Archive for the ‘portfolio’ Category

US stocks represented by S&P500 were up 8.44% for the month of March. The Canadian S&P TSX60 grew by 7.99%. Morgan Stanley’s EAFE was 3.74% higher. While we are still 49% lower than the high in November of 2007, we have rallied 8% off the low point earlier in March.

While most of the worries and economic turmoil persists, there has been some measure of relief to the stock markets. We are at a point of growing divergence between wall street and main street. More evidence is expected of shrinking economies in North America and overseas yet these backward looking measures were not reflected in the recent buoyant return to stocks across the world.

The short term return to investment returns is random but momentum trends do make themselves known. For this positive return environment to continue investors will have to ignore the results from main street. They will have to ignore the fact that consumers are saving more and deferring large purchases. The market will have to rally in the face of lower earnings reports from companies and yes more bankruptcies and higher unemployment figures. There are no assurances, risk is pervasive even from these price levels. If this is the beginning of a turnaround in fortune for the stock markets then it would be consistent with the beginning of other bull markets, shrugging off the bad news and climbing higher in spite of the evidence.

It is always great to enjoy New Years Eve with friends and family. This years’ festivities were highlighted by a real desire to see the end of what has been a very trying year for just about everyone I can think of. The only thing in doubt for our Canadian equity market, the S&P TSX,  on the last trading day was whether-or-not we would beat 1931 as the worst percentage return year on record. A 100 point down day would have captured the dubious honour. We avoided this ” insult on injury” finishing 150 points higher, down about 33% for the year .

In the investment industry, risk is usually defined as volatility or differences in return experience when compared to the average expected value. If monthly returns are plotted, we would expect most values would cluster around the middle -  average value of  about one percent with progressively fewer values as we move away from the average.  This normal distribution would imply that values outside plus or minus 10%  should occur a couple of time every 100 years.   The stock market is different. There are many more large numbers – both positive and negative. Behavior finance experts explain some of this experience in term of investor psychology. In statistical terms this is a fat tail distribution. More values  appear at the extremes and the average value is less descriptive of actual experience. In 1987 the Dow dropped 23% in one day. That shouldn’t happen in our lifetimes, but it did.

Individual stocks are much more volatile than broad markets. The returns are similar, you just capture more risk to get similar returns and there is a big cost to getting it wrong. Yet risk to these approaches is often defined in terms of average volatility to broad market indexes. This is very misleading and causes a good deal of unnecessary confusion when portfolios don’t perform as advertised. It seems to me that an important part of our job as investment advisors is to minimize risk. We don’t try to manage money for improbable events, even if it would have worked last year. We mange assets so as to capture expected return with the highest probability of success. Fat tails shouldn’t alter that effort.

Background
In 2003 the Canadian Federal government agreed to investigate whether an  account would be a useful and appropriate way to help Canadians save more money. This undertaking eventually led to the introduction of the tax free savings account (TFSA) for 2009. It has borrowed from the Roth IRA in style and intent.

Rules For TFSA

Contributions are not tax deductible. You must be 18 years of age or older, a Canadian resident and be able to supply a valid social insurance number to participate. Initial contribution limits are $5,000.00 per year and will be indexed to inflation. Excess contributions will be taxed at 1% per month so this is something you really want to avoid. Unused contributions will be carried forward indefinitely. Contributions are not related to earned income. Any amounts withdrawn are added to the contribution room the following year.

Income and capital gain are not taxable while retained in a TFSA or when withdrawn. Income earned or amounts withdrawn will not be added to income tested benefits or credits delivered through the tax system. In addition these amounts will not effect OAS, GIS or Employment insurance benefits.

The qualified investments mirror RRSPs. Arms length entities such as stocks, bonds, mutual funds etc… . Small private shares may qualify subject to certain conditions. Interest on borrowed money to fund TFSA is not deductible., though a TSFA can be used as collateral for a loan.

No attribution rules apply so the TFSA will be used for income splitting purposes. The tax free status is lost at death though a tax free roll-over is possible if a spouse or common law partner is named as beneficiary.

Strategies

These flexible plans do not replace RSPs. They will be used most effectively in conjunction with pension type investments.  If you contribute a maximum to an RRSP and have savings outside that plan then the TFSA should be maximized.

Perhaps the best uses will be around family income splitting strategies. Parents or Grandparents can transfer up to $5,000. per year for each young adult or grandchild. Recipients can take the money out without tax and new room will be created for future savings.

This is also a welcome new vehicle for those who have high pension adjustments and have little use for RRSPs.

Other Notes

For young adults, a  tax return is required to build TFSA contribution room

Anti Avoidance rules apply to guard against transactions designed to shift taxable income to TSFA

This introduction will be supplemented by additional strategies in future posts.