Written by: Terry Willis, CFP, Vice President
May 17, 2012

I read an article the other day about the wife and family of Ruslan Salei, the Belarus hockey player who, along with 43 others, died in the Lokomotiv plane crash in September of last year.  Ruslan was only 37.  The article spoke of how the family, and specifically his wife Bethann, have been coping since that horrific day. Obviously, it has been a challenge for her. A single mom now, raising three young children would be hard for anyone. Before his death, he and Bethann had made a deal: she would take care of the children; he would take care of her.  Now it was all on her shoulders.

Luckily they had found time to ask the question, ”what could happen?”  Bethann and Ruslan had been together for 14 years, married for six, and were raising a family with a home in California and another in Belarus. Ruslan had accumulated plenty after collecting NHL pay cheques for 14 seasons (just over $22 million) and this year in the KHL was another year of guaranteed money. So when answering the ‘what could happen?” question they found themselves at an attorney’s office in July 2011, putting the finishing touches on their wills, planning the estate and setting up trusts for the kids. This is what good financial planners do— they ask their clients the difficult questions, not necessarily the same questions everyone is concerned about at the moment.  A good financial planner would not primarily focus on how to invest $22 million, but takes the client’s entire financial situation into consideration.

Professional athletes/teams travel— it comes with the territory. NHLer’s between October and April of any given year will drop their battered bodies into an airplane seat on 80 or so occasions and rack up between 50,000 and 90,000 air miles. From city to city, from country to country, people want to see and will pay for watching them compete. Their god-given talent/character along with their years of practice allows them to be great at something that most of us aren’t. Sometimes though, mistakes/accidents happen while traveling and people get hurt or worse.  

Had Ruslan and Bethann not asked the question, “what could happen?” the weight on Bethann’s shoulders would have been even heavier. A good financial planner takes a comprehensive look at the whole financial picture, including but not limited to, estate planning, portfolio management, cash flow management (budgeting), life insurance needs and debt management.  These different parts of a financial plan work together to achieve a client’s financial goals.  Ruslan and Bethann took the time to ask the right questions, which provided clarity around their financial picture, and operated as they both had wanted. It is hard to understand and put into perspective one’s own mortality with the fame, the fortune, the physical talents and the admiration that comes with it all. Sometimes though, life becomes out of our control, so taking control while we still can is key.

Bonds are an integral component of your portfolio that insulate it from the heightened volatility typical of equity investments and also provide a more reliable source of income.  In other words, you seldom have to worry about a double-digit loss occurring the week before a regular or ad hoc withdrawal is required.  If you believe that the primary goal of investment management is to preserve capital, as we do at T.E. Wealth, then an allocation to bonds continues to make sense for your portfolio. 

Interest rate worries are especially prevalent because of the aging population in North America with many either approaching retirement or already retired.  Many people are no longer in what we refer to as the wealth accumulation stage of their lives, but are withdrawing funds (or soon will be) from their investment portfolios to replace lost employment income.  Industry statistics show a continuous flow of assets out of equity mutual funds into fixed income in Canada and the United States.  We find it interesting that this persists given the paltry yields on these investments. 

Low bond yields have been fodder for many an investment article or financial news segment of late.  Rates are near 50-year lows, which has sparked debate as to whether it might be time to get out of bonds…entirely.  The big question is how far and fast could rates conceivably rise?  The Bank of Canada (BoC) has hinted that they might move ahead of the Fed, but it is unlikely they would do so in an aggressive manner.  Meanwhile, the Fed has pledged that it will retain the current zero interest rate policy (ZIRP) until 2014… unless, we see a significant ramp up in inflation.  However, deflation is truly the bigger concern.  While commodity prices suggest we have inflation on our hands, wages and real estate [in the US in particular] suggest we are wrangling with deflationary demons, which puts a damper on overall prices and in turn, the general economy.  Assuming deflation outpaces inflation until 2014, there is very little interest rate risk associated with bond investments.  But, once rates actually start to rise this will translate into declines in the value of existing bond holdings.  (Recall that there is an inverse relationship between the price of a bond and its yield.) 

The media are devoting far more copy and airtime to the inflation angle of the story, but rates could actually go down further if we enter a deflationary cycle. Deleveraging is going to remain a drag on economic growth for an extended period of time and low growth rates (forecast at 2.1% in the US & 2.6% in Canada for 2012) are insufficient to offset the current degree of slack in those economies.  And, while the likelihood of a Japan-style scenario is remote, this is precisely when bonds can afford you a good measure of portfolio protection. 

It’s true that rising rates will hurt the bond component of your portfolio, but we still believe it makes sense to maintain an allocation to bonds through all market cycles.  As with any well-diversified balanced portfolio, not every segment can advance at all times.

Steven Belchetz, MBA, CFA, President & Chief Investment Officer, T.E. Investment Counsel Inc.

June MacKinnon, CFA, Director of Research, T.E. Investment Counsel Inc.

Single female clients will soon comprise more of your book. Data from the Vanier Institute for the Family finds more than half of 80-year-old women live alone at some point, compared to less than a quarter of men the same age. What’s more, the same report says only 46% of women and 44% of men are now expected to marry by age 50.

While financial-planning basics don’t change for singles, there are issues to keep in mind. First, the Conference Board of Canada finds women earn $0.79 on the dollar compared to men. Second, single women can’t access the same tax-saving options as married couples. Their earnings can be further hit if they need to take time off to care for children or aging parents; or if they’re disrupted by a lengthy illness or disability.

Kristi Buchanan, an advisor with Sun Life Financial in Victoria, BC, says advisors sometimes make inaccurate assumptions about singles. For instance: “They’re not married, so they don’t have relationships that could impact their financial decisions.”

That’s not true. Siblings, nieces, nephews and even friends could all influence single clients’ estate plans. To suss out these ties, Buchanan asks whom they care about most; whom they consult on financial matters; and who they want to have inherit their money.

Kathryn Jankowski, VP and Financial Divorce Specialist at T.E. Wealth in Toronto, takes it a step further. “I invite [influencers] to appointments. The plans I put forward have to have acceptance from them as well.”

FINANCIALS FOR ONE

Jankowski’s single clients think about money differently. While her married clients tend to be concerned about the big picture, singles focus on spending and saving. Having only one income means singles are less able to build up a cash buffer. They have to cover all necessities, including retirement savings, before considering discretionary expenses, like cable television and annual vacations. She recommends they also set aside at least six months of living expenses—more if they’re self-employed or work in high-turnover sectors.

Also important but often overlooked: insurance. “Never assume single clients don’t need insurance because they don’t have dependents,” says Buchanan. “All efforts to build wealth and provide retirement options can be undone in an instant if a major illness strikes. Discussing disability, critical illness and long-term-care insurance are a must.”

Read: How singles can build financial buffers

For singles who own large homes as a result of inheritance, divorce or widowhood, Jankowski suggests they consider downsizing or turning them into income properties, especially if gross housing costs (calculated as mortgage payments, maintenance fees, property taxes and utilities) start overtaking 33% of monthly spending. She’s told clients, “Downsize to half and you could retire five years earlier.”

In a hot market, renting out part of the house can offset expenses, but “if you have to pay to make a basement rentable with a separate [entrance and] kitchen, the costs may outweigh the benefits,” she says. Becoming a landlord also means having to account for vacant months and a new set of maintenance costs that stem from having non-owners under your roof. Further, rental income is taxable, so net revenue will depend on the client’s marginal tax rates.

For clients hoping to buy homes on a single income, Kim Dewar, portfolio manager at Odlum Brown Limited in Vancouver, suggests saving aggressively in RRSP accounts so they can avail themselves of the home buyer’s plan.

“[These clients] have a much lower margin for error, which reduces the portfolio’s ability to accommodate volatile investments,” she says.

For savings plans under three years, Dewar recommends high-quality fixed- income investments or GICs. Clients who will buy homes in five years could add a small portion of blue-chip equities to their allocation.

She says companies like Apple have consistently provided growth, while banks and utility stocks counter with stability and income. Dewar also diversifies the equity portion of the portfolio across the 10 global industrial sectors.

CAUTIOUS GROWTH

When singles are feeling bullish, Dewar advises they err on the side of caution. She makes sure clients maximize their RRSPs; put leftovers in TFSA accounts; and channel

additional surplus into conservative blue-chip stocks, bonds or GICs.

“A 60-40 equity-to-bond allocation is considered a good mix for many clients,” Dewar says. “When markets do well, we sell some of the equity and buy fixed-income, and vice versa to keep within the prescribed allocation range. By sticking to a strategic asset allocation, we force ourselves to sell high and buy low.”

Nancy Graham, an Ottawa-based portfolio manager at PWL Capital Inc., targets inflation. “You don’t want to be too conservative. Not taking risk can also be big for these clients. If you think about where fixed-income rates are, and where inflation and taxes are headed, very conservative portfolios may not provide what you need in retirement.”

A passive manager, Graham’s portfolios comprise thousands of Canadian, U.S. and international securities. She also allocates to fixed-income, REITS, high-yield bonds and income trusts. Her mantra: minimize expenses through low-cost funds and ETFs, capture market returns, and manage taxes once assets spill outside RRSPs.

“Markets are difficult to outperform over long periods of time. That’s why we own the market, tilt for value and small premiums, and stay away from idiosyncratic risk of single-security holdings.”

While taxes are secondary to risk management, reducing them increases returns. Each year-end, Graham reviews her client’s portfolios, sheltering taxable gains where possible, or practicing tax loss harvesting where clients can benefit.

“If we have clients with big capital gains, we may be able to realize an offsetting loss by moving within the asset class, or holding different securities within a similar risk profile. Let’s say a client has a REIT that’s been doing well. In rebalancing holdings, we may sell a portion of this holding and realize capital gains. [If she has] unrealized losses in an international asset class, we may realize a portion of those losses to offset the gains.”

LEGACY MATTERS

Estate planning comes with added complications for single, childless women, since the choice of executor isn’t always obvious. Clients often use this as an excuse not to write a will, but you should explain the consequences (potential delays; dishonoured wishes; probate costs; frustration for family) of not having one.

Read: Tips for singles to leave legacies

Executors should be younger to ensure they’ll be alive when clients die. Dewar recommends selecting alternate executors in case the original choice is unable or chooses not to act. Jankowski further suggests picking executors from the same province, or at least the same country, because it makes the process simpler. And the will must also specify that executors can hire legal and accounting help.

Clients can use corporate executors when they don’t have a relative who fits the bill. If it’s a difficult estate, they can be appointed to handle the technical problems in conjunction with a family member, who takes care of the personal matters.

Using professionals will also protect clients if they grow apart from loved ones over time.

Despite these complexities, singles are typically confident, self-sufficient, and willing to work with investment partners. Those qualities make them great clients.

Originally published in Advisor’s Edge.

Written by: Robert Broad, Vice-President & Investment Counsellor, CIM, CFA

This is the second in a three-part series. 

As noted in the first part of this three-part series, we would like to continue the conversation on some of the “innovations” in the investment industry that have not made it into the hands of our clients.  While we are not against these ideas all of the time, or for all people, our belief seems to be that simple and understandable is better.

Principal Protected Notes (PPNs): These products, which have some similarities to index-linked GICs, were huge through the first half of the last decade. The goal was to participate in the growth of some sort of portfolio, while preserving the capital value in the event of market declines. The manager or sponsor set aside enough money with a third party financial institution to guarantee the return of principal at maturity. The balance was then invested to generate a return. Typically investors had to commit their money for anywhere from five to ten years in order to take advantage of the capital guarantee.  

Many of these PPNs got more and more confusing as time went on. They started out being based on simple indexes.  But then returns were linked to individual stocks, managed portfolios, commodities, and all sorts of obscure combinations.  And the exposure to the underlying portfolio also became more confusing with many funds using leverage and unusual “portfolio insurance” strategies. A large number of these instruments did not make it through the crisis. While most delivered on the principal guarantee, many had to shut down the managed portfolios (and potential for upside) when markets declined beyond a pre-determined breakeven point. There are still some investors waiting for the guarantee period to run out in order to get their original investment back. 

The critical issue with these products was that clients had to sacrifice quite a bit of liquidity for not that much potential upside. Usually, only about 30% of the portfolio was “managed” since the majority of the capital had to be set aside to cover the principal guarantee.  Fees and expenses made it unlikely that the investment portion of the structure would achieve a sizable rate of return. Second, as noted, the products tended to get more confusing over time and we do not invest in products we cannot understand. Finally, if you are willing to invest your money and not touch it for 10 years, you will do just fine in most diversified baskets of stocks and bonds and most likely outperform these packaged products.  

Insurance/Guaranteed Minimum Withdrawal Products: The genesis of these products was back in the 1990s as insurance companies offered guarantees on mutual funds held for 10 years. More recently insurance companies have been marketing “Guaranteed Minimum Withdrawal” programs for investors who are scared by the equity markets (similar products have existed in the U.S. for some time and are called variable annuities).  At first glance, these sound attractive.  Most promise the return of your capital and also offer “bonuses” (which sound like return but aren’t really) for tying up your money prior to retirement. But the promise is usually only to repay the capital over a 20-year time frame that commences when you reach retirement. 

The key selling point is usually that the biggest risk an investor faces is a significant stock market decline in the early years of retirement. It is certainly true that declines early on in a withdrawal program detract from the long-term sustainability of a portfolio. But, most investors would be better off doing something else with the bulk of the money. The fees on these products are typically high and the “insurance” feature adds an extra layer of cost.  After all the fees are accounted for it is very unlikely that many investors will get the positive surprises as part of the equation used to promote these products. The added irony is that these tend to sell very well after market declines, precisely when the protection you are paying for is the least beneficial. 

We think the security investors desire can actually be achieved through a well-thought-out portfolio. Locking in a 3% fee for 20 years makes it very unlikely these products will come out ahead.

Commodity or Gold Funds: With the benefit of hindsight, buying gold would have been a great idea 12 years ago; it has increased significantly in value. But, we have never been able to wrap our heads around why the price changes. If you own a bunch of businesses, their share prices will likely rise over time as revenues and profits increase. From year to year or even decade to decade, stocks may not exactly follow fundamentals, but over a lifetime of investing they nearly always do.  Taking profits on gold positions hinges on finding someone wiling to buy it at a higher price in the future. We have no idea what the actual value of an ounce of gold should be and nor do most investors. Though some very smart people argue that it should rise further, we aren’t willing to make an uninformed bet on that being true.

In fact, we tend to avoid most concentrated commodity investments for our clients. The real issue is that we are already in Canada and there is limited diversification benefit to be had for Canadians by adding more commodities.  Our stock market is heavily tilted to commodity companies, with almost 25% in energy and 20% in materials. Our currency also tends to follow commodity prices. Overall, it seems we have more than enough exposure to this story. 

Leveraged or inverse ETFs: These products provide easy access to the movement of various market indices or commodities. While the number of choices is huge, most allow investors to gain positive or negative exposure to markets with a single trade. Like much of the ETF space, there is a wide variety of choices including commodities, currencies, bonds and stocks.  You can be short or long almost anything. In addition, you can now generally up the ante and get double or triple exposure to markets. So, on any given day if the market moves by 1% you might gain or lose double or more with these kinds of products.

While they certainly have a place for active traders, these products don’t necessarily suit buy-and-hold investors. We also suspect that many people who buy these don’t quite understand how they work. The risk profile of these products can be quite different than the market over time. They are certainly innovative and there are a number of people who are quite happy that they can easily gain or eliminate exposure to the market with a simple trade. But, most investors should probably not be using these as part of a long-term investment strategy. Our approach, which tends to focus on buying and holding a diversified portfolio of stocks and bonds for the long term, doesn’t really lend itself to these kinds of short-term trading vehicles.

Again, our goal is not to pick on the industry or say that what others do is wrong. There are many way to build and manage a portfolio but the goal of these posts is really to give an idea of the way T.E. Wealth analyzes solutions. In the next post we’ll finish off with a few more innovations we have yet to use for our clients.

Written by: Robert Broad, Vice-President & Investment Counsellor, CIM, CFA

This is the first in a three-part series.

Our approach is to find solutions that work and stick with them. Generally, we wouldn’t buy into an approach unless we thought it was going to work for the long term. Markets won’t always cooperate, but sound investment approaches should provide value over time. This can be misconstrued as a lack of activity, but people are often unaware of the work going on behind the scenes.

Occasionally, our clients wonder if there are more exciting things they should be doing with their investments. We are always on the lookout for new ideas and approaches that might benefit our clients. The reality is that there aren’t all that many worthwhile new ideas! Investing is pretty basic: blend together stocks, bonds and cash to participate in the long-term growth of the global economy. If we can find more opportunities for diversification and enhance returns, we’ll take full advantage. But, in the retail or high net worth space it is seldom that easy. Sometimes investing is about what you don’t buy, rather than what you do.

We see dozens of pitches a year from our peers in the investment management industry. With $2 billion in assets, T.E. Wealth is generally considered worth talking to. The firms we do end up doing business with can certainly benefit and attract quite a lot of assets. Many of these meetings will entail one manager telling us why what they do is different than what anyone else is doing. A smaller subset will be new products or strategies sold to retail or institutional investors.

Unlike most counseling firms, we have the ability to buy and custody almost anything in the marketplace. In fact, we maintain investments in many quality products in the ETF space and have also been adding mortgage funds as alternatives where appropriate; not all innovation in this industry lacks merit. However, a significant proportion of new product ideas seem to run the risk of benefiting the sellers more than the buyers, at least in our view.

We believe it makes a difference that we are not dependent on commissions at T.E. Wealth. Most new products sold to clients in the investment world attract commissions for those who are selling it. While we certainly charge our clients a fee, our compensation is not affected whatsoever solutions we recommend.

In the next couple of blog entries I thought it would be interesting to highlight some of the products we chose not to recommend to our clients over the years and some of the reasons why. We are not trying to suggest that these alternatives are bad or that no one should ever purchase these investment products. On balance though, our feeling is that most of these just don’t make sense for a broad range of our clients. This list is by no means exhaustive, but covers some of the more popular ideas to surface in the last decade or so. I will start with just one product, and add a few more in future posts.

Indexed Linked GIC’s: These are a way for investors to buy a product that provides a capital guarantee, but still participate in the potential upside of the equity markets. Rather than collecting interest, the return profile of these GIC’s is linked to an equity index or basket of indices. Therefore, investors can participate in the upside of markets without having to live through the potential downside. This sounds like a great deal! But, of course this security comes with a cost.

Our issue with these products is that the upside is generally quite limited. Most of these GIC’s will only pay a portion of the market return over the holding period. Usually, the portion of market return they provide is from 30-60% depending on the issuer and the terms of the GIC. So, if the stock market is up by 30%, you will only be up by 9-18%. Note that dividends usually don’t factor into the potential return for these investments either, which leaves more money on the table.

So, let’s assume that we buy into index linked GIC’s as a long-term strategy. If we assume the stock market has a reasonable chance of providing a 7% return over time, how would this work if we used index linked GIC’s instead of direct investments in the market? To begin with we miss out on the 2.5% return that comes from dividends. This brings the expected stock market return down to 4.5%. If we assume a 50% participation rate, the investors return will be 2.25% per year over 5 years. This is then taxed as income. So if you are in a taxable account you would pocket about 8% in total over five years assuming a relatively low 30% tax bracket.

An investor who just buys the index will do much better. You would have pocketed after-tax dividends of almost 9% and seen growth in value of almost 21%, for total growth of about 30% after tax (this assumes capital gains tax is also paid at the end of five years, but there is no reason an investor would have to sell). If we were to compound this difference over many 5 year periods, you can see how it would really add up. Now sometimes the GIC will win. There are certainly periods when market returns will be below zero. But these periods are quite rare and over a lifetime of investing, you are much more likely to be in the 7% or better range.

In our view, rather than buying a bundled product, risk reduction is generally best managed at the portfolio level. Investors would be better off owning more bonds or GIC’s directly and having an equity they can live with. The likelihood of any index linked GIC providing equity-like returns over the long term is very limited.

The successful candidate will have a university degree (preferred) as well as their CFP designation. A minimum of 2-3 years work experience in Financial Planning and Seminar Presenter.

Responsibilities 

• Deliver presentations to employees of TEFC’s corporate clients on all aspects of financial planning.

• Prepare, customize, update and revise PowerPoint presentations.

• Willing to work outside normal office hours and travel to remote locations.

• Ensure evaluations and attendee sign-in sheets are completed, collected and returned to Administrator.

• Keep fully informed of relevant regulations and legislations.

• Assist department manager with ongoing project management of corporate client base.

• Enter meetings/presentations/specific work completed in time tracking system.

• Complete monthly expense reports.

Qualifications

The candidate would have:

• Excellent communication skills (written and verbal).

• Team player with strong interpersonal skills.

• Able to work in a fast paced environment handling multiple projects simultaneously.

• Excellent organizations skills with attention to detail.

• Ability to use own initiative and work independently.

• Have career oriented mind with clean cut professional appearance.

• High consideration for integrity and strong work ethics.

To apply for this position forward your resume in confidence to Tammy Newsted at tnewsted@tewealth.com

Apply Now

Please complete the form below or email a copy of your resume to hr@tewealth.com to apply for a position at T.E. Wealth. All form fields marked with an asterisk (*) are required.

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Luxury cars, glittering jewels and cozy cottages build a formidable illusion of wealth. But these hallmarks of conspicuous consumption don’t always add up to high net worth. This harsh reality jolts many possession-rich and cash-poor folks when their advisors tally assets against liabilities, and reach grim conclusions about future cash flows.

“People tend to assign arbitrary numbers to illiquid assets, and believe they’re worth a lot,” says Calgary based Nicholas Miazek, manager of financial planning at T.E. Wealth. When drawing up a net-worth statement, he makes a point of dividing the two and showing people what they can actually spend.

If clients won’t liquidate assets like primary residences or cottages, Miazek takes them off the table when making net-worth determinations, and helps them plan for alternative sources of income.

Some advisors assume clients will liquidate their properties halfway into retirement, downsize, and invest the resulting cash, “but most people aren’t inclined to move down the property ladder,” says Miazek. “If they’re selling a $500,000 home in the suburbs, they’re most likely buying a half-million dollar condo downtown.”

Elizabeth Summers, CFP, FMA, FCSI, a financial planner at TD Waterhouse in Victoria, B.C., prefers to account for real-estate assets on net-worth statements, because that’s where average Canadians are most heavily invested. “After all, a client with $5,000 in the bank and an $800,000 home—fully paid off—has much more net worth than a client with just $5,000 in the bank,” she says. “If needed, he or she could sell the home to meet retirement needs, or take out a home-equity line of credit.”

A net-worth statement that includes all liquid and illiquid assets serves another important purpose for Summers’ older clients. “It’s a very accessible source of information for their executors. If you don’t have details of your home in there, executors won’t know whether they have a mortgage that needs to be discharged.”

David Chucko, partner at PwC in B.C., breaks real estate into two categories when determining net worth. “Consumption real estate is one where you write a cheque to own it; investment real estate is one where someone else writes you a cheque to own it.”

While investment properties generate cash flow, personal-use properties often end up as a legacy for the next generation. For that reason, Chucko advises clients to buy only what they can comfortably afford, and not lock too much money into illiquid investments.

Money mirage

In addition to real estate, RRSPs constitute a large chunk of average clients’ technical net worth. But Dessa Kaspardlov, CEO of KL&A, Financial Planning Consultants in Windsor, Ont., cautions against weighting them too heavily on networth statements. “RRSPs aren’t a savings or chequing account you can draw upon at will,” she says.

Many clients also have a lot of net worth concentrated in their employer’s stock options or purchase plans, pension plans, or group RRSPs. “From an investment perspective, that’s a very high concentration of risk,” Miazek says. “A natural disaster, regulatory or legal change, or other unknown variable could quickly impact this portion of the pie.”

Part 1: Accounting for Tax
Some tax-efficient investments aren’t worth the risk

By Brynna Leslie

Tax should never be the primary driver for decision-making on a portfolio, but a properly structured portfolio always takes tax into account.

Regardless of asset class—money market funds, fixed income, or equity—clients can find ways to earn money in a tax-efficient way. Planning to reduce the tax burden must first coincide with the risk objectives and risk tolerance of your client, says Matthew Harvey, owner of Harvey Financial Solutions Inc., in Kincardine, Ont. “Investment strategies that take tax into account can be complicated and risky,” says Harvey. “Many of them are designed for the financially mature individual—affluent, high-income, and high-net-worth. Clients should not sacrifice expected rates of return just for a tax benefit.”

Understanding LSIFs

Nowhere is this truer than with labour-sponsored investment funds (LSIFs). Through LSIFs, federal and provincial governments use tax incentives to encourage investment in small- to medium-sized Canadian start-ups. Federal rules allow investment up to $5,000 per year in these funds, and that investment is eligible for a 15% federal tax credit, and an additional 15% provincial tax credit in some provinces.

Ontario recently increased the investment cap to $7,500 per year, and it offers an additional 5% tax credit on investments in research-oriented LSIFs. Like flow-through shares, the idea is these funds will grow over time. But they have initial investment risks that would deter most individuals. Typically, there is a lock-in period of eight years for these funds, so selling early means shareholders will not be eligible for the tax benefits. LSIFs are also known as labour-sponsored venture capital corporations (LSVCCs), or simply retail venture capital.

When they emerged a decade ago, fund managers salivated at the prospect of offering clients an investment fund that would see up to 35% in annual tax credits per year. Managers initially had a two-year window to invest the funds however they liked, contributing to the early euphoria.

“LSIFs looked great,” says Harvey. “Managers were able to throw the investments into some mild equity and bonds and watch it grow, while their clients got thousands of dollars back from the government.”

But then things changed. A mandate came down that the investments had to be transferred into a government-specified group of funds. “The fund managers were essentially handcuffed,” says Harvey. “They had to find companies that hadn’t been around that long, within a very small region in Canada, or in a particular province.” By then, investors were already locked into the program.
As a result, many have come to see LSIFs as high-risk venture capital.

“You have to be prepared to lose the capital,” says Harvey, who hasn’t sold any LSIFs since he became licensed to do so six years ago. “You have to have a reasonable expectation of losing it. [Otherwise], LSIFs may not be for you.”

Corporate class funds

Unlike LSIFs, corporate class funds (CCFs) have a much broader appeal. Some say they are the mutual fund world’s answer to the tax-efficient competitiveness of ETFs. Corporate class structures are set up as mutual fund corporations with multiple share classes. These instruments are good for people who want to buy and sell often to switch into a different fund or class share, without realizing regular income as a result.

Under a single corporate umbrella, traders can sell units of an equity fund to buy a bond fund when it’s deemed favourable, for example, and normally not realize capital gains in the transaction. “It’s a rollover at the same tax base,” says Nicholas Miazek, a consultant at T.E. Wealth in Calgary, Alta. “For a client that’s rebalancing to a more conservative asset mix later in life, it’s not going to trigger a taxable event.”

CCFs have appeal for a wide range of investors. A growing number of Canadian seniors, for example, are selling their homes and realizing the equity. They’re ideally situated to use CCFs for both income protection and a decent tax shelter. “All of a sudden, these seniors find themselves with half a million dollars in cash, but if it earns interest, it may disqualify them for government benefits they’re receiving,” explains Harvey.

While income from the sale of a principal residence is not taxable, the interest they’d earn if they put the money into a savings account is. Likewise, mutual funds typically distribute income evenly among shareholders—in the form of dividends, income or capital gains—as the funds are bought and sold.

But within the CCF, shares are generally traded within the same group of corporate funds, so investors don’t realize any income—and are not taxed—until they choose to redeem their individual shares.

“With CCFs, they can retain the earnings and let them build inside the fund,” says Harvey. “The fund manager can draw on the principal to supplement their income without being penalized on the tax side, and their government benefits can be restored.”

Investors can set up a formal plan, where they can draw 5% to 10% annually from the principal tax-free. As with segregated funds, CCFs allow a return-on-premium (or return-on-principal) that is tax-free. Unlike segregated funds, however, CCF investors are able to defer the tax on the growth in their shares.

Word of caution

Say an investor puts $300,000 into a CCF and leaves it for 10 years, at which point it’s worth $400,000. If the investor then wants to withdraw $10,000, she would be allowed $7,500 (¾ of the total investment) tax-free, but would have to pay tax on the other $2,500.

If, however, she decides 10 years later that she wants to switch to a CCF income plan, she can still draw on the principal with no tax penalty. So appealing are the potential earnings and tax-sheltering opportunities of CCFs—and others—that some planners have been advising more affluent clients to take out loans, with tax-deductible interest, in order to invest. But this high-risk strategy is not suited to everyone.

“You never know how the value of the underlying units will change if you invest in CCFs,” says Miazek. “If they plunge in value, you’ll have a large loan liability, [but won’t] have the capital to repay it. And there are so many new products coming out, that it’s impossible to say how these funds will react in different markets.”

Miazek also warns that CCFs are known for marginally higher fund management fees and broker transaction costs, in what is still a new market. “The fees can have a drag on your net return,” he says. “Sometimes you’re willing to pay a higher expense ratio if you know you’re going to get the return. “The biggest pitfall is always the history of the fund manager; I’m not sure we have that history with CCFs yet.”

The other thing to keep in mind is that although CCFs greatly reduce distribution of funds, there is no guarantee distribution will be eliminated altogether.

Bottom line

Most planners caution clients against investing just for the benefit of immediate tax savings or deferral. “It’s not all about immediate tax sheltering,” says Miazek. “Tax exemption now is often not as important as how the underlying assets are managed year-over-year.”

Insurance as an investment

Most advisors wouldn’t recommend insurance purely as an investment vehicle. But for those who need coverage, topping up a term life plan with a permanent life package can offer an alternative to GICs, as a tax-sheltered, fixed-income investment.

Earnings within a universal or whole-life plan are tax-deferrable—providing they meet CRA guidelines—until the policyholder cashes in. “Permanent life insurance is primarily designed to accommodate a long-term need, upon death, but along the way can be a very powerful, low-risk investment,” says Matthew Harvey, owner of Harvey Financial Solutions Inc., in Kincardine, Ont. “For young adults, who foresee having lifelong insurance needs anyway, it can offer them the opportunity to build up funds in a fixed-income investment that generates average returns of 5% per year.”

Harvey says 75% of permanent life insurance he sells, however, is to people over 55, many of whom wish they’d considered a plan earlier. “People in this age group have often shifted a good portion of their assets into fixed-income investments,” explains Harvey. “Now they have the added benefit of building those guaranteed investments within their life insurance plan, rather than in a GIC, which would be subject to tax.”

ETFs offer tax benefits

With ETFs, your clients hold a basket of shares that mirror fluctuations in the stock market. There’s not a whole lot of buying and selling, which means investors aren’t receiving monthly or annual income from the funds.

“With ETFs you only get taxed on capital gains or losses when you sell your own shares,” says Cheng-Chung Yu, president of Cheng-Chung Yu Professional Corporation in Markham, Ont. “And when you cash out, most of your earnings will be subject to tax on capital gains, not income or dividends.”

Originally published on Advisor.ca.