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Ted Rechtshaffen: Why I made my daughter pay for her first year of university

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Teaching financial responsibility and financial lessons should be an important part of a university education

A few years back I wrote an article that was not very popular with high school students. I suggested that a great financial lesson to teach a child or grandchild is to have them pay for at least one year of post-secondary tuition, ideally the first year. Among the many reasons is that the child becomes a partner in their own education and it helps them to take school seriously from day one.

Well, now my oldest child is in first year university and she has paid her first year’s tuition. So far, it didn’t turn out to be that difficult.

One of the key lessons is that I told my daughter of this expectation when she was in Grade 8 or 9 so she had time to work and save up money. Thankfully, she took on the challenge and she has been a good worker and saver along the way. I know that this will not work so smoothly with different personalities. One important benefit of having a responsible oldest child is that my two younger children looked at their sister and have said, “I better start working at 14 or 15 so I will have money to spend and have enough for tuition in first year.” The bar has been set and the expectation communicated.

This all sounds nice, but the important financial lessons are just getting started.

In the days before heading off to school, my daughter asked me a good question. Who will pay for my basic expenses that aren’t covered? Clothes, food beyond the meal plan, some extra spending money. We could answer one of three ways: 1) You are covering all of it; 2) We are covering all of it;
3) We will help cover it.

I know what I don’t want to happen. I have seen many young adults graduate from university without ever being responsible for their own bills and their own budgets. Suddenly at 22 or 23 or 24 the parents are surprised that their kids do not have any of these important financial skills. We view this as an important part of her university education.

What we want to do is to teach financial responsibility and financial lessons. After some thought, we decided that we were not comfortable with either of the first two answers. We were more comfortable with number three, but that still leaves important questions such as: How much will we help? How will you receive the help? What happens if you “run out of money”?

Here is how we answered them.

I reviewed this with my daughter to come up with what we thought was a reasonable budget for these expenses. I told her that we would review it in January to see how it was going.

I told her that I want to pass financial responsibility for her spending to her. That meant that we were going to transfer a monthly amount to her bank account at the beginning of each month. That was hers to use as she saw fit, but she is not getting any more money if she runs out. We don’t want to tell her how to spend her money, we want her to figure it out. If she wants to spend all her extra money on Zola, her African Grey Parrot (don’t ask), and nothing else, it is up to her.

If she does run out of money, it isn’t a crisis. She has a roof over her head and a food plan. She can last until the following month.

Another area for financial lessons comes from credit cards. I actually want her to get a credit card. I want her to understand that putting things on a card is simply deferred payment. If she is late paying, I want her to understand the interest rate. I want her to understand that a minimum monthly payment is not the amount owing.

If the credit card bill comes to her parents, she will not learn these important lessons.

There are a few cards with no fees that require no personal income, and can be obtained by a student as long as you are a Canadian resident over 18.

A great resource to find these cards can be found here:

https://www.savvynewcanadians.com/best-student-credit-cards-canada/

Most importantly, we want to raise someone who appreciates that money doesn’t simply come from her parents. She needs to work for the money and understand its’ value.

She needs to learn to be a good shopper.

She needs to learn how to pay bills.

She needs to feel the consequences of being a saver or a spender.

Ultimately, just like the other parts of being a parent, we want her to develop the skills to be a strong, smart and independent person. The only way that will happen on the financial side is by giving her the freedom to succeed and fail financially. The best way I know to ensure financial problems is to not give your child any of these tools until they have a full-time job.

As someone once told me, “Little people, little problems; big people, big problems.” Just as in other parts of life, it is much easier to learn lessons from the little problems so that you don’t have to face big problems unprepared.

Reproduced from The Financial Post – October 29, 2019.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

TriDelta Q3 Report – Are the markets in better shape than you thought?

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Overview

It is amazing how the day to day can seem very volatile, but when you step back far enough, returns have been fairly steady.  Q3 was one of those quarters.  July was good, August was bad, and September was good.  When you add it all up, the quarter was not great, but decent.

The TSX was up 2.5%, the S&P500 in Canadian dollars was up 1.5% and the MSCI world index was up 2.1%.  This was a rare quarter where Canada outperformed on the strength of Utilities, Consumer Staples and Financials.

The TriDelta Pension fund had a strong quarter, up 4.5%, while the Growth fund was still solid with a 2.3% gain.

The Canadian Bond Index was up 1.2% while preferred shares were up 0.5% on the strength of a rebound in September (after more weakness in July and August).

Despite these numbers, the recession chatter is as strong as ever.

Should we be worried?

How is TriDelta responding?

Where do we see things today and what are we doing about it?

We do not believe that a bear market is imminent.

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.

Today, we see none of the four circumstances in place.

Current growth rates in the U.S. are 2.0%, while Canada is at 1.6%.  These are not booming growth rates, but solidly better than a recession.

Oil prices did see a big drop from October 2018 to December 2018 and rebound, but it was well under 100%.  2019 has actually had more stable oil prices than we have seen in general.  As you can see below, there has been small positive trend for the past 3.5 years.

We are actually seeing Fed loosening of policy as the Fed Funds rate has been lowered twice this year.  As per the chart below, after four years of slowly raising rates, the tide has turned the other direction in 2019.

Valuations on the S&P500 are currently just slightly above their 25 year average based on a forward price/earnings basis, and in a reasonable space on a 12 month trailing basis.

When we take these factors along with our belief that Donald Trump will ease up on China trade demands and tariffs if stock markets are falling, we do not believe in an imminent bear market.

Despite this relative optimism, we do recognize some real risks that include:

  • Slowing growth
  • Few obvious catalysts for near-term market growth
  • Fear that the Fed won’t lower rates as fast as the market expects
  • Brexit dangers
  • Trump….just saying
  • Middle east hotspots in Syria, Iraq, Turkey.

When we net things out our view is slightly positive.  We did have a fairly defensive stance in the third quarter with both higher cash (10%) and a market hedge position in our funds (4%).  We are now slowly lowering our cash weighting, but will likely keep the small hedge in place for now.

Stocks

We are spending a little cash by adding to Emerging Market exposure.  We simply believe that Emerging Markets are undervalued and will benefit more than the rest of the world if the U.S. and China trade improves.  Year to date, Emerging Markets are up only 2.0% while the S&P500 in CDN dollars is up 18.8%, and we believe that gap should narrow.

We are also moving a little more towards Financials and Consumer Staples and a little away from Consumer Discretionary.

Interest Rates

U.S. – The Federal Reserve looks likely to lower rates another quarter percent in late October.  There may be a tougher case to be made for another cut in December as there are currently some Fed Governors clearly against further cuts.  Having said that, the market is still expecting further cuts after October.

Canada – The Bank of Canada is really standing alone as the only major economy that is not planning to lower interest rates any time soon.  Their view is that growth is reasonable and employment is strong while their biggest concern is consumer indebtedness.

Preferred Shares

We see more value in Preferred Shares than many Bonds at this point, in particular perpetual or straight preferred shares that have dividend yields in the 5% to 5.5% range.  While rate reset Preferred Shares provide the most value, and did see a big improvement in September, we still see more volatility on this side of the market.

Alternative Investments

We will soon be sharing information on a new offering from TriDelta that will represent some of our best thinking on the income focused Alternative Investment space along with better liquidity, better pricing, and full flexibility to be held in registered and non-registered accounts.  Stay tuned.

Canadian Dollar

We believe that there could be some strength in the Canadian dollar over the next year as U.S. interest rates fall below Canadian levels.  The very different view on interest rates between the two countries should provide a solid support for the Canadian dollar.  In fact, we have now put in place a 25% hedge on US$ in our funds when we often have no hedge in place.

TriDelta Private Funds

We paid another distribution in the first week of October.  Over 17% of the remaining value of the TriDelta Private Fund 2 (High Income Balanced Fund) was distributed out as cash.  Over 4% of the remaining value of the TriDelta Private Fund 1 (Fixed Income Fund) was distributed out as cash.  We expect to pay further distributions next quarter as more of the underlying investments mature or are sold.     

TriDelta Ranked one of the Top 10 Wealth Management Firms in Toronto by AdvisoryHQ

Here is what California-based Advisory HQ had to say about our firm:

“TriDelta’s holistic financial services approach ensures clients get personalized help from experts in a variety of financial specialty sectors. This provides additional value and ensures a client’s financial strategy is fully integrated.

With a deep bench of professionals, a wealth of financial education resources, and a talented team, TriDelta Financial earns 5-stars as one of the best financial advisors in Toronto….”

Summary

As we head into the final quarter of the year, 2019 continues to feel like a recovery year from the weaknesses of the second half of 2018.  Despite the fear that seems ever present, we do not see a particularly weak investing environment.  In the short term, anything can happen, but our slightly cautious approach should weather such storms and allow us to take advantage of opportunities.

At TriDelta we will continue to focus on being nimble in the short term, being a leader in the Alternative Income space, and helping clients plan for the long term.

Here is to a beautiful fall for everyone.

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Ted Rechtshaffen

President and CEO

Paul Simon

VP and Head of Fixed Income

Lorne Zeiler

VP, Portfolio Manager and
Wealth Advisor

FINANCIAL FACELIFT: Can Chelsea and Chad ‘make it all work’ with a second baby on the way and a possible career change?

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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 October 4, 2019

Chelsea and Chad are earning big and saving mightily, but with a second baby on the way, Chelsea is mulling a possible career change that would cut her income substantially. They are both 34 with a toddler, a mortgage-heavy house in Toronto, and two rental condos.

Chelsea earns $250,000 a year in sales, Chad $115,000 a year in technology. Their condos – their principal residences before they got together – are both generating positive cash flow. With the “main breadwinner” taking a year off and big mortgage payments, they are wondering how to “make it all work.”

They ask whether they should continue paying down their home mortgage aggressively, and whether they should borrow against their rental units to invest. “There is a lot of money coming in and out of our accounts monthly, with property tax, condo fees, and so on,” Chelsea writes in an e-mail. They wonder whether they are managing it optimally.

“We just keep saving but with no clear goal in mind or understanding if our planning is sound,” she adds. They have a “strong desire to maintain a safety net,” and to have a “sound strategy for retirement.”

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

What the expert says

Mr. Ardrey started by running the numbers Chad and Chelsea provided for their income, savings and expenses. To his surprise, his software showed the couple had a $45,000 a year surplus – even after accounting for savings and tax refunds from RRSP contributions. “I believe this is significant leakage in their spending that they have not recorded,” he says.

“Because most people know what they earn and what they save, I can only assume this is being spent,” the planner says. He has included an additional $45,000 worth of expenses in their plan to account for the discrepancy. This takes their adjusted spending to $205,000 a year, including mortgage prepayments.

“This is the primary issue that Chelsea and Chad need to address before any others,” Mr. Ardrey says. “A material change in expenses will affect all financial projections and analysis, including making sure they have sufficient life and disability insurance,” he adds. “I recommend that they go through a detailed budgeting process as soon as possible.”

Both Chelsea and Chad have defined contribution pension plans or group registered retirement savings plans at work to which both they and their employers contribute. As well, they both make maximum contributions to their tax-free savings accounts.

In addition to the registered savings, they make an extra payment of about $12,000 each quarter ($48,000 a year) on their mortgage, and tuck away $2,000 a month ($24,000 a year) in a non-registered savings account. In the past, they have used this money for RRSP top-ups, TFSA contributions and mortgage payments. More recently, they have been setting it aside to help offset the drop in income during Chelsea’s mat leave. Chelsea will get 60 per cent of her salary for the first 16 weeks and employment insurance benefits thereafter.

Their rental properties bring in an additional $19,800 a year for Chelsea and $14,820 for Chad after expenses, but before taxes.

Chelsea and Chad have a $719,000 mortgage on their principal residence and a $42,000 mortgage on one of the rentals.

It is unfortunate that Chelsea and Chad have so little debt against their rental properties and so much against their principal residence, because the rental mortgage interest is tax deductible, but interest on their principal residence mortgage is not.

Although a common thought would be to leverage the equity in the rentals to pay off the principal residence, the Canada Revenue Agency has recently disallowed a similar strategy. For interest to be tax deductible, the use of the borrowed money must be to produce income, the CRA says. The intention of the transaction and the assets pledged for security are both immaterial in this determination. The agency is reviewing tax deductibility on a case by case basis.

Chad and Chelsea ask whether they should use their surplus cash flow to pay off the mortgage or invest. They might be better off financially investing, Mr. Ardrey says. That’s because the after-tax cost of the mortgage interest is low: 2.54 per cent based on the current mortgage rate on their principal residence.

“To break even on investing instead of making extra mortgage payments, assuming a 50 per cent tax bracket and earning interest income, they would need to earn 5.1 per cent on their investments,” he says. This would be even more appealing if they engaged in tax-efficient investment planning and had more of their returns coming from dividends and capital gains, Mr. Ardrey says.

For their children’s education, the annual RESP savings of $2,500 for each child will fall short of the future costs by about 50 per cent, the planner says. The current average cost of postsecondary education is $20,000 a year. Historically, these costs have outpaced inflation, so he assumes the education costs rise at the rate of inflation plus two percentage points. If Chad and Chelsea want to fully fund their children’s education costs, they will be in a position to do so at the time simply by redirecting the surpluses from their non-registered investing to the education expenses, he says.

Next, Mr. Ardrey looked at how Chelsea’s lower income would affect the family finances. If Chelsea changes careers, earning $125,000 a year, they will not be able to make extra payments to their mortgage for the time being. As well, they would not be able to add to their non-registered savings. They would have to reduce their spending by a significant amount: $20,000 a year after-tax, to $137,000 a year. That’s a reduction of the $48,000 for the extra mortgage payments and $20,000 of actual spending. This would continue until their first child is 12, in 2029. If they are both working full-time with good income, they will likely have to have some form of before and after school care, the planner says. By the time the older one is 12, most agree that they can be responsible enough to babysit.

The reduced savings would affect their retirement, but they would still be able to retire comfortably, Mr. Ardrey says.

Finally, Chad and Chelsea would benefit from having a full financial plan prepared, Mr. Ardrey says. “A comprehensive financial plan will create a road map for them to follow.” In their case, it is not the retirement that is unclear, it is the next 10 years, he adds. “Having a plan will help them make the right financial decisions for both today and tomorrow.”

Client situation

The person: Chad and Chelsea, both 34, and their children.

The problem: How to prepare themselves financially for the career change Chelsea is considering. Should they keep paying down the mortgage, or should they borrow to invest?

The plan: Draw up a budget that tracks their actual spending to determine where the leakage is. If Chelsea changes jobs, be prepared to cut spending and halt the mortgage prepayments for a few years.

The payoff: A clear road map across the next decade or so when their cash needs will be greatest to open roads later on.

Monthly net income: $22,900

Assets: Bank accounts $100,000; her TFSA $69,000; his TFSA $71,000; her RRSP (including group RRSP) $233,000; his RRSP $83,000; his DC pension plan $8,000; RESP $9,500; principal residence $1-million; her rental condo $700,000; his rental condo $350,000. Total: $2.6-million.

Monthly outlays: Mortgage $3,820; property tax $695; home insurance $160; utilities $160; maintenance, garden $75; extra mortgage payments $4,000; transportation $455; groceries $350; child care $1,300; clothing $200; gifts $50; vacation, travel $1,000; dining, drinks, entertainment $380; grooming $75; subscriptions, other personal $60; drugstore $10; life insurance $275; disability insurance $225; phones, TV, internet $70; RRSPs $3,500; RESP $210; TFSAs $835. Total: $17,905. Surplus: $4,995.

Liabilities: Residence mortgage $719,000 at 2.54 per cent; rental mortgage $42,000 at 3.15 per cent. Total: $761,000.

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

Making the most of an RESP

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With kids heading back to school, education planning and registered education savings plans (RESPs) are at the forefront of discussions that financial advisers are having with many investors – whether these clients have children in a postsecondary institution or saving for them to go into one in the future.

The RESP is an enticing vehicle for investors because the federal government provides a 20-per-cent matching grant through the Canada Education Savings Grant (CESG), which is subject to both an annual maximum of $500 and a lifetime maximum of $7,200. The unused CESG accumulates each year a child is alive, even if no RESP is open. And if no contribution was made in a year of the child’s life, a double contribution can be made to reach back for a year of the grant. There are no annual limits on contributions, but there is a lifetime limit of $50,000.

When investors contribute toward a child’s RESP, conventional wisdom tells us that they should take advantage of the free money in the 20-per-cent CESG. But is that always the right decision? Let’s consider three scenarios for contributing to the RESP, assuming a 5-per-cent annual rate of return:

Scenario 1: The investor contributes $2,500 a year, beginning when the child is first born, to the maximum of $50,000. The RESP receives $7,200 from the CESG and produces total income and growth of $43,654. The total value of the RESP when the child is 19 years old is $100,854.

Scenario 2: The investor contributes $50,000 into the child’s RESP in the first year of the child’s life. The RESP receives only $500 in CESG, but produces income and growth of $83,492 for a total RESP value of $133,992 when the child is 19 years of age.

Scenario 3: The investor contributes $16,500 into the child’s RESP in the first year, then contributes $2,500 a year thereafter until reaching the lifetime limit of $50,000. The RESP receives the full CESG of $7,200 and produces income and growth of $62,386. The total value of the RESP when the child is 19 is $121,486.

What this shows is that front-loading RESP contributions is more valuable than receiving the government grant. Of course, for many people, putting $50,000 into an RESP in the first year of a child’s life is unfeasible, but the more that could be invested at once earlier on, the better.

If the RESP is maximized and additional educational savings are desired, two other methods can be used to save for a child’s education. First, if the child is 18 years of age or older, she will have contribution room in her tax-free savings account (TFSA). Thus, contributions could be made to the child’s TFSA to supplement the RESP. Second, if the child is under the age of 18, an informal trust could be used to save for her education. (A note on taxes: If the contributions to the informal trust come from the parents, then income from the account will attribute to the parents for tax purposes, but capital gains will not.)

When it’s time for the child to draw down on the RESP, the account is divided into three sections: contributions, CESG, and income and growth. The contributions could be withdrawn tax-free; but the the CESG and the income and growth must be withdrawn as an Educational Assistance Payment (EAP), which is taxable to the child.

There are no restrictions on withdrawing the contributions once the child is attending a postsecondary institution. The EAP does have some additional rules. The main ones are that the child must provide proof of attending a qualifying institution and that the withdrawal is limited to $5,000 in the first 13 weeks when the child begins postsecondary education.

Those restrictions aside, it’s best to maximize the EAP withdrawals over the contributions wherever possible. Any remaining grant is repaid to the government and any remaining income or growth is taxable to the subscriber (parent) as an Accumulated Income Payment (AIP).

The AIP not only has the detraction of being taxed at the subscriber’s marginal tax rate, but also carries a 20-per-cent tax penalty on top of that. The 20-per-cent tax penalty is taken off the top and then the remaining 80 per cent is included as income to the subscriber. The only ways to avoid this tax penalty and retain the value of the assets in the RESP are for the investor to transfer up to $50,000 of these assets to his or her registered retirement savings plan, if he or she has the contribution room, or to another child under a family RESP plan.

Having these EAP payments taxed in the child’s hands is the most advantageous. Even if the child is working while she’s in school and has income in excess of the basic personal amount, her education credits will be enough to offset any taxes owing from the RESP, in most cases.

As much as it’s advantageous to maximize the EAP, in the case of a family RESP, the subscriber must ensure he or she doesn’t exceed $7,200 of CESG withdrawal per child. Each child is permitted only $7,200 of CESG as a maximum. Thus, if more than that amount is withdrawn from the CESG for the older child, the government will demand repayment and take the overpaid grant funds back from the RESP. That, in effect, means those assets are lost to the younger child.

The RESP is a great savings tool. Understanding its intricacies will help to maximize its value. On the flip side, failure to do so could be a costly mistake for investors and their children.

Reprinted from the Globe and Mail, August 28, 2019.

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

FINANCIAL FACELIFT: Rosy projection for long European vacation, then retirement in B.C. hides ‘substantial risk’

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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 August 2, 2019

To celebrate the sale of their house for an impressive sum, Dave and Deborah are planning a long European holiday followed by a big move: from Toronto to a popular retirement destination in British Columbia, where they plan to buy a new home.

Dave, who is 67 and self-employed, will be retiring from a successful career in communications. Deborah, who is 57, is self-employed in the human-resources field. She plans to continue working part-time after they return from overseas. Together, they have substantial savings and investments.

“Our big change is that we have just sold our house in Toronto for $1.7-million net and will be taking a year and a half to travel in Europe when the sale closes,” Deborah writes in an e-mail. “The idea is to invest the proceeds from the house sale in a self-directed [discount brokerage] account consisting entirely of dividend equities,” Deborah adds. “My husband doesn’t like bonds as an investment.”

They would live off the dividends while they are in Europe, Deborah adds, then use the lion’s share of the principal to buy a house in B.C. Dave manages their investments. “He is the first to admit he is not a professional investor and feels he’s in a bit over his head,” Deborah writes. Once they return to Canada, their retirement spending target is $90,000 a year after tax.

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

What the expert says

When their house sale closes, Dave and Deborah plan to use $53,000 of the $1.7-million proceeds to top off Dave’s tax-free savings account, Mr. Ardrey says. They plan to invest the remainder in “dividend aristocrats” and live off the dividend income while overseas. When they return to Canada at the end of 2020, they plan to buy a home for an estimated cost of $1.3-million.

Mr. Ardrey’s calculations include spending of $120,000 a year in Europe (which would not be covered entirely by the dividend income), retirement spending of $90,000 a year after tax, an inflation rate of 2 per cent a year, and that Deborah earns $20,000 a year working part-time to the age of 65. Both save the maximum to their TFSAs each year, but they no longer contribute to their registered retirement savings plans. They delay collecting Canada Pension Plan and Old Age Security benefits until the age of 70 to get the higher payments.

In addition to their house sale proceeds, the couple have $685,000 in RRSPs and $98,000 in TFSAs. Dave also has $544,000 in a corporate investment account that he can draw tax-free.

Next, Mr. Ardrey looks at the couple’s existing investments. Their current asset mix is 9-per-cent cash equivalents, 1-per-cent bonds and 90-per-cent stocks and stock funds. Of the 90 per cent in stocks, 45 per cent is in Canada, 38 per cent in the United States and 7 per cent is international. The historical rate of return is 5.4 per cent. Because they have a substantial proportion in exchange-traded funds, their investment cost is only 0.39 per cent a year, leaving them with a rate of return net of costs of 5.01 per cent.

“Based on these assumptions, Dave and Deborah will be able to meet their retirement goals,” Mr. Ardrey says. Deborah would still have total assets of $5.3-million by the time she is 90, the planner says. If they wanted to spend more and leave only their home as an estate, they could increase their spending by $24,000 a year to $114,000.

What could go wrong?

“Though this projection looks quite rosy, I would be remiss if I did not address the substantial risk in their plan,” Mr. Ardrey says. “Equity volatility.” Including the house-sale proceeds, Dave and Deborah would have 96 per cent of their assets invested in stocks during their stay in Europe.

They’d be ignoring a basic rule of investing: Don’t invest money that is needed short term in marketable securities.

“What if, during their European dream vacation, stock markets had a major decline?” the planner asks. That would affect their retirement plans dramatically. He looks at a second case where their portfolio suffers a 20-per-cent drop during that time. Rather than being able to surpass their spending target, they’d have to pare it from $90,000 a year to $84,000.

Mr. Ardrey suggests some alternatives. The $1.3-million they’ll need to buy a new home in a year or so should be invested in guaranteed investment certificates, or GICs, where they’d be sure to get their money back. “The primary goal of these funds needs to be capital preservation,” the planner says. Dave and Deborah should keep in mind deposit insurance limits, he says. Canada Deposit Insurance Corp. insures Canadian-dollar deposits at its member institutions up to a maximum of $100,000 (principal and interest) for each account. For example, they could open an account in Dave’s name, another in Deborah’s and a joint account at each of four institutions for $100,000 each. “So they could fill their need with four institutions for most of the savings and $100,000 more at a fifth,” he adds.

“Another option would be to purchase the home in B.C. before leaving on their trip,” Mr. Ardrey says. This would remove any uncertainty about what they will have to pay.

With the remaining investments, Dave and Deborah should look at revising their strategy to reduce their stock-market risk, the planner says. They should have a balanced portfolio of large-capitalization stocks with strong dividends and a mix of corporate and government bonds of different durations. Although Dave isn’t keen on bonds, they could enhance their fixed-income returns – and reduce volatility in their portfolio – by investing a portion of their capital in carefully vetted private debt and income funds, Mr. Ardrey says.

These private funds can be bought through an investment counsellor. If they hired one and put a portion of their fixed-income assets in private debt and income funds, they would have a projected return of 6.5 per cent with 1.25 per cent a year in investment costs, for a net return of 5.25 per cent. That’s better than the 5.01-per-cent historical rate of return on their existing portfolio and it would reduce their investment risk.

Client situation

The person: Dave, 67, and Deborah, 57

The problem: How sound is their plan to invest the proceeds of their house sale in blue-chip stocks and live off the dividends for the time they are in Europe?

The plan: Invest the money needed to buy the new house in GICs, or consider buying the house in B.C. now.

The payoff: Greatly reduced investment risk

Monthly net income: $8,335

Assets: Cash $15,000; stocks $544,070; her TFSA $79,640; his TFSA $18,775; her RRSP $419,995; his RRSP $264,640, residence $1.8-million. Total: $3.1-million

Monthly outlays: Property tax $685; home insurance $195; utilities $250; maintenance, garden $125; transportation $400; groceries $290; clothing $175; gifts, charity $80; vacation, travel $200; personal care $90; dining, drinks, entertainment $255; subscriptions $35; doctors, dentists $165; drugstore $35; phones, TV, internet $280; RRSPs $1,500; TFSAs $900. Total: $5,660

Liabilities: None

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 Q2 Report – The Fed to the Rescue

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The second quarter of 2019 has felt a little like Canada’s Wonderland. You climb the roller coaster, then you experience big ‘wind in your hair’ descent, then another climb. At TriDelta, we definitely work to smooth out your portfolio returns much more than the typical stock market, but I am sure that most of you still felt a bit of the roller coaster as you reviewed portfolios online or through monthly statements.

While the overall returns for equity markets were positive in the second quarter, volatility returned in May. After the stock market continued its strong year-to-date returns in April with the S&P500 (US) rising by 3.9%, the S&P/TSX Composite (Canada) increasing by 3% and Euro Stoxx 50 (Europe) up 4.9%, May saw the reversal of fortunes with the S&P500 declining 6.6%, TSX dropping 3.3% and Europe down 6.7%. June returns were positive again at +5% for the S&P500 (although only 1.8% in Canadian dollars due to a 3% increase in CAD during the month), +0.5% for the TSX and +3.7% for Europe.

Bonds performed well with the FTSE TSX Bond Universe index rising by 2.55%. during the quarter with much lower volatility than the stock market (bonds have sold off a bit so far in July). Preferred shares continued to struggle, with the BMO 50 Preferred Share index declining by 2.4% in the quarter, but have performed well recently with a 0.5% rise in June and so far +1.5% in July. Preferred shares continue to offer high tax-efficient dividend yields, especially relative to other income investments. If bonds prices stabilize, preferred shares could also enjoy some capital gain. For more information on the Preferred Shares market, the reason for its decline, and the opportunity for positive future returns, please click here.

While declines can be stressful, even during periods of overall rising equity markets, it is worth remembering that equity markets have typically provided higher returns than most other asset classes, particularly bonds, but with much higher volatility. Even though equity markets (as represented by the S&P500 in the US) have generated positive calendar year returns roughly 70% of the time, in a typical calendar year, equity markets experience declines of 5% or more 3 times and one decline of 10% or more.

TriDelta clients on average were up between 0.25% and 1.5% during the quarter with the biggest difference being the percentage exposure to Preferred Shares. Our basket of alternative investments continued to perform in line with expectations, with private debt funds up approx. 2%, mortgage investment funds up 1%-2% and real estate up 2.5%, outperforming stocks.

So the key question for most investors is why the strength in April and June vs. declines in May? And more importantly, are we in for weak equity markets like we experienced in Q4 2018 when the S&P500 fell 20% from its peak before recovering? Or can we expect strong market conditions, like Q1 2019 when nearly all major markets were up at least 10%?

Earnings, valuations, cash flows and growth rates should ultimately dictate long-term returns for investors. In fact, most classic equity and market valuation models are based on trying to forecast future earnings and cash flows from an investment based on growth rates, but also bond yields. Sometimes, short-term declines are the result of seasonal factors, or major headlines, such as the continued trade discussions between US and China and in May the threat of US tariffs on Mexico. Often though there may be no clear reason for short-term declines. But in recent years, accommodative monetary policy has definitely been a factor in the strength of (and sometimes weakness in) the equity markets.

Why Central Banks Matter?

Central Banks main goal is to use monetary policy (primarily by setting government interest rates, but also by buying and selling government or related bonds in the market) to keep inflation at stable, predictable levels (price stability). The US central bank, the Federal Reserve, actually has two mandates of price stability and full employment.

Since 2008, central banks lowered interest rates to unprecedented levels and even engaged in quantitative easing, buying long dated bonds, to lower longer-term interest rates. The actions of central banks influence money supply, bond yields and even overall economic growth as more flexible monetary conditions can help protect companies and investors. Companies with higher levels of debt can more easily pay and finance credit. Lower borrowing costs can increase profits for corporations and can be used for dividend increases or share buybacks. Lower rates also encourage individuals and endowments to invest in riskier assets when holding cash that offers only meager returns. Higher dividend paying equities appear more attractive in a low yield environment as they offer higher yields than bonds with the potential for upside (they also have the potential for downside if prices drop). Higher valuations seem more reasonable in an environment of low rates, so stock prices go up and investors seeking higher returns bid up growth stocks.

The Q4 2018 sell-off was impacted by fears of slowing growth, a breakdown in US-China trade discussions, but also due to more hawkish central banks. In fact, when the US Federal Reserve (the ‘Fed’) raised rates in December, then commented that it expected future interest rate increases AND expected further reductions in its bond holdings, this threw fire on an already nervous equity market, accelerating declines in stocks, before recovery began just after Christmas.

Presently, US President Trump is demanding that the Federal Reserve reduce rates, Wall Street is anticipating a rate cut later this month AND at least two more rate cuts within twelve months. If this were to occur, the Bank of Canada, which has been neutral, would have to lower rates as well or see the Canadian dollar rise significantly due to the higher yield of Canadian bonds vs. US bonds. The problem is that while yes the world’s growth rate is slowing and lowering rates would help spur growth, most US economists do not see the need for rate cuts. They still anticipate GDP growth of over 2% in both 2019 and 2020, slower, but still a good growth rate for an advanced economy ten years into a recovery. They expect the unemployment rate, already near historical lows, to decline even further, and for inflation to be slightly above 2% (the Fed’s target rate), so these economists do not see a need for near-term rate cuts. (Source: Blomberg Economics, July 8, 2019). Most members of the Federal Reserve are economists. So who will win? Wall Street and the President or the more conservative economists? Much like the Kawhi Leonard watch to determine which basketball team he signed with, the Fed’s decision will also be followed and analyzed throughout the summer.

US Federal Reserve Interest Rate Expectations

The green line reflects the projected Federal Funds Rate (interest rates) per members of the Federal Reserve at July 12, 2019. The yellow line reflected those projections at December 31, 2018. For example, at the end of 2018, the Fed expected rates to stay at approximately 2.4% in one year’s time and now expect rates to be closer to 1.5% over that period.

At TriDelta, we think the result is likely to be somewhere in the middle. We will get at least one rate cut in 2019, but possibly later than July and we may see only 1-2 additional cuts within the next 12 months. If this is the case, Wall Street is likely to be disappointed and we could be in for a few months of volatility.

As a result, we have focused equally on capital preservation as well as growth. The stocks currently in the equity portfolios have higher yields than the overall market, as well as lower volatility (Beta) and cheaper valuations (as measured by Price / Earnings ratios). We also presently hold higher levels of cash in our equity funds. Our bond portfolios hold shorter terms to maturity than the Canadian bond universe and has improved its credit quality. We also continue to believe that investing a portion of clients’ portfolios in income-focused alternative investments should provide less volatility and a higher level of income than a typical stock and bond only balanced portfolio.

We will continue to monitor market conditions, particularly leading indicators, developments in trade discussions and their impact on the world economy, as well as technical factors that may give indications of potential market movements and which sectors to favour.

Update on Private Investments

At the end of Q2, both TriDelta Fixed Income and High Income Balanced Funds made additional distributions based on investments being sold or maturing. Distributions for the Fixed Income Fund were roughly 0.5% and just over 13% for the High Income Balanced Fund. Additional distributions are expected near the end of Q3 as certain bonds mature and others are sold.

Summary:

We continue to search for value in under covered areas of the market, such as a promissory note issued by a leader in the litigation finance field that pays our clients a 10% yield, as well as stocks, preferred shares and bonds trading below historical averages or offering higher levels of growth than are priced in by the market. We are also focused on capital preservation, income and reducing overall risk through prudent management and diversification.

We hope that you have a chance to enjoy the sunshine and good weather that we are presently experiencing. Summers in Canada are too short, so they must be savoured.

 

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Ted Rechtshaffen

President and CEO

Anton Tucker

Exec VP and Portfolio Manager

Lorne Zeiler

VP, Portfolio Manager and
Wealth Advisor

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