A Compendium of Essential Tax Resources and Links

The April 30th deadline for filing 2008 personal income tax reports has come and gone but tax planning is a never-ending process and indeed is more effective done far in advance instead of at the last minute, so here is a list of tools, information sources and calculators for Canadian investors.

Portals
1. Taxtips.ca - rules, tips, tax rates, federal/provincial budgets, accounts (RRSP, RRIF, TFSA etc), glossary, calculators
2. Taxes.ca - no calculators but everything else above plus lists of professionals, links to many government tax websites, blog
3. Canada Revenue Agency - all the official stuff like forms, bulletins and guides, plus a helpful primer on income tax, info on newer deductions, how to Netfile a return electronically with list of approved software; good search tools, FAQs and topic directories

Calculators - for tax planning and estimation
4. Ernst & Young 2008 personal tax - ultra-simple, enter your taxable income and the calculator estimates (using the basic personal tax credit only) income tax for each province in total and marginal rates on eligible and ineligible dividends, interest/ordinary income and capital gains, very handy when you have a taxable and tax-sheltered investment accounts to see which types of securities should go in which account
5. Ativa.ca - neat graphical display with slider to show same thing as Ernst & Young
7. Taxtips.ca Canadian Tax Calculator - the intermediate to advanced version, like an abbreviated tax form with various types of income, deductions and credits

Tax News, Tips and Blogs - to remind us all of the latest developments, the implications, the gotchas and possible strategies to legitimately minimize what we pay
8. Grant Thornton Domestic Tax Service - tax news with tips for individuals from a professional firm
9. Ernst & Young Managing Your Personal Taxes 2008-09 - includes 15 pages on investing in the 87 page guide
10. Journalists Tim Cestnick (Globe and Mail), Jonathan Chevreau aka Wealthy Boomer (National Post), Larry MacDonald (Canadian Business)
11. Individual Bloggers Canadian Capitalist, Thicken My Wallet, Million Dollar Journey, Canadian Personal Finance Blog, WhereDoesAllMyMoneyGo by Preet Banerjee - gain from their experiences but be aware that they are not professionals and their opinions are just that, not advice, as is the case with this blog
12. Books - buy them online, read them offline at leisure; many titles are available at Chapters or Amazon. One I've used and found very useful with intermediate level detail is Tax Planning for You and Your Family 2009 by KPMG professionals from Carswell Publishers. Usually the "Dummies" series books are solid, so Tax Tips for Canadians for Dummies 2009 is likely a good intro level book.

Software - to prepare and Netfile income taxes electronically
13. List of CRA-certified programs with links to the companies
14. Reviews and assessments - Wikipedia, CanadianFinancialDIY on the web versions

Oh, and one bonus set of helpful links to reduce the stress - tax humour!
Tax Blogger, Taxes.ca, Income Tax Humour, Tax Humor (Tom Anton)

Using Indices to Benchmark Your Investment Results

Once you have investments, you probably, or should, want to know how they are doing. A natural first check is simply to look at an account statement and see if the investments are up or down. Next might be a comparison to the rate of inflation at the Bank of Canada to see if you have gained or lost in real terms.

Markets as a Benchmark
A third measure is to compare against how everyone else is doing, in other words against the market. Doing better than the market - out-performance - is a more severe test of success. For example, if your investments went up 8%, that might seem quite good. However, if the overall market went up 12% then you are 4% short of the average, not so good. Conversely, in 2008 stock markets everywhere were significantly down, anywhere from 30 to 45%, so if your investments only went down 10%, that was great performance!

What is a Market Index?
A market index, such as the TSX, the Nasdaq or the S&P quantifies the rise or fall of a collection of stocks, which may represent a market like the TSX. The S&P / TSX Composite includes the largest and frequently traded companies traded on the Toronto Stock Exchange (TSX), currently 208 companies, which represent about 95% of the total value of Canadian equities. Or an index might represent a mixture of government and corporate bonds or other securities.

There are thousands of indices worldwide for stocks, bonds, commodities, real estate, industry sectors, regions, investing styles. Which securities are in an index and in what proportions can have big effects on performance numbers, so it is important to pick appropriate indices to really compare your apples with other apples and not with oranges or chimpanzees.

With that in mind, this post sticks to basics and commonly-accepted theory to suggest some principles and a list of indices for a Canadian individual investor.

Principles for Choosing Indices

• Asset classes for boundaries - assumes that you the investor look at your securities as a portfolio - an integrated whole diversified among asset classes; results in choosing broad indices and keeps the number down, thus easier to manage tracking
  
• Market capitalization weighting - presumes that the "market knows best" so that big companies are big in the index even if it seems out of line at times; avoids fundamental indicator selection and/or weighting, capped-weighting (a limit on how much of the index one company is allowed, going back to the tech bubble when Nortel made up 40% of the TSX at one point)
  
• Total return - incorporates dividends as opposed to price movements only since a dividend is real money in the account
• Canadian dollar (CAD) conversion - unless you plan to keep and spend the investment return in US dollars (USD) or whatever other foreign currency, then the value expressed in Canadian funds is the right yardstick and we know that currency swings can be dramatic, pushing returns either up or down. For the ones below that don't give values in CAD, go to the Bank of Canada currency converter for the beginning and end date USD-CAD rates
  

The Indices

1) Equity

• Canada - S&P / TSX Composite Total Return at Yahoo Finance
• USA - Dow Jones Wilshire 5000 (Full-cap) - 99.9% of the total of US equity vs only 80% for the better-known S&P500; includes selector to convert results into CAD and for any time period
• Global - excl USA
• Developed Countries - Dow Jones Wilshire Global Developed ex US; selector for dates and CAD currency; alternative is better-known MSCI Barra EAFE (Europe Australasia Far East) but value in USD must be converted to CAD
• Emerging Market Countries (incl Russia, India, China) - MSCI Barra EM (Emerging Markets); value in USD

2) Bonds

• Canada - DEX Universe Bond Index from PC Analytics
• USA - Lehman US Aggregate Bond Index
• Global - Lehman Global Aggregate Bond Index

3) Real Estate

• S&P Canada REIT, USA and Global available in CAD; to access you must register first but it's free.
  

4) Commodities

• Dow Jones AIG Commodity Index in Google Finance under symbol DJAIG; in USD must convert to CAD
  

Socially Responsible Investing - Putting Your Money Where Your Morals Are

Perhaps the ongoing financial crisis has made you leery of corporate ethics and you want your savings to be invested in companies that will save not destroy the planet? If so, you can consider the option of ethical investing, or as it is better known Socially Responsible Investing (SRI).

What is Socially Responsible Investing?
SRI means investing in companies or funds that meet criteria, either of doing or being good, or of not doing bad or making harmful products. Of course, what one person thinks is good or bad may not be so for another and a wide range of criteria are used to either screen in or out companies. Example criteria:

Negative Screens for the Bad - firearms, military weapons, nuclear weapons, nuclear power, alcohol, tobacco, gambling, pornography, animal exploitation / testing, human rights abuse, environmental harm, child labour, genetic engineering, support of dictators or oppressive regimes, unsustainable timber harvesting

Positive Screens for Good - environmental protection, pollution control, conservation, recycling, waste disposal, wind power generation, safety and security such as protective clothing, fire alarms, senior alarm systems, ethical employment, equal opportunities employment, public transportation, good corporate governance, aboriginal relations, community involvement

More on the pros and cons of screening criteria:
Jon Entine's Ethical Investing on the Corporate Governance website
CBC News' backgrounder Ethical Investing

How to Find SRI Companies and Funds?
There are many choices of SRIs amongst individual company stocks, mutual funds and exchange traded funds.

Mutual Funds: Jantzi Research provides a list here (click on the download of the Canadian SRI Investment Review 2008) of the 109 SRI mutual funds available to Canadians as of June 2008.

ETFs: There is only one Canadian ETF so far - iShares Canadian Jantzi Unit (symbol XEN) - though the Social Funds website reports that Claymore has decided to launch the Global Environment 60 Index ETF. There are also ETFs traded on US exchanges which are thus available to Canadian investors - see this handy list on Stock Encyclopedia. The names of many give an idea of which screens have been applied but the only real way to verify is to check the prospectus.

Companies: The quickest and easiest way to find SRI companies is to check the holdings of relevant SRI ETFs. Otherwise, look for information at index creators like Jantzi Research in Canada or KLD Indexes in the US.

It's ethical but is it profitable?
It is hard to give a definitive answer to this question. Mutual funds can be seen in the above-mentioned Jantzi list to both underperform and outperform relative to peer funds and to the related benchmark index. Differentiating the effect of the constraint of SRI from the results of good or bad analysis by active fund management is difficult. The relatively new iShares XEN ETF (it was launched in May 2007) seems to be tracking the TSX index quite closely as shown in the Google Finance chart below - the fact that the 60 holdings in XEN considerably overlap the top 60 in the TSX may simply mean that XEN is another form of the same thing.

With SRI, maybe it's possible to feel a bit better about investing. Certainly these days, that's a welcome change.

Is Putting Money into the Stock Market Just Gambling?

That question summarizes the disillusionment of many individuals who have watched stock markets plummet worldwide. Years of hard-earned savings have seemingly evaporated in a flash.

Let's compare gambling and investing.

Gambling in casinos, lotteries, sports betting etc. =

• win-lose - one person wins, the other loses, money simply moves from one to the other;
  
• odds stacked against the player, and a significant chunk of the total bet of all players ends up in the hands of the house;
  
• very short-term, at most a matter of weeks till the payoff comes, feeding on desires for instant gratification;
• a fixed date and time, most often not of your choosing, when the game is decided;
• wide payoff gap between winning and losing, more win-all vs lose-all than a just-get-your-money-back situation
  
• skill doesn't count for much in determining success, it's mainly random chance and where skill can be useful, like sports betting, odds-makers remove most of that possibility.

The bottom line for gambling - you have little or no control of the outcome and you are more likely than not to lose all the money you put into it.

The opposite is true of Investing.

First, buying stock means buying part ownership in companies providing products and services that are of real value in the real economy. By and large they are productive, grow and make profits and therefore there is a positive expected return to stocks. That does not mean they all make money all the time and that competition doesn't ever drive some right out of business but the overall odds are positive for gains that reflect a growing economy. Put another way, the stock market is not simply win-lose, it is more often win or greater win with some lose. The simplest and best way to achieve the benefit of overall market growth is to diversify by holding many companies in many sectors.

Second, there is lots of information available and skill can count a lot in successfully selecting the good companies and assessing reasonable prices for the shares. Skill, rather than luck, predominates.

Third, investment time lines are not fixed. No one forces an investor to sell shares and take a loss at the moment. If one's investments are down temporarily, it is possible to wait out market downturns. Stock market investment should not be short-term. To increase the odds in one's favour, the longer the period of investment, the better. When investing in equities, being able and ready to commit to leaving the money for ten years is a fairly safe rule. This chart from Assante Asset Management shows positive returns for every ten-year rolling period for major world equity indices since 1980.

The Bear-Bottoming Process chart image below from dshort.com shows how recovery eventually occurred from all the major recessions and bear markets since 1950, fluctuating around a trend line of long term economic growth.

At times it took very long for stocks to recover to previous peaks, the longest in the USA being from the 1929 crash to 1954 - 25 years later. That's why the diversity of a portfolio should extend beyond stocks to other asset classes, as discussed in previous post Asset Allocation, some of which will have positive returns when stocks do not. At the extreme, if you think we are in for a 1929-like crash, expect to die sooner than 25 years from now and want to spend all your money before dying, then stocks are not the best place to put money. As noted before in Setting Investment Objectives, the moment when funds are to be spent is a key consideration as to which type of investments - stocks or otherwise, to choose.

Gamble for long enough and you will almost surely lose everything but if you invest for long enough, you will almost surely not lose.

Income Trust Tax Issues for Investors

For an investor who seeks regular and substantial cash returns, income trusts are a potential investment. Currently the TSX Income Trust Index, which is the average of all the income trusts traded on the TSX, provides an annual cash yield (cash / market price) of over 9%.

It is important to recognize however, that income tax can alter the net return. The cash distribution can be one or several types of income that are taxed at markedly different rates when income trusts are held in a taxable non-registered account.

The income may be composed of one or more of:

• Other Income, including Foreign Income - taxed at the highest rate, 100% of a taxpayer's marginal rate (see the TaxTips.ca page with links to the rates for all Canadian provinces)
  
• Eligible Dividends - taxed at the lowest rate for most tax brackets, the amount varies by province but gradually scales up with total taxpayer income till it is about equal to capital gains
  
• Capital Gains - in most tax brackets is in between Income and Dividends at 50% of a person's marginal rate
  
• Return of Capital (ROC) - not taxed at all immediately though it reduces the Adjusted Cost Base of the investment with the effect that one pays capital gains when the income trust is eventually sold

Other Income does comprise the bulk of the distributions for most income trusts. The iShares Canadian Income Trust Sector Fund (symbol XTR on TSX) invests in the aforementioned index and its 2008 distributions broke down as approximately 81% Other and Foreign Income, 18% ROC, 1% Eligible Dividends and negligible Capital Gains.

The story doesn't end there because individual income trusts may diverge greatly from the norm and therein lies a potentially more attractive investment after tax.

Examples (2008 figures):

• Jazz Air Income Fund (JAZ.UN on TSX) - 100% Other Income
• Atlantic Power Corporation (ATP.UN) - 60% Other Income, 40% Eligible Dividends
• Epcor Power LP (EP.UN) - 68% Other Income, 32% ROC

Many of the trusts offering a good dollop of ROC or Dividends in fact fall into the utilities sector.

How To Find the Tax Distribution Breakdown
Unfortunately, there seems to be no centralized source with the breakdown for all income trusts. It is therefore necessary to look on each trust's website where the information for past years can be found under a link for Investor Information, Distributions or Tax Information. Most often a pattern is visible by looking at several years past - sometimes ROC is decreasing as companies use up the depreciation that generates the ROC, sometimes it bounces around a lot, as seems to be with Epcor and, sometimes it is stable.

Each year an investor will receive a T3 from the trust showing the actual numbers to report on the tax return. For the LP legal structure adopted by Epcor, the form is a T5013.

The Rule Change in 2011
Investors need to keep in mind that in 2011 all income trusts, except qualifying REITs, will begin to be taxed as corporations, ending the current system whereby all income is passed through before taxes to be taxed in the individual investor's hands. This means trusts will have a lot less cash to distribute after paying the corporate taxes. But the Other Income will then become dividends and the net after-tax amount for taxable investors will be about the same according to PriceWaterhouseCoopers' Planning for 2011 and Beyond (see page 6 of the report). Many trusts provide a statement on their website and in the annual reports as to how they plan to deal with the rule change and it is recommended reading before making an investment in a particular trust.

A previous post on Income Trusts discussed their potential and listed other important factors to investigate before investing. It is never a good idea to invest solely for tax reasons. Tax should be part of the overall assessment.

Disclaimer: this post should not be taken as investment advice or a recommendation of any particular securities. It is meant for information and to stimulate thought for the DIY investor.

Investing Ideas from Warren Buffett and Stock Market Superstars

Renowned investor and second richest man in the world Warren Buffett made a huge purchase of shares in investment banker Goldman Sachs at the very time last September when the world's financial system was on the brink of collapse. For a few months, it looked like a bad deal as GS continued to fall by half again to a bottom in November (see Google Finance chart for GS image below). The steady march upwards since then means that Buffett has made a 30% paper profit on the warrants alone.

A retail investor who had tagged along on Buffett's coat-tail and bought common shares at $133 on September 24th, the day his purchase was announced, would be up 12% as of June 5, 2009, when the price closed at $149.47. Add in the depreciation (see Bank of Canada's exchange rate converter) of the Canadian dollar (CAD) versus the the US dollar (USD) and the profit for a Canadian goes up to 19%.

Lessons from this example:

• picking winners is possible but not easy - there is a reason Buffett is so rich; though not infallible (and he admits to his mistakes, which many of us refuse to do - "it wasn't me, it was the market" - and thus fail to learn) his judgement and knowledge are more often right than wrong
• it takes courage, daring and risk to make a lot of money - few would dispute that the world financial system could have collapsed, taking GS and Buffett with it, yet he bet big - $5 billion is a lot even for Buffett (maybe 15% of his net worth). But should individual investors commit big like him? It is necessary to ask oneself whether one knows enough - a fool with courage is still a fool.
• patience and nerves are required too - imagine sitting there November 20th when the price had fallen to $52. The tough question at that moment - would it continue to go down or would it be time to sell as so many investors do out of resignation or disgust. It is interesting to note that today, despite being ahead by a healthy margin, Buffett is still not selling, unlike so many investors limit their gains by selling winners too soon. (I think he wants to reclaim richest man spot from Bill Gates of Microsoft)
• foreign currency swings can enhance returns, as in this case, or they can reduce them. As the financial and economic crisis seems to be abating, the Canadian dollar has been climbing against the USD, reducing the net gain on a GS investment.
• it's worth watching the moves of such savvy investors for ideas. The investments of a whole raft of US investors can be found on GuruFocus. There are highly successful Canadian investors too - people like Stephen Jarislowsky and Eric Sprott who seem all too willing to impart their opinion on the state of financial and economic affairs. Canadian Business magazine recently published a Top Ten Canadian Investors list.
  

Given that Jarislowsky is number 601 on the Forbes list of richest people in the world for 2009, with a few good ideas from him and other investing superstars maybe we can all move up a few notches too.

Note that any commentary here is just that - commentary - and not an investment recommendation.