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special information series: easy money

Toronto-based Chartered Accountant Karen Slezak, a partner at Soberman LLP’s Taxation Group, says, “After the last couple years in the market, many people are shying away from equity investments. Tax is one part of the puzzle, but it’s important that it not be the only focus.”

After experiencing volatile markets over the last two years, most investors are crystal clear on the fact that aiming for higher returns means accepting greater risks. As a result, many are embracing an alternative strategy - more gain, less pain.

By minimizing investment fees, management expenses and taxes, investors can maximize their so-called 'net-net-net' returns (after fees, inflation and taxes) without incurring any additional risk whatsoever.

And while increasing net returns by just a few per cent through cost and tax reduction may not sound life-changing, consider the following: for an investor who saves and invests $500 per month for 25 years, just a two per cent saving means the difference between a retirement portfolio of $294,000 (a five per cent average annual return) and one of almost $394,000 (a seven per cent average annual return).

For good reason, the popularity of lower-cost options is rising. In fact, new online investors are less and less likely to be stock traders seeking quick profits - and more likely to be long-term investors building a balanced retirement portfolio, says Jason Storsley, president and CEO of RBC Direct Investing.

On the tax side of the equation, investors are increasingly applying previously often-overlooked planning strategies that can dramatically improve their bottom line. One is sheltering interest income. Investors who hold investments such as bonds and GICs inside a TFSA won't pay tax on the income when it's withdrawn. While rates vary among provinces, in Ontario, investors who hold the same vehicles outside of a tax-sheltered plan may pay as much as 46 per cent.

"The tax-free savings account is an ideal vehicle to park interest income in," says Karen Slezak, partner, Taxation Group, Soberman LLP.

A second source of shelter, of course, is the more familiar RRSP. "With a $5,000 annual TFSA limit (which can be carried forward indefinitely if unused), people will often overweight their RRSPs with interest income, and hold those investments that generate dividends or capital gains outside of any of these tax-sheltered vehicles," says Ms. Slezak.

Though tax planning is a crucial element of wealth creation, "You don't want the tax tail wagging the investment dog," she cautions.

Instead, Ms. Slezak advises her clients to choose good investments and then see what can be done to minimize the taxes.

"It is a balance of risk and rewards. For example, outside of tax-sheltered plans, your best tax position is in capital gains. But after the last couple years in the market, many people are shying away from equity investments. Tax is one part of the puzzle, but it's important that it not be the only focus."

Index funds, with management expense ratios (MERs) that are generally below one per cent, are also benefiting from investors' newly acute attention to costs.

In January, BlackRock, Inc., the corporate parent of iShares Canada, announced that ETF investment in Canada had reached $30 billion, up almost 30 per cent over the last five years. In the same time period, traditional mutual funds increased their asset base by 5.6 per cent. "ETFs (index funds that trade on a stock exchange) are growing in popularity among our investors," says Mr. Storsley, noting that because ETFs trade similar to stocks, investors also benefit from lower trading costs.

Investors are also wisely tapping into investment education and planning tools made available by online brokers, sometimes at no cost.

"One of the areas that our clients tend to gravitate toward on our website is our practice accounts," says Mr. Storsley. "It's fully integrated into our website. Investors are given $100,000 worth of no-risk practice money and are then able to invest in the various stocks, bonds, mutual funds, ETFs and options available. It's a way to gain confidence and investment knowledge."

Financial and investment calculators, including an asset mix calculator, help RBC Direct Investing clients fully understand their tolerance for risk, their time horizon and their investment objectives, says Mr. Storsley. "From there, they are able to develop an understanding of what percentage of their portfolio should be put toward equities, bonds and money market or other cash-type options."

He adds, "We offer extensive learning resources, tailored to help investors advance to the next level of knowledge, whether they're novice investors interesting in learning about mutual funds and portfolio diversification, or more sophisticated investors ready to take on option trading and other advanced strategies."

Plan on the tax man

While working to maximize returns, remember that tax planning errors can end up being enormously expensive in both money and frustration.

A requirement that is too often overlooked by investors, says Karen Slezak, partner, Taxation Group, Soberman LLP, is that there may be U.S. estate taxes to be paid on U.S. investments. "A lot of Canadians don't even think about paying taxes in the U.S., because they're not U.S. citizens or residents. But if you own more than $60,000 in U.S. securities, directly or in your RRSP or RRIF, you are subject to U.S. estate tax on those investments."

Another potential stumbling block is managing money for children, she says. "Many people hold accounts in trust for their children. That's okay for fairly modest amounts, but if the amount is more significant, they should really look at formalized trust arrangements."

Finally, she says, "There are a number of things that can be done to minimize probate costs, which is particularly important in those provinces in which they can be significant, such as Ontario and B.C."

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