Holding your child’s hand when they purchase their first home

Financial success often involves making good decisions and avoiding big mistakes.

Parents who spend the time to teach their children the basics of finances will help start them off on a more informed path.

One of the first big decisions your adult child may make is with regards to the purchase of a home. They will have a higher probability of making a good decision when you guide them through all the basic information of home ownership. You can be the steady hand during a stressful and emotional decision.

The following are the ten basic pieces of information they should know:

1. Working with a Realtor

The first thing I would tell your children is the importance of working with a good Realtor. Also, teach your children that the purchaser is not the one who pays the commissions when the house sells. The seller of real estate pays a commission that is typically split between the real estate agent who listed the house for sale and the Realtor who represents the buyer. The Realtor should know exactly what you are looking for and be able to provide you realistic offer prices that fit your budget.

2. Why you need to work with a lawyer

I would also recommend talking to your children about finding the right lawyer or notary to work with when purchasing real estate. The branch of law that deals with the transfer of legal title of real property from one person to another is called conveyancing. Ideally, you know of a good lawyer that deals with conveyancing that you can introduce to your son or daughter. The lawyer will be able to assist with holding the money (in trust), handling the transfer documents, ensuring a clean transfer for title with land titles (i.e. ensuring no liens, etc.), and preparing the purchaser’s statement of adjustments.

3. Explain B.C. Property Transfer Tax (PTT)

Although the buyer does not have to worry about paying real estate fees, they do have to be prepared to pay the PTT. For the purposes of explaining the PPT, we will use the average selling price of a single-family home in Victoria, which was $846,500.00 at the end of September, according to the Victoria Real Estate Board. In B.C., the PPT is a tax charged at one per cent on the first $200,000 of the purchase price and two per cent on the remainder. For the average selling price of a single-family home in Victoria, your child will have to pay the following:

$200,000 x 1 per cent =$ 2,000

$646,500 x 2 per cent = $12,930

Total PTT$14,930

4. Insurance

Protecting your most important financial purchase is prudent. Having home insurance will also be mandatory if your child has a mortgage with a financial institution. Consider pulling out your insurance policy and explaining the terminology to your child will give them some basic knowledge to help them get started. Your child should obtain an understanding of the different coverages and deductible levels, and how those decisions impact premiums. Sometimes insurance companies will request that certain improvements are done to the home to ensure continued insurability or avoid exclusions of coverage. Insurance companies are becoming more risk sensitive. As a result, they are requiring some home owners to go through a home inspection process to continue insurability. Insurance companies may hire third-party inspectors to assist with managing this risk. They will prepare a Residential Appraisal Report that would typically show deficiencies and recommendations that need to be addressed. These deficiencies and recommendations may result in future costs.

5. Utilities

Often times, if your child has been renting, they may be unfamiliar with the concept of the total cost of utilities. Obtaining an understanding of the common utility charges, such as water charges, garbage pick-up, natural gas, electricity, sewer, internet and telephone will help them better prepare for the total cost of home ownership.

6. Assessed values

The assessed value of a property is broken down into the parcel land and the improvements (home and other structures). Many times during real estate transactions, the selling price is grossly different from the assessed value. It’s helpful to ensure your child understands that these values are not necessarily an accurate reflection of value.

7. Property taxes

Tax records are public information. At any time you can go into the municipal hall and look up the taxes due on the property. When you are looking at homes with a Realtor, they will also be able to provide the history of property taxes for any home that you are looking at. This information is readily available on the systems that Realtors have access to.

8. Building inspection

As parents, I think it is important to assist with the emotional aspect of purchasing a home. It may be far too easy for a child to quickly fall in love with a house without doing the full due diligence. Most people would say that it is prudent to get a building inspection done.

As with any profession, there are good inspectors and not-so-good inspectors. My personal experience with building inspectors is that they are not all created equal. Helping your child pick a building inspector with a good reputation is important. You want to help them find a building inspector that will take a very thorough look at the house go onto the roof, go into the crawl space/attic).

If you, or the building inspector, find serious deficiencies then you can either attempt to negotiate a lower price or walk away. Parents may have a more objective view of the condition, and work that would be required to maintain the property.

I once had a client that visited a house ten times prior to making a purchase — I loved hearing that. I realize that when good opportunities come along that buyers often don’t have that flexibility. When you do make an offer on a home that you are interested in, I would certainly encourage your child to make it subject to a building inspection. This will enable you to do a thorough walk through with your child.

9. Initial costs

With any house purchase, you will have initial costs that need to be factored in.

Normally, appliances and window coverings are not included in the purchase price unless specifically included in the offer. Ensuring you have equipment to maintain the property (i.e. lawn mower, weed eater) is also a factor.

A thorough walk-through of the property will enable you to obtain an understanding of the other initial costs you would need to factor in. Sometimes helping your children pick up used items initially will assist them budget when excess cash flow is tight.

10. Financial terminology

Without opening your pocket book, you can help educate your children about financial terminology. Help them summarize the typical information that the bank will require for a mortgage application (two years of tax returns, notices of assessments).

Talk to them about saving and what types of accounts to put their savings into (Tax Free Savings Account, Registered Retirement Savings Plan or investment/bank account).

Discuss a plan on how to come up with the down payment. Ideally, when your child purchases their first home, they can get away from the cost of mortgage insurance.

In order to do this, they will have to put 20 per cent down.

Discuss the difference between variable rate mortgages and fixed rate mortgages with your children. In some home equity type mortgages, you can have a mixture of both variable and fixed. Another option is to have different durations or terms to maturity. As an example, your child could have half of the mortgage funds in a three year variable rate and half in a five year fixed rate.

Parents can also help children with financial support when purchasing a home.

Next week, we will outline some of the ways parents can help their children financially and how this is typically structured.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138.

 

Buying your first home — know the numbers

One of the most rewarding investments is the purchase of a principal residence.

Getting away from paying rent and building equity can be a significant financial step in the right direction. Many younger people today may not know the numbers regarding what it would take for them to make such a significant purchase. My recommendation would be to begin by setting goals and gaining knowledge.

This article should not replace meeting with a financial institution and getting specific advice from a mortgage specialist. As a starting point, I want to illustrate some numbers using the average selling price of a single-family home in Victoria, which was $846,500.00 at the end of September 2019, according to the Victoria Real Estate Board. Also, for illustration purposes, we can use the average selling price of a condo being $511,600.00 in Victoria at the same point in time.

What are the key ratios that you look at?

The four key ratios for mortgages are: Total Debt Service Ratio (TDSR), Gross Debt Service Ratio (GDSR), Loan To Value ratio (LTV), and Pressure Test Interest rate (PTI).

To calculate your Total Debt Service Ratio, take your total debt and divide it by your income. Total debt for this ratio includes the new mortgage, heat, property tax, condo fees, car loans, etc. Your income is the amount that is represented on your tax return or T4 slips. Once all of these numbers have been verified, the ratio cannot exceed 44 per cent. For example, if your gross monthly income is $6,000 per month, then the total overall debt cannot exceed $2,640 per month.

Gross Debt Service Ratio is similar to the TDSR. The main difference is that the GDSR only takes into account mortgage-related debt. Mortgage-related debt would include mortgage payment, heat, property taxes and condo fees (if applicable). Once you have this information, you apply the same formula of taking your mortgage debt and dividing it by your income. Typically, the ratio for GDSR cannot exceed 39 per cent. Using the same numbers as above, if your gross monthly income is $6,000 per month, then the total mortgage-related debt cannot exceed $2,340 per month.

The Loan To Value Ratio is another key ratio used by mortgage lenders. When mortgage lenders look at this ratio they are first looking to determine if the mortgage is a high ratio mortgage or a regular mortgage. A high ratio mortgage is one where you are financing more than 80 per cent of the value of the home. When you have a LTV of more than 80 per cent, you then are required to get mortgage insurance. A regular mortgage is when the LTV is lower than 80 per cent and there is no requirement to obtain mortgage insurance.

The Pressure Test Rate is essentially a stress test to see if you could handle higher mortgage payments if interest rates were to rise. Currently, the rate used in Canada is 5.19 per cent which can be changed by the federal government. This rate decreased in July 2019 for the first time in three years. For any person applying for a mortgage for a new purchase, refinancing an existing mortgage, or purchasing an investment property, they are required to have the PTI test applied.

Determining a down payment amount on a property is not black and white.

The down payment amount can fluctuate because the mortgage amount can fluctuate based on your income and ability to handle the ratios mentioned above. The down payment can be as low as five per cent with the assumption that the applicant’s income is able to support the other 95 per cent. For any down payment that is less than 20 per cent, you must factor in the high ratio insurance premium. For any down payment which is 20 per cent and above, then there is no high ratio insurance involved, and you would have a better chance at getting a higher approved mortgage amount.

Using the average selling prices for a home and condo in Victoria, mentioned above, let’s look at both regular and high ratio mortgages with respect to the required down payments. This provides four different down payment scenarios as follows: house with a high ratio mortgage; house with a regular mortgage; condo with high ratio mortgage; and condo with regular mortgage. The high ratio mortgages will require mortgage insurance and we assumed a 20 per cent down payment on the regular mortgages.

House price $846,500

Scenario 1: House High Ratio Mortgage

  • $500,000*5 per cent = $25,000
  • $346,500*10 per cent = $34,650
  • Total down payment = $59,650

(Note: CMHC-insured mortgage loans require five per cent down payment on the purchase price portion up to and including $500,000 and ten per cent down payment for the purchase price portion between $500,000 and $1,000,000).

Scenario 2: House Regular Mortgage

  • $846,500*20 per cent = $169,300 (Minimum down payment to avoid mortgage insurance).

Condo price $511,600

Scenario 3: Condo High Ratio Mortgage

  • $500,000*5 per cent = $25,000
  • $11,600*10 per cent = $1,160
  • Total down payment $26,160

Scenario 4: Condo Regular Mortgage

  • $511,600*20 per cent = $102,320 (Minimum down payment to avoid mortgage insurance).

Understanding how mortgage insurance works

There are three companies in Canada that provide insurance for high ratio mortgages: Canadian Mortgage and Housing Corporation (CMHC), Genworth and Canada Guarantee (CG). All three of these companies can do high ratio mortgages and can provide more options for banks and customers. As an example, sometimes the CMHC might not approve a deal so the banks may need other options in order to have the mortgage insured and approved. For insurance premiums, it’s based on the per cent of a down payment up to 20 per cent.

To illustrate this, we will use CMHC insurance. Below we have included a table from the CMHC website for the premiums. Most questions can be looked up on the CMHC’s website.

Loan-to-Value

Premium on Total Loan

Premium on Increase to Loan Amount for Portability

Up to and including 65%

0.60%

0.60%

Up to and including 75%

1.70%

5.90%

Up to and including 80%

2.40%

6.05%

Up to and including 85%

2.80%

6.20%

Up to and including 90%

3.10%

6.25%

Up to and including 95%

4.00%

6.30%

90.01% to 95% – Non-Traditional Down Payment

4.50%

6.60%

Using Scenario 1 for a house above, let’s walk through the math. If the house purchase price is $846,500 and your down payment is $59,650 then the mortgage amount is the difference, or $786,850. Therefore, using the table above the mortgage insurance premium is $31,474. This is calculated by multiplying $786,850 x four per cent. The mortgage amount that would need to be approved would be $818,324. This is calculated by adding the original difference of $786,850 plus the mortgage insurance premium of $31,474 = $818,324.

Using Scenario 3 for a condo, let’s walk through the math. If the condo purchase price is $511,600 and your down payment is $26,160, then the mortgage amount is the difference, or $485,440. Therefore, using the table above the mortgage insurance premium is $19,417.60. This is calculated by multiplying $485,440 x four per cent. The mortgage amount that would need to be approved would be $8,324. This is calculated by adding the original difference of $485,440 plus the mortgage insurance premium of $19,417.60 = $504,857.60.

What would your monthly payments be?

For illustration purposes, let’s assume you are going with a five-year fixed interest rate of 2.89 per cent, a 25 year amortization, and a monthly payment schedule.

Let’s go back to the previous four scenarios:

House price $846,500

Scenario 1: House High Ratio Mortgage

  • Purchase price: $846,500
  • Down payment: $59,650
  • Insurance premium: $31,474
  • Mortgage amount: $818,324
  • Payment per month: $3,826.64
  • House price $846,500

Scenario 2: House Regular Mortgage

  • Purchase price: $846,500
  • Down payment: $169,300
  • Mortgage amount:$677,200
  • Payment per month: $3,166.72

Condo price $511,600

Scenario 3: Condo High Ratio Mortgage

  • Purchase price: $511,600
  • Down payment: $26,160
  • Insurance premium: $19,417.60
  • Mortgage amount:$504,857.60
  • Payment per month: $2,360.81

Condo price $846,500

Scenario 4: Regular Mortgage

  • Purchase price: $511,600
  • Down payment: $102,320
  • Mortgage amount:$409,280
  • Payment per month: $1,913.87

The above monthly mortgage payment numbers were taken from the CMHC online calculator. You can change any of these numbers to fit your specific scenario. To purchase a house with a 20 per cent down payment and avoid mortgage insurance, your approximate family income would have to be $115,000 (assuming you have no other debts). To purchase a condo with a 20 per cent down payment and avoid mortgage insurance, your approximate family income would have to be $75,000 (assuming you have no other debts). These numbers are only approximate numbers to be used as a general guideline to help you begin the process of planning the largest financial decision you may make in your life.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138.

Who cares for your pet after you pass?

About 15 years ago, I had a client with a terminal illness.

Her biggest concern wasn’t about her own health, but rather who was going to take care of her dog after she died.

I hadn’t really given that type of question a lot of thought until that day.

Today, one of the questions we ask clients is if they have any pets. For many of our clients, their pet is a member of the family. Your pet is dependent on you for its survival and well-being. A contingency plan should be in place if something were to happen to you. When we ask clients about who will take care of their pet(s) when they pass away, most have not considered the matter, let alone made any concrete plans.

Ideally, you have a family member or friend in mind who could care for your pet. To be sure, it is best to have this discussion with the individual to make sure they would be willing and able to care for your pet in the event something were to happen. You should ensure that the new owner is able to keep the pet. Allergies, being too busy, conflict with other pets, prohibition of pets in the new owner’s residence and lack of interest are a few complicating factors for you to consider.

Let us assume you have found the right individual to care for your pet(s). It is not possible for you to leave money to your pet in your will. A pet is considered property under the law. It is, however, possible to leave a pet to the named individual to care for. A simple method is to leave your pet to the named individual, which we will call the “caretaker,” within your will.

Normally a sentence would be added in this section of your will to deal with the contingency of the caretaker being unable or unwilling to care for your pet. One approach in this situation is to give your executor the power to select an appropriate person to take in the animals.

Another approach is to establish a more formal arrangement for your pet’s care. Some people refer to this as a Pet Trust.

Let’s say you have a dog named Marley. You could establish the “Marley Fund” in your will. Although you cannot leave money directly to Marley, you can establish a trust for Marley’s care.

In order to establish this type of trust, you must have a caretaker that you also name as the trustee. The Marley Fund would receive a sum of money payable to the trustee/caretaker provided that the trustee/caretaker uses it to look after Marley. Similar to up above, a sentence would be added in the Marley Fund section of your will to deal with the contingency of the trustee/caretaker you previous chose being unable, or unwilling, to care for your pet. Normally, you would give your executor the power to select an appropriate trustee/caretaker to accept the money from the Marley Fund and take responsibility for caring for Marley.

Naturally, the above paragraphs brings up the discussion of how much money should be left through your will for the care of your pet(s). Several media stories have talked about the ultra-wealth leaving millions of dollars for their pet(s) care to the trustee/caretaker. Those stories are certainly not the norm. In the majority of the wills I have reviewed with these clauses, the amounts are much more modest.

It should be relatively straight-forward to estimate a reasonable dollar amount to designate for the trustee/caretaker. The calculation could be based on your assessment of the life expectancy of your pet, age of the pet and an estimate of the annual costs.

Perhaps the largest annual costs for caring for pets are veterinarian costs if your pet needed specific medical care. Some of our clients have pet insurance for which they pay monthly insurance premiums. Similar to adult term insurance, the premiums are normally adjusted upward as the pet ages. The insurance approach can easily be budgeted out for future cash flows. Even when a pet is covered under insurance, small deductibles are still normally payable. The estimated annual cost of insurance and the deductibles could be part of the calculation.

Each pet is different. Grooming costs, equipment costs and medications will fluctuate. Estimating food and other costs for your pets should also be a relatively easy exercise. The budget could even include the costs of pet cremation and burial, as well as an extra amount for your caretaker/trustee for the time caring for your pet.

You could simply leave a flat dollar amount to the trust or create a methodology that is outlined along with the estimated remaining life of your pet. You could create a budget that says it costs roughly $2,000 a year for your pet. If you feel you would like to leave $2,000 for each estimated year of life left for your pet you would have to know your pet’s age and estimated lifespan. If your dog’s breed has an average lifespan of 12 years then you could build this formula into the calculation. The amount that you set aside for the caretaker for a three-year-old dog (nine years estimated remaining lifespan) would be greater then the amount you set aside for a ten year old dog (two years estimated remaining lifespan). If you use this type of methodology we would recommend you discuss this with the caretaker to make sure they are agreeable.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at www.timescolonist.com. Call 250.389.2138.

 

Taking care of aging parents and their finances

Over the years, we have helped clients overcome many different challenges. This article focuses on the challenges of looking after our parents as they age. This is a complex responsibility as it involves emotional and financial management. Handling these effectively requires different skills. Below are a few points to assist with the financial challenges.

Our parents looked after us for many years. They cleaned up after us, dealt with us through the hormonal teen years and helped us with our education. This support helped launch us into our adult lives when we left home and started our own families.

As our own kids are becoming educated, our parents are getting on in years. Eventually our parents reach a stage where they need our support and the caretaking roles begin to be reversed. As already mentioned, supporting aging parents can be complicated. In some cases, aging parents are able to make rational financial and lifestyle decisions. In other cases, they are not. In some cases, they are accepting of change. In other cases they are not.

We have seen many cases of physical impairment and cognitive decline. In some cases, aging parents may lose hearing, speaking, vision, mobility/walking and other taken for granted abilities that help us with our daily living. Cases of cognitive decline could involve normal aging or a more serious decline of mental function. Typically the cognitive problems involve memory, language and judgement. Having worked with a variety of clients over a couple of decades, we have been able to see first-hand the impact of the aging process on financial issues first-hand.

It is advisable to talk to your aging parents about financial issues while they still have full cognitive functions. Most people don’t know how to begin such a conversation. One approach could be to print off an article like this and ask your parent what they think. It is possible they are not seeing the impact of age on themselves. If you are avoiding the discussion and not prepared, your aging parent may be unresponsive to even the best-intentioned help if you wait too long.

How involved children are in dealing with their parent’s financial, mental, physical well-being and lifestyle can differ from culture to culture. Even within a culture, different families have different formulae for how to help aging parent. I’m assuming that if you are still reading this article, you or someone you know wants information on how to help aging parent(s). This just might be one of the most difficult things you will have to do, but hopefully this article will give you some tips to make it a bit easier. Here are our top ten discussion points to consider when dealing with your aging parent’s financial situation:

1. Trust is the No. 1 component that I see as being important. If you are trying to help your aging parents, I would stress to your parents that your discussions will be kept strictly in confidence unless it is agreed issues can be talked about with others. Trust will be completely lost if a person in those discussions does not respect that concept. In order for all parties to communicate opening, they have to feel that what is discussed will not leave the room unless agreed upon. I think all loving relationships are based on trust. If trust has been lost over the years then you have a big obstacle to overcome.

2. The second most important item to talk to your parents about deals with capacity. It is very easy to procrastinate and avoid discussing the challenges of aging. Over the last couple of decades, I have helped hundreds of families go through this important step through a series of discussions. Similar to the advice that I give clients, an important point to highlight to your parents is any form of planning has to be done while they have capacity and are physically able. The more time you have the more likely you are to ensure your parents are taken care of in accordance with their wishes. Don’t wait until it is too late.

3. Ensure you talk to your parents about having all the important legal documents in place, including an up to date will, power of attorney and health-care directives. The discussion should involve you getting an understanding of all the key people helping your parents (i.e. lawyer, accountant, insurance adviser).

4. In addition to the standard legal documents, it is often worth discussing setting up banking power of attorney and financial power of attorney. With banking power of attorney, you can monitor the bank statements to screen for unusual transactions or withdrawals. Unfortunately, the elderly are a vulnerable population and targets of fraud. The primary benefit of having these power of attorney documents in place is the ability to assist with paying bills and making other financial decisions. Another benefit is the position of oversight to ensure that they do not become a victim of fraud.

5. Consolidate bank and investment accounts. If your parents have multiple bank accounts then get them to explain the rationale for having more than one. In the majority of situations one bank account is sufficient. You should try to ensure that all OAS, CPP, RPP, RRIF and income payments are deposited automatically into one bank account. Automatic expense payments should also all be done from the one bank account. Having investment accounts at different financial institutions causes added work to keep in touch with more than one adviser and to monitor the disparate investments. If your parents have three RRIF accounts, then they are getting three times the statements and tax slips. As they age, it is easier to consolidate all RRIF accounts together, consolidate all TFSA accounts together and have only one non-registered account. We encourage you to talk to your parents about reducing the number of bank accounts and financial institutions they deal with if you are getting multiple statements from different institutions.

6. Taking some of the volume of information off their plate can be helpful. A simple example of this is assisting with correspondence they receive in the mail. If you find that your parents are no longer opening and reading their mail, or simply have lost interest in looking at it, then it is relatively easy to get their financial mail (i.e. monthly statements) redirected so that you can take care of it and monitor it. We can also arrange it so both you and your parents receive all mail from our institution.

7. One example of correspondence that is important to stay on top of is from Canada Revenue Agency. Helping your parents file their annual tax return by organizing the information and ensuring it is filed can help them deal with something that can be quite daunting and confusing. Gathering information related to health care costs and medical receipts can be complex. Ensuring your parents are applying for all the tax credits (i.e. Disability Tax Credits) and claiming all receipts can minimize their tax bills and ensure they are compliant. Create a system for your parents to keep all receipts (i.e. medical receipts). You can go through and see what needs to be kept and what they can get rid of. You can help them safely dispose of confidential information and statements. You can help your parents respond to any assessments and ensure that any required instalment payments are made.

8. Obtain a copy of your parent’s financial plan. Normally the plan is a great starting point to obtain a complete listing of your parent’s net worth and the previous recommendations and actionable steps. Having this in writing, with concrete actionable steps, helps ensure your parents execute the appropriate financial strategies. If they do not have a total wealth plan, then you may suggest that they have one completed. One component of a total wealth plan deals with estate planning. The planner completing the plan can bring this component up during the presentation which I would encourage you to attend with your parents. Obtaining any memorandums to deal with personal household items or digital directives with logins and passwords is also helpful.

9. If your parents are currently not working with a portfolio manager then you could recommend that they meet with one. Prior to the meeting, you could assist your parents in creating a cash flow summary, both incoming and outgoing. A portfolio manager would want to have a clear understanding of your parent’s investment objective and risk tolerance. An Investment Policy Statement (IPS) could be created summarizing the discussion. One part of the IPS would cover the required cash flow to transfer from the investment account to the bank account (frequency and dollar amount). A portfolio manager can do trades on behalf of your parents without having to call them on each trade to make a decision. In some situations we can coordinate meetings with our private banker who can also service the client’s day-to-day banking needs. This can be particularly helpful if your parents do not live in close proximity to you.

10. Prepare a financial data organizer that has all of the above documents organized or a summary of the details where originals can be found. It should include a summary of all accounts and insurance policies. It should list all the advisers and professionals assisting you in your banking, financial, insurance, and legal documents. If your parents have a safety deposit box then you should know where the key is and what the purpose of it is.

Some of us are better prepared to help an aging parent than others. Our personal wealth, resources, time, health and family situation, including our ability to set and maintain healthy boundaries are all factors. Trust is the No. 1 factor to ensure the best outcome for assisting your aging parents. Once that trust is established, you and your parents should have clearer and better communication. A capable portfolio manager can act as an invaluable intermediary in this kind of situation. We can assist with having the initial meeting and discussions. We can also assist in mapping out a plan that is triggered at certain points (i.e. death of one parent, health deteriorates, etc.). Depending on how the plan is created you may find yourself gradually or abruptly taking over some responsibilities. The more you plan today, the easier this process will be.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138.

Understanding what flows through your estate

At every stage of our client’s lives, we feel they should have an up to date will.

Unforeseen events can happen and planning is essential to ensure your assets and estate are distributed according to your wishes.

The term “estate” can be used different ways. For purposes of this article, we will refer to any assets that are divided according to your will as forming part of your estate.

Below we will illustrate the “estate” term using various options that a client has with respect to their investment accounts, both registered and non-registered.

Registered accounts

Examples of registered accounts are Registered Retirement Savings Plans, Registered Retirement Income Fund, Locked-In Retirement Account, Locked-In Income Fund and Tax Free Savings Account. When a client opens a registered account, one of the questions we ask them relate to who they would like to name as beneficiaries. A client can name an individual(s) or simply name the estate as beneficiary.

In the majority of cases, couples will name their spouse the beneficiary of RRSP/RRIF accounts to obtain the tax deferred roll-over to the surviving spouse on the first death. With a TFSA, benefits exist for naming your spouse as the full amount of the deceased’s TFSA can roll into the surviving spouses TFSA without using up the survivor’s contribution limit. When a person or persons are named beneficiary on a registered account it essentially bypasses a person’s estate.

Individuals also have the option of naming their “estate” the beneficiary on their registered accounts. When “estate” is named, it is extra important for clients to have a will. Essentially, your will divides all registered accounts where “estate” is named.

In reviewing a client’s will, we have at times noted conflicts with what the will says and who the named beneficiary is on a client’s account. Some clients will want to specifically put account numbers and types of accounts within a will. This is not necessary if you have named beneficiaries on the accounts. It also can add confusion in your will if you leave certain accounts to certain individuals within your will — the specific outcome may not be as desired as the account values will change over time. In the majority of cases, we encourage clients not to mention the types of accounts and account numbers within a will. We encourage clients to focus on having a detailed plan with respect to their overall estate.

Non-registered accounts

Common types of non-registered accounts include individual, joint tenancy, tenancy in common and corporate accounts. Couples typically like to have investment accounts held in joint tenancy. Most joint tenancy accounts will have both couples names and then “Joint With Right of Survivorship” or “JTWROS” after the names.

Typically, with a JTWROS for couples, on the first passing, nothing flows through the deceased’s estate. In other family situations (i.e. not a spouse) where accounts have been structure for estate planning purposes only this may not apply. The surviving spouse would essentially bring us in a copy of the death certificate and notarized copy of the will.

Once these documents are brought in, we would have a couple of documents for the surviving spouse to sign (i.e. Letter of Indemnity and new account documents). Typically, a new individual account is opened in the name of the surviving spouse and then the securities would be rolled over as they are, including the book values, into the new account.

When a person passes away with an individual account or holds a percentage of assets in a tenancy in common ownership within their account, this would flow into the person’s estate.

Probate and executor fees

There are no probate fees for estates under $25,000, 0.6 per cent on the portion of the estate from $25,000 to $50,000, in B.C. The maximum compensation is five per cent for executors in B.C.

With couples, we typically try to arrange joint tenancy on all assets to ensure probate can be avoided on the first passing. In many cases, couples name each other executors to eliminate or reduce the executor costs.

In some cases, such as complex family situations (i.e. second marriages, children from a previous relationship), it is not always possible to avoid probate and executor fees to achieve your primary goals. Your primary goals will trump other goals such as avoiding probate and executor costs. In some situations, it is best to structure things so that probate and executor fees may apply.

Certainly on the second passing, it becomes more difficult to avoid probate and other costs such as legal and accounting. In some cases we are able to set up family meetings to deal with complex situations or to do further estate planning after the first passing.

Charts and visuals

I often use charts when discussing estate planning. I find it can be useful to help clients understand and visualize the purpose of a will. I’ll start the process by drawing a bucket in the middle of a blank page. On the bottom of the bucket I will write the word Estate. On the top side of the bucket, I will write the word will. I then pause to make sure that the clients understands that the will only divides what goes into the bucket. Many things can be structured to avoid the bucket altogether (i.e accounts that have named beneficiaries and JTWROS accounts).

On the left hand side of the page, I will begin listing all the assets that the individual has. Examples of typical asset listed include an RRSP, TFSA, boat, vehicle, bank account, non-registered account, house and life insurance policy. In each one of these examples, we draw a line to see which part of your estate flows directly to the bucket and which part of your estate flows directly to a beneficiary or joint owner.

We also draw a faucet on the right hand side of the bucket. The faucet represents probate fees, potential executor fees, accounting fees, legal fees and other costs outlined in the meeting.

Primary estate goals

Minimizing probate fees and executor fees are typically in the secondary goal category. As much as clients would like to avoid unnecessary fees, it should never trump achieving your primary goals. During an estate planning meeting, the majority of the time is spent mapping out details of your primary and secondary goals. Primary goals could be specific directions with respect to income taxes, protecting assets, succession planning for a business, asset distribution and transition, providing for family and friends and charitable giving.

These estate planning discussions are done to hopefully ensure all is structured correctly. Once we know what you are trying to achieve then we can compare your goals, both primary and secondary, to your existing will to ensure the two are aligned. If they are not aligned, then we could, in conjunction with your other professional advisers (lawyer and accountant), provide options or suggestions. Another goal of these discussions is to ensure your estate is distributed in a timely manner and to manage expenses and taxes in an efficient way.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director, wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250-389-2138.

 

Updating your list of key contacts

We begin every meeting with our clients by reviewing a summary sheet of key macro items we believe are important for the client to either understand or communicate to us.

We provide new clients with a financial checklist to take home, fill out and return to us either by email, mail or at our next meeting. In many ways, it is similar to if you were visiting a medical professional for the first time. In order for the medical professional to best help you, they would need to know both your and your family’s health histories.

The purpose of this article is to outline some of the reasons why we ask for this information.

Accounting information

Do you prepare your own tax return or do you have someone prepare your taxes on your behalf? If you have an accountant, then at a minimum we obtain the name of the individual(s) you work with, the firm name, mailing address, phone number, fax number and email. We also like to know when the relationship began. If you do not have an accountant, then how is your return prepared (software package, paper version, family member)? We have all new clients complete a Canada Revenue Agency (CRA) representative form as a starting point. With your consent, this enables us to get some background information and all carry-forward limits. We obtain alerts from CRA when our clients get new mail (Notices of Assessments, reassessments, review letters). Often we are able to review this before our clients receive it. If we are not able to assist the client directly, then we can point them in the correct direction.

For our corporate clients and incorporated medical professionals, it is important for us to speak at least annually, if not more frequently, with their accountants. We can provide the accounting firm with the information they require to expedite the preparation of corporate and trust returns. It also enables us to document the structure, shareholdings, and overall strategy with respect to tax sheltering, dividend payments and wages. This information needs to be consistent with all financial planning documents we prepare.

Legal information

One of the sections on our professional checklist requests details regarding the lawyer and notaries you work with. For our corporate and trust clients, they may have a different lawyer to help with the structure, records office and minute filings. All clients should have a notary or lawyer that helps prepare their personal legal documents. This is perhaps the area where we have to nudge clients along a bit as the natural tendency is often procrastination.

The benefit of us asking new clients to fill out the professional checklist, and asking existing clients to update or provide this information, is that it encourages people to dedicate time to get it done. The most basic of questions we ask is whether our clients have a will. We believe it is important to know when it was last updated, where the original(s) are kept and who the executor and alternate executors are? We also advise clients that we do not prepare wills and don’t require copies of our clients’ wills unless they have questions and concerns. When we have estate planning meetings, I will always want to know how our clients ultimately want their estate distributed. If the will does reflect their most current wishes, then I will work with their lawyer to ensure it is updated.

We also obtain details regarding power of attorney, including legal, bank, and financial information. Unlike wills, there is no registry for powers of attorney. We ensure that we document details that clients provide, and request that they confirm no changes at every meeting. In cases where clients are aging we will encourage them to bring the representatives that they trust in to meet with us prior to a situation where the client’s capacity can be questioned.

Often the legal section of our checklist is returned without the requested information or incomplete. In some cases, it may be because the client didn’t understand the question or that it is not applicable. Many people want to know about the different types of power of attorney and health care directives (i.e. representation agreement) available, but have never really talked to anyone about it.

Perhaps the most important part of this exercise is that it enables our clients to open up about personal situations that have been bothering them. After working with clients for a couple of decades, there are very few situations that we have not found solutions for if clients want to talk about it.

Banking information

When clients first open up accounts, they must provide a copy of a void cheque to ensure we have the correct details. In some cases, we have clients who have multiple bank accounts at different institutions. Many couples have joint accounts. Some clients choose to have individual accounts. Our elderly clients have, at times, had questions about setting children up as power of attorney on bank accounts and investment accounts or setting them up as joint owners. We try to both simplify our clients banking needs while at the same time ensuring they understand the pros and cons of each decision that they make.

Every investment account is linked to a bank account. It is possible to have different bank accounts linked to different investment accounts. That can get a bit confusing, especially as our clients are aging. We generally encourage closing unnecessary accounts and consolidating them into one Canadian chequing account. In this one account you can have all your deposits transferred in including CPP, OAS, RPP pensions, and withdrawals from your financial institution. Establishing a good relationship with one banking institution makes sense to have one point of contact. It makes cash-flow planning and taxation administration easier. Whenever our clients change their banking information they must let us know so we can update the applicable link to the investment account(s).

Insurance information

When clients come to the insurance section of the checklist, people often don’t have a clear understanding of what insurance coverage they have. Some may have had insurance they purchased years ago, but are fuzzy on all the details. Sometimes clients bring in policies that have lapsed, have been replaced, or converted. In other cases, they are fully in force. For existing in-force policies, we document all details, including why the insurance was initially put in place. We also obtain details of the cost of insurance and any periodic cash-flow needs to fund. In some cases, the insurance is fully paid up. In other situations, premiums are set to be paid monthly or annually normally. When we see monthly premium payments, we normally talk to the client about converting to annual as the cost of insurance is typically slightly lower. With annual payments we are also able to coordinate payments from a non-registered account to insurance companies on our client’s behalf. We ensure that cash flow is available to fund and we can make the payment direction, similarly to us making installment payments to CRA.

In some cases, our clients have no insurance and they do not need insurance. In other cases, our clients have young families, or have significant debt loads, partnership agreements, compliance with separation agreement clauses, etc. When there is an obvious need we will outline how risks can be managed in the scope of an overall financial plan.

Asking questions about insurance and obtaining details of all in force policies enables us to understand the full picture. One of the side benefits of gathering all insurance details is that it is required information to complete a comprehensive financial plan. Within a financial plan, a section covers insurance. Insurance can often help provide solutions to concerns, protection, taxation benefits, and estate maximization and ensuring asset transfers after taxes have been paid.

Family information

For every client, we request that they provide us some background of their family dynamic, usually via a family tree, starting with details on their parents. If their parents are deceased, then we request that they provide their age at the point of their death. This type of information is useful from a genetic footprint standpoint. In situations where parents are still living it opens up many discussions. Are your parents currently dependent on you or will they need assistance as they age? In some cases, we will encourage our clients to bring their parents in and we can assist them with any questions. When parents are living, there will likely either be some form of future cost (i.e. extended care, funeral costs) or future inheritance. This information is useful when mapping out future cash flow needs and financial plans.

Obtaining details about siblings is also important, as they, too, can provide information from a genetic standpoint. We have many situations where we can set up siblings and our clients on joint family accounts if the situation is right. When siblings open up accounts, it provides more options for estate planning with parents, such as in-kind distributions. Siblings can also be an option with respect to executor and powers of attorney depending on proximity, age and knowledge level.

Information on children and grandchildren is also important to know. For younger children and grandchildren, the discussion can initially focus on setting up Registered Education Savings Plans. We will often discuss with our clients what type of assistance, if any, they want to provide to any minor children once they become adults. In some cases we have clients that feel they have no obligation to assist their children after they leave them. Some feel they feel an obligation to fund education costs only. Others want to extend the assistance to helping their children purchase their first home. Every client is different and we try to get an initial understanding of where they are within this wide spectrum.

When family members combine accounts at one institution, it is referred to as “house-holding.” As overall asset levels rise and reach certain thresholds, then fees as a percentage can decline for all family members.

We also want to obtain details outside of a family tree if non-family beneficiaries are listed on life-insurance policies and registered accounts. At times, we have had beneficiaries that live overseas and have been challenging to reach. Making sure we have up-to-date addresses and phone numbers of key individuals that are part of your estate plan.

Finally, many of our clients have pets that are an integral part of their family and have concerns about what will happen to them as part of their estate. We can provide solutions that give pet owners options and peace of mind.

Other information

With extended families and complicated family situations we ask our clients to provide marriage contracts, prenuptial agreements or any information that gives us a complete understanding. We also ask clients to provide any additional details that they feel we should know. Stated another way, are there any specific concerns that are bothering them?

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250-389-2138.

 

Time management helps with work-life balance

Getting the most out of your day involves a significant amount of organization and goal setting.

Working on your big-picture goals may take some time.

Sometimes you have to stop everything you’re doing and step back to establish your work-life balance goals. Although you may lose some time in the short-term, you will be on track to saving significant time in the long-term.

First, working on short- and medium-term goals that have actionable steps will lead to your bigger long-term goals. It is surprising how doing multiple little changes can free up more of your time.

One of the biggest time wasters is spending too much time on things that we are not experts at. If you believe “time is money,” then spinning your wheels on something that requires specific expertise is a mistake.

Opportunity cost

One of my favourite lessons in microeconomics is the concept of opportunity cost. The concept can be applied at various levels. To illustrate, let’s assume Louise can earn $80 an hour doing her self-employed professional job. Louise has a small home that needs a paint job, but also wants to have some vacation time. Louise has the option to either hire a painter or take time off work and paint the house herself. The painter could paint the house in four days (32 hours). The painter’s hourly rate would be $30. The painter has the tools and the expertise to paint the house quicker. It would likely take Louise six days (48 hours) to paint the same house. From a purely economic standpoint, it would make no sense for Louise to paint her own house. If Louise hired a painter, she would have to pay $960. Louise would lose $3,840 in lost income if she decided to do this herself. Although she would save $960 by painting the house herself, she would either lose six days of her vacation time or lose $3,840 in lost earnings. Either way, Louise should likely not paint her own house.

Hiring a wealth adviser.

The same concept of opportunity cost can be applied to financial services. Whether working or retired, individuals have the choice to either manage their own money or getting a wealth advisor. An adviser would have all the tools and the expertise that will hopefully save their clients a significant amount of time. If in the short-term, you spend time finding the right wealth adviser, this should save you a considerable amount of time in the long run.

Consider a managed account

Portfolio managers are also able to offer managed accounts that enable them to execute trades on a discretionary basis. It is not necessary for the portfolio manager to talk to you about every trade in your account. You will know that if you are busy, away on holidays, or simply have other interests — someone is always keeping an active eye on your finances.

Periodic phone meetings

Not every meeting with your wealth adviser has to be done in-person. When your time is limited, you can ask your adviser to set up a phone meeting. As a suggestion, you can rotate in-person meetings with phone meetings. Some clients would prefer not to deal with traffic and parking. When phone meetings are set up, we will send the agenda, holdings detail and recommendations out ahead of time by secure email. The benefit of the phone meetings is that you can look at the documents before the actual phone conversation.

Consolidating accounts

Handling less paperwork will help you get more out of your day. For risk management and efficiency purposes, we encourage clients to consolidate accounts with one financial firm. Having multiple RRSP and TFSA accounts, at different investment firms, increases the amount of time you need to effectively manage your overall holdings. Position size, sector diversification, geographic exposure and underlying holdings are all easier to manage if you are at one financial institution. You will also have fewer income tax slips come tax time.

Online access

Online access allows you to look at your investments at your leisure, either through a phone app or via a website. Once you have online access set up, you also have the option of going paperless. This can save you time in the long run either looking information up or not having to file or shred paper copies that are mailed to you. Online access will assist you in getting rid of some of the paper clutter and knowing that your financial information is always available at your fingertips. Paperless option also ensures that you will not be impacted in the event of a postal strike or disruption to mail service.

Agenda items

One of the most important parts of meetings is for us to stay connected with our clients on important financial cash flow updates and issues outside of financial items. I encourage clients to email me any specific questions prior to our telephone meeting or in-person meetings. We will always add those specific items to a meeting agenda and ensure the proper amount of time is allotted to cover everything. As wealth advisers, we realize that not all goals are financial. In many cases it takes financial resources to achieve non-financial goals. If you have a life event or a situation in your life that is concerning you we have likely had a past client that has gone through something similar. We can either propose options to you that will save you time or point you in the direction of the right people to talk to.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the TC. Call 250.389.2138.

 

 

 

The snowball effect on net worth

Over the years I’ve had many people ask me for advice for someone wanting to improve their financial position. Below are a few of the concepts of how people generate wealth over time. These may seem like elementary concepts but can be valuable for someone new to investing.

Savings trumps investing

The first concept I want new investors to learn is that savings is more important than investing initially. I can illustrate this with a simple example of Jack Jones who is 35 years old and has $50,000 in capital to invest in his RRSP.

Let’s make the assumption that Jack can make six per cent a year on his investments. If Jack does not contribute to his investment account then his account balance at the end of the year is $53,000.

In talking to Jack, we encouraged him to think about saving $500 per month (or more), this would contribute $6,000 per year to his RRSP. The investment return only contributed $3,000 to annual growth whereas the savings was $6,000 in one year, far greater than the investment returns.

If Jack is serious about improving his wealth over time, then savings initially is the key until the account value gets built up.

The snowball effect

Visualize yourself as a kid making a snow man. You would start with a small snowball and then begin rolling it on the ground. As it rolls it gets larger. The more you roll it, the more rapidly the growth occurs. The snowball effect can be described as both good and bad.

The bad snowball effect relates to when people get themselves into a bad debt situation.

Examples of high interest debt include: delinquent bills, credit cards, non-favourable business loans, car loans, and other personal loans. Spending beyond your means is a sure way of destroying wealth accumulation.

If interest costs and debt are spiraling out of control then it leaves little discretionary cash flow after each pay cheque. In the worst scenarios, net worth is declining every month.

The good snowball effect positively impacts investors who have accumulated significant savings/investments. Up above we mentioned that savings is more important for Jack. Below in a table we have outlined the growth for Jack’s portfolio over 10 years, assuming he doesn’t contribute and makes a six per cent annual rate of return.

Beginning balance Return Ending balance Accumulated earnings
Year 1 $50,000.00 $3,000.00 $53,000.00 $3,000.00
Year 2 $53,000.00 $3,180.00 $56,180.00 $6,180.00
Year 3 $56,180.00 $3,370.80 $59,550.80 $9,550.80
Year 4 $59,550.80 $3,573.05 $63,123.85 $13,123.85
Year 5 $63,123.85 $3,787.43 $66,911.28 $16,911.28
Year 6 $66,911.28 $4,014.68 $70,925.96 $20,925.96
Year 7 $70,925.96 $4,255.56 $75,181.51 $25,181.51
Year 8 $75,181.51 $4,510.89 $79,692.40 $29,692.40
Year 9 $79,692.40 $4,781.54 $84,473.95 $34,473.95
Year 10 $84,473.95 $5,068.44 $89,542.38 $39,542.38

After 10 years, Jack’s net worth would have accumulated to $89,542. Over a 10-year period, Jack’s net worth increased only $39,542.

Another example: Jill Jones has $1,000,000 in an investment account at the beginning of the year. Below we have put a similar table for Jill assuming she earns the same six per cent rate of return and makes no further contributions.

Beginning balance Return Ending balance Accumulated earnings
Year 1 $1,000,000.00 $60,000.00 $1,060,000.00 $60,000.00
Year 2 $1,060,000.00 $63,600.00 $1,123,600.00 $123,600.00
Year 3 $1,123,600.00 $67,416.00 $1,191,016.00 $191,016.00
Year 4 $1,191,016.00 $71,460.96 $1,262,476.96 $262,476.96
Year 5 $1,262,476.96 $75,748.62 $1,338,225.58 $338,225.58
Year 6 $1,338,225.58 $80,293.53 $1,418,519.11 $418,519.11
Year 7 $1,418,519.11 $85,111.15 $1,503,630.26 $503,630.26
Year 8 $1,503,630.26 $90,217.82 $1,593,848.07 $593,848.07
Year 9 $1,593,848.07 $95,603.88 $1,689,478.96 $689,478.96
Year 10 $1,689,478.96 $101,368.74 $1,790,847.70 $790,847.70

The larger the accumulated savings balance, the larger the potential accumulated earnings and the greater the snowball effect of accumulating wealth, especially over time. It is tough to get the full snowball effect until one has saved enough to get the base level of capital.

Although Jack and Jill both made six percent, Jill was able to accumulate $790,847.70 of additional wealth, while Jack only accumulated $39,542.38. Jill is fully able to take advantage of the snowball effect in a positive way. The magic of compounding investment returns is magnified when you have accumulated enough savings — making money on money.

Investing rather than speculating

Investing is the concept of thinking longer term and picking solid well run companies. Speculating is more short-term type trading that may or may not have the desired long term outcome. The probability of making a mistake and moving backward when speculating is higher.

We would rather encourage savings and investing rather than speculating.

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the

 

 

The Greenard Group’s 10 principles on how we pick stocks

Over the years I have been asked several times how we pick our stocks. The process for picking stocks really begins with our overall investment philosophy. All decisions are made in the context of achieving the best risk adjusted returns for the entire portfolio over a medium to longer term. Returns can be achieved through both distributions to shareholders (i.e. dividends) and share price appreciation. Here are a few principles we consistently have used over the years:

1) Zero speculation

Nearly all of our clients have one primary investments objective — capital preservation. Our clients have worked really hard for their money and they don’t want to lose it.

One of the guiding principles we believe in when picking stocks is investing for long term rather than speculating on any short term volatility. Sometimes people have asked me what the difference is.

One of the ways that I have described it is the mind set of thinking longer term (investing) and avoiding the temptation of shorter-term (speculating). It can be tempting to jump on the latest craze or hot stock pick suggested by a friend or neighbor in the hope of a significant gain in a shorter period of time.

One client told me years ago that he likes to grow wealthy slowly. He was willing to forgo all short term significant gain opportunities to ensure his capital was prudently invested in solid well-known companies. Avoiding the mistakes was more important than trying to hit home runs.

Although we steer away from giving advice for clients wishing to purchase speculative names, our general comment is to keep the position size small, hold it in a non-registered account (to claim the loss if it does not work out) , as future performance data will be impacted if our model portfolio recommendations are not adhered to.

2) Large capitalized companies only

Another guiding principal is avoiding smaller and medium capitalized companies. From our experience, the smaller and medium sized companies often have greater levels of volatility and greater risk.

Our equity selection process focuses 100 per cent on the largest capitalized companies within Canada, United States, and outside of North America. Our screening process first begins with approximately 1,200 constituents companies as follows the 500 largest companies in the U.S., the 350 largest companies in Europe, the 250 largest companies in Canada, and the 100 largest companies in the Asia/Pacific region.

We feel that a portfolio biased only to Canada has, and will continue, to underperform other markets over time. Although 1,200 individual companies may still seem like a lot, once the other principles below are applied the subset of companies narrows and becomes reasonable.

3) Corporate profitability

We will never purchase a company that is not profitable. The most simple of ratios to look at when assessing profitability is Earnings Per Share (EPS). If a company is not making money, it is automatically excluded. Projected growth in earnings or future outlooks provided by analysts can provide a good rationale for what will drive growth in earnings for the company.

We spend a significant amount of time reviewing internal and external research reports from analysts — with both positive and negative comments. Past profitability normally gets a company on the initial subset of companies to be considered, though future and current profitability are even more important.

4) High capital efficient companies

What does “high capital efficiency” mean? Let’s break it down to two terms we use returns on invested capital (ROIC), and free cash flow (FCF). All companies finance operations either through the issuance of debt or equity. The cost is the interest rates on the debt and dividend expectations on the equity.

Leverage is perhaps the one component we will focus on. A company that has internally sourced capital is always in a better situation then one that relies on external capital. A company that has low financial borrowing costs and leverage will have less dependence on external financing and external events. The more predictable a company’s ROIC and FCF are the better.

5) Lower leverage

If a company is profitable it can naturally expand its operations organically (with its own profits). If a company wishes to grow faster than the current profits allow, then it must choose to issue additional equity or debt to finance assets purchases or acquisitions.

Many advisers will look at various ratios to screen for good stocks. The financial leverage ratio is definitely worth looking at. It is relatively easy to calculate. From the financial statements you must determine the total debt of the company and the total equity held by shareholders. You simply divide the total debt by total equity. The normal rule of thumb is that this should not be above a level of 2.0, though some exceptions exist.

Leverage is essentially when a company borrows money with the expectation that the profits made from borrowing the money will be greater than the cost of the amount borrowed (i.e. the interest costs) . If a company is financing its operations by continually taking on debt and other liabilities then naturally it is riskier than a company with less leverage. This is especially the case in periods when interest rates are rising.

6) Prudently managed

Investing in companies that are prudently managed is a key component to any quality stock. This is particularly important as the landscape is constantly changing and we have to feel confident that management will make prudent changes to stand the test of time. Understanding what the company does is fundamental to selecting the stock. Management of the company should be able to provide information that makes sense.

A simple starting point is the company’s annual reports which are all available on each company’s website. My favourite section to read in financial statements is the “Management Discussion and Analysis”, also referred to as the MD&A.

An independent auditor must prepare and audit the company’s financial statements. The information is historical which immediately discounts its use from a planning standpoint.

The one exception is the MD&A statement. Although this statement is not audited it does give the management’s opinion on the current results (compared with previous results) and provides a forecast of future operations. Thoughts and opinions can be expressed that should include both positive and negative information. After reading the information you still don’t understand what the company does, or you do not agree with the future direction, then it’s best to avoid.

7) High cash in-flow

High net cash in-flow, consistent cash flows, and predictable cash flows are all attractive features to equities we add to the portfolio. If a company has a “burn rate” (term used to describe a company losing money and how quickly the company’s shareholder equity will be used up) it is automatically excluded on several grounds. A company must have high net cash-in flows to be considered in the model portfolios.

If companies have consistent earnings that are also predictable, we often refer to this as having an annuitized income stream. Royalty rights, contract obligations, licensing, subscription revenue, locked in contracts, membership fees, renting/leasing can all be sources of annuitized cash flow.

8) Competitive advantages

Within Canada, our favourite companies to invest in are those with a competitive advantage. We love companies that have a natural monopoly. Any business or industry that is capital intensive and has a high cost to entry is worth considering. In Canada we have some examples, such as banks, telecommunication, railways, and utilities.

We feel that well established companies that have competitive advantages are generally lower risk and have more predictable cash flows. They are lower risk in the sense that they do not have the immediate threats of new entrants to replace the product or service.

9) Corporate governance

One of the components we review is overall transparency and how that may impact shareholder returns. Transparency begins with the company policies, controls, compensation for executives, and communications to shareholders. We ask ourselves, is management providing clear information on the direction of the company that is understandable?

We always use caution if activities are overly complex and are not transparent. The more complex the accounting policies, the more scrutiny that needs to be put on a company. Are the executives and managements objectives also aligned with shareholder interests? Do we understand the direction the company is taking with any mergers, acquisitions or spinoffs?

10) Complimentary to other holdings

Our model portfolios typically have 30 to 35 holdings when fully invested. When we add or remove a stock from the model portfolio we must assess the impact of diversification and correlation. Typically when a stock is removed from a particular sector, we would replace it with a better holding option within the same sector.

Strategically we may change the weighting of sectors depending on our outlook for the economy and the stock market cycle. When adding stocks to a portfolio it is important to also look at how they are correlated to each other.

It’s important to have a disciplined approach to your criteria by which you pick stocks. If those criteria’s are stuck to consistently we feel that you’ll have fewer losses and more successes.

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250-389-2138. greenardgroup.com

 

 

Inheritance enhances retirement and estate plan

Over the years we have helped new clients and existing clients deal with inheritances. In the majority of cases the inheritances are coming from parents. These can be done upon the parent’s passing away but are also done while they are alive in more and more cases. In other cases we have clients receiving inheritances from uncles/aunts, siblings, friends, and other individuals.

The greater the inheritance the more critical it is to get some professional advice. One positive part of receiving an inheritance in Canada is the money is not taxed. Following are some topics we would discuss when a client receives an inheritance.

Paying off debt

We like the idea of paying off debt, especially personal mortgages, credit cards, and lines of credit that are not tax deductible.

To begin with, we obtain a summary of all loans, current rates, and repayment penalties, if any.

If only some debt is repaid, then the highest non-deductible interest rate debt should be paid off first. If fees or penalties apply, it is important to obtain an understanding of these and your wealth adviser should be able to map out the best options.

If you still would like to invest some, or all, of your cash then you’re best to take a new loan out for the specific purpose of investing.

The interest expense incurred from the money borrowed is generally tax deductible if the purpose of the use of the borrowed funds is to earn income in non-registered accounts.

Increased income

One of the results of receiving an inheritance is that your annual taxable income is likely to increase. If you purchase GICs and bonds, you will have to factor in the interest income received. If you purchase equities, you will have tax efficient dividend income to report and some deferral options.

We provide an estimate of what the income will be once the investments are selected and calculate an estimated income tax liability if the funds are invested in a non-registered account.

Type of non-registered account

If you feel a non-registered account is your best option you should determine the type of account.

If you are single the choice is easy; an individual account. If you are married or in a common-law relationship, you may consider to open an individual account and keep the funds only in your name. Alternatively, you may open a joint-with-right-of-survivorship (JTWROS) account with your spouse or common-law partner.

The person who received the inheritance would be primary on the account. If a non-registered account is already opened then we have a discussion regarding the risk of commingling funds in the event of a marriage breakdown.

This discussion has many other components to talk about including tax, income splitting, and estate wishes. Consulting a family law attorney may be required in cases of marital breakdowns.

Topping up RRSPs

One way to defer some of the above income is to deposit funds into a tax sheltered Registered Retirement Savings Plan, if contribution room exists.

The greater your income, the better this option is. If your income is at or below the lowest tax bracket then there may be other options you would want to consider.

The determining factor is your future income expectations. As an example: John received $250,000 as an inheritance. He is using $150,000 to pay off all debt and would like to invest the remaining $100,000. John has accumulated a $140,000 RRSP deduction limit, as he has never contributed the maximum each year. John plans to work for the next five years and earns approximately $80,000 in T4 income.

One option we may suggest to John is to contribute the $100,000 into his RRSP and claim $20,000 a year as a deduction over the next five years assuming that there is no extra cash flow for additional contributions. One of the main benefits of putting funds in the RRSP (and not claiming the full deduction right away) is that all income is tax sheltered.

Tax Free Savings Account

Any income earned within the TFSA is tax free, if you have never set up a TFSA, the cumulated TFSA contribution limit for 2019 is $63,500. It may be worthwhile to understand the advantage of this type of account and top up to the maximum limit. Starting in 2019, the annual limit is $6,000, indexed to inflation thereafter.

If you have both non-registered account and TFSA, then we would recommend you to transfer your assets (up to the maximum limit) from the non-registered account into the TFSA, to take advantage of the tax-free feature.

Skipping a generation

Sometimes the people receiving the inheritance do not need the funds themselves. In these situations we often map out a strategy that will skip to the next generation. Sometimes this will help younger generations pay off mortgages, purchase a home, or build up retirement savings

Structure of accounts

Many Canadians only have RRSP or TFSA accounts. Often when significant funds are received (inheritance, sell of a business, life insurance proceeds), people open their first non-registered account.

One thing that we see is people buying GICs and bonds where the interest income is fully taxable in a non-registered account while leaving the equity investments which have tax-efficient dividend income within their RRSP. When this happens, the structure of investments is backwards.

There are many benefits of consolidating investments at one institution, including lower fees and more account options. It is beneficial to deposit the inheritance cash into a non-registered account at the same institution as the RRSP. If this is done then the structure can be corrected.

We are able to do a series of trades that will correct the overall structure will ensure that interest income on fixed income is tax sheltered within the RRSP. By holding Canadian equities in the non-registered account, you will receive the benefit of the dividend tax credit, and taxation of capital gains and losses.

Updated documents

Obtain the appropriate forms to update your investment accounts, Powers of Attorney, beneficiaries and ownership. We always encourage people to update their Will and other legal documents (if necessary).

Kevin Greenard CPA CA FMA CFP CIM is a Portfolio Manager and Director, Wealth Management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week in the Times Colonist. Call 250-389-2138.