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The end of the rate-hike cycle should mean a return to stock market gains. That seems to be the consensus among market pundits at the moment. But the same pundits are always quick to hedge their bets, saying that a recession or economic slowdown still isn’t out of the question. The reality is that no one knows when or how all this will unfold.
The stock market is an emotional place, driven by the elemental emotions of fear and greed. And as we saw through 2023, either one of those can turn the market on dime. That led to a lot of volatility last year as investors rushed into and out of this or that sector, driven by the latest investing fad.
The latest fad (and yes, it is a fad), is “Artificial Intelligence,” which contributed to the surge in large-capitalization tech stocks – think chipmaker Nvidia, software company Microsoft, cloud computing firms like Amazon.com, and hardware manufacturers like Apple.
Geopolitical turmoil, can have a short-term impact on market sentiment. And 2024 is packed with these – for instance, the Ukraine/Russia war in Europe, Israel fighting Hamas terrorists in the Middle East, alarming sabre rattling by China over its threatened invasion of Taiwan.
The U.S. 2024 election campaign promises to be full of even more fireworks than usual, and could dampen market sentiment until the dust settles in November.
Prudent investors won’t bet on any of these trends. So, while markets have been steadily rallying from last October’s lows, at this point it’s wiser to reduce cash allocations and increase equity holdings very gently.
Personally, I don’t like to play the market timing game, because ultimately it’s impossible to consistently call market tops, bottoms, and turning points. But it is possible to follow basic investment principles that will guide you in growing your wealth.
I’m often asked what three investing principles that I would put at the top of the list. Here they are.
1. Create tax-free dollars
Tax is the single largest cause of wealth erosion in Canada today and accounts for a 28% impact. So it’s important to shrink the tax take as much as possible. There is one sure-fire way to create tax free dollars:
Tax Free Savings Account (TFSA). The beauty of the TFSA is that you never pay tax on the investment growth inside the plan, and all withdrawals from the plan are tax free. So open a TFSA and max it out every year. And do it regardless of how old or young you are today.
The contribution limit increases to $7,000 (from $6,500) in 2024. This means that if you have never contributed to a TFSA, you may have a cumulative contribution room of $95,000.
Let’s say you are 30 years old today and make $50,000 a year. You have $10,000 in a TFSA and you contribute $5,000 at the start of each and every year until you stop working at age 65. Let’s target a reasonable 8% average annual compounded rate of return on the investments inside TFSA over that period. By the time you reach age 65 in 35 years, you would have $1,067,412 in the TFSA.
2. The“4 D” method to cutting taxes
Tax-saving doesn’t end with TFSAs. In fact, there are a number of tax-saving strategies that I call the “4 Ds”: deduct; defer, diminish; divide.
Deduct and defer. This is a strategy you’ll use when you put money into a Registered Retirement Savings Plan (RRSP). You get to deduct your contribution from your income. And tax on income earned from investments in the plan is deferred until you withdraw your money from the plan at retirement.
Divide and diminish. If you have children a Registered Education Savings Plan (RESP) will help you “divide” income by splitting it with your children, thus “diminishing” the tax. This structure allows you not only to save for your children’s post-secondary education but it also cuts your overall tax bill.
When contribute to an RESP, you are transferring future tax liability. You achieve “divide” by essentially putting money into your kids’ names as beneficiaries of the RESP. The investments in the RESP growth tax-free until your children withdraw it pay for a qualifying post-secondary institution. At that time, the income is taxed at your child’s tax rate, which will most likely be next to zero, while you will very probably be in your peak earning years with a tax bracket as high as 50%. You have just accomplished what may be a decade of tax-deferred growth.
3. Minimize investment costs
Investment costs can be a big hurdle to achieving good investment returns. Mutual funds, for example, are probably the most popular vehicle in Canada for investing for retirement. But the cost of holding a mutual fund can be very high. Fund managers’ compensation, advisor’s fees, and administration costs can push a fund’s management expense ratio (MER) to 2.5% or more.
MERs of segregated funds are even higher ranging from 5% and up. This is paid out by the fund, reducing assets, and thus cutting the return to investors. A commission, or “load,” which is paid by the investor directly to an advisor or broker, will increase the cost of the fund even more.
In a strong bull market with stocks growing 10% to 15% per year, most investors don’t mind the excessive expense. But when markets slow down to more typical single-digit returns, that MER can really dig into your overall returns, especially in the longer term.
To minimize costs, shop around for the best value for your money. When shopping for funds or pools offered by advisors and planners, compare long-term returns with management expense ratios. As a rule of thumb, your return in general should exceed the rate of inflation plus the management fees by at least three percentage points.
Robyn Thompson, CFP, CIM, FCSI, is president of Robyn Thompson Money, the founder of Castlemark Wealth Management, keynote speaker, TV personality, and wealth consultant. Visit her new website Robyn Thompson Money and follow her on LinkedIn and Instagram.
Notes and Disclaimer
Content copyright © 2024 by Robyn K. Thompson. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.
The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.
Image: iStock.com/Nopparat Promtha
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