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.

Your Investment Return - What Is It Telling You?

I find it shocking, how many people have no clue what their investment returns are for any given year let alone their historical returns. Some investment firms have been purposely opaque in respect of reporting investment returns for their clients. It is hoped that with the introduction of CRM2 (see this article) there will be far greater transparency in respect of the returns generated on your investments and the fees you pay your investment firm.

As of December 31, 2016, your investment statement should start reporting a personal rate of return. From what I understand, the reporting of your returns will only be mandated for 2016 and prior year investment returns do not have to be reported (some investment advisors/managers are very lucky; as 2016, the first year of reporting was a strong market year and this may allow them to hide poor past performance - thus, I would also request personal return information for the last three years, the last five years and since inception in addition to the 2016 return information). While your statements will not necessarily provide index benchmarks for you to compare your return against, at least you will have a return number!

If you have an investment advisor or investment manager and they have not reviewed your returns and strategy on a yearly basis before this required reporting, I would put them on notice you are disappointed and expect far more going forward. In addition, you should also review the investment fees you paid in 2016, which should also be provided on your statement. If you manage your own investments, you should be reviewing your performance on a yearly basis, or you are doing yourself a disservice.

Okay, enough with my rant. Today I actually intend to talk about what your investment returns are actually telling you about your investment strategy and investment policy and whether you are adhering to your strategy or chasing returns. (As an aside, if you are a good writer, you always tell your audience what your intended topic is within the first couple lines, you do not wait until the fourth paragraph. So do as I say, not as I do :).

Your Investment Strategy

When you engage an investment advisor or investment manager etc. the first thing that should be done is to create an investment policy statement and strategy based on your needs and risk. This will include a target allocation between fixed income and equities and target allocations between different asset classes and global diversification among other considerations. You should also be provided benchmark indices to compare your fixed income, Canadian, U.S. and World allocations against; unfortunately, this is often not provided.

For this post, let’s assume for simplicity sake that you want an asset mix of 30% fixed income and 70% equity which is allocated 30% Canadian, 30% World and 40% United States.

What Are Your Returns Telling You?

For purposes of illustration, I am going to use 2015 stock market returns since there were some of the larger variances within portfolios I have seen in years (I personally observed returns ranging from up 12% to down 17%). I will only briefly comment on 2016, since most statements are just being mailed.

So why the wide variance in returns in 2015? The reason was simple. The Canadian markets and resource stocks in particular were weak and preferred shares, especially rate reset preferred shares (due to low interest rates that were not contemplated when the shares were issued) were hammered. The TSX ended 2015 down around 11%. The U.S. market was down around 3% or so (but there was a huge foreign exchange gain where you held U.S. stocks because of the increase in the U.S. dollar relative to the Cdn dollar). World markets were also fairly weak.

So I ask you. If you had a 3-5% return in 2015, was that good or bad? This is a loaded question. If your allocation was the 30/70 mix I note above, that was probably somewhat expected and almost all due to the 30% or so increase in the U.S. dollar. Is that good investing or proper fund allocation? I would say a bit of both.

I noted that I saw people with losses as high as 17%. Was this bad? The answer surprisingly could be yes or no. If you had a large Canadian equity allocation with a resource bent (some people believe in investing most of their funds in the country they will live and retire in) then, the 17% loss may not have been as bad as your initial reaction and somewhat expected. That same portfolio will have exploded to the upside this year. Personally such a portfolio has too much volatility for me, but it may have been in adherence to that person’s investment strategy. Where you had a 17% loss because of rate reset preferred shares the investment industry sold and pushed (especially to seniors), but did not understand, that is another story.

For those people who had a 12% return in 2015, these returns were solely because they were over-exposed to U.S. stocks. I would say those returns, while excellent, were gained at the expense of risk (too much U.S. stock allocation) and you would have to understand the downside risk on a reversal in the dollar.

Some people told me their advisors did a great job over-allocating to the U.S. in 2015 and they were scaling back in 2016 (these conversations were in early 2016) to protect against a F/X reversal. When I hear comments such as the above, I cringe, since this says to me that their advisor has not created a disciplined strategy, but is stock picking, which more often than not, ends up badly.

2016 Returns

This year both the Canadian and U.S. markets have done very well. So if we look at the sample portfolio, one would expect a return somewhere between 8-11%. If you are this person and your returns are 18% I would want to understand why I outperformed far greater than my expected asset allocation. A better than expected return may indicate something amiss with your investment mandate. The same goes if your return was 6%, why were you below your expected return?

In conclusion I suggest the following:

1. Ensure your investment advisor/manager provides you with current and historical returns don’t just accept the 2016 returns that will be on your December, 2016 statement. Meet with them to discuss your returns and compare them to your intended strategy and investment policy and compare your returns to benchmark indices you agree upon. Ensure the returns you are provided with are net of management and investment fees and that the returns are not varying significantly from your expected returns. Variations both up and down may be cause for concern.

[BTW: If you are unhappy with your advisor and looking for a change, let me know. Depending upon your asset base, I or a colleague, may be able to assist you with financial planning and investment oversight and provide you access to several investment managers I work with directly (as an accountant I cannot provide specific investment advice, so I must work with an investment manager)].

2. If you manage your own investments, ensure you have created an investment strategy that it is written down and then compare your returns to what you expected and ensure you kept a disciplined approach in line with your strategy.

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.

Stocks with Capital Gains- To Give unto Ceasar or not

I have always been confounded by people who are reluctant to sell a stock that has increased in value because they have to pay capital gains tax. It goes without saying, that income taxes can have a significant impact upon your portfolio’s value over time. Obviously, the longer you can avoid paying income tax, the greater capital you will have at work. However, some people are so adverse to paying income tax on their stock gains, that they are paralyzed from making a sound investment decision.

The underlying question that I will try and address in this blog is: how much a factor should the income tax on your capital gain be when selling shares, if you cannot find a viable replacement equity? I suggest it should be a non-factor.

It should be noted that this blog will revolve around the sale of individual stocks, not mutual funds; as some corporate class funds can be utilized to defer capital gains. I have also not considered an equity monetization strategy based on the assumption that for most readers, monetization is not practical, as I have only seen it used one or twice in all my years practice.

While writing this blog, I came across an interesting statement in Sacha Peter’s Divestor Blog (a favourite on my blog roll) that was right on topic. In his blog “Links and after-tax calculations,” Sacha states that he finds it personally very frustrating to hold onto investments that have appreciated beyond what he considers to be its fair value, but he is "prevented" from selling these stocks because of the capital gains taxes that he would incur.

I commented on Sacha’s blog that I did not really understand his comment. I stated that "Capital gains tax in Canada is 23% or less and to me, that is not an onerous rate. Yes, one never wants to pay tax, but I see people hold onto stocks because they don’t want to pay the tax on stocks that have appreciated past their fair value and the stock sharply corrects. To me, 23% or less is not a large detriment to take a profit when you compare it to the 46% you pay on interest and employment income and compare it to the potential true cash loss you may incur by holding a stock that should be sold.”

Sacha’s response to my comment was “I agree with you from a practical perspective. Academically I outlined a scenario in my previous post that illustrates the situation.” Sacha then provided the  example below which follows the conventional wisdom in regard to selling stocks. This conventional wisdom is succinctly expressed by Greg Forsythe of the US security firm Schwab; "Sell an existing holding if another stock compatible with your risk tolerance is available that provides higher return potential after subtracting any taxes and transaction costs in executing the swap".

Sacha says “Let’s take a hypothetical investment between two securities. Security ABC is a perpetual bond, paying $10 per unit. Security DEF is a perpetual bond of the same issuer, with substantively the same seniority/call provisions as ABC, paying $8 per unit. Your marginal rate (to make the math easy) is 50%.

Let’s pretend you bought ABC for $80, netting a pre-tax yield of 12.5% and after-tax yield of 6.25%. If ABC is now trading at $100/share, what price does DEF have to be in order for the decision to be a net positive? Assume frictionless trading costs, and capital gains taxes are payable immediately upon disposal. For this to be a break-even transaction, your $95 ($100-$5 tax) in after-tax dollars must equal the income of the prior portfolio, mainly $10. $10/$95 = 10.53%, so you must buy DEF below $76/unit in order for your transaction to make financial sense."

Sacha continues "I will again completely agree that this academic exercise is of little use in the grey and fuzzy world of investing in that you never quite know whether you got fair value correct and whether the geniuses on the other side of the computer screen think their idea of fair value is higher or lower.”

Just to be absolutely clear, I am not picking on Sacha. I asked him if I could use his response in this blog, I am just using his response for discussion and illustration purposes. In the above response, Sacha compares two securities based on coupon rate and unrealized gains. His example requires comparable alternatives and is not necessarily his analysis for the sale of a single stand alone stock.

Now, I am not the academic or mathematician that Sacha is, but I guess my issue with conventional wisdom is should one not consider the valuation of a stock and the net proceeds that will be achieved after-tax instead of always looking for a break even alternative or stock with a potentially higher return (i.e.: an alternative may not always be available when you wish to sell a stock and thus, should the income taxes then not become a moot point?).

To illustrate, if I bought Nortel at $50 and sold it at $100, since I thought $100 was fair value, I would have had approximately $88 in my pocket after-tax. Now, look at the many Canadians who held onto Nortel as it rose in price. As I recall, many people were concerned Nortel was way overvalued, but they did not sell their shares because they did not want to pay the large income tax bill associated with their gains. Following with the above example, when Nortel was $130, you could have sold and realized approximately $112 after-tax. At $115 you would have realized $100 after-tax and, as noted above, at $100 you would have realized approximately $88 after-tax.

However, many Canadians held on and did not sell until the $60 range or less. At $60 you would have realized approximately $57 after-tax. Your net after-tax loss of not selling at a pre-determined fair value of $100 was $30 or more, even after paying the income tax.

It is my suggestion that once you feel a stock has hit full value, place a stop-loss order at that pre-determined value and look past the paralyzing income tax decision to your after-tax proceeds and return. Deal with what you will do with those funds as a standalone question.

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.