4 steps to getting investment income without paying the CRA more taxes


Most investors like a high-income yield, but are you one of them? Do you need monthly income to pay your bills? Is this income earned in a taxable account? If you don’t need the monthly income from investments and you have taxable investment accounts, there is likely a way to lower your taxes.

Let’s start with the basic tax payable on investment income in a taxable account. In Ontario, if you are in the top tax bracket (income of more than $235,675), your marginal tax rate will be the following depending on type of income: Interest income: 53.53 per cent; non-Canadian dividends: 53.53 per cent: ineligible Canadian dividends: 47.74 per cent; eligible Canadian dividends: 39.34 per cent; capital gains: 26.77 per cent; and return of capital: zero per cent.

For greater clarification on a few items, depending on the income of the corporation, many private-company dividends could fall into either eligible or ineligible. For return of capital, it is zero per cent today, but it essentially serves as a deferred capital gain.
Article content

The order of the list stays largely the same regardless of your income, except at lower income levels when the eligible Canadian dividend comes in at a lower tax rate than capital gains.

In general, earning steady income from investments makes sense even if we’re talking about lowering investment income in taxable accounts. A study of the S&P 500 going back 80 years found dividends made up between 25 per cent and 75 per cent of total returns depending on the decade. As a result, I am a fan of dividends, but how do you balance this with a lower tax bill?

With this tax knowledge as background, here is a four-step process to balance a desire for income with a lower tax bill.

Allocate appropriately among accounts

Tax-sheltered accounts such as the registered retirement savings plan (RRSP), registered retirement income fund (RRIF), tax-free savings account (TFSA) and registered education savings plan (RESP) are all good places for income investments that may not be taxed. Interest income and United States dividend income (other than in the TFSA) are ideal for these accounts. Even high-dividend investments might be a better fit here.
Article content

If you don’t have any taxable accounts (non-registered or corporate), then being strategic about where investments sit is generally not very relevant.

If you do have taxable accounts, it is important to try to allocate the most tax-efficient investments to the accounts that will owe tax. This might mean holding investments in a non-registered or corporate account that generate no income, return of capital or eligible Canadian dividends.

Do you really need monthly or quarterly income from investments?

Are you drawing funds to cover expenses? If so, having steady investment income is likely of value. If not, there isn’t any cash-flow need to earn more investment income. You might even prefer holding stocks with no dividend or zero-coupon bonds.
Article content

Even if you require a monthly cash flow, keep in mind you can still sell an investment to raise this cash. From a tax perspective, if it is in a taxable account, this will generate capital gains (or losses), and each dollar will result in a lower tax rate than interest income.

Find more tax-efficient investments

Alphabet Inc., Constellation Software Inc. and many other stocks don’t pay any dividend at all. These types of stocks tend to be growth companies, and lean towards technology, so there are risks, but they will generate no income for tax purposes until you sell them.

Real estate investment trusts (REITS) with high return of capital can provide you with cash flow, but still no tax bill in a current year. Public REITs can have high income, but a sizable return-of-capital component. For example, Slate Grocery REIT has a current yield of 7.4 per cent. In 2021, 58 per cent of its income was return of capital and another 12 per cent was capital gains. There are also many private REIT investments where all income is return of capital.

Consider a home equity line of credit

This strategy is currently out of favour because interest rates are high, but it is often a lower-cost source of cash flow if you would otherwise need to draw funds out of your RRSP, RRIF or corporate account.

Given that it could create a tax bill in the 40-to-50-per-cent range, it might be more tax efficient to get cash with a borrowing cost in the single digits. Of course, low single digits would be better.

This strategy makes the most sense when your funds would otherwise not be taxed for many years. It can be less valuable if you are simply deferring the tax on the income for a year or two.

It can also make sense in some cases for retirees who would otherwise lose some or all their Old Age Security benefits because their taxable income is too high.

Like most things in life, balance and nuance can be important. They say you shouldn’t let the tax tail wag the investing dog. That said, paying meaningfully higher taxes than is necessary should at least get you to pay attention to that wagging tail.

Reproduced from the National Post newspaper article 14th February 2023.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP®, CIM®
President and CEO
(416) 733-3292 x 221

23 investing and personal finance thoughts for what’s to come in ’23


As we headed into 2022, I shared 22 financial thoughts for 2022. As it turned out, they were largely accurate, with one meaningful exception. I predicted an increase in interest rates and inflation, but, like many others, the hikes exceeded my more modest view. Looking towards 2023, interest rates and inflation will once again be key to our financial future, so let’s start there.

Inflation will slowly and fairly steadily decline in 2023: We will likely get back to the range of three to four per cent by the end of the year in Canada. The declines may not be as fast as we hope, but the reduction in inflation will be welcomed on many fronts and will certainly relieve some of the pressure on interest rates.

Expect to see the first interest rate declines late in 2023: Interest rates have almost peaked from a central bank perspective, and while they may not go down for a while, I expect to see the first declines late in 2023. This is a little earlier than the Bank of Canada is currently indicating. Unfortunately, it will not give any immediate relief to those with variable-rate mortgages.

Five-year fixed mortgage rates will not decline; they may even rise: From a bond-market perspective, the five-year rate is unreasonably low given the rest of the market. While my earlier thought relates to the Bank of Canada rate, we believe there needs to be an upward adjustment in five-year bond yields to normalize the yield curve from the inverse yield curve we have today. We expect this will happen in the first half of 2023.

Residential real estate will go down, then up: Economic fears do not make major financial decisions such as buying a house easy. Between higher mortgage rates than many have seen in their lifetimes, some fears around employment and those who might need to sell because of lost jobs, I see a weaker market in early 2023. That said, immigration targets of 465,000 people will be very supportive of the overall market, and I expect a small housing recovery later in the year.

Rents will go up, then maybe down: Greater demand from larger immigration combined with those who can’t afford to buy anything will continue to push rents higher in the early part of 2023. But we expect this to lose steam somewhat as the real estate market comes down and the overall economy is weaker. The practical implications are that some people will adapt to this, leading to more people per residence, either because children are living at home longer or people add roommates to be able to afford rent.

Recession? Yes, but manageable: It seems fairly clear that central bankers’ efforts to slow inflation down will slow growth down. The technical definition of a recession — two or more consecutive quarters of negative growth — will likely take place. Nevertheless, high immigration numbers and the potential support of lower interest rates should keep us out of a major recession.

Unemployment will rise: Recessions lead to lower earnings and higher unemployment. Along with a greater number of people looking for work due to immigration, we would expect to see unemployment rates rise to more than six per cent by year-end from 5.1 per cent currently.

Working from home will be reduced: The work-from-home trend isn’t going away, but there is nothing like a recession and higher unemployment to motivate employees to do what their companies ask. If cutbacks are looming and you are asked to work from the office four days a week, you don’t want to be the one that says no.

Retirements will be delayed: Many people approaching retirement age are looking to continue working, because rising inflation is creating some justified concerns. The greater ability to work from home has also made the decision to extend work a little easier for many. Considering some of the low employment rates we have seen, many employers are more than happy to accommodate extra years of work from older employees.

Government pension payouts will be meaningfully higher: This isn’t so much a prediction as a fact that hasn’t received a lot of attention. Inflation has some benefits for retirees as government pension payouts will grow 6.3 per cent in 2023. Canada Pension Plan (CPP) payments as well as Old Age Security (OAS) are tied to inflation, so if you can maximize those benefits, you could receive as much as $24,000 combined in 2023. And OAS benefits are a little higher still for those 75 and older.

Inflation means higher tax thresholds and OAS clawback limits: The OAS clawback will kick in once personal income is $86,912 in 2023 as opposed to $81,761 in 2022. This may allow increased planning opportunities to capture more OAS. In addition, the top federal tax bracket will move up to $235,676 from $221,709, along with smaller increases at all tax bracket levels. There may be some additional planning in 2023 to help take advantage of these changes.

Energy costs will be increasingly dependent on China: I believe that the prices of oil and natural gas will not meaningfully decline in 2023, but the emergence of China from COVID-19 restrictions could support strong energy demand. China is always difficult to predict, but it seems likely that China will follow the rest of the world in meaningfully easing COVID-19 restrictions over time. This will be the biggest driver of prices in 2023. Of course, an ongoing conflict in Ukraine and Russia could also provide some price support.

Metals and materials will recover in 2023: After a big drop off in the last eight months of 2022, China will be supportive of growth in metals and materials prices. This will be key as a global economic slowdown will move prices the other way. Overall, we think the recovery of China demand will carry the day.

The loonie will stay in the low end of its seven-year range: The Canadian dollar has since 2015 spent most of its time trading within a few cents of 76 cents U.S. Today it is around 74, and we expect it to mostly be in the 72-to-74 range. One of the big reasons will be the United States ending up with a higher interest rate than Canada.

Ukraine and Russia will continue to raise risks: We would obviously like to see a resolution of the conflict, but there doesn’t seem to be a clear route at this point. This leaves challenges for many markets such as energy, wheat and uranium. Unfortunately, the ongoing conflict will likely lead to continued supply challenges in these markets and result in higher-than-normal prices.

Bitcoin will survive but likely won’t see a meaningful recovery: Last year, I didn’t even want to comment on bitcoin. With the current FTX debacle, government regulation will become much tighter. Smaller cryptocurrencies may not survive, and the largest names will have to survive under much tighter scrutiny, which goes against the prevailing culture of independence. I think that is called growing up.

Cannabis stocks need U.S. legalization and that isn’t likely to happen: The window might have been open for the legalization of cannabis in the U.S. for the past couple of years, but it clearly wasn’t one of President Joe Biden’s priorities. That doesn’t seem to have changed. As a result, it will be tough to see real gains in this space.

There will be an increased demand for financial and estate planning: As uncertainty grows about the economy and inflation, there is more concern about our own financial futures as well as those of our children and grandchildren. We saw this in 2009, and many Canadians in 2023 will be searching for those who can provide greater guidance, financial peace of mind and tax-minimization strategies.

Canada will outperform U.S. markets again: U.S. markets had until 2022 largely outperformed Canada for a decade. From 1999 to 2010, though, Canada had largely outperformed the U.S., which suggests there are longer-term trends at play here. With the bloom off the rose of high-growth tech stocks, a return to better value and a resource recovery, the advantage for Canada looks to continue. We also expect Europe to do better because the current overall view is too negative today.

Larger-cap, profitable and good-cash-flow stocks will be the place to invest: They will benefit from a desire for stability from investors as well as the ability to use their capital to target those that need to raise money (see Royal Bank of Canada’s purchase of HSBC Holdings PLC’s Canadian business.)

Bonds will perform much better: Bonds had a historically bad year in 2022. But the fundamentals are different today. It is possible to find yields to maturity of five to seven per cent. We don’t expect much help for bonds in 2023 from rate declines (probably more help in 2024), but the much higher starting yields will help overall returns.

The health-care crisis will lead to greater spending on the sector: I don’t pretend to know the correct medicine for a Canadian health-care sector that seems to be breaking at the seams. But I believe governments will face great political pressure to invest more in a variety of resources to support the industry. Also, expect Canada to keep things relatively easy to get approved for medical assistance in dying (MAID).

2023 will see better overall returns: It may be a bumpy ride and a low hurdle, but higher income yields will be supportive of balanced portfolios in a way that we didn’t see in 2022. In addition, the flattening interest rate environment will help. A recession will hurt earnings, but we expect meaningful return improvements overall.

Reproduced from the National Post newspaper article 29th December 2022.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP®, CIM®
President and CEO
(416) 733-3292 x 221

Financial Post / Rechtshaffen: Avoid these five mistakes when estate planning to preserve family peace


Some decisions can lead to terrible family rifts that never mend

Family feuds get ratings. Just look at Prince Harry and Meghan Markle.

But we’re more interested in promoting peace and harmony within families, especially when it comes to estate planning. This can often be more difficult when an estate is larger in value.

Some estate planning decisions can lead to terrible family rifts that never recover. Here are some of the biggest mistakes we see.

Treating family members differently

Family members are different. They have different skill sets and different levels of responsibility and maturity. Some are kind and giving, others take and take. But if you want to create big family fights, leave your assets to your children in an unequal manner. Leave 45 per cent to Joe and 45 per cent to Susie, but 10 per cent to Bill.

People do this all the time, and they may have very valid reasons for doing so, but it is still a recipe for disaster. The best scenario is if you can comfortably tell Joe, Susie and Bill in advance why you are doing this. To do so without explanation will very likely lead to anger and jealousy between the children when they find out.

Our general recommendation is to try to leave assets equally even if you don’t think it is fair.

Pass the family cottage to multiple children

You love the family cottage and your wish is to keep it in the family for your kids and grandkids to enjoy for decades to come. This can be a very dangerous part of the estate plan, because your children may not necessarily feel the same way about the cottage that you do. Or they may really like the cottage, but could use the cash instead.

It is rare for the next generation to be fully in line on this issue. Sometimes it is just geography: one child moves away and won’t use the cottage much. But even if they all like it, they might get into issues about repairs and renovations or scheduling who uses it when. Families can sometimes get along fine with a little distance, but spending too much time under the same roof can create problems.

We generally recommend either selling the cottage in your later years or, if you keep the cottage, make sure it is openly discussed. Some solutions can include setting up life insurance set up to specifically pay taxes and perhaps one or two children, so that the remaining children can afford to keep the cottage. Open communication is key, but often a sale is the cleanest approach.

Don’t tell the kids anything about your money

You might think your money isn’t their business. They can find out your true net worth after you are dead. This approach is akin to lighting a bomb with a very long fuse.

One of the biggest problems here is that there may have been times in your children’s lives when they really needed financial help, but they don’t really need it any more. Children who now realize you could have easily helped during the difficult times, but chose not to do so can get angry.

It is true that it isn’t the children’s or beneficiaries’ money to spend in advance. Yet there is often a sense of betrayal at keeping such a significant secret, as well as a sense of missed opportunities to do more during one’s life.

This silent approach also often eliminates any ability to understand what might be most meaningful to your children or beneficiaries. Maybe less so in terms of cash, but in terms of family heirlooms or property. Perhaps a piece of art or furniture was really important to two children, but there was never any discussion about it, so it is now completely left to them to fight over. This may sound like a small issue, but many families have split up forever over just this type of scenario.

If you sense a theme here, it is that communication is key. Don’t keep things so private that you avoid having the discussions that need to take place.

Purposely or inadvertently leaving most or all assets to a new spouse

This sometimes happens by accident due to poor planning around ownership titles, lack of pre-nuptial agreements or the unintended naming of beneficiaries on investment accounts or life insurance. Other times, it is meant to hurt the children … and it will. The hurt can certainly go both ways and is often a major issue when a spouse is not fairly treated.

Either way, you want to be extra careful in these situations to first understand what you hope to accomplish, and then make sure your documents are aligned to achieve this.

Significant charitable giving

Of course, you are more than entitled to give all your money to charity, but if it isn’t discussed with your so-called traditional beneficiaries, there can be fights with the charity that can last a long time. There have been cases where intended charitable gifts have been overturned because it wasn’t deemed fair to the other beneficiaries.

An old colleague referred to wills as the last words a parent says to a child. If that message leads to questions or misunderstandings, a child will sometimes think it means a parent didn’t really love them, or loved them less than others. This is the foundation of many family fights.

My best advice is to communicate what you are doing and why, and to do so while you can still explain your rationale to your family. If it feels very difficult to do, then imagine the reaction when you are not there.

Put another way, if it seems too difficult to have this discussion now, maybe that is the push to make some changes to your estate plan to make it easier on those left behind.

Reproduced from Financial Post, November 9, 2022 .

Ted Rechtshaffen
Provided By:
Ted Rechtshaffen, MBA, CFP
President and CEO
(416) 733-3292 x 221

Financial Post / Rechtshaffen: Mo’ money, mo’ problems: Even the wealthy are worrying about their financial future


There’s a list of problems that are only created with more money

They say the best time to plan for the future is when things are going well.

Of course, that’s in a perfect world. In today’s world, people are nervous and concerned about their finances, and so we are seeing an increased demand for financial planning. In some ways, this makes perfect sense. If someone’s financial future looks good when things are bad, they can be fairly confident they will be OK under most circumstances.

The increasing demand at our firm is from what most would consider wealthy Canadians, generally those with a net worth of $3 million to $30 million. Now, I can see some eye-rolling and groaning right about now. “What do these rich people have to worry about?” Well, there is an old saying (and a newer song): Mo’ Money, Mo’ Problems.

Some issues and concerns are similar across the wealth spectrum, while others are unique to those with a lot of money. Let’s take a look at one area that would affect the wealthy differently than most, but may be of particular concern at the moment: gifting to children or grandchildren.

Gifting to family is simply not on the agenda for many Canadians. Just like the instructions on the airplane tell you to put safety gear on yourself before helping a child, your financial plan should look after yourself first before seeing if you can help others. But if you are in the position to easily help others, then this is likely a consideration, especially when it comes to real estate.

To look at a fictional example, if you have three middle-aged children and nine grandchildren, ranging in age from five to 25, things can get worrying if gifting to them was part of your planning.

What sometimes happens is that the oldest child is looking to buy a home, and the parents may decide to contribute $200,000 to the down payment. However, the question isn’t how much they can afford to contribute to the oldest child; it is how much they can afford to equally contribute to all three children.

If they can’t afford to gift $600,000 ($200,000 to each child), then they can’t afford to gift $200,000 to the first child. Not all parents will contribute equally to their children, but many will plan to.

Often, the gift to the oldest child will take place several years before the gift to the youngest child. What happens if there is a lot of inflation over that time? Do you gift more than $200,000 to the youngest, given the $200,000 is now worth much less than it was maybe eight years earlier? What if you simply don’t feel you can afford to give that much money today to the youngest? Is there a way to give less?

It can be even harder when it comes to grandchildren. There are nine of them in our example, and a gift of $50,000 can easily be perceived as a $450,000 commitment. Given the 20-year age gap, how will that be managed effectively? What if the first four grandchildren receive this gift and the last five don’t?

Yes, these are first-world problems of the wealthy, but they are real issues. Families can split up over favouritism from parents, and these types of gifting issues can sometimes be the cause of it.

To help manage this process, we encourage families to work out a financial plan that will provide greater insight into their financial future on an annual basis. With this information, they can better plan out potential gifts and see what they truly can or can’t afford. They can also determine which types of accounts or holdings are best used to fund these gifts.

Maybe the result of this planning is to be a little more cautious at the beginning to help ensure an ability to fund gifts in good and bad times. As we say, you can always choose to gift more in the future, but it is tough to get a gift back if you gave too much.

My firm has put together a free report on the 10 key financial planning questions of high-net-worth Canadians, along with some thoughts on how to best answer those questions. Some people will look at these questions and directly relate to them. Others will be in a different place and say they wish they had those problems.

But there are some universal concerns regardless of wealth. These relate to making sure you and a partner will be OK, trying to make the most of what you have and how you can best help the larger family.

That core is the same, but there’s definitely a list of problems that are only created with more money, and there needs to be some good planning to deal with them, especially in this environment.

Reproduced from Financial Post, October 5, 2022 .

Ted Rechtshaffen
Provided By:
Ted Rechtshaffen, MBA, CFP
President and CEO
(416) 733-3292 x 221

Financial Post / Rechtshaffen: Interest rates are still rising, but investors should start preparing for when they come back down


Variable rates will likely be a benefit once again in the midterm

The Bank of Canada over the past 30 years has had six periods of interest-rate hikes, ranging from 1.25 to 3.2 percentage points, before this most recent set in 2022.

The one thing they all had in common was that it didn’t take long for each of them to be followed by a period of declining interest rates, ranging from 1.25 to 5.125 percentage points.

One logical reason for this is that rate rises are meant to slow down the economy, and rate declines are meant to boost the economy. There is a general view that the increases typically start too late, and so rates are still rising after the economy is already slowing. Once they really start to take effect, the impact can be too much, and the central bank has to do a quick about-face.

Let’s do a quick review of the six rises and falls since 1994.

In October 1994, the Bank of Canada’s overnight rate was 4.94 per cent. Over the next four months, it rose significantly to 8.125 per cent — a rise of 3.2 percentage points. Over the following nine months, it declined to 5.94 per cent, and one year later it was sitting at three per cent. This was a large rise and fall historically, but it outlines how quickly rates can rise and how steep the ultimate decline can be.

The next period of rate adjustments saw the overnight rate rise to 5.75 per cent from three per cent over a 15-month period in 1997 and 1998. The subsequent decline wasn’t as steep, but it did drop over the following nine months to 4.5 per cent in May 1999.

In October 1999, the rate was still 4.5 per cent, but then rose to 5.75 per cent by May 2000. One year later, it was back to 4.5 per cent and it was all the way down to two per cent by January 2002.

Over a 25-month period from March 2002 to April 2004, the rate went from two per cent to 3.25 per cent and back to two per cent.

During a relatively prosperous time, the rate rose to 4.5 per cent in July 2007 from 2.5 per cent in August 2005. But the financial crisis of 2008 started to rear its head, and rates fell first to three per cent by April 2008 and all the way to 0.25 per cent a year later.

More recently, the rate in June 2017 was at 0.5 per cent, rose to 1.75 per cent by October 2018, and then dropped to 0.25 per cent by March 2020 when COVID-19 began.

What does this mean for today? So far, we are 1.25 percentage points into an interest-rate-hiking cycle. Some think there are another one or two more points in front of us. Others think it will be less than that. What if the overnight rate goes from 0.25 per cent (where it was in February 2022) to 2.75 per cent? For many of us, that would be a bad thing because our borrowing costs would be meaningfully higher. However, if we were somewhat confident that rates would soon be heading down from there, would that ease our concerns?

History suggests this will happen. The six hiking cycles averaged 13 months in length. The current one is four months in. The six declining cycles began on average 5.7 months after the hikes stopped, but it happened within three months in three of the six scenarios. The average interest rate hike was 1.95 percentage points and the average decline was 2.85 percentage points.

History can be a guide, but certainly not a clear roadmap. If all we did was simply look at the averages here, it would suggest that we have another 0.7 percentage points of rate hikes, which would take another nine months to reach. Interest rates would then start to decline by September 2023 and eventually drop all the way back to 0.25 per cent (or more if it was possible).

Of course, each scenario is different, so things won’t simply follow these averages. The causes are different and the starting point on interest rates is different. That said, this cycle has been very repetitive over the past 30 years.

If I had to guess, I would expect the rate-hiking timeline will be shorter than 13 months, but that rates will move up by more than just 0.7 percentage points. I believe the start of the rate declines might happen sooner than September 2023. The implied policy curve for Canada currently suggests that rate hikes will peak in six months and then start to decline with the following year. This doesn’t mean that this is a fact, but it shows that even today, the implied policy rate is giving some indication of the same cycle we have seen several times before.

Another clue as to why the next cycle might look like the past is that even the Bank of Canada has said one of the reasons for increasing rates is so it will have some greater tools and leverage to help the economy by lowering rates if we go into a recession or something similar.

If that is the future, what does that mean for investors and borrowers?

Variable-rate borrowers will feel more pain in the near future, but it isn’t a one-way road. Variable rates will likely be a benefit once again in the midterm.

If you are looking at buying guaranteed investment certificates, annuities or bonds, it may still be a little early to lock in or invest, but there will likely be a sweet spot to do so later this year or in the first half of next year.

High inflation and higher interest rates seem like the obvious situation today, but this may shift in the not-too-distant future, so don’t go overboard with this investing thesis as it can turn on you. You want to be nimble.

The key message here is that we should not panic about runaway rate hikes. They will continue to rise, but it is also very likely that we will see rates fall shortly after the hikes stop. Maybe this rollover will happen by the end of this year or at some point in 2023, but being prepared for this scenario will allow for some investment opportunities and debt opportunities to be maximized.

Reproduced from Financial Post, July 12, 2022 .

Ted Rechtshaffen
Provided By:
Ted Rechtshaffen, MBA, CFP
President and CEO
(416) 733-3292 x 221

Financial Post / Rechtshaffen: Hang on a minute: Inflation is actually good for some people


Don’t fear inflation if you have low or no debt, higher assets and are receiving some form of indexed income

There are few words in the financial world scarier than inflation.

Many remember the early 1980s and mortgages of 20-plus per cent, but if you are a student of history, or even lived in certain countries during periods of hyperinflation, you might recall these unbelievable cases: in Venezuela, consumer prices grew at 65,000 per cent from 2017 to 2018; in Zimbabwe, the daily inflation rate was 98 per cent from March 2007 to mid-November 2008; in Hungary, the daily inflation rate was 207 per cent between August 1945 and July 1946. Now that is an inflation problem.

In North America, our inflation rates have never really topped 20 per cent annually. I am not suggesting 20 per cent is nothing to be afraid of, but for many of you, inflation may actually be your friend.

One of the fundamental components when we do a financial plan for clients is a fair estimate of annual spending. If the client doesn’t have any debt, then this annual spending number is the only part of the plan that is negatively affected by higher inflation. For example, if someone spends $100,000 a year and inflation is 10 per cent, then the same level of spending would be $110,000. They now have an extra $10,000 of costs to worry about.

Now let’s look at parts of the plan that will be helped by higher inflation.

Let’s say this same client, a couple both aged 70, does not have a defined-benefit pension to fall back on, but they receive full Canada Pension Plan (CPP) and partial Old Age Security (OAS) benefits that total $50,000 a year. This income is fully indexed to inflation and, based on the 10-per-cent inflation rate, it will now go up to $55,000 a year. This couple would have $5,000 of that extra $10,000 covered by index increases in their government pensions.

Next, the couple has $2 million in investment assets and likes to keep $150,000 in high-interest savings accounts and money market funds. These were earning one per cent in a low inflation environment, but in a 10-per-cent inflation world, they are now perhaps paying six per cent. The extra five percentage points on $150,000 is $7,500, which puts them in a positive cash flow position.

Next, they have another $1.85 million of investments. In a high inflationary world, you want to invest differently than in a low inflationary one. It isn’t as easy to mathematically show a net benefit or negative in this part of the portfolio, but there are some ways that we would manage investments differently (we are doing so to some extent now) that can add net dollars.

Let’s start with bonds. For most clients, we have already been holding significantly lower weights in bonds than usual. The reason was that yields on bonds were so low, and there was a heightened risk that rising interest rates would hurt bond returns. This has been the case.

However, there will be a time when holding bonds goes back to traditional weights or even higher. If inflation is 10 per cent, yields on bonds will be much closer to 10 per cent than they are today. Simply owning bonds and collecting the coupon payments will generate much higher income. In addition, at 10-per-cent inflation, the odds of interest rates going back down to more normal levels from there would be much greater, and this would also add to bond returns.

We aren’t there yet, and may not get there, but the point is that when inflation and interest rates reach a high enough level, bonds once again become a good investment option for almost all clients and that hasn’t been the case for a few years.

As a quick example, the Fidelity Canadian Bond Fund in its first five years from 1988 to 1993 returned an annualized 8.7 per cent. The same fund is negative over the past five years, with a five-year annualized return of -0.31 per cent. If $200,000 was invested in this fund during higher inflationary times than we’ve had during the past five years, the difference at the end of five years is more than $106,000, or over $21,000 on an annual basis. That would certainly have a big impact on the extra $10,000 in costs that high inflation brought to bear.

In terms of other investments, you traditionally want to be more in value than growth stocks during high inflation periods. The main reason is that growth investments rely on a high value of their future potential. If interest rates are high, a dollar in five years will be worth much less than if interest rates were low. As a result, many growth stocks (good and bad ones) are getting hit hard this year.

Value stocks generally include sectors such as utilities, consumer staples, some real estate and commodities. These hard assets have traditionally been less reliant on high future growth, and more reliant on quarter-to-quarter profits and stable-to-growing dividend payments. As a firm that leans towards value investing, we certainly don’t mind a little inflation.As a quick aside on value vs. growth, a 2016 study by BofA Securities Inc. found that the average annual price return of value stocks since 1926 was 17 per cent versus 12.8 per cent for growth stocks. It found that value outperformed growth in roughly three out of every five years during this period. Since 2016, there is no question that growth has meaningfully outperformed value, but that has turned in the past year. We believe, based on this history, there might be a long period of value outperformance ahead.Getting back to real estate, this is one hard asset that people sometimes say will benefit from inflation, while others say it will decline due to higher interest rates. Both are right, which means you need to be careful in terms of how you invest. For example, a real estate investment trust with a larger ratio of debt would be in for a rougher ride than one with lower debt.

One private REIT we currently invest in is Rise Properties Trust, which is focused on residential rental properties in suburban Seattle and Portland. Its rental income is tied much more to inflation than Canadian residential properties, because of the relative lack of rent control in those markets and a culture that moves more frequently, thereby allowing average rental income to be more closely tied to current (inflationary) rates.

Of course, many people do suffer from rising inflation. If you have high debt and low assets, as many younger people do, rising inflation is a real risk and concern. However, don’t fear inflation if you have low or no debt, higher assets and are receiving some form of indexed income (including CPP and OAS). It is actually your friend.

Reproduced from Financial Post, June 14, 2022 .

Ted Rechtshaffen
Provided By:
Ted Rechtshaffen, MBA, CFP
President and CEO
(416) 733-3292 x 221