Portfolio manager can act for clients more quickly than traditional adviser

Over the years, I have had great discussions with people about financial decision-making. It is tough for most people to make decisions on something they don’t feel informed about. 

Even when you are informed, investment decisions can be challenging.

When you work with a financial advisor, you have another person to discuss your options with. In the traditional approach, an advisor will present you with some investment recommendations or options.  You still have to make a decision with respect to either confirming the recommendation and saying “yes” or “no,” or choosing among the options presented. As an example, an advisor may give you low-, medium-, and high-risk options for new purchases. An advisor should provide recommendations that are suitable to your investment objectives and risk tolerance.

Another option for clients have is to have a managed account, sometimes referred to as a discretionary account.  With this type of account, clients do not have to make decisions. The challenge is that very few financial advisors have the appropriate licence to even offer this option.   To offer it, advisors need to have have either the Associate Portfolio Manager or Portfolio Manager title.

When setting up the managed accounts, one of the required documents is an Investment Policy Statement (IPS). The IPS outlines the parameters in which the Portfolio Manager can use his or her discretion. As an example, you could have in the IPS that you wish to have a minimum of 40 per cent in fixed income, such as bonds and GICs.

Portfolio Managers are held to a higher duty of care, often referred to as a fiduciary responsibility. Portfolio Managers have to spend a significant time to obtain an understanding of your specific needs and risk tolerance. These discussions should be consistent with how the IPS is set up. Any time you have a material change in your circumstances then the IPS should be updated. At least every two years, if not more frequently, the IPS should be reviewed.

The nice part of having a managed account with an up to date IPS is that your advisor is able to make the decisions on your behalf. You can be free to work hard and earn income without having to commit time to researching investments. You can spend time travelling and doing the activities you enjoy. Many of my clients are intelligent people who are fully capable of doing the investments themselves but see the value in paying a small fee. The fee is tax deductible for non-registered accounts and all administrative matters for taxation, etc. are taken care of. A good advisor adds significantly more value than the fees they charge. This is especially true if you value your time.

Many aging couples have one additional factor to consider. In many cases one person has made all the financial decisions for the household. If that person passes away first, it is often a very stressful burden that you are passing onto the surviving spouse. I’ve had couples come in to meet me primarily as a contingency plan. The one spouse that is independently handling the finances should provide the surviving spouse some direction of who to go see in the event of incapacity or death. In my opinion, the contingency plan should involve a portfolio manager that can use his or her discretion to make financial decisions.

In years past it was easier to deal with aging clients. Clients could simply put funds entirely in bonds and GICs and obtain a sufficient income flow. With near historic low interest rates, this income flow has largely dried up for seniors. When investors talk about income today, higher income options exist with many blue chip equities. Of course, dividend income is more tax efficient than interest income as well. A portfolio manager can add significant value for clients that are aging and require investments outside of GICs.

Try picturing a traditional financial advisor with a few hundred clients. A traditional financial advisor has to phone and verbally confirm each trade before it can be entered. The markets in British Columbia open at 6:30 AM and close at 1:00 PM. An advisor books meetings with clients often weeks in advance. On Tuesday morning an advisor wakes up and some bad news comes out about a stock that all your clients own. That same advisor has 5 meetings in the morning and has only a few small openings to make calls that day. It can take days for an advisor to phone all clients assuming they are all home and answer the phone and have time to talk.

A Portfolio Manager who can use his or her discretion can make one block trade (the sum of all of his clients’ shares in a company) and exit the position in seconds.

Sometimes making quick decisions in the financial markets to take advantage of opportunities is necessary. Hands down, a Portfolio Manager can react quicker than a traditional advisor who has to confirm each trade verbally with each client.

Another good reason to have an accountant – Rules change on foreign reporting

In 1997, the Canada Revenue Agency (CRA) proposed changes on how foreign property is reported. In 1998, CRA introduced the reporting of certain foreign property by requiring all Canadian tax filers to answer, “Did you own or hold foreign property at any time in 1998 with a total cost of more than CAN $100,000?” If you answered “yes” to this question then you were required to complete a “Foreign Income Verification Statement” – CRA and accountants refer to this form as T1135. In my experience, the biggest misunderstanding people have relates to the term “foreign property” and what is included and excluded. An accountant is invaluable in providing guidance in complex areas such as these.

Since 1998, modifications have been made to the T1135 but the form was relatively easy to complete as CRA provided broad monetary ranges for disclosure (i.e., $100,000 to $300,000; $300,000 to $500,000; etc.) and broad categories (i.e., shares of foreign companies without the name of the companies or the investment firm, real estate without the specific location, bank accounts without the name). This information was all that was required, along with a general indication of where the foreign property was held.

In June 2013, CRA released a new version of T1135, to be applicable for 2013 and later taxation years. CRA then delayed its application so that it would only apply for taxation years ending after June 30, 2013. The new version of T1135 was very detailed and many tax practitioners felt it was too onerous. The new T1135 required more detailed information on each specified foreign property. The additional information would require the following for each specified foreign property: name, country code, institution, maximum cost during the year, year-end cost of the property, income or loss, and capital gain or loss.

Accountants and financial advisors were sorting out the logistical nightmare of these new requirements. Many individuals who prepare their own income tax returns are likely unaware of the new requirements or the penalties for not complying.

After listing the new requirements, CRA complicated it further by providing exclusions from the detailed reporting, including specified foreign property where the Canadian resident received a tax slip (T3 or T5). CRA provided different options with respect to how the new T1135 form could be completed (i.e. standard reporting method versus transitional reporting method).

Near the end of February 2014, CRA announced new transitional relief for Canadians who must comply with the more detailed T1135 information reporting. At this stage, the transitional relief applies only for the 2013 taxation year. This relief is only allowed for investments that you received a T3 or T5 for the income. Other investments that issue slips such as a T5013 do not meet the exclusion and must be listed in detail. This relief is intended to assist taxpayers in transitioning to potentially the more onerous reporting requirements in future years. The transitional relief will allow CRA time to respond to concerns raised by Canadian residents.

One of these reliefs relates to individuals who have foreign property held in non-registered investment accounts with Canadian securities dealers. Rather than reporting the above details of each specified property individually (i.e. each individual stock), investors are able to report the combined “market value” of all such property at the end of the 2013 taxation year.

To illustrate we will use John Smith whose only foreign property is the 30 US stocks he holds in non-registered account 999-99999 with ABC Financial. For illustration purposes only we also assumed that the T3/T5 reporting exception is not being utilized for any specified foreign property. As of December 31, 2013 Mr. Smith’s book value on his USD investment account is $150,000 USD, and the market value is $250,000 USD. The USD to CAD dollar exchange rate on December 31, 2013 is 1.0636 per the Bank of Canada website. The USD to CAD dollar average exchange rate for 2013 is 1.0299148 per the Bank of Canada website. Mr. Smith received a T5 slip totaling $9,000 USD in income on his US dollar denominated account. Mr. Smith’s investment advisor sent him a realized gain (loss) report showing a net realized gain on 2013 dispositions of $14,300 CAD on his US holdings. The first step is to determine if the “book value” of certain foreign property exceeded $100,000 CAD at any time during 2013. Mr. Smith’s case is easy as his book value clearly exceeded $100,000 CAD on December 31, 2013 – he is required to file the T1135. The 2013 relief mentioned above allows Mr. Smith to greatly simplify the reporting with respect to his US dollar brokerage account in section six of T1135. Under Description of property he can enter “ABC Financial Account # 999-9999”. Under Country code he enters CAN even though he owns stocks in the US and other countries. Under Maximum cost amount during the year he can enter “0”. Under Cost Amount at year end he enters the “market value” in Canadian dollars of the account at the end of 2013 which is $265,900 (calculation: market value $250,000 US x year end exchange 1.0636). Under Income (loss) he enters the converted amount of $9,269.23 (calculation: income $9,000 USD x average exchange 1.0299148). Under Gain (loss) on disposition he reports the $14,300 amount from the realized gain (loss) report that his advisor already sent him which is denominated in CAD dollars.

The above analysis should not lead people to do the form themselves unless they understand all the reporting requirements thoroughly. It is by no means a comprehensive explanation of the revisions. I would strongly urge any person who has foreign holdings (outside of registered accounts) to discuss their reporting obligations with their accountant and advisor. Under the CRA website (cra-arc.gc.ca) you can search for T1135 (and other foreign disclosure forms) to obtain general information and answers to commonly asked questions. The website also has a table of penalties for not filing various disclosure forms applicable to your situation. As an example, Mr. Smith could be fined $25 per day (up to a maximum of $2,500) for not filing the T1135. If CRA feels that Mr. Smith knowingly didn’t file the form the maximum fine is $500 per day (up to a maximum of $12,000). The penalties above can also apply to prior years, albeit the prior year’s forms were relatively simple to complete and the taxpayer may have innocently not filed because they were unaware of the requirement to file.

The deadline to file Form T1135 has been extended to July 31, 2014 for all taxpayers. Currently, the T1135 form cannot be electronically filed. Most tax correspondence on Vancouver Island goes to the Surrey Taxation Centre; however, the paper copy of this form must be mailed to the following address: Ottawa Technology Centre, Data Assessment and Evaluations Program, Verification and Validation, Other Programs Unit, 875 Heron Road, Ottawa ON K1A 1A2.

This article is intended as a general source of information and should not be considered as personal investment, tax or pension advice. We are not tax advisors and we recommend that individuals consult with their professional tax advisor before taking any action based upon the information found in this publication.

Benefits to early conversion of RRSP to RRIF

The Registered Retirement Savings Plan (RRSP) is for “saving.”   This savings and tax deferral within an RRSP can continue until the age of 71.  In the year you turn 71, you have to either close your RRSP by either taking the money out, purchasing an annuity or transferring it to a Registered Retirement Income Fund (RRIF). 

From a taxation standpoint, it is rarely advised to de-register 100 per cent of your RRSP in one year and withdrawal the cash.  This would only be advised when an RRSP is very small or there is a shortened life expectancy or financial hardship.   Purchasing an annuity as an RRSP maturity option is a final decision that can not be reversed.  Upon your death, the annuity option often leaves nothing for your estate or beneficiaries.  

For many reasons, conversion of your RRSP to a RRIF is the most popular and flexible method.  Most of your savings will continue to be tax deferred with a minimum withdrawal amount being determined annually based on the previous December 31 value.  In the year a RRIF is set up, there is no minimum withdrawal amount.   All RRIF’s set up after 1992 are considered non-qualifying.  The following minimum RRIF withdrawal amounts are the non-qualifying annual percentage by age on December 31st: 

Age                 Per Cent        

72                    7.48    

73                    7.59

74                    7.71

75                    7.85

76                    7.99

77                    8.15

78                    8.33

79                    8.53

80                    8.75

81                    8.99

82                    9.27

84                    9.93

85                    10.33

86                    10.79

87                    11.33

88                    11.96

89                    12.71

90                    13.62

91                    14.73

92                    16.12

93                    17.92

94 or older      20.00

To illustrate how the above schedule works, we will use 71-year-old Barry Campbell who has saved $1million in his RRSP.  Barry is single and he chose to convert his RRSP to a RRIF account in the year he turned 71 and he will begin taking annual payments next year.  Barry has had years of complete deferral but this is coming to an end.  Based on the above minimum RRIF schedule, Barry will be required to withdraw $74,800 ($1 million x 7.48 per cent) and have this amount included in his taxable income.   Unfortunately, Barry doesn’t have a choice at age 71.  Based on Barry’s total income with the RRIF, he is projected to have half of his old age security clawed back (required repayment) based on his high income.  If Barry were to pass away, the majority of the RRIF would be taxed at 45.8 per cent.  Unfortunately, Canada Revenue Agency (CRA) would receive nearly half of Barry’s lifetime savings within his RRIF.   

We feel it is important for clients to understand the taxation of a RRIF in a most likely scenario of normal life expectancy and shortened life expectancy.   RRIF accounts for couples greatly reduce the taxation risk of shortened life expectancy by being able to name your spouse the beneficiary and avoid immediate taxation of the full account balance.  In 2007, CRA introduced pension-splitting, which provides taxation savings for most couples with eligible pension income. RRIF withdrawals at age 65 or higher are considered eligible. 

Beginning in 2009, CRA introduced the Tax Free Savings Account (TFSA) that provides tax savings for individuals and couples.  The savings is a result of all income (interest, dividends, and capital gains) generated within the TFSA not being taxed ever.  There is no taxation upon your death.  The amount that can be put into a TFSA is limited by a relatively small amount each year. People who are serious about saving for retirement often contribute to both an RRSP and TFSA.

Given the introduction of pension splitting and the TFSA, many people should be looking at converting their RRSP to a RRIF before the age of 71.  When we are helping clients with the optimal time to convert their RRSP, we look at their marital status, health/genetics, and other investments.  With other investments, we create two baskets (A and B) to analyse what we call the “bulge.”  A bulge is when you have too much concentration in either basket A or B.  Basket A is the total amount in your RRSP accounts.   Basket B would include bank account balances, non-registered investments, and your TFSA – none of which will attract tax on the underlying equity if used.  Basket A may also include your principal residence if the intention is that this will be sold and the capital used to fund retirement.  

We caution investors not to create a bulge – having too much in either basket means you may not have the right balance as you enter retirement.  Taking advantage of deferral opportunities over time often makes sense.  Having too much in basket A means you may have very little flexibility if an emergency arises and you need cash (new roof, vehicle).   If A / (A + B) is greater than 75 per cent (a bulge) then we would recommend you speak with an advisor to determine in you should convert your RRSP to a RRIF early.  Above, we noted Barry has $1 million in basket A.   Barry also has $250,000 in basket B.  With these numbers Barry has a bulge percentage of 80 per cent. 

A financial plan prepared while you’re working largely results in savings strategies to reach your retirement and other goals.  In retirement, a financial plan is prepared to create withdrawal strategies that are tax efficient and smooth out your income during your lifetime.  They can also be prepared in conjunction with estate planning.   

Kevin Greenard CA FMA CFP CIM is an Associate Portfolio Manager and Associate Director with The Greenard Group at ScotiaMcLeod in Victoria.  His column appears every second week in the TC.  Call 250-389-2138.

It’s that time: Tips on filing tax returns

Every year, more and more Canadians are preparing their returns using discount tax software.  It  links cleanly to the Net File process that eliminates having to mail your return to Canada Revenue Agency.     

For many basic returns, where all you have is your T4 and T5 slips, preparing your own return with tax software takes very little time.  The CRA website is a good reference for individuals at home wanting basic information on your tax return. Go to http://www.cra-arc.gc.ca/menu-e.html where you can select individuals and families. 

You can sign up for My Account, which allows you to track your refund, view or change your return, review income tax slips, check your benefit and credit payments and check your TFSA  and RRSP limits.  You also have the ability to set up direct deposit, though I don’t encourage it for individuals still working or those who own a business. 

If your situation is not basic, or you’re not sure if you are taking advantage of all tax credits, then you should find a qualified accountant if you don’t already have one.  If you have a business, or are uncertain on how to do your tax return, then you will find the services of a good accountant to be invaluable, especially as they save you the headache of fixing a tax return not initially prepared properly.  Your accountant will also ensure you are minimizing tax and taking full advantage of tax credits.  Fees paid to your accountant for tax advice are generally deductible while the cost for personal income tax software program is not.   

One tax tip could easily result in significant tax savings that would offset the cost of having your tax return professional prepared.  For those individuals using a tax preparer, I recommend you fully complete any questionnaires or checklists that they may have sent to you at the beginning of the year. 

If you are an employee who can deduct some employment expenses, print off a T777 tax form from the CRA website and organize your receipts and expenses accordingly.  Fill in the T777 as a draft version for your accountant to review.  If you have a small unincorporated business, print off the appropriate tax schedule and organize your receipts and expenses according to the same categories.  If you have marketable securities we recommend that you have your advisor prepare a realized gain-loss report to reduce the time your accountant needs to spend on this part of your tax return.  Giving an organized package to your accountant will ensure that the time they spend on your return is utilizing their professional knowledge rather than the administration of organizing receipts. 

In the years when I worked in public practice as a Chartered Accountant, I would have a range of packages dropped off.  Some were dropped off too early and were still missing slips.  Others were dropped off too late and fees and penalties would apply.  In some of the worst cases, I would receive a box full of receipts that had no organization to them.  Information delivered at the right time in an organized manner lowered accounting fees. 

One of the key steps accountants do is a comparative analysis of what you reported last year versus the current year.  As an example, if you had four T5 slips (for reporting dividend and interest income) last year and you only have two this year, your accountant should be asking why.  A big step that can assist your accountant (especially if your accountant is new) is to include your prior year’s tax return with your current year information with an explanation for any differences. 

I recommend you go through your slips from the prior year and compare to the current year.  You should have an explanation for why, such as consolidated investments, retired or sold investments in the prior year. 

If you have changed investment firms during the year, I recommend you take extra caution at this step as you are likely to get twice the slips that you previously had for the year of change.  Talking to your new financial advisor should assist you in obtaining a list of all the slips that you should be expecting.  Some of these slips are sent by the financial firm you are dealing with and others may be sent directly from the company that you invested in.

Whether you use an accountant or prepare your own tax return, it always pays to stay organized.  Set up a file system that either has copies of your current and past returns.  In many cases, files and documents are being converted to electronic form, which should be backed up periodically to prevent loss of data if your hard drive fails or you get a new computer.

As tax time looms, it’s prudent to get your plan in place

This time of year you should be talking with your financial advisor about where to put your hard earned money.  Will you contribute to an RRSP or pay down debt?  Or should you do both by contributing to an RRSP and using the tax savings to pare debt?

Contributing to an RRSP should be done with a view of keeping the funds committed for a longer period of time and pulling them out at retirement, hopefully when you’re in a lower income tax bracket. This option is suitable for individuals who have stable income.  If it’s debt reduction, you always have the flexibility of taking out equity in your home later on if capital is needed. On the other hand, if you need capital and your only access to savings are from your RRSP you will have to make one of the most common RRSP mistakes – deregistering RRSPs before retirement and paying tax. In addition, you will not have the RRSP contribution room replenished.

Since 2009, financial options were further complicated with the introduction of the Tax Free Savings Account (TFSA). The main benefit of an RRSP is the deferral of income within the account until the funds are pulled out. Another is the tax savings in the period in which the contribution is first applied. The TFSA has the same first benefit of an RRSP, deferral of all income including interest, dividends and capital gains. TFSA contributions do not provide you a tax deduction; however, withdrawals are not taxed at all. Withdrawals can be replenished in the next calendar year. .

Business owners have the ability to have active small business income taxed at a lower rate. Most owners are encouraged to pull out only the income they need to live on. The rest of the income is left in the corporation. Income paid out of the corporation is either through dividends wages, or both. Should business owners still contribute to an RRSP or TFSA when income is already taxed at low rates?  Wages paid helps future CPP benefits and also creates RRSP deduction room.  Dividends paid can be tax efficient, but do not create RRSP room and have no benefit for CPP purposes.  Some organizations provide RRSP programs that involve matching and length of service programs that are linked to the member’s RRSP.

Singles have a higher likelihood of paying a large tax bill upon death. With couples, the chances that one lives to at least an average life expectancy are far greater. Couples can also income split where the higher income spouse can contribute to a spousal RRSP.

If you have a good company Registered Pension Plan (RPP), you may not have a great a need to have an RRSP. If a person had debt and a good RPP then the decision to pay down debt is a little easier than someone that doesn’t have an RPP at all. Individuals who have no other pensions (not counting CPP and OAS) really need to consider the RRSP and how they will fund retirement.

Income levels below $37,606 in BC are already in the lowest income tax bracket. Contributing $5,000 to an RRSP while in the lowest bracket would result in tax savings of approximately $1,003 or 20.06 per cent.  Income over $150,000 is taxed at 45.8 per cent and this same contribution would save $2,290.   I would encourage the lower income individual to put the funds into a Tax Free Savings Account or pay down debt depending on other factors. If the lower-income individual’s income increased substantially, then the option to pull the funds out of the TFSA and contribute them to an RRSP always exists.

In order for your advisor to provide guidance about the right mix between TFSA, RRSP, or paying down debt, they require current information.  In some cases, your advisor should be speaking with your accountant to make sure everyone is on the same page.  Every situation is unique and your strategy may also change over time.  Preparing a draft income tax return in late January or early February helps your advisor guide you on making the right decisions.

The submitting of your completed tax return should be done only when you are reasonably comfortable you have all income tax slips and information. Some investment slips, such as T3s, may not be mailed until the end of March. We recommend most of our clients do not file their income tax return until the end of the first week of April.  By providing projected tax information to your advisor in January or early February you have time to determine if an RRSP should be part of the savings strategy. If it is not, the discussion can lead to whether you should pay down your mortgage or contribute to your Tax Free Savings Account.  

Most mortgages allow you the ability to pay down a set lump sum amount (such as 10 or 20 per cent) on an annual basis without penalty.  Every January you are given additional Tax Free Savings Account room. 

Fee-based accounts benefit investors in the long run

A fee-based account is a tranparent way of paying your financial advisor.  The fee is charged based on the market value of the assets being managed, and it is distinctly different than a transactional account, where commissions are charged for every buy-and-sell transaction. 

When clients open up a fee-based account, they sign a fee-based agreement that establishes the agreed upon fee, how the fees are calculated, when the fees will be charged and the accounts involved.   

There are a number of benefits for clients in moving to a fee-based account. 

Working on a “fee for service” basis, rather than a commission or transactional fee basis, means the best interests of the client are more aligned with those of the advisor. If fees are based on the market value of the account, then the only way an advisor will be compensated further is if they can grow your account in value.  If your account declines in value, then so does the compensation paid to your advisor.  

Another benefit of a fee-based account is the additional services clients receive from their financial advisor.  Financial professionals today are rarely called stock brokers because the services offered extend well beyond buying and selling stocks. Financial planning meetings cover many topics such as tax and insurance as well as education, retirement and estate planning. 

Financial professionals today spend a significant amount of time understanding each client’s needs and integrating this into an increasingly complex tax and regulatory environment. 

As a result, the amount billed for fee-based accounts is referred to as an “investment council fee” for income tax purposes.  The main benefit is the fees relating to non-registered accounts can be deducted on your income tax return as a carrying charge.  If your fee is one per cent before tax, and your marginal income tax bracket is 30 per cent, your fees have a net cost to you of only 0.70 per cent.   

Fees are typically charged quarterly. As an example, Jane Wilson opened a new fee-based account and invested $750,000 on Jan. 1 with an annual fee of one per cent.  She will have no fees charged for three months. Around the middle of April, the first quarterly fees would be charged at $1,875 ($750,000 x 0.25 per cent).  Wilson’s fees are one-quarter of one percent after each quarterly period. 

Other methods of compensating that are not fee-based often have commission charges upward as high as five percent on the first day of buying the investments. For an advisor to be successful with a fee-based business, he or she needs to establish good long term relationships. 

The periodic payment of fees better aligns the interests of clients and financial professionals.  When explained to clients, most would prefer to spread out the fees over time as services are provided versus paying a large amount on the first day.  

One question we are asked is how the quarterly fees are actually paid.  To illustrate we will use Don Spalding, who has three investment accounts totaling $750,000 – $500,000 in a non-registered account, $200,000 in his RRSP account, and the remaining $50,000 is in a Tax Free Savings Account. 

There are a few different options for how Spalding can cover the quarterly fees. 

The first option is to have the fees charged to each of the respective accounts.  Wilson had only one account and the fee of $1,875 was simply charged to that one account.  Mr. Spalding has three accounts and each account is charged the respective amount based on one-quarter of one percent of the market value of each account. 

The first quarterly amount for Spalding is $1,250 for the non-registered account, $500 for the RRSP, and $125 for the TFSA.  He has the option of keeping cash in each account to cover the fees, depositing cash quarterly or selling investments. 

With fee-based accounts, Spalding has the option to instruct us to designate the billing of the fees to come out of one account.  Don could instruct us to pay the fees for his RRSP and TFSA accounts from the non-registered account.  This enables him to maximize the amount he maintains in his registered accounts keeping it tax sheltered. 

The payment of fees from a designated account enables an advisor to fully invest the non-designated accounts and to utilize compounding growth strategies such as the dividend reinvestment plan.  Fee-based accounts can assist with income splitting as the higher income spouse can pay the account fees of the lower income spouse.

Liquidity is another benefit of fee-based accounts.  As there is no cost to buy investments, the same applies to changing or selling investments.  If you require money for any reason, there is no commissions payable for selling or rebalancing your investments.  Rebalancing can include reducing a position that has performed well, dollar cost averaging on a position that has underperformed, adjusting sector exposure, modifying asset mix, and changing the geography of your investments. 

Another benefit of fee-based is the ability to link additional family members to the platform.  Clients with children and grandchildren often would like introduce them to the benefits of full service brokerage, but do not individually have the capital to be able to open accounts on their own.  This could include parents wishing to assist adult children in opening and funding Tax Free Savings Accounts and grandparents who wish to open Registered Education Savings Plans for their grandchildren.  Fee-based accounts that are linked can make wealth transfer strategies within the family group of accounts significantly easier.

Extra due diligence on private investing

The private market is used by public and private companies to raise money. Most of the money raised comes from investment funds and institutional investors. However, a relatively small percentage is used to finance venture companies and start-ups, which can be risky investments for the average retail investor. This is especially true when compared to investing in long-established companies that trade in the public market.

Private start-up companies have a high probability of failure. It’s also possible for fraudsters to exploit investors who don’t understand this type of investment. However, whether a private market investment is a fraud or simply fails, the financial impact is equally devastating. Investors need to be aware of the risks involved in the private market and protect themselves by researching their investments, and understanding their risk tolerance. When it comes to the private market, don’t invest more than you can afford to lose.


The public market is effectively the stock market, where investments trade openly. In order for a company to issue the securities (as part of an Initial Public Offering), they must issue a document called a prospectus. The prospectus includes the company’s audited financial statements, and must disclose aspects of the investment such as relevant risks and material information about officers and directors. The issuance of the prospectus is required for the shares to trade on the stock market. Public companies are also required to make ongoing disclosure of material facts and changes to their business.


Also commonly referred to as the exempt market, this is where companies sell their securities under various exemptions from the prospectus and registration requirements outlined in The Securities Act and Rules. Many private real estate investment corporations and mortgage pools would be considered the private market. The Securities Act and Rules provide for a number of exemptions from the registration and prospectus requirements of publicly traded companies. Some examples of exemptions used by the private market include selling to the following individuals: close family, friends, business associates of a principal, people with a minimum of $1 million in financial assets, individuals with net income before taxes of more than $200,000 (or $300,000 when combined with spouse), and individuals with net assets of at least $5 million. One of the bizarre exemption rules is that if you can invest $150,000, and pay cash at the time of the trade, then you are exempt (even if this means that you pulled every dime together to make the purchase happen).

If someone doesn’t qualify for one of the above exemptions, then there is always the offering memorandum exemption. The “OM” can be used to sell securities to anyone, provided the investor sign a risk acknowledgement form. At times, the people selling private investments have abused these exemptions in order to have the uninformed investor become eligible.


One of the biggest challenges with private investments is trying to sell the investment after you have purchased it. Private investments are normally illiquid and have restrictions on resale. 


When considering a private investment you should ask if the person is licensed with the Investment Industry Regulatory Organization of Canada (IIROC) or the Mutual Fund Dealers Association (MFDA). These can easily be confirmed by phoning IIROC or the MFDA directly. Another method to check registration is to go to the Canadian Securities Administrators (CSA) website (www.securities-administrators.ca). Unregistered salespeople are allowed to sell private securities. Many investors are unaware that unregistered salespeople are not bound by the same suitability requirements as registrants and are under no obligation to ensure that the investment is suitable for your investing needs. You will have very little recourse if the investment goes badly. If you are dealing with an unregistered salesperson then more due diligence is required.


If a client calls with a request to execute an unsolicited buy order on a higher risk stock, I always suggest keeping the position size small. Unfortunately, when it comes to private investments, the above disciplined position size approach is often ignored. Putting all of your savings into one investment is simply not prudent risk management, but this happens more often than it should. The saddest stories involve individuals who were encouraged to take out a home equity loan and use the proceeds to purchase the private investments. It is so important for investors to be honest with themselves about their risk tolerance, and to thoroughly understand the level of risk they are taking on with their investments.


Many private investments do not have audited financial statements provided to investors, although these are required if the investments are sold under an offering memorandum. Compounding this lack of accountability, we often hear of a complex web of companies or transactions that would be impossible for outside investors to obtain a clear picture of the financial stability. A good rule of thumb is to remember that there is rarely a good business case to be made for complexity. If an investment is difficult to understand, or if the person offering it can’t explain it clearly, you might be better to walk away.


Prior to investing, understand where you rank in the hierarchy if the investment fails. Owners of common shares are usually the last investors to be paid if things go wrong. Primary and secured creditors (often large financial institutions or institutional investors) will be first in line to be repaid. Primary creditors may have specific security over the main assets. The individuals or companies that are first in line would force a liquidation event on various grounds such as violation of covenants, if they felt they were not going to get their full piece of the pie. This often leaves nothing for the average retail investor.

Before investing in the private market, I suggest reading the BCSC’s Private Placement Guide and reviewing investright.org, the BCSC’s consumer protection sight. If you suspect that an investment may be a fraud and need assistance, phone the commission at 1-800-373-6393.


New disclosure rules on adviser’s fees could reduce ranks

Over the next few years, you are likely to hear more about what is referred to as the “client relationship model,” or CRM.  CRM is a regulatory requirement introduced by the Canadian Securities Administrators to enhance disclosure, which partially came into effect this year.  Further phases over the next three years are intended to enhance the standards financial firms and advisors must meet when dealing with clients.  These amended rules provide greater disclosure requirements for advisors and enhance the standards they must meet when assessing the suitability of investments for their clients.

The key objective is increased transparency for investors surrounding the fees they pay, services they receive, potential conflicts of interest and the performance of their accounts

All of these mandatory disclosures will be phased in from 2014 – 2016.   Similar CRM mandatory disclosure rules were implemented in Australia and England.  The implementation of the changes in those countries resulted in a significant reduction in the number of financial advisors working in the industry once rules required them to be transparent about all the fees charged.  I suspect that once the new rules are fully implemented, there will also be a reduction in advisors working in Canada.    

To help illustrate how these changes may affect you, let’s look at GICs and mutual funds.

Many people may be aware that when a financial institution receives investments from people, they then lend that money to other people at a higher rate, simply acting as an intermediary for profit. What most people likely do not know is that every time you invest in a GIC, the financial institution makes a spread, or simply put, a profit. 

Depending on the rates of the day and the length of the term that profit could be range from 10 to 25 basis points per year invested.  The range of the fees could be as low as 0.10 per cent for a one year GIC to 1.25 per cent for a five year GIC.   So on a $100,000 GIC for 5 years, your local financial institution might make between $500 (low end) and $1,250 (high end).  One percent equals 100 basis points in financial lingo.  Low-end is calculated 10 basis points x five years x $100,000.  High-end is calculated 25 basis points x five years x $100,000.  Starting this coming July, all financial institutions will have to disclose this to everyone. 

Let’s move to mutual funds. Take that same $100,000 and assume that you invest it into a balanced mutual fund. There are three potential ways the advisor could get compensated for their advice.  They could charge a fee initially, between one and five percent – referred to as Front End (FE). 

Front End is sometimes referred to as Initial Service Charge (ISC).  Some advisors have adapted a structure similar to banks and don’t charge a Front End fee.  Other advisors could do a Deferred Sales Charge Fee (DSC), where the client pays nothing initially but the advisor collects around five per cent immediately, so in this case, $5,000 from the mutual fund company because you are now committed to that fund family for six or seven years.

The fees to redeem the DSC mutual fund in the first couple of years may be approximately five per cent, and declining over a six or seven year period at which point the fund can be sold for no DSC costs.

There is also a variation called Low Load (LL) which is simply a form of DSC. If you see DSC on your statements, you know you are locked in.   Then inside, embedded in every mutual fund is an ongoing management fee.  As an example, a typical Canadian equity fund may have a 2.5 per cent embedded annual fee that is divided up amongst the advisor every year along with the mutual fund manager and their company.   These combined fees are often referred to as the Management Expense Ratio (MER).  I have found that the MER is rarely disclosed and, with the new rules, it will have to be.

It is very likely that many investors do not know how their advisor makes money or what fees they really are paying.  Knowledgeable and professional investment advisors, just like a good accountant, deserve to charge a reasonable fee for their service. But unlike accountants who send you a bill, investment advisors can currently sell you a product and not tell you what they just made.

More advisors are moving to a fee-based approach which is transparent and, in many cases, tax deductible. There is so much more to come that it may be a good idea to start asking questions now. The next time your banker or your advisor speaks to you about a new investment, consider asking for a complete breakdown of what fees you are paying going in to the investment, what the advisor is getting paid, if any fees apply to sell the investment, and what your fees will be each year thereafter for the advisor to manage your affairs. 

Advisors that have always provided complete transparency to their clients will not need to make any changes in the way they communicate with their clients. In fact, they may end up benefiting from the CRM changes. 

Greater scrutiny required for transfer of funds

Years ago, investors could bring cash into a brokerage firm and have it deposited into their investment account.  Those days are gone and the movement of funds is all electronic. 

One of the requirements when opening an investment account is to provide banking information.  We ask new clients to provide a void cheque for two primary reasons – to support that you are resident and to set up an electronic link between your investment account and your bank account.  

We have clients who have different bank accounts linked to different investment accounts.  As an example, Mr. and Mrs. Smith each have registered accounts with us and they have linked them to their respective individual bank accounts.  Mr. and Mrs. Smith also have a non-registered joint with right of survivorship account that they have linked to a joint bank account. 

We can link your investment accounts up to any financial institution.  There are a few advantages to having your bank and investment accounts at the same place, including one card and password to see everything.   

The electronic process is both done automatically and manually.  To illustrate we will use Mr. White and Mrs. Brown.  Mr. White is required to withdraw $24,000 from his RRIF account during the year.  He has requested payments of $2,000 are sent to his bank account automatically at the end of each month.  Mrs. Brown is planning a vacation with her grandchildren and would like $5,000 as a one-time transfer.  This transfer is an example of a manual process of a one-time transaction.  In both cases, the amounts are transferred electronically to the account linked to the specific investment account when the account was opened. 

If your bank account changes it is important to notify your financial institution so they can update your information accordingly.  Although the above payments to Mr. White and Mrs. Brown were electronically executed, they were both verbally confirmed by the advisor.  This part is important to stress as financial advisors can not take instructions to amend banking information, or transfer money, by email for security reasons.    

We often have clients who want us to send money to children, family members, or other third parties.  Similar to personal requests, and changes to banking information, third party requests for transfer of funds can not be done by email.   These types of requests require both verbal confirmation and a signed letter of direction providing details of the transfer request.   This is to protect client accounts against unauthorized email instructions, known as spoofing, and fraud.  The letter of direction can instruct us to issue a cheque payable to another individual.  The letter of direction may also provide wire transfer instructions.

Clients are often surprised to learn that we can purchase many different foreign currencies and do so quite frequently. 

We have clients who wish to purchase certain currencies throughout the year when exchange rates are favorable.  These same clients may maintain bank accounts in different countries, the most common being the United States.   In other cases, they have intentions to wire transfer the funds to assist family members living abroad. 

If we have purchased euros, British pounds or pesos for a client then these funds can be wired in the same currency if they provide the recipient’s banking information including, name, address, bank name, account number, routing platform (also known as ABA Number, IBAN or SWIFT), routing number, bank address, bank city, bank region, and bank country.

Clients who have a discretionary investment account set up with a Portfolio Manager results in the ability for the Portfolio Manager to use their discretion to buy and sell investments.  This discretion does not extend to transfers in and out of the investment account, or transfers between accounts.  In some cases, we have clients that wish to fund their annual Tax Free Savings Account (TFSA) by transferring either cash or securities from their non-registered account to their TFSA.   This type of transfer would require the client’s verbal permission prior to execution. 

Advisors can send money to your bank account but we are not able to transfer money out of your account even if we have your verbal permission.  The only exception to that is if you have set up, and signed, a Pre-Authorized Contribution (PAC) form that instructs us to withdrawal a certain amount at set dates.  As an example, Mrs. Grey contributes $500 every month into her RRSP account through a PAC.  At the end of every month, $500 is transferred from Mrs. Grey’s bank account to her RRSP investment account.

With online banking it is often possible for you to transfer money between accounts.  As an example, you can move money from your savings account to your investment account relatively quickly, especially if your bank is related to your investment firm.  We caution people to double check amounts prior to moving funds into an RRSP and TFSA account.  There are strict penalties for over-contributions.   Even if your investment accounts are at a different institution, most provide the ability to set another financial institution up as a payee (similar to a bill payment) to facilitate transfers.

When clients sell a home or a major asset, the proceeds from this sale may result in you receiving a cheque from a law firm or the buyer.  If the cheque is in your name and you wish to deposit this immediately at a financial institution then the cheque would be considered a third party cheque.  Investment institutions may still be able to deposit these cheques; however, there is greater risk as the issuer of the cheque is not you.  Financial institutions should ask the reasons for the third party cheque and where the source of the funds are from.  An alternative to providing this information is for you to request that drafts, certified cheques, and regular cheques be made payable directly to your financial firm and in the memo field you can provide instructions to have “In trust for” and your name and account number entered.  Another alternative is to deposit the third party cheque into your own bank account and write a personal cheque directly to your financial institution.   

Liquidity in investments

Investments that can be bought and sold easily are considered to be liquid. Investments that are difficult to buy or sell are considered illiquid. Liquidity is one of many important objectives of investing. We can actually look at liquidity in several different ways, and for purposes of this article I’ve broken it down to four general discussion items, as follows: Basic Rules of Settlement, Liquid for a Cost, Exceptions to Liquidity, and Ratio of Liquid to Illiquid.

Basic Rules of Settlement

When buying and selling different investments, there are specific rules with respect to transaction dates and liquidity. Two dates are often used to describe transactions, trade date and settlement date. Trade date is fairly straight forward to understand. It is normally the day your purchase or sell is first executed. If you spoke to an advisor after cut off times (i.e. market hours) and your advisor entered the order for the next market day then trade date would be the next market day. Settlement is a little more difficult to understand and changes with different investments. The following is a chart with the most common investments and the respective settlement dates:

Common Investments

Settlement Date = Trade Date + (below)

Money Market Mutual Funds

1 business day

High Interest Savings Accounts

1 business day

Short Term Bonds (3 years or less)

2 business days

Long Term Bonds (3 years plus)

3 business days

Mutual Funds

3 business days

Canadian and US Equities

3 business days

European and Foreign Equities

Depends on market

To illustrate trade date and settlement date we will use a typical week with no public holidays. Michelle purchases a stock named ABC Company on Monday – this is the trade date. Settlement as per the above schedule for equities is the trade date plus three business days – settlement is on Thursday. What this means is that Michelle does not have to deposit money into her investment account until Thursday, even though the investment was purchased on Monday. If Michelle already had money in a high interest savings account then her advisor could sell a portion of this investment on Wednesday to cover the purchase. The opposite happens when an investment is sold. Let’s assume that a few months go by and Michelle needs some money and sells ABC Company on Monday – this is the trade date. Although we did the trade on Monday, the settlement date is Thursday. We would not be able to transfer funds to Michelle until the settlement on Thursday. We explain settlement to new clients to ensure they give us a few days notice if they require funds.

Liquid for a Cost

At any time you should have the right to make a change in your investments without it costing you a fortune. Having flexibility with investments ensures you never feel like you are backed into a corner with no options. We recommend asking the liquidity question prior to making any investment decisions – what will it cost me tomorrow if I need to sell. Everyone should know the total cost to liquidate an entire portfolio. When I have sat down with people wanting a second opinion the first thing I look at is the types of investments they have and what it would cost to make any necessary changes. I will use Wendy who came in for a second opinion as an example. Wendy was holding a basket of proprietary mutual funds that were originally sold to her more than two years ago on a deferred sales charge (DSC) basis. I explained that with proprietary mutual funds they can not be transferred in-kind (as is). Her only option was to sell the mutual funds, and transfer the net cash after redemption charges, if she wanted to make a change with her investments. In explaining DSC mutual funds to Wendy, she was shocked to know it would cost her four per cent (or $23,200) of her $580,000 investment account to make a change even though she has owned these investments for more than two years. Immediately Wendy felt she was backed into a corner. I explained to Wendy that if she had sold these mutual funds soon after she purchased them two years ago then the cost would have been $37,700. Although Wendy had liquidity, it was liquidity for a cost – she had no idea. In my opinion, every investor should avoid being backed into a corner with excessive liquidity costs.

Exceptions to Liquidity

Not every investment will be easily converted to cash. Your principal residence is one investment that is not easily converted to cash. Many assets that people buy either have restrictions on when they can be sold or take significantly longer than the settlement dates for common investments noted above. Examples of investments that are not easily liquidated include: infrastructure assets, private real estate investments, antiques, art work, private companies, hedge funds, flow-through investments, venture capital funds, etc.. Some investments have in the fine print that they reserve the right to suspend redemptions under certain circumstances. It can be very frustrating for people who have invested in illiquid investments and would like their money back. Prior to purchasing any investment you should determine if it is liquid, illiquid, or has the possibility of becoming illiquid. If it is illiquid you should be prepared to hold it until key dates are reached or a liquidity event occurs.

Ratio of Liquid to Illiquid

A good exercise for all individuals is to list all of your investments and categorize them in the liquid or illiquid category. In my opinion, everyone should have some liquid investments, including cash as an emergency reserve, or investments to either obtain income, growth, or a combination of both. There is no set rule on what ratio of liquid to illiquid investments people should have. As a general guideline, younger individuals may have more illiquid investments, especially if they have real estate with debt or the higher risk tolerance to invest in illiquid investments. Another general guideline is that as people age, or if they have a lower risk tolerance, the ratio may favour liquid investments.