Tag: Investing

FOMO and market timing

Turbulence can breed troublesome behaviour

Fear-of-missing-out — FOMO — can have a dangerous influence on investors who subscribe to ‘market timing’. Acknowledging that there is always a time when you enter, remain and exit, market timing suggests that you can get better investment returns by predicting when to move in and out of markets or asset classes, sometimes on short timelines. 

Witness yesterday, October 24, 2018: With eyes & ears pealed to devices awaiting the Bank of Canada interest rate call (it went up by 0.25%), markets took a tumble. Closest to home, the Toronto index had its largest one-day decline since 2015. 

Are these events connected, could you have predicted this, and could you have moved to avoid fallout? “Maybe” on all counts, but most importantly on that last one, should you?

The financial planning lens 

Financial planning is the broad view of you, informed by your past and aware of your future, so that you can act confidently in your present. A critical component of this is how you view and manage your investments, from the overall purpose of funding your future, down through the particular parts with nearer-term intentions. 

As conditions change out there, you need to make appropriate adjustments so the investments continue to serve your defined purposes. It’s about getting and staying informed, and being at-the-ready. You’re not merely reacting and being driven by observations, but rather responding in a measured manner that always comes back to you. 

From principles to the practical – What experienced financial advisors say and do 

Market timing as a concept has been around as long as markets. As to its ease-of-use and effectiveness, the website Investopedia points to research from Morningstar that suggests it most often comes up short in both respects. That said, none of us are made of pure logic. We’re emotional, some more than others (especially in turbulent markets), which makes the notion of market timing enticing. How do you keep yourself on-track?

First, look to your advisor to provide you with insight, backed up by credible research, until you are content that you understand what is going on presently. That’s what our advisors do, and based on their experience they can share how they have dealt with this in the past. And without downplaying the seriousness, relevant stories and analogies also help as emotional reinforcement, so here are some I’ve collected from a few of our advisors:

Not in my house 

Advisor Paul Shelestowsky asks, “If one day you woke up and found out your $500,000 house is now worth $450,000, would you sell it, put the money in cash, rent for 6 months, then buy your house back for $500,000?”

Cruising along

Advisor Nancie Taylor points out that, “Cruise ships will often run into rough water during a voyage, but you don’t jump on the life rafts and abandon ship. You trust the captain and crew to get you to your destination.”

Wear blinders, but don’t act blindly

Advisor Jordan Damiani sums up, “Blinders keep a race horse focused on the track ahead, not on the distractions at the side. In fact, they’re not blinders at all – they’re ‘focusers’.” In short, focus on your individual time horizon, goals and risk tolerance, with diversified investments that take speculation out, so you have a successful long-term result. 

Market pullback? Financial planning!

This is the time when financial planning really, REALLY matters

There is no getting away from it: When investment markets turn negative, it doesn’t feel good. Though we know that there will be ebbs and flows in the economy and in our investments, it can feel overwhelming while it is happening.

So, without denying the reality of the market numbers, let’s calmly shift our focus from IT to YOU.

Informed by your financial planning 

Your investments are one part of your financial life. And your financial life is one part of your … life. The big tool we have available to manage that journey is the process of financial planning.

That means understanding where you are currently, so that you can live responsibly within your present means. It also means looking to the future and the needs you will have then, saving for that eventuality, and managing those savings in an informed way.

The informed way that we manage savings is more commonly known as “investing.”

Yes, your investments are critical to your life’s journey, but let’s be candid: You are not about to spend everything in your investment portfolio today, just because of market movements yesterday. By the same token, if – or rather when – there is a bounceback, that’s also not a personal signal to you to spend immediately.

Diversification has many faces 

Every investor who has worked with a financial advisor will have had the conversation about the benefits of diversification. It’s the ‘not-all-the-eggs-in-one-basket’ wisdom that advocates not overly focusing on a single security, or economic sector or geographic area.

As importantly, the concept of diversification applies to you personally, as much as to what is in your accounts. There is a natural progression over a financial lifetime – learning, earning, saving, investing and spending – but at any given time you will be engaged in more than one of these activities.

To the point, if you have a well-rounded financial plan where each of these is properly addressed, then the current fluctuation of your investments should not throw you into a panic.

Looking even closer at the investments, time is also a diversifier. As your advisor will counsel, your investment approach should always take into consideration your comfort with risk and the timeline for when you expect to use that money. Not only will you not be withdrawing everything right now, you won’t be taking it in a lump sum at any one point in future. Practically, you are setting yourself up for a flow that will carry on over the course of many years.

Maybe you’re in the midst of that drawdown mode now, or maybe it’s years ahead. The good news is that time generally works in your favour to allow your investments to recover, even in the face of a significant market pullback. The key is to have an up-to-date investment policy statement and financial plan so that your portfolio continues to fit your evolving needs.

Stay informed so you can stay the course

In that light, I am certainly not suggesting you ignore market movements. Observe them, inquire into them and learn from them. That includes listening to and learning from your own emotional response.

Some present anxiousness is to be expected, but you still need to have the comfort and confidence your portfolio is constructed to suit your long term needs.

Whether interest on T-series distributions is deductible

At issue

Borrowing money for investment is a way to leverage up the amount of capital on which you can generate income. Of course that can also work against you by magnifying losses, but whichever way the performance goes, the interest on that borrowed money is usually tax-deductible.

For a straight buy’n’hold investor, deductibility is in turn straightforward. But when the borrowed money is repositioned in some way – whether by the investor’s actions or by the operation of the investment itself – deductibility can be brought into question.

Mutual funds – return of capital

In Van Steenis v. The Queen, the taxpayer borrowed $300,000 in 2007 to invest in units of a mutual fund.  The fund had the capacity to return capital to investors, a feature often called ‘tax-efficient’ or t-series funds. In this case, the fund returned capital each year up to 2015, to a total of $196,850. Mr. Van Steenis used some of that money to pay down his loan, but the majority was used for personal expenses.

The Canada Revenue Agency reassessed Mr. Van Steenis for his interest expense deductions from 2013 to 2015, denying the portion related to his personal expenses.

Requirements for interest deductibility

As background, there are four requirements for interest deductibility:

  • interest must be paid or payable in the year.
  • it must be pursuant to a legal obligation on the borrower to make the payment,
  • the money must have been borrowed for purpose of earning income from a business or property, and
  • the amount of interest must be reasonable.

Importantly on the third point, it is the current use of borrowed money that is relevant in determining the income-earning purpose. On appeal, Mr. Van Steenis’ position was that he borrowed the money in 2007 to purchase mutual fund units, and that he continued to own those same fund units in the years in question, so therefore he should be entitled to continuing interest deductions.

Furthermore, he had no control over how the fund company characterized the distributions. He argued that though the fund was returning capital from its perspective, that does not necessarily correlate with each unitholder’s actual invested capital, and therefore he should not be bound by that characterization.

Ruling on continuing purpose

The judge did not accept Mr. Van Steenis’ arguments. Almost two-thirds of his capital was returned to him over the years, and more than half of that was used for personal purposes. Returning to that third deductibility requirement, there was no longer a direct link between the borrowed money and investment in the fund units.

In support of this finding, the judge points to the fact that a mutual fund trust is by its nature a flow-through structure. Income that it distributes to unitholders is included in their income and deducted from the fund’s income. By contrast, capital distributions result in a dollar-for-dollar reduction in the unitholder’s adjusted cost base, according to specific provisions of the Income Tax Act.

In sum, a return of capital reduces the amount of the investor’s own money that is in fact invested. If the entire returned capital had been used to reduce the borrowed principal, all ongoing interest charges would have been deductible because all remaining outstanding indebtedness would still be directly connected to the fund units.

As it was, more than half of that money was spent on personal expenses, and you don’t get a deduction for personal spending.