Thursday, 26 May 2016

Someone told me stocks are risky

Someone I just met today started a conversation with me.  We got onto the topic of the stock market.  He flat out said that stocks are risky, it's pure gambling.  He gave me the example of how someone told him to buy Royal Bank stocks because it was a great bank stock and a great company overall.  I started to like this conversation with this person, whom I'll call A.S.  well A.S. said that he bought 200 shares of RY.TO at $80 for an investment of $16,000 and then it dropped to $69 for a loss of $11 times 200 shares for  total loss of $2,200.

There is a way to lower the risk of investing in stocks, that is to buy stocks when they have fallen in price which is discounted in a way.

Unfortunately, most investors become greedy and buy stocks when they rise and become scared and sell when share prices fall.  Shouldn't it be the opposite if you want to a successful investor?  So if go back to the scared investor selling, isn't it the people behind the stocks who sell that is making the act of investing risky if they act irrationally.

Reasonable Thinking

Remember the saying, "buy low, sell high"?  It's so true, why do people do the opposite?  When you do the opposite, you are locking in your losses and therefore you have realized the risk.  People who hold stocks in downturns because they know the stock will rebound are the most successful investors out there.

One way to invest in a reasonable way is to buy quality stocks with a long time horizon when they are priced correctly on a dip.

So going back our example with A.S., his friend who told him Royal Bank stock was a good investment, he forgot to say for the long term.  Royal Bank at $80 a share was fairly valued, the dividend would have been a decent 3.90%.  It is a quality business which raises its dividend on a regular basis.  Is a leader among the big 5 banks.  All good traits of a solid business.

Your investment is not completely safe even when you buy a quality company at a good price.  There was a moment in time that even Royal Bank dipped down to $48 or even $25 during the crisis in 2008. Now if you bought then, you would be very happy with your investment.  Goes back to buy low sell high which a lot of investors forget.


The real risk comes when you sell at a loss or sell them for less than what you paid for them.  Risk happens when the investor can't hold onto Royal Bank shares when it falls to $48 a share.  There is no need to sell quality companies that have a downturn,

Final Thoughts

Investing in stocks isn't risky.  It is the investors owning stocks who can act irrationally that make the act of investing risky.  If you buy quality dividend stocks for the long term, you should not have anything to worry about.  When there is a downturn, you still receive your dividend just as when there is an upturn, you get your dividend.  Remember buy low and sell high.  That statement still works after all this time.

Saturday, 21 May 2016

Earn $50,000 in dividends and pay no $0 in tax

A nice thing about dividends is that they are taxed at a lower rate then interest and other income.

Most people have heard of this but what most don't know is that depending on your province where you are taxed, its possible for an individual with no other sources of income to earn nearly $50,000 in dividends without paying any tax at all.

How you ask?  Two main things, the dividend tax credit and the basic personal amount available to all Canadians.

What is the Dividend Tax credit

When you receive a dividend, the money comes from a corporation's after tax profits.  Because the company has already paid some tax, it wouldn't be fair to make a shareholder pay again?

Solution, a gross up on the dividend.  On your tax return, you gross up the dividend ( 2012 gross up is 1.38) received basically you are converting it back it pre-tax amount.  Next you figure out how much tax you have had to pay on that grossed up amount, based on your marginal rate.  Finally, you subtract the dividend tax credit.  The end result, is the tax you would actually have to pay on the dividend.

Let's put the dividend tax credit into an example, it might be easier to see how it works instead of just having  definition typed out for you.  Let's say you live in Ontario and you have been carefully building a portfolio over the years and it is now worth $1.2 million.  In this example, you will be receiving $47,888 in dividends which equals to a 4% yield.  A very possible setup given the dividend yields in today's environment.  Let also assume that you have no other sources of income.  You would gross up your dividend of $47,888 (times 1.38) to $66,085 which is what you would report on your income statement.

If anyone that knows just the basics of income tax, they would say, what the?  I get $47,888 in dividends and I report $66,085?  That is just wrong.  But look at the table at the bottom of this post, you will see the how you do not have to pay any tax.  The total federal tax of $11,549 is offset  by the basic personal tax credit and by the federal dividend tax credit.

Also note, that at income levels below $10,882 in 2012, you are getting two credits working for you, the dividend tax credit and the basic personal credit.

it's the same story for Ontario tax.

Other provinces have the same provincial calculation but they all have the same story, the amounts vary but the same story is there.

If a tax payer claims other credits such as spousal, or child credits.  They may be able to earn even more dividend income and still pay no tax.

The above example is for information purposes only and uses 2012 data and is to get you thinking but as always, please consult a tax professional for all your tax questions.

Final Thoughts

We all heard of winning the lottery and living off the interest.  Well, not all of us will win the lottery but over the years, the power of dividend investing shows it's true colours, you can make your own lottery and live off the interest (dividends in this case) and pay no tax.  Now who wouldn't want that?  Think about it.

Federal tax

1st $42,707@15%                         $6,406
(66,085-42,707)@22%                    $5,143
Less basic credit 10,822@15%       (1,623)
DTC 66,085@15.02%                     (9926)

Net Federal tax                                  0

Ontario Tax

1st $39,020 @5%                          $1,971
(66,085-39,020)@9.15%                 $2,476
Less basic credit $9,405@5.05%    (475)
DTC $66,085@6.4%                      (4,229)
Net                                                  0
Add Sur Tax                                     0

Total Ontario Tax                              0

Monday, 9 May 2016

Age of rule thumb - Asset allocation

The popular "age of rule thumb" states that a portfolio should get more conservative as a person gets older.  For example, a 30 year old with several years of investing and earnings ahead of them should allocate about 30 percent of his or her portfolio to fixed income and the remaining 70 percent to equities which have a higher risk, but potentially higher returns.

An 80 year old on the other hand would have, who can not afford to take much risk should allocate 80 percent of his or her portfolio to bonds or guaranteed investment certificates and just 20 percent to equities.

This is an easy rule to follow and maybe at one point it made complete sense.  It has survived all these years as a guide which to me should not be carved in stone.  It can be changed or modified to fit today's investor.  Today's investor are retiring earlier and living longer, thanks to better health care and nutrition, their money must last longer also.  That's is why the age of rule thumb to me is way too conservative.

In today's financial world, the proper asset allocation will always be talked about and discussed.  Maybe it should start with this rule or maybe it should not.  But to most investors, it is what allocation they are comfortable with, they must know the risks to make an informed decision.  To pigeon hole them into this type of asset allocation without options to me seems, wacky.  Yes wacky.  There are old standbys and traditions in the financial world of investing that just seem wacky.  Why do people follow what was done in the past?  Does it make it right for today's world?  Think about it, would I call you from a rotary phone or would it be obvious to call you from a cellular phone?  Kinda the same there here, would I follow the same asset allocation as my grand parents?

Modification to Age or rule

Why not multiply the person's age by one one-hundredth of their age and capping the fixed income percent at 50?  For example, a 40 year old would have 40 times 0.4 or 16 percent in fixed income.

A 70 year old would have 70 times 0.7 or 49 percent in fixed income.

Anyone older than that should have a 50-50 mix.

There are other factors like how much will an investor need to withdraw from their portfolio.  If a retired investor is withdrawing about 7 percent a year from their RRSP, they would need to take that into consideration.

A wealthy investor who lives off the 1 percent of their assets can afford to invest in more equities than the previous example.

Health also need to be a consideration, if you sense that you are going to live longer, then you need to make sure you have enough money to last all those years.

There you have it, my views on a modified formula to determine asset allocation of one's portfolio.

It is not as easy as plugging in numbers into a formula but now you can make a more informed decision about your asset allocation.

Please leave any questions or comments