Don’t be distracted

  By Guest Blogger Sinan Terzioglu

More Trump bombast. More market drops. As always, volatility brings the fear of loss. A client recently asked:

“Is this a good time to be investing? My portfolio has dropped in value and I think based on all the news and commentary from analysts on TV the markets are going to drop further especially after the run up we’ve had. The world seems like a mess right now. Maybe I should sell everything and hold cash while we wait for the next recession?”

Depending on the assets you hold, volatility may not equal risk if the probability of suffering a permanent loss of capital over your intended holding period is low. If you plan to use the funds for a significant purchase in the short to medium term, then investing in the stock market would obviously grow risk. But if you are investing towards a long term goal, like funding retirement, history tells us volatility of diversified and productive assets is not risky.

Over long periods of time investing and holding an ETF tracking the S&P 500 index has never – repeat, never – been a losing position. Of course there are no guarantees about the future but based on historical data there’s a 95% probability of a positive return on the S&P 500 over any 10-year period and no losses when expanded over 20 years. By adding bonds the probability of a negative return over a 10-year period drops to 0%.  That’s why Garth promotes balanced and globally diversified portfolios.

Many investors believe they’re managing risk by deviating from a long term plan and temporarily moving to cash. Wrong. This attempt to time the market is one of the riskiest things one can do when investing towards long term goals.

A recent study done by J.P. Morgan analyzed the 20-year period for the S&P 500 index from January 4, 1998 to December 31, 2018.  If you’d invested $10,000 at the beginning of the period and stayed fully invested the account would have grown to $29,845 – an annualized performance of 5.62%.  If missed just the 10 best days over this period the overall return would be cut in half. If you missed the 40 best days the investment would have been worth $4,241 which resulted in an annualized performance of -4.2%. So out of ~5,000 trading days that is less than 1% of the time that is responsible for the difference between a decent profit and a significant loss.

Are you smart enough to pick those few days, and sit in cash the rest? Hardly.

Think about all that’s happened in that 20 year period, from the tech bubble bursting in the early 2000s to the financial crisis of 2008-2009 and the worst December since the Great Depression (2018). The markets have experienced a correction on average once every two years and yet people live in fear of the next one. Former Fidelity fund manager Peter Lynch once said “far more money has been lost by investors preparing for corrections than in corrections themselves.”  Investors significantly increase their odds of investment success over the long term by just staying invested, periodically re-balancing and avoiding expensive distractions. Most important is staying out of their own way and not making emotional decisions based on the last traded price.

Opportunity Cost

A recent RBC poll found that more Canadians now have TFSA accounts over RRSPs, but many are still not using them to their full potential. The survey found 43% are misinformed and think TFSAs are for savings, not growing investments over the long term. 28% of people use them for mutual funds, 19% to hold stocks, 15% for GICs or term deposits and just 7% for ETFS.  Some good news is two out of three TFSA holders said they have not withdrawn money from their account.  Keep in mind that if you do withdraw you don’t lose the contribution room but you can’t re-contribute the withdrawn funds until the following calendar year.

The opportunity cost of not taking advantage of a TFSA for long term compound growth is enormous.  Assuming a 7% compound annual growth rate a 20 year old that starts investing $6,000 a year for 20 years and doesn’t invest again would have over $1,000,000 by the age of 60. Compare that to someone who doesn’t start to invest in a TFSA until the age of 40 at which point they start saving $20,000 a year for 20 years. Assuming the same rate of return their account would be worth $875,000.

Needless to say in an era of record student debt and continually rising living costs this is not realistic for many people just out of school but even those who have the means are missing the opportunity.  I am continually shocked when I hear about people aggressively paying down their mortgages with low interest rates without ever having contributed to a TFSA and missing out the magic of tax free compound growth.

Taking full advantage of a TFSA can help fund a retirement by keeping you in a lower tax bracket as withdrawn funds do not count as income. This can allow investments in registered accounts such as RRSPs and LIRAs to continue growing tax deferred.  For couples who designate one another as a Successor Holder, the surviving spouse gets all the rights related to their partners TFSA with no tax consequences.  Only spouses or Common-law partners can be named as Successor Holders. (At Turner Investments we open all TFSAs for couples with one another designated as Successor Holders).

The miracle of compound growth doesn’t get a lot of attention in a shortsighted market but for those that utilize TFSAs and are able to think long term, stay the course and avoid distractions, they have an incredible opportunity to take advantage of it but it takes time. Over 97% of Warren Buffett’s fortune was earned after the age of 60 because of compound growth.  Over the previous decades if he had let price volatility get to him and he made emotional decisions we never would have heard of him.

Education

The cost of education continues to rise. Annual tuition plus room and board can easily cost over $25,000 a year. But if you start saving early an RESP is another incredible opportunity for contributing sponsors to utilize the power of compounding.

Contributions grow tax free while getting a 20% government grant of up to $500 per year, for contributions of $2,500 each year.  You can contribute up to $50,000 to an RESP but will only receive a grant for the first $2,500. Lower and middle income families are eligible for additional grants.

The lifetime grant limit is $7,200 so by contributing $2,500 a year for 14 years it’s an automatic 20% return on top of the growth of the capital plus dividends and interest that accrue over time.  The earlier contributions start, the better. Contribution room can be carried forward, however you’re only permitted to receive missed grants one year at a time.  So if your child was born in 2017 and you start contributing in 2019 then you can receive up to $1,000 in grants for a $5,000 contribution and catch up on the remaining missed grant the following year.

When money is being withdrawn from an RESP to pay for education, the grants and growth will be taxed as the child’s income but since they most likely will be in the lowest tax bracket total taxes will be low. Like a TFSA, if contributing to an RESP with the intention of using it 15+ years in the future, it is best to invest in diversified equity ETFs with exposure to Canada, the US and foreign markets. $2,500 contributed every year for 14 years while collecting $500 in grants each year will grow to over $80,000 assuming a 7% compound annual growth rate.  So $35,000 in contributions and $45,000 in grants and growth.

Sounds like a pretty sweet deal to me. Unless you’re too scared to grab it.

Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.   

Dr. Garth

The Dr. is IN.

I have been regularly reading your blog for the last 6 months. It’s been a great source of information, as well as self-reflection. At 35, married and 2 kids, I have realized I am far behind in terms of net worth compared to some your other readers. Our household income is around 250K. Total savings including RRSP and TFSAs is around 200k. We have been renting a semi in GTA for 2000 for the last 3 years, while the average rent in the area for semis has gone up to 2,600.

I have been holding off buying a house, though wife really wants to, for the last year or so. However recently there has been an opportunity that is making me rethink. There is a builder in Milton offering a zero percent mortgage for the first 3 years, on semi costing around 780K, with 15 percent down payment. I am thinking it’s a sound investment to buy that property, rent it out (I have researched, others are renting these properties for 2700 a month- which covers the entire mortage) while I continue to stay in my current rental (saving 600 every month vs the market) till my landlord decides to kick me out (potentially a year or 2 from now).

Would love to get your thoughts on this? Am I making a big mistake buying a year or so before a recession? Thanks a bunch for all your awesomeness! Your blog is such a great resource. Thanks, Raheel.

Okay, R, if your Toronto-dwelling wife wants a house, why would you even consider buying a rental for other people to live in, way out in Milton where there are probably bears? Just because it sounds cheap? Because the mortgage rate is 0% for thirty-six months?

Then give yer head a shake. Fuzzy thinking will get you into trouble. Bigly. First, the interest you’d save over three years – about $32,000 – is already priced into the house. This is a sales gimmick, the same as reducing the selling sticker on the property. But it’s not much of a discount – just 4%. A little dickering without the 0% mortgage would get you a better deal.

Second, you’d lose money. Even a 0% mortgage plus property tax and insurance equals at least $2,800 a month. Add in the lost opportunity cost of your $120,000 downpayment, and the true cost is $3,400 – far less than rent. Third, this is a naked new-build house. No trees. No deck. No grass. No backyard. What kind of tenants will you attract? Fourth, as a rental from Day One any gains in value will be taxed as capital gains. If you sell in a year or two, profits will be considered business income and taxed at your marginal rate. Fifth, this is in Milton. Get a grip. It’s probably snowing there already.

Of course, this little insanity would also consume more than half your liquid net worth while plunging you into debt of more than $600,000, and delivering negative cash flow. But on Sundays your wife can go out to weed the yard. That should work out well.

First off, I’d like to thank you for the nightly reads. Your blog was recommended to me by my father and now I’m hooked. It is usually where our conversations end up (did you read Garth’s blog today!?) My wife and I (30, married a month) have approximately 50 k sitting in our TFSA in a high interest saving account. I’ve been advised by my…financial advisor that we should not be invested in any ETF’s right now since we are planning on using this money to buy our first home and that we can’t risk losing it by investing it in the market. I am finding it difficult not being invested in ETF’s since like you mentioned in your NOPE blog on August 20th, ” High-interest savings accounts barely pace inflation, and rates of return will be falling even lower in the months to come”.

Since our parents who would like us to stay close by, and rates being at 2.5-2.99%, we believe the next quarter or so may be a good opportunity for us to get into the housing market. With that being said, are there any other investment vessels we can consider besides HISA that won’t eat up a portion of our investments if a recession does present itself? Thanks for your help and all of your advice…Please feel free to use me in your blog, this moister has thick enough skin lol. Thanks, Steve.

I hope so. Bad idea. You’ve got fifty grand between you, have been married a few weeks and plan on buying a house within three months? How can you be 30 and be so naive? Unless you make a huge joint income, you’ll never qualify for enough (given the stress test) to buy more than a concrete box in some desolate tower – which you can rent for far less. This is a pathetic amount of money for two working adults to have accumulated. Did you blow it all on a honeymoon to Nevis? And how do you know if this union is going to work? Is this your bright idea, or hers? Do you really want to lock yourselves into a steaming pile of debt (and a potential nightmare getting out if the thing blows up)?

As for your question, keep the money in the HISA if you’re seriously house-horny. If not, the entire $50,000 invested for a year might earn enough to buy a new couch. Then you’ll have a place to sleep.

Hi Garth, I follow your blog and investment advice frequently. I’m contemplating helping my 32 year old son buy a house in Toronto.

I delayed over the past 10 yrs thinking major corrections were likely to happen but the opposite occurred and the prices soared. There is much talk of a looming Canadian recession so wondering if we could be on the cusp of a correction? Naturally he has a long term horizon for the house value so wondering if we should just jump in. Thanks, John.

There’s no recession looming, except in the media headlines. The economy is fine. Unemployment is low. Companies are making money. Little inflation. Robust consumer spending. Sure, a slowdown is inevitable after a decade of growth, but it’s not even close yet. When it comes, house prices will decline. So why not wait? Maybe by then your adult, middle-aged child will then be able to stand on his own. Like you did.

Gotta go. Tee time.