In Search of the Holy Grail
A couple of years ago, a client asked, “Is there such a thing such as a “No-Risk” Investment?”. That question can be likened to the search for the Holy Grail. A definition for the Holy Grail, according to Wikipedia, (a source of information that most people use and all academics disparage), is “any elusive object or goal of great significance.”
2022 has been a year of decline and some recovery for those of us invested in the equity markets. For those of us who had money earmarked for a specific purpose, we would be either greatly disappointed or we put off our decision to turn the investment into cash. I know several people who delayed renovations and vacations because they did not want to trigger a loss on their investments. There are risks within the equity markets just as there are significant opportunities. Welcome to the Stock and Bond Markets! For those people who do not like the ups and downs of the equity markets and want certainty, luckily there exist Guaranteed Investment Certificates (GIC’s), Money Market Funds and other interest-bearing investments.
Investments that have guarantees attached to them are not truly risk-free. For example, a local bank has advertised their GIC’s with a terrific, compounded rate of return of 3.50 % for 5 years. That sounds wonderful, but what is the “Real Rate of Return” on this investment once inflation and taxation are factored in? Presently, inflation is running at approximately 6.9% so it is not hard to see that your buying power will be less in the future than it is today. On top of that, income tax must be paid on your non-registered GIC investment. The net result of this type of investment shows that by locking in for 5 years, you are not as far ahead as you may think.
So, what is a person to do? In Canada, we have access to 2 investment vehicles that can reduce the tax risk. If you are still young and are investing for retirement, a Registered Retirement Savings Plan will defer your taxes to when you redeem cash for retirement. The other option, called a Tax-Free Savings Account or TFSA, eliminates the tax-risk totally.
When trying to determine what is the best investment, the answer is usually not one or the other. It is usually a variety of investments so that all manners of risk are spread sensibly. Three thousand years ago, King Solomon, attributed to be the wisest and most wealthy man in the civilized world ever wrote: “Give portions to seven, yes to eight, for you do not know what disaster may come upon the land.” (Ecclesiastes 11:2)
In conclusion, work with a competent financial advisor, especially as your wealth grows. Because one’s money is so emotionally linked to us, a good advisor helps drain the emotion from your buying and selling decisions, while being able to supply some guidance on taxation.
- The advertised rate of return on a GIC is not what you really earn. Get your advisor to calculate the “Real Rate of Return” factoring Inflation and taxes into the equation. A good advisor should be able to figure it out on a financial calculator at their desk.
- If you want to figure it out yourself, here is a good starting place: https://www.investopedia.com/terms/a/after-tax-real-rate-of-return.asp#:~:text=To%20calculate%20the%20real%20rate,a%20dollar%20in%20hand%20tomorrow.
- For most investments, especially mutual funds, you never lose until you sell!
- Next week’s blog will focus on income from investment funds. Have a great week!