Financial Jungle

Darren Rowse from ProBlogger is hosting another get-together among bloggers. The mission is to write a top 5 list on any topic relevant to the blog, and the winning price is a cool $1001. But more importantly, I want to elevate Financial Jungle’s presence in the blogging ecosystem, and mingle with fellow bloggers who share similar interests.

A discussion over at MillionDollarJourney prompted me to do a little digging into Market Growth GICs offered by Canadian banks. Many investors are risk-adverse, while not wanting to relinquish the growth potential of the stock market. This is why Market Growth GICs are so seductive. Investors’ original principal is guaranteed regardless of what the market is doing, while the performance is linked to the market indices tracked by the products. Being a cynic, I’ve investigated and uncovered the following five gremlins of Market Growth GICs:

1. No Dividends – They stole my precious!
Although Market Growth GICs do track the underlying index, investors forgo the dividends issued by the securities along with the juicy dividend tax credits. As an example, the iShares S&P/TSX 60 ETF rewards their investors with 1.66%, which isn’t available to Market Growth GIC investors.

2. Higher Tax Rate - Give it to us and wrrrriggling! You keep nasty chips.
Since Market Growth GIC investors don’t actually own a piece of the index, gains on GICs are taxed as regular income instead of the more favourable tax treatments from conventional capital gains. For instance, if you’re in the 40% tax bracket, you owe 40 cents for every dollar made in GICs, while you owe only 20 cents in ETFs.

3. No Tax Deferral - NO! That would kill us. Kill us!
Taxes are due each year with GICs, while you can defer capital gain taxes for as long as you hold the ETFs. Let’s do a quick example. If you start with a $1,000 GIC that returns 10% each year, you keep only 6% after tax. Compound this to 5 years and you’re left with only $1,338. On the other hand, you can zoom ahead with ETFs by deferring taxes until the very last year, and are left with a generous $1,488.

4. Capped Return – Don’t follow the light.
A five-year Market Growth GIC offered by TD Bank caps the cumulative return at 60%. This is an annualized compounded return of 9.8%, which is the approximate long-term return for stock markets. As a result, investors have no upside potential relative to the index, while the down side relative performance is –9.8%.

5. No Capital Tax Loss Saving - Stupid fat hobbit, it ruins it.
In the event the market is still down after five years, the principal protection feature kicks in and you recover your loses, however you waive the tax-loss saving to offset capital gain taxes of your other investments.

Principal protection to me is an illusion, because inflation alone will erode the future purchasing power, which is ultimately what you’re trying to protect. If maintaining purchasing power is your objective, stop fooling around with Market Growth GICs, and buy a traditional a 5-year GIC instead at 4.47%. If you still want some exposure to the stock market without exposing yourself to market setbacks, segregated funds are good alternatives. Even though they’re somewhat expensive, you’re compensated with other benefits, which include estate planning advantages, automatic reset of death benefit guarantee, and creditor protection. An example of a segregated fund is CI Signature Dividend GIF which has a price tag of 4.18% MER.

Further readings:
- TD Canada Trust Market Growth GIC.
- How Segregated Funds Protect Your Investments (CI)
- How segregated funds work (Million Dollar Journey)

ps. thank you Canadian Capitalist for bringing this event to my attention.

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Always be nice to the people who play Lotto 6/49. You never know.

Although I’m not a frequent lottery player myself, the story is always the same. Like a regular Joe, I put off my will planning, tax filing, oil change, dentist visits, and etcetera. You name it. Yet, whenever I buy lottery tickets, I immediately kick off a fresh spreadsheet in my head planning how much to spend, how much to invest, how much goes to my parents, in-laws, siblings, relatives and friends. That’s right, my friends. You know the jackpot that I didn’t win? I was going to share it with you. How about that poker game, eh?

Not all investments must return tangible dollar figures. The odds of holding a winning ticket is 1 in 13,983,816, or 0.000007%. Why do people keep buying them when the odds are enormously low? Because it’s fun to dream, it creates excitement around the office, and it promotes positive thinking:

Ahhh, I stepped on dog poop! It must be my lucky day. I must buy Lotto 6/49.

Who says money can’t buy you (short-term) happiness? Don’t get me wrong, as I’m not a compulsive gambler. There is a propeller hat on my rationales. I usually wait for the big jackpots with these two theories in mind.

Theory One: Better Odds Without Paying More

Assuming a two-dollar ticket has a 1 in 13,983,816 chance of winning an initial jackpot of, say, $4 millions. If I wait for the jackpot to reach $28 millions, I can pool $14 with 7 friends to buy 7 tickets. Now I have a 7 in 13,983,816 chance of winning the same $4 millions for the same price.

Theory Two: Better Expected Return On The Dollar

7 in 13,983,816 is the same as 1 in 1,997,688. If you divide $28 million by 1,997,688, your expected return on a ticket is $14. Since each ticket costs $2, your expected return on a dollar is $14/2 = $7, or a little less if someone else holds the same numbers as you.

Boy. I’m such a nerd.