The Wealth Management Blog

“There is too much debt in the world and if Greece defaults on its debt, this will be good for the markets in the short term, especially if it defaults big."

That was the message we heard yesterday morning from Barry Allen of Marret Asset Management, considered by many to be the top manager of high yield bonds in Canada and one of the external managers we use for yield mandates.

Barry was in to give us an update and his view was uncharacteristically optimistic: “Now that the European Central Bank has put a floor under European banks with its 3-year loans, smaller governments can now default without bringing down the banking system."

Barry contends that Greece and Portugal should, and will, default and this will be good for the overall global deleveraging that will continue for several years.

He also reminded us that Italy runs a structural budgetary surplus and has a strong industrial base that “makes good things people all over the world want to buy", especially luxury goods desired by the growing affluent classes in emerging markets.

He thinks Italy will be successful in its efforts to crack down on tax evaders, citing the amusing anedote of the recent tax raid on the luxurious winter resort of Cortina D'Ampezzo.  Tax inspectors found 42 top-end cars registered to people with declared annual incomes of 22,000 Euros (about $29,000 CAD). The investigation highlights the problem of tax collection in Italy, which Barry thinks will ultimately be resolved given the strong sense of nationalism and patriotism in that country; the upper middle class “will do their part to put the country back on sound fiscal footing."

Barry's overall message was that Europe is in better shape than the world has given it credit for. Not exactly a screaming ‘buy signal’, but still upbeat news for a grey January morning in Toronto.

"Am I wealthy?"

It’s a question we are often asked by clients.

Given that many of them live modest lifestyles, a lot of them don't feel wealthy. 

A study by Fidelity Investments found that 42% of American millionaires do not feel wealthy. The investable asset level at which they said they would feel wealthy?: $7.5 million.

Ironically, of the 58% who said they do feel wealthy, $1.75 million of investable assets was the amount at which they reported feeling wealthy.

So who is ‘wealthy’ in Canada?

This month's issue of Report on Business magazine published a summary of Canada’s highest income earners: The top 1% -- 246,000 Canadians – earn a minimum of $169,300 per year; the average income for this group is just over $400,000.

The top 0.1% make an average of $1.49 million and a rarefied 0.01% of Canadians get by on $3.83 million a year.

Still, these people are what Thomas J. Stanley, author of the Millionaire Next Door would call ‘Income Statement Affluent’; income being an imperfect predictor of net worth.

According to Investor Economics, a research firm specializing in financial services, there are an estimated 562,000 households in Canada having more than $1 million in investable assets and 19,000 households with $10 million or more.  According to Report on Business magazine, there are 24 billionaires in Canada.

Perhaps wealth, like age, is just a number; it's more about how you feel.

Do you feel wealthy? How much would you need to feel wealthy? What would happen if you decided to feel wealthy even if your actual net worth doesn’t yet meet your definition of wealthy?

Yesterday marked what could be a watershed moment for investors in Europe as Germany managed to sell €3.9 billion worth of six months bonds at a negative interest rate. Marginally negative, but it demonstrates that investors are so worried about the economy in Europe that they are willing to pay Germany for the privilege of lending it money. When these bonds mature, investors will receive less money than they invested. They would quite literally be better off sticking their money under a mattress.

Investor sentiment worldwide is cautious with a tremendous amount of cash sitting on the sidelines. Recently, I’ve had several conversations with prospective investors who have asked whether their capital would be safe in GICs. The answer to this question is not straightforward as we first have to define what “safe” means.

If the question is whether I believe that investors will get their money back and earn a return on GICs, then the answer is “yes”. The Canadian banking system is strong and well capitalized. There is no reason to believe that investing in the debt of these banks is risky, unlike the view many investors are taking towards European banks.

The majority of high net worth investors worked very hard to build their net worth and are naturally risk averse. They generally state that at the very least, they want to preserve the value of their portfolio. I generally interpret this to mean that they want the portfolio at a minimum, to grow greater than the rate of inflation. By stating they want to preserve the value of their portfolio they are really trying to say, “preserve my standard of living”.

So, if the question is whether I believe that investors will preserve the value of their capital by investing in GICs, the answer is “no”. A dollar today, invested in a GIC will be worth less in the future.

Investing in a locked-in one year GIC with a major bank will result in a return of 1.15% on which tax must be paid at the highest marginal rate (for this purpose assume 46.41%). The Bank of Canada puts the rate of inflation at 2.90% on a year over year basis. Since last March, the inflation rate has hovered around 3.0%, at the higher end of the Bank of Canada's target range. In the graph, I have plotted how a portfolio invested in GICs would grow, after tax, if invested at 1.15%. I have also plotted the effect inflation would have on the cost of goods.

For the purpose of this exercise, I have assumed that these rates hold steady going forward. In five years, the purchasing power of a dollar invested in a GIC would decline by 10.6%. In other words, a dollar invested in GICs today will be worth 89.4 cents five years from now, if inflation stays the same. With so much cash flooding the system, inflation rates may well be higher in future years, and the return more negative.

GICs can be a good solution for the short term when uncertainty remains high, but they will do little to protect the value of your portfolio or your standard of living over time. So what do you do?

We still believe a well diversified portfolio managed with some cash (i.e. T-bills) as a defensive measure and a a client’s tolerance for risk in mind will outperform the markets and preserve your standard of living. 

A new year, new resolve, new goals.  Each January about 40-45% of us, research shows, make new year's resolutions.  Among the more common resolutions:  get better organized and take greater control of financial affairs.

If those are on your list for 2012, we've updated our handy month-by-month calendar of tasks, 'to dos' and reminders to help you get and keep on top of your financial affairs. Even if you're already in good shape, you're likely to find something on the list that could help you improve your overall picture -- and peace of mind.

January

Review balance sheet for all family entities (i.e. trusts, corporations, family members) and take action to:

• Redeploy cash effectively either to reduce debt or to obtain higher returns.
• Review prior year's investment portfolio results against appropriate benchmarks and determine strategy for the coming year.
• Review relative capital inside versus outside the business and take appropriate action.
• Restructure balance sheet to minimize non tax-deductible debt and consolidate where appropriate.

Revise pre-authorized corporate tax remittance.

Pay interest on prescribed (PS) rate loan by January 30th. If you don’t have a PS loan, consider it; rates continue to be at their lowest levels.

Establish priorities for charitable giving rather than rush giving decisions at year end. Revise preauthorization of payments for changes in giving accordingly.

Caregivers should maintain accurate records of expenses to claim the new Family Caregiver Tax Credit.

February

Maximize RRSP, TFSA & RESP contributions for all family members to take advantage of tax sheltered compound growth.

Consider spousal RRSP and RRSPs for kids over the age of 18.

Make contributions to TFSA accounts.

Collect receipts and other information for tax filings in March (trusts) and April (personal).

Arrange for medical in preparation for 'health management' plan for self and family members.

Consider paying out a taxable /capital dividend to preserve your company's qualifying small business corporation status.

RRSP deadline for 2011 is February 29th.

March

Remit Q1 personal tax installment by March 15th.

File trust tax and information returns by March 31st.

April

File personal tax returns for all family members and pay any outstanding liabilities by April 30th (April 15th for U.S. filings).

Revise personal tax installments for the balance of the year.

Review Q1 investment portfolio results.

May

Review 'health management' plan and assess related insurance needs for all family members.

Review amount of emergency funds and arrange for line of credit or put cash into savings to ensure you have a minimum of 3 months of living expenses.

Discuss income/family expectations for university/college kids returning home to set expectations for the summer and September enrollment.

Review your notice of assessment and take appropriate action.

June

Remit Q2 personal tax installment by June 15th.

File personal tax return by June 15th if self-employed.

Pay out any prior year accrued bonus from company by June 30th.

If over 40, consider setting up an Individual Pension Plan (IPP) or Retirement Compensation Arrangement (RCA).

Explore opportunities to sprinkle the capital gains exemption on shares in your business to other family members.

July/August

Review Q2 investment portfolio results.

Consider mid-year reflection on longer-term plans for you and family members through family summit or family council.   Reflect on personal, business, family and financial goals, philanthropic/stewardship objectives etc. and develop action plan for implementation in Q3 and Q4.

Determine most effective tuition funding strategy for upcoming school year. Also, review student living accommodation and opportunities to buy vs. rent.

Encourage and support your children in establishing their own savings and investment plans.

September

Remit Q3 personal tax installment by Sept 15th.

Review estate plan (e.g. will, power of attorney, life insurance).

Review shareholder’s agreement.

Consider the merits of incorporating and/or an estate freeze.

Consider transferring property to other family members to minimize current and future tax liability. If you have a child turning 18, there are additional opportunities.

October

Review Q3 investment portfolio results.

Review cash balances and invest surplus cash.

Review medical expenses for the past 12 months (including those of dependent parents) to determine if there are tax deduction benefits.

November

Begin year-end tax planning:

• Review status of unrealized capital gains and losses on investment portfolio and take appropriate action to minimize taxes for the current and prior years.
• Consider a private or community foundation to shelter large capital gains.
• Consider flow through shares or other tax sheltering opportunities.
• Ensure at least minimum RRIF and IPP (new) withdrawals are made prior to year end.

December

Make all charitable, political donations (in cash or publicly-traded securities), IPP contributions and unused RESP and TFSA funding by December 31st.

Determine bonus/dividend policy for your company.

Ensure amounts paid or payable from trusts to beneficiaries are properly documented.

Income splitting: ensure family members are paid for work done during year.

Any loans from the company to shareholders should be eliminated prior to year-end.

Final review of tax loss selling opportunities. Remember carryback of losses to shelter 2009 gains expire at year end.

Earlier this week the U.S. Bureau of Labor Statistics (the “Bureau”) announced that the US unemployment rate had dropped to 8.6% and that 278,000 jobs had been created. On the surface, this seems like great news; however, I have a healthy degree of skepticism over an improving U.S. job market.

Let me explain.  US employment peaked in March 2007 and bottomed in October 2009 losing 7.94 million jobs in the process. Unemployment rose by 8.9 million people over the same period, so it’s reasonable to assume that nearly 1 million people entered the labor force over that time and were unable to find jobs. 

Since the bottom in October, 2009, unemployment has fallen by 2.3 million but this drop includes 595,000 people who are no longer looking for work but would surely take a job in a New York minute if one was offered.  If one nets out this “marginally attached” group the number of unemployed has now only fallen by 1.7 million people. So there are still 7.2 million people who either lost their jobs or couldn’t find one during the credit crisis and recession.

The Bureau reported that the labour force has actually fallen by 138,000 people over the same period.  How can the labour force not grow when the population is growing? According to World Bank estimates and the U.S. Census Bureau, US population has grown by 3.6 million people; 2.0 million of which are between the ages of 20 and 65…working age. In other words, on average, the U.S. has added an additional 90,000 working age people per month since October 2009. Where did these people go if the labour force didn’t grow?

Even if one accepts the Bureau’s 2.2 million jobs having been created since October, 2009, that barely absorbs the growth in the population of working aged citizens let alone makes any dent on those who actually lost their jobs.

It gets worse. If one adds the number of people who are working part time because they can’t get full time work to the number of unemployed the total is a staggering 15.6% of the U.S. labour force! One out of every 6.5 working people in the U.S. are earning significantly less than they were before the recession. 

Why does this matter? The consumer represents 70% of GDP in the US.  Without a meaningful improvement in jobs, the US economy will continue to languish.  When making decisions about where to invest we need to understand whether the economy is improving and whether corporate profits are likely to grow from improving demand. Our analysis goes much deeper than the reported headlines. We consult economists, analysts, our independent investment managers, our clients who own businesses, and we conduct our own research. Digging deeper enables us to gain more insight into whether an apparently improving statistic actually translates into a growing economy. In the case of reported labour statistics, we don't believe it does.

I opened the Globe and Mail today to read with interest the article, How the rich are investing in real estate right now, written by Thane Stenner.

Mr. Stenner had an interesting take on what he defined as four different types of real estate investors. As readers of this blog know, real estate has long been an important plank in our investment platform and I thought the subject merited further discussion of the different types of real estate investment opportunities available to high net worth investors:

Development Real Estate – A longer term investment, this category delivers some of the highest returns available in the real estate asset category. However, it is also the riskiest in that capital can be tied up for years as the property is developed and leased out to tenants.

Opportunities in this category include loans, which offer higher than market yields due to the risk associated with vacant land, and capital investments, where the investor takes ownership of a portion of the property along with the developer. An economic downturn, however, can result in these properties remaining undeveloped, and potentially tying up your investment for longer than anticipated.

Income Producing Real Estate – Both commercial property and multi-residential housing units offer an excellent way to reduce risk and earn a steady cash flow. However, for passive investors, it is important to have experienced and well-qualified property managers who understand the day to day complexities of this type of real estate. After all, who wants a call at 2:00am because of a leaky pipe?

Well-diversified portfolios will include investments in many different properties in many different geographic locations thus reducing the risk associated with any one real estate market. Income- producing residential real estate usually performs very well during economic downturns as those who are unable to afford a home turn to rentals.

Turn-Around Real Estate – An offshoot of income-producing real estate, these diamonds in the rough offer the potential for both capital gains and income. Purchasing a property that is undervalued due to a lack of capital investment and investing more to bring the units up to current standards can result in higher rental income and a capital gain when the property is eventually sold. Unlike “flipping” a house, however, investing in turn-around apartment units requires more capital and a longer term commitment. In the article,

Mr. Stenner points to the United States as another example of this category. Areas where property may be undervalued, such as Arizona for example, can present an opportunity to investors. However, investors should understand that employment, economic growth and competing developments will all have an effect on whether these investments ultimately grow in value. In addition, Canadian residents should be aware of the added costs from non-resident taxes, legal and accounting fees from having to file US tax returns if you earn income, and the potential impact of estate tax.

Mortgages – There is a large secondary market for loans completely unrelated to the big 5 banks. Developers and investors often turn to this market because they need to close faster than a bank is willing to or because the bank is unwilling to lend (for any number of reasons unrelated to the opportunity available). Often, the secondary market proves to be more flexible than the banks are willing to be. These loans are often shorter term and have higher yields and carry the property as collateral in the event that the borrower is unable to make payments.

For our part, we invest in all four of these categories, with the majority being invested in income real estate. We do so to diversify and enhance our returns.

While Mr. Stenner points to a number of publicly traded securities or Real Estate Investment Trusts (REITs) as a method for investing in real estate, in my view, this reduces one of the key advantages to real estate: risk reduction.

While these securities often do not have high correlations with the overall market, they typically still fall in value when public markets undergo periods of volatility. In 2008, the S&P/ TSX Composite Index fell 49.3% from its high. The TSX Capped REIT Index fell 62.66% from its high and that fall began much earlier than the broader market.

While it is true that REITs distribute significant cash flow, making this category attractive, they are still subject to market volatility. Private real estate investments may offer some advantages in that their value does not bounce around with the stock market everyday and potentially offer more re-development or capital gain potential than public investments. The challenge however is they are typically more difficult to access for individual investors.

Real estate should be an investment held in every investor’s portfolio. However, it is a complicated asset category and unless you have the expertise, you may want to find professional managers who understand and specialize in this area.

Coming off of a couple of weeks of topsy turvey markets, it’s understandable if investors are feeling a little rattled these days.

Some comfort may be taken in the perspective of someone who has managed through more than a few bear markets:  Dennis Starritt, one of Canada’s investment luminaries and a key manager of the Newport Canadian Equity Fund.

Dennis joined us for a chat at one of our recent Inside the Tent events (where we bring together thought leaders from our network to discuss topics of interest). Judging from the engagement of the audience – there were more questions than we could accommodate in an hour and a half – he certainly captivated everyone’s attention with his views.  We offer a short recap that may be useful for these times.

I recently had the experience of counselling a long-time client who, despite a very secure financial position, was overcome with anxiety about money. What became clear to both of us after a lengthy and at times emotional discussion was that her anxiety was not about money at all. Rather it was about her obligations to her children, as the sole beneficiary of her late husband’s estate.

It’s a scenario we see frequently: a surviving spouse, usually the wife (life expectancies between men and women being what they are) of a sole or principal income provider, with more than sufficient capital to sustain her lifestyle is anxious and unsettled. Through discussion, we come to understand that the uneasiness is related to guilt over spending money that is perceived to be earmarked for heirs.