Man holding credit card while online shopping

How To Use Your Tax Refund

You were a good citizen. You were organized, gathered all of your tax forms, receipts and filed your taxes promptly.

As a result, you are now the recipient of a nice chunk of change from Justin and the Premiers in the form of your tax refund!

Your tax refund might feel like free money, but it is not. In actuality, this is the repayment of an interest-free loan that you gave the government without even knowing it. Throughout the year, you either make periodic remittances if you are self-employed (or otherwise required) or you have tax taken off each paycheque by your employer. Your tax refund is the return of overpayments that you made relative to the income tax that you actually owed at the end of the year. Hence, this is why it is called a refund. Your tax refund was indeed your money all along.

But now, the big question is, “How should I use my tax refund?”

Before you buy that new iPad or fly to Jamaica, here are a handful of recommendations.

How You Should Use Your Tax Refund

1. Pay Down Consumer Debt

Consumer debt is debt related to consumption, instead of debt that is tied to an asset that can appreciate.

This is priority #1. This would likely be priority #1 on any list for that matter.  Paying down your consumer debt is so important that it should likely be #1, #2 and #3 on this list.

This prolonged low-interest rate environment that we have lived in seems to have lulled many Canadians into a false sense of security around carrying consumer debt. According to the 2018 BDO Affordability Index, 46% of Canadian households don’t earn enough income to live debt free.

But not all debt is created equal. The largest area of concern is high-interest debt.  High-interest debt generally comes in the form of credit cards (up to 20% APR), payday loans (>100% APR and upward), and high-interest lines of credit (10% APR or more).  Rates mentioned are illustrative and not a minimum threshold for concern.

If you are carrying high-interest debt, paying it down will almost always be the best use of your funds. You should focus on paying down your debt with the highest interest rate first.

In essence, consumer debt is what you owe for the material things or that you already have or the experiences that you have already had. To put it another way, instead of using your tax refund to buy an iPad, you still need to pay for the iPad that you purchased years ago.

2. Open An RESP For a Family Member

Education costs are continually on the rise.  A year of post-secondary education at a Canadian university can cost up to $20,000. Starting to save early in a child’s life is prudent given the rising costs.

RESPs are an excellent way to save for a child’s education for a few reasons.

  • Free Money!

The Government of Canada matches 20% of your contributions, up to a maximum of $500 per year. This is called the Canada Education Savings Grant (CESG).

There is also lifetime maximum for CESG contributions that the government will make of $7,200.

  • Tax-deferred investment growth

Money held within an RESP grows tax-deferred. Similar to an RRSP, all of the growth of the funds within the RESP has the benefit of tax-deferred compounding. Tax-deferred investment growth has been proven to be a winning wealth builder.

  • Taxed in the hands of the beneficiary

Unlike an RRSP, contributions made by yourself into the RESP are not deductible from your income. As such, you will be contributing after-tax dollars into the account, similar to a TFSA.

However, the CESG amounts and the investment income are then taxed in the hands of the beneficiary (i.e. your child or niece/nephew) upon withdrawal. This can provide significant tax savings. Students are typically in a low-income period of their lives during schooling, and they should generally be in a lower tax bracket than the contributor during this time.

These advantages should be capitalized on early and often in the life of the beneficiary to maximize the CESG and tax deferral. Use your tax refund to start an RESP and take the free money!

3. Contribute to your RRSP/TFSA

If you don’t require the free CESG money for a family member, you can shift your attention to your personal savings.

Whether you contribute to your TFSA or your RRSP will vary based on your individual situation. I prepared a rundown on things to consider when answering the question, “Is an RRSP contribution right for me?

When making your determination of where to put the money, the primary question that you should ask is “When will I need the money?”

Funds in your RRSP are intended for your retirement, but they could also be withdrawn to buy a home using the Home Buyers Plan or to go back to school via the Lifelong Learning Plan.

Another perk of an RRSP contribution is that it can increase your tax refund for next year if you deduct it against your 2019 income.

If you need this money for the near term (other than for purchasing a home or for going back to school), TFSAs provide added flexibility around withdrawals. This is an ideal place to keep your emergency fund. If you do not have an emergency fund in place, then bump this up ahead of the RESP plan in terms of priority.

If you have questions around what option is best for you, you should speak with a financial planner.

4. Mortgage Paydown

The market is sending mixed messages about where interest rates are going in the intermediate term. However, we know that we have been experiencing a prolonged low-interest-rate environment.

The party should come to an end sooner-or-later, and rates could rise.

There are a few key benefits to paying down your mortgage:

  • Defence against rising rates

As rates rise, so will your mortgage payments on a variable mortgage. Even if you have a fixed rate mortgage, it will come up for renewal inevitably, and all else being equal, your payments will increase along with the interest rate.

  • Guaranteed rate of return

Let’s assume that you have a mortgage rate of 3.5%. By paying down a portion of your mortgage, you have just achieved a guaranteed after-tax return on your investment of 3.5%! I challenge you to find a guaranteed investment that will pay you that rate of return after-tax.
This guarantee, however, doesn’t contemplate foreclosure risk, or any of the other risks associated with homeownership. That said, paying down your mortgage is an excellent way to achieve your long-term financial goals.

  • Lower monthly payments

As you lower your outstanding balance, your monthly payments become lower.  Some mortgages implement these changes immediately, while others will update the payments a set interval.  In either case, when you have less to pay back, you can pay less each month.

  • Mortgage renewal flexibility

A lot of digital ink has been used lately discussing the challenge that some are facing renewing their mortgages.

The Government of Canada introduced rules to stress-test an individual’s ability to afford their mortgage payments when rates rise. As interest rates rise, so does the benchmark rate for the stress-test.

By paying down your mortgage, your outstanding balance and future payments will be reduced, and this will ease the challenge of meeting the stress test.

When deciding whether or not to use your tax refund to pay down your mortgage, you should investigate the repayment terms before making your decision. Some are flexible, while some are stringent and may come with fees or penalties. Speak with a professional to understand the implications of making a pre-payment against your mortgage.

5. Get a Fee-Only Financial Plan

Naturally, this is a self-serving recommendation, but I wouldn’t be doing my job if I didn’t mention it.

A financial plan is an investment in your overall financial well-being.  Having a solid financial footing sets you up for success in all other aspects of your life.

A good financial plan can help you better understand your spending, ensure that your investment mix matches your risk tolerance, identify if your current savings will allow you to reach your goals, assess your risk management, or map out how to make your savings last through retirement. And let’s face it, if you are reading this article, then you probably have questions about how to optimize your financial situation.

A financial plan can also help you assess each of the above options for the use of your tax refund based on your individual situation.

An additional benefit is that many of Novel’s clients have been able to achieve significant savings on their investments by executing a Novel Fee-Only Financial Plan. This ultimately means that, depending on your current investment products, the cost of a fee-only financial plan can pay for itself, even in the first year!  Investment options that can pay for themselves tend to be few and far between in this day and age.  Taking steps to secure your financial well-being is an excellent use of your tax refund.

The Brass Tacks On Using Your Tax Refund

Don’t be so quick to spend that tax refund. After all, it was your money to begin with, not the government’s. There are several things that you can do to put that money to work for you.  Each of the options have pros and cons, and they may not all be appropriate for your situation. Resist the urge to spend it frivolously and instead use your tax refund wisely. Then again, sometimes you just need to go to Jamaica.

If you would like to schedule a free consultation to discuss your options for maximizing the use of your tax refund, please contact us.


Self-Directed Brokerage Screen

How To Execute a Stock or ETF Trade

This guide will help you execute a trade through your self-directed brokerage account. 

This walkthrough will show specific screens from the current Questrade platform, but the steps are relevant for any self-directed brokerage account that you may have.  For additional visual help, Questrade has a video showing how to execute a trade.

  1. Open and Fund your account.

We have prepared a guide on how to open a self-directed brokerage account.

  1. Log in to your account and select the account that you want to make the trade from (i.e. TFSA/RRSP/Non-Registered)

  1. Access the Trading Screen

To do so, you can either click on the ‘Trading’ icon from the drop-down menu from the top-left of the screen, or you can click the ‘Trade’ button in the top right.

Questrade Account Screen

 

  1. Determine the amount that you can invest on the trading screen

When you reach the trading screen, you can see your current balances in the account:

      • Cash
        • The amount you are currently holding in settled Cash in this account.
      • Market Value
        • The current market value of your investments in this account.
      • Buying Power
        • This is the maximum amount that you are able to invest on your next trade.
        • This amount will be reduced by any buy trade that you execute.
        • See below FAQs for an explanation around buying power vs. cash
  1. Lookup the security that you want to trade

In the top right corner of the screen, look up the security that you want to trade by entering either the symbol or the proper name, and select it from the drop-down that appears.  In the example above, we have looked up XIU, which is the symbol for the iShares TSX 60 ETF.  This security is traded on the Toronto Stock Exchange (TSX), which is why the symbol includes the trailing ‘.TO’ in the name shown in the drop-down menu.

Questrade ETF Lookup

  1. Enter your trade details

NOTE: ONLY PLACE TRADES DURING MARKET HOURS.

After hours trading is risky and is not recommended.  For reference, the TSX is open from 9:30 am – 4:30 pm EST.

On the order entry screen, you are given the current quote information for the security.

NOTE: Quote information is usually delayed by 15 minutes.

Questrade ETF Order Entry

      • Last Price
        • The price paid on the last trade for this security
      • Bid Price
        • The current price being offered on open buy orders
      • Ask Price
        • The current selling price being requested on open sell orders
      • Bid Size
        • The # of units of the current bid order
      • Ask Size
        • The # of units being offered at the current ask price

When buying an ETF, we recommend that you offer as close to the ask price as possible.  When selling, offer as close to the bid price as possible.  If you are trading index ETFs, the spread between the bid and ask will generally be nominal.

In this example, we placed a limit price of $22.37 per unit, which was $0.01 higher than the ask price.  Across the 100 units that were being bought, this was $1 total more than the current ask price for this ETF.  This is a nominal amount to ensure that you should be able to have your trade filled.  If you were to offer only at the bid price, your trade may not be able to be filled by the broker.

Once you determine the price to be offered, you will enter the parameters of your trade and Click “Buy” or Sell”.

      • Quantity
        • The number of units/shares to purchase or sell
      • Order Type
        • Only ever execute Limit trades
        • This dictates a maximum price for a buy order and a minimum price for a sell order.
      • Price
        • The price that you are willing to pay for the security (close to Ask on Buy, close to Bid on Sell).
        • Ensure the bid and ask price are close together.
      • Duration
        • How long you want the trade to be open for.
        • As prices are dynamic, there may not be a buyer or seller at the price that you enter at the exact moment that you make your trade.
        • As such, the trade will stay open for the duration you indicate
        • Only execute trades that are open for the Day duration
  1. Confirm that the details of the trade are accurate

A splash screen will appear for you to confirm the details of your trade.  You will see the total trade cost and your updated buying power.  If the details are accurate, click ‘Send Order’.

Questrade ETF Buy Confirmation

  1. Check the status of your order

You will be shown a pop-up with the order details.

In the screen below, you see the status as ‘Executed’.  This means that the trade has been filled.  It was filled at $22.36 per unit (the Fill Price), which was less than the limit price we submitted at $22.37.

Questrade ETF Order Details

If the status is showing as ‘OPEN’, then your trade has not been filled.

If the unit price moves higher than your limit price on a buy order, then you may have to raise your limit price by modifying your order.  The opposite is true on a sale, where if the price moves lower you may have to lower your asking price to have your trade fulfilled

After you close the Order Details pop-up, you will be returned to the Trading screen.  Go to the Orders screen by clicking on ‘ORDERS’ in the upper left menu on the Trading screen.

Questrade Order Menu

 

On the Orders screen, you will see the order that you just placed.

Questrade Orders Screen

Select the trade and adjust the limit price if the bid/ask price moves after you have placed your order.

Once the trade has been filled – you are done!

Congratulations!  Understanding how to make a trade puts you in a position to take control of your finances and manage your own investments.

Trading FAQ

Trading (3)

After you place a trade, the transaction is in what is known as the settlement period.  What this means is that there is a period where the brokerage works to move the securities and cash between the accounts of those parties involved in the trade (i.e. cash out, stock in or vice versa).

The day that you execute the trade, to either buy or sell, is the trade date.  The settlement date is typically trade date + 3 days (i.e. T+3).  Your buying power is measured on a trade date basis, where your cash balance is on a settlement basis.  If you execute no other trades, your cash and buying power will be equal after the trade has settled.

This is an instruction to the brokerage.  When you place a market order, the broker will make the trade at any price that the market will bear.  When you place a limit order, they can not go above (on a buy order) or below (on a sell order) the price that you provide.

Your hope is to place orders that are fulfilled very quickly.  A lot can change from day-to-day in the market, and leaving trades open longer than a day is not recommended.  Other duration options are:

  • GTD – Good-Till-Date
    • Expiry date specified by the user, but cannot be open longer than 90 days
  • GTC – Good-Till-Cancelled
    • Expires only if cancelled by the user, or 90 days, whichever is sooner.
  • GTEM – Good-Till-Extended Market
    • This means that the trade will be active in extended trading (until 5:30 pm for Canada exchanges), which is not recommended due to added risk.
  • FOK – Fill or Kill
    • This is a trade that is executed immediately and completely or not at all. This trade type is useful for active traders who trade large volumes of securities.
  • IOC – Immediate or Cancel
    • Similar to FOK, the trade must be executed immediately, but the IOC trade will allow for a partial # of the securities of the order to be fulfilled.  FOK is all or nothing.

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Account Opening Form

How To Open a Self-Directed Brokerage Account

Opening a self-directed brokerage account is an essential step toward taking control of your finances.  This forms an integral component of the Execution phase of the Fee-Only Financial Planning Process.  A self-directed brokerage account allows you to buy and sell stocks, ETFs and other securities.

In order to open an account, you will need some information accessible before you begin, as it will be required as part of the process:

  • Government-issued Photo ID
    • Driver’s License or Passport
  • Current account information if you will be transferring funds into your new account
    • Account #s for each account (RRSP, TFSA, etc.)
    • Institution name and address

The below walkthrough is specifically for our recommended brokerage Questrade, but the steps will be similar for any self-directed brokerage.  This process should take you about 30 minutes to complete but can be done in phases.

Note: We only recommend that you open an account if you will be transferring $5,000 or more.  When you have $5,000 or more, you will not be charged fees for inactivity in your accounts.

Self-Directed Brokerage Account Opening Steps:

  1. Go to questrade.com

  2. Click on “Open An Account” in the top right portion of the landing page

  3. Select the accounts that you wish to open.

Our recommendation is to open an Individual Margin, RRSP, and TFSA account.  These are the 3 basic account types that are appropriate for all Canadians.

Select the Self-Directed account options, not the Questwealth options. Questwealth accounts charge management fees for pre-packaged portfolios.  We have covered elsewhere how management fees negatively impact your portfolio

Questrade Account Opening Selection Screen

On the right-hand side of the screen, you will have the opportunity to enter an offer code.

If you enter the code “uajekubi” you will receive a $50 trade commission rebate.  This is offered as part of the Questrade affiliate program. To understand more, please read our affiliate policy.

  1. Create a user ID and enter your basic personal information

The name that you enter on this screen must match the government issued photo id that you will upload as part of the account opening process.

  1. Build Your Profile

Next, you will expand on the personal information provided in the previous step.

The questions that you answer in the next steps are standard procedure when opening an account with a financial institution.  These questions help to prevent money laundering and sanctions avoidance.  This is a good thing.  You can refer to the Questrade Privacy Policy if you have any questions or concerns.

You will have to enter information in 4 different categories:

      • Personal Information
      • Employment Information
      • Financial Information
      • Citizenship Information

Questrade Build Your Profile Screen

  1. Account Opening Questions and Documents.

For this next step, you have to complete some paperwork and answer questions for each account that you are opening.

From the account summary screen, click on an account to complete the setup.

Questrade Account Setup Selection Screen

There are a separate set of questions for each account, as well as paperwork that must be signed and submitted prior to being able to open your account.  It is during this step where you must upload the copy of your photo-id to the website.

Questrade Account Questions and Documents

  1. Fund your account

Now it’s time to put some of that hard-earned money of yours into your new account.

You have a few options at your disposal.

Questrade Account Funding Options

If you are transferring an RRSP or TFSA to your new accounts, you must use the ‘Transfer account to Questrade’ option.  Any other form of funding would result in a contribution to your account, which may put you over your contribution limits for either your RRSP or TFSA.

When transferring accounts, they can only be transferred into the same type of account (i.e. RRSP into an RRSP).

For a limited time, if you are transferring an account of $25,000 or more, you may be eligible to have your transfer fees that are charged by your current institution (the transfer out) covered up to $150 by Questrade.

If you are transferring your account, you will have 3 options available to you. 

      • Transfer in-kind
      • Transfer in cash
      • Partial

Transferring in cash means that your stock/ETF positions will be liquidated by your current institution and converted to cash.  This can have some unintended consequences, such as incurring brokerage trade commissions, or tax bills for realized gains (or losses) in your non-registered accounts.

Transferring in-kind means that you are moving your stocks and ETFs over while keeping your adjusted cost base/book values intact for tax purposes.  This is the recommended option.

A partial transfer would be for only a portion of your account, as opposed to the full value.  A cash transfer is appropriate if you are holding securities, such as mutual funds, which are unable to be held in your brokerage account.

Account transfers can take up to a month or more, depending on the financial institution.

Minimum initial funding in order to buy stocks or ETFs is $1,000 per account.

 

And that’s it!

Once your accounts are funded, you are now able to trade stocks, ETFs and other securities.

We have prepared a guide on how to execute a stock or ETF trade  for your reference.

Was this guide helpful?  Are there other guides that you would find useful? Let us know in the comments.


Investment Trader Terminal

The Case Against Active Portfolio Management

 

Being active is for the gym, not your portfolio.

“When did you get so clever?”
“When I realized I wasn’t as clever as I thought.” 
― John Connolly, The Infernals

Hubris.  The fatal flaw.  And a common trait of the average actively managed fund manager.

“I will be different!” … is what I envision them saying, as they march onward in the quest for alpha.

Each and every day, throngs of asset management employees spend hours poring over reams of data, performing endless analysis and searching for the golden nugget of information that will give them an edge over their competition.  And unfortunately, each and every day, the majority fail.

They fail.

Day after day.

Month after month.

Year after year.

This isn’t up for debate, it has been empirically proven.

The investment management industry attempts to sell you on their superior expertise to maximize your investment gains. 

We have all seen ads similar to this one:

Advertisement from investment firm that claims outperformance

However, they are really spending a lot of money on marketing in vain.

There are 2 factors to consider with respect to their performance.

INVESTMENT RETURNS

The most critical aspect of measuring a mutual fund’s returns is their performance against its benchmark

For example, if you wanted to buy a mutual fund that invested in Canadian stocks, that mutual fund would likely be benchmarked against the S&P/TSX Composite Index.  The actively managed mutual fund would then invest in an attempt to outperform that index.  It would do this in 2 primary ways:

  • Only investing in certain stocks while avoiding others, some examples may include

    • investing in banks but not oil & gas;
    • investing specific bank stocks instead of all bank stocks
  • Timing the market by investing more or less in an attempt to avoid losses and capitalize on upward momentum gains.

There are other ways that certain funds may be able to achieve gains (e.g. options, hedging, etc.), but not all are appropriate for the average mutual fund.

SPIVA scorecards track the performance of mutual funds against their respective benchmarks.  Below is a summary of some of their most recent findings.

Summary table which shows that the vast majority of mutual funds don't beat their benchmark index

Simply put another way, the best performing sample only saw 37% of mutual funds beat their index.

Funds are often judged based on quartiles.  This means that for a given class of funds, such as US Large Cap funds, they are measured against their competition in the group via a ranking from top to bottom.  The top-performing 25% of funds would be in the top quartile and the bottom 25% in the bottom.  Because they are grouped together in this manner, many fund managers aim to simply not be an outlier amongst their peers.  Why do you ask? How do you think a fund manager’s year-end performance review with their boss would be if they were in the bottom quartile for a given year?

This is what gives rise to the concept of closet indexers.  What this means is that supposedly actively managed funds are in fact aiming to mimic their respective benchmark so that they can avoid appearing in the bottom quartile of their group.  This is relatively easy to do by investing in the entire, or close to it, benchmark.  For example:  If the TSX was made up of 1/3 Financials, 1/3 Oil & Gas and 1/3 Mining companies, the active manager could invest in 2 or 3 companies for each segment of equal weights. 1/3 of the assets invested each of Financials, Oil & Gas and Mining, and you have likely just avoided the bottom quartile.  This would not yield outperformance but would rather perform similarly to that of the entire TSX (in this simplified example).

INVESTMENT EXPENSES

The other key consideration with active management is expenses.  Active management costs more.  It costs more in a few ways:

  • Higher Management Fees or MERs for mutual funds
  • Higher trading costs due to trading in and out of stocks.
  • Tax bills for realized gains

The cost argument is always best approached by comparison.  If you simply bought an index fund that tracked the TSX, you would pay less in management fees than an actively managed fund.  For example, TD offers many mutual funds, but I have included an example below of their cheapest TSX Index Fund and an actively managed fund which intends to outperform the TSX.  Below is a summary of their MERs and relative performance (data source 1 and 2).

Comparison of TD Mutual Funds

To be clear, TD is used in this example, but this is something that you would likely find at nearly any mutual fund vendor with respect to expenses on the actively managed side. That said, the e-series offering from TD is one of the lowest cost options of its kind.

Now, consider how many of these actively managed funds may be closet indexers in conjunction with the higher prices that they charge for management…  That sounds like a recipe for underperformance, not their promise of outperformance.

If you choose to invest with a portfolio manager who would be purchasing individual stocks, instead of a mutual fund, this is where the trade costs add up.  Every time that the asset manager switches into and out of a stock, they have to pay a commission to the brokerage that houses your account.  This means, that through being active in an attempt to outperform, there can be substantial fees related to stock trading.

The additional contemplation of active stock trading is taxes.  Every time that you trade a stock in a non-registered account (i.e. outside of a TFSA or RRSP) you realize a gain or loss.  This could mean that you are stuck with a surprise tax bill at year end because of all the active trading that you are doing.  This means that the money owing in taxes cannot be reinvested and compounded for your benefit, but instead will be sent to our good friends in Ottawa.

If you go back and look at the advertisement shown above, you will note that it doesn’t indicate whether the returns are before or after fees.  How do you think the return figures might change if you factored in 1, 3, 5 or more years of fees into the equation?

 

THE BRASS TACKS

Asset managers would like to sell you on their superior intellect and clever ability to pick individual stocks that are winners.  History has told us otherwise.  Index investing guarantees you the effective market return at a lower cost.

Think of it this way:

You are writing an exam and have 2 potential study methods.

Study Plan A gives you a 20% chance of being average or better and an 80% chance of being below average and the material will cost $600.

Study Plan B gives you a 100% chance of being average and costs $100.

Study Plan B would be a no-brainer.

So I will leave you with one final question:

Who’s clever now?


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