Tax Gain/Loss Selling 2021 Version

In keeping with my annual tradition, I am today posting a blog on tax-loss selling, except this year, I changed the title to tax gain/loss selling (to include some planning for stocks with capital gains). I am posting on this topic again because every year around this time, people get busy with holiday shopping (or at least online shopping these days) and forget to sell the “dogs” in their portfolio and consequently, they pay unnecessary income tax on their capital gains in April. Alternatively, selling stocks with unrealized gains may be beneficial for tax purposes in certain situations.

Hopefully, based on the strong stock markets of both 2020 and 2021, you do not have many unrealized capital losses. However, the last half of 2021 has been very sector oriented and you may have stocks that were hit on the sector rotation. In fact, in a November 22nd Globe and Mail article by Tim Shufelt, he noted that 17% of S&P/TSX composite stocks were down by at least 10% year to date. That was before the large market drop on Black Friday.

In any event, if you have an advisor, ensure you are in contact to discuss your realized capital gain/loss situation and other planning options by next week and if you are a DIY investor set aside some time this weekend or next to review your 2021 capital gain/loss situation in a calm, methodical manner. You can then execute your trades on a timely basis knowing you have considered all the variables associated with your tax gain/loss selling.

I am going to exclude the detailed step by step capital gain/loss methodology I usually include in this post. If you wish the detail, just refer to last year's post and update the years (i.e., use 2021, 2020 & 2019 in lieu of 2020, 2019 and 2018). 

You have three options in respect of capital losses realized in 2021:

1. You can use your 2021 capital losses to offset your 2021 realized capital gains

2. You can carry back your 2021 net capital loss to offset any net taxable capital gains incurred in any of the three preceding years

3. If you cannot fully utilize the losses in either of the two above ways, your can carry your remaining capital loss forward indefinitely to use against future capital gains (or in the year of death, possibly against other income)

Tax-Loss Selling

I would like to provide one caution about tax-loss selling. You should be very careful if you plan to repurchase the stocks you sell (see superficial loss discussion below). The reason for this is that you are subject to market vagaries for 30 days. I have seen people sell stocks for tax-loss purposes with the intention of re-purchasing those stocks, and one or two of the stocks take off during the 30-day wait period—raising the cost to repurchase far in excess of their tax savings.

Thus, you should first and foremost consider selling your "dog stocks" that you or your advisor no longer wish to own. If you then need to crystallize additional losses on stocks you still wish to own, be wary if you are planning to sell and buy back the same stock. Your advisor may be able to "mimic" the stocks you sold with similar securities for the 30-day period or longer or utilize other strategies, but that should be part of your tax loss-selling conversation with your advisor.

Identical Shares

Many people buy the same company's shares (say Bell Canada for this example) in different non-registered accounts or have employer stock purchase plans. I often see people claim a gain or loss on the sale of their Bell Canada shares from one of their non-registered accounts but ignore the shares they own of Bell Canada in another account. Be aware, you must calculate your adjusted cost base over on all the identical shares you own in all your non-registered accounts and average the total cost of your Bell Canada shares over the shares in all your accounts. If the cost of your shares in Bell is higher in one of your accounts, you cannot pick and choose to realize a gain or loss on that account; you must report the gain or loss based on the average adjusted cost base of all your Bell shares.

Superficial Losses

One must always be cognizant of the superficial loss rules. Essentially, if you or your spouse (either directly or through an RRSP) purchases an identical share 30 calendar days before or 30 days after a sale of shares, the capital loss is denied and is added to the cost base of the new shares acquired.

Tax-Gain Selling 

While typically most people are looking at tax-loss selling at this time of year, you may also want to consider selling stocks with gains for the reasons discussed below.

Donation of Marketable Securities

If you wish to make a charitable donation, a great way to be altruistic and save tax is to donate a marketable security that has gone up in value. As discussed in this blog post, when you donate qualifying securities, the capital gain is not taxable and you get the charitable tax credit. Please read the blog post for more details. 

2022 Budget

While I don’t comment on rumours and conjecture, there are many tax commentators who feel there is a good chance the capital gains inclusion rate will increase from 50% to a higher rate in a future budget. If you are in that camp, you may wish to lock in capital gains at the lower rate. As no-one knows if the capital gains rate will change, you need to review this with your advisor as the sale will be taxable immediately, even if you buy-back the same security (there are no superficial gain rules).

Settlement Date

It is important any 2021 tax planning trade be made by the settlement date, which my understanding is  the trade date plus two days (U.S. exchanges may be different). See this excellent summary for a discussion of the difference between what is the trade date and what is the settlement date. The summary also includes the 2021 settlement dates for Canada and the U.S.

Corporations - Passive Income Rules

If you intend to tax gain/loss sell in your corporation, keep in mind the passive income rules. This will likely require you to speak to your accountant to determine whether a realized gain or loss would be more effective in a future year (to reduce the potential small business deduction clawback) than in the current year.

Summary

As discussed above, there are a multitude of factors to consider when tax gain/loss selling. It would therefore be prudent to start planning now with your advisors, so that you can consider all your options rather than frantically selling at the last minute.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Tax-loss planning for the COVID stock market

Last year I cut with tradition and did not post my annual tax-loss planning/selling blog. However, because of COVID, my client’s portfolio returns and realized capital gains/loss positions are “all over the place.” I have never seen such disparity in my career, so I am again posting a tax-loss planning/selling blog. Consider it part of your required tax considerations during these uncertain times.

The reasons for the disparity I note above are as follows:

1. With the 35% or so drop in the stock markets at the beginning of COVID, some people “bailed” or sold off certain holdings to go to cash. Those that held their positions (and noses) or added to them likely do not have any realized capital losses this year, unless they sold selected stocks that were hit during COVID.

2. Certain conservative portfolios fared worse this year than in a typical market dip, due to precipitous declines in transportation, entertainment, preferred shares, or real estate REITs.

3. Those who held technology, medical or pharmaceutical stocks, and certain food-related stocks were rewarded with astronomical gains in 2020.

If you fall into category #1 or #2 or have realized capital losses this year, I suggest you review your capital gain/loss situation early this year. In the good old days, I suggested you undertake this task before you get busy with holiday shopping, but many people won’t go much further than their computer to shop this year. So, you can probably do both simultaneously.

While most investment advisors and managers are pretty good at contacting their clients to discuss possible tax-loss planning/selling, I am still amazed each year at how many advisors do not discuss the issue with their clients. If you have an advisor, ensure you are in contact to discuss your realized capital gain/loss situation and other planning options by next week.

If you are a DIY investor or maybe even if you have an investment advisor, you may wish to set aside some time this weekend to review your 2020 capital gain/loss situation in a calm, methodical manner. You can then execute your trades on a timely basis knowing you have considered all the variables associated with your tax gain/loss selling.

I would like to provide one caution about tax-loss selling. You should be very careful if you plan to repurchase the stocks you sell (see superficial loss discussion below). The reason for this is that you are subject to market vagaries for 30 days. I have seen people sell stocks for tax-loss purposes with the intention of re-purchasing those stocks, and one or two of the stocks take off during the 30-day wait period—raising the cost to repurchase far in excess of their tax savings.

Thus, you should first and foremost consider selling your "dog stocks" that you or your advisor no longer wish to own. If you then need to crystallize additional losses on stocks you still wish to own, be wary if you are planning to sell and buy back the same stock. Your advisor may be able to "mimic" the stocks you sold with similar securities for the 30-day period or longer or utilize other strategies, but that should be part of your tax loss-selling conversation with your advisor.

One additional note: While I don’t comment on rumours and conjecture, there are many tax commentators who feel there is a good chance the capital gains inclusion rate will increase from 50% to a higher rate in a future budget. If you are in that camp, you may not wish to crystalize your capital losses in 2020 but rather save them for the future, so that you deduct the losses at a higher inclusion rate.

Reporting capital gains and capital losses – The basics

All capital gain and capital loss transactions for 2020 will have to be reported on Schedule 3 of your 2020 personal income tax return. You then subtract the total capital gains from the total capital losses and multiply the net capital gain or loss by ½. That amount becomes your taxable capital gain or net capital loss for the year. If you have a taxable capital gain, the amount is carried forward to the tax return jacket on Line 127. For example, if you have a capital gain of $120 and a capital loss of $30 in the year, ½ of the net amount of $90 would be taxable and $45 would be carried forward to Line 127. The taxable capital gains are then subject to income tax at your marginal income tax rate.

Capital losses

If you have a net capital loss in the current year, the loss cannot be deducted against other sources of income (unless you are filing for a deceased person. In that case, get professional advice as the rules are different). However, the net capital loss may be carried back to offset any taxable capital gains incurred in any of the three preceding years, or, if you did not have any gains in the three prior years, the net capital loss becomes an amount that can be carried forward indefinitely to utilize against any future taxable capital gains.

Planning preparation

I suggest you should start your preliminary planning immediately. These are the steps I recommend you undertake:

1. Retrieve your 2019 Notice of Assessment. In the verbiage discussing changes and other information, if you have a capital loss carryforward, the balance will be reported. This information is also easily accessed online if you have registered with the CRA My Account Program.
2. If you do not have capital losses to carry forward, retrieve your 2017, 2018 and 2019 income tax returns to determine if you have taxable capital gains upon which you can carry back a current-year capital loss. On an Excel spreadsheet or multi-column paper, note any taxable capital gains you reported in 2017, 2018 and 2019.
3. For each of 2017, 2018 and 2019, review your returns to determine if you applied a net capital loss from a prior year on line 253 of your tax return. If yes, reduce the taxable capital gain on your Excel spreadsheet by the loss applied.
4. Finally, if you had net capital losses in 2018 or 2019, review whether you carried back those losses to 2017 or 2018 on Form T1A of your tax return. If you carried back a loss to either 2017 or 2018, reduce the gain on your spreadsheet by the loss carried back.
5. If after adjusting your taxable gains by the net capital losses under steps #3 and #4 you still have a positive balance remaining for any of the years from 2017 to 2019, you can potentially generate an income tax refund by carrying back a net capital loss from 2020 to any or all of 2017, 2018 and 2019.
6. If you have an investment advisor, call your advisor and request a realized capital gain or loss summary from January 1 to date to determine if you are in a net gain or loss position. If you trade yourself, ensure you update your capital gain or loss schedule (or Excel spreadsheet, or whatever you use) for the year.

Now that you have all the information you need; it is time to be strategic about how to use your losses.

Basic use of losses

For discussion purposes, let’s assume the following:

• 2020: total realized capital loss of $30,000
• 2019: taxable capital gain of $15,000
• 2018: taxable capital gain of $5,000
• 2017: taxable capital gain of $7,000

Based on the above, you will be able to carry back your $15,000 net capital loss ($30,000 x ½) from 2020 against the $7,000 and $5,000 taxable capital gains in 2017 and 2018, respectively, and apply the remaining $3,000 against your 2019 taxable capital gain.

As you will not have absorbed $12,000 of your 2019 taxable capital gains ($15,000 of original gain less the $3,000 net capital loss carryback), you may want to consider whether to sell any other stocks with unrealized losses in your portfolio so that you can carry back the additional 2020 net capital loss to offset the remaining $12,000 taxable capital gain realized in 2019. Alternatively, if you have capital gains in 2020, you may want to sell stocks with unrealized losses to fully or partially offset those capital gains.

Identical shares

Many people buy the same company's shares (say Bell Canada) in different accounts or have employer stock purchase plans. I often see people claim a gain or loss on the sale of their Bell Canada shares from one of their accounts, but ignore the shares they own of Bell Canada in another account. However, be aware, you have to calculate your adjusted cost base on all the identical shares you own in, say, Bell Canada and average the total cost of all your Bell Canada shares over the shares in all your accounts. If the cost of your shares in Bell is higher in one of your accounts, you cannot pick and choose to realize a loss on that account; you must report the gain or loss based on the average adjusted cost base of all your Bell shares, not the higher cost base shares.

Creating gains when you have unutilized losses

Where you have a large capital loss carryforward from prior years and it is unlikely that the losses will be utilized—either due to the quantum of the loss or because you are out of the stock market and don’t anticipate any future capital gains of any kind (such as the sale of real estate)—it may make sense for you to purchase a flow-through limited partnership. (Be aware: although there are income tax benefits to purchasing a flow-through limited partnership, there are also investment risks and you must discuss any purchase with your investment advisor.)

Purchasing a flow-through limited partnership will provide you with a write-off against regular income pretty much equal to the cost of the unit; and any future capital gain can be reduced or eliminated by your capital loss carryforward.

For example, if you have a net capital loss carryforward of $75,000 and you purchase a flow-through investment in 2020 for $20,000, you would get approximately $20,000 in cumulative tax deductions in 2020 and 2021, the majority typically coming in the year of purchase. Depending upon your marginal income tax rate, the deductions could save you upwards of $10,700 in taxes in Ontario—as an example.

When you sell the unit, a capital gain will arise. This is because the $20,000 income tax deduction reduces your adjusted cost base from $20,000 to nil (there may be other adjustments to the cost base). Assuming you sell the unit in 2022 for $18,000, you will have a capital gain of $18,000 (subject to any other adjustments), and the entire $18,000 gain will be eliminated by your capital loss carryforward. Thus, in this example, you would have total after-tax proceeds of $28,700 ($18,000 + $10,700 in tax savings) on a $20,000 investment.

Donation of marketable securities

If you wish to make a charitable donation, a great way to be altruistic and save tax is to donate a marketable security that has gone up in value. As discussed in this blog post, when you donate qualifying securities, the capital gain is not taxable and you get the charitable tax credit. Read the blog post for more details.

Superficial losses

One must always be cognizant of the superficial loss rules. Essentially, if you or your spouse (either directly or through an RRSP) purchases an identical share 30 calendar days before or 30 days after a sale of shares, the capital loss is denied and is added to the cost base of the new shares acquired.

Disappearing dividend income

Every year I ask at least one or two clients why their dividend income is lower on their personal tax return. Typically, the answer is, Oops, it’s because I sold a stock early in the year that I forgot to tell you about it. Thus, if you manage you own investments; you may wish to review your dividend income being paid each month or quarter with that of last year’s to see if it is lower (of course this year it may be lower due to COVID related dividend cuts). If the dividend income is lower because you have sold a stock, confirm you have picked up that capital gain in your calculations.

Creating capital losses - Transferring losses to a spouse who has gains

In certain cases, you can use certain provisions of the Income Tax Act to transfer losses to your spouse. As these provisions are complicated and subject to missteps, you need to engage professional tax advice.

Settlement date

It is my understanding that the settlement date for Canadian stock markets in 2020 will be December 29, as the settlement date is now the trade date plus two days (U.S. exchanges may be different). Please confirm this date with your investment advisor, but assuming this date is correct, you must sell any stock for which you want to crystallize the gain or loss in 2020 by December 29, 2020.

Corporations - Passive income rules

If you intend to tax-loss sell in your corporation, keep in mind the passive income rules. This will likely require you to speak to your accountant to determine whether a realized loss would be more effective in a future year (to reduce the potential small business deduction clawback) than in the current year.

Summary

As discussed above, there are a multitude of factors to consider when tax-loss selling. It would therefore be prudent to start planning now, so that you can consider all your options rather than frantically selling at the last minute.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Is the Financial World out of Sync?

I hope everyone had a good summer. At times our great weather almost made me forget we are living in a COVID-19 world.

And then I looked at the daily health reports, the economy and the markets - and remembered that we are truly living in a time of pandemic. From a financial perspective, wherever you turn the signs are there: yet the stock and real estate markets seem to be vastly out of sync with the stark economic reality of the pandemic world. Let’s explore that disconnect. 

Bay Street and real estate vs. main street

At the beginning of the pandemic, I like most of you personally felt the financial stress and dislocation caused by COVID.

But I also felt my clients’ concerns and worries, which were extremely distressing over the first couple months. Together we worked to solve the financial challenges related to their businesses (which were often temporarily shuttered), and to understand the government programs – which were released at what seemed like a daily clip and often revamped later on. During this initial period, the stock market fell 35% or so, as one might have expected, and the housing market ground to a halt.

However, after the initial drop off the cliff, the stock markets started a steady climb back to their January 1, 2020 levels, and the housing market heated up. I am aware of two cases in the Toronto area where not only was the sale price of houses substantially over the listing price, but there were so many buyers that the seller had the buyers write letters explaining why they want the property.

This return to form in the financial and housing markets continues — even as wide swathes of the Canadian population struggle. Millions of people are receiving the Canada Emergency Response Benefit (CERB). Small business owners can’t restart their business or are working just to break even or keep the lights on for better days. Employees across the country have been temporarily laid off or have lost their jobs.

Let us review the possible reasons for the financial and housing markets’ strength in a weakened economy.

Stock markets

Over the years, the stock market has taught us that we usually cannot predict its direction. As a result, it is generally best to hold your portfolio and even buy when everyone is running for the exits.

Yet COVID investing seemed different. While some of us were smart enough or bold enough to buy at the pandemic’s deepest lows in March (not me), most people needed all their discipline not to liquidate their equity holdings in some part. I am in no way a market historian, but this pandemic crash looked scarier. The world’s economy came to a standstill and the economic destruction seemed like it would take years to overcome.

So why did the markets turn on a dime and go bullish? Why have they showed no sign of flagging? Why do they continue to defy the larger economic trends? The reasons are varied, but based on articles I have read by financial experts and the numerous discussions I and my client's have been in with investment managers, these are the top ones I have read or heard:

1. “Don’t fight the Fed.” It’s an American phrase referencing the Federal Reserve, but the point is valid in Canada too. The Bank of Canada (like the Fed) has provided an unprecedented liquidity injection to keep the market afloat.
2. Markets reflect a long-term view. They have discounted our current economic and social issues for an expected brighter future.
3. The markets have built in a vaccine discovery in the next 6-12 months.
4. Interest rates are so low that you must be in equities or you will have a negative absolute return after inflation in GICs and T-bills. This reason is put forth by investment managers in every conversation I have been involved in.
   
5. The travel, entertainment and retail industries do not have a significant impact on many stock market indexes.
6. Technology and healthcare have flourished in many cases during COVID, and these sectors make up a significant portion of the U.S. indexes that many Canadians invest in. (On the Canadian exchanges, Shopify has also helped carry the Canadian market rebound.) The stock market recovery reflects the success of technology and healthcare - not the health of the larger economy.
7. The larger companies have hoards of cash to keep them afloat and take advantage of companies with lesser balance sheets.
8. Some people have flipped from being scared of being in the market to having a fear of missing out on the rebound.

While the market has soared, some experts warn that the market is in a bubble of historic proportions. So, keep in mind, these are unusual times, and the market can turn around and surprise us to the downside just as easy as it can continue to climb.

In retrospect, maybe I should have seen the stock market bounce-back coming, but I clearly misunderstood. Based on the 8 reasons discussed above, clearly the stock market can be strong while the world’s economy is essentially shut down. But I have asserted only that I am blunt, not that I’m smart.

Housing market

One would have thought that many people would hesitate to purchase real estate during COVID-19 due to the uncertainty of their jobs and the economy. However, the housing market in Ontario and many parts of Canada has seemed impervious to the pandemic, which I would not have envisioned in late March.

The experts seem to agree on the below reasons for a strong housing market. I’d also like to say a big thank you to my colleague George Dube – a veteran real estate investor and accountant – for his insight.

1. Large shortages in the supply of homes and a relative abundance of buyers led to competition and bidding wars. On the supply side, many people just hunkered down and did not want to risk selling into a pandemic market.
2. Those who were fortunate to keep their jobs had fewer places to spend and decided in many cases to renovate and fix their current homes rather than purchase a new home, reducing supply.
3. Many people decided to purchase cottages rather than move to new city homes. If I can’t travel for vacation, people said, I want to have access to a cottage property. This is especially true while we still don’t know when COVID will recede and when we will see an effective vaccine. People staying in their homes reduced the inventory of homes for sale.
4. Interest rates are so low, so the cost of carrying a mortgage for the foreseeable future is extremely low and unlikely to change based on government economic policy.
5. The lack of activity in March and much of April led to a catch-up period releasing pent-up demand.
6. People concluded working from home is going to be the new normal in some fashion. They realized the money they had saved to eventually buy a home in the city could be redeployed to purchase a home in the suburbs or in a more rural area. This led to a spike in many areas outside big cities. While this moderate exodus would theoretically soften prices in urban areas, the fact is that the fundamentals in those markets are strong enough to keep prices high. It should be noted that this exodus from the cities has reportedly caused some softening in the personal condominium market, as many of the people looking outside the large cities would have been condominium purchasers.

All this being said, it is worth differentiating between housing and other real estate subsectors. For example, the retail and larger commercial office building markets are seeing the “expected” drop in demand given COVID, due to the loss of foot traffic and employees being told to work from home. On the other hand, in the industrial sector, the massive growth in online ordering has increased the need for space to accommodate logistics and warehousing.

So, is the financial world out of sync? I personally feel the answer is still at least a lukewarm yes, if you like me feel there is or should be some kind of direct correlation between the economy and the stock and real estate markets. But as I have noted above, the correlations can sometimes run parallel and may not intersect, so that may be a misguided view. We shall see in another year or two whether the stock and real estate markets got ahead of themselves, or whether this was just the first phase of even stronger markets. Interesting times either way.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

COVID-19: Finances, Retirement, and the Impact on Small Business Owners

Not to assume I speak for all my readers, but my guess is that many of you are feeling like I do, knocked off kilter by limited social interaction, restricted working conditions and the disconcerting feeling of watching your retirement savings dwindle and finances sag.

I have not even mentioned the most serious issue: health. You or a family member may have contracted the new coronavirus. And if you have managed to avoid it, you may still be concerned for yourself and your loved ones, some of whom may be especially vulnerable.

Financial concerns

The financial concerns because of this virus are real. Whole industries such as travel, entertainment and oil have been hit extremely hard. Financial transactions have slowed or ground to a halt in certain industries. Many if not all businesses will be impacted by the economic consequences to fight this virus. Some will bounce back quickly, others more slowly.

We are impacted as employees, small business owners or retirees vis-a-vis the security of our jobs, the stability of our businesses and how we fund our retirement (with retirement funds down 10-30% depending upon your asset mix, in a matter of weeks). The anxiety we all feel is rooted in a reality that will not be fully measurable until the virus recedes and normal life resumes. But normal life will eventually resume, and we can take action now and in the future, to put us in the best position to rebound from the financial challenges of coronavirus.

I have received various questions from individuals and business owners. I will address those questions in this post.

Individuals

I have been asked two questions in particular by individuals:

1. Should I reduce my equity exposure to limit my stock losses?
2. I am near retirement - should I delay my plans?

Equity Exposure

In a perverse way, COVID-19 has forced many of us to learn about our risk tolerance and ability to handle the volatility of our current investment allocation; that volatility is often correlated to the level of equity we hold. If you cannot sleep at night with your current equity or investment allocation mix, then maybe you have too much investment risk and you need to speak with your investment advisor.

This discussion should revolve around whether your equity allocation truly suits your investment objectives and whether the potential volatility of your equity holdings is appropriate for your risk tolerance, now that you have been on the roller coaster ride and can quantify your risk aversion.

You will have noticed I have not directly answered the "should I reduce equity" question. That is because (1) as an accountant I cannot provide investment advice and (2) the answer is really based on your risk tolerance and other factors specific to your own situation. 

As a side commentary, while a requirement of the investment industry is to determine a client’s risk profile and create a portfolio that suits that profile, I would suggest this risk determination is often superficial. Most of us do not understand our true risk tolerance until a situation such as the markets’ rapid reaction to the virus knocks your portfolio down 25% in a matter of days.

The better investment managers I deal with, not only determine your risk tolerance through an interview process but also back-test your tolerance for that risk over the markets for the last 30 years or so. They do this before they invest your money. It would be interesting to see who has been more stressed recently, those with risk tolerances determined purely by questionnaire and discussion and those who also back-tested before they invested. I would guess the latter.

Retirement Plans

It may or may not be too early in this ordeal to alter your retirement plans. We have previously discussed how the sequence of returns can affect your retirement. While sequence of returns technically deals with your investment returns when you start retirement, the reality is that whether practically or psychologically, this significant drop in our retirement savings could impact when we start our retirement.

There is no one-size-fits-all answer to this issue as it will be very fact specific. If you have a pension from your job or some other anticipated flow of funds in retirement, a stock market decline may not be a large longer-term issue assuming the market bounces back at some point like it has done historically.

However, if you were going to draw on your retirement funds immediately upon retirement, the reduction in your nest egg in this bear market could severely impact your retirement plans.

My suggestion is that once things settle down, you review your plans (including the preparation of an actual financial plan or a review/update of an existing plan) with your financial planner, financial advisor or accountant. You will then have objective valuation of whether your retirement date may need to be pushed back a year or two.

Small Business Owners

Small business owners face a whole bunch of concerns sparked by COVID-19 that employees don’t need to manage. These fall into both short- and long-term buckets.

Short-term concerns

Short-term practical concerns include items like how you manage your cash flow, will insurance cover any of the lost profit or expenses and what are business owners’ employment responsibilities.

Many small business cash flow issues are addressed in this document.

I have been informed by colleagues at my firm who deal with preparing insurance claim reports and the related costs that there is no standard answer to whether a company’s insurance coverage will cover any of their losses due to COVID-19. Each claim will come down to the specific wording of the policy and how that policy deals with such terms as “pandemic,” “infectious disease” and “business interruption.” A legal interpretation may be required in many cases.

The employment law questions are complex and unique in this current situation, and unfortunately, I tell my clients they need to talk to their employment lawyer.

Clients are also asking if Ottawa or provincial governments will provide aid to help keep their businesses afloat. This is a fluid situation. The feds have announced a robust stimulus package, with many details still to follow. [ Note: after publishing this post, the Emergency Care Benefit and Emergency Support Benefit were subsequently rolled into the Canada Emergency Response Benefit (see details here)]. The provincial and territorial governments may also chip in to help their constituents.

Longer term concerns

As discussed earlier, certain industries and businesses have been hard hit by the economic slowdown caused by the virus, and almost all businesses will suffer to some degree – Netflix and Amazon are likely two of the high-profile exceptions. For a couple of the business owners I work with who have been considering selling their business, this sobering event has crystalized the risk of having their retirement concentrated on one major asset: their business. This is known as concentration risk.

They have now come to realize that almost any type of business could be severely impacted by a black swan event such as COVID-19. The risk to their retirement is significant if the concentrated business asset loses value due to an unanticipated event, especially close to their retirement date.

I think once the dust settles, some business owners may get very serious about the process of getting their business ready for a sale, whether in a year or over a couple years. As part of that process, they may undertake a value enhancement process to increase the sale price, by taking the necessary management, technological and other steps to become more attractive for a buyer (unashamed plug, BDO has specialists that assist you in achieving this value enhancement and others that can then take your business to market once the enhancement has been accomplished).

Tax considerations for difficult and uncertain times

Here is a link to a BDO publication released on March 16 about tax considerations for difficult and uncertain times. It is a good read.

A final note on the personal side of coronavirus

This was not a blog post I expected to write. Typically, at this time of the year, I write about how tax season is going. Coronavirus has disrupted our lives, sometimes in small areas that punch way above their weight.

Let me say upfront, I understand restricted social interaction including the cancellation of most sporting events is a minor inconvenience to help slow down the spread of the virus. In comparison to those who have fought wars or escaped warzones or been subject to other horrific issues, social distancing does not compare.

That being said, as most readers are likely aware, I am a big sports guy and I follow the Leafs, Raptors, Blue Jays, NFL football (sorry, CFL fans, I used to love the Argos, but that was many moons ago) and golf, among others. Like many of my friends, I have been shocked by the void of not having sports available to take our minds off the coronavirus as we have had during other economic downturns or communal crises, like SARS or even 9/11. The social distancing that is saving lives has also taken away a diversion that could help sustain everyone’s mental health.

I had never given it much thought, but when I went to my computer to surf and get my mind of the virus issues, I quickly realized the majority of my internet favourite list is made up of sports and investment sites. With no sports to write about and no desire to hear more bad investment news, my internet surfing has ground to a halt. Amazon is now the beneficiary of my increased Kindle book downloads. Probably a better thing intellectually, but I still have a sports void.

For those of you who expected this week to see Part 2 of the excellent series on Alter Ego and Joint Partner Trusts by Katy Basi, I hope to bring that to you in two weeks or when current events dictate. We are living in strange times, and I’ve always taken pride in The Blunt Bean Counter being a living blog, one that responds to events in the market and in our lives. It’s not business as usual for any us, but together we will get through this. I wish you and your families the best of health and a quick financial recovery.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Investing Like Your Grandmother (or Grandfather). The Results May Surprise You

When I was a young accountant and happened upon an estate return, I was often amazed at how much wealth the grandmother had accumulated at death. This applied to grandfathers too, but women tend to live longer, so I noticed the tendency more with grandmothers. The accumulated wealth was typically in conservative marketable securities bought over many years.


What I found remarkable, as I saw this time and time again, was that blue-chip stocks dominated these portfolios. (Mutual funds were just coming into vogue and no one had heard of an exchange traded fund (ETF).) Each portfolio had the big Canadian banks, insurance companies, utility companies and the Bell Canadas, Canadian Tires and Thomsons of the Canadian stock universe, plus some large high-quality U.S. stocks sprinkled in. Being a naïve and arrogant young investor, I somewhat derisively at the time called these stock holdings “grandmother portfolios.”

As I look back, an older me should have given my younger self a good swat upside the head, as these portfolios hit on most of the critical tips investment managers and experts still suggest today (other than maybe a little more global diversification and possibly some alternative investments):

• They were fairly well diversified.
• They very rarely turned over.
• They contained stocks that generally paid dividends that grew over time.

Shredding my old tax returns – an eye-opening experience

So why am I talking about grandmother portfolios? Well, a couple months ago I followed my own advice and shredded some of my older personal tax returns. While shredding the returns, I entertained myself by looking at the income earned each year and the capital gains (Schedule 3), which detailed my stock dispositions for each year.

I have always liked to have some risk in my portfolio, and over the years have taken some shots with disruptive technology stocks, “find that big gold mine” stocks and “let’s hit the gusher” oil stocks, among other rather poor stock selections. However, I was astounded when I looked at how many of these flyers resulted in capital losses on my old returns.

The technology stocks included such household names as:

• Samsys Technologies (RFID readers)
• International Verifact (forerunners of point-of-sale payment terminals)
• GenSci Regeneratrion (bone repair and generation for dental use)
• Zeox Inc. (using Zeolite for environmental waste)

Some of the crazy gold picks included such sterling names as:

• International Pursuit
• Gerle Gold (actually looking for diamonds in the Northwest Territories)
• South Pacific Resources (a stock that followed in the draft of Bre-X when it was going up)

And the oil stocks included:

• Dome Petroleum (a famous oil stock for those of you of my vintage)
• Mart Resources (a Nigerian oil play)

The above names are meaningless, but entertaining to me and maybe a couple readers. But what shocked me about my shredding exercise was how many flyers I had actually gone for over the years. (I actually hit on a couple others, but that was luck and not relevant to this post.)

My point is, I was shocked at the time and effort — let alone the money — I wasted trying to chase down the next big thing. 

Moral of the Story

While I have slanted this post on purpose to make a point (I typically also had a substantial part of my portfolio in quality stocks and alike), in retrospect I would have had a larger nest egg if I had stayed away from the above speculative flyers and only bought higher grade stocks.

As an accountant I cannot tell you what stocks and bonds to purchase. But after my shredding exercise, I would suggest the following general investing principles be considered:

1. Buy high-quality stocks, ETFs or mutual funds.

2. Keep the turnover of these securities to a minimum.

3. Diversify across countries and sectors.

4. Consider stocks that pay dividends that grow over time.

5. Keep your flyers to a minimum — or better yet, don’t take any flyers.

In conclusion, invest like your grandmother.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

5 Lessons Investors Can Learn from the Raptors' Championship Run

The Toronto Raptors are the toast of the town and the talk of the National Basketball Association. Fresh off a championship run that surprised some pundits, they now have basketball higher-ups wondering how to replicate their success.

For The Blunt Bean Counter, I’m more interested in the lessons investors can glean from the Raptors’ success – especially tips around the psychology of investing. Both sports and investing mix hard analysis with emotion. We all know the role emotions play in sports. Less known are the psychological challenges of high-stakes investing. Researchers call them behavioural biases.

As Canadians continue to bask in the glow of Raptor success, here are five lessons investors can learn from this historic championship run. 

#1: Herd mentality

The Raptors won a championship by going their own way. President Masai Ujiri set the tone with his bold acquisition of Kawhi Leonard – who was recovering from injury and had played only nine games the previous season with the San Antonio Spurs. Coach Nick Nurse adapted the maverick approach to the hardcourt, where he innovated on both offence and defence to help the Raptors win their first championship.

What investors can learn

Following the herd can be tempting as an investment strategy — popular stocks and funds often look like successful stocks and funds. In reality, smart investors take note of the investment climate but also stop to question the hysteria of the markets. Staying true to your investment policy and principles is important not only for picking stocks, mutual funds and exchange-traded funds, but also for timing decisions to buy and sell.

Avoiding the herd doesn’t need to push investors to the extremes of contrarian investing – but it does require independence and well-defined goals.

#2: Overconfidence

All athletes need to master that balance of confidence and overconfidence – avoiding the pull of “too high or too low.” The Raptors made a mantra of the practice, by preaching the benefits of “staying in the moment.” Because when playing top-flight teams like the Golden State Warriors and Milwaukee Bucks, an overactive ego can prove as damaging as a faulty jump shot.

What investors can learn

What goes for athletes is also true for investors. So many investors think that a few smart investing moves will translate into long-term investing genius. In this way, overconfidence ties into self-attribution bias, when investors believe their success can be attributed only to their investing acumen. If only investing were that straightforward. Even legendary investor Warren Buffett has made mistakes while wrestling with the limits of human intelligence and the inevitable factors beyond his control.

#3: Diversification

The Raptors present an interesting case of a superstar paired with balanced team. While Kawhi Leonard proved pivotal to the team’s success, several Raptors contributed double-digit scoring. This led commentators to describe the Raptors as one of the more balanced championship teams in recent memory. The Raptors’ tendency towards balance only grew as the postseason progressed, and helped the team compensate for a Kawhi limited by injuries and opponents’ double-teaming defences.

What investors can learn

It may constitute almost the first rule of investing, but we tend to forget it: diversify your holdings. Much as basketball teams can’t rely on scoring from one or two sources, investors can’t depend on big gains from a small number of similar investments. Portfolio risk needs to be spread among a variety of investment vehicles and various sectors.

Some investors fail to diversify due to familiarity bias. The theory goes that people trust – and select investments based on - what they know best. They will therefore focus on domestic stocks and funds or those stocks and funds that are household names. By investing in international stocks, adding holdings in several sectors and including both low- and high-risk investments, investors put themselves in a better position. A word of caution: when exploring less familiar investments, seek out dependable research and advisors.

Familiarity bias can also be viewed as a home vs. international bias from an investing perspective.

As I am writing this, Kawhi has not yet decided whether to stay with the Raptors or return home to play for the Los Angeles Clippers, the other rumoured option. He is weighing many factors, but his choice pits Los Angeles, where he was born and raised and has family and friends, against Toronto, an international destination that is somewhat familiar but is still a foreign location and certainly not home. If Kawhi looked at this from an investment perspective, clearly he should sign with Toronto. (And now I’m showing my own bias – for the Raptors.)

#4: Worry

It’s not just sports fans who experience anxiety as they live and die with their teams’ fortunes. Even professional athletes have been known to lose sleep due to worry, as former Raptor Jonas Valanciunas has acknowledged. When tired athletes bring the previous night’s restlessness to the court, their performance generally suffers. Raptors management recognizes this, and educates the players on how to use rest to prepare their bodies and minds for competition. This year’s edition of the Raptors was also helped by a coach, in Nick Nurse, who cultivated a calming culture.

What investors can learn

Losing sleep may not directly influence investing performance in the same way as it drives on-the-court results. But researchers have uncovered interesting ties between worry and investing. Victor Ricciardi, who studies the psychology of investing, found that increased worry about a stock decreases an investor’s risk tolerance for that stock and the chances they will buy it. People may want to control their worries – but we all struggle to master our emotions around investing. For some this can lead to sleepless nights, which can certainly impact us at the office and at home. Part of investing is matching our risk tolerance to our rest tolerance.

#5: Anchoring

Raptors’ fans may not know the anchoring bias by name, but they know it all the same. Years of seeing good teams bowing out in the playoffs – sometimes in embarrassing fashion – conditioned fans to expect defeat for the team. Their beliefs about the future were “anchored” in past Raptors performances. So much so, in fact, that one American sportswriter asked Raptors players about Torontonians’ so-called defeatism. Acquiring Kawhi Leonard helped shift fans’ perceptions, but many still found it difficult to believe this year would be different. Now a championship has given Raptors’ fans an entirely new, and positive, anchoring event to form their expectations in the future.

What investors can learn

Anchoring bias can unsettle our portfolios in surprising ways. The classic investing example concerns purchase price: investors hold on to a stock because they remember their purchase price, not the stock’s decrease in value. They use that original price as an anchor. On the other end of the spectrum, investors may exhibit an extremely low tolerance of risk based on past performance. Think of a new investor who lived through the record one-day TSX drop in 2008 and runs from the markets as a result. Even the investing styles of our parents can anchor our perceptions of the correct way to invest.

Anchoring, like all investing biases, is difficult to avoid. Even our best attempts at fully rational investing behaviour can’t rid us of the emotions that make us human. What we can do is know our personal biases, understand why they may exist and access the best research and professional advice possible so that facts and data inform our investing decisions. And be sure to ask questions; even advisors have their investing biases. Professional advisors should be able to explain their investing recommendations to you.

I hope you found this post fun and informative. As this is the last original post until September (I will post The Best of The Blunt Bean Counter a couple times a month in July and August), I wish you a great and safe summer.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

What is your Wealth Advisor Thinking? One Professional Reveals Lessons Learned from her Clients

Getting professional wealth advice – or really any professional advice – can be frustrating. We are asked to open up our lives and disclose our thoughts to someone who is initially a stranger. Personally, I’d love to know what my professional advisors are thinking on a whole range of issues.

This week senior wealth advisor Carmen McHale of BDO Canada LLP takes a step from behind the desk to share her thoughts on the past five years of dispensing wealth advice. She also wanted to thank two colleagues – Indy Sebastian and Eric Wipf – for their help in reality-checking her thoughts.

___________

When asked to write about what I have learned from clients in the past five years, my initial thought was – everything. But that might take too long to cover. So instead I’ll focus on one area that I find fascinating: the emotional biases I first learned of in textbooks and now see in investing practice. Emotional biases arise from impulse, intuition and feelings and can result in irrational decision-making. Because they are all about how we feel and react – they are impulses, after all – they are harder to mitigate.

Knowing ourselves is something many of us take for granted, feeling that it comes naturally – but how well do most of us actually know ourselves? We may think that there is no one we know better, but the truth is, we are often blind to our deficiencies. Despite our attempts to stay impartial, our emotions sway us more than we care to admit.

Loss aversion

When a decision is made to invest, it is usually based on what we think we will gain. Although a good advisor will focus on communicating the downside risks associated with investing, it is very hard to know how we will feel about that downside until it actually happens.

When it does happen – because it will – are we going to fall prey to our emotions, or will logic prevail? If your portfolio is down 10% and your advisor is telling you to stay the course, are you going to take that advice? If an investment results in a loss, will you be able to swallow the loss as a sunk cost and sell the investment – or will you want to keep it until it bounces back? Will you want to sell an investment too soon because you are afraid your gains will turn into losses?

So what have I learned? That no two families or situations are the same, and while logical reasoning attempts to quantify risk in an investment policy statement, often when faced with a real investment loss – the experience of seeing it – revisiting the investment policy statement reveals the tolerance for losses is lower than originally thought. With honest communication about how the investment policy is there in part to reflect the tolerance for risk, advisors can help keep a client’s plans on track.

Overconfidence bias

Overconfidence bias is thinking you know more than you do about a certain topic, or thinking you have more control about an outcome than you do. I have worked in Calgary for my entire career, and often deal with professionals in the oil and gas industry – they know the industry and believe in it. This leads them to over-weigh their investments. Their current and future income is based on the price of oil; add to that a large concentration of oil and gas stocks in their portfolio and the risk is amplified.

Unfortunately, this compounded risk reared its ugly head in the last few years in Alberta, setting many oil and gas professionals’ best-laid plans off track. The markets can take down anyone, regardless of investors’ level of knowledge.

So what have I learned? To present alternative scenarios. One that over-weights investments in line with the overconfidence bias and one with a balanced portfolio. Canadians have become better versed in the extremes of markets, and whether it be the oil and gas professional or the real estate speculator I have learned to discuss the lows with clients and hope that the risk and volatility resonates.

Self-control bias

As a lover of chocolate, I am very familiar with this bias. Time after time, I buy a bag of chocolate raisins and think I can limit myself to a handful. We tend towards immediate gratification.

In an investing context, there is the inability to focus on the long-term goals – like not saving enough for retirement and only realizing when you are 55 that you are running out of time. This can lead people to take excessive risks when investing. Clients often think that the markets will solve the problem if their portfolio can just get them a 15% return.

So what have I learned? That for the most part clients really just want to know where they stand. Given a detailed action plan, they can focus on short-term goals while understanding the long-term focus. I have learned I need to be the practical voice and provide the client with the tools and knowledge to make the right decisions, and be there for them along the way.

Regret aversion

This is all about not taking action because you do not want to be wrong – you try to avert regret. When you have this emotional bias, you are more likely to do what everyone else is doing. This can cause investors to over-concentrate their investments in well-known companies. Then, if the position goes down, it is not your fault because you were simply following the herd. Regret aversion is about avoiding making true decisions and then rationalizing the poor decisions that were made.

In these situations, I try to educate clients on the various investment management options that exist in the marketplace. Most are familiar with bank representatives and investment brokers where the advisors assess your risk tolerance, time horizon and performance objectives to determine which asset classes are most suitable - but investors ultimately make the buy and sell decisions, and the advisor’s role is primarily to offer an informed opinion.

On the other hand, I am a big proponent of discretionary investing, which is a more hands-off approach for the client. In discretionary investing, advisors still collaborate with the client to assess their investment goals. But it removes the ultimate investment decisions from the client and transfers them to the advisor, who communicates the investment decisions and reports the results. Discretionary investing provides the necessary framework around investment decisions and helps to remove many of the emotional biases surrounding investment decisions.

So what have I learned? That many clients like to have a “play” portfolio – where they can invest a specified amount of money in less popular companies. Clients enjoy the opportunity to do their gambling here without having to worry about their nest egg.

Status quo bias

This is the urge to do nothing. As human beings we typically dislike change. Staying with the status quo is much easier. People feel greater regret for bad outcomes that result from a new action taken than for bad consequences that come from doing nothing.

Changes from the status quo will often involve both gains and losses, but the tendency to overemphasize the avoidance of losses – loss aversion – will favour keeping things the way they are. This leads to inaction when action may be called for.

So what have I learned? That most clients meet with me to challenge this bias, and most people when given small, quantifiable actions generally want to challenge this bias.

Lessons and the investment journey

What have I learned from clients over the years? That even the well versed in the irrationalities of the market fall prey to the reality of emotions. And of course, as humans we are creatures of nature – so even when we do know our weaknesses, we may shy away from hearing hard truths. The fear of needing to break detrimental habits built up over a lifetime, or the realization that our behaviors have prevented us from meeting our financial goals.

One of the major roles we fill as advisors is that of the voice of reason. We strive to be the objective practical eyes, guided by experience, assisting our clients in navigating these biases in the context of their overall goals. We strive to help our clients understand that these goals are not achieved by leaps and bounds but by well-considered small steps – that proverbial journey of a thousand miles.

Carmen McHale is a senior wealth advisor for BDO in Calgary. She can be reached at cmchale@bdo.ca, or by calling 403.956.0103.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Boring is good when investing

Jonathan Chevreau of the National Post recently wrote a column titled “Investing is boring; If you want excitement, go to Las Vegas”. The premise of the article is that “successful investing should be boring, which may explain why so many excitement-seeking investors suffer disappointing returns.” Mr. Chevreau goes on to discuss a self-published book by Edmonton-based wealth counselor Marshall McAlister, titled The Brilliance of Boring Investing: An Academic Approach to Portfolio Design. Chevreau notes the book begins with a quote from Nobel laureate Paul Samuelson: “Investing should be dull. It shouldn’t be exciting.” He then goes on to note that there’s a paradox, in that McAlister notes “the portfolio process that requires less work from investors can actually deliver the best long-term investment returns.”

John Heinzl of the Globe and Mail also recently had a column advocating a passive portfolio. The article asks “What is the biggest threat to your portfolio?” and the answer is “you.” One of the self-defeating behaviours he notes is “You thrive on excitement.” Heinzl says investing is not supposed to be entertaining, but the 24/7 flow of information, really over-information, and conflicting reports cause many to buy and sell constantly. He notes the important thing is to have a focused strategy, instead of trying to know absolutely everything about an investment.

I am not surprised by the assertion that boring investing brings forth the best returns and that passive investing beats active investing. (I wrote this blog a few weeks ago, but this week there has been a discussion on passive investing by the Canadian Capitalist, Michael James On Money and the Canadian Couch Potato). I however, will not focus on the passive investing issue per se, but on John Heinzl's observation of personal behaviours.

Mr. Heinzl’s comments about over- information ring true to me personally. I am an information hound. At times using Sedar, Canadian Insider, reading financial statements, management discussions and analysis, frequenting stock bulletin boards and listening to conference calls and so on. However, lately I have stepped back from active investing to some extent and I have been able to view other active investors with a more dispassionate view. I am astounded, especially in reading stock chat boards, at the amount of information constantly dug up by posters. They often drive each other crazy with this over-information, especially in quiet periods, when the company they are invested in does not release pertinent information. It is quite eye-opening viewing this information feeding frenzy from the outside.

Some investors are able to filter this morass of information into coherent research and due diligence and thrive on information, however, most investors are not able to process over-information dispassionately. Personally, I enjoy having a few speculative stocks, my Las Vegas as Mr. Cheverau would say; however, I agree, you need a lot of Iowa and North Dakota to be a successful investor in most cases.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Patience and Conviction in Investing

The expression “patience is a virtue”, has no truer application than investing. Patience typically necessitates conviction, which can be fleeting in the investment world. Most everyone who has ever invested in the stock market has regretted selling a stock too early because their conviction wavered. As Warren Buffett has stated “The stock market is designed to transfer money from the active to the patient.”

It has taken me several years to understand that part of the key to conviction, and staying focused on your long-term investing goals is realizing that your conviction, in many cases, will be tested. The market often does not reward your conviction with even the slightest acknowledgement by way of a small stock price increase. The stock market is cold hearted and does not care about your conviction or timelines, and may mock you and continually test your conviction by trying to convince you that have made the wrong decision.

That is, you may buy a stock at $12 and it trades for three to four years (or longer) between $10 and $12, and your conviction waivers. Then, suddenly, that stock finds market acceptance - be it through a significant transaction for the company, an analyst starting coverage, or just that sector becoming the flavour of the year with no underlying change to the company. Waiting out the stock market to have your convictions confirmed is often the hardest aspect of investing, as timing and conviction don’t often seem to converge.

An interesting sidebar to investment conviction, at least in my case, is that it has revealed a personality flaw. For someone who is typically not jealous or envious of others and open to discuss stocks I own, I have noted I have some resentment towards people when I know they have purchased a stock and received the same absolute dollar gain in two months that took me five years to achieve. It is not the monetary gain that causes this resentment, but the fact they did not have to suffer in the trenches with the same doubts and stress and persevere like I did - especially where the stock has been volatile, or had downward pressure. I know this is very small of me and I should just be satisfied my conviction proved correct, but I know others that feel the same way. I wonder if any of my readers have the same feelings, or is the fact your conviction proved correct satisfaction enough?

I return to Mr. Buffett to conclude, “With each investment you make you should have the courage and conviction to place at least 10% of your net worth in that stock.”

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

The Kid in the Candy Store: Human Nature, RRSPs, Free Cash and the Holy Grail

Several weeks ago I read a column by Rob Carrick titled “Why TFSAs Trump RRSPs for the young and lower paid.”. The column was premised on a paper by Jamie Golombek of CIBC on why TFSAs beat RRSPs as a better retirement savings for some Canadians. This topic has subsequently been beaten to death, but in this blog I want to concentrate on the exchange I had with Jamie in regard to human nature and its impact on investing.

The Globe and Mail had an online discussion about the above article and I sent in the following comment: “The problem with technically correct solutions is that they ignore human nature. As a Chartered Accountant I can tell you people consider their RRSPs holy and try their best to never withdraw from them. A TFSA or any accessible account is like candy, you stare and stare and then indulge.”

Jamie responded "you may be surprised to learn that that 80% of all RRSP withdrawals are made by individuals under age 60, generally pre-retirement! Not much of a holy grail!" Jamie's paper also reports that recent data shows 1.9 million Canadians withdrew $9.3 billion from their RRSPs in 2008 and taken in conjunction with the 80% withdrawal statistic noted above, suggests RRSP funds are being used well before retirement age to supplement income.

Jamie clearly considered the human nature aspect of investing in his report (see Accessibility of Funds on page 5) and provides statistics to develop or support the thesis of his paper. I have no issue with his statistics or his assertion RRSPs are being used to supplement retirement income by those under the age of 60. I do object however, to his contention that RRSPs are not considered the Holy Grail.

In my practice, I have observed that RRSPs are the Holy Grail for most of my clients. More importantly, RRSPs seem to act like those invisible fences for dogs and form an invisible barrier to prevent my clients from "grabbing" at their RRSPs; although I think Jamie would suggest the barrier may have some holes in it based on his statistics.

I asked Rob Carrick his thoughts on the matter and he responded, "I'm stunned every time I read stats on how many people take money out of their RRSPs, never mind TFSAs. The harder it is to withdraw from a retirement savings vehicle, the better."

On the surface, it is difficult to refute Jamie's assertion without my own statistics. Numbers are numbers. But, if we could dig a little deeper the same numbers may tell a different story. Here is where human nature and its impact on investing come into play. Human nature, like physical nature, takes the path of least resistance. At the end of the day, my professional observation of human nature takes me down the same road as Rob: the greater the barrier, the better - even if some ignore the barrier. Anyway, I will leave this for the psychologists to study and will return to my laboratory, being my office, and provide some personal experiences on human nature and free cash.

RRSPs, The Holy Grail Or Just Full of Holes

In my accounting practice, it has been my experience based on discussions with my clients, that they withdraw RRSPs almost exclusively for financial need only and not for discretionary purposes. I will concede that my client’s incomes are well above the national average and thus they may not be a representative sample. If we could somehow ask each person who withdraws funds from their RRSP in Canada, “why are you doing such and what is the intended use of the funds?", I am convinced that the vast majority would answer we are taking out the funds due to financial need and not for discretionary purchases. Most people take a certain pride and comfort in their RRSP savings. There is a peculiar permanency in investing in an RRSP that is not nearly as tangible in a TFSA or other savings account. Non-RRSP savings accounts seem to represent “leftover money”. RRSPs represent security from old age impoverishment. That is the Holy Grail. Most people cash out RRSP’s only under financial duress. Financial duress is not the same as supplementing income.

So what about those alarmingly counter-intuitive statistics that would suggest we have become an unholy nation desecrating their RRSPs? It is highly probable in my humble opinion, that many Canadians are convinced that they have to contribute to a RRSP by the various advertisements they are bombarded with in January and February each year by financial institutions and at the urging of financial commentators and in fact, many were really not in a position to contribute to their RRSP in the first place, thus dooming their RRSP from inception and inflating the withdrawal statistics.

I See It, I Want It

Now, assuming we are not compelled to withdraw our savings (or perhaps more aptly borrowings), restricted savings accounts are like invisible fences, or the glass in front of the candy counter. Withdrawing cash from an accessible savings account like a TFSA is relatively easy. Especially when we see that cash as “leftover earnings”, or as a well-deserved reward for how much we’ve earned or how hard we’ve worked. If we move away from restricted accounts such as RRSPs, the invisible fence seems to turn off. Now the buying is easy. Self-restraint is hard. Accessible cash quickly winds its way along the path of least resistance and a cash register.

I often observe the sweet lure of accessible cash in the actions of many self-employed individuals and professionals in respect of their quarterly personal income tax installments. Some make significant sums of money, but you would not believe how many don't have the funds to make their quarterly income tax installments. This results in huge income tax liabilities around April 30th and installment interest and penalties for failure to make these required installments. Why don’t they have this cash you ask? In some cases they have not collected their accounts receivable or received allocations from their partnerships, but in many cases, they have spent the free cash that should have been allocated to their income tax installments on discretionary items only because it is was easily accessible and winking at them.

A hot topic that has been widely debated recently is whether it is better for small business owners to eschew salary and RRSPs in favour of leaving the funds in their holding company. Technically leaving the money in the corporation is correct (although I have some reservations with this strategy because you stop RRSP contributions, lose eligibility for CPP income in the future if no salary is taken, and potentially forgo the deductibility of child care expenses if no salary is taken) but in my opinion, the candy (ie: available cash) will prove too tempting for most people and some of those corporate funds will find their way to cover that vacation they wanted in Europe or that new car or boat they have their eye on; whereas if those funds were contributed to a RRSP, the invisible fence effect would come into play. I have observed this first hand with the typical current holding company structure where excess profits from a operating company are moved to the holding company; this new twist would only create more accessible cash to potentially be withdrawn.

Intuitively Rationally Irrational

Although not directly related to free cash, an example of personal behavior superseding fundamental financial common sense is in relation to income tax refunds. Individuals can file a form T1213 to obtain waivers to reduce income tax withholdings in certain circumstances, but almost no one does. Ignoring the administrative issue of obtaining the income tax withholding reduction, which may contribute in part, individuals just love their lump-sum tax refunds (usually as result of their RRSP contributions) and they intuitively know they would not save an amount equal to the same lump-sum income tax refund if they had their income tax withholding reduced on a bi-weekly or semi-monthly basis.

I have only anecdotal evidence to prove people consider their RRSPs the Holy Grail. But really, is it unreasonable to accept that TFSAs or other non registered accounts are merely shelves displaying the cash candy to which our sweet tooth cash cravings will inevitably succumb? The path of least resistance generally ends at the cash register in the candy store. The high road is easier to follow when the candy case is locked. A financial vehicle that people feel is “locked in” will help stymie our natural inclination to self-indulge and spend and will only be accessed under financial duress and not necessarily as a supplement to retirement income. Now that is a Holy Grail indeed.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.