Cameron Passmore CIM, FMA, FCSI

Portfolio Manager

Benjamin Felix MBA, CFA, CFP

Associate Portfolio Manager
  • T613.237.5544 x 313
  • 1.800.230.5544
  • F613.237.5949
  • 265 Carling Avenue,
    8th Floor,
  • Ottawa, Ontario K1S 2E1

The TFSA is not a Toy

It may be a flaw in the name. The government-intended use of the registered retirement savings plan is clear, retirement, but the tax free savings account is less commonly viewed as a long-term savings vehicle. I often meet investors who are using their TFSA to trade individual securities; the TFSA is their ‘play’ account. They are likely acting under the influence of their own overconfidence bias, imagining the large tax-free profits that they are going to make when their bet on a stock pays off, and not considering the significant negative consequences of taking unrecoverable losses within the TFSA. An unrecoverable loss occurs when a security loses its value and never recovers, something that can easily happen when trading individual securities.

Something lost, nothing gained

If a stock picker loses on a bet in a taxable investment account, they are able to claim a capital loss which can be used to offset a future capital gain, dampening the blow of the loss. When losses are taken within the TFSA, this is not the case. Just as capital gains are not taxed in the TFSA, capital losses cannot be claimed. Assuming an investor is taxed at the highest marginal rate in Ontario in 2016, and they have taxable capital gains to offset, a $1,000 capital loss is worth about $268 in tax savings. Losing out on this tax savings makes an unrecoverable loss in a TFSA about 37% more damaging than an unrecoverable loss in a taxable account.

It’s all fun and games until someone loses their TFSA room

Any amount withdrawn from the TFSA generates an equal amount of new room the following calendar year. For example, if a $5,500 TFSA contribution was invested and grew to be $6,500, the full $6,500 could be withdrawn before December 31 and $6,500 of new room would be created on January 1 of the following year. Conversely, in the event of an unrecoverable loss, the amount of the loss will permanently reduce available TFSA room. If a similar $5,500 investment in the TFSA decreases in value to $4,500 and never recovers, there is only $4,500 available to be withdrawn, and the TFSA room has suffered a permanent decrease.

Losing a bit of TFSA room may seem trivial, but consider that $5,500 invested in a well-diversified portfolio* held in a TFSA for 30 years would be expected to grow to about $34,000, while the same investment in a taxable account would be expected to grow to about $15,000 assuming the highest marginal tax rate in Ontario in 2016. A seemingly meaningless loss of TFSA room today has meaningful long-term repercussions.

Between the significant future value of properly used TFSA room, and the lack of recourse for losses in the TFSA, it is an especially risky account to gamble with.

*80% globally diversified equity, 20% globally diversified fixed income, 6.11% return comprised of 1.94% interest, 0.49% dividends, 1.84% realized capital gains, 1.84% unrealized capital gains, net of a 1% management fee.

By: Ben Felix | 0 comments

Luck vs. Skill

On March 2nd, 1962, Wilt Chamberlain scored 100 points for the Philadelphia Warriors in a 169 – 147 win over the New York Knicks. This set the NBA single-game scoring record which still stands today. The game was not televised, in fact, no video footage of the game has ever been located. The stadium was only half full, and no members of the New York press were present. Audio recordings do exist, but only of the fourth quarter. Despite the lack of evidence, it’s not hard to believe that Chamberlain, who averaged 50.4 points per game that season, could score 100 points. His skill was obvious, and any coach would be confident putting the ball in his hands. Placing confidence in the skill of a money manager is much more challenging; the stock market is a world of randomness.

Imagine that a financial advisor who engages in security selection states an average annual return of 30% over a ten year period – a return in line with the 3 top performing hedge funds in the world. Unlike mutual funds, individual financial advisors do not have public performance disclosure requirements or standards, so much like Chamberlain’s 100 point game, supporting data for these numbers might be hard to find. However, assuming that the returns are accurate, they raise an interesting question: should a financial advisor who has produced returns of 30% per year for the past 10 years earn the confidence of investors?

Wilt Chamberlain was a physical specimen, and it was obvious that he wasn’t just getting lucky when he attacked the basket. It’s not nearly as obvious, though, when a financial advisor’s performance is due to skill rather than luck; while Chamberlain was clearly competing against smaller, less athletic players, stock pickers are competing against large institutions and hedge funds. Is it reasonable to believe that a financial advisor has more knowledge and expertise than their institutional competition? Is it likely that those 30% returns will persist?

As an investor, there is a choice to be made between following science-based academic evidence, which points to low-cost globally diversified market based investing, or following investment strategies that, while empirically successful over relatively short periods of time, have not been peer reviewed or statistically proven to persist through time. If capital is being used to achieve specific goals, like retirement, then following the evidence is the only responsible way to invest.

By: Ben Felix | 0 comments