RRSP's continue to be a valid (although underused) savings strategy

September 30, 2010

RRSP’s continue to be a valid tax and investment strategy
“When investing for retirement, no other registered plan offers tax advantages as compelling as the RRSP,” says Jamie Golombek, Tax Advisor for CIBC.  Annual contributions reduce tax owing and investments grow tax-deferred well into retirement. With lower retirement incomes and income splitting available between spouses, withdrawals from RSP’s are typically taxed at lower rates.
RRSP contributions are 18% of an individual’s earnings from the prior year, the amount of income needed in 2009 to generate the maximum contribution room of $21,000 is $122,222. Looking ahead, the RRSP contribution limit for 2010 has been increased to $22,000.

Next year, in 2011, will be the first year the RRSP limit increase will be indexed to inflation, at $22,450, generated when 2009’s income is at least $124,722.

Higher-income earners can take advantage of their spouse or partner’s lower tax rate once they begin withdrawing from their RRSP in retirement by contributing to a Spousal RRSP now. Higher-income contributors receive a tax deduction for contributions made to their spouse or partner’s plan and spousal contributions do not interfere with the other spouse’s or partner’s own RRSP limit.

RRSPs can be used to invest in financial goals other than retirement, such as education or a first home. First-time homebuyers can withdraw up to $25,000 tax-free from an RRSP under the Home Buyers’ Plan and can repay the funds, interest-free, over a 15-year period. Failure to repay, however, will cause the amount to be included in income.

Under the Lifelong Learning Plan investors can also withdraw up to $10,000 in a calendar year and up to $20,000 in total from an RRSP to help pay for training or education for yourself or your spouse or partner. The LLP withdrawal must also be repaid, over a 10-year period, to avoid having it included in income.

Many investors find it much easier to make small but regular contributions than to come up with large lump sums annually. Consider setting up a regular investment plan for clients to ensure that contributing to their RRSPs is a priority all year long.

For personal RRSP contributions, I recommend applying to CRA using Form T1213 for a reduction of payroll tax at source. By doing so, you can benefit from a tax reduction throughout the year, instead of waiting until you file your tax return next spring.

Market Timing – Oct 28 09

November 5, 2009

The appeal of market timing is almost too good to resist. Who wouldn’t want to have sold their equities (stocks) in early Sept of 2008 (high point) and bought in March of 2009 (low point)? We either feel we’ve missed a great opportunity or are upset because we feel we’ve lost something when comparing our statements over the last few years. Much of the media and many investment newsletters claim significant returns can be made by timing the market. The reality is, it is extremely difficult to market time consistently. No one has developed a consistent methodology for successfully timing markets that improves returns over holding a 100% equity portfolio over the long term.
If asked to name the greatest investors alive today or in history, you might name Benjamin Graham (Father of value investing), Warren Buffet (one of his students), Charles Brandes (Benjamin Graham’s stock broker) or Peter Lynch (manager of one of the largest and most successful mutual funds in history – Fidelities Magellan). None of these great investment managers were market timers – they were stock pickers. They would buy a stock when it was undervalued and then sell it when it was over valued and then buy something else. They focused on the valuation of the stock – not the market. Their track record of returns proves why they are held in such high esteem.
Try naming a well known “market timer”. There may be a few people that could come up with individuals who called one or two major stock market corrections – but not one market timer has been able to consistently call market declines or bear markets. The market crash in Oct of 1987 was called by Marc Faber (one of a few who guessed right) and he was able to “dine out” on that call for years. He continues to publish a newsletter “Gloom Boom and Doom” despite its relatively low rating for accuracy of predictions. Due to the appeal of market timing, calling just one major stock market decline correctly would be highly profitable to anyone. Media interviews and a successful book are a given.
Benjamin Graham developed an investment approach called “value investing” which is accepted and practiced by many investment managers and has withstood the test of over 60 years of market history. There is no similar “market timing” methodology as widely accepted – although many continue to propose they’ve found a method that works or “guarantees you can beat the market!” If there was a method that worked consistently, it would be taught to chartered financial analysts and they would be using it.
A U.S. advisor modeled a 50-50 stock and bond portfolio of US stocks going back to 1925 and compared it to an approach where he increased stock exposure when stocks were considered cheap and decreased stock exposure when stocks were considered expensive. The portfolio that was adjusted annually did do better than the straight 50/50 stock and bond portfolio, but it still didn’t do as well as an all stock portfolio! Adjusting allocations with market conditions will do better than a fixed allocation but riding through the ups and downs of the stock market seems to be the way to make the most returns in equities.
The article linked below analyzed the accuracy a market timer would have to achieve to better the returns of a portfolio fully invested in stocks. The analysis suggests a market timer would have to be right 74% of the time to do better than just staying fully invested. In other words make 3 out of 4 correct calls to beat a 100% fully invested stock portfolio.
Although the evidence to the contrary, market timing will continue to be appealing for a number of reasons;
1 – Stock markets have experienced long periods of decline. Investors become anxious and impatient for returns to materialize. There have been approximately 5, 10 year periods where US stocks were flat to slightly negative since 1930, given the volatility of stock markets, anyone can pick a number of periods between stock market peaks and troughs where returns are negative. However, just holding on to the equities until the recovery occurred brought the returns back to positive numbers. We need to think about owning stocks as we do owning a house – despite temporary declines in both types of assets, we need a certain allocation to stocks in our portfolio for their growth and future income just like we need a home for its (tax free) growth and shelter.
2 – Avoiding pain is three times more important to us then experiencing pleasure. One of our most basic and necessary survival instincts is to avoid pain. No longer does famine or the saber tooth tiger represent danger – now it’s the stock market because of the financial security we need. We also see greater benefit to an immediate result than we do from long term results. Avoiding the immediate pain of a declining portfolio is more appealing than the long term financial security of that portfolio. In a world where the real risk is financial security, investors who recognize the long term benefits equities offer – and have designed portfolio’s with sufficient cash and bonds to protect against market declines, do not necessarily see a drop in market value as painful. They see it as an opportunity to purchase or rebalance into equities which will recover and provide significant returns in future.
3 – The belief that this time is different. Although 200 years of market history has proven stocks have recovered from declines and gone to higher peaks each and every time – there continues to be a believe that, “this time it’s different!”. Since none of the major market declines in the last 75 years previous to the one we experienced in the fall of 2008, have occurred during our investment life time, we feel that the one we are experiencing is somehow different from all the others. Stock market history tells us, although each market decline occurs for a different reason – all declines follow similar patterns. It’s the timing of these patterns which is different and cannot be predicted in advance.
Although market timing has not proven to be a consistently successful strategy there are strategies and tactics that have. We’ll discuss these in next months’ newsletter.


October 24, 2009

As I write this letter, it’s two weeks from the end of the third quarter in what continues to be one of the most eventful years we’ve seen in stock markets and the economy in decades.
It’s also one year since the weekend that shook the foundations of Wall Street and of the global financial system – when Lehman Brothers collapsed, Merrill Lynch vanished as an independent entity and AIG was taken over by the U.S. government.

In light of that, I thought it might be worthwhile to briefly summarize where we’ve been this year, where we are today and the prospects for the period ahead – and also to highlight some lessons from last year’s financial collapse.

Where we’ve been

Six months ago, in early March, it truly did feel like the world might be coming to an end – talk of a return to a Great Depression like economy dominated radio, television and newspaper. Understandably, fear was rampant – and stocks responded to these nightmarish scenarios by hitting the lowest levels in years, with financials especially hard hit.

Although no one knew it at the time, that turned out to be the bottom. Since then, we’ve seen the economy move back from the precipice – there is a growing consensus that we’ll return to economic growth in the second half of this year. The Economist magazine recently ran a cover story discussing the extent to which the economic recovery was led by Asia.

As a result, we’ve had a strong recovery in markets – from their bottom in the beginning of March, stock markets are up over 50%, retracing a good portion of the losses since last fall.

The second quarter of this year, from March to June, was especially strong when compared to all quarters since 1956.  In that time the Canadian market has only had three quarters that rose more than this one.

In the meantime, here are six lessons from the last twelve months:

1. We were reminded of just how volatile stocks can be.

2. And of the importance of true diversification.

3. Many investors discovered that they’re less comfortable with risk and volatility in their portfolio than they had believed.

4. Investors were also reminded of the need to focus on what they can control – understanding cash needs and thinking through how much risk they can live with to fund those needs.

5. In some cases, investors began rethinking retirement plans as a result.

6. Finally, we were reminded that in today’s world, we need to expect the unexpected.

Where we are today

A year ago, the market was characterized by rampant optimism. The Canadian market had hit a new high in June of 2008 and any concerns were set aside as minor annoyances.  By contrast, six months ago the market was overwhelmed by absolute pessimism – there was no sign of hope anywhere.

Today, the market is somewhere between those two extremes and many investors can be characterized as extremely nervous.

As a general rule, I think a certain level of healthy concern is positive – what gets investors in trouble is an excess of either optimism or pessimism. While today’s mood may be too much on pessimistic side, I think being cautious in the current market makes sense … provided that prudent caution doesn’t cross the line into panicked inertia.

The good news is that there are still opportunities for investors who are prepared for short term volatility. I spend a lot of time listening to the best market minds and to managers who have lived through multiple cycles. I am reassured that most say that they are still finding very good value – not to the extent that they did earlier this year, but still well ahead of what they would have seen a year ago.

The outlook going forward

In August, Business Week ran a cover story called “The case for optimism.”

The premise was simple: Beyond the issues facing the global economy, there are many underlying positives that give cause for optimism if we look out two and three years and beyond.

There are things happening under the surface that will drive economic growth … and with that economic growth will come growth in stock prices. Examples include the positive impact of technology, the recovering US housing market, the revitalization of economies and the incredible energy from the developing world’s educated youth and emerging middle class

Click Here to access all the Business Week stories on The Case for Optimism:

Click Here to view a three minute video with interviews with CEOs of Dow Corning, Eastman Kodak and Intuit.


Let me close by talking about market volatility.

In 1907, U.S. financier J. Pierpoint Morgan single handedly averted a banking panic among U.S. investors.  Later in life, someone asked him his best guess on the direction of markets. His answer: “They will go up and they will go down.”

One hundred years later, that’s still the best answer to someone looking for a short term market forecast. No one can predict market movements in the immediate period ahead – all we can do is understand clearly how much short term volatility we can live with, adjust our portfolios accordingly and stay focused on the horizon as we deal with the rough waters. No one likes volatility … but for most of us it’s the necessary price to arrive at our ultimate destination.

“The price of long term out performance is short term volatility.”

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