Many investors missed an opportunity in March to use a simple investment strategy. The strategy increases investment returns and reduces risk over time. While most investors followed the media closely as markets declined and fretted over whether to reduce their stock holdings, those who followed the strategy were less anxious, and their portfolios fared well.
The simple strategy is known as rebalancing. Many institutional investors, such as pension funds and endowments, use its systematically. Among individual investors, rebalancing is perhaps the most neglected investment action.
You set up a portfolio with a certain asset allocation, called a target allocation. A typical allocation is 60% of the portfolio in stocks and 40% in bonds.
Whatever your target allocation is, over time the markets change the allocation. Some investments will rise in price while others will decline. Among investments that rise, some will rise more than others. The same will happen among investments with declining prices.
Your portfolio will stray from its target allocation, and at some point it strays too far from the target allocation. That causes both a problem and an opportunity.
The problem is that the risk and return profile of your portfolio has changed. When you set up the target allocation, it was because that allocation over time would give you the combination of risk and return most likely to meet your goals and be consistent with the level of risk you are comfortable with. When market moves change your portfolio’s allocation, the risk and return profile of your portfolio changes.
When the risky part of your portfolio, such as stocks, are in a bull market, after a while stocks will be a higher percentage of your portfolio. If your target percentage for stocks was 60%, it might climb to 70% or 75% in a bull market. That means your portfolio has much higher risk then when you started. When the next bear market or correction hits, your total portfolio loss will be higher than you planned. It’s time to rebalance by selling some of the stocks that have done well and buying more of the investments that haven’t done as well.
The opportunity created by rebalancing is that you’re selling high and buying low. You rebalance by selling or otherwise reducing the investments that have done well and buying those that haven’t done as well.
Look back at the stock market decline in March. Panic selling and forced selling drove prices of most assets down, especially stocks. As markets were declining, an investor with a systematic rebalancing strategy would have purchased more stocks near the market bottom of March 23. By increasing the stock allocation after stocks declined significantly, the portfolio is likely to return to its previous high value faster. It will own more stocks during the recovery than if the investor hadn’t rebalanced. The higher stock allocation gives the portfolio a higher return when stocks bounce back than it would have had at the lower stock allocation.
A problem many investors have is they turn rebalancing into a market timing exercise. They wait to rebalance until they think markets have hit bottom.
Rebalancing should be systematic and unemotional. You should rebalance after the portfolio allocation has changed by a fixed amount. You determine in advance how much you’ll let the portfolio’s allocation change before bringing it back to target. You might find yourself regularly reducing stocks during a bull market and buying stocks during a market decline.
Studies show that systematic rebalancing increases long-term investment returns above a buy-and-hold strategy while reducing risk and volatility.
Foreign Investment Review – A Warning In The Time Of COVID-19
06 June 2020
Lawson Lundell LLP
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The Canadian government, concerned about the impact of COVID-19 on corporate valuations, has issued guidance that it will pay particular attention to foreign direct investments of any value (meaning, even investments that are not subject to review under the Investment Canada Act (the “ICA”)). The government’s announcement does not amend the ICA, nor any thresholds for review. But it does issue a warning that the government intends to use the tools it has to review investments, including the national security review provisions under the ICA.
While the enhanced scrutiny is to apply to any acquisition of an interest in a Canadian business involved in public health or the supply of critical goods and services to Canadians or to the Government of Canada, all foreign investments by state-owned investors, regardless of value, or private investors assessed as being closed tied to or subject to direction from foreign governments, are also considered targets for such review.
One can expect that Canadian companies involved in manufacturing needed supplies to address COVID-19 healthcare requirements (for example manufacturers of personal protective equipment), or companies involved in vaccine research or other health technology would be of particular concern. As to critical goods and services, we can look to the Government’s own Guidance on Essential Services and Functions in Canada during the COVID-19 pandemic for assistance. In that guidance, the Government cites energy and utilities, information and communication technologies, finance, health, food, water, transportation, safety and manufacturing.
The first real test, however, of the Government’s application of its enhanced review will be a gold miner, TMAC Resources Inc., which operates the Doris gold mine in Nunavut’s Hope Bay. In a deal announced two weeks ago, China’s Shangdong Gold Mining Co. Ltd. will pay just over C$207 million for TMAC, which has been struggling financially. TMAC is listed on the Toronto Stock Exchange and has lost significant value since its IPO. Control and the majority equity interest in Shandong is owned by the Chinese Government. Whether Shandong can establish that the acquisition is of net benefit to Canada, and particularly so with such declared enhanced scrutiny, remains to be seen. There has been certain concern expressed by the security community in Canada about Beijing’s control over critical metals and minerals. Gold is, in volatile financial circumstances, a safe haven investment.
As a general caution, foreign buyers should consider the guidance from the Canadian government on the ICA. Foreign investment is still recognized as beneficial with a compelling case for the transaction. But at the least, potential acquirors should be alive to the potential for a greater degree of review, and should consider the time-frame for review and when to submit an application for review, including a pre-closing notification under the ICA.
Originally published May 25, 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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As a military couple, Mark and Meredith have relocated seven times in the past 10 years, so they’re looking forward to moving back to their original home – now rented out – when they eventually retire.
Mark, an officer with the Canadian Armed Forces, is age 44 and earns about $142,400 a year. Meredith, an employee at the Department of National Defence, is 47 and earns $72,660 a year. Her income has suffered from long spells in places where no work was available. They have a 12-year-old daughter, two houses and substantial mortgage debt.
Mind you, they’ll be well-fixed when they retire from the military. At the age of 55 Mark will be entitled to a defined benefit pension, indexed to inflation, of $116,000 a year plus a bridge benefit of $12,838 to the age of 65. From 65 on, he will get $134,623 a year.
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At 58, Meredith will also be entitled to a DB plan: $35,427 a year plus a bridge benefit of $988 until she’s 65. After that, she will get $39,315 a year.
First, though, they want to pay off their mortgages. They’re not sure which one to tackle first or whether they would be better off investing their surplus funds. “My husband thinks that it would be better to invest extra dollars [in financial markets] because our mortgage interest rates are low,” Meredith writes in an e-mail.
We asked Robyn Thompson, president of Castlemark Wealth Management Inc. in Toronto, to look at Mark and Meredith’s situation. Ms. Thompson is also a certified financial planner.
What the expert says
Mark and Meredith have $2,715 a month in surplus cash flow that they can use for debt repayment, investing, or increased lifestyle spending, Ms. Thompson says. They are using $1,000 of this to make prepayments to the mortgage on their original family home, now rented out.
In addition to their two properties, they have investment assets in their various accounts totalling $305,515, with 60-per-cent equity, 30-per-cent fixed income and 10-per-cent cash. Both have unused RRSP room that they are carrying forward to reduce taxes payable on their retiring allowances (a taxable, one-time payment on retirement in addition to their pensions) – $80,000 for him and $25,000 for her.
The couple would like to retire at the age of 55 with an annual after-tax income stream of $72,000 in today’s dollars (or $106,234 at retirement, indexed at 2 per cent), the planner says. When they do, they plan to move back to their original house and rent out their current residence.
Complicating matters is the fact that they have, at different times, declared one property or the other as their principal residence, Ms. Thompson says. “This will create a taxable capital gain on the property that is eventually sold,” she notes.
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For example, renting out part or all of a principal residence changes its use to an income-earning property. So capital-gains tax may apply for the period during which the property was used to earn income. Mark and Meredith would still be able to claim the principal residence exemption for the period in which they used the house as their primary residence.
“It is therefore critically important for Mark and Meredith to keep detailed records of when and how each property was used along with receipts for any improvements made, no matter how minor,” Ms. Thompson says.
Given their substantial income and relatively modest living expenses, Mark and Meredith will be able to achieve their short- and long-term financial goals, the planner says. “They have some catching up to do with their tax-free savings account contributions and prepayments toward the mortgage, but they are in a rock-solid financial position,” she adds.
The couple’s investments have done well, delivering an annualized rate of return of 8 per cent going back to 2013, Ms. Thompson says. The value of their portfolio shrank somewhat in early 2020 as a result of the stock-market meltdown triggered by the COVID-19 pandemic, the planner says. “But they have a long time horizon and view the market downturn as a short-term event.”
Their portfolio consists mainly of Canadian and U.S. large-cap, blue-chip stocks, exchange-traded funds and a small mutual-fund allocation. They use an investment adviser to whom they pay 1.65 per cent a year. The adviser does not provide planning or tax services.
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The registered education savings plan for their daughter is allocated 50 per cent to fixed income and 50 per cent to equities. Using a 4.5 per cent expected rate of return and a 2 per cent inflation rate, at their current contribution rate the RESP will grow to $73,028 by the time their daughter starts university at the age of 18.
Now for the mortgages. Mark and Meredith are paying 1.95 per cent interest on the $468,560 mortgage on their original home (rented out for $36,000 a year). Their current mortgage payment on the original house is $40,685 annually. In addition, they are making an extra payment of $1,000 a month, or $12,000 a year.
When the mortgage comes up for renewal next year, the interest rate could well be higher, the planner says. She assumes a 2.39 per cent interest rate at renewal. Instead of paying $1,000 a month, they could cut their prepayment to $500 monthly and redirect the surplus cash flow of $6,000 a year to their tax-free savings accounts, where they have unused contribution room. There the investments are forecast to grow tax-free with an expected real rate of return of 4.5 per cent annually, the planner says. “They will still have the property paid off by [Mark’s] age 55.”
As for the house they are living in now, they plan to rent it out for $2,000 a month after they retire. Rather than paying off the $215,000 mortgage, the planner recommends they continue with it, deducting the mortgage interest along with the other expenses. They could use the net cash flow first to contribute to their TFSAs and then invest any surplus in a non-registered, balanced portfolio.
“Meredith’s first inclination is to pay off the mortgage as fast as possible,” Ms. Thompson says. “This is not always the best option in a low-interest rate environment.” For Mark and Meredith, using cash flow to maximize TFSA contributions makes more sense at this point, the planner says. “With a properly diversified, balanced portfolio, the after-tax compounded annualized rate of return on their investments inside the TFSA is likely to exceed the compound interest payable on their mortgage.”
At Mark’s age 56, the first full year they are both retired, Mark and Meredith will have after-tax income of $169,160 a year. After-tax lifestyle needs and the mortgage payment on the rental will total $120,408 a year, giving them plenty of room to expand their goals if they choose to.
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The people: Mark, 44, Meredith, 47, and their daughter, 12
The problem: Should they invest their surplus or pay off their mortgages?
The plan: Catch up on their TFSAs first. Lower the extra payments on their original house and invest the difference. Leave the mortgage on the second house when they retire.
The payoff: Making the best use of their money.
Monthly net income: $16,160 (includes gross rental income).
Assets: Cash $7,000; emergency fund $20,000; her TFSA $52,300; his TFSA $30,815; her RRSP $96,905; his RRSP $80,375; RESP $38,120; residence $450,000; rental $750,000; estimated present value of his DB pension plan $2.36-million; estim. PV of her DB plan $863,000. Total: $4.7-million
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Monthly outlays (both properties): Mortgages $4,570; property taxes $990; water, sewer, garbage $115; home insurance $150; electricity, heat $215; maintenance $895; garden $100; transportation $780; groceries $800; clothing $180; gifts, charity $315; vacation, travel $1,250; other discretionary $30; dining, drinks, entertainment $700; personal care $30; club membership $15; pets $15; sports, hobbies $120; other personal $450; health care $25; disability insurance $370; phones, TV, internet $130; RESP $200; TFSAs $1,000. Total: $13,445
QUEBEC — Premier François Legault has not ruled out another government bailout of struggling Bombardier Inc., which announced Friday it plans to eliminate 2,500 jobs because a slump in demand for business jets.
But Legault said if his government did proceed, it would not make the same “mistakes” of the former Liberal government, which chose to invest in the C-Series program and not Bombardier in general.
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He said he also would obtain guarantees on the preservation of jobs, the head office and make sure the company’s executives not pay themselves fat salaries and bonuses.
The former Liberal government of Philippe Couillard invested $1.3 billion in Bombardier’s C-series program, which was later sold to Airbus. Quebec still holds its shares in the firm, which were valued at $700 million in the last provincial budget.
Legault Friday seemed to suggest in his remarks that the money is lost.
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