirement savings of all working-age American families, which the EPI defines as those between 32 and 61 years old, is $95,776. Almost 40 million households have no retirement savings at all.

Only 65% of Canadians are saving for retirement and on average have about $84,000 in retirement accounts. (RRSP & TFSA)

Frightening Canadian Energy Policies

  1. No access to foreign markets for oil & gas (besides the U.S.)
  2. Cancellation of Energy East pipeline (buying oil from the Middle East, selling discounted oil to the U.S.)
  3. Construction delays in Trans Mountain & Keystone XL pipelines
  4. No accountability for carbon tax revenue (how is this money spent?)
  5. 4 billion dollars of extra interest payments for reduced hydro rates in Ontario

Release the Nukes

What list of potential horrors would be complete without the prospect of nuclear war? The current tense relations between the U.S. and North Korea make that horrible concept more plausible and in addition to the terrible death toll and destruction of property, the financial impact on the world economy would be hard to imagine.

Remember the famous quote of Albert Einstein, “I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones.”

Now remember the leaders who have their fingers on their respective nuclear buttons. ARE YOU FRIGHTENED YET?

HAPPY HALLOWEEN!

 

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Why you should look under the ETF’s hood

A fund’s name might seem like a good starting point for gaining an initial understanding of how it is constructed. Unfortunately, names turn out to offer little help for evaluating funds. There is simply no universally accepted system in use by ETF providers and research to classify funds. For example “Infrastructure” would seem to have something to do with the amenities, roads and power supplies needed to operate society.

Names can be deceiving! To illustrate, I went to one of my favorite ETF provider’s web site to look under the hood. I was looking to find some discrepancies. It took some time but the geographic allocation in the fact sheet on the BMO Global Infrastructure Index ETF (ZGI) wasn’t global at all but had the majority of their holdings in North America.

  • 66.02% United States
  • 25.16% Canada
  • 6.71% United Kingdom
  • 1.56% Mexico
  • 0.56% Brazil

The top ten holdings also have a lot of pipeline companies who pay construction companies to build the actual  infrastructure.

  • Enbridge 10.07%
  • American Tower Corp 8.82%
  • National Grid Plc 6.71%
  • TransCanada Corp 6.68%
  • Crown Castle Intl Corp 6.07%
  • Kinder Morgan 5.87%
  • P G & E Corp 5.17%
  • Sempra Energy 4.25%
  • Williams Cos 96%
  • Edison International 3.82%

It takes years for pipeline companies to benefit from any new capacity to come on line. On the other hand, companies who specialize in construction & engineering like SNC-Lavalin or Aecon would see immediate revenue growth. I would recommend looking for another infrastructure ETF that had more global exposure with holdings of construction & engineering type companies.

Another example is the BMO S&P/TSX Equal Weight Industrials Index ETF (ZIN) which has a small discrepancy. The fact sheet says it has 26 industrial holdings but two of those holdings include airlines. (Air Canada 5.46% & Westjet 4.13%)  Now both of these companies buy industrial products but they specialize in transportation.

Here are some key steps all investors should take when evaluating ETFs:

  1. First, decide if you are going to be a do-it-yourself investor or work with an advisor. As their name suggests, ETFs are traded on exchanges, so they can be bought and sold like stocks through a discount brokerage.
  2. Make sure you understand the index underlying the ETF you are considering. Focus on how the index is constructed, what it tracks and how long it has been around. A longer record will reveal how the index responded to different market conditions.
  3. Check the fund’s fact sheet, are the underlying holdings and geographic allocation accurate? How does the exchanged traded fund compare with similar funds from other providers?
  4. Avoid ultra-short and leveraged ETFs, leave those to professional traders.

Ultimately, the proper implementation of ETFs in a portfolio requires, like all investment decisions, due diligence, caution and persistence. ETFs can offer many attractive features but their long-term value depends on how well they fit into an individual’s portfolio.

To evaluate an appropriate fit, investors have to be prepared to look under the hood.

 

 

 

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.