The Government Did Something Right?

With the recent market upturn, I imagine many people are thinking that "life is returning to normal". I for one, do not aspire to that notion - in fact many people believe that what we are seeing in the markets lately is the "new normal".

How are people reacting to the market ups and downs? A recent survey found most people are still contributing to their RRSP's and only 8% were planning on saving less. This may change slightly as 2009 brings about the introduction of the Tax Free Savings Account (TFSA). This new product, which you have undoubtedly started to hear about, will alter the way we "save" for our futures. Please note that while this product will benefit most people, the way it should be implemented with vary from person to person, and family to family. Since everyone's situation is different, we will need to consider all the facts before designing a plan.

Jonathan Chevreau described in his National Post column that the TFSA would shake up the investment industry. Ellen Roseman writes in her Toronto Star column that the TFSA will really complement the RRSP. Tim Cestnick made a "comparison" of the benefits in his Globe and Mail column.

So what should you do? Over the next two months I plan to present the product in greater detail and explain how it will benefit people in different ways. Here's a quick example:

A young couple (mid 20's) with one child, who are saving for their first home versus an older "empty nester" couple (mid 50's) with high incomes.

• The younger couple need an emergency fund, and an account to save money for big ticket purchases. They can also use the account as collateral for borrowing. This could be invested in a high interest savings account.
• The older couple need a way to save outside of their RRSP's without incurring added taxes. The TFSA offers additional tax sheltered contribution room. They could invest up to $500o each per year (the contribution limit will grow over time), and TFSA's are not subject to "attribution" rules where one spouse earns most or all of the income. They could invest in a range of non-registered mutual funds, trading as often as they wish, and not subject to capital gains taxes, or having to claim dividend or interest income.

Here are a list of the top 10 things to know about the TFSA.

1. The Tax-Free Savings Account lets you invest while not being taxed on interest or investment earnings.
   
2. You can contribute a maximum of $5000 a year. A couple can each contribute $5,000. If you contribute $5,000 each year for 5 years you’d have more than $25,000 earning interest Tax-Free!
   
3. You can have more than one Tax-Free Savings Account and you can also have Tax-Free Savings Accounts with more than one financial institution. Like RRSP’s you will need to keep track of how much you’ve contributed so you don’t exceed your limit.
   
4. Unlike an RSP, you don’t have to pay any tax on money you take out of your Tax-Free Savings Account, and withdrawals from your Tax-Free Savings Account don’t affect your ability to qualify for Federal benefits like the Child Tax Benefit, Guaranteed Income Supplement, Old Age Security benefits, Age credit, or Goods and Services Tax credit – so you’re not penalized for saving.
   
5. You’ll be able to open savings accounts, GIC’s and mutual funds tax-free.
   
6. Unlike an RRSP, money you put into your Tax-Free Savings Account will not be deducted from your income on your tax return.
   
7. Just like an RRSP, when you file your tax return each year, the government will determine your remaining available Tax-Free Savings Account contribution limit for the coming year.
   
8. If you take money out of your Tax-Free Savings Account, you don’t lose the contribution room. You get it back in the following year. If you don’t make the maximum contribution you don’t lose the contribution room. The unused contribution room gets carried over to the following year. There is no limit to how much or how long contribution room can be carried forward.
   
9. You can open a Tax-Free Savings Account if you are 18 years of age and a Canadian resident.
   
10. The Tax-Free Savings Account comes to Canada January 1, 2009, but we can arrange the paperwork now.

What Floor Would You Like?

Have you ever got onto an elevator where they have someone who sits on a little stool and presses the buttons for you? While I question the wisdom of paying someone to simply push some buttons from a financial perspective, with the recent ups and downs in the markets of late I sometimes want to ask them to take me to another building.

Nouriel Roubini is an economist who actually predicted much of what we are going through back in 2006 (I wish I had seen this back then). In an interview on Bloomberg today, Roubini expects US markets to remain flat or drop further through the end of 2009. He believes there is still some downside risk in the markets as earnings for non-financial companies drop and as companies default. He made an interesting comment that "Americans can no longer use their home as an ATM". He expects the recession to end by the end of 2009 assuming the financial system issues get fixed.

Today's US Federal rate question is no longer an "if they drop rates" but by how much. Experts are split between a 50 and 75 basis point drop but it seems safe to expect a 50 basis point drop to leave room for future decreases. Along this point, expect a sideways shift in US markets today until the Fed rate decision release this afternoon.

On the home front, members of defined benefit pension plans may need to wonder how this affects them. A defined benefit plan (as opposed to the more common defined contribution plan), needs to have sufficient assets on hand to pay pensions current and future. If they do not have enough money (deficit), then they are required to increase funding. With recent market declines, a Globe and Mail article explains how forcing them to make up deficits could in theory bankrupt the companies. They are currently appealing to the government to relax rules due to extraordinary circumstances.

Lastly, Fidelity Investments provided an interesting history of the Toronto Stock Exchange. Going back to 1970 and up to September 2008, what would you think the value of a $100 investment would be? Would you believe $38,500? In that time, we have experienced six bull markets with an average return of 174% over 58 months and six bear markets (we're in number seven right now) that returned -31% over 10 months.

The 38 year history is of interest as it clearly defines a normal "working career" in length and explains the importance of not only early investing but consistent investing. Picture someone born in the year 1952, graduated from high school in 1969 and receiving a "gift" of $1,000 from a wealthy relative. Properly invested, with no further contributions, it would grow to $385,000 and produce approximately $2,000 in retirement income.
This is in spite of recent market declines.

One last thing - with Halloween coming in a couple days, I thought you might appreciate the humour in this...

Spooky Things Are Happening...

Have you ever watched a "scary" movie - you reach the last minutes of the movie and the hero/heroine have survived only to discover that Freddy or Jason isn't really dead. Are we coming to something like that in Canadian real estate market?

For the past several years, I have been stating that I fully expect the Canadian housing market to go into a deep slide. How much remains to be seen, but a drop of between 10% and 30% would not be out of the question. With the real estate markets in the US already teetering on the brink, we are now seeing signs of what is to come in Canada.

When governments decrease lending rates to battle the "axis of evil" (thanks GDub), ultimately they will need to eventually raise them to combat inflation. For those who have never done a mortgage for over 8% interest rate, heed this warning - currently people in variable rate mortgages could be paying as low as 3%. What would you do if the rates went up to 8%?

On a mortgage of $300,000 (not an unusual amount in the GTA), your bi-weekly payments would go from roughly $650 to $1050. Think it couldn't happen - obviously no one can be certain, but we are in uncharted territory and we have seen rates that high in the past 15 years so why not now?

A recent Globe and Mail article highlights the similarities between the Canadian and US housing markets. Any further recessionary pressures will eventually lead to a decline in housing prices especially in locations that have seen rapid price increases (Alberta). Luckily, Canadians have to actually qualify for mortgages as opposed to the US which eventually led to the sub prime collapse. Yet we are already seeing trends emerge - no more 100% financing and dramatic changes to variable rate mortgages. Refinancing becomes more difficult as bank funds dry up; imagine how much equity you can borrow once you reach that wonderful point that 20% of US homes are at - negative equity (meaning they owe more than the value of their home). Recent blips in US housing markets should not be interpreted as meaning all is well in the world - Barrie McKenna believes that all is not well and may not return to normal for two more years.

What should you do? When clients ask this, I always use the same refrain - Upgrade in a down market and downgrade in an update market. If we go into a decline of 20%, then the more expensive home becomes "relatively cheaper". If you're a first time buyer, then when markets drop will represent a tremendous buying opportunity. The only question then becomes when will they hit the bottom. One last point to all the people out there who watch television shows that deal with buying 10 homes and renting them out - a client of mine purchased an investment property to supplement his retirement income. Five years later he sold the property. He said something that has stuck with me to this day;

The only people I was able to rent to were people I didn't want to rent to.

Step Right Up and Ride The Market Coaster

Sometimes the nicest things happen when you least expect them. The first bit of news is a link to a fantastic chart from Invesco Trimark that shows a historical perspective on why reacting now is the worst thing to do.

Every morning I receive emails from several different media outlets with links to financial related issues. Monday morning's Advisor.CA link delighted me to no end. Essentially an interview with three different senior management at three investment firms, it reallt reflects the views of many people within the investment field. Here is the link to the article, but I pulled out the main points below.

The article deals with the issue of "capitulation" - that point when investors quit being investors.

"While we've had markets in pretty steady decline, volumes don't really suggest capitulation yet," says Norman Raschkowan, chief investment officer at Mackenzie Financial. "In meetings with investors and advisors, the sense I have is that people are maintaining focus on their longer term financial goals and their personal plans.
"I don't sense a degree of panic from the average investor that you might associate with these kind of movements in the markets."

"There are a number of investors out there and most of them are not informed," says Curwood. "They get panicked by headlines in the paper, so some people run for the exit. As people sell out, that's the point you talk about market capitulation, when retail investors throw their hands up and say I want out at any cost."

Jeffery Shaul, president and CEO of Robson Capital Management, says market capitulation tends to happen all at once. There's usually a large decline that occurs throughout the day, but he says we haven't seen that yet. And, that might not be a good thing.
"What often happens to mark the bottom is an oversold market where you get all these sellers going out at once and capitulating," he explains. "But this kind of steady decline means people are holding on, which suggests we're not at a bottom."
Shaul expects more problems to crop up in the American economy before the markets turn around. He's worried about rising credit card default levels in the U.S., and when major corporations are forced to re-evaluate their pension assets. "You're going to find significant deficiencies in funding, he says. "Then you're going to continue to see worsening in the real estate market and significant layoffs," he adds.

"There's definitely a bad psychology out there right now," says Bruce Curwood, director of research and strategy at Russell Investments Canada. Curwood is slightly more optimistic. He says markets always come back, and with government intervention, it's likely things will turn around; he's just not sure when that will happen.
But it's a good sign that Warren Buffett is still planting money into the market, he says, because if he's doing it then things can't be that dismal. "He's one of the best investors in the world and he's trying to take this as an opportunity to invest."

It's a strategy others should follow. Curwood explains that if your clients are already invested in the market, they are already down, so why sell? "It's not the time to make a major decision or do anything dramatic," he cautions. "Markets are moving; there are huge swings over the course of the day. Just hunker down, put the money in a strategy you can tolerate for a long time. Don't sell out after going down 35%."

(Note - not everone is down 35%. This depends on the asset mix you hold).

Curwood points out that there are still a lot of companies with great value, even in the financial sector. He explains that when things get bad they get tarred with same brush, which means entire sectors are down whether they should be or not.

For the average investor, dipping a toe back into the market is still a frightening proposition. Raschkowan says clients may be waiting on the sidelines until they can get a better grip on what is happening.
"I think it will be mild in North America, but I think we will go through a recession," says Raschkowan. "People will now be waiting to se how companies have fared as they've had to work through this period of capital market disruption and slowing growth."

So should the market fear market capitulation or not? For the savvy client, it can't come soon enough. "Some of the best opportunities in the marketplace occur when the retail investor is running and taking all their money out of equities," says Curwood. "But, on the flip side, when retail investors are throwing their money at the market, it's time to get out."