It makes my blood boil whenever I see someone holding the wrong kind of instrument for the account type.
As Canadian Investors the government gives us three types of investment accounts to stash away our money.
The RRSP, The TSFA, and the Non Registered Account.
In this post I would like to give my point of view on which type of investment is best suited for each account. I'm not going to discuss which account type is better. I personally Max both my TSFA and RRSP on the first trading day of the year. so my opinon on RRSP and TSFA max them both asap all the time.
The RRSP:
- This is the only place to hold bonds. (if you are going to be holding bonds at all) 100% of your bonds should go into your RRSP.
- REIT's
- Income Trusts
- International dividend paying corporations ( not canadian eligible dividend paying corporations)
The TSFA:
- no bonds, okay you can hold a Junk bond ETF, the point is not to be conservative. put investment grade bonds in your RRSP.
- REIT's
- Income Trusts
Non Registered Accounts:
- CANADIAN ELIGIBLE DIVIDEND PAYING CORPORATIONS.
- Preferred shares paying eligible dividends.
- Non dividend paying corporations where your income will be comming from capital gains.
- Stock options you intend to generate capital gains with.
- Never ever ever hold bonds in here.
In general you want your RRSP to be more conservative than your TSFA. This is because more risk in the TSFA will likely generate higher tax free earnings. You can manage your overall risk by lowering the risk in the RRSP. Thats why I think its okay to hold a Junk bond ETF in a TSFA, because it will likely pay more than a government of canada bond and so you will likely pay less tax.
As for the Non Registered Account, This is where you want to realize your capital gains, since they are taxed most favourably and then earn your eligible dividends. do not hold bonds in here you might as well fill in box 465 to donate your tax refund to the Ontario Opportunities fund.
Friday, April 30, 2010
Thursday, April 29, 2010
Avoid Management Fees Like the Plague
When I walked into RBC today there was a poster advertising their RBC Monthly Income Fund. It said a $100,000 investment can provide you with $375 a month in Income. I can see how this Interests some people especially seniors.
Canadian asset management companies make a kings ransom off management fees. I understand that some people do not have the time nor skill to manage their own investments. Lets say you don't want to manage your money yourself, because you don't have the time, experience, scared to screw it up or whatever excuse that is fine. But what I can not understand is holding a high MER mutual fund when there most certainly is an equivalent ETF that will charge a fraction of the management fees.
I don't want to hear the an excuse like I'm waiting for my mutual funds to recover before I switch to ETF's. When your mutual fund recovers so will the ETF. The two move together. In fact funds compare themselves to the index they follow and ETF competitors to see how well they achieved their stated objectives which is to track their benchmark as closely as possible.
I do not own any mutual funds or ETF's myself, but I do hold shares in Canadian asset managers (AGF and GS) the poeple who manage mutual funds. Because I think asset management is a good business with outrages fees that people seem to be happy to pay.
Let us take a look at a few mutual funds offered by RBC and compare them to their equivalent ETF's
RBC Canadian Short-Term Income Fund MER: 1.16%
iShares DEX Short Term Bond Index Fund (XSB) MER: 0.25%
RBC Canadian Dividend Fund MER: 1.70%
iShares Dow Jones Canada Select Dividend Index Fund (XDV) MER: 0.5%
RBC Jantzi Canadian Equity Fund MER: 2.04%
iShares Jantzi Social Index Fund (XEN) MER: 0.50%
If I were to tell you, How would you like to make a guaranteed 1% more on your portfolio without taking on more risk. Its going to sound like a scam. That is because you are being scammed.
RBC's mutual funds MER's are actually decent for the mutual fund industry. Mutual funds have more costs than ETF's since they have to deal with deposits and withdrawls. ETF don't since you and sell the units on the market.
go sell your mutual funds right now and buy some ETF's.
Canadian asset management companies make a kings ransom off management fees. I understand that some people do not have the time nor skill to manage their own investments. Lets say you don't want to manage your money yourself, because you don't have the time, experience, scared to screw it up or whatever excuse that is fine. But what I can not understand is holding a high MER mutual fund when there most certainly is an equivalent ETF that will charge a fraction of the management fees.
I don't want to hear the an excuse like I'm waiting for my mutual funds to recover before I switch to ETF's. When your mutual fund recovers so will the ETF. The two move together. In fact funds compare themselves to the index they follow and ETF competitors to see how well they achieved their stated objectives which is to track their benchmark as closely as possible.
I do not own any mutual funds or ETF's myself, but I do hold shares in Canadian asset managers (AGF and GS) the poeple who manage mutual funds. Because I think asset management is a good business with outrages fees that people seem to be happy to pay.
Let us take a look at a few mutual funds offered by RBC and compare them to their equivalent ETF's
RBC Canadian Short-Term Income Fund MER: 1.16%
iShares DEX Short Term Bond Index Fund (XSB) MER: 0.25%
RBC Canadian Dividend Fund MER: 1.70%
iShares Dow Jones Canada Select Dividend Index Fund (XDV) MER: 0.5%
RBC Jantzi Canadian Equity Fund MER: 2.04%
iShares Jantzi Social Index Fund (XEN) MER: 0.50%
If I were to tell you, How would you like to make a guaranteed 1% more on your portfolio without taking on more risk. Its going to sound like a scam. That is because you are being scammed.
RBC's mutual funds MER's are actually decent for the mutual fund industry. Mutual funds have more costs than ETF's since they have to deal with deposits and withdrawls. ETF don't since you and sell the units on the market.
go sell your mutual funds right now and buy some ETF's.
Wednesday, April 28, 2010
How Much Do You Sell Your Time For
Employment is a contract between you and another entity where you sell your time in return for some sort of compensation.
Take your after tax income from employment and deduct any work related costs, divide it by the number of days worked. and you will come up with what price you are selling your days for. I use days of work not hours worked, because most of the day is spent either at work, preparing for work or recovering from work.
I am a full time employee, my annual salary here is $93,000 sounds decent sure, but after deducting Tax, EI and CPP my job nets $61,980.00
However to get to work and back, i have to include my monthly transportation costs which include
$200 gas, $250 ETR407 (toll route) and $250 depreciation for the extra mileage on my car. This adds up to $700 a month. I will still keep my car if i didn't work. however these extra costs are only to get to work and back.
This brings my net employment income to $53,580
I get 3 weeks of paid vacation. so that 53,580 gets divided by 49 weeks x 6 days = $182.24 a day.
I used 6 day a week because I usually sleep in on Sundays this is included as " time recovering from work"
I am selling my time for $182.24 is it worth it? definitely not. But welcome to the real world my friends, no job is worth it. your time is priceless and no amount of money can be worth it. but this is a good reminder of the value of money.
Now whenever you consider a purchase, instead of thinking of it in terms of dollars and cents. think of it in terms of days. Is this new shiny IPAD for $599 + tax really worth 4 days of work? would you rather have this toy or have 4 days off?
An even more disturbing yet realistic way to evaluate the opportunity cost of this purchase assuming 7% compounded returns these 4 days of work off now would be worth 8 days of work 10 years later. or 16 days of work 20 years later. or 32 days 30 years later. purchasing an IPAD today will delay your retirement by 1 month !
looking at it in terms of an income stream, the opportunity cost for this IPAD, purchasing a dividend stock yielding 4% a year comes up to 9.5 cents a work day. This single purchase could have replaced 0.05% (1/2000) of your income perpetually and inflation adjusted. your salary is not perpetual and is not inflation adjusted. in other words this purchase could have provided for 1/2000 of your needs for the rest of your life and then leave it for your kids to inherit.
Now before you run back to the apple store to return your IPAD. Life is not about money. Life is about enjoyment, if you enjoy your IPAD keep it. The whole point of personal finance is to maximize enjoyment. but first you must build your assets then start spending. otherwise you will be doomed to the rat race forever.
Take your after tax income from employment and deduct any work related costs, divide it by the number of days worked. and you will come up with what price you are selling your days for. I use days of work not hours worked, because most of the day is spent either at work, preparing for work or recovering from work.
I am a full time employee, my annual salary here is $93,000 sounds decent sure, but after deducting Tax, EI and CPP my job nets $61,980.00
However to get to work and back, i have to include my monthly transportation costs which include
$200 gas, $250 ETR407 (toll route) and $250 depreciation for the extra mileage on my car. This adds up to $700 a month. I will still keep my car if i didn't work. however these extra costs are only to get to work and back.
This brings my net employment income to $53,580
I get 3 weeks of paid vacation. so that 53,580 gets divided by 49 weeks x 6 days = $182.24 a day.
I used 6 day a week because I usually sleep in on Sundays this is included as " time recovering from work"
I am selling my time for $182.24 is it worth it? definitely not. But welcome to the real world my friends, no job is worth it. your time is priceless and no amount of money can be worth it. but this is a good reminder of the value of money.
Now whenever you consider a purchase, instead of thinking of it in terms of dollars and cents. think of it in terms of days. Is this new shiny IPAD for $599 + tax really worth 4 days of work? would you rather have this toy or have 4 days off?
An even more disturbing yet realistic way to evaluate the opportunity cost of this purchase assuming 7% compounded returns these 4 days of work off now would be worth 8 days of work 10 years later. or 16 days of work 20 years later. or 32 days 30 years later. purchasing an IPAD today will delay your retirement by 1 month !
looking at it in terms of an income stream, the opportunity cost for this IPAD, purchasing a dividend stock yielding 4% a year comes up to 9.5 cents a work day. This single purchase could have replaced 0.05% (1/2000) of your income perpetually and inflation adjusted. your salary is not perpetual and is not inflation adjusted. in other words this purchase could have provided for 1/2000 of your needs for the rest of your life and then leave it for your kids to inherit.
Now before you run back to the apple store to return your IPAD. Life is not about money. Life is about enjoyment, if you enjoy your IPAD keep it. The whole point of personal finance is to maximize enjoyment. but first you must build your assets then start spending. otherwise you will be doomed to the rat race forever.
Tuesday, April 27, 2010
Fixed Rate Mortgages are Scams
I went to TD today to get a new mortgage discharge statement because their mortgage rates have gone up. so the penalty for breaking the mortgage on that property has dropped by $3,000 so I am happy about that.
however the TD branch mortgage lady kept telling me how great fixed rate mortgages are and that the rates are rising and how it is much safer to get a fixed rate.
I think that the mortgage lady at TD is just doing her best to giving advice that she thinks is correct. The same advice she hears around the bank and gives to everyone getting a variable mortgage. however in my mind this sounded a lot like FUD.
let us look at the numbers
the best 5 year fixed rate mortgage around is 4.3 %
the best variable rate mortgage around is prime - 0.5 % = 1.75%
to simplify the calculation, we are going to pretend the best variable rate is 2% and the best fixed rate is 4% giving an artificial advantage to fixed rates, and we will also ignore the fact that the mortgage balance is smaller at year 5 than it is at year 1 making the fixed rate deal even sweeter.
In order to win with the fixed rate deal you need the variable rates to look like this:
year 1: 2%
year 2: 3%
year 3: 4%
year 4: 5%
year 5: 6%
just to break even.
prime at 6.5% 5 years from now will make half the country unemployed and homeless.
so even after the sweetener assumptions and favourable adjustments to the fixed rate mortgages it is still a clear loser.
on top of that you will have to hold this mortgage to maturity or suffer paying the IRD penalty as I am. while the penalty on a variable rate would be 3 months interest.
and not to mention the significantly worse cash flow profile a fixed rate mortgage will create.
I don't understand why anyone would get a fixed rate mortgage. I don't understand why there is even a debate about which is better !
never go for a fixed rate mortgage.
however the TD branch mortgage lady kept telling me how great fixed rate mortgages are and that the rates are rising and how it is much safer to get a fixed rate.
I think that the mortgage lady at TD is just doing her best to giving advice that she thinks is correct. The same advice she hears around the bank and gives to everyone getting a variable mortgage. however in my mind this sounded a lot like FUD.
let us look at the numbers
the best 5 year fixed rate mortgage around is 4.3 %
the best variable rate mortgage around is prime - 0.5 % = 1.75%
to simplify the calculation, we are going to pretend the best variable rate is 2% and the best fixed rate is 4% giving an artificial advantage to fixed rates, and we will also ignore the fact that the mortgage balance is smaller at year 5 than it is at year 1 making the fixed rate deal even sweeter.
In order to win with the fixed rate deal you need the variable rates to look like this:
year 1: 2%
year 2: 3%
year 3: 4%
year 4: 5%
year 5: 6%
just to break even.
prime at 6.5% 5 years from now will make half the country unemployed and homeless.
so even after the sweetener assumptions and favourable adjustments to the fixed rate mortgages it is still a clear loser.
on top of that you will have to hold this mortgage to maturity or suffer paying the IRD penalty as I am. while the penalty on a variable rate would be 3 months interest.
and not to mention the significantly worse cash flow profile a fixed rate mortgage will create.
I don't understand why anyone would get a fixed rate mortgage. I don't understand why there is even a debate about which is better !
never go for a fixed rate mortgage.
Monday, April 26, 2010
Refinancing Deal in the Works
I am refinancing one of my rental properties which I have a 50/50 partner with to take advantage of the lower rates and the bubble era high valuations that have been going around. I'm going to write about my options and the reason behind the madness.
The Property has been appraised at 900,000 the bank has only approved this refinancing to 75% loan to value so the maximum mortgage I can take is 675,000.
The current mortgage owing is 538,000 and unfortunately it is on a 5 year fixed 5.25% interest rate with 19 months left of the term. If I want to break this term the penalty interest rate differential (IRD) is a whopping 18,000.
I could blend and extend the mortgage to a new 5 year fixed term. and so not pay any penalties. however I have decided to pay the penalty and get a new 5 year closed variable rate.
It is hard to stomach an $18,000 penalty, however you have to look at it as if this cost was already incurred 3.5 years ago when the old mortgage was put together. Holding onto this mortgage till maturity will result in paying higher interest costs that more than offset the penalty. you may feel better that your not paying the penalty. but it is not a wise choice since it will cost more overall.
The option I will go with is a new 5 year closed variable rate which is going to result in the best cash flow profile for this property. The new mortgage payments are 1,000$ per month less than before and will remain constant for the next 5 years. on top of that I will get a cheque for the $117,000 half of which will be mine.
I have been in the rental property business for 7 years now, and from my experience getting a fixed rate mortgage is a costly mistake that i will never make again. when you buy a fixed rate mortgage you are saying that you know more about interest rates than the bank does. you know rates better than the market. in effect you are swimming with the sharks betting against them and you are thinking that you can win.
The Property has been appraised at 900,000 the bank has only approved this refinancing to 75% loan to value so the maximum mortgage I can take is 675,000.
The current mortgage owing is 538,000 and unfortunately it is on a 5 year fixed 5.25% interest rate with 19 months left of the term. If I want to break this term the penalty interest rate differential (IRD) is a whopping 18,000.
I could blend and extend the mortgage to a new 5 year fixed term. and so not pay any penalties. however I have decided to pay the penalty and get a new 5 year closed variable rate.
It is hard to stomach an $18,000 penalty, however you have to look at it as if this cost was already incurred 3.5 years ago when the old mortgage was put together. Holding onto this mortgage till maturity will result in paying higher interest costs that more than offset the penalty. you may feel better that your not paying the penalty. but it is not a wise choice since it will cost more overall.
The option I will go with is a new 5 year closed variable rate which is going to result in the best cash flow profile for this property. The new mortgage payments are 1,000$ per month less than before and will remain constant for the next 5 years. on top of that I will get a cheque for the $117,000 half of which will be mine.
I have been in the rental property business for 7 years now, and from my experience getting a fixed rate mortgage is a costly mistake that i will never make again. when you buy a fixed rate mortgage you are saying that you know more about interest rates than the bank does. you know rates better than the market. in effect you are swimming with the sharks betting against them and you are thinking that you can win.
Thursday, April 22, 2010
April Dividend Income Report
Dividend Lover Non Registered Portfolio: $1,656.00
Dividend Lover TSFA Portfolio: $1,823.58
Dividend Lover RRSP Portfolio: $9,719.52
Total Yearly Dividend Income before tax: $13,199.10
Since this is the first Report, there isn't much to compare to. but the idea is to continue to track and grow this number as time goes by.
Dividend Lover TSFA Portfolio: $1,823.58
Dividend Lover RRSP Portfolio: $9,719.52
Total Yearly Dividend Income before tax: $13,199.10
Since this is the first Report, there isn't much to compare to. but the idea is to continue to track and grow this number as time goes by.
REITS a Poor Man's Way to Invest in Real Estate
REITS are corporations that invest most of their assets in real estate. Some REITS specialize in a certain type of property like apartment, commercial, industrial, hotel, hospital, retirement residence etc. Most REITS invest in different provinces to provide some kind of regional diversification.
I personally own a lot of REITS, my TSFA is 100% invested in REITS and my RRSP is about 80% REITS. However the Dividend Lover non registered portfolio does not hold any REITS.
First off, REITS do not pay an eligible dividend. Therefore your dividends are 100% taxable. So REITS should not be held in a non registered account.
They are good in TSFA/RRSP because the REIT Corporation itself does not pay tax. Then since you are holding it in a TSFA/RRSP you do not pay tax either. So the result is a win win win. And whenever you have a win win win it usually means that government is losing.
I'm not going to go into too much detail explaining what REITS are you can find 100 other blogs to explain that. What I'd like to do here is to voice my opinion on investing in REITS vs. straight out investing in real-estate.
Now REITS are corporations, so they have cheaper access to capital than you personally would when you buy real-estate. However these savings are offset by the salaries payed to management. On top of that this is only true for owning commercial or industrial properties.
Interest charged by banks on residential properties is much lower than that charged for owning commercial properties. you can personally get a residential mortgage for a lower rate that the largest reit can.
The REITS themselves are leveraged because they issue debentures and have mortgages. However you could personally achieve higher leverage, either by using CMHC financing, or by putting together a creative deal. The most leveraged Reit white rock (WRK.UN) is equivalent to getting 75% mortgage financing.
The REITS are diversified, more liquid than any real property you can buy. That is true.
However REITS do not pass on to you many of the benefits of owning real-estate. Such as being able to write off expenses against the properties income from your car lease, cell phone, etc. The more properties you own the more you expenses you can get away with.
Real property also allows you to take CCA (capital cost allowance) i.e. Depreciation. You could depreciate the property and you the depreciation to offset income, and so defer taxes for years and years. Unlike REITS where you will be paying taxes on your distributions without any deferral.
Therefore it is better to buy properties than to buy REITs. I call them the poor man’s real-estate. Because you do not need much capital to get started. But much of the benefits of owning real-estate are missing.
The bottom line is, only buy REITS in and RRSP/TSFA. Never own them in a non registered portfolio. If you want exposure to real-estate in a non registered portfolio you can buy corporations that invest in real-estate such as killam (KMP) or first capital realty (FCR). Which are not operating as REITs.
I personally own a lot of REITS, my TSFA is 100% invested in REITS and my RRSP is about 80% REITS. However the Dividend Lover non registered portfolio does not hold any REITS.
First off, REITS do not pay an eligible dividend. Therefore your dividends are 100% taxable. So REITS should not be held in a non registered account.
They are good in TSFA/RRSP because the REIT Corporation itself does not pay tax. Then since you are holding it in a TSFA/RRSP you do not pay tax either. So the result is a win win win. And whenever you have a win win win it usually means that government is losing.
I'm not going to go into too much detail explaining what REITS are you can find 100 other blogs to explain that. What I'd like to do here is to voice my opinion on investing in REITS vs. straight out investing in real-estate.
Now REITS are corporations, so they have cheaper access to capital than you personally would when you buy real-estate. However these savings are offset by the salaries payed to management. On top of that this is only true for owning commercial or industrial properties.
Interest charged by banks on residential properties is much lower than that charged for owning commercial properties. you can personally get a residential mortgage for a lower rate that the largest reit can.
The REITS themselves are leveraged because they issue debentures and have mortgages. However you could personally achieve higher leverage, either by using CMHC financing, or by putting together a creative deal. The most leveraged Reit white rock (WRK.UN) is equivalent to getting 75% mortgage financing.
The REITS are diversified, more liquid than any real property you can buy. That is true.
However REITS do not pass on to you many of the benefits of owning real-estate. Such as being able to write off expenses against the properties income from your car lease, cell phone, etc. The more properties you own the more you expenses you can get away with.
Real property also allows you to take CCA (capital cost allowance) i.e. Depreciation. You could depreciate the property and you the depreciation to offset income, and so defer taxes for years and years. Unlike REITS where you will be paying taxes on your distributions without any deferral.
Therefore it is better to buy properties than to buy REITs. I call them the poor man’s real-estate. Because you do not need much capital to get started. But much of the benefits of owning real-estate are missing.
The bottom line is, only buy REITS in and RRSP/TSFA. Never own them in a non registered portfolio. If you want exposure to real-estate in a non registered portfolio you can buy corporations that invest in real-estate such as killam (KMP) or first capital realty (FCR). Which are not operating as REITs.
Friday, April 16, 2010
My Take of Preferred Shares
Fixed Income instruments are an important part of a portfolio. however holding bonds in a non registered account is a bad idea. It is also a bad idea to be 100% invested in equities. This is where preferred shares can fill a void.
Most Canadian Preferred shares pay an eligible dividend unlike bonds which pay interest income you get to take home more of your money and stop the government from reallocating it to seniors and welfare drug junkies.
Preferred shares add a new asset class to your portfolio, therefore reducing volatility ( though as a dividend investor volatility shouldn't bother you too much ), provide dividend income that is even more reliable than common share dividends, provide more security to your principal investment and depending on the type of preferred share usually offer higher dividends than common shares.
Now all these are great points, but what’s the catch? We all know there is no free lunch. The catch here is that you are forgoing any capital appreciation. Yes they are shares, but in reality they are fixed income instruments. Your dividends do not increase, and the share price does not significantly increase / decrease.
Preferred shares also expose your portfolio to interest rate risk, similar to bonds. If rates rise, these fixed dividend paying non appreciating shares, There value will drop with higher interest and rise with lower interest.
Preferred shares come in different shapes and sizes I'm not going to go over it here. But Google "guide to preferred shares" for a good pdf from Scotia bank that explains preferreds and provides some commentary.
50% of the Dividend Lover non registered portfolio is in preferred shares. But do as I say not as I do. Depending on your age and risk tolerance treat preferred shares as you would fixed income instruments to come up with the right asset mix.
My allocation in Preferreds in outsized making the portfolio more conservative because I do not own any other fixed income instruments anywhere else, and because I am using excessive leverage, therefore must lower the risk in the portfolio to balance the risk added by leverage.
Now you might be thinking that intrest rates are rising why would I buy these preferred shares? well Prepetual Preferred shares follow the 30 year government of canada bond interest rate + some kind of premium related to the issuer and other details. Changes in the short term interest rate is tempered because of the shape yield curve and long term interest rate. That and the expectation of higher interest rates down the road are already factored into the price. Your not the first person to figure out rates are rising.
Most Canadian Preferred shares pay an eligible dividend unlike bonds which pay interest income you get to take home more of your money and stop the government from reallocating it to seniors and welfare drug junkies.
Preferred shares add a new asset class to your portfolio, therefore reducing volatility ( though as a dividend investor volatility shouldn't bother you too much ), provide dividend income that is even more reliable than common share dividends, provide more security to your principal investment and depending on the type of preferred share usually offer higher dividends than common shares.
Now all these are great points, but what’s the catch? We all know there is no free lunch. The catch here is that you are forgoing any capital appreciation. Yes they are shares, but in reality they are fixed income instruments. Your dividends do not increase, and the share price does not significantly increase / decrease.
Preferred shares also expose your portfolio to interest rate risk, similar to bonds. If rates rise, these fixed dividend paying non appreciating shares, There value will drop with higher interest and rise with lower interest.
Preferred shares come in different shapes and sizes I'm not going to go over it here. But Google "guide to preferred shares" for a good pdf from Scotia bank that explains preferreds and provides some commentary.
50% of the Dividend Lover non registered portfolio is in preferred shares. But do as I say not as I do. Depending on your age and risk tolerance treat preferred shares as you would fixed income instruments to come up with the right asset mix.
My allocation in Preferreds in outsized making the portfolio more conservative because I do not own any other fixed income instruments anywhere else, and because I am using excessive leverage, therefore must lower the risk in the portfolio to balance the risk added by leverage.
Now you might be thinking that intrest rates are rising why would I buy these preferred shares? well Prepetual Preferred shares follow the 30 year government of canada bond interest rate + some kind of premium related to the issuer and other details. Changes in the short term interest rate is tempered because of the shape yield curve and long term interest rate. That and the expectation of higher interest rates down the road are already factored into the price. Your not the first person to figure out rates are rising.
CIBC Investors Edge Unadvertized Deal
CIBC is now offering 6.95 Trades for accounts above $100,000 without buying the edge advantage package.
I recently opened an RRSP account with RBC Direct Investing with the intention of transferring my RRSP from CIBC Investors edge to RBC.
RBC is offering $9.99 trades if you have more than 100,000 in total in all your accounts. I did not want to buy the CIBC edge advantage package, because I did not trade much in my RRSP. I did about 2 or 3 trades a year, Therefore CIBC was charging an outragous $24.95 per trade.
After initiating the transfer I got a call from CIBC, and they offered me $6.95 trades without buying the edge advantage package for all my accounts with them and any accounts with the same mailing address.
so I asked CIBC to stop the transfer to RBC.
A few days later RBC called me and asked why did i want to transfer out. They could not match the 6.95 trades, but they did offer me to join their "royal circle" which gave some extra features, most notably was access to Dominion Securities analyst reports, And for you leverage Lovers, they have a tiered system for margin intrest rates going down to prime for borrowing $100,000+ unlike CIBC which offer prime +1.25%The rest of the features i didn't care for.
For now my RRSP is staying with CIBC. However for you high rollers with accounts totalling $250,000+ and are using $100,000+ in margin the RBC royal circle deal is better assuming the 1.25% lower interest covers your $2.03 extra expense per trade.
I recently opened an RRSP account with RBC Direct Investing with the intention of transferring my RRSP from CIBC Investors edge to RBC.
RBC is offering $9.99 trades if you have more than 100,000 in total in all your accounts. I did not want to buy the CIBC edge advantage package, because I did not trade much in my RRSP. I did about 2 or 3 trades a year, Therefore CIBC was charging an outragous $24.95 per trade.
After initiating the transfer I got a call from CIBC, and they offered me $6.95 trades without buying the edge advantage package for all my accounts with them and any accounts with the same mailing address.
so I asked CIBC to stop the transfer to RBC.
A few days later RBC called me and asked why did i want to transfer out. They could not match the 6.95 trades, but they did offer me to join their "royal circle" which gave some extra features, most notably was access to Dominion Securities analyst reports, And for you leverage Lovers, they have a tiered system for margin intrest rates going down to prime for borrowing $100,000+ unlike CIBC which offer prime +1.25%The rest of the features i didn't care for.
For now my RRSP is staying with CIBC. However for you high rollers with accounts totalling $250,000+ and are using $100,000+ in margin the RBC royal circle deal is better assuming the 1.25% lower interest covers your $2.03 extra expense per trade.
Wednesday, April 14, 2010
Your Money Working For You
You are a CEO building a Corporation from the ground up. This Corporation is going to fund your retirement, pay for your house, kids, and whatever other comforts life comforts you desire.
The employees of this corporation are hard workers. I would even go as far as to call them slaves. These workers do exactly as you say without any complaints. Do not require a salary, do not require health insurance, can be redeployed to do different jobs no training required, and will outlive you and continue working after you are long gone.
No I'm not talking about Robots. I'm talking about Dollars. Every Dollar you own is an employee in your corporation. You can put him to work doing various tasks, and he will produce more Dollars.
This Corporation once big enough will support and eventually replace your need to produce income through employment.
When you get your pay check and spend all of it. You have sold away some of you employees in return for whatever goods/services you spend normally spend you pay check on. These employees are gone and are now working for someone else.
However if you can retain part of your pay check, you can deploy these employees do work for your corporation and grow your corporation.
Your Money, Your Employees, Your Corporation.
The employees of this corporation are hard workers. I would even go as far as to call them slaves. These workers do exactly as you say without any complaints. Do not require a salary, do not require health insurance, can be redeployed to do different jobs no training required, and will outlive you and continue working after you are long gone.
No I'm not talking about Robots. I'm talking about Dollars. Every Dollar you own is an employee in your corporation. You can put him to work doing various tasks, and he will produce more Dollars.
This Corporation once big enough will support and eventually replace your need to produce income through employment.
When you get your pay check and spend all of it. You have sold away some of you employees in return for whatever goods/services you spend normally spend you pay check on. These employees are gone and are now working for someone else.
However if you can retain part of your pay check, you can deploy these employees do work for your corporation and grow your corporation.
Your Money, Your Employees, Your Corporation.
Cash Flow is King
We all heard Robert Kiyosaki rhetoric. I generally dislike the guy’s methods, predatory seminars and the entire network marketing crowd. Though I must agree with him when it comes to his opinions on cash flow.
Say you are putting together a deal. Rental real-estate, a business plan or whatever your are trying to put together. It is important to take a good look at the cash flow projections.
Yes it’s great that you can make money later, off some kind of capital gain. But good cash flow makes a deal even sweeter.
Say you have project A that will give you a decent capital gain 5 years from now. The deal will set you back $100 a month. I.e. project A has $100 negative cash flow. How many of these projects can you maintain at the same time? 1, 2, 10?
On the other hand take project B, it will produce no capital gains at all in 5 years, however it does generate $100 a month in cash flow. Now I'm going to ask. How many of these projects can you maintain? Of course the answer is as many as you can get your hands on.
The point I'm trying to make is that even though some endeavours have a big payoff later. As long as they carry a negative cash flow there will be a limit on how many you can have going at the same time.
A deal that generates a positive cash flow does not limit the number of deals you can simultaneously make. In fact it opens doors to bigger and better deals. With the excess cash flow providing more flexibility for the next deal you make.
Now I'm not saying positive cash flow is easy to come by. In fact the truth is, the benefits of positive cash flow are not a secret, and in fact it is highly sought after. You have to put on your creative deal making hat.
Say you are putting together a deal. Rental real-estate, a business plan or whatever your are trying to put together. It is important to take a good look at the cash flow projections.
Yes it’s great that you can make money later, off some kind of capital gain. But good cash flow makes a deal even sweeter.
Say you have project A that will give you a decent capital gain 5 years from now. The deal will set you back $100 a month. I.e. project A has $100 negative cash flow. How many of these projects can you maintain at the same time? 1, 2, 10?
On the other hand take project B, it will produce no capital gains at all in 5 years, however it does generate $100 a month in cash flow. Now I'm going to ask. How many of these projects can you maintain? Of course the answer is as many as you can get your hands on.
The point I'm trying to make is that even though some endeavours have a big payoff later. As long as they carry a negative cash flow there will be a limit on how many you can have going at the same time.
A deal that generates a positive cash flow does not limit the number of deals you can simultaneously make. In fact it opens doors to bigger and better deals. With the excess cash flow providing more flexibility for the next deal you make.
Now I'm not saying positive cash flow is easy to come by. In fact the truth is, the benefits of positive cash flow are not a secret, and in fact it is highly sought after. You have to put on your creative deal making hat.
Tuesday, April 13, 2010
When to use Leverage
The effect of leverage is to amplify gains (or losses). You need be aware of leverage, respect it, and use it properly in order to build wealth.
Every other well off rich guy got there by borrowing as much money as possible, starting a company, then have the company borrow as much as possible.
Leverage is an essential part of wealth building especially in the early stages where you need outsized gains and can afford the risk. You have less on the line. You can fall down, get up and walk again with much less consequences than later in life.
The news keeps saying how banks were leveraged at 30 to 1, and how insane it is. However consider this. When you buy a rental property with a conservative 20% down payment, you are leveraging 5 to 1. Put 5% down and you are already at 20 to 1 leverage. Is that risky? Yes. But there is nothing wrong with it, especially when whatever you are leveraging has decent interest coverage, i.e. produces enough income to cover interest and more.
In fact leverage is one of the most attractive features of real-estate. A rental property that yields 6%, financed with 3% debt and 20% downpayment, gives an 18% yield. If it wasn't for leverage why would you go through all the trouble? You could go buy some discount perpetual preferreds that yield 6% and be done with it.
What to leverage
What is being leveraged is also an important factor. If that rental property is legal, insured, fire retrofit, has AAA tenants and produces a decent interest coverage, and the interest rate on your loan is somewhat fixed. Then you should leverage as much as possible. If you can even pull off 100%+ leverage good for you go for it.
On the other hand, if what you are buying is a single family home converted into a low income rooming house, the fire department and the city are calling you all the time about zoning and fire safety issues, half the tenants are on welfare and the place is falling appart. even though you could be generating a thoeretical 12% yield. do not even think about leveraging something like that.
I used real-estate here as an example, this also applies to stocks, its is dangerous to leverage a technology stock trading at 40x+ PE, however it is perfectly fine in my books to leverage a utility or pdf1 preferred stock or other high investment grade instruments.
When you use leverage you are adding risk, interest rate risk, amplifying gains/losses. You need to balance this out by using a safer investment.
The other factor to consider is your own risk tollerence. If you are getting ready for retirement part of your portfolio should be in cash equivalents, forget about leverage. If you are still in your early 20's then you should probably not leverage either because of your lack of experience in whatever you are investing in. add leverage as you gain experience. so probably in your mid 20's until you start having those little dependants we call kids. then its time to adjust your risk tollerance.
The banks who were leveraged at 30 to 1 thought their investments were AAA rated; meaning the risk to their principal involved was close to nil. Even though they were wrong. The lesson is only leverage safer investments.
Every other well off rich guy got there by borrowing as much money as possible, starting a company, then have the company borrow as much as possible.
Leverage is an essential part of wealth building especially in the early stages where you need outsized gains and can afford the risk. You have less on the line. You can fall down, get up and walk again with much less consequences than later in life.
The news keeps saying how banks were leveraged at 30 to 1, and how insane it is. However consider this. When you buy a rental property with a conservative 20% down payment, you are leveraging 5 to 1. Put 5% down and you are already at 20 to 1 leverage. Is that risky? Yes. But there is nothing wrong with it, especially when whatever you are leveraging has decent interest coverage, i.e. produces enough income to cover interest and more.
In fact leverage is one of the most attractive features of real-estate. A rental property that yields 6%, financed with 3% debt and 20% downpayment, gives an 18% yield. If it wasn't for leverage why would you go through all the trouble? You could go buy some discount perpetual preferreds that yield 6% and be done with it.
What to leverage
What is being leveraged is also an important factor. If that rental property is legal, insured, fire retrofit, has AAA tenants and produces a decent interest coverage, and the interest rate on your loan is somewhat fixed. Then you should leverage as much as possible. If you can even pull off 100%+ leverage good for you go for it.
On the other hand, if what you are buying is a single family home converted into a low income rooming house, the fire department and the city are calling you all the time about zoning and fire safety issues, half the tenants are on welfare and the place is falling appart. even though you could be generating a thoeretical 12% yield. do not even think about leveraging something like that.
I used real-estate here as an example, this also applies to stocks, its is dangerous to leverage a technology stock trading at 40x+ PE, however it is perfectly fine in my books to leverage a utility or pdf1 preferred stock or other high investment grade instruments.
When you use leverage you are adding risk, interest rate risk, amplifying gains/losses. You need to balance this out by using a safer investment.
The other factor to consider is your own risk tollerence. If you are getting ready for retirement part of your portfolio should be in cash equivalents, forget about leverage. If you are still in your early 20's then you should probably not leverage either because of your lack of experience in whatever you are investing in. add leverage as you gain experience. so probably in your mid 20's until you start having those little dependants we call kids. then its time to adjust your risk tollerance.
The banks who were leveraged at 30 to 1 thought their investments were AAA rated; meaning the risk to their principal involved was close to nil. Even though they were wrong. The lesson is only leverage safer investments.
Monday, April 12, 2010
The 3% rule
Financial Freedom is as simple as this one line equation. If it were teaching a class in finance this would be the first thing I would tell my students on the first day.
If you can live off 3% of your net worth annually, then you are set. 3% is a low number, and you need a lot of assets to be able to live off of 3% a year but that’s the cold hard truth. Anyone telling you otherwise is misguided.
Now if your thinking "I have portfolio of dividend stocks that are already paying me X% dividends, can't I simply live off the dividends?" the answer sadly is no.
First you have to pay tax on your dividend income. You are smart enough to buy Canadian corporations paying an eligible dividend, so you've reduced your tax burden good job. But unfortunately you still have to pay some tax.
Second inflation is eating away at your income stream. Your dividends need to increase as time goes by. Sure companies increase their dividends. That’s good. But if the yield on your portfolio is more than 3% it means you have stocks that are giving out a high payout ratio, and so have less retained earnings to reinvest in capital expenditures and so grow their earnings. Therefore you must reinvest some of the dividends earned to keep the dividend income increasing to fight off inflation. Same goes if you have any fixed income instruments, whatever yield you get above 3% must be reinvested in order to keep up with inflation.
Thirdly your assets need to last more than 30 years. You’re not 65 years old. If your income stream dies out after 30 years you are in trouble. I am 30 years old; I need my income stream to last for at least 65 years. Therefore one must model for a perpetual inflation adjusted income stream. Not a broke in 30 years model.
A 3% withdrawal rate would allow your assets to support an inflation adjusted income stream in perpetuity.
Expenses =< Net Assets * 0.03Now you read all these retirement experts touting that with a 4% withdrawal rate you will not likely outlive your money. However these models are built with assumptions. Many assumptions. Such only needing to sustain that withdrawal rate for 30 years, because you’re retiring at 65 and dyeing penniless at 95.
If you can live off 3% of your net worth annually, then you are set. 3% is a low number, and you need a lot of assets to be able to live off of 3% a year but that’s the cold hard truth. Anyone telling you otherwise is misguided.
Now if your thinking "I have portfolio of dividend stocks that are already paying me X% dividends, can't I simply live off the dividends?" the answer sadly is no.
First you have to pay tax on your dividend income. You are smart enough to buy Canadian corporations paying an eligible dividend, so you've reduced your tax burden good job. But unfortunately you still have to pay some tax.
Second inflation is eating away at your income stream. Your dividends need to increase as time goes by. Sure companies increase their dividends. That’s good. But if the yield on your portfolio is more than 3% it means you have stocks that are giving out a high payout ratio, and so have less retained earnings to reinvest in capital expenditures and so grow their earnings. Therefore you must reinvest some of the dividends earned to keep the dividend income increasing to fight off inflation. Same goes if you have any fixed income instruments, whatever yield you get above 3% must be reinvested in order to keep up with inflation.
Thirdly your assets need to last more than 30 years. You’re not 65 years old. If your income stream dies out after 30 years you are in trouble. I am 30 years old; I need my income stream to last for at least 65 years. Therefore one must model for a perpetual inflation adjusted income stream. Not a broke in 30 years model.
A 3% withdrawal rate would allow your assets to support an inflation adjusted income stream in perpetuity.
Are we there yet? Dividend Lover Finacial Freedom Self Test
We all dream of the day when we can finally quit the rat race, so here is my universal test for are you there yet or not.
Say you quit your day job. That means your salary will stop. You are claiming that you would be able to live a certain life style using a standard you see as acceptable for the rest of your life.
Before you go around the office and tell it like it is to everyone from the ceo to the janitor. I suggest going through the Dividend Lover Financial Freedom Self Test.
For the next 6 months, you are going to pretend your salary does not exist. You are claiming you can live without it. Okay then let’s see you live without it. Take you salary all of it. Not 75% not 90% of it, all of it, and deposit it into a savings account for the next 6 months.
If you can live off whatever alternate income streams you have put together for 6 months, then you have earned your financial freedom, and have build up a nice emergency cash cushion to set you off on your way. Congratulations you have crossed the finish line and beat the rat race.
If you can't pull off 6 months of 100% saving your salary, then my friend you are not ready yet. Get back to building alternate income streams; dividend investing etc. you still need your salary. Try again next year.
Some of you may not agree with the 100% savings rate because of claims that for example my transportation costs will be less, I will spend less on clothes, I don't have to buy those expensive lunches at the office cafeteria, well I disagree, you have to save 100% because you will drive your car around when you quit, you will wear clothes, you can't be naked all the entire time. And you will eat out in restaurants instead of a cafeteria. That and you need the extra safety margin for unexpected expenses ( or expenses you forgot to budget for )
Even if you fail the test don't be discouraged. you now know how close you are to your target. Say after 6 months you managed to save 50% of that salary, guess what you are half way there.
Say you quit your day job. That means your salary will stop. You are claiming that you would be able to live a certain life style using a standard you see as acceptable for the rest of your life.
Before you go around the office and tell it like it is to everyone from the ceo to the janitor. I suggest going through the Dividend Lover Financial Freedom Self Test.
For the next 6 months, you are going to pretend your salary does not exist. You are claiming you can live without it. Okay then let’s see you live without it. Take you salary all of it. Not 75% not 90% of it, all of it, and deposit it into a savings account for the next 6 months.
If you can live off whatever alternate income streams you have put together for 6 months, then you have earned your financial freedom, and have build up a nice emergency cash cushion to set you off on your way. Congratulations you have crossed the finish line and beat the rat race.
If you can't pull off 6 months of 100% saving your salary, then my friend you are not ready yet. Get back to building alternate income streams; dividend investing etc. you still need your salary. Try again next year.
Some of you may not agree with the 100% savings rate because of claims that for example my transportation costs will be less, I will spend less on clothes, I don't have to buy those expensive lunches at the office cafeteria, well I disagree, you have to save 100% because you will drive your car around when you quit, you will wear clothes, you can't be naked all the entire time. And you will eat out in restaurants instead of a cafeteria. That and you need the extra safety margin for unexpected expenses ( or expenses you forgot to budget for )
Even if you fail the test don't be discouraged. you now know how close you are to your target. Say after 6 months you managed to save 50% of that salary, guess what you are half way there.
Saturday, April 10, 2010
Yield on Cost, A Misleading and Meaningless Term
Companies paying a sustainable and consistently growing dividend are considered the holy grail of dividend investing. This has led some bloggers to coin the term yield on cost as a method to keep track of their dividend returns.
Yield on cost is calculated by dividing current dividend income by the dollar amount originally paid to purchase the stock. As corporations grow their dividends the yield on your original investment grows.
Say for example you purchase 100 shares of a stock at $10 a share, yielding $10 every quarter, and so you’re getting a 4% yield. And your yield on cost is 4%
5 years later after some dividend increases the shares are paying $16 every quarter so you are getting a 6.4% yield on cost
However this term fails to take inflation into account. This makes yield on cost totally meaningless. Worse it makes it misleading.
The above example used 5 years, but what if you do not know how many years have passed for this yield on cost calculation, doesn't that make it meaningless?
Say we bought one Enbridge share for a split adjusted $1.72 in 1981, our yield on cost today would be a whopping 100%. Big number, but what does it tell you.... nothing. The shares were bought using 1981 dollars. The yield on cost does not care to take this into account. In today’s dollars your investment is worth $50 and your current yield is 4%.
Yield on cost is a useless feel good number because it ignores inflation. a more useful number would be yield on real cost.
Yield on cost is calculated by dividing current dividend income by the dollar amount originally paid to purchase the stock. As corporations grow their dividends the yield on your original investment grows.
Say for example you purchase 100 shares of a stock at $10 a share, yielding $10 every quarter, and so you’re getting a 4% yield. And your yield on cost is 4%
5 years later after some dividend increases the shares are paying $16 every quarter so you are getting a 6.4% yield on cost
However this term fails to take inflation into account. This makes yield on cost totally meaningless. Worse it makes it misleading.
The above example used 5 years, but what if you do not know how many years have passed for this yield on cost calculation, doesn't that make it meaningless?
Say we bought one Enbridge share for a split adjusted $1.72 in 1981, our yield on cost today would be a whopping 100%. Big number, but what does it tell you.... nothing. The shares were bought using 1981 dollars. The yield on cost does not care to take this into account. In today’s dollars your investment is worth $50 and your current yield is 4%.
Yield on cost is a useless feel good number because it ignores inflation. a more useful number would be yield on real cost.
Friday, April 9, 2010
RBC Skip a payment Mortgage Option
RBC mortgages offer a feature called "skip a payment" where you don't make a mortgage payment that month, and the interest is added to the principle. RBC allows you to do this once per anniversary year, starting from the second year of your mortgage.
This will increase your mortgage amortization, and cause you to pay more interest over the life of your mortgage. But on the other hand you will have cheap more money in your hands to invest.
One of my rental properties is financed through RBC, and I tend to call them up every year and ask them to skip a payment. It’s easy to find a place to deploy this new found capital to earn more than the prime -0.4 of tax deductable debt it is costing. So in my books skipping a mortgage payment is a win win situation.
However this year I was presented with the opportunity to reamortize this mortgage, since when I first got it prime has dropped significantly, and the mortgage amortization had dropped to about 15 years.
My goal here is to increase the cash flow, so I had to figure out what to do:
1. skip a payment this month then re-amortize the mortgage.
2. re-amortize the mortgage then skip a payment next month.
I had to sleep on this one, for the longest time I thought that both were equivalent. In both cases you’re not paying anything next month. So the amount you pay is the same. The amount you owe the bank is the same.
However now that I am older (yes) and wiser (not really) I realized that option 2, re-amortize then skip would produce better cash flow. The reason being is that the re-amortization would occur over a longer period of time. (The new amortization will include the skipped month) while in option 1 the new amortization will not include the skipped month. Therefore the monthly payments therefore the cash flow in option 2 will be slightly better.
This will increase your mortgage amortization, and cause you to pay more interest over the life of your mortgage. But on the other hand you will have cheap more money in your hands to invest.
One of my rental properties is financed through RBC, and I tend to call them up every year and ask them to skip a payment. It’s easy to find a place to deploy this new found capital to earn more than the prime -0.4 of tax deductable debt it is costing. So in my books skipping a mortgage payment is a win win situation.
However this year I was presented with the opportunity to reamortize this mortgage, since when I first got it prime has dropped significantly, and the mortgage amortization had dropped to about 15 years.
My goal here is to increase the cash flow, so I had to figure out what to do:
1. skip a payment this month then re-amortize the mortgage.
2. re-amortize the mortgage then skip a payment next month.
I had to sleep on this one, for the longest time I thought that both were equivalent. In both cases you’re not paying anything next month. So the amount you pay is the same. The amount you owe the bank is the same.
However now that I am older (yes) and wiser (not really) I realized that option 2, re-amortize then skip would produce better cash flow. The reason being is that the re-amortization would occur over a longer period of time. (The new amortization will include the skipped month) while in option 1 the new amortization will not include the skipped month. Therefore the monthly payments therefore the cash flow in option 2 will be slightly better.
Thursday, April 8, 2010
Say no to Bonds ( unless its in you RRSP/TSFA )
Whenever someone tells me they are holding bonds as part of their fixed income allocation in a non registered account I sit them down and explain to them why they should have told me sooner.
In short, bonds are evil. they generate interest income. Interest income that is taxed at a prohibitive 46.41% rate, unlike dividends. when the tax man is done with you, you only get to keep $53.59 out of $100.00 unlike eligible dividends where you get to keep $73.43 from $100.00 hence the 1.37022 money factor used to compare dividend income with interest income.
It is even more ludicrous if you have a non tax deductible mortgage on your primary residence. go sell your bonds immediately, and pay off the mortgage. a mortgage in essence is a short bond position. if you own both bonds and a mortgage. you essentially have a bond spread position, and the spread is not in your favor.
The correct way to invest in fixed income securites in an non tax advantaged portfolio is to invest in preferred shares. ( a topic for a future post ). These provide you with eligible dividend income, and much of the security of pricipal that comes with bonds.
In short, bonds are evil. they generate interest income. Interest income that is taxed at a prohibitive 46.41% rate, unlike dividends. when the tax man is done with you, you only get to keep $53.59 out of $100.00 unlike eligible dividends where you get to keep $73.43 from $100.00 hence the 1.37022 money factor used to compare dividend income with interest income.
Dividends received by Canadian residents from Canadian corporations are taxed at a lower rate than interest income due to the dividend tax credit, which recognizes that a dividend is paid from the after-tax earnings of the corporation. Using the most recent proposed 2010 Ontario tax rates, an investor in the highest income tax bracket pays 46.41% tax on interest income and 26.57% on dividend income. Hence, the lower tax rate applied to dividends provides a significant advantage. After tax, an investor would retain $73.43 from $100.00 in dividends, but only $53.59 from interest income. Therefore, an investor would need approximately $1.37 ($73.43/$53.59) of interest income to equal $1.00 of dividend income before taxes are paid. This difference in the amount of income required before taxes is described as a “pre-tax interest equivalent” amount. This can be calculated by multiplying the amount of dividend income by a factor (1.37022 in the case of Ontario) that takes into account the different tax rates for dividends and interest.No one under any circumstances should own bonds in a non tax advantaged portfolio. It is ludicrous to do so.
It is even more ludicrous if you have a non tax deductible mortgage on your primary residence. go sell your bonds immediately, and pay off the mortgage. a mortgage in essence is a short bond position. if you own both bonds and a mortgage. you essentially have a bond spread position, and the spread is not in your favor.
The correct way to invest in fixed income securites in an non tax advantaged portfolio is to invest in preferred shares. ( a topic for a future post ). These provide you with eligible dividend income, and much of the security of pricipal that comes with bonds.
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