Tuesday, January 21, 2014
Bonds - A Worthwhile Investment?
Should you invest in bonds? Short answer: not right now. Long answer: bonds seems attractive. Bonds issued by a government, or a high-quality, well-performing corporation are quite secure and provide guaranteed cash flow. However, bond prices (their value) falls when interest rates rise. Why, you ask? Because if you own a bond that pays 3% interest, then rates rise to 4%, people will not want to buy your bond at face value (the amount you paid for it when it was issued) because they can now get new bonds that pay higher interest. If you invested $100 in a bond at 3% interest, you get $3 per year. New bonds now pay $4 per year interest on that same $100 investment. So, in order to get people to buy your bond (assuming you want to sell it), you have to sell it at a discount. In this example, you'd have to sell it for $75 ( 3/75 = 4%), since at that price level, investors would be getting the same 4% return as if they'd bought one of the new bonds. And as we're currently in an environment where interest rates are at an all-time low, they can only go up. So bonds can only perform worse than they have been lately.
All this being said, bonds can be used to stabilize a portfolio. Assuming you hold a bond to maturity, you have a (nearly) guaranteed set of cash flows and principal. You may only get 3% interest on it, but you're sure to get this 3% per year and recoup your investment when the bond matures (assuming its a government bond or high-quality corporate bond). Less risk = less investment return.
I personally wouldn't be investing in bonds right now, unless you can get a high-quality bond that pays 5% or more per year, and you intend to hold it until it matures.
Tax Free Savings Accounts
It has come to my attention that not many people are aware of all the features of the TFSA. Most people think it's just a savings account that happens to be tax free. This is costing people a lot of money.
A huge part of the problem is in the name. It should have been called the Tax Free Savings Plan, or the Registered Savings Plan. Adding the word "account" just confuses people. The TFSA is similar to the RRSP in many ways, the major one being that any investments held within it grow tax free. You will never pay any tax on any investment gains, dividends, interest or other forms of gains on the investments held within your TFSA. However, unlike the RRSP, there is no tax deduction. With the RRSP, you pay income tax when you withdraw the money from your RRSP in retirement (hence why the government gives you a tax refund if you contribute to an RRSP). With the TFSA, you pay tax right away (meaning the money you invest in your TFSA is after-tax money, since it comes from your take-home pay). The benefit is that you will never pay any form of tax ever again. No tax on investment gains, no income tax on TFSA withdrawals.
Pretty much any investment that is eligible for an RRSP is also eligible for your TFSA. Stocks, bonds, GICs, mutual funds, ETFs, and others. So don't waste this valuable tax advantage by putting your annual TFSA contribution in a plain old savings account. Invest like you normally would.
So here's a point-form description:
1) TFSA investments grow tax free (like an RRSP)
2) Your TFSA contributions are not tax deductible (unlike an RRSP). However, this means that since you've already paid the income tax on the money you invested, you will never again pay any form of income tax on anything to do with your TFSA (unlike the RRSP, where your withdrawals are taxed later on)
3) The annual contribution limit is $5,500 per year (contribution room that isn't utilized carries forward)
4) If you withdraw money from your TFSA, you can only re-contribute it the following year
5) TFSA is just a term like RRSP - meaning that the TFSA is a registered account(s) where you can hold all sorts of investments
6) Think of the TFSA as a Tax Free Savings Plan - not calling it an Account will make it easier to remember that it can hold all sorts of investments
7) Money withdrawn from your TFSA in retirement is not considered income - unlike the RRSP. This means that income-tested government benefits (such as Old Age Security payments) will not be affected. If you withdraw $80,000 a year from your RRSP, the government will tax you on that income and start clawing back your OAS payments. If you withdraw $80,000 from your TFSA, you will not only owe no income tax at all, but your OAS payments will not be affected.
A huge part of the problem is in the name. It should have been called the Tax Free Savings Plan, or the Registered Savings Plan. Adding the word "account" just confuses people. The TFSA is similar to the RRSP in many ways, the major one being that any investments held within it grow tax free. You will never pay any tax on any investment gains, dividends, interest or other forms of gains on the investments held within your TFSA. However, unlike the RRSP, there is no tax deduction. With the RRSP, you pay income tax when you withdraw the money from your RRSP in retirement (hence why the government gives you a tax refund if you contribute to an RRSP). With the TFSA, you pay tax right away (meaning the money you invest in your TFSA is after-tax money, since it comes from your take-home pay). The benefit is that you will never pay any form of tax ever again. No tax on investment gains, no income tax on TFSA withdrawals.
Pretty much any investment that is eligible for an RRSP is also eligible for your TFSA. Stocks, bonds, GICs, mutual funds, ETFs, and others. So don't waste this valuable tax advantage by putting your annual TFSA contribution in a plain old savings account. Invest like you normally would.
So here's a point-form description:
1) TFSA investments grow tax free (like an RRSP)
2) Your TFSA contributions are not tax deductible (unlike an RRSP). However, this means that since you've already paid the income tax on the money you invested, you will never again pay any form of income tax on anything to do with your TFSA (unlike the RRSP, where your withdrawals are taxed later on)
3) The annual contribution limit is $5,500 per year (contribution room that isn't utilized carries forward)
4) If you withdraw money from your TFSA, you can only re-contribute it the following year
5) TFSA is just a term like RRSP - meaning that the TFSA is a registered account(s) where you can hold all sorts of investments
6) Think of the TFSA as a Tax Free Savings Plan - not calling it an Account will make it easier to remember that it can hold all sorts of investments
7) Money withdrawn from your TFSA in retirement is not considered income - unlike the RRSP. This means that income-tested government benefits (such as Old Age Security payments) will not be affected. If you withdraw $80,000 a year from your RRSP, the government will tax you on that income and start clawing back your OAS payments. If you withdraw $80,000 from your TFSA, you will not only owe no income tax at all, but your OAS payments will not be affected.
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