The assault

After the election comes a Throne Speech. Late in October, maybe. They’re always packed with vagueness, fluff and unicorns. Normally we’d get an economic statement of some kind, but this year the pre-Christmas session of Parliament will be too short.

So the real news will be in the budget, earlier than usual. March. Maybe even February, from Chrystia our non-financial Finance Minister. Gulp. Remember the Libs’ campaign slogan? “Forward. For Everyone.” Except if you have wealth.

The Street’s anticipating changes coming for the capital gains inclusion rate. That means profits selling rental properties, gold wafers, a cottage, stocks, ETFs and a mess of other stuff will be hit. Currently you get a deal. Half the gain on a sale is tax-free. The other half is included in annual income.

On an income of $90,000 the average tax rate is 26% and marginal rate of 31% (each dollar above 90k taxed at that level), so small capital gains would still leave you with 85% of the proceeds. Not bad.

Larger gains push annual incomes and tax rates higher. Those in the top tier (incomes over $230,000) have a marginal rate in provinces like Ontario of 53.3%. That means 73% of the capital gain are retained, while the rest is sucked off by the deities on Parliament Hill. Compared with the Hoovering earned incomes received, this is not such a bad deal.

Ironically, it was Liberals who dropped the inclusion rate to 50%. Paul Martin did that, erasing the previous 75% level as part of a $58 billion tax cut in his 2000 budget. Yes, tax cut. From Liberals. The same guys who trashed the deficit. But the Libs of two decades ago were radically different dudes from the tax-and-speed gang currently in control of the nation. Now we have red ink washing over the gunwales with a government hooked on spending and starved for more revenue while it has zero plans to ever balance the books.

Now, before we go further, let’s address this question: why are capital gains taxed less than income from employment, rent from your tenants or interest on a GIC?

A few reasons. First, by offering a lower tax rate on capital gains from investing corporate shares (or funds holding them), for example, the tax code acknowledges risk-taking. You might gain. You might lose. But the activity of putting money into jobs-creating and goods-producing enterprises is beneficial for everyone, since this grows the economy. Collecting interest from a GIC or getting paid to show up at work do not constitute the same risk.

Second, a lower cap gains rate recognizes investors are being whacked by inflation on the assets being sold. The tax applies to their inflated nominal value, so not only do investors pay a levy on the real return, but also on the inflation which has been created by central banks. Not the case for employment interest or collected rents, which is paid and taxed in current dollars.

Third, capital gains taxes are paid on money which has already been taxed. The same dollar was hit by income tax, sales taxes and payroll taxes. If invested in equities or funds, the money was taxed again in the hands of corporations, then taxed once more when shares or units were sold, generating a capital gain. Enough already. And not the case with your salary, which is taxed just once.

Fourth, capital gains tax future consumption because savings are reduced, while present consumption is untaxed. The net effect is to discourage investing and saving, and to favour spending. Not good for society as this reduces future available capital and has a negative impact on long-term economic growth. Buying a house with 20x leverage, in other words, borrows against the future. Investing in corporate assets, in contrast, puts money away for future use. Liberals used to understand that.

Okay, so now what? If the Street’s right and Chrystia drops the hammer, what avenues are available to thwart her?

Well, gains can be triggered now, of course, at the 50% inclusion rate. You can also sell off losers to claim against profits. But only sell if you planned on dumping these assets within the next few months anyway, since long-term investment goals should not be irrevocably altered by potential tax changes.

Make non-registered assets into registered ones. Contributions in kind can shift things into a TFSA or RRSP (if you have the room) from a non-reg account. Of course capital gains tax will be triggered, but you can escape transaction charges.

Obviously making full use of tax-free and retirement savings accounts becomes even more of a no-brainer if the inclusion rate jumps. Remember that the TFSA limit is $75,500 (rising to almost $82,000 next year, or over $150,000 for a couple. RRSPs are unlimited but based on earned income – up to over $28,000 this year. Nine in 10 Canadians have not maxed either, and the amount of unused room grows dramatically every year (because the masses are blowing their brains on real estate). Add in other shelters like RESPs for your kids or maybe the new FHSA for the thing in your basement, and there’s much opportunity to grow money and pay no tax. Among these the TFSA stands uniquely. Max it.

The election’s over. The people have spoken. Take cover.

About the picture: “I’ve read your blog since it started,” writes Dean. “I even went to one of your “Live Performances “ in Edmonton about years ago! This is Fitz our 6 year old Doberman-Boxer-Bulldog cross. He is a very happy and sleepy boy. He has his own instagram page too! My wife loves him more than me! Dog_with_the_lips_of_a_man. Thanks for all your good advice!”

Note to Viewers: A mysterious glitch eliminated all comments to the post which were published on September 26th. The webmaster team has attempted recovery, but thus far without success. If you stole these comments and now repent, you may leave them in a plain box at the east gate, by the moat. – Garth

What to do with cash?

RYAN   By Guest Blogger Ryan Lewenza

I’ve been writing research reports and blog posts for a long time now and sometimes I get my best ideas from the readers. Recently I had a good suggestion from a blog dog to cover the topic of what to do with cash given the very low interest rate environment. Unfortunately with yields so low there are few good options, but I’ll do my best to examine the landscape and the different options.

There has never been a better time to be borrowing gobs of money. With the Covid-19 outbreak and ensuing deep recession, central banks have slashed benchmark interest rates to rock bottom levels. Currently, the Bank of Canada (BoC) overnight rate sits at a previously unheard level of 0.25%. While millennials love these low rates, retirees, generally, loath these record low levels.

Why? Because they’ve worked hard to accumulate wealth and financial assets and now they are retired and need income from the portfolios to live off, so they are getting hosed by these low interest rates.

BoC has cut rates to rock-bottom lows of 0.25%

Source: Bloomberg, Turner Investments

Let’s first look at the safest investments you can own – Canadian government bonds. Below I plot the yields of different government bond maturities, also known as the yield curve. With our benchmark rate at 0.25% this has brought down yields across the entire curve. Currently 1-year T-bills are yielding a paltry 0.25%, with 2 and 5-year yields at 0.4% and 0.8%, respectively.

Even longer term maturities are yielding around just 1.5%. That’s not going to provide enough income to pay for a trip to Europe, much less a pitcher of beer!

Canadian Yield Curve

Source: Bloomberg, Turner Investments

Next up are GICs, a traditional safe haven for retirees. Below is a sample of current GIC rates from various financial institutions. Looking at the top-tier issuers like the banks, they’re paying roughly 0.4% for 1 year, 0.8% for 2-years and they finally get to 1% at a 3-year term. And you’re locked into these so you better not need the funds before the maturity date.

Current GIC Rates

Source: Turner Investments, Raymond James

Next up I reviewed some of the prominent money market funds and high interest savings accounts (HISAs). Currently they range from 0.7% to 1.35% and the benefit of these products is the ease to get in and out with little to no cost. We like to use these HISA ETFs and money market funds for this reason.

Now if roughly 1% yields does not pique your interest then you need to consider moving up on the risk curve by looking at short-term and corporate bond funds. Short-term bond ETFs are currently yielding around 2-2.5% while corporate bond ETFs are yielding around 3%. Not bad yields but these come with additional risk if interest rates rise or if we see a big risk-off event, which would cause credit spreads (yield differential between government and corporate bonds) to blow-out.

Lastly, investors could look at preferred shares, which pay higher yields and are dividends so they are more tax efficient. Many of the main preferred share ETFs are yielding around 4%. Now these are not GICs or government bond substitutes as they come with higher volatility. But, when adjusted for the different tax rates between dividends and interest income, at a roughly 6% interest-equivalent yield, they could be an option for those investors who can handle the additional volatility. Of course within a diversified and balance portfolio.

So looking at the different options, I believe the best options for investors looking to invest cash in a lower risk vehicle, are the high interest savings accounts and short-term bond ETFs. There you would be looking at yields of roughly 1-2%. While not great, and definitely losing purchasing power after adjusting for inflation, they are the best options (of a bad bunch) if looking for higher yields than your typical GICs.

And final point. All those adverts you see for 8% returns and no risk. Bupkis! There is a reason why they are paying you 8% and the banks are paying you 0.5%. Whether it’s income trusts, Yellow Pages, or asset-backed commercial paper, there is always more risk than investors anticipate and the ‘reach for yield’ often ends in tears. So know what you’re investing in!

Yields of various shorter-term investments

Source: Turner Investments, Company Websites
Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.