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Automatic portfolio rebalancing can help your investments

Portfolio rebalancing

Automatic portfolio rebalancing allows investors to avoid emotional investing and benefit from buying low and selling high.

Common investor reactions to a falling market are to become upset, nervous and maybe even angry. It’s really important to be wary of these emotional responses to market volatility. Emotions can cause people to sell low and buy high.

It’s the job of advisors to help their clients see the advantages of volatility at every life stage, instead of simply reacting to the constant ups and downs.

Markets are unpredictable. They go up and down all the time because the values of individual companies, sectors and regions are constantly changing. Knowing that there will be volatility is the only thing we can predict with certainty: this creates a huge opportunity to put it to work for you.

One way of making volatility work in your favour is to use automatic portfolio rebalancing. Investors who work with a good financial advisor don’t need to know how to rebalance a portfolio, the advisor will do that for them.

How portfolio rebalancing works

A typical investment portfolio is made up of three parts, or asset classes:

• Equities (individual company stocks or equity mutual funds and ETFs): these investments usually fluctuate the most.

• Fixed income investments (for example, GICs and bonds): these investments typically fluctuate less than equities.

• Cash and cash equivalents (for example, money market funds): these have virtually no fluctuation, except between different currencies.

If a typical balanced portfolio has say 60 per cent equities, 35 per cent fixed income and five per cent cash, a “rebalance” would be the act of brining it back to these target allocations.

When looking at how to rebalance a portfolio that has grown in an upmarket (the equity portion of the above example now represents 70 per cent of the total value), the financial advisor would sell some equities and move the profit into the other two portions. In simple terms, they would be selling high. The opposite is also true.

If the equity portion of a portfolio falls in value, it means those investments are worth less than they were when the portfolio was last rebalanced. To restore balance, money gets moved from the fixed income and cash portions to buy equites when they are cheaper. In simple terms, they would be buying low.

This process of automatic rebalancing overcomes the emotional biases that can affect an investor’s long-term potential to generate optimal returns. When investors understand how rebalancing works, they’re less inclined to feel anxious when markets dip. They can see volatility as an opportunity to buy low and sell high.

How to rebalance a portfolio throughout your life stages

Rebalancing plays a part in helping you reach your goals throughout your lifetime. During the accumulation phase of life, you’re trying to grow your assets. In the distribution phase, you are turning your assets into an income-generating machine that will pay for your retirement lifestyle.

Discuss rebalancing with your professional financial planner

Your CFP professional can go through how to rebalance your portfolio with you and show you how it can work for you at any stage of your financial journey. They can even use technology to make this rebalancing automatic at set intervals.

A CFP colleague recently mentioned the following, which perfectly highlights why proper rebalancing is so important: “I’ve never met someone that panicked during a market downturn and sold equities that didn’t wish they’d stayed calm and capitalized six months later”.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.


Using Tax Free Saving Accounts for long-term saving

A better use for TFSAs

As contribution room continues to grow, the Tax Free Savings Account (TFSA), once considered a quaint savings vehicle, is now becoming a powerful retirement tool.

When the TFSA was introduced in 2009, it was mostly used as a place to stash a bit of short-term money. Back then, you could only contribute $5,000 per year, but additional room has been generated every year since.

If you’ve never contributed to a TFSA, were 18 or older in 2009 and have been a resident of Canada since then, you would have contribution room of $81,500 in 2022.

As contribution room grows, the TFSA is becoming an even more important savings vehicle. Why? Because any money in a TFSA is allowed to grow tax-free. That includes interest, dividends and capital gains.

Now that contribution room is more substantial, I want to answer questions about how people should be using their TFSAs.

Is the TFSA becoming more of a long-term savings tool?

It is. If you received a 5% annual return on a $5,000 investment and held it in your TFSA for 20 years, it would be worth $13,226 and you wouldn’t have to pay taxes on the $8,226 of growth. An investment of $81,500, however, with the same return, would be worth $216,244 in 20 years. That growth of $134,744 would also be completely tax-free.

So, people are starting to see significant growth, and that encourages them to look at the TFSA as more of a long-term savings vehicle.

What’s one mistake people make when it comes to their TFSA?

The most common one we see is around withdrawals. When you remove money from the account, you can’t add it back until the following year. For instance, if you take out $5,000 in 2022, you can only re-contribute that amount in 2023. But some people treat TFSAs like a bank account and move money in and out repeatedly which causes them to over-contribute (and incur penalties).

Should an RRSP still be the first place to invest for high-net-worth individuals?

Many of them should still be using RRSPs because RRSP room is generally higher than with a TFSA. Some high-income earners generate $29,210 a year in RRSP room (the maximum RRSP contribution allowed for 2022), so there’s a big tax saving there.

In general, if your marginal tax rate is higher today than it will be in retirement, then you should use an RRSP. Younger people with lower incomes might be better off contributing to their TFSA, and then later, when their income increases, use that TFSA money to fund their RRSP.

What is a good way for a high-net-worth individual to use their TFSA today?

Now that there’s more contribution room, if you were to maximize your RRSP, this would generate a fairly significant tax saving. Rather than spending the refund, you should invest it inside a TFSA and start accruing even more tax-free money.

For people over 71 who don’t need the income from their Registered Retirement Income Fund (RRIF), but are forced to withdraw the minimum payment each year, think about putting your after-tax RRIF proceeds into a TFSA. You’ve now converted taxable investment income into non-taxable income.

Can you have investments inside your TFSA that are similar to those in your RRSP?

You can, but right now a lot of people still think of it as a short-term savings vehicle. That will change as people get older and have more money in their TFSA. People should be giving the same amount of consideration to the investments in their TFSA as they do to their RRSP.

Eventually we’ll have a situation where people will have hundreds of thousands of dollars in their TFSA, depending on how well they’ve done.

We’re not there yet, but you shouldn’t treat the TFSA as a lesser account.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.

Small rise in interests rates can result in a big cost to you

Cost of rising interest rates

On June 1, the Bank of Canada raised its prime rate by another 50 bps and also signaled additional hikes were coming soon.

Canadians with variable rate mortgages would be wise to keep an eye on announcements from the bank regarding these hikes and understand how they will be impacted.

Large jumps in Canada’s prime rate can have a serious impact on mortgage payments for anyone who holds a variable mortgage since these mortgage rates tend to rise and fall along with the bank’s prime rate.

Let’s say your variable mortgage rate was at two per cent, then by the end of the year it rose to three per cent after the prime rate increases. Here is an example of how that could impact various mortgage payments (assuming a 20-year amortization):

• A $600,000 loan at 2% has a monthly mortgage payment of $3,032.94

• A $600,000 loan at 3% has a monthly mortgage payment of $3,322

As you can see, a variable rate increase of one percentage point can mean thousands more dollars in mortgage payments over the course of a year. This could put considerable pressure on your cash flow, regardless of the level of your household income.

Whenever interest rates look likely to start climbing, some homeowners are likely to begin wondering whether they should lock into a fixed rate mortgage or continue to stay on the variable rate ride.

This decision often boils down to an individual’s appetite for risk. Some people feel more comfortable knowing that their interest rate (and therefore their mortgage payments) will remain the same. It certainly makes budgeting a lot easier.

Switching, though, isn’t quite that clear-cut. In some cases, going from a variable rate to a fixed rate mortgage could require you to break your current mortgage, which can come with a prepayment penalty which may or may not be significant. Some companies, however, will waive this charge for clients who want to convert their variable mortgage to a fixed rate of equal or longer term.

For lenders that charge a penalty to convert from a variable to a fixed rate mortgage, the amount of time you have left on your mortgage term may determine whether converting it is worth the cost. The closer you get to your term’s maturity date, the lower your costs are likely to be. However, should rates continue to rise, locking into a fixed rate sooner may save you more on interest costs in the long run.

There is something else to consider: how much and how frequently rates are expected to rise. While variable rates could move higher than current fixed rates over time, in the short term the fixed rate is likely to be pricier than your variable rate, so you’d need to plan for the additional costs.

There are also options available other than just straightforward variable and fixed rate mortgages. It’s possible to set up a variable rate mortgage with a fixed payment. When rates rise, you pay more in interest than principal and vice-versa if rates fall. The benefit is that, from a budgeting perspective, the amount you have to pay remains the same.

When it comes to mortgages, it is often best to start with a financial planner first to build out a full financial plan and determine what value of a home you can actually afford. They can help you map out the implications of each option in the context of your long-term goals.

Then, you can go see a mortgage specialists confidently knowing what type of mortgage you need (and how much you can actually afford and not what amount you happen to get approved for) so that they can then find the right provider for you.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.


2022 tax season is over

Taxes done

Most Canadians have now filed their taxes which means they will not think about them at all until next spring comes around. But the time to start tax planning is now.

Waiting until next year’s tax filing deadline at the end of April, or even until the RRSP deadline at the end of February, could be too late if you’re trying to take advantage of every opportunity to reduce your tax bill.

But with a little bit of advanced planning during the year, you’ll have a better chance of lowering your taxes.

If you receive a regular paycheque, it’s easy to think your income and the taxes you pay are on autopilot. Taxes and CPP/QPP contributions get deducted, contributions get made to a company benefit plan, and it can seem like you don’t have a lot of control over the numbers.

The truth is, you have more control than you think, and there are ways to lower your tax bill and put more money to work.

Planning doesn’t need to be complicated. You only need to locate a few documents and set aside a little time to chat with your CFP professional. Key documents include:

1. Your notice of assessment sent from the Canada Revenue Agency (and available online if you have a CRA My Account)

2. Your latest pay stub and your best estimate for any income from upcoming bonuses or commissions

3. Recent statements for non-registered investments

This information will help your financial planner determine if any action needs to be taken before the end of the calendar year to maximize tax savings for you. Depending on your situation, they may even be able to help you reduce the taxes deducted by your employer so that you benefit from those tax savings during the year rather than waiting until next spring.

Planning for the “Rs”

These are your registered accounts. These accounts are either tax-deferred or tax-free. They include:

• Registered Retirement Savings Plan (RRSP)

• Tax-Free Saving Account (TFSA)

• Registered Education Savings Plan (RESP)

• Registered Disability Savings Plan (RDSP)

When planning to optimize your contributions to registered accounts, consider the order of events. For example, a contribution to your RRSP will generate tax savings. You could then contribute that amount to your RESP to benefit from grants from the federal and some provincial governments.

Consider capital gains and losses

Sometimes, it makes sense to sell investments that have gone down in value, because you can use the loss to lower your taxable income, if you have taxable capital gains in the current year or the last three years. You should seek the advice of a qualified tax specialist before taking this step - your financial planner can guide you through the steps and potential tax advantages.

Maximize your bonus

If a bonus is paid directly to you, you will probably have taxes withheld at source. However, if your employer allows it, some or all of the taxes on your bonus may not have to be withheld if your bonus is paid directly to your RRSP.

Setup a prescribed rate loan

As discussed in more detail in one of my columns a few weeks ago, a prescribed rate loan to a family member with lower income can provide significant tax savings for some people.

Year-end and the RRSP contribution deadline are not the only times when you should be planning the best way to minimize taxes. A little extra attention throughout the year can reap big rewards.

Work with your professional planner to make proactive changes to your living financial plan so you can take full advantage of tax-efficient strategies that will enhance your overall financial well-being.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.

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About the Author

Brett, designated as a chartered investment manager and certified financial planner, is the regional director (Okanagan) for IG Wealth Management.

In addition to his “day job," Brett was appointed to the board of directors of FP Canada (formerly FPSC) in 2014, named as the board’s vice-chair in 2017 and took over as board chairman in 2019. 

Brett has been writing a weekly financial planning column since 2012 and provides his readers with easy to understand explanations of the complex financial challenges that they face in every stage of life.

Enhancing the financial literacy of Canadian consumers is a top priority of Brett’s and his ongoing efforts as a finance writer and on the regulatory side through the FP Canada board focus on this initiative.   

Please let Brett know if you have any topics that you’d like him to cover in future columns by emailing him at [email protected]

The views expressed are strictly those of the author and not necessarily those of Castanet. Castanet does not warrant the contents.

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