I am a retiree who manages my own stock portfolio. I need to be a bit aggressive because the total potential income is inadequate for my retirement needs, so I allocate 5 to 8 per cent to gambling on startups. I originally bought these stocks in my tax-free savings account expecting that if I got lucky, the significant gain would be tax-free. However, I failed to consider the other edge of the sword, which is that losses are not claimable. Do you have an opinion as to where I should best hold them?
If it were my retirement money, I wouldn’t be gambling on startups at all. The risk of losing all or part of your investment is too great. According to Statistics Canada, just 63 per cent of new companies remain in business after five years, and the survival rate drops to 43 per cent after 10 years. Even among companies that make it, many limp along for years and never achieve the ambitious goals set out in their business plans.
Yet many investors can’t resist the allure of a big score, so they pile into startups, “story” stocks and initial public offerings.
“A wealth of research demonstrates that IPOs have, in general, lousy returns with very high risk,” investment adviser and author William Bernstein writes in his book, The Investor’s Manifesto. But investors still flock to them because “IPOs are the investment equivalent of a lottery ticket.”
The data bear that out. Of the 8,286 U.S. IPOs from 1975 to 2015, nearly 60 per cent had negative returns after five years, according to data compiled by University of Florida professor Jay Ritter. Of those, about 70 per cent lost more than half of their value, as measured from the closing price on the first day of trading. Just 1 per cent of IPOs posted five-year returns of 1,000 per cent or more – the proverbial “ten-baggers” that investors dream about.
With odds like that, do you really believe you can reliably pick the winners and avoid companies that run out of cash, get crushed by the competition or turn out to be frauds? Unless you possess special insights about a particular company, it’s like throwing darts at a dartboard. Capping your startup investments at 5 per cent to 8 per cent of your portfolio will help to control your risk, but that doesn’t make it a good idea.
There is, however, a relatively safe way to get exposure to those rare stocks with big returns. Instead of buying individual companies, consider holding broad exchange-traded funds that track indexes such as the S&P/TSX Composite, S&P 500, Nasdaq 100 or Russell 2000. When the next Microsoft, Amazon or Shopify comes along, you’ll be guaranteed to own a piece of it. And you’ll avoid the risk that one of your picks blows up in your face.
You mentioned that you want to generate more income in retirement, but startups won’t help in that regard because they don’t pay dividends. Another option is to invest in blue-chip dividend stocks – such as banks, utilities, power producers, telecoms and real estate investment trusts – that will enhance your cash flow without unduly increasing your risk. Many such stocks raise their dividends regularly, so your income will grow in retirement and protect your spending power from inflation. (For examples, see my model Yield Hog Dividend Growth Portfolio at tgam.ca/dividendportfolio.)
As for the tax implications of gambling on startups, you are correct that losses in a TFSA cannot be used to offset capital gains for tax purposes. But you’re investing with the intention of making money, not losing it. If you expect, on balance, to lose money investing in unproven companies, you shouldn’t be doing it in the first place.
On the other hand, if you expect to make a killing on startups – that is, you are confident that your gains from a few home runs will far outweigh potential losses from the others – then it would make sense to hold your stocks in a TFSA. That way, if you do get “lucky” and one of your stocks goes to the moon, you won’t face any capital gains tax on your net winnings. The problem here is that the decision on where to hold your risky stocks depends on how they perform, and that’s not known.
Finally, don’t just rely on your portfolio to make ends meet in retirement. If money is tight, look for ways to cut your expenses. This could include small things, such as switching to a cheaper cable or cellphone package, or more significant changes such as downsizing your home. These things are under your control, unlike the returns of risky startups.
Bottom line: If you try to gamble your way to a happy retirement, you could end up imperilling it instead.
E-mail your questions to email@example.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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