PWL Capital November 4, 2015 Living in Retirement Market Research Elections, Markets and Investors Markets might be indifferent to election outcomes but investors should pay attention. I was interviewed on election night for financial magazines: Advisor and Moneysense about the impact of the change of government on personal finance. What follows are some of the items we discussed, not all of which made it to publication. The impact of Election outcomes on capital markets Based on a 2009 study the impact on capital markets of the choice of government is negligible whether Conservative or Liberal, minority or majority. This is consistent with the idea that company profits are impacted by many forces outside government control. That the immediate election outcome rarely has an impact on markets is consistent with the view that they are an effective information processing engine which incorporates news into prices. Certainly mixed messages between how commentators thought the market should respond and how it actually behaved were in evidence the morning after the election. The National Post newspaper ran two items on it’s front page. One declared: “Dear Justin Trudeau: World’s big investors aren’t interested in buying up Canada’s debt” The other reported: “The Canadian dollar’s slide came to a halt amid speculation the country can cope with the extra spending that may result from Justin Trudeau’s election victory.” Political Risk While markets may be indifferent to elections, market returns are not the same as investor returns because we never invest alone; the Canadian Revenue Agency is always there as our partner. Fiscal and pension policies can redistribute wealth between different segments of the population by changing tax rates or it can move wealth from the present to the future, by changing source deductions (pensions, unemployment insurance). Governments sometimes signal their intentions in advance but not always. The new Liberal government has signaled changes in income tax rates so that middle income earners (between $44,700 and $89,401) will experience a tax savings worth up to $670 a year per person but those earning above $200,000 will pay more. On a $250,000 income, for example, the tax increase will be $1,329.50. An example of the impact of a change that was not signaled in advance was the change in unit trust taxation announced by the then newly elected Conservative government in October 2006 that saw popular Canadian unit trusts lose up to 20-25% of their value. Retirees in particular had come to rely on unit trusts as a source of income and saw an immediate reduction in their standard of living. Income splitting for retirees was introduced to partially offset some of the damage. Of note that this was not part of the election platform, in fact the incoming Prime Minister, Stephen Harper had explicitly promised to protect income trust from additional taxation. Whether signaled or not these changes are outside the control of the investor and are investment risks. The best defence is diversification across different governments (i.e countries), something that many unit trust holders learnt the hard way. One of the most discussed items impacting investors in the Liberal’s proposals was the change to the limit on annual contributions to the TFSA. The Conservative government increased the limit to $10,000 and the Liberals campaigned on restoring the previous limit of $5,500. Assuming a 5% return on the difference of $4,500, and 30% tax on that growth, suggests a potential tax saving of less than $70 annually. For investors who have the spare income to save then paying less tax on their savings is clearly a benefit but they are unlikely to reduce their savings rate as a consequence. For others who would struggle to put aside additional savings and are likely to have a lower average tax rate then the tax incentive is not likely to be an effective motivator to save more. In short, fiddling with TFSA limits is largely irrelevant if the goal is encourage additional savings. Pension Reform Pension reform is back on the agenda. The Conservative government promised consultation on allowing voluntary CPP contributions. The Liberals are more committed to a mandatory expansion of the CPP, perhaps negating the need for the proposed Ontario Retirement Pension Plan (ORPP). However, under present rules any changes to CPP will take 39 years to make their full impact as an enhanced pension. However the impact could be significant, especially for middle income families. For example, the ORPP would provide an estimated annual pension of $9,970 for someone with a salary of $70,000. Whether this is an additional pension income for retirees is subject to debate and depends on whether the employee contributions are at the expense of savings elsewhere and whether other government benefits will be clawed back due to this additional income. Purely from a retirement perspective, different age cohorts will be paying attention to different aspect of government policy: Young adults in their 20-30s should pay attention to pension reform, despite the long time horizon, as they are likely to be the beneficiaries of any changes. Those in their 30-40s might be more concerned about reducing mortgage debt and saving for post secondary education for their children. For adults in their 40s and 50s attention begins to turn to maximizing savings for retirement, so tax breaks on savings and good workplace savings schemes can be important. For near retirees and retirees the focus turns to government policy on taxation on withdrawals from pension sources and the extent to which government benefits are reduced by taxation or means testing. For everyone, diversification both within Canada and globally avoids overreliance on any government, now or in the future. Share: Facebook Twitter LinkedIn Email