Three Investment Matters to Consider for the New Year
An Introduction to Investment Planning – Part 6
1. Contribute to your Tax-Free Savings Account (TFSA)
As of 2020 your contribution room has increased another $6,000. If you have been age 18 or older since 2009, and a resident of Canada throughout that period, you now have up to $69,500 in contribution room available.
|Year||Annual Contribution Limit||Accumulated Contribution Room|
|2009||$ 5,000||$ 5,000|
|2010||$ 5,000||$ 10,000|
|2011||$ 5,000||$ 15,000|
|2012||$ 5,000||$ 20,000|
|2013||$ 5,500||$ 25,500|
|2014||$ 5,500||$ 31,000|
|2015||$ 10,000||$ 41,000|
|2016||$ 5,500||$ 46,500|
|2017||$ 5,500||$ 52,000|
|2018||$ 5,500||$ 57,500|
|2019||$ 6,000||$ 63,500|
|2020||$ 6,000||$ 69,500|
2. Registered Retirement Savings Plan (RRSP) Season
The first two months of every year bring advertising for “RRSP season.” The last day to contribute to your RRSP to have it count for the 2019 tax year would ordinarily be February 29 (yes, 2020 is a leap year), but because the 29th falls on Saturday, you have until Monday, March 2. Some ways to deal with the contribution:
If you have the wherewithal to contribute to your RRSP right now, go ahead and do it. These days, contributions can often be made online.
Contribute Over the Next Two Months
If you don’t have all that you want to contribute immediately available, consider breaking up the contributions over the next two months. For example, if you wish to contribute $5,000 and you are paid bi-weekly, you might want to break it up into five contributions. Contribute $1,000 now, and then on each subsequent paycheque (you will probably have four pay periods in January and February), contribute an additional $1,000.
Your bank or credit union will be eager to arrange an RRSP loan for you. This is not my favourite way to contribute to an RRSP because you are having to pay interest on the amount borrowed, and there is no tax deductibility for the interest on a loan to invest inside an RRSP. However, there is a way to turn your loan repayments into a good habit. Set up a loan repayment schedule so that you will have your loan paid off by the end of June. Beginning in July, arrange for a pre-authorized contribution for the same amount through to the rest of the year. Going forward, when you receive your Notice of Assessment from the CRA with your new RRSP contribution limit, you can make adjustments to your periodic contributions to match your limit.
Set Up Pre-Authorized Contributions
The scenario above applies even if you aren’t paying off a loan. Set up periodic pre-authorized contributions to your RRSP. You will never have to take out an RRSP loan again, and even better, never have to pay attention to the seasonal RRSP ads clamouring for your attention.
3. Rebalance Your Accounts
Without Adding New Money
This is easily done if you have a TFSA, an RRSP and/or other registered accounts because there are no tax consequences for rebalancing. Unless you have a single fund that holds a diverse range of investments, you will generally want to consider periodically rebalancing your holdings. Consider the following situation: At the beginning of 2019 you opened a TFSA within which you have invested in four different mutual funds: a Bond fund, a Canadian equity fund, a US equity fund and an International equity fund. When you made your initial investments, you decided that each fund should make up 25 percent of your account. Let’s imagine that you had $10,000 to begin with and invested $2,500 into each fund. Now, one year later, the funds are no longer at the same balance. The following table will illustrate.
|Fund||2019 Value||Target %||Current Value||Current %||Rebalanced||Difference|
|Bond||$ 2,500.00||25.00%||$ 2,606.50||22.47%||$ 2,899.56||$ 293.06|
|Canadian Equity||$ 2,500.00||25.00%||$ 3,009.50||25.95%||$ 2,899.56||-$ 109.94|
|US Equity||$ 2,500.00||25.00%||$ 3,117.75||26.88%||$ 2,899.56||-$ 218.19|
|Int’l Equity||$ 2,500.00||25.00%||$ 2,864.50||24.70%||$ 2,899.56||$ 35.06|
|TOTAL||$ 10,000.00||100.00%||$ 11,598.25||100.00%||$ 11,598.25||$ –|
You can see that the account grew in 2019, but each fund grew by different amounts. By the time one year had passed, the account overall had grown by almost 16% but the US Equity fund now made up almost 27% of the account while the bond fund made up less than 23%. In order to bring all four funds back into balance, you need to sell a portion of the relative overachievers – the Canadian and US Equity funds – and use those proceeds to buy the underachievers – the Bond and International Equity funds. The beginning of the year is the perfect time to do this.
By Adding New Money
In the table above, I assume you are not contributing new money to the account. Adding new money involves a slightly different approach to rebalancing, which you can see in the table below. In this new scenario, the value at the beginning of 2020 is the same as above, but instead of rebalancing from your strong performers to your weak performers, you contribute another $10,000 to your account and rebalance by adding different portions of the new deposit to the various funds. You still want to maintain your 25 percent balance across all four funds. Here is an approach that you can take.
|Fund||Current %||Current Value||Target %||Target Value||Difference|
|Bond||12.07%||$ 2,606.50||25.00%||$ 5,399.56||$ 2,793.06|
|Canadian Equity||13.93%||$ 3,009.50||25.00%||$ 5,399.56||$ 2,390.06|
|US Equity||14.44%||$ 3,117.75||25.00%||$ 5,399.56||$ 2,281.81|
|Int’l Equity||13.26%||$ 2,864.50||25.00%||$ 5,399.56||$ 2,535.06|
|Cash||46.30%||$ 10,000.00||0.00%||$ –||-$ 10,000.00|
|TOTAL||100.00%||$ 21,598.25||100.00%||$ 21,598.25||$ –|
You want to distribute that $10,000 contribution among your four funds so that when it’s all done, you have zero cash and each fund is worth the same amount. The answer is to take the difference between your target value and your current value and invest accordingly. You’ll see that in the right column, labelled “Difference,” each fund gets a slightly different amount, but the $10,000 gets fully distributed. Happily, this approach to rebalancing is a good way to deal with non-registered accounts. Since you are not selling any of your funds, you don’t have to deal with the tax consequences of capital gains or losses.
My next blog topic will address passive indexing versus active management.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, accounting or legal decisions.