Entries from June 2020 ↓

Rate sex

Four months of virus, now. Ten million cases globally. The bug eating Texas and Florida. The White House losing control. Air Canada, Westjet ditching distancing. Masks everywhere. Condo units flooding the GTA market. Second wave with more hoarding threatened. No hockey in Vancouver. Locusts in India. Civil unrest in America. Toronto finances crumbling. Eight million on the dole and a million mortgages unpaid. Elevators as death traps. A US election that’ll rock the world.

Did I miss much? This is a year we’ll ne’er forget. And it’s not even July.

But enough doom, blog dogs. Let’s leave the gore and desperation for the MSM. For even in the darkest night there burns a flicker of hope. Many, actually. Today we’ll celebrate the unexpected gift just bestowed upon us by those two evil powers, Covid and the CRA.

It’s called the prescribed rate of interest. Yes, exactly. I’m aroused too. Here’s how it works…

Every few months the revenue guys set a new rate, based on three-month T-bills. Because the cost of money has been crushed by the Bank of Canada in response to the virus, the rate (effective Wednesday) plunges by half, way down to just 1%.

So what?

So you can now loan buckets of money to your married spouse, common-law partner or other family members at a rate which is absurdly low to accomplish income-splitting. Even better, if you set this loan up over the next three months (the rate could be hiked again later in the year), then the 1% is permanent for the life of the borrowing. It’s fixed, not variable. So imagine having that in place six years from now when the rate is, say 5%. Big win.

How does this income-splitting, prescribed-rate thing work?

Simple. If you and your squeeze earn different levels of income with one of you in a higher marginal tax bracket – or perhaps one person at home looking after the spawn – create a loan. Money is borrowed (at the ridiculously low rate of 1%) by the partner who is taxed less, then invested. Because it’s a loan, not a gift, all gains or income flowing from the investment portfolio belong to the borrower and are taxed in his/her hands. In other words, no attribution back to the person who actually made and owned the money. If the dough had been handed to the less-taxed person to invest and came as a gift, all returns or profits would be attributed back to the donor, and taxed at his/her higher rate.

There’s more. The interest, as piteous as it might be, is tax-deductible. So a stay-at-home mom, for example, can have a portfolio financed with a spousal loan and deduct the cost of that borrowing from the investment income. The same can be accomplished for minor children through a family trust. Loan the trust money. It pays 1% per year to get it. The funds are invested with the kids as beneficiaries. They get the benefit of the investment income and likely pay no tax. Or the trust can be used to finance their education (such as private school tuition) pay summer camp fees or buy them drums and amps.

Remember how beneficial dividends can be, by the way. A family trust could earn more than $53,000 per year, per kid, and pay not a nickel in income tax, if that is the beneficiary’s sole source of income. Same with a spouse who is out of the workforce, engaged in child care.

To make this loan arrangement work, there must be documentation in place which will withstand CRA scrutiny. Have a written promissory note drafted and ensure there’s a physical, actual, real exchange of interest by January 30th of each year. That payment is taxable in the hands of the lender and (as mentioned) deductible to the borrower.

Moving income and assets into the hands of a less-taxed family member through this type of loan can save your household a bundle. Just like establishing a spousal RRSP, into which the higher-earner contributes and reaps the tax break, but the money belongs to the spouse who can eventually withdraw it at a lower rate. Ditto for the strategy of the common expenses (food, accommodation, dog food) being paid by the person who earns the most while the other partner does all of the investing.

This, by the way, is completely opposite to the way 90% of most marriages work. Especially those suspicious, secretive husbands and wives who keep their finances separate and suffer financially (and emotionally) as a result. (Why did you get hitched if you don’t trust?)

Finally, the virus.

It’s not going away, as planned. Some US states are even suspending or reversing reopening measures. Trump ain’t helping. Economic activity will be further impacted. Mr. Market’s taking a dim view of it all. Volatility is returning. Assets values will be under pressure after a meteoric rise. The period between now and the American election (if there is one) could bring big opportunity.

What a wonderful time to loan all your money to your heartthrob. Just remember the 1% must be paid in cash not cuddles.

Oracle wisdom

DOUG  By Guest Blogger Doug Rowat


There are many famous Warren Buffett stories, but perhaps my favourite is the one told by his first wife, Susan Buffett.

As the story goes, one day when Susan was sick she asked Warren for a bowl for her bedside because she was feeling nauseous. Warren banged around in the kitchen and eventually came back with a colander. Frustrated, Susan explained that this wouldn’t work because it had holes in it. Warren returned to the kitchen, banged around some more and returned with the same colander but this time on a cookie sheet.

Such is the impossibility of trying to decipher the mind of a genius.

Though much has been written about Warren Buffett, perhaps those who have deciphered him best, at least in terms of his approach to investing, are David Clark and Mary Buffett (Warren’s daughter-in-law).

Their many books on Warren contain great insight into his techniques and approach to the market. While too numerous and complex to detail in their entirety, one surprisingly straightforward factor that contributes to his investing success is simply this: he buys old companies.

Why? Because Warren likes companies that have predictable products and predictable profits. And a brand-name product or service that’s been around a long time, preferably decades, gives a company a durable competitive advantage, which usually results in better and more consistent performance. Warren’s famous explanation of why he likes Wrigley’s chewing gum, which was first introduced in the 1890s, perhaps says it best: “I don’t think the Internet is going to change how people chew gum.”

David Clark and Mary Buffett detail his preference for old companies in their book The Warren Buffett Stock Portfolio:

Why is OLD so important to Warren? It has to do with the product or service the company is selling. Take Coca-Cola for an example. Coke has been manufacturing and selling the same product for well over a hundred years. It spends very little on research and development and has to replace its manufacturing machinery only when it wears out. This means that the company gets maximum economic use out of its plants and equipment before it has to replace them.

Old also goes to the nature of the product. Do you think that if Coke has been selling the same product for the last hundred years, it will be selling the same product ten or twenty years from now?

Now, I don’t highlight this passage to recommend buying Coca-Cola stock—my preference for broad-based and diversified ETFs, as well as my Raymond James compliance department, prevents me from making this recommendation. However, I do highlight the passage to emphasize the importance of considering a company’s age before investing in it. It’s certainly not a complicated strategy, but nevertheless, all things being equal, buying older is better.

Indeed, when I looked at the components of the S&P 500 and ranked them all by ‘years of incorporation’ and simply split the Index in half, the oldest half has outperformed the youngest half over both the past five years and the past 10 years. Unsurprisingly, these older companies have also been less volatile. (Looking at periods longer than 10 years gets problematic as the number of data points gets scarcer as too many younger companies actually don’t have 15-, 20- or 30-year trading histories.) What’s even more remarkable is that the youngest half contains a large proportion of high-flying information technology and consumer discretionary stocks such as Netflix and Amazon. Yet collectively, the old fuddy-duddies, like Johnson & Johnson and Kroger, still came out on top overall. In fact, virtually all of the top-10 oldest companies were incorporated prior to 1900 (some prior to the Civil War!).

The youngster in the top-10 was Eli Lilly, but even this company was still incorporated over a century ago in 1901. (To put 1901 into perspective, there were fewer than a million phones in use in the US and carrier pigeons were still sometimes used to send messages.) So, clearly, in terms of business models, any companies that’ve been around for a hundred years or more must know a thing or two about creating and offering successful products and services.

I further examined how this older-is-better approach has infiltrated (albeit somewhat unintentionally) our own portfolio management at Turner Investments. In particular, with our Canadian equity exposure. For many years now we have taken a non-benchmark approach to the Canadian equity market, overweighting an ETF that minimizes volatility and dramatically limits energy exposure. However, as it turns out, this ETF also contains companies that are much older on average than those in the overall S&P/TSX Composite. Unsurprisingly, the ETF that we selected has strongly outperformed:

Better with age

Source: Bloomberg, *measures years of incorporation
Click to enlarge

So, Warren Buffett, as usual, was right. Older is better.

Companies, it seems, are like fine wines: they get better with age.

And finally, this came in my junk mail this week. Could there be a surer sign that Covid-19 is becoming a normalized part of our lives? I hope that they’re all actually smiling under those masks…

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.