Newsletter Q&A
Every newsletter, I challenge readers to a skill-testing question! See how well you understand personal finance and investing by signing up to my newsletter.
November 14, 2024
How are capital gains taxed?
When you sell a stock, ETF or mutual fund and it has gone up in value from the time you bought it, you have a capital gain. The gain is the difference between book value (how much you paid to buy it) and the market value (today's value). The good news is that you don't have to pay tax on all of these gains, only half.*
When you file your tax return, half of the gains get added to your income for the year. It's like you earned more money (which you did, without working). To figure out in advance how much tax you will owe on these gains, find out what your marginal tax rate is. This is the rate you pay on "the next dollar of earnings" (because you are increasing your income with capital gains), not to be confused with your average tax rate, which is lower than your marginal tax rate.
It's that simple.
*Half of gains are taxed up to $250,000 worth of gains. Over this amount, 2/3rds is taxed. Another nice problem to have.
October 10, 2024
What is the difference between an RRSP and a locked-in RRSP?
A locked-in RRSP, also called a locked-in retirement account or LIRA, is required if you are transferring money from a pension. This can mean a defined benefit pension plan or a defined contribution pension plan you had with an employer. Once you transfer money from a pension to a LIRA you can no longer contribute to it. You'll use a regular RRSP for that. When you turn 71 you will have to have switched your LIRA to a LIF, just like you switch an RRSP to a RRIF. The main difference between a RRIF and a LIF is the maximum withdrawal amount. There is no maximum withdrawal permitted with a RRIF, but there is with a LIF.
August 4, 2024
What is a P/E ratio?
A P/E ratio is the price-to-earnings ratio. The numerator - price - is the stock's price per share. The denominator - earnings - is the earnings per share for a one-year period. The P/E ratio tells you how much you are paying for each dollar of earnings the company generates, the equivalent of calculating how much you are paying per pen when you buy a pack of them. P/E ratios are important if you are looking at investing in individual stocks because they tell you whether you're getting a good deal or not,
Analyzing the P/E ratio isn't simple, though, for several reasons. One reason is because a good P/E ratio for a Canadian bank (RBC has a P/E of 13x) won't be the same as for a U.S. technology company (Microsoft is at 33x). Why? Because the Canadian banks are, quite frankly, boring investments with pretty predictable earnings. A U.S. tech company on the other hand has a lot of potential and so you're willing to pay more for that future growth.
Novice investors should be careful about using P/E ratios are their primary investment criteria. However, a very high P/E can certainly be a warning sign that a stock is caught up in a frenzy and being price well beyond its earnings potential such as Nvidia's P/E ratio 79x earlier this summer.
June 26, 2024
What's the difference between price return and total return and why does it matter?
Price return is simply a calculation of how the price of your investment changed. Total return measures the price return plus it accounts for any distributions (usually dividends) the stock, mutual fund, or ETF made.
A price return would simply be the gains you made on a stock divided by the amount you paid to buy it. If you bought $5,000 worth of Royal Bank and after a year your investment went to $6,000, your price return is $1,000/$5,000 = 0.2. Multiply by 100 to get 20%. If RBC paid you dividends of $200 during the year, your total return is ($1,000+$200)/$5,000x100 = 24%.
It's important to look at total return when comparing the performance of different stocks or funds. Receiving a dividend is a form of return - it's a cash return instead of a capital gain. It's like calculating the return on a GIC: if you only looked at the price return it would be 0% but adding in the distribution - the interest it paid you - your return might be more like 5%.
Total return is also important because often a stock or mutual fund with a low distribution will have a better price return. This is because companies that pay a juicy dividend often are slower-growth companies like banks, insurance companies, and utilities. On the other hand, companies that don't pay a dividend are usually expanding and growing at a faster rate and their stock prices reflect this. You can read more about this here.
May 13, 2024
Why do mutual funds and ETFs make distributions?
Mutual funds and ETFs invest in individual stocks (and bonds and other things). These stocks pay dividends. If you owned the stock directly, you would be paid the dividend every quarter. But because the fund owns the stocks, the fund gets the dividends. However, these get passed along to you through a distribution. This might happen monthly, quarterly or annually.
For ETFs and mutual funds that are invested in stocks, your distribution will be made up primarily of dividends. However, you might also receive a capital gains distribution (usually only annually) if the fund realized capital gains during the year. Funds that aim to provide a high level of regular income will also generate interest income from bonds and other fixed income products, and may also pay a return of capital distribution (ROC).
Each of these distributions is taxed differently. If you hold the funds in a registered account, that's irrelevant but if you own them in a non-registered account, you will receive tax slips showing dividends, interest, and capital gains amounts that you have to pay tax on. Note that ROC is a bit different - you don't pay tax on the income but when you sell your fund, you'll have a bigger capital gain at that time.
If you don't need regular income, get registered in a DRIP - dividend re-investment program. This will reduce or eliminate the build-up of cash in your account since instead of getting cash, you'll get more units of the fund. (You still have to pay the tax, though.)
April 16, 2024
Imagine you gift a young person $500 for their TFSA on their 18th birthday on the condition that they add $50 a month, increasing that amount by $10 a month every year until age 65. So in the first year they add $600. In the second year they add $720, in the third year they add $840 and so on. If they invest in an all-in-one ETF like VGRO or ZGRO and earn 7% per year on average, at age 65:
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How much money will they have?
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$414,699
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$733,882
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$803,409
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$651, 235
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How much of that came from investment growth versus their own contributions?
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79%
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62%
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26%
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41%
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Yup, that's right. Almost 80% of that money was made from investment returns. Only $164,160 came from contributions; $609,222 came from investment gains. And because it's in a TFSA, there are NO TAXES to be paid on this. Ever.
Who says it's hard to be a millionaire? Your young person is almost 3/4 of the way there! All they have to do is start with $120 a month instead of $50 (that's still just $1,440 a year!) and they will have over a $1-million by age 65.*
*Now, to be fair, a million dollars in 2071 is not the same as a million dollars today but you get the point.
March 31, 2024
Why would you want to have a spousal RRSP?
A spousal RRSP allows you and your spouse to balance out your incomes in retirement. This is because the owner of the account is the one who pays income tax on the withdrawals. If one partner has a large RRSP and the second person has little to nothing in their RRSPs, you could end up with one partner having a high income and one have a low income. This will result in a higher family tax bill than if you were able to even out your incomes a bit more.
Most commonly, a spousal RRSP is used in couples where one person has a high income during their working years and the other has low to no income. A common example is when one spouse is employed and the other is at home raising children.
There are a lot of nuances with spousal RRSPs and they aren't for everyone. You can find lots of resources online explaining how they work.
March 12, 2024
What is a ticker tape?
A ticker tape is a list of stock symbols and prices. You often see the ticker tape running at the bottom of an all-day news channel or a financial website. The original ticker tape was a ribbon of paper that printed from a machine that transmitted information over telegraph wires telling investors the updated stock prices. The machine made a ticking sound, thus the moniker. Each stock has a ticket symbol to identify it. Ticker symbols are still used today despite the use of electronic trading and sadly, the demise of the real ticker tape.
February 26, 2024
Name three places you can go to buy a mutual fund. Name two places you can go to buy an ETF.
Places to buy a mutual fund include:
1. Bank branch - Walk into a branch and they'll be very happy to recommend their own funds to you. You can also phone the call centre.
2. A financial advisor - Mutual funds are one of several products (a popular one) offered by financial advisors.
3. An online broker - Choose and buy them yourselves through an online broker like Questrade, Scotia iTrade or TD Web Broker.
4. A financial planner - Not all financial planners sell mutual funds but many do.
5. An online bank - Tangerine and Simplii are two online banks that offer a limited range of mutual fund portfolios.
Places to buy an ETF include:
1. An online broker - The most common way to buy an ETF. The choice is endless.
2. A financial advisor - Not all financial advisors sell ETFs and if they do, they might not offer them to you unless you ask.
3. A financial planner - See financial advisor above.
February 9, 2024
What does MER stand for and what does it mean for investors?
MER stands for Management Expense Ratio. It's another term for "fee".
The MER is the ratio of the fees investors pay divided by the value of the fund. It's expressed as a percentage. An MER of 2% means investors pay 2% of the amount they invest in the mutual fund. This fee is taken off the performance of the fund. For example, if the investments in the fund went up 8% in a year, the investor only gets 6% if there is a 2% MER. This is why the fees can feel hidden.
The expenses of a mutual fund include paying for the managers and analysts. It also includes administrative costs like marketing, record keeping, compliance and so on. A big part of the MER on many funds (but not all) is the trailing commission. This is a commission paid to the person who sold the fund to you. A trailing commission is often 1%.
The fund's MER is usually shown up front on a mutual fund online profile and in fund documents like Fund Facts. Make sure to look at a fund's MER before investing.
To read more, have a look at this good primer that Sun Life put together.
January 25, 2024
What are preferred shares?
A. Shares in a company that pay a dividend that is more secure than the dividend on regular shares.
B. Shares in a company that give the holder a bigger ownership stake than regular shares.
C. Shares that have more voting rights than regular shares.
D. Shares that have a minimum guaranteed value.
The answer is A. The defining quality of a preferred share is its dividend. Preferred shares always come with a dividend attached. Many common shares (oops, more lingo - common shares are regular shares) also come with a dividend. The difference is that should a company run into financial difficulties, preferred shareholders receive their dividends before common shareholders, making the dividend more secure. If a company goes under and is liquidated, preferred shareholders rank higher that common shareholder on the ladder in terms of receiving value for their shares.
Prefs are mostly known for their high dividend yields and very stable and predictable dividend payments. This makes them attractive for people who want to generate income from their investments. However, they are many kinds of preferred shares and they can be complicated, with many features. This makes it hard for the average person to pick the good ones. Finally, dividend shares don't fluctuate much in value and have lower capital gains than common shares, making them more of a fixed income product than an equity product.
January 16, 2024
Which of the following is an investment and which is an account?
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GIC - Investment. You invest in a GIC, which can be held in an account or on its own if you buy it through your bank branch.
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TFSA - Account. You can open a TFSA, transfer money into it and buy many types of investments in it.
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Mutual fund - Investment. A mutual fund can be held within an account or on its own if you buy it through your bank branch.
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RRSP - Account. You can open an RRSP, contribute money to it, and then buy the investments within the account.
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Exchange-traded fund - Investment. ETFs can be held in a variety of accounts.
This can be confusing because if you open an RRSP at a bank branch, it will likely be an RRSP savings account. If you want to invest in a mutual fund or a GIC within your RRSP, these will show up as separate line items on your online banking.
If you have an account with an online brokerage like WealthSimple or Questrade, or if you work with a financial advisors, you will get a statement for one account and on that statement you will see all of the investments you have inside that account.
The bottom line is this: when you open an account like an RRSP, TFSA, FHSA or RESP, you money will not be invested. It will sit in a savings account earning next to nothing. You need to take the next step and invest it.
December 14, 2023
What is the deadline to do the following:
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Contribute to your TFSA?
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Make donations that you can claim in 2023?
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Make an RRSP contribution that you can claim in 2023?
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File a tax return if you are self-employed?
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Pay taxes owing without incurring a penalty?
1. Trick question! There is no deadline. You can contribute to your TFSA anytime since there are not tax implications.
2. December 31, 2023. Note though that you can claim that contribution for either 2023 or 2024 (or save it for a future year).
3. February 29, 2024. (Hey! It's a leap year!)
4. June 15
5. April 30 (even if you are self-employed and don't have to file until June 15)
November 30, 2023
How are CPP and OAS payments determined?
Canada Pension Plan (CPP) payments are based on the number of years you contributed to the CPP and on your income during that time. The calculation is a little complicated, and involves tallying up your earnings (or "YMPE"), dividing it by the number of months you contributed and multiplying by 25%. It's more complicated than that because you can exclude years in which you didn't work (for specific reasons like parental leave). For younger people, this calculation won't be quite right due to changes being implemented to CPP, which means higher contributions and higher payouts.
An easy shortcut is to take the number of years you contributed to CPP while earning at least $65,000 (in today's dollars) and divide that by 40. Apply this percent to the maximum CPP payment ($1,306 a month).
You can also get an estimate from the government through My Service Canada but beware that the calculation might not be accurate, due partly to the fact that they assume you'll keep working full-time until retirement.
OAS is simpler. How much OAS you will receive is based on the number of years you lived in Canada after the age of 18. To get the full payment ($707 a month), you need to have lived in Canada for 40 years. Partial payments are calculated based on the percentage of years you lived in Canada. For example, if you lived here for only 20 years, you'd get half the payment.
November 15, 2023
What are heuristics and how might they lead to making poor decisions?
A heuristic is a mental shortcut to help us make decisions more quickly and avoid mental overload. We use heuristics all the time and often don't notice. Heuristics are essential for getting through the day as it means we don't have think so hard about every single decision. For example, do I need a fork or a spoon for this dinner? If you are having soup, you use a spoon. If you're having pasta, you use a fork. You don't analyze what will happen if you use the fork to eat the soup - you just know that soup needs a spoon.
Heuristics can be detrimental too, of course, as it can lead to making poor decisions. For example, when it's February 28th and we are a day away from being able to make an RRSP contribution for the past tax year, some people might think "If I make a contribution, I will get a tax break therefore I should make a contribution." This is a shortcut since what you should be asking is "What is my tax rate now and what will my tax rate be in retirement? Does it make financial sense to make this contribution? Am I better off using this money for something else like paying down my mortgage or contributing to my TFSA?"
Using heuristics is often fine - but be aware when using a shortcut is dangerous.
November 2, 2023
What is a mutual fund trailer fee?
A trailer fee - or trailing commission - is money paid to a financial advisor by a mutual fund company for selling their product. A trailing commission can be as much as 1% of the amount of the clients' money the advisor has put into the fund. For example, if your advisor puts $300,000 of your money into a mutual fund managed by CI Financial, CI will pay the advisor 1% of that - or about $3,000 a year.
Of course, CI isn't really the one paying the advisor: you are. That's because you will pay a fee for owning the mutual fund, which can easily be 2% or more a year. 1% of that goes to your advisor and the remaining amount goes to CI for managing the fund.
You don't see the $6,000 a year you are paying in fees to CI because it comes right out of the value of your investment. You don't get a statement or invoice showing this amount.
Why does this matter? A mutual fund might not be the best investment for you. You might be able to own ETFs or index funds instead, which are far cheaper. But these funds don't pay a trailing commission. As much as a financial advisor would like to offer you the cheaper option, they would be sacrificing a nice commission to do so.
October 26, 2023
If the yield on an exchange-traded fund today is 3.6%, what does this mean for someone investing in the fund? Does it mean the same thing for someone who bought the fund two years ago?
The yield on an exchange-traded fund (or mutual fund or stock) is calculated as the dollar amount of the distribution per unit divided by the price of the units. Wait! Don't stop reading - it's gets easier.
Remember, when you invest in an ETF, you buy units of the fund, which represents one piece of the entire fund (similar to buying a share of a company). For ETFs that pay distributions, each unit is entitled to receive a certain amount of income paid out to the unit holder. For example, XIC paid 27 cents per unit as its last quarterly distribution. So, if you owned 100 units (about $3,000 worth), you'd have received a payment of $27.
So how do you calculate the yield? XIC pays its distributions quarterly - so in a year you'd get $27x4 = $108. If you bought your 100 units today at a price of $30.14, your yield would be 3.6% ($108/$3,014). You could also calculate it by determining how much you would get per unit ever year and dividing it by the until price, which is $1.08/$30.14.
As you can see, the quoted yield on an ETF only applies today. If you bought your units two years ago and paid $27.50, your calculated yield will be higher ($108/$2,750 = 3.9%) but that's kind of a meaningless number. The yield is really only meaningful on the day you invest in the fund because it's a measure of the value you're getting. The higher the yield, the better. It's a way of comparing which fund might be better value, or whether you'd rather invest in a dividend-focussed ETF or a GIC.
As an existing unit holder, what really matters if the dollar amount you're getting from the ETF.
October 18, 2023
Match the appropriate asset allocation with the account.
Note: Cash includes savings accounts and high interest savings ETFs. Fixed income includes bonds and GICs. Equities include stocks, preferred shares, stock mutual funds and stock ETFs.
FHSA: Saving to buy a house in less than 5 years
RRSP: Saving for retirement in 20 years
Non-registered: Emergency savings
RESP: Child is 15 years old
100% cash, 0% fixed income, 0% equities
0% cash, 20% fixed income, 80% equities
20% cash, 80% fixed income, 0% equities
10% cash, 55% fixed income, 35% equities
FHSA: Money for a down payment that you'll need in less than five years needs to be safe. You cannot take the risk of needing to withdraw all of it at once right after a market downturn. This could have devastating consequences for your ability to buy the home you want. Right now, locking in some of your FHSA money into GICs is a great idea as rates are high. You could also use high interest savings accounts, HISA ETFs and bond ETFS.
RRSP: Your time horizon isn't 20 years - it's 20 years + the number of years in retirement. So you can afford some volatilty. Go heavy on stocks, equity ETFs and equity mutual funds.
Non-registered: Emergency funds should always be liquid - cashable GICs, HISA ETFs, and savings accounts.
RESP: When your kids are little, you can go heavy on equities because you've got a 10 year+ time horizon. But once they start getting closer to graduating high school, start thinking about GICs, HISA ETFs, and bond ETFs.
October 13, 2023
Over any given 20-year period, what percentage of the time has the U.S. stock market risen?
100% of the time. Historically, the stock market has always risen over long time periods. Even over any given 10-year period the market has been up 88% of the time. That's a pretty good bet to make.
The most important takeaway from this data is that any money you need in the short-term should not be invested in the stock market. Use a safe investment like GICs, high interest savings accounts, or HISA exchange-traded funds.
For your super long-term goals like retirement, the stock market is the place to be.
October 3, 2023
Aside from gaining exposure to different countries, what is another important benefit of investing outside of Canada?
The Canadian stock market is dominated by two sectors of the economy: financials and energy. Financials make up 30% of our market, most of that being banks. Energy is almost 20%. This means that banks, insurance, oil and gas producers, and pipeline companies make up almost half of the market. Not exactly great diversification.
The U.S. market however looks really different. About 27% of the S&P 500 is Technology and 13% is Healthcare. As you can see, the U.S. market has a lot of companies in sectors that are barely present in Canada.
Combining investments in Canada with investments in the U.S. (and elsewhere) means you'll be getting exposure to more sectors instead of being overly reliant on the performance of banks and oil producers.
Sept 27, 2023
Can you earn dividends by owning exchange-traded funds or do you have to own individual stocks?
You can receive dividends when you own exchange-traded funds- in fact, some ETFs are designed to pay a high dividend amount.
Of course, you'll also get a dividend if you own individual stocks.
Canada has some great dividend-paying companies, companies that have a long history of reliably paying a dividend and increasing it year after year. The banks make great dividend investments, as they have been paying a dividend for over 100 years! Other good dividend payers include utility and telecom companies.
If you buy a high-dividend ETF, expect to see it dominated by these sector. One drawback of being a dividend investor is a lack of diversification into other sectors like technology and consumer.
Sept 19, 2023
What kinds of income are you allowed to split with a spouse in retirement?
If one spouse has far more income than the other spouse, they would probably benefit from income splitting. This evens out the income between them and lowers the overall tax bill.
The types of income you can split in retirement include:
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Payments from a pension plan
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RRIF payments (an RRSP becomes a RRIF in retirement) and LIF payments (a LIRA becomes a LIF)
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Canada Pension Plan (CPP) payments
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Annuity payments
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Payments from certain foreign pension plans
There are others, but these are the main ones. For pension, RRIF and annuity payments, you make the election to split the income on your tax return and this split can change year-to-year. If you want to split CPP payments, you need to make an election with the CRA by completing a form. This pension split will remain the same year to year unless you request to cancel it.
Another way to split income in retirement is by using a Spousal RRSP.
There are more rules around income splitting so make sure you do some thorough research before jumping in!
Sept 13, 2023
Which type of investment income is taxed the least favourably: capital gains, interest, or dividends?
Interest income.
You earn interest income from savings accounts, GICs and bonds. This income is taxed like regular income. You simply add it to your employment income and calculate your overall tax payable.
Capital gains are quite favourably taxed. You receive capital gains when the value of your stocks, ETFs or mutual funds goes up. If you hold these in a regular/non-registered account, you will realize a capital gain when you sell the investment. You'll have to pay income tax in the year you sell. However, the good news is that you only have to pay tax on half of the capital gains, not all of it.
Dividends are also favourably taxed due to the dividend tax credit. The dividend tax credit allows you to reduce your overall tax payable on the dividend income. Whether dividends or capital gains are a better deal from a tax perspective depends on how much total income you have. In fact, if your total income (employment+pension+CPP+OAS+RRIF+investment income) is below about $50,000, you pay no tax on dividends.
Sept. 6, 2023
Why does a passively-managed exchange-traded fund charge a much lower fee than an actively-managed mutual fund?
When a fund is actively-managed, it means that someone or a group of people are picking and choosing stocks. "Should we buy more Amazon?" "Should we sell Dollarama?" They do this all day long, all week long, all year long. These people have to be paid. In addition, a mutual fund sales person or investment advisor has to sell the funds to the general public. In order to incentivize a salesperson to sell a particular fund, the fund company pays them an ongoing commission, called a trailing commission. This cost of this "trailer fee" is included in the fee you, the investor in the fund, pays. There are other fees involved as well, but these are the big ones.
ETFs that are passively-managed don't have to pay anyone to pick stocks, and also don't (usually) pay trailer fees to salespeople, making them much cheaper for investors.