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Capital gains tax is one of the lowest you’ll ever pay

Hand with pen pointing to GAIN word on the paper - financial and investment conceptsThere are three forms of Investment Income in Canada: Interest, Dividends and Capital Gains. Each Is taxed differently. Here’s a reminder of how smart investors use their knowledge to taxation rates, especially tax on Capital Gains, to protect their returns.

With stocks, you only pay capital gains tax when you sell or “realize” the increase in the value of the stock over and above what you paid for it. (Although mutual funds generally pass on their realized capital gains each year.)

Several years ago, the Canadian government cut the capital gains inclusion rate (the percentage of gains you need to “take into income”) from 75% to 50%. For example, if an investor purchases stock for $1,000 and then sells that stock for $2,000, then they have a $1,000 capital gain. Investors pay Canadian capital gains tax on 50% of the capital gain amount. This means that if you earn $1,000 in capital gains, and you are in the highest tax bracket in, say, Ontario (49.53%), you will pay $247.65 in Canadian capital gains tax on the $1,000 in gains.

The other forms of investment income are interest and dividends. Interest income is 100% taxable in Canada, while dividend income is eligible for a dividend tax credit in Canada. In the 49.53% tax bracket, you’ll pay $495.30 in taxes on $1,000 in interest income, and you will pay $295.20 on $1,000 in dividend income.

Three capital-gains strategies

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Four psychological biases investors must understand

Concept of stress with gear in the head of a businessmanIn our last post we highlighted that behaviour might just be the biggest source of trouble for investors.  People just aren’t psychologically wired to make investment decisions that are good for them and often do things that are potentially harmful.

Our brains have evolved to create protection mechanisms that in many instances are helpful – just not when it comes to investing!  The subconscious creates short cuts designed to save us time when making decisions and to protect us from pain, both emotional and physical: basically, these short cuts help us perform better in “fight or flight” situations.  While many of these biases and their implications for investors have been documented by the likes of Daniel Kahneman, Amos Tversky and others, we think the following four stand out:

1.) Familiarity Bias

We tend to stick with what we know, whether that is products we buy, places we frequent or stocks in which we invest.  Presumably this heuristic evolved over time to help us make quicker decisions and keep us safe but when it comes to investing it can have the opposite effect.  For example Canadian investors tend to overweight their portfolios towards Canadian stocks, a common phenomenon globally but Canadians are among the most extreme examples of what’s known as “home bias.”

While Canadian investors might feel more comfortable owning the shares of companies they read about in the news most often and that are closely tied to our own economy, from an investment perspective they are taking on unnecessary risk by being overly exposed to specific companies in the oil, mining and financial sectors.  Canadians would be better off from a risk and reward perspective if they were to diversify more outside of Canada.

2.) Recency Bias

We tend to remember things better that happened more recently than we do things that occurred further back in time.  If you look at expert forecasts from Wall Street analysts going back in time, they tend to forecast very high returns just at or following market peaks (like the internet bubble) and low returns following market bottoms (like during the 2008/2009 financial crisis): clearly not very helpful and if so-called experts fall victim to the same biases, what chance do the rest of us have?  Markets are volatile and move in cycles:  anchoring on recent trends or sentiment might lead us to make decisions that result in the opposite of what’s good for us.

3.) Overconfidence Bias

Daniel Kahneman believes this to be the most dangerous of all behavioural biases and the most difficult to overcome.  Just like driving ability, people tend to believe they have a better than average ability to pick outperforming investments or investment managers.  This bias leads people to ignore overwhelmingly convincing evidence, often at their peril.

For example, despite the fact that data shows that paying high fees for active investment management leads to lower returns on average and greater uncertainty of outcomes, people continue to try to beat the market or find winning investment managers.  (Full disclosure, Chalten Fee-Only Advisors espouses an evidence-based low-cost, largely passive investment philosophy!).

4.) Herding

It’s a lot more painful to be wrong on your own than be wrong when everyone’s wrong.  Surely the herding mentality stems from some innate desire to feel included, to avoid being exposed whether right or wrong.  The result of herding in the investment world is that once trends develop there tends to be a “bandwagon effect” that becomes difficult for many investors to resist.  “Fear of missing out” or FOMO as it’s popularly acronym-ed these days can drive individuals to make irrational investment decisions they might normally avoid if deciding independently.

The net effect of the above is that people make investment decisions that are harmful.  Often the result is that investors buy into euphoric market peaks and sell out at the bottom of market panics.  It is no surprise that studies show that investment returns earned by individual investors are not only lower than market index returns but lower than those of the mutual funds in which they invest: investors just get in and out at the wrong time.

And if it’s not enough of a struggle that we have these psychological biases to battle against, most of the financial media and investment industry use communication and advertising practices that are specifically designed to exploit all of our psychological pitfalls!

How can you win?  To begin with, develop a investment plan that fits in with your overall financial plan.  Define parameters that address your ability, need and willingness to take risk and then use your plan as an anchor (in this case an anchoring bias is OK!) to keep you on track and avoid being swayed by both external noise and internal psychological biases.

graham-bodelGraham Bodel is the founder and director of a new fee-only financial planning and portfolio management firm based in Vancouver, BC., Chalten Fee-Only Advisors Ltd. This blog is republished with permission: the original ran on September 14th on Bodel’s blog here.  

Top 5 Credit Card myths Busted

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by Kevin Chu, RateHub.ca

Special to the Financial Independence Hub

Credit cards, much like any financial product, seem to create anxiety for many. With so many rumours surrounding credit cards, we decided to turn to top influencers in the community for help on busting these myths and sharing the facts.

Here are your top 5 credit card myths busted once and for all:

Myth #1: Having a credit card means you are financially irresponsible

Credit cards are a great way for you to start building credit and earn rewards from everyday purchases. If you’re spending wisely and are paying off your balance each month, credit card debt won’t be an issue.

Myth #2: Getting a credit card will hurt your credit score

The exact opposite is actually true here. The best way to establish credit is to start by getting a credit card. By paying off your debt in full each month, there’s nowhere but up for your credit score. Be wary of credit utilization though. A high utilization ratio will affect your credit score negatively.

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Robo-Advisers disrupting wealth management industry but Service could determine how much

Male hands on the keyboard in front of computer screen with financial data and chartsAs my article in the print edition of Monday’s Financial Post goes into in some depth, the recently released DALBAR study on North American robo-advisers highlights several challenges the pioneering industry faces with new customers, or in poaching them from the established wealth management industry.

See the headline Service ‘gaps’ in robo advice: Dalbar study (page FP1). You can find the online version here under the headline ‘Robos are getting a pass’: Study points to gaps in automated investment advice.

Many older and wealthier clients may get “poached” from the traditional wealth management industry, whether retail mutual funds, banks, investment counsellors, full-service brokerage or other segments. Of course, in some cases, robo-advisers are landing “new” money from young people who may never have invested before. Millennials are a big focus of some robo-advisers (such as Toronto-based Wealthsimple).

Last Tuesday, the Hub ran a blog outlining the major points issued in the Dalbar press release, and we also published reaction from three Canadian robos: JustWealth, NestWealth.com, Wealthbar and the aforementioned Wealthsimple. See Becoming a Robo-Advisor Client may be challenging, Dalbar finds.

The 126-page study — which not all robo-advisers have seen — contains plenty of information that couldn’t be summarized in the FP piece. It begins by noting that these services are “one of the fastest growing segments in the wealth management space” and that they have “managed to capture significant share of wallet from the established wealth management providers in … a short period of time.” The report mentions that Wealthsimple has grown to $500 million in assets from a standing start in 2014.

The report has a relatively small sample size: 45 mystery shoppers  (15 US, 30 in Canada) were asked to sign up to various Robos. Almost half of them were in their 30s. To assess risk, Dalbar directed these mystery shoppers “to ask for high returns in a short time period to test risk response mechanisms.”

Below, I present some more highlights that have not yet been covered:

Robo firms covered in the Dalbar report

First, the report looked at five American robo-advisers and ten Canadian ones (interesting that there weren’t more US ones!)

The US firms were Betterment, Charles Schwab, Future Advisor, TradeKing Advisors and Vanguard. (interesting that the oft-cited Wealthfront is not in: Dalbar told me it was based on what clients chose.)

The Canadian firms were (in the order Dalbar listed them): BMO SmartFolio, Invisor, JustWealth, Modern Advisor, NestWealth, Questrade Portfolio IQ, RoboAdvisor Plus, Smart Money Capital, Wealthbar and Wealthsimple.

Why clients chose particular services

Asked why clients chose a particular service, 100% of Betterment clients cited convenience while 100% of Vanguard clients cited reputation. WealthSimple clients cited equally (25% each) advertising, convenience, executive team and reputation. Interestingly, 75% of BMO clients cited its bank affiliation, and 25% its reputation. Invisor was a 3-way split between advertisements, executive team and product selection. JustWealth was an even 4-way split between advertisements, reputation, convenience and — this is interesting — being the “first to return my initial contact.” The latter point also accounted for 25% for NestWealth, Wealthbar and Modern Advisor. For NestWealth, the other three reasons, all an equal 25%, were convenience, platform offered and reputation. For Questrade  Portfolio IQ it was 67% convenience and 33% reputation.

Reasons for Choosing vary with Client income levels

The report broke clients down into three clients with annual incomes that I’ll call low, medium and high: $60,000 to $75,000, $75,000 to $100,000 and $100,000 to $150,000 or more.

For the low-income clients, Convenience was most often cited, 30% of the time, followed by Platform Offered (26%) and Reputation (17%) and Pricing (9%).

For the middle-income clients, Reputation was most important, at 38%, followed by First to Return Initial Contact at 19%, executive team at 13%, and equal 6% allotments for Advertisements, Bank Affiliation, Convenience, Platform offered and Pricing.

For high-income clients, Reputation was most important in 33% of cases, followed by even 17% allotments to advertisements, bank affiliation, convenience and executive team. Remember these are small sample sizes, but none of the high-income clients even cited pricing, platform offered , product selection, or First to Return Initial Contact.

Motivations for trying a Robo-Adviser

Curiosity seemed to be a major driver for wanting to check out a robo service in the first place, Dalbar found, followed by lower fees and convenience. Not surprisingly, lower costs dominated for the high-income group, 83% citing it, followed by 17% time saving. For the middle-income group, 44% just cited the desire to try new technology; this was also cited by 30% of the low-income group. The two lower-income groups were also influenced by the fact robo-services let you start investing with relatively small amounts of money.

Cross-border differences in account opening times 

Time to open an account varied from five to more than 30 minutes in Canada. Canadian users needed up to six times more time to open than their US counterparts. 75% of US robo users needed just 10 or 15 minutes to open an account, while 70% of Canadian robo users needed 15 to 60 minutes.  Most Canadian users felt it took “too long” to open an account and US robos were perceived as being much easier to work with than their Canadian counterparts.

Dalbar singled out NestWealth as being most consistent, with most clients able to complete a risk assessment questionnaire in 15 to 30 minutes. US robo firms were faster but mostly because the questionnaires were shorter.

Aman Raina’s robo-experience

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The Great Retirement Con Game

many water bottles on blue backgroundI don’t like to admit it, but over the years and due to circumstances largely beyond my control, I have turned into a skeptic.

I wasn’t born that way, but who here can blame me for turning into one with all the crazy stuff going on in this world? Today people seem to say anything they want. They just make stuff up. If you want proof of this, just watch the race for the presidency in the US. Enough said.

I discovered I was a skeptic one day while drinking bottled water.  I used to get clean drinking water at several places in or outside my house. I just had to pick up the hose and there it was, as much as I wanted and best of all, it was free. I think we can all agree that when healthy things are free that’s a pretty rare and good thing, especially these days.

But things changed after I married the Contessa and became “sophisticated.” Water was no longer free and I began a new routine of driving to the grocery store to buy bottled water. It didn’t stop there, because I now drink a particular brand of water called “Smart Water,” probably not a very smart thing to do as it costs more than regular bottled water.

Have you read about what’s inside your bottle of water? The nutrition label is all zeros, because there’s nothing in it besides water.

It’s incredible how advertisers have been able to convince us to start drinking bottled water when we all have free clean water to drink at home. I would love to meet the person who came up with the idea that we need to drink eight 8-ounce bottles of water a day in order to stay healthy.

In North America bottled water is a $170 billion dollar industry. I don’t know where all this bottled water is coming from, but I can’t get this image out of my head of a couple of people sitting in a bathtub somewhere filling up water bottles. That’s what being skeptical does to you.

Beware The Spin Doctors

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