Keep a close eye on your holdings

Recently we had Adam and Betty Gray walk in for a second opinion on their investments.  They brought in their investment statements, comprised of nine accounts with three different financial institutions.  Two of the accounts they had were called managed accounts.  The first managed account statement held Canadian equities and was 10 pages long with over 80 companies, while second statement had another 60 foreign companies.   All of the positions were extremely small.

When we summarized all of the Grays’ holdings we noted that they held over 200 equity holdings.  In some cases we noted that some of the 200 companies were held in different investment accounts.

The Grays had never recorded all accounts in one summary before and were surprised to see the number of companies and the level of duplication.  Certainly, they had felt that they had lost the ability to control what was going on and to react to the rapidly changing economic conditions.

We also asked to see trading summaries and tax returns for the last three years to see how the Grays had recorded realized capital gains (losses).

Here are the comments we had for the Grays:

Average Cost

Canadians must use what is referred to as “average cost” when calculating the adjusted cost base of an investment.  Years ago, the Garys purchased from Institution A, 100 shares of TD Bank at $25 pershare (total cost = $2,500).

Several years later another 100 shares were purchased at Institution B at $45 per share (total cost = $4,500).  More recently, 28 shares were purchased within the Canadian managed account with an adjusted cost base per share of $61 per share (total cost = $1,708).   The adjusted cost base at each institution would not be correct, as they are not factoring in the shares owned elsewhere.  The average cost for tax purposes is equal to $38.19 per share.   The Grays had incorrectly reported some dispositions in prior years by not factoring in average cost.

Superficial Loss Rules

One of the challenges with managed accounts is having the same holdings at different institutions, increasing the likelihood of violating the superficial loss rules.  The superficial loss rules essentially deny a loss if the same position sold at a loss is reacquired within 30 days.  We noted a few situations where Canada Revenue Agency would have denied a loss they had reported.  Luckily they have never been audited.

Diversification

Diversification tends to be a popular word in finance.  The Grays were over-diversified in the number of institutions and individual holdings.  One of the recommendations we had was to consolidate their investments.  We recommended they transfer all accounts in-kind accept for the two managed accounts.  We had estimated the tax consequence of an in cash transfer for the managed accounts and the net result was a net capital loss.   One of the goals we set was to eliminate the duplication so that fewer trades would be required and tax reporting would be easier.

Position Size

In total the Grays had $500,000 in total investments, 60 per cent (or $300,000) of which was invested in equities.   We explained to the Grays that a portfolio with 30 companies ($10,000 initial investment in each company) would provide an appropriate level of diversification.  The Grays had 200 companies, some with as little as $740 and as much as $32,000.  The $740 position size is too small to really benefit from price appreciation.  The $32,000 position size is becoming excessive and is adding unnecessary portfolio risk with little potential for additional return.  By transferring the managed accounts in cash, the accounts will be moving towards the goal of 30 quality companies.

Passive Approach

The Grays had essentially taken a hands-off approach when they opened managed accounts.  They were paying a fee of two per cent to have their portfolio managed.  They understood that the portfolio manager was external to the investment advisor they generally spoke with.  They also understood that the portfolio manager had the discretion to make changes within their accounts.  After the last couple of years, the Grays wanted to do three things:  reduce the cost of managing their portfolio, become more active with their investments, and better monitor their investments.

Reducing Costs

A fee-based account at one per cent was a low cost option for the Grays.  They would effectively be reducing estimated costs from $10,000 currently to the proposed $5,000, representing a $5,000 annual savings.

Active Approach

Most portfolios should have a mixture of longer term hold investments and some trading positions.  We mapped out a strategy for both buying and selling.  We outlined how market and limit orders can be used for both buying and selling.  They also felt that stop loss orders were prudent in some cases to protect profits and limit losses.

Monitoring

Even if you have an investment advisor who is providing you with recommendations, it is important to monitor what is going on.  It became nearly impossible for the Grays to monitor their 200 investments.  By consolidating and reducing the number of holdings, the Grays will be in a better position to monitor their finances.