Bond avoidance, reverse mortgages, U.S. bank ETFs and other investing concerns

It’s been a while since we checked the inbox so let’s see what questions people are asking.

Can I avoid bonds?

Q – My wife and I are both retired and lucky enough to have defined pensions with an annual cost of living index as an additional benefit. I therefore see this as reliable income and do not invest in bonds. Am I wrong to think in this way? – Joseph S.

A – I suggest you’re missing a key point. The bonds in a portfolio are not just for income. In fact, high-yield stocks offer better cash flow. Bonds provide portfolio diversification and reduce volatility. In normal times – 2022 was an exception – bonds provide a buffer if the stock market falters.

The volatility meter on the Steadyhand website illustrates the effect of owning some bonds. In 2018, a 100-per-cent equities portfolio would have lost 4.7 per cent. A traditional mix of 60 per cent equities, 40 per cent bonds would have reduced that loss to 2.3 per cent. In 2011, a loss of 5.9 per cent with an all-equity portfolio would have become a small gain of 0.1 per cent with a 60-40 balance. The most dramatic impact would have been 2008, where an all-equity loss of 29.4 per cent would have been reduced to 15.2 per cent.

The meter also tells us that over the long term, an all-equity portfolio generates superior results. Each investor most decide if they can handle the increased volatility. – G.P.

Debt repayments and reverse mortgages

Q – I have been reading about debt and investments. I have been to the bank to try to consolidate bills and mortgage. Searching the internet was confusing as there are too many options. The increase in interest rate also messed me up. Can you give me some advice? Any thoughts on reverse mortgages? – Rita K.

A – It sounds like you have a complex financial situation. Here are a couple of thoughts.

If you’re seeking to consolidate debt, a conventional mortgage or a home equity line of credit are probably the cheapest ways in which to borrow at present. That said, the interest cost is much higher than it was before the Bank of Canada started to raise rates. Whatever you do, I suggest you do not lock in a long-term rate. It appears interest rates will begin to drop later this year, so choose a variable rate loan.

Reverse mortgages charge a higher rate than a conventional mortgage or a line of credit, so the value of your home is eroded more quickly. The offset is you don’t have to repay the loan unless you move or die – in the latter case, the estate must repay. Also, if the money from a reverse mortgage is invested, the interest on the loan may be tax deductible. Ask a tax professional for help if you go that route. – G.P.

U.S. dollar bank ETFs

Q – I have a good portion of my portfolio in USD. I would like to invest in an ETF that is focused on Canadian banks/financials that is in USD. I do not want to convert USD to Canadian dollars currently. Are there any ETFs that you would recommend? – Frank S.

A – Take a look at the BMO Canadian Banks Covered Call Canadian Banks ETF (US dollar units). The trading symbol is ZWB.U on the TSX.

This ETF holds an equal-weighted portfolio of the Big Six Canadian banks, and the mangers write covered call options to boost income. The performance history isn’t impressive but keep in mind the U.S. dollar units were only launched in January 2022. That was hardly an auspicious time, with rising interest rates and recession fears battering the banking sector. As a result, the units show an average annual compound rate of return of negative 6.57 per cent since inception (to Feb. 29). The Canadian dollar version of this fund (ZWB-T) has been around since 2011 and shows an average annual gain since inception of 7.72 per cent.

I think banking stocks will make a strong recovery as recession fears recede and interest rates begin to decline later this year.

The fund currently pays a monthly distribution of 14 US cents per unit for a yield of 7.2 per cent. The MER is high, at 0.72 per cent.

A Google search will reveal other options if you want to make comparisons. – G.P.

Transferring to a TFSA

Q – I am considering using an in-kind transfer to move funds from a non-registered Canadian investment account to my TFSA account. I currently have $17,800 contribution room in my TFSA. I am semi-retired and otherwise I’m not able to use all the available TFSA contribution room.

I understand that if I transfer non-registered shares and ETFs to my TFSA, Canada Revenue considers it a deemed disposition. None of the investments in my non-registered account are in a loss position, so I understand I will have to pay 50-per-cent capital gains on the amount I have earned from these investments (which will be about $1,200). I also understand that once the funds have been transferred into my TFSA, any further increase in value will not attract capital gains tax. This is my rationale for transferring the funds to my TFSA.

My questions are as follows:

1. Even though it will attract capital gains, is it a good idea to transfer investments from a non-registered account into my TFSA, given that I have contribution room and no other way to contribute that much?

2. Is there a better or worse time of year to transfer investments from a non-registered account into my TFSA?

3. If my income is less in 2024 than it was in 2023, will that make any difference to the amount of capital gains? (I think not, but thought I’d ask).

4. Is there a way to offset the capital gains? – Kathleen D.

A – Your rationale is correct, and I suggest you go ahead with your plan. As to timing, the sooner the better. The markets are on the rise right now and the coming interest rate cuts should be a stimulus for more gains. To the extent that happens before you make the change, your capital gains will increase and so will your tax bill.

Your income does make a difference in the tax you will be assessed. The rule is that 50 per cent of your gains are taxable at your marginal rate. So, the higher your income, the higher your rate.

Capital losses can be used to offset capital gains, but you say you don’t have any. Once the money is in the TFSA, gains and losses have no tax impact. – G.P.

Canadian Banc shares

Q – I’m curious as to why Canadian Banc (BK-T) shares with a NAV of $19.75 are selling for $10 to $11, while paying a monthly dividend of around 13 cents. They invest in the big six Canadian banks, so should be very secure investments. They use covered calls to raise the dividend over what banks are paying. If their shares were valued at the NAV of $19.75, the dividend would be about 8 per cent which seems about right, given the banks are paying out dividends in the 4-5-per-cent range. Many thanks for any insight you can provide. – Kerry G., Smithers, BC

A – Canadian Banc is one of several companies offering split shares based on bank stocks. Premium Income Corp. is another. All operate in much the same way, with an issue of preferred shares that offer guaranteed dividends and an A share issue that offers capital gains plus any dividends remaining after the preferreds have been paid.

All the A split shares that I looked at have NAVs (net asset value) that are far higher than the trading price. This may be due to the high volatility in these shares. In January 2022, BK was trading at $15.16 a share. As I write, it is at $10.73, down almost 30 per cent. The 14.4-per-cent yield, based on the latest distribution, may look attractive. But the total payout over that period did not cover the capital loss, leaving investors with negative total return.

Of course, other time frames will produce different results. Buying now, while the shares are cheap, may be a winning strategy. Just be aware of the risk. – G.P.

If you have a money question you’d like answered, send it to gordonpape@hotmail.com and write Globe Question on the subject line. I can’t guarantee a personal response but I’ll answer as many questions as possible in this space.

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