Gordon Pape is now a contributor to Globe Unlimited's Inside the Market. Click here to read more about our latest addition to columnists.
It's been a while since I looked into the Q&A section of my inbox and, no surprise, there were a lot of queries waiting for me. So let's get right to it.
The markets
Q – I would like you to look into a crystal ball. The IMF just said that the risks to the global economy are significant yet everybody's comment is positive about the TSX reaching new highs. I am just wondering if we are climbing again the proverbial "wall of worry" and getting a bit overexcited. It looks like there is a general feeling among investors, especially those that missed the boat in 2013, that you might miss the gains that accrued "to everybody else" if you do not plunge into investing now. This is a perfect scenario for a crash. Am I too cautious? – Claudia P.
A – As I wrote last month, I expect to see a stock market correction of 10 per cent+ at some point this year, followed by a rally. Despite the weak start to 2014, we have not experienced a correction of anything like that magnitude so far. The S&P 500 in New York was off only 0.7 per cent year-to-date as of the close on Feb. 21 while the S&P/TSX Composite was actually up 4.3 per cent, to many people's surprise. (stocks have risen even further over the last few sessions). Therefore, I continue to advise caution about making stock purchases. The markets are overdue for a significant pullback. – G.P.
Investing in TFSAs
Q – As a low-income person, I cannot afford to plunk down $5,500 all in one shot so I would like to buy a TFSA by instalment. Is it possible to do this? – Katie K.
A – Actually, you don't "buy" a TFSA. You open a TFSA account, in the same way as you would open a bank account. You can then deposit any amount you wish, whenever it is convenient. Some people use automatic contribution plans, instructing their bank to transfer a certain amount each month into the TFSA. Be sure you choose the right type of plan for your needs. There are savings plans, GIC plans, mutual fund plans, multi-purpose plans, and self-directed plans. For more details, read my book titled Tax-Free Savings Accounts. – G.P.
GIC investing
Q – I have a basic understanding of investments and I have never considered GICs as a good place to invest. However, circumstances have changed and security has become much more critical for me. My bond funds are struggling and I have a large amount of cash sitting in a savings account. Have GICs become more viable, especially ones like TD Bank's, which are linked to the equity markets? – Pam B.
A – I have never recommended equity-linked GICs and would certainly not do so now with stock markets so high and a correction likely. If you want the security of GICs, I suggest you swallow hard and accept the low rates being offered on regular certificates. A five-year ladder – dividing your money into five equal parts and investing one-fifth each for one, two, three, four, and five years – is the most effective approach. – G.P.
RRSP withdrawals
Q – I would be grateful if you could answer my questions about the withholding tax on RRSPs. I was taken aback to find that the $400,000 portfolio I had built up over 20 years, by means of a defined contribution company pension plan, would be reduced by 30 per cent on withdrawal. When I read about company and group RRSPs there is never any mention of this percentage. My annual income will not exceed $40,000 when I start to withdraw. Why do I have to pay 30 per cent and also be taxed on the balance that I take in each year? I am surprised that there never seems to be any transparency about this level of taxation in literature about RRSPs. – Clare B.
A – There may be some confusion in your question. For starters, RRSP withdrawals (along with RRIF and pension plan payments) have always been taxable. You received a tax deduction at the time you made the contribution so you're expected to pay tax at the time of withdrawals Tax-Free Savings Accounts are different – no tax deduction, no tax on withdrawals.
The 30 per cent figure appears to relate to the withholding tax on withdrawals over $15,000. This is withheld at source, but is not the actual tax you pay. That will be based on your income and marginal tax rate. If your rate is less than 30 per cent you'll get a refund; if it is more you'll be assessed additional tax at the time of filing. So the 30 per cent (or less if the withdrawals are smaller) is effectively a down payment on your tax bill. – G.P.
Preferreds in a pullback
Q – You have suggested there is likely to be a pullback in the market. What do you think preferreds will do during a pullback? – John K.
A – That depends on the trigger for the correction. If it relates to interest rates and/or concern over the tapering of quantitative easing, preferreds and other interest-sensitive securities will be affected. However, if rates are not a major factor in the pullback – for example, if it is a simple case of profit-taking – then preferreds should remain reasonably stable. So far this year, the S&P/TSX Preferred Share Index is up 0.4 per cent whereas the Composite is ahead 3.7 per cent to Feb. 21. – G.P.
If you have a financial question you'd like answered, send it to me at gordonpape@hotmail.com and write "Globe question" on the subject line. I can't promise a personal reply but I will answer the questions of broadest interest in future columns.
Gordon Pape