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Investing for the Long-Term

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Long term investingOne of the things that often frustrates investment clients is the language used by investment professionals when markets go down. While the terminology is meant to soften the blow or put the current situation into context, the client is often left annoyed and confused. To help bridge the gap in understanding, I want to explain one of the main terms that you are likely to hear over the next few weeks, “investing for the long-term” or having a “long-term focus,” and why this is the perspective that clients should take during times like these.

Bull and Bear Markets

During bull markets (when stock markets are moving higher), the economy is typically growing, people are seeing their employment prospects and income increase, their assets (home and investments) are rising, so investors and corporate managers feel optimistic about the future.

The stock market is supposed to be priced on a forward looking basis. This means that the price of a stock is supposed to reflect future earnings and cash flow that the company will generate. In fact, one of the main valuation methods used is the Dividend Discount Model – a stock’s price is calculated based on future dividends investors expect to receive. During bull markets these forecasts are rosier, so higher stock prices are justified by assumptions of high growth in corporate earnings. In addition, because everyone is optimistic and does not want to miss out on the perceived easy gains, they are willing to pay higher and higher multiples to buy today.

During bear markets, as we are currently experiencing, everyone thinks of a worst case scenario. They assume that the expected economic downturn will remain for a very long period and often cannot foresee the inevitable recovery that takes place months later. As a result, they assume earnings will drop dramatically and stay low forever and therefore heavily discount the price they would be willing to pay for the same stock that only months ago they thought was a great purchase at a much higher price. In this environment, the emotion of fear and worst case scenarios are exacerbated by the negative news reports, leading many people to just want to exit the stock market no matter the price. Consequently, nearly all stocks and other risk assets (REITs, preferred shares, corporate bonds) drop in price regardless of the stability of their business model, their financial strength or if they had a reasonable valuation prior to the panic.

While I believe we are likely to have at least a technical recession in Canada (2 quarters of negative economic growth) and I think the number of cases of coronavirus and its associated stresses on the health care system and the economy, is likely to get worse in the short-term, this is the period where a long-term perspective is necessary.

What Is a Long-term Perspective?

Your investment portfolio is designed to grow not only until you reach retirement, but also to generate income (or dividends) and capital gains that will support your lifestyle in retirement. Given current lifespans, this could be 20-40 years and even possibly the lifespan of your beneficiaries, so your portfolio has a very long timeline. During periods of market declines bargains start to appear that can lay the foundations for ensuring that your long-term goals are met. I will provide a few examples below.

Canadian Banks

One of Canadians favourite pastimes is to complain about the record profits of the banks and their high service charges. Over the past few weeks, investors have only seemed to care about the risk to these banks’ loan portfolios due to the increase in credit provisions for bad loans or reduced capital market activity that occurs during recessions. Bank of Montreal (TSX: BMO) recently dropped over 40%. As a result, on Thursday, March 12th, it was offering a dividend yield of over 7% and was trading at an earnings multiple of only 7 (historical average is closer to 12 times earnings). While it is quite likely earnings will decline in the near-term, considering that the Canadian banks have an oligopoly on the Canadian financial markets and highly diversified asset bases (wealth management, lending, international operations), it is highly likely that in just a few years, if not sooner, Canadians will once again be complaining about their record profits, which will be reflected in higher share prices. On Thursday close, most of the Canadian banks were offering similar bargain prices, e.g. Bank of Nova Scotia was trading at 7.7 time earnings with a 6.7% yield. TD was trading at 8 times earnings with a 5.9% yield and CIBC was trading at 6.7 times earnings and offering an 8.4% yield. Buying in this environment provides a high current yield and likely capital gains in the future.

Pipelines

There is no question that Alberta and Saskatchewan are feeling real pain once again due to the massive price drops in oil prices from the expected economic slowdown and the game of chicken being played by Saudi Arabia and Russia, but only a few months ago the media was complaining about there not being enough pipeline capacity to handle all of the Canadian oil and gas production. In addition, hundreds of thousands of barrels of current production is being handled by higher price and less safe railway network – if there are near-term cuts, this is where it will likely come from. As a result of the current fear, Enbridge Inc. (TSX: ENB) had dropped over 35% and at end of day Thursday was offering a yield of over 9%. Enbridge has numerous projects expected to come on-line in the next few years and has provided guidance that it intends to raise its dividend each year into the near future. Other pipelines, such as Interpipeline (TSX: IPL), Pembina (TSX: PPL), TransCanada (TSX: TRP) have had similar and in some cases larger price declines with some of these companies offering current dividend yields of over 10%.

REITs

One of the more stable asset classes for income oriented investors in the past few years has been Real Estate Investment Trusts (REITs), which are actively managed portfolios of real estate holdings. Over the past few weeks, REITs have not been immune to the drop in the stock market, even though the real estate market is holding up well. As a result, many REITs have dropped 30% or more, offering compelling opportunities. For example, Northwest Healthcare (TSX: NWH.UN), which is a global REIT focused on health care related real estate (hospitals, doctor’s offices, etc.), recently saw a price decline of over 25% despite recording record profits just last week. The net asset value of the REIT’s portfolio is estimated at $13.17 per unit (35% higher than current trading price), its occupancy rate is 97.3% and the average tenant’s lease term is 14 years.1 The current yield is 8.3%, which is fully covered by the REITs cash flow. Many other REITs have seen price drops of 30% or more in the past week despite excellent fundamentals, strong management teams and a portfolio of real estate assets that would make institutional investors like pension plans salivate.

Preferred Shares

This is an asset class that is a hybrid security, meaning that it has some attributes similar to stocks and some similar to bonds. Preferred shares trade on stock exchanges, like stocks, but preferred share investors receive priority vs. equity holders in terms of dividend payments and capital protection. Unfortunately, they are also typically less liquid than many stocks and as a result do not have a lot of institutional ownership, but that also means they can and presently do trade at compelling prices. Enbridge Preferred Share Series D (TSX: ENB.PR.D) recently experienced a 35% price drop. This preferred share is a fixed rate reset, meaning that it pays the same dividend rate for 5 years and then that dividend rate is reset based on the yield of the 5 year Government of Canada bond plus a spread. As of Thursday, March 12, it was offering a dividend yield of over 11%. There is the risk that the dividend rate will be reset lower at its next anniversary date, but to put this in perspective, that date is 3 years into the future. Prior to the reset date in March 2023, an investor buying at Thursday’s closing price of $10.50 would receive $3.48 in dividends prior to the reset date and the new reset rate based on current yields would be 7.26%, still pretty high. Based on the recent price drops in the market, investors can currently buy rate reset preferred shares offering yields similar to the Enbridge example above and perpetual preferred shares, which consistently pay the same yield forever at yields of over 6%.

The Long-Term Perspective

While equity markets are likely to be volatile over the next few weeks to months and could even potentially go lower than Thursday’s lows, investors can find bargain investments similar to the ones listed above to help secure their financial future and long-term goals. For example, a one million dollar portfolio invested into some of the securities listed above would result in an annual income stream of over $70,000 plus the potential for significant price appreciation when markets return to normal. Considering that most financial plans are based on an average return of 4%-6%, this is the environment, despite the massive fear, when investors need to remain calm, not be forced sellers, and remain focused on that long-term income stream they want to support their future lifestyle.

During this period, the greatest skills your financial advisor can have are to remain calm, use a rational mind to assess the situation and clearly communicate with clients to relieve their anxiety and fear. The greatest asset a client has is time – the time to withstand this period of weakness to build a strong portfolio offering a high level of income and potential for growth.

[1] https://web.tmxmoney.com/article.php?newsid=6210584082240133&qm_symbol=NWH.UN.

Lorne Zeiler
Written By:
Lorne Zeiler, CFA®, iMBA
Senior VP, Portfolio Manager and Wealth Advisor
lorne@tridelta.ca
416-733-3292 x225

Hear a recording of today’s (March 12th) TriDelta Investment Conference Call

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After markets closed today, TriDelta Financial did an investment conference call to outline what we were doing heading into

2020, what signs we are looking for today to reinvest some funds, and what we might be investing in.

You will hear from:
Ted Rechtshaffen, MBA, CIM, CFP, President and CEO
Cameron Winser, CFA, Senior VP, Head of Equities
Paul Simon, CFA, VP, Head of Fixed Income

 

 

We hope that the call will give you a little comfort during a very uncomfortable time.

If you have questions about your personal situation, please don’t hesitate to contact your Wealth Advisor.

 

Thank you,

TriDelta Financial

Strategies to Make Your Money Last Longer in Retirement and to Reduce Taxes

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Lorne Zeiler, Portfolio Manager and Wealth Advisor, was one of the experts interviewed on current strategies that can be used by investors to reduce overall taxes paid in retirement and to the estate. Lorne Zeiler focused on the benefits of gifting.

gam-masthead
Written by:
Special to The Globe and Mail
Published November 11, 2020

Most people spend decades saving and investing for retirement. Once they get there, the focus shifts to spending their hard-earned money – and maybe leaving something behind for family or charities.

The key is having enough money to live comfortably in retirement, while also continuing to generate investment income and reducing taxes, where possible. It helps to have a financial strategy, including which accounts to draw from and when, to help meet your retirement needs and goals.

Below are some tips for managing money in retirement, to make your assets last longer.

Maximize government benefits

Most Canadians contribute to the Canada Pension Plan (CPP) or the Quebec Pension Plan (QPP) during their working years, benefits that are paid out in their retirement years. Many Canadians also qualify for other government benefits such as Old Age Security (OAS) and the Guaranteed Income Supplement (GIS).

These benefits together can provide a total of about $25,000 in retirement income for the average Canadian, says Carol Bezaire, senior vice-president of tax, estate and strategic philanthropy at Mackenzie Investments.

The OAS and GIS government benefit programs aren’t based on the amount contributed over a person’s working life, but are instead dependent on marital status and income. It’s why Ms. Bezaire says it’s important to maximize any available tax credits that can affect your income level, such as the federal age amount non-refundable tax credit, which is available to individuals who are 65 or older and can be claimed on your personal income tax return.

“If you plan your other retirement income wisely, you can create a cash flow that allows you to access as much in government benefits as possible,” Ms. Bezaire says.

Make tax-efficient withdrawals

Kathryn Del Greco, vice-president and investment adviser with Del Greco Wealth Management at TD Wealth Private Investment Advice in Toronto, says most of her clients use their non-registered savings and investment accounts as their first source of cash flow in retirement, letting the more tax-efficient accounts such as the registered retirement savings plan (RRSP), registered retirement income fund (RRIF) or tax-free savings account (TFSA) continue to benefit from tax deferral or avoidance, in the case of the TFSA, for as long as possible. The plan will, of course, vary depending on the client’s age and other factors, such as the start of a company or government pension payout.

Ms. Bezaire recommends investors review their non-registered investment mix to favour investments that generate capital gains, which are currently the most tax-efficient form of income. She also suggests minimizing investments that generate interest and foreign dividends, while favouring Canadian dividends and corporate class mutual funds. Interest income is 100-per-cent taxable, and dividends from foreign investment are not eligible for tax credits, unlike Canadian investments. “Be careful with dividend income,” she says. “It is also used in calculating the OAS and GIS clawbacks.”

For most registered plans, such as RRSPs and RRIFs, tax will have to be paid on the amount of any withdrawals as income. To get cash flow from these deferred capital gains, Ms. Bezaire recommends selling some investments each month to get the cash flow you need by using a method called a systematic withdrawal plan (SWP). These types of withdrawals can be set up monthly, quarterly or annually. With a SWP, investors are taxed on the capital gain or loss triggered from the withdrawal, which has preferential tax treatment, while the balance is a return of your original investment, which is not taxable.

Consider pension-splitting

For couples in which one partner has significantly greater pension income than the other, pension-splitting can be an effective way to reduce taxes in retirement, says Jamie Golombek, managing director of tax and estate planning at Canadian Imperial Bank of Commerce.

The government allows Canadians to split up to 50 per cent of most pension income with their spouse.

Mr. Golombek says that, for each $10,000 of pension income allocated to a spouse, the tax savings could be up to $3,000 annually, depending on which province you live in and the difference in tax rates between spouses. He notes the income reduction can also help preserve some income-dependent benefits from government programs such as OAS.

Go ahead and gift

Gifting assets isn’t just a kind thing to do, but can help reduce taxes in an estate, says Lorne Zeiler, vice-president, portfolio manager and wealth advisor at TriDelta Financial in Toronto. In Canada, there are no taxes on gifting assets, for either the giver or receiver, unless an asset is sold before the gift is made.

One strategy Mr. Zeiler favours is opening TFSA accounts for kids that can be funded annually. “They are likely in their prime spending years,” he says. “so saving may be difficult and by opening TFSAs, this allows the gifted assets to grow tax-free.”

Also, gifting money to children or a charity can provide support when they need it most.

Use your home

Retirees shouldn’t overlook their homes as a potential part of their retirement plan. “A home is often the most valuable asset people will own in their lifetime, which means they may want or need to use it to help fund their retirement,” Mr. Golombek says.

One option is to rent your home, or part of it. You will be taxed on rental income, after deducting related costs, which may include expenses such as utilities and maintenance. Another option is downsizing to a smaller home with fewer expenses, particularly if the upkeep of a larger home becomes too onerous.

If you sell your home and it qualifies for the principal residence exception, you will not be taxed on the capital gain, Mr. Golombek says. If it is not your principal residence, you will generally be taxed on 50 per cent of the capital gain.

If you can sell your current home and can get more money after tax than it would cost to buy or rent a new home, you may be able to put the difference toward retirement savings, he says.

Get retirement-ready

We make career plans, vacation plans, even dinner plans, but too often people don’t make a plan for what can be their most important stage in life: retirement. And while having a plan sooner, rather than later, is always recommended, it’s never too late to seek the help of an adviser to figure out how to make your assets last in retirement.

“If you haven’t done a financial plan yet, now is the time to do so,” says Ms. Del Greco.

It’s crucial for retirees to have a clear understanding of their expenses, cash-flow needs, sources of income and taxes, Ms. Del Greco says.

Working with an adviser can help investors assess their current financial situation and identify objectives to help them maintain the quality of life they’re seeking in retirement.

“Because your time horizon is not as long as it once was when you were younger, decisions you make today will have a significant impact on your ability to enjoy your retirement years stress-free,” Ms. Del Greco says.

Advisers can also help investors assess their risk tolerance, which may be less in retirement with the focus on preserving wealth.

Ms. Del Greco recommends retirees maintain one or two years of their income needs in safe, liquid, low-risk investments, which gives them the flexibility not to have to sell equity positions at a loss during a period of volatility.

Lorne Zeiler
Presented By:
Lorne Zeiler, CFA®, iMBA
Senior VP, Portfolio Manager and Wealth Advisor
lorne@tridelta.ca
416-733-3292 x225

Tips on How to Get the Most from your RRSP

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Lorne Zeiler, Portfolio Manager and Wealth Advisor at TriDelta Financial, was one of the experts asked about strategies to maximize the benefit of RRSP accounts and how to reduce overall taxes based on the timing of withdrawals and use of Spousal accounts.

gam-masthead
Written by:
Special to The Globe and Mail
Published February 7, 2020

The season for Canadians to make their last minute contributions to their registered retirement savings plans (RRSPs) for the 2019 taxation year is in full swing. The investment industry is pulling out all the stops to educate Canadians on the advantages of putting their retirement nest eggs in these tax-deferred vehicles.

But while Canadians hold a total of more than $40-billion in their RRSPs, there remains a lot of confusion over what they actually are and how they work.

We spoke to three investment experts on the front lines to find out some of Canadians’ biggest RRSP misunderstandings.

Sara Zollo, financial advisor, Sara Zollo Financial Solutions Inc. at Sun Life Assurance Co. of Canada

One thing most Canadians understand is the immediate tax break that comes with an RRSP contribution. Each dollar invested is deducted from taxable income, which results in a tax refund from our highest tax bracket.

But Ms. Zollo says many people don’t understand that those contributions and any gains they generate are taxed fully when withdrawn.

”People think that it’s not a big deal. ‘I need some extra money, I’m just going to take it from my RRSP.’ You’ve just done two negative things: You’ve added that income to your taxable income for the year and you have now lost that contribution room,” she says.

The tax implications of withdrawing from your RRSP are the same as contributing – but in reverse. Each dollar is added to total taxable income in the year it’s withdrawn. Those in a higher tax bracket could actually be paying more taxes than they saved when they made their contribution.

To make matters worse, allowable lifetime RRSP contribution space is limited and not regenerated once a withdrawal is made. Ms. Zollo says many Canadians confuse this aspect of the RRSP with a tax-free savings account (TFSA), in which contribution space is regained the year after a withdrawal is made.

She notes that many of her clients are aware of the exceptions to the rule if funds from an RRSP are withdrawn for a down payment on a first home or to go back to school – provided they are returned to the RRSP after a certain time period.

In any other case, she says, the best time to withdraw from an RRSP is during a year when the plan holder’s taxable income is low. That’s usually in retirement, but it can also be during difficult times.

“If somebody lost their job and they have no other source of income, that’s a worthwhile time to revisit an RRSP withdrawal,” she says.

Lorne Zeiler, vice-president, portfolio manager and wealth advisor, TriDelta Investment Counsel

When an RRSP holder turns 71, the plan must be converted to a registered retirement income fund (RRIF). A RRIF is like a reverse RRSP: Money goes out instead of going in.

Once an RRSP is converted to a RRIF, the Canada Revenue Agency requires minimum withdrawals based on the total amount in the plan, which could result in withdrawals in a higher tax bracket. If the amount reaches a certain threshold, Old Age Security (OAS) benefits could be lowered or clawed back.

Mr. Zeiler says many Canadians aren’t aware they can lower their tax bills earlier in life by converting their RRSPs to RRIFs before they turn 71.

“It’s a phenomenal time to take [assets] out from an RRSP or RRIF, if they’re quite large, because that might be your only or main source of taxable income, so you could withdraw it at a very low tax rate,” he says.

Mr. Zeiler says it might make sense for investors with high-value RRSPs to make the conversion to an RRIF before they begin collecting OAS or Canada Pension Plan (CPP) benefits, which are included as taxable income.

Other benefits of an early conversion include lower fees for RRIF withdrawals and avoiding a mandatory withholding tax on RRSP withdrawals.

“You can open a RRIF, convert as much of your RRSP into that RRIF and have a source of income. As long as you’re only taking the RRIF minimum, there’s no withholding tax,” he says.

Mr. Zeiler says another common misunderstanding is that spousal RRSPs are irrelevant now that income-splitting is allowed for couples when they turn 65. Spousal RRSPs permit one spouse to contribute to another spouse’s RRSP and deduct that contribution from the former’s income.

The final objective is to withdraw more RRSP dollars in a lower tax bracket in the lower-income spouse’s hands during retirement, but he says a spousal RRSP is a good form of income-splitting if the spouse retires before 65.

“It only works if it’s a couple, one has a significantly higher income and the other one is more likely to retire early,” Mr. Zeiler says.

He cautions that withdrawals cannot be made from a spousal RRSP until at least three calendar years after a contribution, or it will be taxed in the contributor’s hands.

Mr. Zeiler also says a spousal RRSP is a good hedge in the event the federal government no longer allows income-splitting after 65.

”There’s no limitations to income-splitting today. Who knows? In the future that could change,” he says.

Evelyn Jacks, president, Knowledge Bureau Inc.

Although March 2 is the RRSP contribution deadline, it’s only the deadline to apply any contributions against income from 2019.

Ms. Jacks, a tax expert, says many RRSP holders don’t realize they can carry their contribution room forward indefinitely.

“If your income was unusually lower in 2019 than you expect it to be in 2020 or future years, you can choose not to take the deduction for the contribution that you made and carry those deductions forward to a future year when you expect your income to be higher,” she says.

RRSP contribution limits accumulate by 18 per cent of the previous year’s income. The maximum for the 2019 taxation year is $26,500.

Ms. Jacks blames much of the confusion on the drive to focus on annual contribution deadlines for a quick tax refund and not big-picture tax savings.

“People should think of their RRSPs all year long,” she says.

Lorne Zeiler
Presented By:
Lorne Zeiler, CFA®, iMBA
Senior VP, Portfolio Manager and Wealth Advisor
lorne@tridelta.ca
416-733-3292 x225

FINANCIAL FACELIFT: Can Olivia and Larry retire early with an ideal income of $10,000 a month?

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Below you will find a real life case study of a couple who are looking for financial advice on how best to arrange their financial affairs. Their names and details have been changed to protect their identity. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by:
Special to The Globe and Mail
Published January 10, 2020

People with ambitious financial goals are wise to start planning well in advance. So it is with Olivia and Larry, both 38, who hope to retire from work in their late 50s with substantially more discretionary spending power than they have now.

Larry brings in $125,500 a year plus bonus in a senior management job. Olivia earns $65,000 a year in education. They have a daughter, 4, whom they want to help get established financially when the time comes.

First, though, they plan to sell their Toronto-area house and move back to Montreal soon to be close to family and friends. Larry’s income is not expected to suffer in the move, but Olivia’s could be cut in half. Also, her defined benefit pension entitlement will be lower than if she stayed in her current job.

In 20 years or so, when they retire from work, Olivia and Larry hope to travel extensively, which partly explains why they have set their retirement spending goal so high: $120,000 a year.

“Can we retire early with an ideal income of $10,000 a month after tax?” Larry asks in an e-mail.

We asked Matthew Ardrey, a financial planner and vice-president at TriDelta Financial in Toronto, to look at Larry and Olivia’s situation.

What the expert says

Mr. Ardrey starts by reviewing the couple’s cash flow. According to Larry and Olivia, they spend everything they earn and sometimes have to dip into their tax-free savings accounts (TFSAs) to keep up with their car payments.

Yet when Mr. Ardrey runs the numbers, Larry and Olivia provided, he finds they actually have a surplus of $12,800 a year. (Income includes tax refunds from RRSP contributions.)

“This is a significant difference and does not even account for Larry’s variable bonus, which he requested to keep out of the projection,” the planner says. Because most people know what they earn and save, “we can assume the difference lies in the spending part of their budget,” Mr. Ardrey says. “Thus, a full review of their budget and spending is recommended.” In his analysis, the planner assumes they are spending the extra $12,800 a year on outlays not listed in their monthly expenditure form. That would include items such as household maintenance and repair, for example.

They are saving $650 a month to Larry’s RRSP, which his company matches 100 per cent, $160 to their child’s registered education savings plan (RESP) and $150 each to their respective TFSAs. Olivia contributes $600 a month to her work pension plan, an amount that is estimated to drop to $300 a month when she begins working in Montreal.

Some time in the next couple of years, Olivia and Larry would like to leave Ontario and return to Montreal. They would sell their house and purchase a smaller home in Montreal for about $600,000. “If we assume selling/moving costs of 10 per cent of the selling price, and that they pay off all their existing debts, they will need only a small mortgage of $30,000 for this transaction, which they can pay off in a few years at $1,000 a month,” Mr. Ardrey says.

The move to Montreal will affect their financial situation both positively and negatively, the planner says. Olivia’s income will drop about 50 per cent, which will also affect her DB pension. But their ability to save will increase because of the lower debt obligations. The planner assumes they direct these savings to their TFSAs and Larry’s RRSP. Any remaining surplus could go to a non-registered investment account.

The couple want to retire at the age of 57. Mr. Ardrey’s forecast assumes that at 65, Larry and Olivia will get 80 per cent and 60 per cent, respectively, of CPP/QPP (Quebec Pension Plan) benefits, and full Old Age Security benefits. Olivia’s pension estimate at age 57 is $27,182 a year in today’s dollars because of her reduced income. The couple’s baseline retirement spending target is $7,000 a month, plus $1,000 a month for five years to help their daughter, and another $2,000 a month for 25 years for travel.

Next, Mr. Ardrey looks at what Olivia and Larry can expect to earn from their investments. Their portfolio is 90-per-cent stocks and 10-per-cent fixed income, which produced a historical return of 6.1 per cent a year, he says. In retirement, he assumes their mix becomes more conservative (60-per-cent stocks/40-per-cent fixed income) and that they earn 4 per cent a year net of investing costs.

“Based on these assumptions, they fall short of their retirement goal,” Mr. Ardrey says. “They run out of savings in 2059 when they are 78.” (They would still have Olivia’s pension, their government benefits and their residence.)

If Olivia retired at 57 and Larry worked to 59, “they will reach the break-even point in their retirement spending,” the planner says. To have a surplus, they would have to work even longer, spend less or achieve a better rate of return.

To generate better returns, they could make some improvements to their investment strategy, he says. Larry’s group RRSP is well diversified, but their other investments are almost solely in five Canadian large-cap stocks. This lack of diversification “is adding significant risks,” the planner says.

As long as their portfolio is less than $500,000, they should consider broad-based exchange-traded funds, he says. ETFs offer low-cost diversification by company, asset class and geographic location. Once their portfolio passes the $500,000 threshold, they could consider hiring an investment counsellor or portfolio manager, Mr. Ardrey says. These firms charge a fee based on the size of the portfolio and have a fiduciary duty to act in their clients’ best interests. Investment counsellors tend to offer their clients investments that are not available on publicly traded markets – such as private debt and equity funds – designed to provide steady returns that are not subject to the ups and downs of financial markets.

Client situation

The people: Larry and Olivia, both 38, and their daughter, 4

The problem: Can they afford to retire at the age of 57 and spend $10,000 a month even if Olivia’s income drops?

The plan: Olivia retires as planned, but Larry works another two years to 59. They take steps to diversify their holdings and improve their net returns.

The payoff: Goals achieved.

Monthly net income: $11,685

Assets: Cash $3,120; his TFSA $74,020; her TFSA $66,350; his RRSP $125,510; her RRSP $16,210; estimated present value of her DB pension $42,250; RESP $13,160; residence $1.1-million. Total: $1.44-million

Monthly outlays: Mortgage $3,165; property tax $505; home insurance $60; utilities $300; transportation $650; groceries $570; child care $510; clothing $265; car loan $660; gifts, charity $540; vacation, travel $415; dining, drinks, entertainment $660; personal care $145; other personal $145; life insurance $150; cellphones, internet $170; RRSP $650; RESP $160; TFSAs $300; her pension plan contribution $600. Total: $10,620 Surplus of $1,065 is spending unaccounted for.

Liabilities: Mortgage $526,640; line of credit $26,865. Total: $553,505

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230

TriDelta Q4 Review – Back to ‘normal’

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Overview

At the end of December 2018, markets had just completed one of the worst quarters in several years.  The general view was very weak.

Today, many investors are much more positive after very strong returns in 2019.

Where that leaves us today is much more in the middle in terms of our outlook for 2020.

On the positive side, interest rates remain very low and the general trend is for them to remain at these levels for a while.  In addition, global growth is showing some signs of improvement after real slowdowns in 2019.

On the negative side, U.S. markets are now at the high end of their valuations, and there isn’t a lot of room to go higher unless corporate earnings pick up strongly.  Of interest, most other equity markets, including Canada, have much more reasonable valuations at the moment.

In Canadian Dollars – Total Stock Market Returns in 2019:

*TSX (Canada) 22.9%
*S&P500 (U.S.) 25.7%
*European Stocks 18.6%
*Nikkei (Japan) 16.3%
*Emerging Markets 13.2%
*Hang Seng (Hong Kong) 8.4%

Other key 2019 Returns included:

* FTSE Canada Universe Bond Index 6.9%
*BMO CM50 Preferred Shares 2.1%

What do we see for 2020 and why

We do not believe that a bear market is imminent.

Last quarter we said that historically, bear markets occur when at least two of the following four circumstances are found:

  1. Economic Recession – Two consecutive quarters of negative growth.
  2. Commodity Spike – A movement in oil prices of over 100% over an 18 month period.
  3. Aggressive Fed Tightening – Unexpected and/or significant increases in the Fed funds rate.
  4. Extreme Valuations – When S&P500 trailing 12 months price/earnings levels were approximately two standard deviations higher than the long term average.

As of the moment, we are seeing reasonable growth with expected real GDP growth of 1.8% in the U.S. and 1.6% in Canada, so no economic recession, although certainly not stunning growth either.

There was no major commodity spike in oil prices, even with the recent Iran conflict.

No meaningful increases in interest rates are envisioned.  We expect rates to remain flat or to be slightly down in 2020.

The only bear market risk at the moment is high stock market valuations, but even the overvaluation is not significantly large.  Focusing on the S&P500 in the U.S., the measure is a trailing 12 months Price/Earnings ratio two standard deviations higher than the long term average.  While not trailing, on a forward P/E basis, the S&P500 is at 18.5 vs. a 25 year average of 16.3.  This is 0.7 standard deviations higher than average. 

It is definitely something to be aware of, but not enough, especially in light of the other three criteria to put us in real concern of a bear market.

In addition, other global markets are valued more cheaply than the U.S.

This chart from J.P. Morgan highlights 25 years of the Forward P/E ratio of the S&P 500.

Interest rates fairly flat with slight downward pressure

On the interest rate side of things, the Central Banks in Canada and the U.S. are both signaling little movement for the time being, although the U.S. could lower rates again before Canada does. 

Strengthening of Canadian dollar vs. the U.S.

Our current view is that the CDN$ will strengthen further against the US$ this year.  The main reasons being that the U.S. Fed has lowered rates and may lower further, while Canada has not lowered rates and is less likely to lower them in 2020 vs. the U.S.  As a result, on the short end of the yield curve, Canada is now paying more than the U.S., and that is where much of the international money flow invests in (short term bonds).  The other driver is that there is more relative growth momentum in Canada than the U.S.  What we mean is that in 2018 U.S. growth was about 0.9% higher than Canada.  In 2019, it was only 0.7% higher.  This year, the U.S. GDP growth is forecast to be only 0.2% higher than Canada, despite a much higher Federal government deficit and more accommodative central bank.  We believe that this shift in growth momentum will be positive for the CDN$ vs U.S.$.

Trade Wars

It looks like we are finally seeing some warming on the trade wars.  As expected, the Trump White House is looking for some trade wins heading into the election.  With the imminent passing of the USMCA (what we will still call NAFTA), and the first phase of a China and U.S. agreement, there are signs of some confidence that may support global growth.

Corporate Earnings

Corporate earnings are expected to grow year over year by 16% according to Bloomberg, but the sentiment is for earnings growth to be lower than that.  This tells us two things.  The first is that strong earnings growth is not likely going to help ‘fix’ the high valuations in the U.S. market.  The second is that with reasonably modest earnings expectations, it is a little easier for companies to meet and exceed expectations.  Overall, we see corporate earnings numbers growing but not driving the markets higher.

Oil Prices

According to the U.S. Energy Information Administration, global demand for oil continues to increase.  In fact, the global demand chart below is remarkably steady for a commodity with a price that can be so volatile.  This is important to remember, because with all of the focus on alternative energy it can be easy to believe that Oil consumption is in decline.

Price expectations for oil are pretty flat, in the $55 to $60 per barrel range for West Texas Intermediate, although the general trend over the past 5 years has been higher.

For energy stocks, which have struggled for several years, this stability, and even the belief of stability, can lead to some modest gains for a depressed sector.

How does this impact your portfolio?

Based on this, we are starting to trim our U.S. stock weighting, and returning some of that back to Canada.  We will maintain our Global Stock weightings.  In addition, we see modest returns for bonds in 2020 and would look to be a little higher weighted in fixed rate preferred shares (with 5%+ dividend yields) as well as rate reset preferred shares, which should benefit from flattish interest rates.

Alternative investments remain an important part for our client portfolios and may be even more important given the more modest expectations from stocks.

On a sector basis, we will likely be lightening up on U.S. Health Care and looking for strong Canadian dividend growers.

Our fearless predictions for 2020:

Before we do our 2020 predictions, it is worth reviewing our 2019 predictions, which came in quite accurate overall:

  1. Better than average stock market returns in most major markets including Canada and the U.S.
  2. Interest rates being mostly flat with maybe one ¼% increase in both Canada and the U.S with a real possibility of an interest rate decline in Canada before the year is out.
  3. The Canadian dollar being fairly flat, but being tied more to oil than we have seen in the recent past.
  4. Oil rising but only slowly, and not a significant recovery.
  5. Preferred Shares having a strong year, bouncing back from their late year steep declines.
  6. Marijuana stocks will see a general decline overall as high valuations and uncertain revenues work their way through, but with increasing gaps between the winners and losers. In fact, we expect to see several bankruptcies in 2019 among the weak players in the market, and at least one major blow up of a more established firm (we just don’t know which one).
  7. Cryptocurrencies – need we even comment?

For 2020, our predictions are:

  1. Average stock market returns in most major markets including Canada and the U.S. – likely in the 5% to 10% return range but with more typical volatility.
  2. Canada will outperform the U.S. market for the first time since 2016.
  3. Interest rates will remain mostly flat to small decreases in both Canada and the U.S.
  4. The Canadian dollar will see reasonable gains vs. the U.S. dollar.
  5. Oil prices will mostly trade within a range of $60 +/- $5..
  6. Preferred Shares will have a stronger year as more investors look for bond alternatives.

Based on these short term beliefs, we have a little higher than average  cash weightings in our stock funds, and will lower our weight on U.S. stocks, increasing the weighting in Canada.  We will also more actively use options to protect against downside risk.

In the Growth fund, which is more active in terms of adjusting industries, we will be adding to Canadian Financials and Utilities and reducing U.S. Health Care.

How Did TriDelta do in 2019?

Our 2019 returns were as follows:

TriDelta Pension Pool (Stocks) 17.3%
TriDelta Growth Pool (Stocks) 20.3%
TriDelta’s Selection of Alternative Income Funds +5.5% to +10.5%

TriDelta Private Funds

In mid-January the Private Fund 1 will do another cash distribution.  Over 9% of the remaining value of the TriDelta Private Fund 1 (Fixed Income Fund) will be distributed out as cash.  We expect to pay further distributions on the fund next quarter as more of the underlying investments mature or are sold.  On the TriDelta Private Fund 2 (High Income Balanced Fund), we didn’t pay a distribution this quarter, after distributing over 30% in the previous two quarters.   

Nine Quick Hits of news and items of interest

  1. The TriDelta Alternative Performance Fund is launching later this month. It will provide a diversified mix of our top growth Alternative Investments in one fund that can be held in any account.  To learn more, please contact your Wealth Advisor.
  2. A reminder that now is a great time to top up TFSA’s. There is another $6,000 per person in contribution room for 2020.  If you have never contributed to a TFSA, the lifetime limit is now likely $69,500 for you.  If you have the funds, January is also a good time to do 2020 contributions to RRSPs, RESPs and RDSPs, as appropriate, as it will help you to tax shelter for a full year.
  3. If you like to save money on gas, a great website to look at is gasbuddy.com. The website shows gas prices at individual stations in your area, and includes prices for standard and high octane as well.
  4. Since the S&P 500 market peak in October 2007, the Technology index is up 348.1%. During the same period the Energy index is up just 6.5%.
  5. S. Household Debt Service Ratio is lower today at 9.7% that at any time in the past 30 years. In Canada it is at 13.3% and higher than it has been for many years.
  6. According to the U.S. Census Bureau, average income for those whose highest education was a High School graduate or less was $38,900, Bachelor’s Degree was $71,200 and Advanced Degree was $99,900.
  7. According to the U.S. Bureau of Economic Analysis, the US Trade Deficit stands at 2.3% of GDP. Despite all of the Buy American initiatives and Trade discussions, this level has been quite constant since 2013.  The Trade Deficit peaked around 2006 at 6%.
  8. While it has come down meaningfully from the peak in mid-2019, there is still over US$11 trillion of debt globally that ‘pays out’ a negative yield, meaning the investor is paying the bond holder for the right to own the bond.
  9. The current interest yield on the full Canadian Bond Index today is just 2.15%.

Summary

We expect a slightly lower than average year in stock markets overall, but do not believe that we are heading into a bear market, at least through the U.S. election.

This type of market can bring a relative premium to investments that pay decent dividends and other income returns, especially given the overall low return on cash and GICs.

Volatility is expected to be higher in 2020, and the reasons for volatility can crop up from anywhere, as we have seen with the Iranian conflict already this month.

Our goal for our clients is to build peace of mind through financial planning and developing portfolios that have much less volatility than stock indexes with a focus on income.  While stock markets are historically down three out of every ten years, we aim to have client portfolios that are rarely negative.  This is part of the reason for our Alternative Income weighting in portfolios.

At TriDelta we will continue to be nimble while focused on a long-term plan, a steady and diversified asset mix that is built appropriately for the goals of each client, and an eye on tax minimization.

Here is to a good investment year in 2020 for everyone.

 

TriDelta Investment Management Committee

Cameron Winser
CFA

Senior VP, Equities

Paul Simon
CFA, FRM

VP and Head of Fixed Income

Lorne Zeiler
CFA®, iMBA

Senior VP, Wealth Advisor and
Portfolio Manager

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