National Post (National Edition)
Unorthodox ideas to make you money
RRSP may not always be right thing to do
Some of the best investors are those who think outside the box. They don't follow trends, or the crowd, but instead look for trends that have not yet been discovered.
This column is not about new themes, however, but rather about certain different approaches investors can take that might not be considered “normal” by the investment or analyst community. Investment firms, the media and brokerages tend to position themselves for the average investor. But you're not average, are you?
WHO SAYS YOU NEED
AN RRSP?
For nearly every participant in the investment industry, not having an RRSP is the equivalent of monetary blasphemy. Of course, investment companies want you to have a registered account, because it is very “sticky” money and can generate high fees (if you invest your RRSP in mutual funds). But many investors simply may not realize that having an RRSP can at times backfire on you. The main strategy of an RRSP is to have money compound, and then take that money out when your tax bracket is lower.
But there are two problems here: One, your tax bracket may not be lower. If you are a successful investor elsewhere, or have a nice pension or other income in retirement, it is very possible you will pay a very high tax rate on your RRSP withdrawals (yes, you can defer this by shifting your RRSP to a retirement income fund for a period of time). Since capital gains taxes are (for now) lower than other forms of taxes, an investor who skips an RRSP, and invests only in non-dividend-paying stocks, still gets the benefit of compounding, but their overall tax rate over an investment lifetime might be lower (perhaps significantly) than an investor with a large RRSP account.
The second problem is, does anyone really expect overall tax rates to be lower in the future? Your RRSP withdrawals could, depending on what happens down the road, end up providing more income to the government than it does to you. This debate is too big for this column, and is complicated by what investors may do with any tax refund brought on by an RRSP contribution, but the summation is thus: just because the investment industry says you should have an RRSP does not in any way mean that it is always the right thing for you to do.
MAYBE YOU DON'T NEED
ANY BONDS AT ALL
The industry is always harping about asset allocation. Investors need bonds, or other fixed-income securities, as well as stock exposure, they say. But, maybe you don't. If you can handle volatility, have a long time frame, or are still working (with excess income), do you really need to earn 0.5 per cent on bonds, which is then taxed at the highest rate? Young investors might be able to forgo fixed income entirely. Personally, I'd rather take a chance on a three per cent dividend with growth potential than lose money (through lower purchasing power) on a bond.
MAYBE YOU DON'T NEED TO LOOK AT EARNINGS SO CLOSELY
Sure, corporate earnings are important. But they are not everything. Adobe (ADBE on Nasdaq) reported good earnings this week. But the stock declined anyway. The company's press release, however, indicates Adobe plans a massive hiring spree over the next year. Would a company do this if it expected business to be bad? Not likely. Long-term investors can pick up interesting tidbits from companies such as this, but they need to stop putting so much emphasis on quarterly earnings, first.
YOU CAN CREATE YOUR OWN STRUCTURED PRODUCTS SIMPLY
AND CHEAPLY
Brokers love structured notes, and “guaranteed” products. Of course they do: selling and other fees on these are extremely high. Structured products, and market-at-risk products provide some investment return with some guaranteed principal protection if the market falls by a certain amount. Investors love how they get some upside potential but also some downside protection. From a marketing perspective, it certainly sounds good. But it is not. Essentially, most structured products can be duplicated with nearly no fees. A portfolio with 90 per cent government T-Bills and 10 per cent call options, for example, can provide significant upside potential with just as much — or more — downside protection than most structured products. What's more, such a strategy maintains the most flexibility, unlike structured notes, which often “go to cash” and then just sit there, charging fees, after a market event has occurred.
PAY NO TAXES AT ALL. WAIT, WHAT?
Many investors do not know, that, in some cases, the dividend tax credit can provide very significant tax advantages. If dividends are your only source of income, one can earn a pretty decent amount (nearly $48,000 if you are in Ontario) and pay zero in tax. Note, one can also supplement this income with TFSA withdrawals, also tax-free, if needed. At the current TSX dividend yield of 3.2 per cent, one would need a portfolio of $1.5 million in Canadian dividend stocks to get near to the full tax-free income level. If one has more than this, one could still buy non-dividend stocks for growth, to be cashed in down the road (at attractive capital gains tax rates). We are shocked at how many investors do not know about this possibility. Of course, the government has no incentive to advertise the strategy.
Financial Post
Peter Hodson, CFA, is Founder and Head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals.