Final Exam Notes_ 2277A PDF

Ch. 10 - Investing Fundamentals #1 Boats and Rollercoasters We are so rich compared to much of the world. Top 1% of earners globally earn an annual after-tax income of only $60 000 USD. How do we honour our good fortune? 1. Invest Wisely 2. Obtain Wealth 3. Help Others How do we do it...

Ch. 10 - Investing Fundamentals #1 Boats and Rollercoasters We are so rich compared to much of the world. Top 1% of earners globally earn an annual after-tax income of only $60 000 USD. How do we honour our good fortune? 1. Invest Wisely 2. Obtain Wealth 3. Help Others How do we do it? - You sacrifice a few things you want “now” so that you can instead invest your money and watch it grow. - Then one day you “magically” don’t have to go to work if you don’t want to. How many employees work for you? - If you invest in the S&P 500 you have over 25,000,000 employees that get up every day, fight traffic, put up with annoying bosses, etc., just for you. - Would you rather 100% of your efforts, or small % of theirs? Then one day you will have enough money to: - Never “have” to work again. - Visit all the places in the world you want to see. - Donate money to anybody you want. - Buy your kids a house. - Find out what freedom is really all about.... There is no reason we can’t. - We just need to start being WISE with our money and investing well which is so easy to do these days. - Then we can all enjoy rewarding lives and set up future generations to be able to do what they want, rather than what they must. So many people do not invest because they think it is “risky.” The term “risk” is misunderstood. Which “risk” really matters? - The only risk people focus on in retirement planning and building wealth is “losing money in their investments.” What they should be focusing on is not saving enough money to live a safe and comfortable retirement. Risk in Investing - When people think of “risk” in investing they think, “I might lose all my money”. - Or they might say, “I’m going to lose a lot of money permanently”. - The key words here are “all” and “permanently”. Investing Crab Boat Example Investing in 1 boat. - Some years we might do much better than all the other boats we are competing against. - Some years we might do much worse. - Who knows? By only having one boat we are taking a lot of risk. If we own all the boats - Some boats will do great. - Some boats will do poorly. - Some boats might sink. But overall...since we have all the boats we know we will receive the “average” outcome for all the boats. Risk Rule #1 - Own All the Boats - This idea is called “diversification” and you’ve probably heard about it before. - The truth is you don’t want to own ALL the boats...just all the good boats….so “most” of the boats. So that takes care of the fear of losing “all your money”.  - If you own all the boats, you may lose a couple, but the rest will do ok, and you can use the profits you earn to replace the boats you lost. - If we owned every crab fishing boat, we are now betting on the entire crab industry….not just the success or failure of one boat. - If you invest in ALL the companies in the stock market you are betting on the success of an economy…not just the success or failure of one company. So, let’s stop talking about boats and start talking about stocks. - If you invest in individual stocks you CAN make or lose a LOT of money. Individual Stocks If you pick right….you are going to be RICH! If you pick wrong you’ll be on of those people that say the stock market is like gambling… Risk Rule #2 - Don’t Get Off the Roller Coaster - Except in exceptionally rare circumstances, the only people that get hurt on a roller coaster are the people that somehow get out of the safety restraints! - So just sit tight, keep your hands and feet in the ride at all times....and wait. Stock markets go up like an escalator, and stock markets go down like an elevator. - The S&P has an annualized average return of about 10%. - However, the “average” investor over the 30-year period only averaged 4%? It happens because people can’t “handle” the emotion of the markets going up and down so they “buy high and sell low.” “They” don’t have the right plan to not give in to emotional fears when the market drops. When Investing: 1. Buy all of the boats 2. Don’t get off the rollercoaster If you can JUST do that you will be SO much better off than the average investor! Women are better investors than men due to their patience and less fiddling with stocks than men. The best investors are the ones who are dead because they can’t get off the roller coaster, and the next best are the ones that forgot they had an account. Use volatility instead of risk. Short Term Rule of Thumb - My rule of thumb for short term investing is to keep any money you need (or may need) to spend in the next 5 years in a high-interest savings account. - Yes you will lose “some” money due to inflation, but that’s better than losing a lot right when you need it! Long Term Rule of Thumb - Invest all of the rest of your money in the stock market on a consistent basis, no matter if it is “up or down”…and enjoy the ride! Ch. 10 - Investing Fundamentals #2 What is a stock? - A stock is a share in the ownership of a company. Stock represents a claim on the company's assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. - Whether you say shares, equity, or stock, it all means the same thing. - Holding a company's stock means that you are one of the many owners (shareholders) of a company and, as such, you have a claim (albeit usually very small) to everything the company owns. Yes, this means that technically you own a tiny sliver of every piece of furniture, every trademark, and every contract of the company. - As an owner, you are entitled to your share of the company's earnings as well as any voting rights attached to the stock. - A “public company” is a company whose stock is sold on a public market like the Toronto Stock Exchange or the New York Stock Exchange. - You can own stock in “private” companies too, but they are a lot more difficult to buy and sell. - A given company will have a particular number of shares outstanding on any given day. They can increase this number by selling new shares or decrease this number by buying them back from the public on the stock exchange. - The price of a share of stock will go up and down everyday. The price is influenced by “supply and demand”. - If more people want to buy the stock, the price goes up. - If more people are trying to sell the price goes down. Making Money with Stocks As an investor you purchase stocks with a goal to make money in two different ways: 1. Hope the price will go up over time so you can sell it for a profit in the future (i.e. realize a “capital gain”). 2. Possibly receive a “dividend”. - If a company’s income grows, the company is more valuable so the stock price goes up! - If a company’s income shrinks, the company is less valuable so the stock price goes down! CompanyValue and Stock Price - A company’s value is “supposed” to represent the present value of all future cash flows/income the company will generate. - I say “supposed” to because it is REALLY difficult for anybody to figure this out on a daily basis. - Just think of all the assumptions that need to be made to estimate how much cash flow/income a company is going to generate for years and years and years! What Impacts Cash Flows? - The Economy – Growing? Shrinking? - Competition - New Products/Failed Products - Government Regulation - Taxes - Labour Demands - Inflation - Interest Rates - Supply Chain Issues (see COVID) - Societal Trends (Environment, Health, Etc.) - Global Conflict - Advertising Blunders And ALL of this is different in every country… This is why the stock price of a company is constantly changing. As new information becomes available it is factored into the “market’s” estimations of a company’s future cash flows! Not good and bad, rather better or worse - So…. you as an investor are hoping that companies are finding ways to continually increase their cash flow/net income over time so the value of the company keeps going up! - Once you have “determined” (i.e. guessed) at the value of the company, you divide that by the number of shares outstanding. Estimated Company Value = Share Price # Shares Outstanding - Market Capitalization (“Market Cap”) means “A Company’s Value” Dividends - A “dividend” is a distribution of a portion of the company’s profits. - A dividend is usually received in the form of cash, but can be given in the form of extra stock. - Companies have no obligation to pay a dividend. Invest in Companies That Pay Dividends? - When a company pays a dividend, the “wealth” of the company has decreased by the amount of cash it has distributed. - Imagine a company takes $5,000,000 out of its bank account and distributes it to the shareholders, the business must now be worth $5,000,000 less. - And now that the business is worth less, the price of each share must go down accordingly! Share price goes down when company pays dividends - Some investors don’t want dividends as they prefer that the company keeps the cash to grow the business. - Some investors REALLY like dividends because they want the cash so that they can choose what to do with it. The investor might think the business doesn’t have any viable growth opportunities. “Should” you want a company to pay dividends?  - If you have invested in a GREAT company, wouldn’t you want THEM to keep the money and make the business even better? If they do that it would make the stock price go up! - New companies, or companies with lots of growth potential likely won’t pay dividends as they need to keep their cash. ***POINT NOT ON EXAM*** - Older/established companies with less growth potential likely will pay dividends, as will companies that want to rebalance their capital structure. Companies that pay dividends often - Banks - Insurance - Utilities - Oil/Gas - Telecom - Real Estate Companies that don’t pay dividends often - Tech - Biolabs - Fast growing companies - Startups Why Companies Pay Dividends 1. They DON’T have a better internal use for the cash themselves. i.e. they have no quality growth opportunities. 2. To change their capital structure and thus lower their WACC by distributing retained earnings and raising cash with debt (when prudent to do so). - Many companies DO pay dividends, and on an overall basis they make up a significant portion of an investor’s “total return”. - “Total return” is a combination of the dividends you receive and the increase in the price of the stock. At the end of the day we are interested in maximizing total return. Should you “DRIP”? (Dividend Reinvestment Plan) - You should be able to set up your brokerage account to automatically reinvest dividends back into the SAME investment the dividend came from. - This is an easy way for you to make sure you are already putting your cash to work. - Or, if you’d rather you can let the cash pile up and invest in a different investment. Note: when you automatically reinvest dividends back into the same company you are in the same overall position on the day you buy more shares. You don’t have more wealth. - Remember this when you read articles/blogs/books/etc. that will try to tell you that dividend investing is “best”. Bonds - A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. - Bonds are used by companies, municipalities, states (provinces) and sovereign governments to raise money and finance a variety of projects and activities. - Owners of bonds are debtholders, or creditors, of the issuer. - The “key” with bond investing is that the person that holds the bond doesn’t participate in the profits of a company. - If a company becomes more profitable, the bond holder doesn’t make any more money! - All they get is their promised interest payment. Be an owner, not a lender! Interest Rates and Bond Prices - Most people think bonds are “safe” and “low risk”. - It is true that bond prices move up and down less than stocks. - But bonds prices do fluctuate when market interest rates change.  - It IS true that bond prices fluctuate less than stocks…but they still fluctuate. - Bond prices fluctuate for the same reason stocks do – supply and demand. - Demand changes because interest rates in the market change. Since the early ‘80s interest rates have been trending down which has generally been causing bond prices to go up. So, for 2.5 decades investing in bonds had been a decent investment because bond investors were earning a good amount of interest and bond prices were going up! Should you have bonds in your portfolio? - Until someone is 5 years away from retirement they should think very carefully about WHY they want bonds in there portfolio. - Bonds WILL smooth out the “roller coaster”….but it will also decrease the overall total return of your portfolio as well. - Is a smoother rollercoaster worth lower returns to you? So …. Should you have bonds in your portfolio? 1. The long-term rate of return on bonds is less than the stock market. 2. Since you will NOT get off the rollercoaster….why do you need them before retirement? There is ONE “possible” justification for buying bonds that you may come across. Flight to safety → transfer funds from stock portfolio into your bond portfolio when market crashes - Then, sell bonds and funnel profits from selling bonds into the stock market when prices are low. - The problem with this idea is that we can’t know if it will work well over the long term. Only time will tell. What is an Asset Class? - An asset class is a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. - Asset classes are made up of instruments which often behave similarly to one another in the marketplace. Main Asset Classes - Stock market - Bonds, GICs - Real Estate - Gold - Commodities Cash and Cash Equivalents - (GIC,s Term Deposits, Savings) - Cash is technically an asset class, but we all know that when you hold cash it is slowly losing value over time due to inflation. - So outside of your emergency and sinking funds (and having enough cash on hand to cover your monthly bills), I don’t think it makes sense to hold more cash. Buying Dips - Many people believe you should keep a significant amount of cash on hand to buy into the stock market when it goes down significantly (like in 2020). - I DO think you should “buy the dip”….but not by keeping a lot of cash on hand. - The most difficult thing to do is knowing WHEN to “buy” as the market is falling. - It is a little scary to put your money into a market when it is falling fast. - And if you wait for it to start going back up you may miss a lot of the dip. Investing in Commodities - Commodities refer to agricultural and resource products like oil, natural gas, wheat, orange juice, etc. - Commodities are VERY volatile (see oil prices!) and don’t have a very good long term track record for earning returns. - I don’t think they are a good “long term investment”. Investing in Real Estate - You can also invest in all kinds of real estate other than your house and/or rental properties. - There are ways you can invest in industrial real estate, apartment buildings, storage units, warehouses, nursing homes, etc. - Be careful not to invest “too” heavily in this asset class as you probably already have a significant portion of your net worth tied up in your house which is real estate! Investing in Bonds - When it comes to bonds you can invest in many different types. - You can read more about them in your textbook, or you do your own research. - I’m not going to spend any class time on them as I REALLY don’t want to encourage young people to include them in your portfolio! Types of Bonds - Corporate vs. Government - Short vs. Medium vs. Long Term - Fixed Rate vs. Floating Rate - High Yield vs. Low Risk - Convertible vs. Conventional Investing in Stocks - Now when it comes to “stocks” there are different classes that we do need to learn more about. - Don’t feel overwhelmed by this. It is easy enough to learn. 3 Major Classifications Geography - divide your portfolio into these three geographic locations - North America (Canada, USA), International (Europe), Emerging Markets (Taiwan, China, India) Emerging Markets - An emerging market economy (EME) is defined as an economy with low to middle per capita income that is expected to grow rapidly. - Such countries constitute approximately 80% of the global population, and represent about 20% of the world's economies. Size - “Size” of Company Classified by “Market Cap” - divide your portfolio into these three (four) sizes 1. Large Cap (10 billion - 200 billion) 2. Mid Cap (2 billion - 10 billion) 3. Small Cap (300 million - 2 billion) Growth vs. Value - Divide your portfolio into both Growth and Value stocks 1. Growth Stocks - A growth stock is any share in a company that is anticipated to grow at a rate significantly above the average growth for the market. - You will pay the full “fair” price for this stock and hope to profit by the future growth in the stock’s price. 2. Value Stocks - A value stock is a stock with a price that appears low relative to the company's financial performance, as measured by such fundamentals as the company's revenue, dividends, yield, earnings and profit margins. - You will (hopefully) pay below the “fair” price for this stock and hope to profit when the stock price recovers to its “fair value”. Three Factor Model Rules of Thumb 1. Over a long period of time small company stocks have outperformed (grown faster) than large company stocks. - “Small is better than large” 2. Over a long period of time value stocks have outperformed (achieved a higher return) than growth stocks. - “Value is better than growth” Fama’s research became so famous, and turned out to be so correct, that a large portion of the market started buying “small” and “value”. Once that started happening the “premium” an investor could get has been shrinking. Is the 3 Factor Model Dead? - It is too soon to say if the expected premium on both value and growth are shrinking? Disappearing? Or staying in place. - It may seem hard to believe but 10 - 15 years just isn’t long enough to know. I suggest in your portfolio you have some of: - U.S./Canada/Int’l/Emerging Markets - Small, Mid and Large Cap - Value & Growth Real Estate Investment Trusts - It is tricky to find the long term rate of return for real estate because we need know what kind of real estate we are talking about…and in what country. - “Generally” speaking the stats I’ve seen show you could historically expect to get between 9% and 11% long term by having a very broad-based real estate investment The reason I think we should have all of these in our portfolio: - U.S./Canada/Int’l/Emerging Markets - Small, Mid and Large Cap - Value & Growth Is so we can gain benefits from “rebalancing”. Rebalancing “Rules” 1. Don’t rebalance more than once per year. 2. Rebalance with “new money” rather than selling if you like when your account is still small. 3. Remember that “buying low” is a good thing….even if it can be hard to do. Ch. 10 - Investing Fundamentals #3 Mutual Funds A mutual fund is a “trust” that pools together the money of many different investors who (mutually) share a common investment goal. The money in the fund is then invested (by the fund manager) in various potential investments such as stocks, bonds, etc. Each mutual fund has a stated investment purpose that limits what it can invest in. For example, if a mutual fund says it is a U.S. Large Cap fund, then it can only invest is U.S. Large Cap companies. You don’t have to worry about waking up one morning to find that your U.S. Large Cap fund has started investing in Emerging Market bonds. The purchase/sale of most mutual fund units happens at the end of the day after the stock/bond markets have closed. This is because the “net asset value” of each unit needs to be determined to know how many units you can buy. The “net asset value” of each unit is equal to the total fair market value of all the investments owned by the fund divided by the number of units outstanding. There is NO evidence to support that mutual funds that charge a load outperform those that don’t. If you are going to invest in mutual funds consider “no load” funds to save your money! Similarly, your goal is to pay the smallest MER possible. The MER fee (%) gets taken out of the investment performance each and every year and this really adds up. I’ll prove it to you later in this lecture. Some unscrupulous “investment advisors” may try to sell you mutual funds with “loads” and high MERs. Why? Because they make more money! Don’t let them convince you that these kinds of funds are better. Mutual funds are for profit businesses and they will happily charge you fees if you are willing to pay them! Mutual Funds Not Tax Efficient - Mutual funds are not “tax efficient” – which means if you hold them outside of an RRSP or TFSA you are not going to enjoy the tax consequences. - Mutual funds must “pass on” the tax burden for interest, dividends and capital gains to the unit holders every year. - Mutual funds often generate a lot of capital gains as they “turn over” (meaning buy and sell) the investments they own during the year. - They do this because they are usually trying to move into the “next great stock” and they have to generate cash to pay unit holders who want to sell/redeem their units! Exchange Traded Funds (ETFs) - ETFs are the modern (and in my opinion a better) version of a mutual fund. - They are similar in the sense that investors pool their money together in a fund and that money is invested with hopes of making a return. - There are a few key differences though that I believe make ETFs superior to Mutual Funds.  - ETFs trade on stock exchanges – hence the name! - Therefore, when you buy and sell your shares in an ETF you are almost always buying them from other investors (just like you do with stocks). - You can buy and sell them all throughout the day (they call this intra-day trading). - As such, the price on a share of an ETF goes up and down all day – just like a stock. - ETFs don’t have “loads”. - They do have “MERs” but they are almost always lower than an equivalent mutual fund. - Depending on the broker you use to buy the ETF you may pay a “commission” of between $0 - $9.99 every time you buy or sell. - ETFs are usually much more tax efficient than mutual funds. - This is because most ETFs have very low “turnovers”. They usually buy and hold the stocks/bonds they invest in so rarely trigger capital gains. - As ETFs are bought/sold between investors, the ETF doesn’t need to sell securities to raise cash to “redeem” shares like a mutual fund does. ETFs vs. Mutual Funds - Remember that both ETFs and Mutual Funds are just “vehicles” to invest small amounts of money into a largely diversified portfolio of stocks or bonds. One is a car and one is a truck. Active Investing Active investing, as its name implies, takes a hands-on approach and requires that someone act in the role of a portfolio manager. The goal of active money management is to beat the stock market’s average returns and take full advantage of short-term price fluctuations. It involves a much deeper analysis and the expertise to know when to pivot into or out of a particular stock, bond, or any asset. Active investing requires confidence that whoever is investing the portfolio will know exactly the right time to buy or sell. Successful active investment management requires being right more often than wrong. Traditionally most mutual funds are “actively managed” meaning the fund manger (and their team) have discretion to invest in whatever securities they want as long as they are within the asset class the fund says it is investing in. The mutual fund holders (i.e. you) grant to power to the fund manger to make all the decisions….so you better hope they know what they are doing!!! Because the fund has to hire all of these “experts” and do all of this research is why they charges “loads” and “higher” fees/MERs. Passive Investing If you’re a passive investor, you invest for the long haul. Passive investors limit the amount of buying and selling within their portfolios, making this a very cost-effective way to invest. The strategy requires a buy-and-hold mentality. That means resisting the temptation to react or anticipate the stock market’s every next move. The prime example of a passive approach is to buy an index fund that follows one of the major indices like the S&P 500. When you own tiny pieces of hundred (or thousands) of stocks, you earn your returns simply by participating in the upward trajectory of corporate profits over time via the overall stock market. Successful passive investors keep their eye on the prize and ignore short-term setbacks—even sharp downturns. An “Index” is just a “list” of stocks. The S&P 500 is an “index” (or list) of the 500 largest publicly traded companies in the U.S.A. The S&P/TSX 60 is an “index” (or list) of the 60 largest publicly traded companies on the TSX. The QQQ is an “index” (or list) of the 100 largest publicly traded companies on the NASDAQ. Both Mutual Funds and ETF can be used for Active or Passive (Index) investing. We can simply use “index” funds (preferably ETFs and not mutual funds) to add large baskets of stocks to our portfolio based on just about any combination: - Geography (Canada, U.S., Int’l and Emerging Markets) - Size (Small Cap, Mid Cap, Large Cap) - Value & Growth You can also use index funds to invest a particular sector of the economy if you want to (U.S. Technology sector, U.S. Healthcare sector, Canadian Financial sector, etc.). The philosophy of “passive investing” is to “buy all the boats”. A passive fund (preferably an ETF) will buy ALL of the stocks in a particular index. Fees - At the end of the day FEES MATTER BIG TIME! - The only reason to own a fund with higher fees is IF the people managing a fund can beat the average market return by more than their fee! Professional managers likely cannot consistently beat market returns ETFs YES, Mutual Funds NO Passive MOSTLY/ALL, Active LITTLE/NONE Pros of investing in individual stocks - Can outperform their relative index Cons - You are betting on the company being better in the future than the market projects it to be - You don’t know when to buy or if it will up up/down - Never know when to sell - You have wasted years if the company does not beat the index, how long do you wait? - How many stocks should you hold? More means more research and work, less means more risk - Companies can get net management Never go above 25% of your portfolio Timing the Market - Market “All time high” is bs and should not be a saying, you never know if it is at its peak Lump sum vs Dollar Cost Averaging - Lump sum is better 70% og the time than DCA Ch. 10 - Investing Fundamentals #4 Commission And Investing - If you are only investing a small amount of $$$ on a regular basis you don’t want to be paying any commission to buy an ETF. - The $9.99 fee for TD Direct Investing on a $200 investment represents a 5% “fee”! YIKES! - Consider a broker that doesn’t charge commissions to buy. Norbert’s Gambit - A way to convert between currencies - Find a security listed at CAD and USD - Buy it at 1 currency, transfer it over to the same security priced in another currency - Sell it in the other currency, works both ways Pay Little/No Commissions WealthSimple - ETFs - $0 to buy, $0 to sell - Can hold U.S. dollars in your accounts so only pay conversion fee twice (1.5%) - But….they make you pay a subscription fee of $10/month! - Can have a “USD” dominated account but….they make you pay a subscription fee of $10/month! - (unless you have $100,000 in assets, in which cash there is no monthly fee. Cannot currently use Norbert’s Gambit at Questrade Are Financial Advisors Worth It? - A LOT of people “sleep well at night” knowing they have an investment advisor that is “professionally” managing their money. - People would rather “have a guy/girl” and HOPE that everything is going to workout ok rather than take some time and learn how to do it on their own! - They charge fees – often 1% to 1.5% per year of your total account balance - remember what 1% or 2% does to your long-term returns??? - They can’t pick investments that beat the market (over many decades). A study found that people with advisors did better than those who didn’t because of: 1. Asset allocation (asset class choice) 2. Withdrawal Strategy 3. Tax-efficiency 4. Product allocation (mutual fund, ETF, etc.) 5. Helping clients with goals/needs/timelines What are they? 1. Asset allocation – 100% equities (small, value, etc.). 2. Withdrawal Strategy – stay tuned. 3. Tax-efficiency - RRSP/TFSA, ETF vs MF 4. Product allocation - ETFs 5. Goals/needs/timelines - Set goals, create a budget, make a plan and invest in 100% equities You can do better than the advisors with a little bit of education and you can save the fees associated with hiring an advisor. Do It Yourself 1. Buy 100% equities broadly diversified 2. Value & Growth for the long term 3. Small / Medium / Large for the long term 4. RRSPs & TFSAs are amazing 5. ETFs > Mutual Funds 6. Dollar Cost Average all the time 7. Don’t get off the roller coaster! Real Estate Investment Trusts (REITs) - You can invest in various types of real estate in a Real Estate Investment Trust (REIT). - A REIT is technically a “trust” but acts like a business that invests in/owns/runs various types of real estate - There are over 1,100 REITs in the USA alone. But investing in an individual REIT is like investing in one stock – RISKY! If you want to add REITS to your portfolio you could consider investing in an INDEX of REITs! Hedge Funds Hedge funds are alternative investments using pooled funds that may use a number of different strategies in order to earn active return for their investors. Hedge funds may be aggressively managed or make use of derivatives and leverage in both domestic and international markets with the goal of generating high returns. Hedge funds are most often set up as private investment limited partnerships that are open to a limited number of accredited investors and require a large initial minimum investment. Investments in hedge funds are illiquid as they often require investors to keep their money in the fund for at least one year, a time known as the lock-up period. Withdrawals may also only happen at certain intervals such as quarterly or bi-annually. Qualifying Metrics of an Accredited Investors - Net Assets ($5 mil +) - Income (More than $200,000 or $300,000 joint salary) - Financial Assets ($1,000,000 alone or jointly with spouse In Canada the “general” rules are that non-accredited investors can only invest in hedge funds by investing at least $150,000. Accredited investors can invest much smaller amounts ($25,000 or less). Hedge Funds were originally created to “do well when the market was going up” and to protect your capital when markets were going down. These days Hedge Funds enter into all kinds of investment styles, approaches and philosophies. Some time they make amazing returns, other times the lose everything! However, hedge funds often fail miserably. - The average hedge fund only exists for 5 years. - And about 1/3 of hedge funds fails every year! - But……new hedge funds are opening all the time! If you are interested in making investments “like” hedge funds, you can do so now through so called “Liquid Alts” which are ETFs that try to replicate, or give you exposure to hedge fund and hedge fund like returns. Brokerage Accounts - Let’s talk about “how to actually invest”. - The first step is to open a self-directed brokerage account that allows you to buy mutual funds and ETFs. - Your account can either be an RRSP, TFSA or “taxable account” (“cash account”). Most people have accounts with the brokerages associated with their bank. The advantage to this is that the transfer of funds is usually instantaneous. The disadvantage is that the costs can be a bit higher than other options. The advantage to these is that the fees are either low/zero. The disadvantage is that it can take up to 3 days to transfer your money and customer service “may” not be as good as the large brokerages. It is as simple as: 1. Open the brokerage account (TFSA, RRSP or “Cash/Trading/Non-Registered” 2. Link the brokerage account to your bank account 3. Transfer money 4. Buy the ETFs/Mutual Funds/Stock/Etc. you want online with a few clicks of your mouse! Target Date Funds A target date fund (TDF) – also known as a lifecycle, dynamic-risk or age-based fund – is a collective investment scheme, designed to provide a simple investment solution through a portfolio whose asset allocation mix becomes more conservative as the target date (usually retirement) approaches. Advantages - Diversification - Minimum investment - Automatic rebalancing - Simplicity - Low maintenance cost - Expertise? Disadvantages 1. Bonds! (see earlier class) 2. Equity exposure – you don’t get to choose the equity classes you want (i.e. small, value, etc.). 3. Fees can be more than individual ETFs 4. Every individual's needs/goals are different. “One size fits all” may not make sense. Robo Advisors Robo-advisors are typically low-cost, have low account minimums, and attract younger investors who are more comfortable doing things online. The biggest difference is the distribution channel: previously, investors would have to go through a human financial advisor to get the kind of portfolio management services robo-advisors now offer. Disadvantages 1. Bonds before you want them! (see earlier class) 2. Equity exposure – you don’t get to choose the equity classes you want (i.e. small, value, etc.)! 3. Just because it is delivered/controlled by a computer doesn’t make it “best”….it just makes it easy/convenient. TFSA or RRSP - Which One Is Best? - You can usually contribute more money per year to RRSP than the TFSA - TFSA not taxed and can replace money the following year, RRSP cannot be replaced and is taxed So … Which is it? RRSP tax savings saves you more money on withdrawal from the account if your income is larger than your retirement income. RRSP tax savings spends you more money on withdrawal from the account if your income is smaller than your retirement income. The accounts are the same if you make the same amount in income vs retirement income. **********REINVEST YOUR TAX REFUND FROM YOUR RRSP Problems with TFSA vs. RRSP 1. We can’t know exactly how much income we’ll have in retirement. 2. We can’t know what the “tax brackets” will look like decades from now when you will withdraw money from your RRSP, and 3. Even if the “tax brackets” are the same, we have no idea what the tax rates will be decades from now either.  1. When you are in the lowest federal tax bracket ($1 - $55,867) definitely use TFSA first.*** 2. When your income moves into the second bracket ($55,868 - $111,732) the choice is yours… 3. When your income moves into the third bracket (and above) almost always use RRSP first and TFSA second. ***Remember, you can use RRSP in first/second bracket and choose to defer the tax deduction to future years when income is higher (if you want to)! With RRSP Match - RRSP Matching (up yo point where match is maximized) - FHSA - TFSA - RRSP Without RRSP Matching - FHSA - TFSA - RRSP RRSP Contribution = Tax Refund - When you make an RRSP contribution, and claim the tax deduction, it will almost always lead to a tax refund. - It is REALLY important that you take that tax refund and do something WISE with it. - If you just take it and go on vacation (or some other form of spending/consumption) you are missing an amazing opportunity to grow your wealth. - So do something wise with it (RRSP, clear debt, RESP, emergency fund, TFSA) - You should use BOTH your RRSP and TFSA throughout your life. - RRSP for the ability to use your tax refund for another great financial purpose. - TFSA because there is NO mandatory withdrawal which is AMAZING!!! Should We Buy ETFs in the USA in USD? Advantages - Much greater variety of ETFs are available in the U.S.A. - You might have trouble finding exposure to the asset classes you want only using CDN listed ETFs. - Almost always the fees for (comparable) ETFs are cheaper in the U.S.A. than they are in Canada. - Can potentially avoid 15% withholding tax on U.S. dividends. Disadvantages - You may be subjected to a fee to convert your CDN$ to USD$ (assuming you don’t use Norbert’s Gambit). - You must not let your emotions trick you into worrying about the USD/CDN exchange rate fluctuations. - You must “understand” the difference in reported returns from comparable US and Canadian ETFs. Withholding Taxes 1. U.S. investments that pay dividends WILL NOT withhold income tax on dividends paid to investments held inside an RRSP. 2. U.S. investments that pay dividends WILL withhold income tax (15%) on dividends paid to investments held inside a TFSA. However…IF the ETF is “domiciled” in Canada (meaning it trades on a Canadian stock exchange), like VFV, even though it invests in U.S. stocks, a 15% withholding tax will be charged on all dividends EVEN IF the investment is held in an RRSP. This means you CANNOT avoid the 15% tax on dividends if you buy ETFs on Canadian exchanges that invest in the U.S. - The only way to avoid this is if you bought it as a Canadian on a US stock exchange, and if it is in your RRSP Returns 1. It can be a little tricky to evaluate the “returns” (CAGR) of comparable ETFs. 2. This is because one is giving you the returns IF you changed U.S. stocks into CDN$. 3. The other is showing you the returns of the stocks themselves in USD$. So…you’ll get (basically) identical returns comparing ETFs like VOO and VFV when you sell the USD ETF (VOO in this case) and convert it back to CDN$. Therefore, don’t let the reported returns (on a site like Morningstar) trick you into thinking one ETF is earning higher returns compared to its foreign comparable ETF. Summary - ETFs that sell on U.S. exchanges almost always have lower MERs. - The returns are effectively the same once the US$ are converted back to C$. - 15% dividend withholding taxes can be avoided using ETFs that sell on the U.S. exchanges (except for TFSA accounts). Therefore – U.S. ETFs are probably best (especially when you use Norbert’s Gambit) For SOME asset classes you can buy ETFs that “hedge” out the f/x fluctuations for you (at a higher MER). Options for Hedged investments 1. Targeted Date Fund 2. “All World” Index Funds 3. “Canadian Couch Potato” 4. “Ben Felix Portfolio” 5. Add Your “Sandbox” 6. Ultimate Buy and Hold Ch. 10 - Investing Fundamentals #5 Bitcoin/Cryptocurrency Comparing Currency Fiat - Physical - Issued by governments - Centralized (monitored by government) - Unlimited supply - Restricted by borders Crypto - Digital - Generated by computers - Decrentilized (no one can control) - Limited supply - Unseizable Crypto can lead to tax evasion and Bitcoin is at a high on the stock market. How much do I need to invest every month? 1. Set a goal for how much you want to spend every month (after tax). 2. Determine the before tax amount of #1. 3. Apply inflation to #2. 4. Divide #3 by your chosen withdrawal rate. 5. Estimate how many years you have until retirement/freedom. 6. Calculate how much you need to invest each month to reach your goal. Step #1 - Monthly Spending - The first step in this process is to determine (in “today’s” dollars) how much money you would like to have (after tax) to spend each month. - It is hard to “know” exactly how much you’d like to have so “guess” a little higher than you might otherwise think. - Think of your current standard of living and think if you would want/need more or less than you currently have in a month. Step #2 - Taxes - Now that I have determined that we would need to generate $9,950 in cash from out investments to spend every month. We have to determine how much we “actually” need to withdraw, keeping in mind that we must pay income tax on RRSP withdrawals! - Again, to be conservative, we are going to assume that all our investment income is taxable (i.e. comes from our RRSPs). This assumption will cause use to invest more. - You have to “guess” at what the tax rates will be in the future. - Whatever you guess will be wrong! - Make your best guess now and adjust your plan as tax rates change. Pre-tax income = After tax income (1 - tax rate %) Step #3 - Factor in Inflation - Because of inflation a dollar today isn’t worth the same as a dollar tomorrow because money loses its purchasing power over time. - Therefore, we need to “inflate” my monthly amount to see how much actual income I’ll need in the future. - If we assume that inflation in Canada will stay at is historical core inflation rate of 2.5% then we can calculate how much $13,300 will be when I retire at age 65 using the following formula: FV = PV x (1 + r)^n Step #4 - Divide by “Withdrawal” Rate - Withdrawal rate means “what % of our investments can we safely withdraw each year and not run out of money?” - This is a REALLY important decision. - When determining how much you can take it depends on what your goal is. - The more money you would like to leave to your heirs/charity (etc.) when you die, the smaller the withdrawal rate you want to use. - The less money you want to leave, and the more you want to spend while you are alive, the higher the withdrawal rate you want to use. 4% - is likely the most you can take out IF you don’t want to spend your principle and leave it all to your heirs (inflation adjusted). 5% - 6% - is likely the most you can safely take and “likely” not run out of money before you die. *The less you take out, the greater the chances of a “successful” retirement. Step #5 - How many Years Left? - If I am 19 and want to retire when I am 65, that means I have approximately 46 years left to save. Step #6 - Monthly Investment Needed - Now all we need to do is use all the information determined so far to figure out how much we need to invest each month to reach our goal! - In order to do this, you need to determine what you think your average annual compound rate of return will be. - I “think” I might get 8% - 12% but will plan by using 6% just to be on the safe side! Are you on track to meet goals? Ahead of Target, What Now? 1. Stay the course in case we have a major future income disruption or greater inflation. 2. Stay the course to leave maximum money to my daughter. 3. Retire earlier than 16 years from now. 4. ROCK retirement with lots of fun/travel. Ways to be Conservative 1. Guess a “little” higher on desired spending. (Step #1) 2. Ignore OAS due to likely clawback. (Step #1) 3. Guess a “little” higher on expected tax rates. (Step #2) 4. Assume all income will be taxable even though some will come from TFSA. 5. Use a higher inflation rate than 2.5%. (Step #3) The Best Laid Plans - Most people retire because they have to…not because they want to…so it’s best to be ready in case you have to. - Everybody plans for the “best case scenario”. Life rarely works out that way. What to do? 1. Make your own plan. 2. Review your plan every year to see if you are on track. Adjust any assumptions for new information (e.g. tax rates). 3. Do different “What If” scenarios by changing any assumptions/variables. Withdrawal Rates - 4% withdrawal rate “should” allow you to maintain your wealth to pass it on to another generation - A higher rate puts you at risk of running out of money. - The less you take out, the more “total wealth” you’ll have (because you leave more in to grow). - You need to find a trade-off between enjoying your “freedom years” vs. how large of a legacy you want to leave to your heirs. - Using the flexible approach greatly decreases the likelihood of a conservative portfolio “failing”. - It is important to keep a significant portion of your portfolio in stocks to increase the chances of success. Fixed or Flexible? - Flexible almost guarantees you won’t run out of money, with fixed you may – again depending on withdrawal rate. - Flexible gives you much more to spend while alive, and less to leave to your heirs. - There is no right answer here. As long as you stay in the 3% - 4% withdrawal range, and have enough stocks, you can either decide to enjoy more of your wealth or to leave more to your heirs. It is up to you! The Cash Reserve - The only thing that could ruin your plans to retire when you want to, is a major stock market decline right before, or right after, you retire. - Imagine you retired at the end of 2007 and then in 2008 your stock investments lost 45% of their value!! - In cases like that, regardless of a fixed or flexible distribution approach, you really don’t want to pull money from your stock ETFs! - You want to give your portfolio a chance to recover as much as possible before taking withdrawals. - As such, in order to protect yourself from the stock market crashing at exactly the wrong time, I suggest you consider having 3-5 years worth of cash (or short-term fixed income investments) set aside in a GIANT emergency fund! - Why 3-5 years? Because almost all stock market crashes have recovered (substantially at least) in 3-5 years (remember the tables?). So, the idea is to use the cash you have in reserve when the markets are way down…and when they are up you take your distribution (3%, 4%, etc.) plus a little more and replenish your cash savings to get ready for the next crash! Annuities Definition: - “An annuity is a contractual financial product sold by financial institutions that is designed to accept and grow funds from an individual and then, upon annuitization, pay out a stream of payments to the individual at a later point in time.” Basically, you give an insurance company a lump sum of money now and in return they promise to pay you a stream of payments for a certain period of time. - DON”T buy one if you can help it. If you start saving for retirement from your very first pay cheque from your first “real” job (or at least by age 25…and if you go through the 6-step planning process that we talked about at the beginning of this class… You should have MORE than enough money to give you a GREAT retirement using a 4%, 5% or 6% flexible distribution strategy and therefore won’t NEED an annuity. Here are the major drawbacks of an annuity: 1. High fees (what a surprise) 2. When you die the stream of payments can die with you (or your heirs may get a small settlement). If you die with piles of money left in your retirement accounts however, those can be passed on! 3. If you ever need your money back, you must pay a large surrender charge! (poor liquidity) - Annuities “can” be a good thing for a select group of people. - IF somebody is going into retirement and doesn’t have a large enough amount of savings to keep 3-5 years of cash in an emergency and still have enough to invest then maybe an annuity is right for them. - At least it “should” guarantee them enough monthly income to survive when combined with CPP/OAS. They likely won’t be living the good life or leaving a legacy to their children but hopefully they’ll have enough income to meet their needs. Exponential Technology - As technology continues to change the world, it has the power to both create and erase fortunes! Who has benefited? Twitter, Instagram, Netflix, Walmart, Amazon, etc. Who has been hurt? - Oil Industry – due to “fracking” and “horizontal drilling” - Video Rental Industry – Netflix destroyed it - Music Industry – Cd’s wiped out by MP3. MP3 being replaced by streaming. Record companies hurt by illegal downloads - Newspaper Industry – online media - Automobile Industry about to be ROCKED by electric and self-driving cars. Nano-technology/Healthcare Winners: you/me, tech companies, economy Losers: insurance companies, doctors, hospitals, drug companies