Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

“So what do you make of bitcoin?” – question from a curious investor

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Bitcoin, blockchain, initial token offerings  … yikes!  As financial headlines dedicate an increasing amount of coverage to this relatively new area, it’s left many investors scratching their heads.  What is bitcoin?  Do I need to know about this?  Am I missing out on an opportunity?   Below we present a question and answer that we hope investors might find helpful.

From a curious investor: 

So what do you make of bitcoin?  I am interested in your views on it as both an ‘investment’ and as a game changer.  Much to my annoyance, although I believe the world banks are inflating the money supply and the price of hard assets, this has not shown up in the price of gold.

I do not understand it at all. A friend of a friend has become a millionaire and yes he sold enough to make it real money …

Our response

While we’re by no means experts, we’ve thought about this and where we’re at with bitcoin is that while it may be a game changer, we wouldn’t invest in it as an asset in its own right.

Let me back up a bit.

The underlying technology that allows for the creation of bitcoin and other crypto-currencies , blockchain, is complex but the concept is not complex.  Essentially, rather than having a centralized system such as an accounting system or bank where the data is all held and processed centrally, blockchain allows for the data and processing to be decentralized.

They refer to it as distributed ledger technology.   It’s out there on the web, accessible to anyone but encrypted and secure.  Digital or crypto-currencies are just a really interesting application of this blockchain distributed ledger technology.  Up until now, it’s really only been national central banks that have been able to issue currencies and lots of middlemen (banks, brokers, other lenders) have developed to help manage the system and they all take a little off the top to help keep the system running.  Digital currencies can be huge disrupters of this status quo, cutting out middlemen and removing the central banks from the process entirely (maybe).

Bitcoin just happens to be the leading crypto-currency at this point.  There are lots of other ones as well as what’s referred to as crypto-tokens which not only serve as a medium of exchange but also have some other utility attached to them like they allow you to buy something or to receive a service (loyalty programs are a bit like this).  It’s still very early days in terms of any of these being a reliable medium of exchange.  For example for bitcoin the average transaction settlement time is around 45 minutes and often can be days.  Imagine being at the grocery store and wanting to pay with bitcoin from your digital wallet and you have to stand there for 6 hours before the grocer gets confirmation that you have sufficient bitcoin and can transfer it to the grocer’s digital wallet.  Your ice cream would have melted by then.  People also want a medium of exchange to be stable.  Bitcoin and other crypto currencies are wildly volatile.

Blockchain is a game changer

That said, I do believe the people that say blockchain and the application of it to crypto-currencies is a game changer.   I don’t know where it ends up or even if bitcoin will remain as the main crypto-currency but this could be a massive change.  Continue Reading…

U.S. Inflation: A case of high anxiety?

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U.S. CPI vs. U.S. CPI ex-Food & Energy Year-over-Year Change from 1/31/2010 to 1/31/2018

By Kevin Flanagan, WisdomTree Investments

 Special to the Financial Independence Hub

There is no doubt that inflation fear has reared its ugly head early in 2018, impacting the money and bond markets in rather noteworthy fashion. Some key headline-grabbing measures, such as wages and the Consumer Price Index (CPI), have come in above consensus forecasts to start the year, fueling a case of high anxiety for the fixed income arena. Naturally, the million (or should it be billion?) dollar question is: Are these heightened inflation fears warranted?

As we entered the new year, consensus forecasts for inflation were that readings at both the overall and core (ex-food and energy) levels would essentially remain unchanged. Interestingly, economists’ projections have been revised upward of late and now post slightly elevated readings. Indeed, the CPI is now expected to come in at a year-over-year rate of +2.3%, or 0.2 percentage points (pp) higher than the prior projection. The alternate measure, the personal consumption expenditures (PCE) price index, has been changed to a +1.9% increase (also up 0.2 pp), with the core PCE gauge being lifted 0.1 pp to +1.8%. The bottom line is that these revised estimates now all look for some modest increase from 2017 levels.

What about the Federal Reserve (Fed)? For now, all investors have to go by is the policy makers’ December projections. The March FOMC meeting, scheduled for March 21st, will be the Fed’s next chance to make any potential adjustments to their prior forecasts.. The preferred measure is the PCE price index, and the policy makers provide projections for both the overall and core PCE gauges. The Fed’s central tendency estimate is similar to the revised market consensus, with a range of +1.7% to +1.9% for each index. It should be noted that both the economists’ and the Fed’s current PCE projections still fall below the +2.0% target laid out by the policy makers.

Let’s take another look

So, let’s take another look at the aforementioned wages and CPI numbers. Continue Reading…

My journey to Passive Index Investing, Part 2

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By Dr. Networth

Special to the Financial Independence Hub

After reading My Journey to Passive Index Investing – Part 1, you may think that I have it in for financial advisors.  I don’t.   I believe the majority of financial advisors truly want to help their clients, but either their hands are tied or they have misguided beliefs.

The way financial advice compensation is structured creates a situation which, unfortunately, benefits the financial industry more than the individual investor.   There are also some financial advisors who truly believe active management beats out passive index investing over the long-term, despite high commissions/MERs and strong evidence which says otherwise.  Stay away from these financial advisors, since they have “drank the Kool-Aid.”

I believe a financial advisor with a CFP designation should have a fiduciary responsibility to create a comprehensive financial plan.  This includes insurance, estate planning, portfolio management (using low-cost ETFs/funds), as well as “holding your hand” during the inevitable market corrections.

Is advice worth 1 or 2% in fees?

How much is that worth?   This is a difficult question to answer. I don’t think it is worth the typical 1-2% in fees, which most banks and financial firms charge, especially if you have a large portfolio.  With the implementation of “Robo-advisors” and financial advisors that charge flat-fee or hourly-based (not tied to commissions on products), consumers are now beginning to have more choice for financial advice at a lower cost.

As you may recall, Part 1 ended with me as a newbie staff physician  in 2009 with little financial knowledge and an idea planted in my mind to “check out ETFs.”

It wasn’t until 2010 when I came across an article in the Globe and Mail, by Rob Carrick, where he rated the best personal finance blogs of 2010.  One of the blogs caught my eye: “Canadian Couch Potato,” written by Dan Bortolotti, which has been the best resource for index investing in Canada.

 

Through CCP, I came across another Canadian personal finance blogger by the name of Andrew Hallam, and his book “Millionaire Teacher.  The Nine Rules of Wealth You Should have Learned in School“, which was  originally published in 2011 (updated in 2017).

Hallam’s book is worth the price of admission,  since he has read a ton of personal finance/investing books, and has summarized succinctly in his book.  If you still have doubts whether passive investing beats active investing over the long-term those doubts will be put to rest after reading Chapter 3.   Physicians practice evidence-based medicine, because research backs it up.  The same concept should apply when it comes to investing. The enormous amount of evidence in favour of passive investing is, in my opinion, equivalent to a “Grade A” recommendation in evidence-based medicine. 

I have read my fair share of excellent finance books/blogs, but everything that you need to know about personal finances and index investing in Canada can be essentially found in these two resources.   If you read Hallam’s book and CCP’s blog (in particular his “Model Portfolios“), then you will:

  • Know more than the majority of financial advisors out there

  • Understand that the #1 determinant of your long-term investment returns is your asset allocation (% stocks: % bonds)

  • Understand that the #2 determinant of your long-term investment returns is to keep fees/MERs low by using low-cost index ETFs/funds, which will outperform the majority of actively-managed funds

  • Understand how to manage your own portfolio with low cost ETFs with minimal effort/time  

If you spend a bit of your time with these two resources, then you will eventually be able to save 1-2% MER each year by managing your own portfolio. 1-2% savings on a $1 million dollar portfolio will be $10,000-$20,000 per year, every year, for the rest of your life. That is a considerable amount of money which can be used on your family instead, such as taking 1 or 2 nice family vacation trips per year. For the equivalent amount, how many hours would you need to work at your job?

Once everything has been set up, you only require 30 minutes per month to manage this portfolio.  It really isn’t that difficult, as Loonie Doctor explains. However, taking that first step to managing your portfolio can be frightening and may fill you with self-doubt.   Comparable to a medical student learning a new procedure/skill – “See one, do one, teach one”.  These 2 resources will help you with the “See one” part.  At some point, you will need to take the plunge.   Follow that with sharing your knowledge with others, and you will become an “expert” in DIY passive index investing.

Analysis Paralysis

A point I would like to mention is the “law of diminishing returns” when it comes to learning about index investing.   After a certain point, any additional time spent learning about the nuances of index investing will probably not result in better returns, and may in fact, cause analysis paralysis: Continue Reading…

My journey to Passive Index Investing – Part 1

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By Dr. Networth
Special to the Financial Independence Hub

“If I were you, I would check out ETFs.”

And that’s how it started.   An idea was planted in my head.   A little nudge from a friend of mine.   This was back in 2009, when Exchange-traded Funds (ETFs) were not widely known.   I had never heard of the term before, and I did not know much about investing apart from hearing whispers  that I should just go to MD Management, hand over my money and let them “handle it.”

I was just finishing up with residency/fellowship, and was about to embark on my first staff physician job.  Since my pay cheque was about to dwarf my resident’s salary, I figured I should probably know the basics about investing, so I asked my friend for his advice.   At the time, he was working as a financial advisor at Bank of Montreal (BMO) with “high-net worth clients” (portfolios over $1 million); thus he seemed like a good resource to start with.  Looking back, I am extremely grateful for his honesty and transparency, as he could’ve easily recommended that I hand over my money and let him “handle it.”

I asked him what he recommended to his “high-net worth clients” to invest in.   His answer: BMO mutual funds.  Made sense, since he was at BMO.

Not all advisors invest alongside their clients

Then I asked him what he invested his own money in.  To my surprise, he invested his own money in ETFs, and did not hold a single BMO mutual fund.  I had always thought “wealthy” clients had access to the “best” investment products, so naturally, he would have done the same.

What???   I was confused!

Paraphrasing his answer:   “At the beginning of each month, financial advisors are told to recommend specific mutual funds to their clients in order to meet quotas, which in turn results in bonuses/commission fees.   The funds usually have a high MER (2% and above).   It lines my pockets and the bank’s pockets.  If I were you, I would check out ETFs.”

Looking back, I realize my friend was not your typical financial advisor.  He enjoyed reading books on personal finance/investing topics, and was quite knowledgable about investing.  Needless to say, he become disillusioned with the banking industry with all the sales tactics and the commissions and quotas driven nature of it all.   Not long after our conversation, he left the banking industry to pursue a career in a different industry that made him much happier.

Continue Reading…

Lending to Spouse at Prescribed 1% rate ‘Best Before’ April 1

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“Never spend your money before you have it.”
—Thomas Jefferson

I can’t emphasize enough that time is truly of the essence if you benefit from implementing this simple family lending practice. Interest rates are expected to inch up again and will alter the value of this tactic. Hence, I revisit the benefits of one of the few remaining family income splitting strategies.

It is commonly known as the “prescribed rate” loan. The procedure needs these components:

  • One spouse is in a lower tax bracket than the other, or earns little income.
  • The higher tax bracket spouse has cash to lend to the other spouse.

“The benefit of the prescribed loan strategy is a bigger family nest egg.”

Examine your family benefits from this income splitting opportunity. All loan arrangements and documentation must be in place by March 31, 2018 to derive maximum benefit. The key is to charge interest at least at the prescribed rate on cash loaned to a spouse/partner. That prescribed rate is now set at 1% for loan arrangements made by March 31, 2018.

The lower income spouse aims to accumulate a larger nest egg while the family pays less tax. The good news is that loans don’t have to be repaid for a long time, say 10 to 20 years or more.

My sample case highlights the income splitting strategy (figures annualized):

  • The higher tax bracket spouse lends $200,000 to the other at the 1% prescribed rate.
  • The recipient spouse invests the cash, say at 4% ($8,000) and reports the investment income.
  • The recipient must pay 1% annual interest ($2,000) to the lender spouse.
  • The lender spouse is taxed on the 1% interest, while the recipient deducts it.
  • The recipient is taxed on the net income generated ($8,000-$2,000).
  • This results in annual income of $6,000 shifted to the lower income spouse.
  • A promissory note is evidence for the loan.
  • A separate investment account is preferred for the recipient.
  • These loans are best made for investment reasons, such as buying dividend stocks.
  • A new 1% loan can also deal with an existing higher rate prescribed loan.
  • Multiple prescribed loans can be made at 1% while the rate does not change.
  • Business owners can investigate the viability of prescribed loans to shareholders.

Prescribed Rate Loan – Sampler

Here is a simplified method to think of such loans:

Cash Borrowed at 1% rate:  $200,000
Assumed Investment Income (4%): $8,000
Less: Prescribed Loan Interest (1%): $2,000
Taxable Income for Borrower Spouse: $6,000
Taxable Interest for Lender Spouse: $2,000

The benefit of the prescribed loan strategy is a bigger family nest egg. Your mission is to shift investment income into the hands of the lowest taxed spouse.

Need for speed

Today’s prescribed rate, which is set quarterly, is as low as it can be. However, it is most likely to rise at the next setting later this month. The prevailing expectation is a jump to 2% from the current 1% rate on April 01, 2018. Such an increase reduces the net value of the loan arrangement. Further, we may not enjoy a 1% rate for a long time, perhaps never again. Continue Reading…