Articles

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

0 Comments

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
tedr@tridelta.ca
(416) 733-3292 x 221

22 financial thoughts on what’s to come in ’22

0 Comments

Predicting the future has always been a challenge, and it has become almost impossible with Omicron. That said, I’m optimistic things will considerably improve on the COVID-19 front in 2022, at least from the second quarter onward.

This belief is based on a mix of hope and science that there will be a high enough percentage of people who are fully vaccinated and/or been infected with the Omicron variant so that the tide will turn on this pandemic.

My belief certainly colours my 22 thoughts for 2022 below.

1) Interest rates will stay low. Yes, interest rates will likely rise from extremely low to very low in 2022, but don’t confuse rising rates with high rates. Act as though we are in a very low interest rate world.

2) Energy and metals likely have more room to run. Oil has been so unloved that the valuations on some big 2021 gainers remain super low. Many in the sector have forward price/earnings ratios in the seven range, which is much lower than their historical average and much lower than the overall market.

3) Canada should outperform global markets. This is based in part on having a very small percentage of high-growth/no-profit tech stocks, as well as an overweight to commodities.

4) Increased immigration should help lower wage inflation. This assumes COVID-19 doesn’t hold up this process for too long. More workers at all levels will reduce some of the wage inflation we are currently seeing.

5) Increased immigration should keep residential real estate prices up. Low interest rates, a steady economy and high immigration rates are the three-legged stool for increasing residential real estate prices. Prices went up even without the sizeable net immigration piece during the past two years. The immigration numbers should compensate for the slightly higher rates.

6) Cottage country real estate prices may slow down a little. I say may since it is very much COVID-19 related. As more people work from the office and more people are comfortable travelling internationally, I truly believe there will be a real slowdown on vacation property real estate in Canada. How long it will take to see those drops is the question.

7) Spending will grow. Many people have considerably dropped their spending levels in the past two years. If you kind of feel like you have lost two years of your life, you will try to make up for it — COVID-19 willing.

8) Your car will be more important. There will likely be a significant lag in the comfort level of going back to public transit as more people head back to the office. This will lead to more money being spent on cars, and likely more traffic jams.

9) Your house will be less important. Of course, this is all relative, but we will likely be spending less time in our homes (although it doesn’t feel like it right now). This means more money for concerts, restaurants, travel and experiences, and less for home gyms, swimming pools and gazebos.

10) Living life can mean indulging in things that aren’t so good for you : alcohol, drugs, tobacco, sex, gambling, etc. Sin stocks may do well as the return to living (and spending) has to go somewhere.

11) Fitness and wellness may slip in importance. This isn’t to suggest there are any major negatives in these areas, which have experienced sizable growth over the past few years, but it is somewhat the corollary of thought No. 10.

12) Online shopping and food delivery are here for good, but not with the same buzz. The stock market is forward looking and is always looking at momentum. I believe some of the momentum in this area will decline.

13) Build back better … sort of. There remain some aggressive infrastructure projects and spending that will happen, but it will likely end up being Build Back Better Junior Edition if the United States is any example.

14) Taxes may not be headed higher . There is a clear rationale to raise taxes to help get us out of the huge debt situation, but there are two things in the way. The first is the belief we can grow ourselves out of debt, which may be partially true. The second is the current government is much more comfortable giving money away than asking for more.

15) Demand for mortgages and home equity lines of credit will continue to grow . Even with some increase in rates, the only thing that will stop this area of growth is a flattening or decline in real estate values. This can certainly happen, but it likely won’t be this year.

16) Rent costs will rise . As residential real estate values rise and interest costs rise, the desire among landlords to boost rental rates will be very high. Lack of overall supply will simply make this worse.

17) Retirement residences will still manage to grow. There is no question the pandemic has increased the desire for many seniors to stay at home. Yet with older baby boomers now clearly in this market, the costs of staying home increasing, and the lottery ticket of housing values waiting to be cashed in for many, don’t be surprised if this market continues to grow — in some cases with the ability to buy as opposed to rent.

18) Cryptocurrencies will exist. I know this is a cop-out thought, but the only thing I know for certain is that governments are going to significantly increase the regulation and taxation of this space. Beyond that, I won’t predict anything.

19) Investment fundamentals will return. Something is broken when the IPO of Rivian Automotive Inc., an electric car company with no sales, values it at more than three times that of Honda Motor Co. Ltd. In a world of uncertainty, there will be greater value placed on actual profits and dividends, and less on the companies priced for perfection five years out.

20) Bonds will still struggle. This asset class is broad enough to find some winners, but the core vanilla bond space will find it hard to deliver returns with a combination of low yields and rising interest rates.

21) Inflation is here to stay … for now. I don’t want to use the word “transient” here, but at some point later in the year, inflation will pull back to the range of two to three per cent. This is largely because inflation is measured year over year, and it will be much harder to see five-per-cent inflation rates when compared to the fourth quarter of 2021.

22) The search for investment yield will grow. Many investors like the steady income from an investment portfolio, but there will be an increasing focus on staying ahead of inflation and taxes. This will likely put even more of a premium on investments that can deliver this type of yield.

Reproduced from the National Post newspaper article 31st December 2021.

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

What is our Investment Thinking Today?

0 Comments

Are Stocks Expensive?

If you are talking the Nasdaq U.S. market, the answer is yes.  If you are talking the S&P500 U.S. market, the answer is probably yes.  If you are talking other markets, then the answer may be no.

One measure of valuation is the Forward Price/Earnings multiple, or P/E multiple.  The higher the number, the more expensive the market.

The S&P500 is at 21.3.

The Nasdaq is at 24.6.

In comparison, the Canadian TSX Composite is only at 14.9.

The British FTSE100 index is at 12.4.

The broader Euro Stoxx index is at 15.5.

The Emerging Market index is at 12.5.

Of interest, the TSX has a lower Forward P/E at the moment than it has had for most of the past 3 years.

Another view of the U.S. large cap S&P500 is what is known as the Shiller PE ratio.  This is a different way of measuring valuation.  The Shiller PE is currently at 38.6, which is considered 49% higher than the 20 year average, and very close to the 20 year high.

What Sectors are Less Expensive that we like?

While the process is definitely not as simple as more expensive and less expensive, it should be noted that the five least expensive sectors are Financial Services, Energy, Consumer Defensive, Utilities and Industrials.  The most expensive are Consumer Cyclicals, Real Estate and Technology.

In an environment of rising interest rates and inflation, we continue to like Financial Services, Energy, and Industrials.  These are sectors that should also see some benefits from increased infrastructure spending.

While we are not making significant Geographic shifts, we are very focused on avoiding too much exposure to sectors that we deem expensive and more heavily impacted by interest rate hikes.

Where do dividends fit in?

According to the Hartford Funds, dividend income’s contribution to the total return of the S&P 500 Index averaged 41% from 1930–2020.  Clearly dividends matter.

At a time when bond yields are lower than inflation, there is a greater demand for stocks that can pay a higher dividend.  Of course, that doesn’t even include the benefit of owning Canadian Dividends in a taxable account – which has a much lower tax rate than interest income.

In summary, we like dividend growers with good balanced sheets, we will lean a little more heavily here in 2022.

TriDelta Equity Funds

In 2021, our TriDelta Growth Fund had a return of 28.5%.  This outperformed our equity benchmark of 23.2%.

The Growth Fund is an active fund that looks to adjust its approach throughout the year to be properly positioned for where we see the market today.  We use quantitative analysis as the foundation along with a historical review of how market sectors reacted previously to similar market environments.

Our TriDelta Pension Fund had a return of 16.4%.  While not as strong as the Growth Fund, this fund has a different mandate.  Also using quantitative analysis as a foundation, we focus very much on balance sheet strength, and on long term dividend growers.  This approach aims at less variability, downside risk and higher dividend yields.

The Bond Market is difficult in this environment

Financial heavyweight Citi says that bonds Globally will return negative 1% to 0% in 2022.  This asset class is broad enough to find some winners, but the core vanilla bond space will find it hard to deliver returns with a combination of low yields and rising interest rates.

Where we own bonds, we are leaning shorter term, as they will provide some protection as the market is pricing in too many rate hikes.  What we mean by this is that the market is now pricing in nearly 6 hikes over the next year. We do not see anything near that happening.  It still means rates are going up, but not nearly as much as some think it might.

We do believe that there will be some tactical opportunities here in “next-best” companies like the Rogers/Shaw deal.  Sometimes M&A activity can lead to opportunities.  We would expect more leverage as companies try to borrow as much cheap money as they can, while they can.

Bonds are not cheap but most things are not either, so selective and tactical is our approach.

The Preferred Share Market has fewer opportunities than 2021

Fixed Rate or straight preferred shares are bumping up against a ceiling for enhanced returns.  Many are yielding decent dividends in the 4.5% to 5.25% range today, but have prices at or above $25, with the risk of being called at $25.  This doesn’t mean it is a bad place to invest, but the very strong returns from 2021 be very unlikely to be repeated in 2022.  In 2021, Rate Reset preferred shares saw returns of 29.5%, while straight preferreds had a 9.2% return.  While the 9.2% number pales in comparison, it was still a very solid return for this asset class.  We still see some good opportunities in rate resets but expect both of those return numbers to be meaningfully lower.

One of the challenges in the preferred share market is that the market is shrinking as banks and some oil and gas names redeem issues in favour of cheaper financing via  specialized bonds.  What this means is that investors have to put a premium on the surviving issues, pushing their valuations into and often above their redemption prices.  This is a sector of the market where understanding the details of the company, their capital requirements and the specific terms of a preferred share is extremely important.  It can add meaningful value to buy specific securities vs. the index and some ETFs (although ETFs can be of value for smaller transactions).

Relatively speaking, resets and floaters (this is a pretty small market in Canada) enter the year as a better value than straights due to the rising rate outlook.  We would be looking to avoid reset and floater issues with large reset spreads and approaching reset dates. They are likely to be called and are probably trading at a premium to redemption price. For now, non-bank and non-oil and gas prefs are less likely to be redeemed as issuers have fewer refinancing options and should be safer places to invest.

We will continue to buy straights on dips, especially when rates are moving in a volatile fashion to the upside.  Barring an inflationary mistake, the rate hiking cycle will be a short and small one.

Inflation will be high for the short term, but should come down later in the year and early 2023

Inflation will remain in the mid single digits for much of the year, 4-5%, give or take, but may weaken late in the year.  Whether it is COVID restrictions, sustainability compliance efforts, speculation in commodities, low unemployment or consolidation-induced pricing power, there will be pricing pressures through 2022, but below peak levels seen in 2021.

Alternative Income Strategies – Most are performing well

While Bridging Finance was the big story in this space in 2021, the rest of the industry continued to deliver solid gains.

Alternative Real Estate funds had a good year, with our top fund returning over 26%.

Mortgage funds continued to perform, with returns in the 6% to 9% range.

Our top Private Debt funds should end the full year in the 11% range, with others solidly in the 7% to 8.5% range.

As greater transparency and valuation standards are in place, we continue to see this sector of investing as a key part of most investors portfolios.

 

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

Canadian investors have toughened up, and more lessons my clients have taught me during this crisis

0 Comments

Over the past few weeks I have been having some interesting conversations with clients.

While the conversations usually include discussions about investments, we often spend more time discussing family, health, today’s challenges and tomorrow’s hopes. If it ever wasn’t clear before, it is very clear now that our investments are here to serve a broader purpose — which is to allow us to live as full a life as we can.

As I talk to more clients I will no doubt be learning more from each of them.

Here are my big five takeaways to date:

From a Canadian perspective — COVID-19 truly is unique

Turbulent global markets due to covid-19 In a recent chat with a 99-year-old client who was born in Canada, I asked him if he had ever seen anything like what we are experiencing today. I was surprised when he said “Never in my life.” He did say that things were clearly difficult during the Second World War, but we were never so totally shut down like we are today.

His comment was definitely a jolt to me. This is historic. It is obviously not business as usual. We need to treat it very seriously from a health and investment perspective.

From a non-Canadian perspective — COVID-19 brings back other memories

Another client in his 50s related a story from his childhood, growing up in a war-torn nation. He remembered staying at home, being warned about going outside. He said that he could now better relate to his father’s worries about supporting the family when almost everything was under siege and there was no work to be had.

COVID-19 is clearly bringing memories of war and sacrifice. It is a reminder that life can be hard, unfair and unyielding. The fact that this brings comparisons to terrible times of war is a reminder of how significantly strange times have become.

The Financial Crisis of 2008/2009 has created a tougher investor

During the Financial Crisis, there was fear that big banks would collapse. There was a worry that stocks would drop 90 per cent before it was over. Few if any investors had lived through such a broad and deep investment crash. At the time, there were a meaningful number of clients who had to be convinced not to sell out their portfolios with large losses.

Yet, they ultimately saw how markets eventually recovered and thrived.

Today, most investors lived through 2008 and 2009. Their reactions to COVID-19 related declines have been much calmer. This isn’t to say that everyone feels that way, but a much higher percentage recognize that this pandemic will end, whether in a couple of months or a year. Likely, before it ends, stock markets will make a sizeable comeback.

There remains an overconfidence that people can time the bottom of the market

Some clients have expressed frustration over missing the great investment opportunity of 2009. They have said that they want to take advantage of this new great opportunity. I am with them. They are absolutely correct. The problem is when is exactly the right time to jump in?

The reality is that these markets move extremely fast. As we saw from March 18 to 26, some beaten down stocks jumped 50 per cent or more. However, in order to have achieved all of those returns, you would need to have bought in not just on the right day, but the right hour. To have purchased in that right hour, you would have needed the guts to buy when markets were in free fall. It is possible, but you need to be significantly lucky and have the willingness to go where almost nobody else is going.

On the flip side, many people think that there is another meaningful drop ahead, so they will wait for that one before buying. They may be right, but if they are wrong, then they will have almost entirely missed the ‘once-in-a-decade’ buying opportunity.

If you really want to take advantage of weak markets you have to be willing to buy in at a certain price, accept that it will likely go lower in the short term before it recovers, and keep focused on a year from now. You won’t get it perfect, but you will get it mostly right.

Health, family, friends, investments — in that order

As I mentioned at the top of the article, COVID-19 is a big threat to everyone, but it is clearly a health threat above all else. There are definitely financial fears — and for some these are pressing. Yet, for most of our clients they understand that for now, their goal is to look after themselves and each other. If they do that, everything else will take care of itself.

Several clients have had a consistent message. Their comments sound something like this, ‘We are blessed to be in Canada. We are blessed to still have reasonably good health. We have food. We have shelter. We even have spring. We are thankful to have someone like you to help with our finances, and we are not worried. This too shall pass as long as we have patience and do the right things.’

As big and as bad as this situation has become, I thank my clients for bringing their life wisdom and perspective to this time. I know that they are right and this too shall pass.

Reproduced from the National Post newspaper article 3rd April 2020.

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

Markets are fearful and history tells us that means the time to buy is right now

0 Comments

Knowing what to do in the middle of a highly stressful and uncertain time is very difficult for investors. You have experts on TV telling you to horde cash, while others say today is the best day to buy. They all believe what they are saying, and everyone is really left to guess.

At our firm there are two things that guide us at times like this:

1. Have the right asset mix for you, and stick with it. Market changes should not meaningfully change your asset mix. Your asset mix should change mostly when your personal situation changes. Things like retirement, major purchases, divorce, or significant health changes — all of these might be times for a change to your asset mix.

This work on the correct asset mix insulates those with the least tolerance for losses from some of the damage when things go bad. For those not so insulated, they are OK with it because they understand that this is the price to be paid to get the upside as well.

2. Use data to minimize emotional investing. Our Sr. VP, Equities, Cameron Winser reviewed similar pullbacks over the past 70 years. Since 1950 there have been eight periods on the U.S. S&P 500 when there has been a decline of at least 15% in a 30-day period. Picking the absolute bottom is a guess each time, but at the end of that 30-day period of declines, the immediate and mid-term future was almost always positive.

These are returns without dividends, so they underestimate the actual returns.

Even without dividends, we can see the following:

  • Next 20 trading days (roughly 1 month) — the average return was 9.0 per cent and 7 of 8 were positive.
  • Next 40 trading days (roughly 2 months) — the average return was 12.3 per cent and 8 of 8 were positive.
  • Next 60 trading days (roughly 3 months) — the average return was 10.6 per cent and 7 of 8 were positive.
  • Next 260 trading days (roughly 1 year) — the average return was 28.7 per cent and 7 of 8 were positive.
  • Next 720 trading days (roughly 3 years) — the average cumulative return was 50.1 per cent and 8 of 8 were positive.

We looked at the same scenario for Toronto stock markets. We found nine situations of 15+ per cent declines in a 30-day period. The findings were largely the same.

  • Next 20 trading days (roughly 1 month) — the average return was 6.7 per cent and 8 of 9 were positive.
  • Next 40 trading days (roughly 2 months) — the average return was 8.0 per cent and 8 of 9 were positive.
  • Next 60 trading days (roughly 3 months) — the average return was 8.5 per cent and 6 of 9 were positive.
  • Next 260 trading days (roughly 1 year) — the average return was 21.8 per cent and 8 of 9 were positive.
  • Next 720 trading days (roughly 3 years) — the average cumulative return was 47.9 per cent and 9 of 9 were positive.

Fearful markets are a buying opportunityThis data tells a very important and clear story. Big pullbacks represent good entry points. As I write this, the S&P 500 has crossed the 15 per cent line from peak to trough this month.

This tells us that based on a pretty long history, if you buy into the market after a 15 per cent drop, you may suffer further declines over the next few days, but as you look further out, you will very likely be pleased with the timing of your purchase. It also tells us that if you are fully invested in stocks at a reasonable weighting for you, then now is definitely not the time to be selling.

People will say on each of these events “this time is different.” They are right. Each time the cause of the decline is different, but the constant is human emotion. Fear and greed. Human emotion is the same and it leads the markets to repeat patterns again and again.

The lesson of this fear and greed is that now is likely a good time to be invested in stocks. It may not be the perfect day, but it is very likely to be a good day, as long as your investment timeline is at least a year.

Other things to note is that of the list of 15+ per cent declines in the U.S., six of the eight had further declines of only zero per cent to five per cent after the 15 per cent point.

In October 1987, the decline was worse, but most of it happened on one day. On Oct. 19, Black Monday, the Dow fell 22.6 per cent. In this case, our theory still holds true, in that once that day was done, even though markets were very volatile over the coming weeks, the trend was clearly positive.

The other time with a larger decline was in October 2008. While many of us remember that it wasn’t until March 2009 that things actually bottomed out, let’s say you bought into the market in October 2008 after a 15 per cent decline. You would have had a pretty rough ride for several months, but you still would have been comfortably ahead by October 2009.

The 2008 example also leads to an important lesson at times like this. Patience is a key for investment success. We are currently in a very volatile market situation where every day is a roller coaster. This will likely continue for a few more days, maybe even weeks. It will not continue for months. Panic selling is not a long term activity. It feels like it when you are in the middle of the days or weeks that it goes on, but it will not continue for long.

The other reaction from many people at this point is they say that they will reinvest cash once things settle down. To borrow from Ferris Bueller: “Markets move pretty fast.”

“Once things settle down,” usually means that the market has had a solid recovery. Over the ‘Next 20 Days,’ six of the eight periods saw significant one month gains. You can certainly wait until some meaningful gains have returned, but there is often a sizeable cost for waiting.

Our key message here is that based on long-term historical data that has seen how actual investors react after a 15 per cent decline, this is a time to be adding to or sticking with your stock investments, and not a time to be selling out. Guarantees do not exist, but data, human emotions and history guide us on what to do.

Reproduced from the National Post newspaper article 6th March 2020.

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

Are RRSPs really worth it? The answer may surprise you

0 Comments


More and more people say to me that they don’t contribute to RRSPs. They don’t think it makes sense. If they ask my opinion, my response always depends on the specifics of the person who is asking. For the purposes of this article, I will address a few different scenarios.

For all of these examples, the key factors to consider are the following: In retirement, will the person likely be in a higher tax bracket than they are today, the same bracket, or a lower one? I call this the tax teeter-totter. Will their income likely be meaningfully higher or lower in the next five to ten years? How old are they? Are they married and, if so, how long will it likely be until both spouses have passed away?

Situation No. 1: Higher income, significant RRSP

This person has seen what happens when someone dies with a large RRSP or RRIF. When a single person (including widows and widowers) dies, their remaining RRSP or RRIF balance is fully taxable in the final year. For example, if their final balance is $500,000, nearly half of their account will disappear to taxes. Because of that concern, many people with a sizable RRSP and often high income decide that the RRSP isn’t a good use of their funds. To these people I say, “You are making a mistake.” If you are in a tax bracket where you can get at least a 45 per cent refund on an RRSP contribution, I say take the money today, get many years of tax-sheltered growth, and you can worry about a high tax rate on withdrawals at some point in the future. Depending on the province, this 45 per cent tax rate tends to be in place once your taxable income is above $150,000. While you could make a financial argument that it is possible to be worse off to do an (R)RSP contribution depending on what happens in the future in terms of taxes, given the certainty of tax savings at the front end, I would highly recommend making the contribution.

Situation No. 2: Lower income that could jump meaningfully in a few years, with TFSA room

RRSP Piggy BankIn Ontario, if your income is $35,000, your marginal tax rate is 20.1 per cent. If your income is $50,000, your marginal tax rate is 29.7 per cent. If you are making $35,000 today, but think you might be making $50,000+ in the next couple of years, it is better to put any savings into a TFSA now, and wait to do the RSP contribution until you are making $50,000. This is the situation for many people early in their careers. You will be making almost 10 per cent more guaranteed return (29.7 minus 20.1) by waiting, but will still have the same tax sheltering in the TFSA as you would in the RRSP. In general, if you think you will likely be in a much higher tax bracket in the near future, it is better to hold off RRSP contributions, and save up the room to use when you will get a much bigger refund. As a rule of thumb, I suggest people with a taxable income under $48,000 put any savings into a TFSA before putting it into an RRSP.

Situation No. 3: Income could fall meaningfully in a few years

This is the opposite situation and recommendation to No. 2. If you think that you will be in a much lower tax bracket in the near future (taking time off work for whatever reason), you may want to put money in the RRSP now, and actually take it out in a year when your income will otherwise be very low. Many people do not realize that you can take funds out of your regular RRSP at any time and at any age. While you will be taxed on these withdrawals as income, if the tax rate is very low because you have little other income, it usually makes sense to withdraw the money in those years and put it back when your income is much higher.

Situation No. 4: Couple in late 60s, not yet drawing from RRIF

Some people figure that there is no point to put money into an RRSP in their late 60s because they are just going to draw it out shortly anyways. It is true that one of the values of tax sheltering is the compounding benefit of time. Putting a dollar into an RRSP at age 30 will likely have more of an impact than at age 68. Having said that, often people forget that even if they start drawing funds out of a RRIF at 72 or earlier, they may very well still be drawing out funds 20 years later. There is still many years of tax sheltering benefit. The question goes back to the tax teeter-totter. If they are going to get a 25 per cent refund to put funds into their RRSP, but will be getting taxed at 30 per cent or more when they take it out, then it probably doesn’t make sense to contribute more to their RRSP. It all comes back to their likely income and tax rates once they start to draw funds down from their RRIF.

Situation No. 5: Husband is 72, wife is 58

The answer to the question of how to contribute to an RRSP for couples with a significant age difference depends on the taxable income of each person and the ability to most effectively split income over the next number of years. Larger age gaps can be quite valuable for RRSP investing. One reason is that if the younger spouse has a Spousal RSP, and the older spouse still has RSP room, the older spouse can contribute to the younger spouse’s Spousal RSP. This can be done by the older spouse, even if they are older than 71, as long as the younger spouse is below that age. In this example, if the 58-year-old isn’t working, she can actually draw income out from their Spousal RSP and claim the funds only as their income, even though the 72-year-old had benefitted from the tax advantages of contributing over the years. As a reminder, if the younger person had a large Spousal RSP and the older one had no RSP or RIF, they wouldn’t be forced to draw any income because the younger partner was not yet 71. The one area to be careful of is that for the income to be attributable to the 58 year old and not the 72-year-old, there can’t be any contributions to the Spousal RSP for three years. To take advantage of this scenario, maybe the older partner contributes for many years to the Spousal RSP, but stops three years before the younger spouse plans to draw the funds.

While the RSP is generally a positive wealth management tool for many Canadians, there is a time to contribute, there is a time not to contribute and there is a time to withdraw funds. Each situation may create opportunities to maximize your long-term wealth. Choose wisely.

Reproduced from the National Post newspaper article 19th February 2020.

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