Tuesday, May 6, 2008

Spring, Summer, Fall, Winter and RRSP

Quote of the week:
'If half the available farmland in Germany were used to grow rapeseed, the total production would be 1,500 million litres of biodiesel, less than five percent of the total annual consumption of gasoline in Germany. On that same land it is possible to grow 6.8 million tonnes of wheat, or 41 million tonnes of potatoes. Germany has to choose between producing food or vegetable oil to run its cars.' - Michael Hopf from Greenpeace speaks about Biodiesel crops in Germany.

Surely this cannot be ... a choice no civilized nation should be asked to make! Drive on the autobahn, or eat food?

Commentary for the Week:

Spring, Summer, Fall, Winter and RRSP

Get ready my friends, RRSP season has arrived. This is the time of the year that most of us suddenly realize that the daily grind we go through to get out of our warm, cosy beds will come to an end one fine day. We will retire, - and no, I do not mean to a better place, although that too. I mean retire to the carefree, unemployed, cruising lifestyle that the TV and the millions spent in advertising the latest investments promise us as soon as we develop enough grey hair. For that remote hope, and our somewhat shameless tax-avoidance tendencies, every year we break out the cheque-book and spend 1 hour with our financial advisors investing our money. The TV and the ads with beautiful people assure us that we are on the right track and this RRSP season, we are good in hands. Alas, if only this were true.

For most of us, the RRSP is just a tax avoidance tool, a 2008 deadline to invest if we want to save 2007 tax, so that we can enjoy watching TV for the rest of the year without being asked for money by people too beautiful to say no to. People who, in my opinion, are so gorgeous and maddeningly happy that they have probably never been in finance, don't know a thing about the economy and don't know that the markets are crashing and that all our savings depend on what happens to the TSX, the DOW and maybe even an unknown Cow that is slowly and secretly going Mad (as in BSE) in an impossible place such as Shropshire, England. Also, these people cannot have my best interests at heart as they are always telling me that I want something sickeningly fatty to eat, or that I want to go for a speeding-ticket inducing drive in a tank-inspired SUV that probably needs a quarter of Kuwait's oil to get me to work tomorrow, even though they know that its already 8:30 pm and I just ate and the traffic was so terrible that it took me 40 minutes to cover the distance that would have taken me 4 minutes if I was in Germany and that there is no army on God's green Earth that can make me get into anything with wheels again this day ... but I digress.

Let's get back to RRSP's ... and the myths that surround their complexities. I know that we will all be bombarded with RRSP advice over the next month - I just think we should be prepared for battle.

RRSP's are a legal, 'approved by the government', tax-sheltered, trust account that allow us to save taxes while at the same time saving for retirement. Essentially a trust account held by a third-party for the purpose of providing us income during our retirement, RRSP's are like a basket that someone else is holding for you. Pushing this analogy a little bit more, think of me dutifully pushing around a shopping cart at the grocery store as my wife buys the latest organic mushrooms with the money I was saving for migration to Germany. My wife is the proverbial client, the shopping cart is the RRSP and I am the third party custodian of both the shopping cart and whatever she decides to put in it. She can fill it with good stuff like chocolate, or mouldy growths called mushrooms that pass for agricultural output in our advanced economy. What is in the cart is the actual food, whereas the cart itself is a mere vehicle. Similarly, what are placed inside an RRSP are the actual investments, the RRSP account itself is just a receptacle. The advantage of this receptacle is that whatever one puts in, can be written off against one's income for taxation purposes. This decreases one's taxable income, resulting in a larger tax refund because we have a progressive income tax regime. The other advantage is that whatever is placed in the RRSP also grows tax-free until withdrawal. This means that all growth of the investments inside the RRSP are tax-sheltered and no tax is payable on their growth and rebalancing on a yearly basis. This is true even if there is buying and selling within the RRSP and whether the growth is interest, capital-gains or dividends. Once you withdraw money however, the story changes quite a bit. Withdrawals are considered income by the CRA and so even if most of the growth in the investments held inside the RRSP is from capital gains, you will be taxed as if your withdrawal is income and at your marginal income tax rate. The idea here is to make your original investment grow to such an extent that this higher taxation still leaves you better off.

The other myth about RRSP's is that they have a season (this year's only goes to Feb 28th by the way, not March 1st). Saying that an RRSP contribution should have a season is like saying retirement will have a season, or that 1hr / year thinking about this stuff will allow you to live like the non-people on TV. I find this philosophy extremely problematic. Suppose your investments were like mushrooms instead of stocks or mutual funds, but that you still had to pay for them with your hard-earned money - this will make it more fun. For the first 2 months of the year, everyone else along with their Grandfather buys mushrooms. If the price of mushrooms is high at this time, you overpay for the mushrooms; if the price is low, you buy them at discount. You do not however, know whether the price is high or low at the time you are buying because you do not know if the price will be higher or lower the next month, the next year etc. etc. If you have consistently overpaid for mushrooms over 20-30 years of your working life, not only do you have a biggish collection of mushrooms, you have also spent relatively more to buy them. If you have underpaid relative to the average price however, you have mushrooms as far as your eye can see and they did not even cost you as much as they did in the earlier scenario. This last scenario allows you to either buy more mushrooms (so you can be even more comfortable), or have extra cash lying around. Since there is no predictable way or easy secret that I can give you about how to always be in the underpaying category - you have to be creative. Instead of risking all your cash in one go in Jan or Feb for the previous year's taxes, you have to be pro-active. Instead of buying $19,000 (this year's max contribution limit for some people) of mushrooms in Feb, buy only $1583.3 of mushrooms every month instead. This will ensure that you are buying mushrooms not at one price that might be high, but at an average yearly price. You gamble less with your money this way.

To me, the average price method called Dollar-Cost Averaging (you can ask Sheikh Google) is safer, otherwise you might be stuck with only a few mushrooms in retirement. Surely, having many is better.

(Please do not be offended if you are one of the non-people on TV, I listen to the radio and I am pretty sure that there are some non-people in there as well. Also, for those who did not like the mushroom analogy, I reply that many investments are just like mushrooms - quite mouldy. If you prefer, you can read the name of your favourite stock instead of the word mushroom whenever you come across it because the principle still stands. Also, for those who need discuss their RRSP strategy, if you can get 5 new people to subscribe to this newsletter, I will help you for mere mushrooms - we are sitting at around 1800 subscribers, I would like to get at least another 200 soon).

Finance News:

1. The geniuses that invested in Citi last month are probably not too pleased with this piece of news ... a $10 Billion loss at Citibank with an $18 Billion write-down of assets ... (in addition to all the others that they have announced already) ... http://www.nytimes.com/2008/01/15/business/16citi.html?fta=y

2. Must read story of the week ... about the fund manager who made over 500% for his investors over the subprime issue ... http://online.wsj.com/article/SB120036645057290423.html?mod=hpp_us_pageone ... and how he has hired Alan Greenspan, the man many blame for that mess in the first place ... http://online.wsj.com/article/SB120036783112890507.html?mod=hpp_us_whats_news

3. Who was it that said that subprime would have no effect on the TSX? ... Jeffrey Rubin - Chief Economist at CIBC? ... (refer to IWB issue 3. or http://www.advisor.ca/news/article.jsp?content=20071108_152122_5120 ) ... and now for more of the truth ... http://www.financialpost.com/story.html?id=242110 ... (although since it is the Post, I use the term truth quite loosely) ...

4. Doing an Alwaleed? ... the investment behind the Saudi Prince's fortune ... http://www.economist.com/daily/columns/businessview/displaystory.cfm?story_id=10522716&fsrc=nwl

Economic News:

1. Shocking ... a good article from Marcus Gee?! ... shocking ... do read the article of course because it speaks to how Canadian businesses can begin to expand into foreign markets using the HR resources they have at here at home ... still can't believe it was written by Marcus Gee though ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080116.wibasia0116/BNStory/robColumnsBlogs/home?cid=al_gam_mostview

2. Need some explanation about currency movements and what the loonie's rise means for the Canadian economy? ... a thought-provoking article about a professor with whom many would disagree. Nevertheless, there is some insight here that we can learn from ... http://www.reportonbusiness.com/servlet/story/RTGAM.20080116.wrreynolds0116/BNStory/robColumnsBlogs/home

3. Notional amount of credit derivatives = $43Trillion (yes, trillion), declared losses to date = $100 Billion (approx) ... How much of the former will be recognized as the latter? - Remember, our RRSP's, company pensions, taxes and standard of living depend on the answer ... http://www.economist.com/finance/displaystory.cfm?story_id=10498541

4. US inflation highest in 17 years. Do you remember now that Rio Tinto shareholders walked away from $150B (US)? Do you see why? In the present fight between US money and Gold / Oil / Real Stuff ... which would you pick? ... http://www.canadianbusiness.com/markets/market_news/article.jsp?content=b011628A

Islamic / Middle East Finance:

1. Has Islamic Finance become an issue in the 2008 US presidential election? ... maybe just a little bit ... http://www.ronpaul2008.com/issues/inflation-tax/

2. Mr. Usmani says that 85% of 'Islamic Bonds' are not Islamic, setting off a debate in Bahrain and the international Islamic standards setting body ... http://www.washingtontimes.com/apps/pbcs.dll/article?AID=/20080114/BUSINESS/688156932/wt.test@yahoo.com


1. Time to become vegetarian my friends ... the US has allowed the entry of cloned animals into the food chain ... be afraid - very afraid ... http://www.reuters.com/article/healthNews/idUSN1444947520080116?feedType=nl&feedName=ushealth1100&sp=true

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