I talk to a lot of people who have been working for a while and its become evident that many people don’t have an investment portfolio or have even heard of any investments aside from their bank savings account. It’s not that these individuals are not saving for their future, but trying to reach financial independence by saving and collecting interest from the bank will be a never end endeavor.
The goal of financial independence isn’t about retirement, but it’s really about having your savings or assets make enough passive income to afford all of life’s necessities. At that point, whether you work is really up to you, but you will definitely have more freedom to choose what you want to do. This is where a bank savings account fails.
Even if you are moving your money around from EQ Bank to Tangerine and then Zag Bank to capture a higher promotional interest rate the difference from 1% to 2.5% is negligible. Perhaps the work and effort spent doing that is better off used to learn about investments and how to build a balanced investment portfolio.
Taxes, Taxes and More Taxes!
Why do I advocate investing in equities over the safety of the bank? Simple. It’s the one word we hate and it’s called taxes. Interest income from savings accounts and GICs are probably the worst forms of income that one can receive passively. That’s because interest income is taxed fully at the marginal rate.
For interest income it’s quite simple. Every dollar you earn adds onto your regular income. Depending on which tax bracket you fall into you will get taxed at that rate. Income generated through dividends from investments, on the other hand, are taxed much more favourably. The reason for that is that the companies that provide a dividend have already been taxed before distributing the dividend, so the Canadian Government decides to give you a tax credit for being a recipient of money from corporations. Yes, corporations do give you money, but that’s only if you invest in them. Why the heck did the 99% not tell you that you can receive money from corporations? I know why. It’s because the 99% don’t invest their money!
The amazing thing about dividends is that it’s actually possible to get a tax rebate back on other income earned if you are making less than $45,282. Isn’t that crazy? So if you’re not in the higher tax brackets, you can actually get a tax refund by receiving money from corporations. Now you’ve become Dr. Evil times two!
Let’s take a simple example:
If you make 2% interest on a $10,000 GIC for the year and you have an annual income of $50,000 then the tax you end up paying on the $200 is going to be $29.65. That’s 30% of interest income gone. Poof!
If you make 2% dividend income on a $10,000 investment, the tax payable is only $6.39 if you make $50,000 a year. Now isn’t that a compelling enough reason to invest your money rather than buy a GIC? I know what I would do.
There is a reason why those that save and earn passive money through investments pay less taxes. That’s because the government has lower taxation rates for investments versus earned income or interest income. They know the masses are risk averse so they reward those that are not. It’s not about being rich or poor, but about whether you are willing to take risks to earn income.
Where Are You Getting 2%?
Everyone always comes to me to ask “how are you getting a guaranteed 7% return?”. The answer to this question is “there are no guarantees”. But the least I can do is guarantee my 2% dividend income. That’s actually quite simple to do.
Popular ETFs that track the indexes in Canada all have a very healthy dividend. Both the Vanguard Canada All Cap (VCN) and the BMO S&P TSX (ZCN) index ETFs offer low-cost solutions to investing in the Canadian index and carry a 2.5% and 3.0% dividend yield respectively.
Canadian companies have always earned a reputation for stability in their dividends because of our strict regulations and sustainable growth. Despite the volatility in the stock market, corporations have continued to honour their dividends even in bad years including the crash in 2008.
The only thing you need to remember is that the government is only on your side if you invest in Canadian companies. That means dividends are only taxed more favourably if you receive them from Canadian companies. That’s not to say that you don’t get better treatment for US companies, but the reward is not as great. Though in a real sense, owning US companies is generally a really, really good idea as well. So don’t pigeon-hole yourself to Canadian equities only.
Where Do I Start?
The first hurdle to even starting to invest is saving. When I’m talking about saving I”m not talking about saving for the next iPhone, or for your next pair of shoes. It’s about saving to become financially independent. Remember that the goal is for our investments to pay for our lifestyles so that we can choose to do what we want and work where want to work.
The second hurdle to overcome is fear. We fear what we don’t know and that prevents us from doing it. Everyone fears investing in the stock market because they fear losing money. In reality though, over a period of ten years, a balanced investment portfolio has never lost money. It would be hard pressed to find any 10 year period in history where the stock market had a negative return and for those that did the loss was insignificant.
Only when we’re actually ready to start investing do we start to procrastinate some more. Excuses like “I got a party” or “I’m busy with work” always seems to jump out our of mouths. Honestly, getting started only takes maybe an hour of time. If you can sit down and watch an episode of Game of Thrones, you can probably get your brokerage account open in that time. So what are you life priorities?
For first time investors, there are many ways to test out the waters without being fully committed. For example, take a small amount at first like say $5000 and invest for 6 months. Experience how the market fluctuates, understand how dividends work, talk to financial advisors to learn more about your risk appetite and more importantly keep reading my blog!
Once you become more comfortable rebalance your portfolio by adding more funds. See how that affects the performance of your portfolio. After a year of getting your feet wet, only then will you have more questions to ask, and perhaps more insight on how comfortable you are investing in equities. Best of all you’ll have received dividend income that will far exceed what you would have made with a GIC. Even if the markets are down, you would still have received dividend income.
There are many great resources online for sample investment portfolios, my favourite are the Couch Potato portfolios, you can also use one of the many robo-advisers like Wealthsimple or WealthBar. I’m also an advocate of just trying out mutual funds to start off too at the beginning. Despite the high management fees, the small amount that one usually starts with will have negligible effects at the beginning. Only when you are comfortable with the notion of investing, then you can start looking at low-cost solutions.
If you want to do the Do It Yourself solution, try signing up at Questrade or go to your local bank branch and ask them to set up a brokerage account. Just have two pieces of ID and you’ll have everything done in less than an hour. Seriously it’s that simple. Stop binge watching Stranger Things and get out the door already!