Taking Advantage of Value Stocks

A few posts back, we discussed how researchers Eugene Fama and Kenneth French found that small cap stocks over long periods provide higher returns to an investor than both the overall market average or the large cap stocks, such as the S&P 500 or the TSX 60. The famous "Three-Factor" paper in which they published these results also revealed that Value stocks present attractive properties for an investor.

What is a Value stock?
Any stock whose market price is low compared to some fundamental accounting measure such as book value, earnings, dividends, sales or cash flow is a Value stock. Value stocks are distinguished from their opposite, Growth stocks. The simplest classification, and the one used by Fama and French to describe the Value effect, is based on Price to Book Value. As with small companies, different index providers use different measures or combinations thereof to put stocks into the Value or Growth category. MoneyChimp's Index Styles page tells how the main index providers like Morningstar, Russell, MSCI Barra and Standard and Poors identify the Value stocks (see CanadianFinancialDIY's comparison and opinion on which Value index is best).

Why would Value Stocks interest an investor? Whichever index is used, the same benefits described below, more or less, are observed. It is worthwhile to note that the Value stock benefits also hold in different countries and markets (see William Bernstein's discussion of the Fama French findings and his assessment of actual US and international Value fund performance; another good source is the book All About Asset Allocation by Richard Ferri).

1. Higher returns - Over a long holding period of twenty years or more, Value returns significantly outpace - by 1% up to 4 or 5% annually - Growth and the overall market average. The effect is more pronounced among small companies than large ones. Another MoneyChimp page called Building Portfolios has a couple of simple calculators where a click will show the past performance results of Value vs Growth for large and small caps in the USA. It is essential to note that Value out-performance reliably occurs over long periods. Sometimes Growth stocks go on a run for multiple years beating out Value.
2. Non-correlation with the overall market - Value stocks do not move in tandem (i.e. are not correlated) with the total stock market average. Putting Value stocks into a portfolio with total market funds and other non-correlated assets like bonds and REITs lowers the volatility /risk of the overall portfolio.

Ways to Invest in Value Stocks

• ETFs for US and International Stocks - A couple of dozen choices can be found in the listing of Value Stock ETFs in Stock-Encyclopedia. For those who wish to combine the Small Cap and Value effect benefit, there are several Small Cap Value ETFs. Amongst the PowerShares International ETFs are a number of RAFI index funds, which use a form of value selection. There are ETFs for Europe (Symbol: PEF), Developed Markets excluding the USA (PXF), Developed Markets ex-USA Small and Mid-Cap (PDN), Emerging Markets (PXH) and even for Japan by itself (PJO).
  
• ETFs in Canada - There are two choices: iShares S&P/TSX Value Index ETF (XCV) and Claymore Canadian Fundamental Index ETF (CRQ).
  
• Mutual Funds - Hundreds of Value funds are available in Canada, covering both Canadian and US companies. To find them, go to GlobeFund's Fund Selector page, then in the box Option C / Name type in Value. It will be necessary to wade through the funds one by one to see exactly what criteria each fund uses - usually it is stated in the fund objectives - to determine value. Such mutual funds will go beyond using only fundamental ratios to pick what they consider to be value stocks and will analyze many aspects of each company to try to get superior returns, though only some succeed as the majority do not.
  
• Individual companies - Use a stock filter such as the Globe Investor Stock Filter (note that discount brokers such as BMO Investorline also typically have such a tool within their website) to select companies. Type in a maximum price/book value or price to earnings per share e.g. 1 for P/B and 12 for P/E and run the search. Click the Financial and Ratios tabs to see the numbers and click on the P/B column heading to sort low to high. The stock filter then also allows you to start narrowing the possible investment targets using other fundamental factors like net profits, sales growth, debt level etc. Listing the holdings of ETFs, which are all publicly available on their websites, is a quick way to find reasonably actively traded Value companies since the ETFs usually exclude companies with too little stock trading.

As their name suggests, Value stocks, in whatever form, can be a valuable addition to an investment portfolio.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

The Stock Market "Crashes" (Again) - What to Do?

Last week's stock market declines due to nervousness about the faltering finances and social unrest in Greece prompted news writers to trot out scary words like contagion, default, domino effect, rattled, catastrophe, abyss. Individual investors may feel rising nervousness and worry as to whether another crash as severe as the 2008 sub-prime meltdown is about to unfold. What to do and how to react is the question of the day.

Recognize, Channel and Control Emotions - We humans are not just rational machines. Threats to our well being, financial as well as physical, provoke instinctive fear and flight responses that crowd out our ability to think straight. Step 1 is to be aware of this reality. Markets are not disembodied beings but the collection of humans who trade. Institutional investors are people too and just as prone to emotional reaction. The net result is that markets can get carried away and over-react downwards out of fear. The negative consequences of Greece's problems and possible ricochet effects on other countries may be real, but overdone. Our objective is not to try to ignore our emotional reaction since it will only fester and since it may signal a real threat we should deal with. Our goal is instead to avoid the reactive response - usually to sell in a panic - and to harness our rational self as a second opinion for a considered response.

Control Techniques

• Develop a written investment policy and plan - having a plan such as described previously in a Written Investment Policy itself provides a psychological barrier to too-quick action. Your plan will, or should, take into account that stock markets are volatile and downturns, often significant, do occur. Explicitly envisage a downturn and think what you will do. Better yet, write down what you will do as that will help cement your commitment to actually follow the plan.
  
• Create distance between yourself and the event - Sleep on it, defer a decision till tomorrow, go do something pleasant for a few hours, write down your feelings about the crash. Even something as seemingly silly as pushing yourself physically away from the keyboard apparently helps objectify the market event and allow you to deal with it with a cooler head. Ask yourself what someone else would do, or what you would do if you were managing someone else's investments. A tremendous book that talks about the effect of emotions and such techniques is Jason Zweig's Your Money and Your Brain.

Analyze the Threat - When the emotions have been calmed, it is possible to examine an event like a possible Greek sovereign debt default. Here are some factors to consider:

• Sovereign debt defaults are nothing new, and seem to happen in cycles, as Carmen Reinhart explains in Eight Hundred Years of Financial Folly at Vox EU.
  
• The 1997 Asian Financial Crisis (see summary on Wikipedia) was the last big crisis that caused fears of global financial meltdown. There was contagion to several countries. Though each crisis is unique and Greece could be different, note the size of the stock market "crash" through 1997 and 1998 in this Google Finance chart of the S&P 500. It looks quite small compared to the 2000 tech bubble bursting and the 2008 sub-prime crash.
• 
• 1998 also witnessed Russia defaulting on its debt and the collapse of gigantic hedge fund LTCM, prompting more concerns of financial meltdown. The lesson is that crises have occurred often in the past and the financial world has not imploded. There are options available and suggestions for arresting the Greek crisis from spreading to Spain, Ireland, Portugal and other highly indebted countries (e.g. Barry Eichengreen's It is not too late for Europe). To anticipate that it will be different this time and that financial Armageddon is nigh, one must almost suppose that public authorities will mess up through wrong actions or inaction.

Look at the Impact from a Portfolio Perspective - Investors who diversify have experienced much less loss because the market drop has primarily affected Europe. For instance, the average return since January 1st of a portfolio with these holdings would see a modest decline:

• iShares S&P TSX Composite ETF (symbol: XIC) that tracks Canada's TSX - down 0.3%
• iShares DEX Universe Bond Index (XBB), a mixture of Canadian government and corporate bonds - up 0.2%
• Vanguard European Equity (VGK) - down 15.7%
• SPDR S&P 500 (SPY) - down 1.1%
  

The market downturn may not be over yet as either the reality of countries' debt problems worsens or a possible market over-reaction runs its course. Nevertheless, managing our own emotions and building better expectations will help us get through this latest market nastiness more successfully.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

"Small is Beautiful" - Also True for Investing

The famous and influential 1973 book Small is Beautiful by E.F. Schumacher (see Wikipedia summary) proposed a philosophy that small is good for economics and business. Though the book did not address investing, the title applies to investing as well. Two decades after the book appeared finance researchers Eugene Fama and Kenneth French published ground-breaking results (what is now called the Fama-French Three-Factor Model) which showed that smaller company stock returns outpaced those of large companies over long periods, though at the cost of higher volatility or risk.

What is a Small Company?
They are companies whose total stock market value or capitalization is at the bottom end - thus the term small cap. It is a relative term, where the dollar limit varies by different stock exchanges, mutual funds, ETFs and search tools. The TSX Small Cap Index sets a range of C$100 million to $1.5 billion in quoted market value. In the USA, one popular index is the S&P SmallCap 600, which sets a range of $250 million to $1.2 billion.

Higher Returns and Volatility of Small Companies
The charts below illustrate this reality using Google Finance charts of prices of US and Canadian ETFs that track the small cap sector.

1) Long Term Outperformance - Since June 2000, the small cap iShares S&P 600 Small Cap 600 Index ETF (symbol: IJR) has gained 87% while the total market iShares Dow Jones U.S. Total Market Index (IYY) has lost 10%.

That return advantage is not typical or sustainable over the very long term. Since the 1920s the excess return of small cap stocks in the USA vs large caps has been about 1.5% per year.

2) Volatility - During the recent financial crisis from mid 2007 onwards, small cap stocks in Canada, as measured by the iShares S&P/TSX Small Cap Index ETF (XCS) dropped significantly more than the overall market tracked by iShares Capped Composite Index ETF (XIC) and they still have not regained the lost ground.


Pros and Cons of Small Companies as Investments

• potential for faster growth that is often realized - large companies are so big they cannot and do not grow as quickly - thus the higher returns from small caps
• higher risk of business trouble - the counterpart of faster growth is a higher failure rate for individual companies
• much less tracking and analysis by professional and institutional investors or the business press, so less information is available about smaller companies. This in turn translates into both higher risk and more opportunity for individual investors to find mis-priced stocks.
  
• lesser trading volumes which can mean higher spreads between bid and ask prices and possibly illiquidity, where it is hard to buy or sell
• relatively uncorrelated with other asset classes, which can bring diversification benefit to a portfolio (for how this works and why it is important, see How to Diversify without "Diworsifying" and Asset Allocation: the Most Important Investment Decision You Will Make)
  

Ways to Invest in Small Caps

• ETFs in the USA - For US companies there are several dozen different choices - see the listing of Small Caps in Stock Encyclopedia
• ETF in Canada - For Canadian small companies there seems to be only one ETF at the moment: iShares S&P/TSX Small Cap Index ETF (XCS). ETFs are typically passive index trackers and simply mimic the market.
  
• Mutual Funds - Hundreds of funds are available in Canada, covering both Canadian and US companies. To find them, go to GlobeFund's Fund Selector page then in Option B Asset class pick the US or Canadian Small/Medium. Mutual funds almost always try to outperform the market through active stock selection though only some succeed as the majority do not.
  
• Individual companies - Use a stock filter such as the Glove Investor Stock Filter (note that discount brokers such as BMO Investorline also typically have such a tool within their website) to select small cap companies. Simply type in market cap size minimum and maximum limits (e.g. ones noted in the ETFs above) and run the search. The stock filter also allows you to start narrowing the possible investment targets using fundamental factors like net profits, sales growth, debt levels etc. Listing the holdings of ETFs, which are all publicly available on their websites, is also a quick way to find reasonably liquid small companies since the ETFs usually exclude companies with too little stock trading.

Portfolio Allocation: Authors like Richard Ferri in All About Asset Allocation and William Bengen in Conserving Client Portfolios During Retirement recommend that small companies make up 5% to 15% of a total portfolio depending on individual circumstances.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tech Stocks Revisited Ten Years After the Bubble

Remember tech stocks and the gigantic bubble of the year 2000 followed by the equally severe crash to the bottom in October 2002? How could we forget with the troubles that ensued from the subsequent demise of many companies, which persist to today, most notably with Canada's former tech leader Nortel. What has happened since 2000 and what lessons can be learned?

Tech Stocks have not yet recovered to the peak! - Ten years on, the value of tech shares as a whole are not even close to attaining the peak attained at the end of March 2000. An investor who had bought at the peak an ETF like the Technology Select Sector SPDR (symbol on Amex: XLK), which holds a broad array of tech companies, would be down about 60% as of April 20, 2010. This is much worse even than the overall market, as measured by the S&P 500 Index, which is still 20% below the March 2000 high water mark (see chart below from Google Finance)

Even when measured from much earlier in the bubble on January 1, 1999, before the last euphoric rise through 1999 and early 2000, tech stocks are still down. A small dividend yield, not reflected in the above price graphs (the effects were discussed recently in TSX Composite and S&P 500 Total Market Return) reduced the loss somewhat but since its inception December 18, 1998, XLK has produced total returns averaging minus 1.6% per year. Add in the loss of purchasing power from inflation and, for a Canadian investor, the rise of the Canadian dollar over the US dollar (it has gone up from $0.65 then to more or less par today) and the results can only be termed awful.

Lesson: Once a bubble bursts, it stays burst. A miraculous bounce back doesn't happen and recovery takes a long, long time.

Tech stocks now track the overall market - In the time since the tech crash bottom in 2002, XLK, blue line in the Yahoo Finance chart below, has followed the general pattern of the S&P 500 Index, the orange line, but with peaks and dips. Ironically, the most recent section of the line over the past year and a half has remained consistently above the S&P500 because tech stocks did not fall as much during the 2008 crash when financial stocks declined the most. Since the March 2009 bottom, XLK has paralleled the S&P 500 very closely. This should not be too surprising since the tech sector comprises the largest single sector of the S&P 500, constituting about a fifth of the asset weighting.


Lessons: Tech stocks have slowly become normalized after the 2000-2002 bubble and crash and now are a core part of the stock market, reflecting the fact that information technology and the Internet play a key role in the economy. The length of the tech stock recovery, noted above, is actually a good thing. The stocks are being treated more in line with the overall market.

Most tech stocks have been losers but some are big winners - While the average and the overall mass of tech stocks has been down, when we drill down into individual companies we find a big majority of losers (again, we note, in reference to the bubble years) while a few have powered ahead and have even far exceeded the former peak of 2000.

The difference between the winners and the losers is not due to the success or failure of the company. Nortel's surviving competitor, Cisco, though consistently profitable, has not done wonders for its shareholders. Company success has not equated to stock investor success.

Stock Losers:
Among the highly profitable tech companies, whose names are well known to most people, and which have survived and thrived through the bubble years and continue to do so nowadays, but whose stock has languished as shown on the chart below, are: Microsoft (symbol: MSFT), Cisco (CSCO), AT & T (T), Intel (INTC), Hewlett Packard (HPQ), Oracle (ORCL) and Yahoo (YHOO).


Stock Winners:
On the other hand there are companies which have provided returns ranging from the weakly positive like IBM (IBM), with a 23% gain in ten years, to the middling, such as Symantec (SYMC), right up to superstars such as Apple Computer (AAPL) with a 678% stock price appreciation, Google (GOOG), up 412%, and Canada's very own Research in Motion (RIMM), up 228%. However, as the chart below illustrates, there have been lengthy periods when the stock was in losing territory and other times of significant drops. How many investors could and did retain their faith in the future and actually achieve those gains, one wonders?


The big question - why have some successful companies' stock performed poorly while others have done well? The answer is as individual as the company as one or more possible reasons may come into play:

• Fads - The same mass psychology that caused the tech bubble and crash, has not disappeared and some companies may benefit, or suffer, from this factor
• Future growth prospects - Investors may bid prices up or down, justifiably or not (see fads above!) according to whether the company is in the right or wrong segment e.g. are Apple products, iPhones, iMacs, iPods, etc not the rage currently and in the sweet spot of public demand? Does Microsoft seem a bit passé?
• Employees get the profits, not the shareholder - Some tech companies seem to make a habit of issuing huge amounts of stock options to employees, diluting the share base, and then buying back shares with cash profits, which in effect is an indirect payment to employees.
  

Lessons - With the bubble and the crash long past, the only way to proceed vis-a-vis individual companies is to dive into the analysis of each company - its financial statements, its market position and products, its competition etc - the traditional disciplines of stock assessment. Failing that, owning tech stocks through a broad diversified fund - perhaps a tech ETF such as XLK, or a general market fund such as an S&P 500 or a Total Market fund - is the cautious way to go.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Canadian Equity Market Darlings and Dogs - the Tale of Two ETFs

Want a quick snapshot of those sectors and companies which are currently in or out of fashion with investors and to possibly get a clue to over- or under-valuation? A comparison of the two Canadian ETFs - iShares Large Cap 60 Index (XIU) and Claymore Canadian Fundamental Index (CRQ) - provides the means to do so.

XIU reflects market sentiment since it weights its holdings according to market capitalisation based on current market prices. CRQ reflects recent past actual accounting results since it weights its holdings according to a combination of four accounting (which Claymore calls Fundamental) factors - cash flow, dividends, sales and book equity value. XIU reflects expectations of the future, while CRQ reflects the past. The two are a pretty good match since XIU holds the 60 largest stocks by market cap while CRQ holds the 65 biggest by fundamentals. If a stock or industry sector in XIU has a bigger percentage of the ETF's total assets than CRQ does, it means the market has bid up prices on that stock or sector in the expectation that higher returns will occur there. In the table below, these are called the Market Darlings. The opposite is true for underweight holdings - the market thinks those stocks/sectors will do poorly in future. These are the Market Dogs.

Market Darlings

• Energy and Materials - big bets are on oil and mining companies, like Suncor (SU), Canadian Natural Resources (CNQ), Barrick (ABX), Potash Corp (POT), Goldcorp (G), Cenovus (CVE). That's where the gold is thought to lie, literally and figuratively.

Market Dogs

• Financials! - wow, the over 13% under-weighting difference is huge; the markets dislike banks and insurance companies - especially Manulife (MFC) and SunLife (SLF)
  
• Consumer Staples and Consumer Discretionary - no company in these sectors even appears in the top twenty holdings of XIU; companies like Magna (MG.A), Tim Hortons (THI), Shoppers Drug Mart (SC) and George Weston (WN) are definitely out of favour
• Utilities - as a group are virtually absent from XIU, with tiny holdings of companies like Fortis (FTS) and TransAlta (TA)
  

The Chart for Details The Darlings are Green while the Dogs are Red. Wikipedia's article on the S&P/TSX 60 Index shows all the 60 stocks with their sector.


The Big Question for the Investor: Are those stocks which are overweight in XIU overvalued, or those underweight possibly undervalued? In the former case, there may be short-selling opportunities while in the latter case, simply buying the stock would produce good returns.

The above observations in this post can only be a starting point for further investigation since it is quite possible also that the overweight stocks are not overvalued at all (or the reverse, for the underweight stocks).

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Five Tax Tips for Investor Couples and Families

Last week's post noted five ways any investor can use to legitimately minimize taxes. This week, let's look at strategies specific to couples and families.

All strategies involve income splitting - The objective is to equalize taxable income within a family to lower total taxes, since paying a combination of middle range tax rates means paying less tax than a low-rate or a nil-rate and a high-rate together. Canadian Tax Resource blog provides a short primer in What is Income Splitting?

1. Loan to Spouse/Child at CRA Prescribed Rate - When a high income (and thus high tax rate) earner loans his/her family member money to invest, the gains or income on the investments will get taxed in the hands, and at the lower rate of, the family member. Result: the couple overall will pay less taxes. CRA specifies here the Prescribed Rates on a quarterly basis that allow this to be legitimate. Use the rate labeled " taxable benefits for employees and shareholders from interest-free and low-interest loans". Income Splitting at TaxTips.ca describes more rules on how to do this properly and works through an example. The current rate of 1% is as low as it ever can be (since it must be a positive whole number). Now that talk is turning to when interest rates will rise, the absolute ideal time to implement the loan strategy may be soon. If interest rates rise there is a quarterly lag between when rates have risen and when CRA changes the Prescribed Rate e.g. the 1% rate in effect now is valid at least till June 30th. Meanwhile, the 1% rate is locked in for the life of the loan. That loan becomes increasingly attractive as rates rise and as income and tax savings received by the lower income person compound. The high earner reports as income on his/her tax return the 1% interest received while the low earner can claim the interest as a deduction. A final advantage of the minuscule 1% rate is that since the rules dictate that the interest must actually be paid, the amount will still be small even with a substantial loan (e.g. 1% of $100,000 is only $1,000 interest).

2. Contribute to Spouse's TFSA - The high income spouse, having used up his/her own $5000 annual contribution room, puts money into the TFSA of the low income person. There is no attribution of income back to the high income spouse and the amount grows tax-free.

3. Contribute to Spouse's RRSP - Using the high income earner's own contribution room, income from amounts put into the spouse's RRSP will not be taxed back in the high earner's hands if not withdrawn in the year of contribution or in the prior two years.

4. High Income Spouse Pays Bills (including even income tax payments) with non-deductible cash while the low income spouse invests to earn income that will be taxed at a a lower rate. A variation on this method is for the low income spouse to take out an investment loan from an arm's length third party, e.g. a bank, while the high income spouse pays the interest on the loan. The low income spouse still gets to deduct the interest as an investment expense while all the income is taxed in his/her hands and not in those of the high earner.

5. Transfer Very Low Income Spouse's Dividends to High Earner - If a person has such low income that there is no tax to pay, the dividend tax credit, which is only applicable against tax owing, may not be usable. Combined with the fact that any income (such as dividends) the low income spouse earns reduces the spousal credit amount dollar for dollar, it can be advantageous, and is permitted, for the high income taxpayer to report the dividends received by the low earner on his/her return. KPMG's book Tax Planning 2010 suggests doing the calculation both ways to see what gives off the lowest tax to pay. Should my spouse and I file our tax returns together or separately? on TaxTips.ca gives helpful explanation. Some of the tax preparation software packages automatically figure out the best way if both spousal returns are done with the same package.


Disclaimer: this post is my opinion only and should not be construed as investment or tax advice. Readers should be aware that the above are food for thought and are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Some strategies are more complicated and will not work if not carried out precisely in keeping with the tax rules. Do your homework before making any decisions and consider consulting a professional advisor.

Five Tax Tips for Investors: Capital Gains, Foreign Investments and Charity

Structuring one's affairs to pay no more than the legal minimum amount of income tax is perfectly ok, as Canada's tax collector, the Canada Revenue Agency, states in the first point of the Taxpayer Bill of Rights in CRA's Making A Difference. To that end, here is a list of short and long-term tax reduction ideas for investors to consider and investigate:

1. Carry Back Capital Losses Against Previously Reported Gains - If you have losses that exceed current year capital gains (you must first use your losses against current year gains), you are able to offset previously reported gains for any of the prior three tax years and get a refund of taxes paid. TaxTips.ca explains in Capital Losses how to make the claim. The losses can also be carried forward indefinitely to offset future capital gains. Though all capital gains and losses must be reported on the tax return in the year incurred, it is worth considering past and future marginal rates - claiming the loss against gains saves most tax when marginal rates are high. If you neglected to report a capital loss thinking it did not matter at the time, it is still possible to file an adjusted return (using the T1-ADJ form) for past years and then to use the loss against gains today or in future.

2. Use Past Capital Losses Against Current Year Gains - Last year's Assessment Notice from the CRA will state the amount of any accumulated losses that can be used in the current tax return to offset gains.

3. Select A Favourable Exchange Rate for Reporting Income from Foreign Investments - The CRA allows a taxpayer to choose either the average rate for the year or the rate in effect on the day the income was received. The Bank of Canada publishes rates acceptable to CRA here. If the year average is much higher than the day income is received, the taxpayer ends up with more taxable income in Canadian dollars to declare, which means higher taxes. For instance, the 2009 average rate of Canadian dollars per US dollar was 1.141977 but the year-end rate was only 1.0510. If most of the foreign income came in with year-end distributions, using the year-end rate will produce less Canadian dollars to declare. One caveat is that the same method must be used for all investment income in a particular tax year.

4. Optimize Reporting of the Foreign Income Taxes Paid - When you receive foreign income in a taxable account, (e.g. dividends or interest from US investments), the foreign government deducts tax, usually 15% (the standard amount in international tax treaties). The 15% deducted can be claimed either as a Foreign Tax Credit or as a combination with a Line 232 "Other Deductions". Finding the exact best mix is a circular calculation only determined by trial and error but it can reduce Canadian tax you would need to pay. TaxTips.ca's Foreign non-business income tax and foreign tax credit explains how this works. CanadianFinancialDIY discovered last year that one of the tax preparation software packages TaxChopper performs this optimization calculation automatically.

5. Donate Securities In-Kind to Charity - If the securities have a capital gain, selling the securities and donating the cash to a charity will oblige you to pay a tax on the capital gain. Instead, transferring the securities in kind to the charity as a special tax rule exempts the gain from any tax, as noted in resolution 9 "Donations of Securities" of the May 2008 eMonthly newsletter from financial publisher CCH. The full market value of the donation is still eligible for the charitable tax credit. You can contact the charity to learn how to do this, or you can donate securities online through CanadaHelps.org.

Next week's post will outline special ways by which investor couples or families can minimize their taxes.

Disclaimer: this post is my opinion only and should not be construed as investment or tax advice. Readers should be aware that the above are food for thought and are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Some strategies are more complicated and will not work if not carried out precisely in keeping with the tax rules. Do your homework before making any decisions and consider consulting a professional advisor.