I’ve been looking for a phrase that captures the odd behaviour that investors exhibit when they change strategies based on current market conditions. Ben Carlson at A Wealth of Common Sense neatly summed up this behaviour as investors always fighting the last battle. It’s perfect:
“Not every investor does this but there is a tendency to invest money into the speculative stuff only after it rockets higher during a bull market and invest money into the defensive stuff only after it protects capital during a bear market.”
Investors pour money into the latest fads long after the incredible returns have been made. This happens at the micro level with individual stocks and sectors (think Tesla, or cannabis). It happens with star fund managers and thematic ETFs (Cathie Wood’s ARK funds). It happens when certain investment styles outperform (like the large-cap growth, technology-heavy NASDAQ), or a country or region outperforms (like the S&P 500). It happens with speculative investments (like crypto and NFTs).
I get why investors fall for the hype. There’s a potential paradigm shift or new normal, and they don’t want to get left behind. But it’s classic performance chasing that never ends well.
Out-sized returns don’t last forever, so when the bubble bursts, investors who loaded up on risky assets inevitably bailed out and looked for safety.
That reckoning came in 2022. The riskier the asset (or frothier the price), the harder it fell (crypto, thematics, tech stocks, NASDAQ, S&P 500).
Investors who ignored their risk tolerance from 2019-2022 have suddenly become ultra-conservative, loading up on short-term GICs and cash while they wait for the market to settle down (whatever that means).
On the flip side, retirees who saw the bond portion of their portfolios get hammered last year are moving into dividend stocks and the latest income fad, covered-call ETFs.
The problem is we’re always fighting the last battle. We see last year’s best performer and decide to follow that strategy. But that strategy may have only worked in that specific situation for that specific time period. You can’t go back in time and invest with perfect hindsight. You need to invest with future expectations in mind.
And because we don’t have a crystal ball to see how this all plays out, we need to follow a risk appropriate strategy that we can live with in good times and bad. That means having a bit of FOMO when other strategies are performing better, and having some degree of humility when your investments outperform.
It’s that long-term approach that leads to better, more reliable outcomes for investors. Not constantly fighting the last bull or bear market.
This Week’s Recap:
I’ve received a lot of great feedback from my post last week on the best uses for your TFSA. It’s nice to hear that so many of you acknowledge the many uses of a TFSA (not just to leave a pot of tax-free gold in your estate).
Many thanks to Rob Carrick for highlighting eight ways retirees can save on tax in his latest Carrick on Money newsletter.
Our new house build is coming along nicely. The cabinets were installed this week, and next week is the first round of finishing carpentry. We don’t have a possession date yet, but now it’s looking like mid-April.
Meanwhile, all is quiet on the home selling front. Hopefully with a conditional pause on rate hikes and some good news on inflation we’ll start to see some more activity in the coming month or so.
Promo of the Week:
If you’re looking to start DIY investing with ETFs, or looking to break up with your expensive mutual fund advisor, then you need to check out my DIY Investing Made Easy course.
You’ll find videos explaining why investing has been solved with low cost ETFs, and why investing complexity has been solved by using a single asset allocation ETF. You’ll learn all about these asset allocation ETFs, including which one is the most risk appropriate for you.
I’ll explain which online broker makes the most sense for your situation, and I’ll show you platform-specific videos on how to open your account, add new funds, transfer existing funds, and how to buy and sell an ETF.
You’ll have all the resources you need to become a successful DIY investor, including access to me by email if you need any extra guidance.
Weekend Reading:
A few of you asked what podcasts I listen to regularly. Here’s a list of my favourites right now:
- Rational Reminder – hosted by Ben Felix and Cameron Passmore of PWL Capital, this is hands-down the best podcast for investing and financial decision making.
- I Will Teach You To Be Rich – hosted by Ramit Sethi, this is a look into the lives of couples and money psychology. Every episode is fascinating.
- Cautionary Tales – hosted by Tim Harford, who has the best podcast voice in the business. Wonderful story telling, and there’s always a great lesson in each episode.
- Animal Spirits – hosted by Michael Batnick and Ben Carlson of Ritholtz Wealth Management. They’ve got a great formula to keep you up-to-date on what’s happening in the market and in their lives,
- Money Feels – hosted by Bridget Casey and Alyssa Davies, this is personal finance talk without the usual guilt or shame.
- Stress Test – hosted by Rob Carrick and Roma Luciw, this personal finance podcast looks at the real issues facing young Canadians today.
Speaking of Ben Carlson, congrats to Ben on 10 years of blogging at A Wealth of Common Sense. That’s a decade of consistently posting every weekday – absolutely incredible!
Where do millionaires keep their money? Of Dollars and Data blogger Nick Maggiulli says it’s not where you think.
The Measure of a Plan has updated the investment returns by asset class from 2010-2022. The best (or least bad!) asset in 2022 was short-term treasury bills at -5.2%. The worst? REITs at -31.1%.
Are Canadian dividend funds all they’re cracked up to be? Morningstar dives into the data and says the results are mixed:
“On a trailing 15-year basis, investors in dividend funds have ended up more or less in the same spot as those invested in Canadian equity funds.”
This is what I found in my investing multi-verse of madness post – I could have achieved a similar return had I stuck with my Canadian dividend stocks, but I would have done a heck of a lot more work to get the same outcome.
If 2022 wasn’t the worst year for investors, then when was? Millionaire Teacher Andrew Hallam has the answer.
Tim Kiladze on the high-yield, but defensive ETFs that Canadians can’t get enough of: Covered-call funds. (subs)
How to make the most of your investments in retirement? Why a long-term, cash-flow driven approach to your retirement portfolio is key to success.
Finally, here’s an opinion piece on the cruel and unusual torture of doing your own taxes.
Have a great weekend, everyone!
Sometimes I think I’m the poster child for what not to do with your TFSA. I opened an account immediately when the TFSA launched in 2009 and contributed the maximum annual amount for three years, investing those funds in a couple of dividend paying stocks. I cashed out in 2011 (with a tidy $4,500 profit) to top-up the down payment on the house we live in now. Then I went years without making a contribution because life happened – we bought a new vehicle and developed the basement in our home – so TFSA contributions went on the back burner.
Once we paid off the car and the basement renovation I got super aggressive with my TFSA contributions to make up for lost time. I finally caught up on my lifetime TFSA limit in 2020, and then contributed the annual maximum in 2021 and 2022.
Then I drained the entire balance again to use for a down payment on the house we’re building right now. Catching up again will take a herculean effort, but I can use some of the proceeds from our house sale and then double-up on contributions for several years to get there.
Come to think of it, this is exactly the type of thing a TFSA should be used for. When you need a large lump sum of money without any tax consequences.
Most personal finance experts agree that the TFSA should be used for long-term investing. Indeed, when I run retirement planning projections for my clients, we typically touch the TFSA funds last after draining the RRSP/RRIF and non-registered balances.
While that makes for a nice looking retirement plan with a generous (and tax-free) estate, I’m not sure the best use of your TFSA is to leave a pot of tax-free gold at the end of the rainbow.
Consider one-time expenses that may occur throughout your lifetime. It could be a new vehicle, a home renovation, a bucket list trip, a home “upsize” or a vacation property, financial gifts to your adult children, etc. Where else can you pull funds for these expenses without incurring tax and without impacting Old Age Security benefits? And, oh by the way, you get the contribution room added back the next calendar year.
It’s the TFSA, folks!
Listen, I’ve written a lot retirement plans where the client continues to contribute to their TFSA forever while still meeting all of their retirement spending needs. Hey, if you have more income than you need, then contributing to your TFSA all throughout retirement makes perfect sense.
A forever funded TFSA makes for a great hedge against surprise outcomes, spending shocks, healthcare scares, etc. There are a lot of unknowns in financial planning, so a fully funded TFSA can cover a lot of potential issues. But do you need $1M or more stashed away in your TFSA, just in case? I’d argue in some cases you might be saving just for the sake of saving.
We save to fund future consumption. So let’s start earmarking some uses for our TFSA funds. A great place to start is that list of one-time expenses (new vehicle, home reno, bucket list trip, home “upsize” or a vacation property, financial gifts for your adult children before the will is read). Heck, fund a year-long sabbatical with tax-free money. The point is to assign a purpose to the funds in this account rather than blindly saving forever.
I fully expect that I’ll fill-up my TFSA to the max again someday. But I also expect to drain it again for something intentional. I don’t know what that is just yet, but I know I’ll be glad to have a pot of tax-free money available.
Readers: What plans do you have for your TFSA? A forever investment account? Funding large one-time expenses? A bridge for your early retirement years? A “just in case” reserve? Let me know in the comments.
This Week’s Recap
I introduced my long-awaited DIY Investing Made Easy course to help investors set up and fund a self-directed investing account and buy a single asset allocation ETF.
It’s RRSP season, so I reminded investors about the two-step process of making RRSP contributions (contribute, then invest).
It’s also (almost) tax season, so here’s the difference between tax deductions and tax credits.
Finally, many thanks to Mark McGrath for this excellent piece on 8 overlooked ways to save tax in retirement.
Weekend Reading:
Morgan Housel nails it with this piece in the Globe & mail: The art of spending money – and what it reveals about who you really are.
The Fleischman Is In Trouble effect – on the plight of the so-called working rich.
Here’s Ben Carlson on the psychology of market tops and market bottoms.
A pandemic boom attracted scores of Americans seeking gains. Now amateur investors are retreating to the sidelines.
There’s an ongoing trope about poor seniors eating cat food in their old age. That couldn’t be farther from the truth, with just 3.1% of seniors living below the poverty rate (subs):
Andrew Hallam says predicting the stock market is impossible. Human emotions move asset prices, not economics.
Well-respected economics professor Trevor Tombe says the Bank of Canada did its job: Rising interest rates and inflation look to be ending.
Bob French answers the question, exactly how long is the long-term when it comes to investing?
Fred Vettese says future investment returns may be lower. That means younger Canadians will need to save more than their parents for retirement (subs).
Doug Boneparth looks at Gurus Gone Wild – three of the most dangerous types of content on social media.
Jonathan Clements looks at four financial planing and investing concepts that are helpful in theory, but may not work as intended in the real world.
PWL Capital’s Justin Bender shows DIY investors how to invest their kids’ RESP money over time using low cost ETFs:
Rob Carrick shares five tips for navigating an increasingly tricky GIC market (subs).
Here’s Mark McGrath again, this time on the My Own Advisor blog talking about the taxation of investment income in a corporation.
A hidden paradise. Andrew Hallam says this retirement location may be the world’s best kept secret.
Finally, FP Canada is lobbying the federal government for a financial planning tax credit. This is one of the most common questions I get from clients, as fees charged by fee-only financial planners are not tax deductible.
Have a great weekend, everyone!
This is a guest post by Mark McGrath, CFP®, CIM®, CLU®. Mark is based in Squamish, BC. Over the past decade, he’s worked with over 500 Canadian physicians and their families to achieve clarity, confidence, and comfort with their finances. Follow him on Twitter for more incredibly useful financial planning tips.
More than 1 in 5 working-age Canadians are between the ages of 55 and 64 – more than at any time in our history. With the impending retirement wave, retirement planning is on the minds of more Canadians than ever.
And while planning for a successful retirement involves many uncontrollable factors – things like inflation levels, interest rates, and your own longevity – there are some strategies you can use to increase your chance of success.
Let’s look at eight often overlooked ways to save tax in retirement and keep more money in your pocket.
Some of these may be familiar to you. But I bet there’s a couple you didn’t know about.
Make use of the pension income amount tax credit
If you have qualifying pension income, you may be able to claim the pension income amount tax credit.
A tax credit reduces your taxes owing. If you owe $500 in taxes but have a $200 tax credit, you only owe $300.
The federal amount is 15% on pension income up to $2,000, and each province has their own credit as well. On the federal portion alone, that’s a $300 reduction in your taxes.
The types of income that qualify are:
- eligible pension income such as registered pension plan, RRIF and LIF payments (or both); and
- annuity payments if you were 65 years of age or older on December 31, 2022, or, regardless of your age, you received payments because of the death of your spouse or common-law partner.
While this list is not exhaustive, note that income from OAS benefits, CPP benefits, and QPP benefits do not qualify.
If you don’t report eligible pension income, it might be worth taking some RRIF income before it’s required. You can convert a portion of your RRSPs – say $2,000 each year to a RRIF and get the full pension income tax credit. If you are 65 years of age or older, and your spouse does not report pension income, you can withdraw $4,000, split the income on your tax return, and each qualify for the full credit.
If you have a high income from other sources – say you’re still working, for example – this might not be to your advantage. If you withdraw RRIF income at a high tax rate that would otherwise be deferred into the future when you’re in a lower tax bracket, you may pay more tax now than if you deferred it. Even after accounting for the tax credit.
Using your younger spouse’s age for minimum withdrawals
If you have RRSPs or Locked-In RRSPs, you’ll likely convert them into RRIFs and LIFs eventually. When you do, you are required to make a minimum taxable withdrawal each year. The minimum is by default based on your age, and the percentage goes up yearly.
When you open your RRIF/LIF, you can instead opt to use your younger spouse’s age to calculate the minimum withdrawal.
For example, at age 72, the minimum withdrawal is 5.40% of the account’s value at the beginning of the year. But at age 65, the amount is only 4%.
Since you can always take more than the minimum but never less, this gives you more flexibility – it sets a lower minimum income floor.
One thing to know is that when you take the minimum amount, you are not required to have tax withheld at the source (it’s still taxable, of course). Any amount over the minimum does require withholding tax. Because of this, if you need more than the minimum based on your own age but elect to use your spouse’s age, you might receive less income each month due to the withholding tax. It all comes out in the wash when you file your taxes at the end of the year, but it can be a surprise if you’re unaware of it beforehand.
Once you elect to use either your age or your spouse’s age, you can’t change it. So, if you opt to use your age but then decide you want to use your spouse’s, you’ll have to open a new RRIF, make the appropriate age election, and then transfer your existing RRIF to the new one.
Unlock your LIF account over time
A LIF is a Life Income Fund and is like a RRIF in a few aspects. Where it differs is that there is a maximum annual withdrawal limit each year too. This maximum is the greater of either the amount set out by provincial pension legislation or the growth of the investment account in the previous year.
Each year, you must withdraw an amount between the minimum and the maximum and, like a RRIF, pay tax on it. But you might not know that you can transfer the difference between the maximum and the minimum to an RRSP (if you’re age 71 or below) or a RRIF. Doing so slowly converts a less-liquid asset – the LIF – to a more liquid asset – your RRSP or RRIF.
This gives you more flexibility in case you need to make a large one-off withdrawal, say for an unexpected expense.
Income splitting with a spouse or common law partner
Since Canada uses a graduated tax system, the more income you earn, the higher the tax on each incremental dollar of income.
By splitting income with a spouse or common law partner, you can take advantage of their lower tax brackets and reduce the family tax bill.
For example, in BC, an individual earning $100,000 of income will pay roughly $21,000 in tax. But a couple earning $50,000 each would only pay roughly $13k in tax – a difference of nearly 40%!
There are a few income-splitting techniques available to retirees in Canada:
- Eligible pension income splitting
- Using Spousal RRSPs
- Sharing CPP credits
Pension income splitting
Up to half of eligible pension income can be split with a spouse – the same type of income that qualifies for the pension income amount tax credit.
By moving income out of your hands and into those of a lower-income spouse, you can equalize your family income, use up their lower tax brackets, and reduce your family tax bill.
Using Spousal RRSPs
This one takes some foresight but can shift a substantial amount of income to a spouse.
A spousal RRSP gives the contributor the income deduction, but the account owner – the spouse – claims the income on withdrawal. Say you earn $100k per year, and your spouse earns nothing. If you were to use an RRSP in your own name, you would get a tax deduction on the contributions, but when it comes time to withdraw the funds in retirement, the income is taxed in your name.
Because RRIFs withdrawals are eligible pension income, you can then elect to have half of the withdrawal taxed in your spouse’s name.
Using a spousal RRSP instead, you can shift the entire withdrawal to a spouse – not just half.
Depending on your other income sources in retirement, this can lead to more income in your spouse’s hands, taking advantage of their lower tax brackets.
Another trick with spousal RRSPs is that if you have a younger spouse, you can contribute to them even when you’re no longer eligible to have your own RRSP. Usually, you must wind up your RRSPs by the end of the year you turn 71, most often by converting them to a RRIF.
But if you are still working, you’re still generating RRSP room for yourself – even if you can’t own your own RRSP. In that case, you can contribute to a spousal RRSP if your spouse is 71 or younger.
Sharing CPP
CPP income doesn’t qualify as pension income for the purpose of pension income splitting.
That doesn’t mean you can’t share it, though.
You can share half of your CPP based on the number of years you lived together. It’s calculated by dividing the number of years you lived together by the ‘’joint contributory period’’. This period starts when the older of you turns 18 and ends when you both take CPP payments.
You must both be age 60 or older and receiving CPP payments to qualify.
For example, say Bob and Alice have been living together for 20 years. They’re the same age, and they take CPP payments starting at age 68. That means the joint contributory period is 50 years. Of that, they’ve been living together 40% of the time.
They can share half of 40% of their CPP.
Say Bob’s CPP payments are $600 and Alice’s are $1,000.
The simple way to calculate this is to take the difference in their CPP payments ($400), divide it in half, and multiply it by 40%. You increase the lower CPP amount and decrease the higher amount by this number. In their case, that’s (($400/2) X 40%) = $80 each.
In the end, Bob claims $680 in CPP income, and Alice claims $920.
The only circumstance where the amounts would be equal is if they had been living together for the entire joint contributory period.
And you can’t elect to have only one spouse share CPP – either both share, or neither do.
To share your CPP, you must apply for it through Employment and Social Development Canada. CPP sharing starts as soon as your application is approved, and you can’t apply retroactively.
Claiming medical expenses on the tax return of the lower-income spouse
Certain medical expenses qualify for a non-refundable tax credit. This tax credit can be transferred to a spouse, meaning either spouse can claim it, and qualifying medical expenses can be combined on one tax return to maximize the tax credit.
The tax credit is calculated based on the excess above the lower of two amounts – either 3% of net income or the provincial and federal thresholds for the year. For 2023, the federal threshold is $2,635.
Since either spouse can claim the expenses, it often makes sense to combine the expenses and claim them on the return of the lower-income spouse. That’s because 3% of their income is likely below the threshold set out by CRA, allowing more of the expense to be eligible for the credit.
For example, you and your spouse each incurred $1,000 of eligible medical expenses. At first glance, you would not qualify. Even combining the expenses, the total falls short of the $2,635 threshold.
But assume you are the lower-earning spouse, and your income is $40,000. Since 3% of $40,000 ($1,200) is lower than the CRA threshold, you can combine the expenses and claim the amount that exceeds $1,200 ($800 in this case). Doing so gets you a federal tax credit of 15%, or $120. Each province has a medical tax credit as well, so the savings may be even higher.
The medical tax credit can be claimed for any 12-month period that ends in the tax year. So, for 2023, you can claim expenses from June 2022 to May 2023, for example, if that’s more advantageous for you – as long as you haven’t claimed those expenses previously.
Transferring capital losses to a spouse
While this is situational, if you have capital losses from your investments that you can’t use, there’s a trick to transfer them to a spouse. Capital losses can be used to offset capital gains in the current year, the previous three years, or any year in the future.
To transfer them to a spouse, we must take advantage of the superficial loss rules that apply to non-registered accounts.
Rules prevent you or an affiliated party such as a spouse from triggering a capital loss without also divesting of the underlying asset for a meaningful period. That period is 61 days – 30 days before the loss occurs, the day of the loss, and 30 days after. If these rules didn’t exist, we could just sell an investment when there was a loss and immediately buy it back, crystallizing the loss for tax purposes but not truly disposing of the asset. CRA doesn’t like that.
The rules are designed to capture investments owned by a spouse as well. So, if you sell an investment at a loss, but then your spouse immediately buys it – the loss will be denied.
To see how it works, let’s meet Jane and Darrel.
Darrel has an unrealized capital loss this year. He got caught up in the meme-stock craze and took a bath. He has $20,000 in capital losses but no gains against which to apply them. His cost basis is $50,000, and the market value of his investment is $30,000.
Jane, however, a prudent index investor (and disappointed in Darrel’s investment decisions), has $20,000 in capital gains on her index fund portfolio.
Darrel sells his meme stocks, crystallizing his capital loss.
Jane immediately buys the same meme stocks, in the same amounts, in her own non-registered portfolio.
This does two things:
- Darrel’s capital loss is denied because of the superficial loss rules – his spouse bought the same shares; and
- The $20,000 is added to Jane’s cost basis
So while Jane bought the stocks for $30,000, her cost basis is $50,000. If she waits 30 days to sell the stocks, presuming they are still trading around $30,000 (or even lower!), she can sell them. Since her cost basis is $50,000 due to the superficial loss rules, she now has a capital loss.
Darrel’s loss is her gain.
*A Word About Single Retirees*
As many readers have pointed out, many of these strategies are only useful when there is a spouse or common law partner involved. I do want to address the concern that single seniors are being “punished” though.
Let’s reframe these ideas from the perspective of a couple.
Traditionally, there has been an income disparity between spouses. Without income-splitting strategies, spouses are unfairly affected by the existing rules, and the lower- or no-income spouse’s contribution to household finances is ignored.
For example, if one spouse stays home to raise children, their contribution to the home allows the other spouse to continue to work, earn an income, contribute to CPP, and save in their RRSPs.
Is it fair that this individual bears the entire tax burden for the family both during their working years, and through retirement? Without income-splitting, the family’s taxes are lopsided despite the low- or no-income spouses’ significant contribution to the family.
So while I don’t disagree that there are fewer tax strategies available for singles, I view the rules that single seniors must abide by as the baseline.
And these strategies are in place to prevent couples from being “punished”.
Final Thoughts
Sound planning and strategy can go a long way to ensuring a successful retirement. Using the tax saving strategies above, you give yourself that much more opportunity to enjoy the retirement you designed.