In this Episode, James Parkyn & François Doyon La Rochelle revisit the basics of the recently launched Tax-Free First Home Savings Account (FHSA) and give their listeners some planning ideas.
They also perpetuate their annual tradition and review of the 15th edition of The Credit Suisse Global Investment Returns Yearbook 2023, Summary Edition.
Links to share:
– Episode 51: Update on Active Vs. Passive & Global Banking Solvency — Capital Topics by James Parkyn & François Doyon La Rochelle
– Episode 45: Bond Investing A New Landscape — Capital Topics by James Parkyn & François Doyon La Rochelle
– Episode 38: Review of the Credit Suisse 2022 Global Investment Returns Yearbook — Capital Topics by James Parkyn & François Doyon La Rochelle
– First Home Savings Account (FHSA) – Canada.ca by Government of Canada
– Global Investment Returns Yearbook 2023 – Credit Suisse (credit-suisse.com) by Credit Suisse
– Triumph of the Optimists: 101 Years of Global Investment Returns: Dimson, Elroy, Marsh, Paul, Staunton, Mike: 8601416069784: Books – Amazon.ca by Elroy Dimson, Paul Marsh & Mike Staunton
Read The Script:
François Doyon La Rochelle:
You’re listening to Capital Topics, episode #52!
This is a monthly podcast about passive asset management and financial and tax planning ideas for the long-term investor.
Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.
In this episode, we will discuss the following points:
For our first topic, we will review and comment on the recently launched Tax-Free First Home Savings Account (FHSA)
And next, for our main topic, we will Review the Credit Suisse Global Investment Returns Yearbook 2023
- In the news: The New FHSA
François Doyon La Rochelle: In our first topic today, we will review and comment on the recently launched Tax-Free First Home Savings Account (FHSA). This is a topic that we covered in episode #45 of this podcast back in October 2022 but since then, as of April 1st, the legislation governing these types of accounts has taken effect, so we thought it was a good time to revisit the basics and give you some planning ideas.
James Parkyn: Yes, for many of our clients and our listeners, this is a hot topic that deserves our attention since it’s probably the most significant tax break ever offered to help Canadians save money tax-free for the purchase of their first home.
François Doyon La Rochelle: I totally agree, so let’s start and remind our listeners of the basics of how an FHSA works. The first question to ask is, who can open a First Home Savings Account? So, to be able to open an FHSA, you must be a tax resident of Canada aged between 18 and 71. Furthermore, you or your partner cannot have owned a home in the current calendar year or any of the previous 4 calendar years.
James Parkyn: One interesting nuance here to highlight is, although you can only participate once in the program, if you are now renting, but you were a homeowner let’s say 6 years ago, you could still qualify as a first-time homeowner and open an account.
François Doyon La Rochelle: Correct, once you have opened your account, you can contribute up to $8,000 per year to a lifetime maximum of $40,000. If you don’t contribute the full $8,000 in a given year you can carry forward the unused portions of your contribution room up to a maximum of $8,000. This means that if you contribute less than $8,000 in one year, you can contribute your unused amount in a future year. For example, if you open an FHSA in 2023 and you only contribute $4,000, in 2024 you would be allowed to contribute $12,000. That is the $8,000 for 2024 and the $4,000 for your unused contribution room for 2023. Also, like with the RRSP, your contributions are tax-deductible, meaning that any amount you put in will be deducted from your taxable income, therefore reducing your income tax.
James Parkyn: An interesting planning strategy here, especially for younger folks that are just starting their careers and that may not be earning a lot of money, is that you don’t have to claim a deduction in the tax year you have made your contribution. Your contributed amount can be carried forward and deducted in a later year when your income will be higher. This way you can get a bigger tax deduction for your contribution. For parents wanting to help their adult kids buy their first home, since attribution rules don’t apply, they can give money to their kids for their contributions.
François Doyon La Rochelle: Also, contributions to a FHSA doesn’t have any impact on your regular RRSP contribution room so, if someone is fortunate enough and has the funds available, he could contribute to both type of accounts and use the tax refund to contribute to their regular TFSA. There is an important caveat however, once you open your FHSA, it can only remain open for up to 15 years or up to the end of the year when the account holder turns 71. At that point, if the funds have not been used to buy a first home, it can be transferred on a tax-free basis to an RRSP or RRIF or it can be withdrawn.
James Parkyn: We would not recommend withdrawing the funds as the amount withdrawn would be added to your income and taxed. This said, since the transfer to an RRSP would not impact, nor would it be limited to someone’s RRSP contribution room there is another planning idea here for renters. Lifetime renters that don’t intend to ever buy a house and that have maximized their RRSPs could open an FHSA and maximize their contributions to it. This way, since the funds accumulated in an FHSA can be rolled over tax-free to a regular RRSP the renters would effectively be generating an extra $40,000 of RRSP contribution room.
François Doyon La Rochelle: Yes, this is effectively one of the loopholes of this new program. Even then, if you are unsure whether you will be buying a house in the future, there is not much downside in opening an account and making the contributions because in the end if you don’t buy a house, you can rollover the funds accumulated tax-free to your RRSP or RRIF. So, if you don’t have the funds to make contributions to both the FHSA and the RRSP it would make sense to put money in the FHSA first. Talking about RRSPs, if you were planning to use the funds accumulated in your RRSP to buy your house with the Home Buyers Plan (HBP) you will be happy to hear that you will now be able to use the funds from both types of accounts to purchase your home. As a reminder, at first, when the legislation was introduced, you could not combine both plans.
James Parkyn: This is huge since prospective first-time home buyers could add another $35,000 in down payment.
François Doyon La Rochelle: Yes, this is very interesting, however unlike with the FHSA, the amount withdrawn from your RRSP with the HBP must be repaid within 15 years, starting the second year after the year of the first withdrawal. So, the HBP is essentially only a way to borrow money from your RRSP.
James Parkyn: Correct, in any case, I would recommend anyone to open a FHSA as early as possible to benefit from tax-free compound growth. If you open your account early and you make the maximum contribution each year, you can invest your funds more aggressively since the account can remain open for up to 15 years before you need to cash it out to buy a home or roll it over to your RRSP or RRIF. If you wait too long before opening and contributing to the account, you are giving up on growth since you will need to invest your funds more conservatively.
François Doyon La Rochelle: Yes, investing the maximum early, that is $8,000 per year for the first five years for a total of $40,000 at a 6% annual growth rate could result in approximately $85,000 in 15 years. If you combine this amount with the HBP of $35,000 that’s a total of $120,000 in down payment. If you have a partner that has been as diligent as you that’s $240,000 that could be available for a down payment.
James Parkyn: Yes, and again whatever your investment goals, the key is to let the magic of compounding work for you.
The sooner you start the better you will end up in the long term.
François Doyon La Rochelle: James, many Early Savers ask themselves when they are starting what should I prioritize? The TFSA, the FHSA, or the RRSP, and for those starting a family we can add the RESP. What do you recommend for Early Savers who have competing needs for their savings and can’t contribute to all of them?
James Parkyn: Great question Francois. The answer to me is likely to do your TFSA first because it has the most flexibility in that there are no tax consequences on funds withdrawn and you can put the amount taken out back in but you have to wait the following tax year. There is going to be a lot of FHSA promotion about the tax deductibility but if for any reason you would need to withdraw the funds it will be fully taxable, and you will not have the option to put the funds back in. So, there is no one size fits all answer. If you are sure of buying a home and have sufficient income to claim the deduction, then the FHSA will be a great option. You could even consider withdrawing from your TFSA and contributing to your FHSA and then using the tax savings to put money back in your TFSA.
François Doyon La Rochelle: Finally, for the moment there is only a handful of financial institutions that are presently offering these types of accounts. When I verified, Questrade, the Royal Bank, and the National Bank were the only ones offering it, but you can be sure that other institutions will follow suit in the coming months.
James Parkyn: Lastly, if you are currently in the process of buying a house since there is no holding period before you can withdraw funds from your FHSA to buy a house, you could technically open an account and make the maximum contribution for the year to get a tax refund and then withdraw the money the following day if needed.
François Doyon La Rochelle: Yes, that’s a good point James, thank you!
- Main Topic: Review of The Credit Suisse Global Investment Returns Yearbook 2023 – Summary Edition:
François Doyon La Rochelle: Our Main Topic today is a Review of the 15th edition of The Credit Suisse Global Investment Returns Yearbook 2023 Summary Edition. Our regular Listeners will know we make this an annual tradition. Last year, we put a lot of effort into preparing our Podcast #38 in which we reviewed the 2022 edition of the Credit Suisse Global Investment Returns Yearbook, and we recommend our Listeners to go back and listen to it as the content (The impact of High Inflation on Stocks and Bonds and Update on the benefit of International Diversification) is still very relevant to what is happening in financial markets now. That being said, James, could you give our Listeners an Intro about the Yearbook and explain its purpose?
James Parkyn: Absolutely, I will quote directly from the Introduction: “The Credit Suisse Global Investment Returns Yearbook documents long-run asset returns over more than a century since 1900. A key purpose of the Yearbook is to help investors understand today’s markets through the lens of financial history.” The Yearbook details the returns and risks from investing in equities, bonds, cash, currencies, and factors in 35 countries and five different composite indexes. The Global Investment Returns Yearbook is produced in collaboration with renowned financial historians from the London Business School Professors Elroy Dimson, Paul Marsh, and Mike Staunton who produce the DMS Database. They are also the co-authors of the book “The Triumph of the Optimists” published in 2003.
François Doyon La Rochelle: Reviewing the Yearbook is an annual must-read for us. I would add that it is also a core part of our Podcast mission to share with our Listeners relevant evidence-based research. OK so now James, I’m going to start today’s review by asking you the same two questions as last year. First, why do you as a Portfolio Manager find the Yearbook useful?
James Parkyn: Francois, our discipline, as our regular Listeners know well is to invest with “The Investor Mindset, focused on the long term”. We don’t want to be led astray by short-term noise in the financial media and recent financial market volatility. This challenge is daunting and applies to all Investors including us Professionals. We have said it often on our Podcast: “It is simple to say but not easy to do: We must always be cognizant that we can fall into a trap of trying to “Forecast the Future”. This is why the Yearbook is so useful to us as portfolio managers. The Yearbook helps put current financial market events into context and compare them to long-term capital market history.
François Doyon La Rochelle: I agree, after all the major economic and geopolitical events of last year, it is crucial to take time out and look at financial market history to appreciate the importance of risk management.
James Parkyn: The 2023 Yearbook, like the ones before it, addresses this topic of why a long-term perspective is needed to understand risk and return in stocks and bonds. The events of 2022 should have reminded investors to fear complacency. Larry Swedroe said it well in his article “Lessons from the Markets in 2022. His Lesson #1 for 2022 was: “Just because something hasn’t happened doesn’t mean it can’t or won’t.”
François Doyon La Rochelle: Now for my second question to you James: what are the highlights of this year’s Report?
James Parkyn: I will share my Five Highlights of this year’s Yearbook.
My first highlight is they make the case for the importance of a long-term perspective and with it an appreciation of the laws of risk and return in stocks and bonds. This starts with explaining how even 20 years of data is too short a period to help make asset allocation decisions.
I quote from the Yearbook: “The volatility of markets means that even over long periods, we can still experience “unusual” returns. Consider, for example, an investor at the start of 2000 who looked back at the 10.5% real annualized return on global equities over the previous 20 years and regarded this as “long-run” history, and hence guiding the future. But, over the next decade, our investor would have earned a negative real return on world stocks of −0.6% per annum.”
François Doyon La Rochelle: This is very true and that’s why it’s so important to be careful about “Recency Bias”. The Yearbook also talks about having a long-term perspective on Bonds. What does it say, James?
James Parkyn: I remind our Listeners that for most Investors Recent bias is based on what happened in the last year. The Yearbook makes the case for a much longer time frame. So, to answer your question about Bonds I share another quote from the yearbook: “Long periods of history are also needed to understand bond returns. Over the 40 years until end-2021, the world bond index provided an annualized real return of 6.3%, not far below the 7.4% from world equities. “I believe and the Yearbook concurs that extrapolating bond returns of this magnitude into the future would be foolish. The rapport goes on to say: “Those 40 years were a golden age for bonds, just as the 1980s and 1990s were a golden age for equities. In fact, the real return on world bonds in 2022 was −27%.”
François Doyon La Rochelle: It is so difficult if not impossible to forecast and successfully time big market directional shifts. In our last Podcast #51, we addressed the Active vs Passive results in 2022. The worst category out of the 20 was Global Real Estate with a success rate of only 20%, it was slightly surpassed by the corporate bond category with a success rate of 22.6% and by the diversified emerging markets category with a success rate of 23.4%. So, the vast majority of Active Managers missed the boat and performed poorly in these Asset Classes compared with the passive funds.
James Parkyn: Exactly. My second highlight of the 2023 Yearbook is linked to the first one: “A historical risk premium in equity and bond returns relative to T-bills exists for a reason, that being a necessary payment for the risk of volatility and drawdown.” As our Listeners well know, we have experienced four equity bear markets since 2000 and we need to be paid for such a risk.
François Doyon La Rochelle: This makes total sense when you think that in 2020 with the Pandemic, the world experienced its third bear market in less than 20 years. Markets then staged a remarkable recovery and volatility fell once again. However, in 2022, volatility again rose, and both stocks and bonds fell sharply on inflation and rate hike worries and concerns over the Russia-Ukraine war. This was the fourth bear market since 2000. The Yearbook addresses how portfolio diversification can mitigate such risks.
James Parkyn: Yes, but reaping the benefits of diversification is also a long-term concept and can let you down in the short term. The historically extreme negative returns in 2022 of the classic balanced 60/40 equity/bond allocation are the perfect example.
François Doyon La Rochelle: To me, this point was also made in last year’s Report, specifically that the negative correlations between stocks and bonds were not the long-term norm. The Yearbook makes it clear that stocks and Bonds have a historically positive correlation and that the last 20 years of negative correlation before 2022, were not the norm.
James Parkyn: We have addressed this topic a lot in recent Podcasts. Again, Investors must have a Long-Term Mindset.
My third highlight of the 2023 Yearbook is the topic of stagflation.
François Doyon La Rochelle: For our listeners, it might be good to clarify that stagflation is a term from the 70s, and early 80s, which characterizes an economy with low growth, high unemployment, and high inflation.
James Parkyn: The Yearbook warns there is a “growing consensus that conditions will return to normal with low inflation re-established.” They quote academics Arnott and Shakernia: “A keener look at history would highlight how rare this happens”. They state this would in their view be a “best quintile” outcome with the “worst quintile” being inflation persistence for a decade.
François Doyon La Rochelle: To me, this point is about forecasting the future or trying to guess “the markets’ prevailing psyche.”
James Parkyn: Agreed, but the Yearbook makes the case that inflation and interest rates may not come down as fast as expected based on the very long-term perspective of the data in the DMS Database. My fourth highlight is when they tackle the big question: “What does it mean to be an Inflation hedge?” For instance, most Investors believe that Equities are a hedge against Inflation. The Yearbook provides extensive evidence that stocks, as well as bonds, tend to perform poorly when inflation is higher. It also makes the point that both stocks and bonds perform worse during hiking cycles.
François Doyon La Rochelle: Stocks are not, as is often claimed, the best hedge against inflation. The Yearbook makes a great case that “returns deteriorate for both” stocks and bonds as inflation rises. The Yearbook also makes the case that “Equities performed especially well in real terms when inflation was low.” In periods of deflation stocks actually “produced lower returns than on government bonds.” We discussed this in last year’s Podcast #38.
James Parkyn: Yes, we did, and the 2023 Yearbook makes the point very clearly again this year about the long-run evidence on equity returns. I quote: “While equities have enjoyed excellent long-run returns, they are not and never have been the hedge against inflation that many observers have suggested. Despite this, it is widely believed that stocks must be a good hedge against inflation to the extent that they have had long-run returns that were ahead of inflation. However, their high ex-post (after the fact) return is better explained as a large equity risk premium. The key nuance is that: “It is important to distinguish between beating inflation and hedging against inflation.”
François Doyon La Rochelle: Financial Market returns in 2022 proved the point. Stocks went down in a year of high inflation. The Yearbook makes the case that “Most finance professionals are too young to remember high inflation, bond bear markets, and years when stocks and bonds declined sharply together.”
James Parkyn: The Yearbook provides the long-run analysis needed to place the events of 2022 in context. Now I will share my fifth and final highlight when the Yearbook tackles the topic of Commodities as an asset class and the benefit of holding it in periods of inflation.
François Doyon La Rochelle: We hear a lot of noise about investing in Commodities as an Inflation Hedge and the fact that they are not correlated to Equities and Bonds. What does it say about the role that commodities play as an asset class? Do they offer a hedge against inflation that equities do not?
James Parkyn: To answer your question, I will quote from the Yearbook: “A key conclusion to take away, and highly pertinent today as 60/40 equity/bond strategies have let investors down, is that commodity futures do prove a “diversifier” from an asset allocation perspective, being negatively correlated with bonds, lowly correlated with equities and statistically a hedge against inflation itself.” They go on to say that: “The problem is that the limited size of the asset class cannot solve all the asset allocator’s prevailing inflation-induced dilemmas.” So, it’s nice in theory but not realistically investable for both Institutional and Retail Investors.
François Doyon La Rochelle: James, you refer here to commodity futures but it’s also interesting to raise that the Yearbook also looked at direct investing in commodities.
James Parkyn: The Yearbook finding is that direct investing in Commodities does not provide a hedge against Inflation. I Quote “We find investing in individual commodities have themselves yielded very low long returns.
François Doyon La Rochelle: There is more in the Yearbook that is significant: As we point out to our Listeners regularly on our Podcast, history can provide clues to the future, so we should be cautious about any forecasts.
James Parkyn: Yes, the Yearbook results are long-term averages spanning many different economic conditions. As discussed at the beginning of this podcast, this is because stocks and bonds are volatile, with major variations in year-to-year returns. We need a very long time series to support inferences about investment returns. The Credit Suisse report shows us that even 20 years is often not long enough.
François Doyon La Rochelle: So, James, to wrap things up, given the insights from this Yearbook, and given the backdrop of higher rates and high but slowly declining inflation, how should investors be thinking about their portfolios today?
James Parkyn: François, I think it’s appropriate to repeat our Conclusion from Podcast #38 when we covered the 2022 Credit Suisse Yearbook. I think it’s also important to remember that rising rates and high inflation are just two risk factors that investors face. Equity investors have experienced periods when safe assets, for example, bonds and cash, have been good counterweights to the volatility of stocks. Remember, there are many different risks that you are trying to defend against. There will be times when bonds will be really helpful. I recommend that our listeners always consider their long-term goals, their risk profile, their ability to take risks, and their time horizon. In addition, they should consider the decumulation plan of their portfolios. All these elements should be considered when thinking about the structure of their portfolios.
François Doyon La Rochelle: In conclusion, I quote from the Yearbook: “Bad years happen and, when they do, it is consoling to remind ourselves of the long-run record from global investing. For investors in risky assets, especially equities, the long-run record truly does represent the triumph of the optimists.”
James Parkyn: That is a great quote Francois and hopefully, our Listeners will take inspiration from it. On another note, we hope the recent merger of UBS with Credit Suisse into a mega bank will mean that the tradition will continue, and we will see a 2024 edition.
François Doyon La Rochelle: Thank you, James Parkyn for sharing your expertise and your knowledge.
James Parkyn: You are welcome, Francois.
François Doyon La Rochelle: That’s it for episode #52 of Capital Topics!
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