Investment Strategies Financial Plan Lawyers

Developing an Investment Strategy

1. Determinants of Asset Allocation

The main question in determining the best investment strategy is: What is the most appropriate assets allocation, that is, the mix between shares, bonds and cash? The answer depends on a number of factors that have been identified in the net worth statement:

1. Total family income;

2. Lifestyle and personal expenses;

3. Liquid assets including cash, bank accounts;

4. Non-liquid financial assets, including pensions, RRSPs, tax shelters, annuities, investment portfolios;

5. Liabilities, including credit card debt, consumer loans, investment loans. mortgage.

Ideally, an individual should have 1.5 times amount of liquid assets to short term debt. the real estate fluctuates just like the stock market. The boo, and bust scenario evident in both markets shows why a long term perspective is necessary. Real estate over the past few years has been very strong in some cities and markets. This can be attributed to low interest rates. A decline in real estate can be predicated on high debt levels. What typically happens is that properties purchased for rental purposes are made with borrowed funds typically in a declining interest rate environment when income can pay for borrowed funds.

Real estate is an inflation hedge as are shares. This means a long term time horizon is essential to make an overall return. The 70's was a high inflation era so real estate appreciated. the 80's saw very high rates of interest which resulted in a declining real estate market. From 2001, with low rates, real estate climbed. Rates have been kept at low levels to avoid recession. The recession of 2008-2009 marked a collapse in real estate market.

2. Borrowing for investments

Borrowing to finance a personal property is not a tax deductible, but the money borrowed to make an investment may be tax deductible. Borrowing money in a low interest rate environment to purchase appreciating financial assets offers a potentially higher rate of return than the borrowing rate. The interest cost incurred to realize a capital gain is not deductible. The cost of borrowing in after tax dollars can be calculated using a 5.75% borrowing rate. For an individual in the highest marginal tax bracket of 46.41% in Ontario, the after tax cost would be approximately 2.66% assuming that one is borrowing at prime plus one with prime at 2.7%as of October 31, 2015. this also assumes that the borrowed funds are used to make investments which have the potential to provide twice the rate of return of the borrowed funds. This means one needs to find investments generating income and capital gains of 5% per year. Looking at the average Canadian equity return of 8%over 10 years, this seems a reasonable assumption. A pre-tax return of 8% produces a 4.8% after tax return for an Ontario taxpayer. In 30 year period, however equity returns have been closer to 9% with a 5.4% after tax return. The question is how to pay back and service the debt. An investment with excellent growth prospects but little income means that funds must be available to meet the monthly payments of the borrowed funds.

3. Time Frame

Time frame is the single most important factor to take into consideration in assessing how risk an investor is prepared to take. Time mitigates risk as any long term chart on equity investing demonstrates. An individual with a long time horizon can wait for higher returns in equities. In choosing the type of portfolio that is appropriate, it is helpful to examine the types of returns over the past 30 years. A 2% difference in rate of return over 30 years is significant . Examining rates of return on an initial investment of $35,000 invested at 8%, 10% and 12% return the difference is considerable. Looking at how a $5,000 annual RRSP contribution grows through compounding at different rates shows that after 35 years, there is over 60% more capital as a result of just a 2% improvement in the rate of return. The same points apply to investing outside the RRSP. Suppose an individual needs 12% rate of return. Fixed income is yielding only 1% - 4% currently in Canada. Bonds and corporate bonds are yielding higher rates of return. Such an individual must take more risk to achieve the needed higher rate of return. For example, interest rates in Canada are still close to 30-year lows with T-bills yielding 0.52%, and 10-year bonds yielding 1.55% as of October 31, 2015. Since adding equities to a fixed income portfolio enhances performance, this is clearly an answer for those who have a longer time frame and can assume more risk.

4. Measuring Performance

After portfolio has been in place for one year, it is important to evaluate its performance. The information required is the adjusted cost base of all securities and the date they were acquired. Ideally, a portfolio should have a rate of return that is consistent with an individual's objectives, and in line with the performance of the best money managers. Though it is wise to start evaluating performance after one year, two and three year plus rates of return are perhaps more important than one year returns. All too often, individuals see little performance in their portfolio in the short term. They alter a well thought out portfolio by selling specific securities or mutual funds for other securities and mutual funds to try and improve short term performance, only to find patience would have rewarded them. It is perhaps the hardest rule of investing to understand that the long term historical rates of return are generated by leaving a portfolio in place for a long period of time.

5. Definition and Features of Bonds

When structuring a portfolio for most mature clients, there is normally a significant fixed-income asset class. This is largely because income tends to declines individuals get older and bonds provide a steady stream of income. Also, if a client has a shorter time frame, the fixed income which is a lower risk asset class may be more appropriate. that is because the older client has less time to grow a portfolio, and will seek more returns that equities provide. Equities require a longer time frame due to their inherent volatility and risk. What, then are the merits of each specific asset class: bonds, shares and cash? A definition and discussion of the features of bonds will explain their value. Bonds are debt instruments issued by governments and corporations. The government issues debt to provide goods and services, and to provide transfer payments to the provinces which in return are passed on to taxpayer. Corporations issue debt to fund their operations and ongoing expansion.

The coupon rate is the rate affixed to the bond when a bond is issued. It is the coupon which determines the interest rate or yield. Bond prices fluctuate as soon as a bond starts to trade, and it is the market which determines the price of bonds on a daily basis. Bonds have traditionally been perceived as a low risk investment. Canadian government has never been known to default on its debt obligations, while Canadian corporate bonds are relatively risk free since corporations who issue corporate bonds have almost always been able to pay their debt obligations. Corporate bonds have a higher risk of default than government bonds since corporations can suffer poor business conditions or possible bankruptcy which would prevent them from repaying principal to an investor. The government can resort to raising taxes or printing more money to meet its debt obligations should this become necessary.

6. Interest Rate Risk

The primary risk in bonds that is not a government or company risk is interest rate risk. if one purchases a $100 bond at a specific price with a specific interest rate one is guaranteed the interest rate until maturity when one receives $100 face value known as par. thus, there is little risk that one's capital will be lost providing the bond is held until maturity, or interest rates decline and the bond is sold at a higher price than at which it was purchased. It is important to learn what the experts are predicting on the future direction of interest rates. then and individual's circumstances can be considered along with the macro-economic variables.