Four ways to save for your children’s postsecondary education

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It’s time we formally expanded the list of parental financial obligations to include saving for a child’s postsecondary education.

The cost of university or college, even for children who stay in town, is too expensive to be covered by typical part-time and summer jobs. Student loans can make up the difference, but heavy reliance on them can result in debt that delay financial independence after graduation.

Here are four strategies for parents to help cover the cost of a postsecondary education:

Use registered education savings plans

The pitch for RESPs: Contribute up to $2,500 a year per child and the federal government will provide a matching 20per-cent grant through the Canada Education Savings Grant (more money is available to lower-income families). If you can afford to contribute to an RESP, it’s almost negligent to forgo this grant money.

Start putting money into RESPs when your kids are babies. All you need to get going are social insurance numbers for yourself and your child. You can invest in RESPs in bank branches and through group plans, but a plan held with an online brokerage firm or investment adviser offers the widest choice of investments.

Invest aggressively until your child is 13 and then start reducing risk year by year. There’s a good case to be made that an RESP for a child starting a three- or fouryear program should be entirely in term deposits or a high-interest savings account. RESP withdrawals are taxable in the hands of the beneficiary student.

Get grandparents, aunts and uncles to contribute to RESPs

More and more grandparents are setting up RESPs for their grandchildren and committing to making regular contributions over the years. Expensive housing and daycare mean some parents won’t be able to take full advantage of RESPs. Grandparents can fill the gap by setting up RESPs with their grandchildren as beneficiaries.

More casual help from grandparents is also valuable. Instead of giving a bunch of junky presents to grandkids on birthdays and holidays, grandparents can give just one present and a contribution toward the family’s postsecondary educational savings.

Tax-free savings accounts

Parents who want to save additional amounts beyond RESPs should consider using a TFSA. Also, you can give kids aged 18 and older money to put in their own TFSAs. The TFSA contribution limit for 2016 is $5,500.

TFSAs are worth considering if you’re getting a late start on saving for a postsecondary education. CESG money is only available until the end of the year a child turns 17.

Get your kids to contribute to their own education funds through their part-time job earnings

Starting around age 16, set up a high-interest savings account for your child that will be used exclusively for college or university costs. When the child is working, encourage regular contributions to that account.

Kids often have their own savings goals – concert tickets, smartphones and such. Let them save for those things, but insist on a minimum percentage going into the postsecondary account. Maybe 10 to 20 per cent at first, and more in the final two years of high school.

This article was written by Rob Carrick from The Globe And Mail and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to

Planning your retirement today

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Nearly two-thirds of Canadians are concerned about retirement planning. The other third will worry about it later… but will it be too late? We discussed the topic with Natalia Sandjian, Financial planner.

Generally speaking, do people start planning their retirement too late?

People start to think about their retirement around the age of 50, and that’s far from ideal. You should start planning your retirement once you enter the job market. It’s important to know that ultimately, things will be easier for you if you start saving for retirement early. Compound interest will do a lot of the work for you… if you give it time!

Do people in the workforce see retirement differently than the previous generation of retirees?

Retirement isn’t considered to be the twilight years anymore, it’s a second life. Nowadays, new retirees think, “Now I can try something new!” They want to take on new projects, and keep working on the side, because they want to… or need to.

Has retirement planning become more complex?

Most of all, the reality is different. In some cases, people are retired for as long as they worked. In addition, workers need to be self-sufficient: private retirement plans are increasingly rare, or less substantial, and government pensions are lacking.

In addition to all of this, retirees have a higher debt rate. In the previous generation, mortgages were paid off at retirement. Now, people in their 50s and 60s are coming to see us to refinance their properties.

Since there is less guaranteed income and more expenses over a longer period of time, it has never been so important to properly plan your retirement to keep things simple.

Do your clients have retirement “dreams” that are sometimes… unrealistic?

Yes and no. Basically, clients want to maintain their lifestyle when they are retired.

A decline in their standard of living is by and large their greatest fear. They are afraid that they won’t be able to keep doing what they love. These are far from big, unrealistic dreams! In fact, people keep themselves from dreaming because they are too worried about the financial aspect of their retirement.

Rather, it’s their expected return on investment that is unrealistic: future retirees don’t understand all of the actions that they have to take to make their retirement goals a reality, even if they are reasonable.

What kind of questions do we need to ask ourselves when planning for retirement?

It’s not enough to put your retirement plans in writing. The numbers are important: you need to specify your ideal retirement age, calculate the cost of your current lifestyle (a good indicator of what’s to come), take stock of your current investments and estimate the private and government benefits that you expect to receive at retirement.

What are some common retirement planning mistakes that people make?

Number one: not thinking about it. Number two: not thinking about it early enough!

Of course, when you’re in your twenties and thirties, you have other priorities, like your house and children. You think, incorrectly, that you have enough expenses now and that you’ll invest in your retirement later.

Lastly, another mistake is to think that you can simply save without a plan. If you don’t have any goals, the chances of success are slim…

What specific strategies do financial planners propose?

Financial planners establish customized strategies that take into account clients’ priorities, lifestyles and personalities.

A thirty-something at the beginning of his career will have a pile of expenses, but plenty of time ahead of him. He won’t have the same investment strategy as a conservative woman in her fifties who wants to start making withdrawals over the coming decade.

How often should people update their retirement strategies?

For young people, every five years or with each major life event (birth of a child, marriage or divorce, an inheritance or new job, etc.). If you’re close to retirement, you could use a yearly review.

Smart savings tips for every age

In your 20s: Save regularly, according to your budget. An investment as small as $25 per month can make a difference at the beginning, and will get you in the habit of saving.

In your 30s: Don’t stop saving for retirement, even if this is the time in your life when you’re the most in debt and there’s the biggest strain on your income.

In your 40s: Keep up your savings habit by increasing your contribution according to your financial situation and a well-balanced budget that will leave room for savings and discretionary spending. Because if you make an effort all year long before contributing to your RRSPs, you can buy yourself a reward with part of the tax return you might get.

In your 50s: Make the most of your contributions, and even double them if you notice that you’re not meeting your retirement goals.


Private Wealth Management, realize that you can increase the value of your assets, and those of your family. Discover this premium service.


The opinions in this article are those of the person interviewed. They do not necessarily reflect the opinions of National Bank or its subsidiaries. For any advice concerning your or your business’ finances, please consult your financial advisor or another professional as necessary (accountant, tax expert, lawyer, etc.).

Edited on 22 December 2016 by 

Margin accounts: an advantageous option

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Margin accounts can help you have a better stock market exposure and access to competitive borrowing rates. While it is not a panacea, a margin account is an option worth exploring.

With a margin account, you can borrow funds from your broker under certain conditions. It’s a good way for the investor to have a source of ready cash to take advantage of market opportunities, or to use as an emergency fund, or purchase goods outside of the margin account or to contribute to your RRSP.

Variable margin

The way it works is simple: by transferring quality assets from an unregistered account to a margin account, you can borrow an amount based on the market value of the eligible securities held in the account.

The margin or maximum advance granted by the broker will vary depending on the investment product. For example, it may be 95% to 96% of the value of government bonds, 94% of term and index-linked GICs, 99% of Treasury bills, or 50% of mutual funds. For shares, the advance is tied to the value of the security (up to 70% for shares trading at $5 or more; up to 50% for shares trading between $2 and $5).

The investor will have to provide a minimum amount and pay a margin deposit, which is a security deposit of sorts. Thus, margin accounts do not have a pre-determined fixed amount of margin as is the case for a bank line of credit. They are variable and calculated daily based on the value and type of product held in the account.

To illustrate how a margin account works, let’s look at an investor who would like to invest in company XYZ at $10 per share (security marginable up to 70% of its value) with a deposit of $10,000. Since the investor has a margin account, she can purchase 3,333 shares for a total amount of $33,330, of which $23,330 is advanced by the broker and $10,000 comes from the deposit, which is the set minimum she has to cover. With a cash account, the investor would be able to purchase only 1,000 shares because she had just $10,000 of her own money.

Margin accounts: number of benefits

Competitive interest rates are just one of the considerable benefits of margin accounts. They stand out in fact versus those that you would get on personal loans, credit cards or lines of credit. With a margin account, interest rates vary depending on the amount borrowed, but for a sum of $0 to $9,999, you could qualify for the NBC prime rate plus 1.25%; from $10,000 to $99,999, NBC prime rate plus 1%; and for $100,000 and over, NBC prime rate. Currently the prime rate is 2.70% ¹, meaning there are big savings offered!

Another benefit that bears mentioning is the leverage effect, which gives investors greater market exposure and can maximize their returns. For example, let’s say an investor purchases 1,000 shares for $10 each (security marginable up to 70%), covering the minimum with $3000 of his own money and using a $7,000 advance from his broker. If the security’s value increases to $12, the return will be 67% because he spent just $3,000 initially. In comparison, the return would be only 20% if he had made the purchase with a cash account and used $10,000 of his own funds.

What’s more, the broker can make another advance based on the portfolio’s new value. That’s two big advantages in one!

In addition, when the margin is used to generate income from the stock market, the interest could be income-tax deductible.

It should also be said that you don’t have to use the margin, because the account can be managed like a cash account, making it very flexible.

Risks to consider before opening a margin account

Conversely, the leverage effect that boosts returns can also put the squeeze on, potentially leading to a margin call. If the value of a share falls and the market value decreases, the broker’s maximum advance will decrease as well, resulting in a negative difference. This variation will increase even more if, following the drop, a security that was marginable up to 70% then becomes marginable up to 50%.

In the event of a margin call, the investor will have to provide new capital so as not to exceed their borrowing capacity for the security. To do this, cash or securities can be deposited into the account or securities already held in the portfolio can be sold.

To prevent clients from finding themselves in margin call situations at the slightest market fluctuation, brokers require a cushion corresponding to a certain percentage of the loan value of the largest account position.

While flexible, margin accounts have a few risks that you should be aware of before taking the plunge.

Conditions to enable a margin account

To be eligible, investors must meet certain criteria. For example, for National Bank Direct Brokerage (NBDB), you must have an annual income of at least $35,000, a net worth of $10,000, and a credit report that satisfies NBDB’s criteria, in addition to holding assets worth at least $5,000 in your margin account.

Margin accounts are not for every investor. It’s best to have a good risk tolerance and sufficient market knowledge in addition to being relatively comfortable financially.

¹ This rate is subject to change from time to time without notice.

Note that the use of borrowed money to finance the purchases of securities involves greater risk than purchases using your own funds. When borrowing money to purchase securities, you are required to repay the loan, including its cumulating interests, in accordance with its terms, even if the value of the securities purchased declines.

Edited on 6 April 2017 by 

Big tax changes on the horizon for small business owners

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Rob Tétrault, B.A., J.D., MBA, CIM
Vice-President, Portfolio Manager

Cédric Paquin, B.Comm, CPA, CA, CFP
Wealth Planning Consultant

On July 18, 2017 the department of finance released a consultation paper they publicized as a crackdown on perceived tax loopholes for wealthy business owners.

Personally, we had an uneasy feeling as we read through the proposal. The changes will have significant adverse implications on tax planning strategies widely used for several years by many business owners; not just the wealthy ones! As tax advisers, we always felt the strategies we implemented were available (and encouraged) to compensate our business owner clients for the risk they take, for the jobs they create and for the fact they do not have job security, employment benefits, employer sponsored pension plans, employment insurance, sick days or vacation days. The latest Key Small Business Statistics released by Statistics Canada in 2016 revealed that small businesses employ 70.5% of the labor force in Canada, were responsible for 87.7% of net employment change, accounted for 27% of R&D and contributed an average of 30% to the GDP of their respective province. They are the backbone of our economy! How will these figures be impacted over the long term?

Here is a brief review of the tax planning strategies targeted by the proposal.

Income splitting and multiplication of the capital gains exemption

Corporate structures are commonly set-up with all family members owning shares of the corporation, either directly or indirectly through a family trust. Income splitting can be achieved by paying dividends to lower income family members. The capital gain exemption can be multiplied on the future sale of the business by allocating the capital gain incurred to various family members based on share ownership or per the discretion of the trustee(s) of the family trust.

The “kiddie tax” was introduced in 1999 causing private company dividends paid to minor children to be taxed at the top personal tax rate. Currently, income splitting with minors can only be achieved by paying them a reasonable salary based on the work they perform for the business.

Starting in 2018, the Department of Finance proposes a number of measures to extend the “kiddie tax” to all related family members, whether minors or adults. Dividends received from related private corporations will be subject to the highest personal tax rate unless the amount is reasonable in the circumstances based on the recipient’s labor contribution and/or invested capital.

The capital gain exemption will no longer be available to minors, will not be available for any family member if the capital gain is subject to the extension of the “kiddie tax” rules above and will no longer be available for gains that accrued while the shares were owned by a family trust.

Tax deferrals when passive investments are held inside of a private corporation

Incorporated business owners can take advantage of tax deferrals by leaving passive investments inside of their corporation. For example, a corporation that earns income eligible for the small business deduction pays a combined federal and provincial tax rate of 10.5% in Manitoba. An individual subject to the top personal tax bracket would pay 50.4% in tax. Therefore, a 39.9% tax deferral can be achieved by leaving excess funds inside a corporation allowing for better compound growth and a larger nest egg in the future.

The consultation paper proposes to eliminate the advantage of retaining income in a private corporation. While the Department of Finance did not release any draft legislation they did set out a number of different approaches under consideration.

While it remains to be seen what form the rules will take, they will no doubt result in significantly higher taxes for the majority of business owners. Alternative planning strategies such as individual pension plans (IPPs) and retirement compensation arrangements (RCAs) will likely become more popular in the future.

Converting dividends into capital gains

Much less common than the previous two strategies was a practice we knew was under scrutiny so the proposed draft legislation came in as less of a surprise. The strategy involved embarking on a series of transactions with the effect of converting highly taxed dividends income into lower taxed capital gains.

The consultation paper proposed draft legislation to expand current anti-surplus stripping rules to capture these transactions. Amendments to these rules are effective as of July 18, 2017.


These proposals, if and when they become law, will have considerable impact on tax and estate planning strategies commonly implemented by incorporated business owners. We will closely monitor and advise you of any significant changes or revisions to these proposals as they occur and once they are eventually enacted. No doubt, they will require a careful review of existing corporate structures as well as an analysis of future tax planning opportunities.

Please do not hesitate to contact us if you would like to discuss your situation in more detail.

This information transmitted is intended to provide general guidance on matters of interest for the personal use of the reader who accepts full responsibility for its use, and is not to be considered a definitive analysis of the law and factual situation of any particular individual or entity. As such, it should not be used as a substitute for consultation with a professional accounting, tax, legal or other professional advisor.

Estate planning: have you really considered everything?

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Have you openly discussed your estate plan, Will, and Powers of Attorney with your family? Do you wish to create a scholarship or endowment fund to benefit your alma mater? Have you considered establishing a trust to support a relative’s long-term palliative care? Who will manage it? What are the legal and tax implications for the beneficiaries of your international property?

Dealing with estate issues is a sensitive topic.  Openly discussing your thoughts and plans can be difficult ….and delicate (challenging).  By the same token, you have laboured to build your wealth and you are entitled to determine precisely how, when, and to whom you wish to ultimately distribute your assets. However, if you fail to prepare and sign valid documents, intestate succession law will apply and the provisions of the applicable law are not likely to be in line with what you had in mind.  Clearly establishing how you wish to preserve and transfer your wealth is one of the best investment of your time you can make.

Estate Planning, Estate Settlement, and Trust Services

Naturally, ensuring that family and those close to you, as well as the causes you cherish, have adequate financial support is usually what first comes to mind.   Regarding your estate planning, you will also want to be making choices that avoid complications or litigation and protect the value of your estate by limiting costs, taxes, and settlement delays.  Many factors contribute into the decisions you will make.  Almost as many have consequences and implications you may not even have considered.

Estate Planning

Getting your paperwork in order – Wills, Powers of Attorney, and Trusts

  • In your will, you will determine how your assets are to be distributed or settled. Your Will may include the appointment of guardians for minors, age thresholds when your estate will devolve to beneficiaries, and testamentary trusts. If you already have a will, is it up to date? Is your named executor still willing or able to act? Has your civil status changed? Has your family expanded? Is one of your children now a partner in the family business? If so, how do you intend to divide your estate ‘equitably’ among your children?
  • A power of attorney delegating authority to handle your financial affairs and, in case of incapacity, a power of attorney to manage and support your health care also need to be drawn up.  Have you already drafted these documents?  Have your circumstances changed? Are your original appointees still willing and able to act on your behalf?  Will they require professionals to assist them in implementing strategies and managing affairs for you?
  • Perhaps you wish to establish an inter vivos trust to provide benefits now and in the future…. for your grandchildren’s education, environmental causes, or regular ongoing donations to a charity dear to your heart.  Or you may want to establish a testamentary trust only effective upon death, whereby the capital (or possibly simply the income generated) benefits your heirs or a charity.  In setting up trusts, delineating the terms and putting the financing in place can be intricate.

Estate Settlement Services

Your executor or your beneficiaries can draw upon expertise in implementing the provisions of your will.  Perhaps settling your estate may require establishing the value of your professional practice or the “goodwill” of your business.  Or, your hobby collection (antique cars, art, or a wine cellar) may entail the services of a certified appraiser.

And, once all is in order, the actual distribution of the estate’s proceeds and requisite tax filings need to be handled. This may involve coordinating with your legal advisors, accountants, and tax specialists — as well as affecting the actual transfers of titles, ownership, and assets to your beneficiaries.

At a time when emotions often run high, having professionals who are able to objectively manage expectations and resolve family conflicts, can help reduce stress and provide clarity.

Can I tap my child’s RESP before he starts university?

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My son is going to university in September. Can I withdraw a portion of contributions to his registered education savings plan before he starts school?

The rules regarding RESP withdrawals can be technical, so I put your question to Mike Holman, author of The RESP Book: The Simple Guide to Registered Education Savings Plans for Canadians.

“It is not necessary to wait until the first day of school to ask for money,” Mr. Holman told me.

“Once the child is enrolled, you can start requesting withdrawals.”

You can actually withdraw RESP contributions at any time, he said, but to avoid penalties you would need to provide your financial institution with proof that your son is enrolled in an approved postsecondary program. This could be an official letter from the university, a course confirmation or a receipt for tuition paid. Your financial institution can tell you exactly what documentation it requires.

“I think it’s pretty common for people to do [RESP] withdrawals now because they want to get going for the fall,” Mr. Holman said.

With RESP withdrawals, there are several things to keep in mind.

When making a withdrawal, the subscriber must specify whether the payment consists of a refund of contributions (ROC), an educational assistance payment (EAP) or a combination of the two.

An ROC payment is deemed to come from the original contributions to the RESP and is, therefore, not taxable. These payments can be made to either the subscriber or to the beneficiary (i.e. the student) and there are no limits on the amount withdrawn.

An EAP payment is deemed to come from the income and capital growth inside the RESP, plus any Canada Education Savings Grants, provincial grants and Canada Learning Bonds received.

EAPs are paid directly to the beneficiary and taxable in his or her hands, but because many students have very little income, the tax consequences are often minimal. For full-time students, there is a $5,000 limit on EAP withdrawals for the first 13 consecutive weeks of enrolment. After that, there is no limit on withdrawals as long as the student remains enrolled.

Contrary to what many RESP holders believe, there is usually no need to specify what the money will be spent on. If you are making an unusually large EAP withdrawal, a financial institution could technically ask for receipts to prove the funds are being used for educational purposes, but Mr. Holman said that’s unlikely and isn’t even practical given the myriad expenses students face.

“Tuition, textbooks, housing, transportation, computers, televisions or vacations are all eligible.

Anything goes,” he writes in The RESP Book.

Cash has been building up in my tax-free savings account. Rather than having it sit there as dead money, can you make any recommendations as to how I can still get a return, no matter how small, on this cash? Would a money-market fund make sense?

The problem with money-market funds is that the management expense ratio eats up a big chunk of the already puny yield. A better option are the high-interest savings accounts offered by discount brokers. These products, which currently pay about 0.75 per cent to 0.8 per cent, are bought and sold like mutual funds and can be held in non-registered accounts as well as TFSAs, registered retirement savings plans and other registered accounts. Like regular savings accounts, they’re also covered by Canada Deposit Insurance Corp. (with the exception of U.S. dollar savings vehicles). The interest rates aren’t huge, obviously, but convenience is a big plus because the money is at your fingertips should you decide to cash out a portion of your savings to invest in stocks, mutual funds or exchange-traded funds. Typically, these products have initial minimum investments of $500 or $1,000. There should be no fees or early-redemption penalties, but be sure to verify this with your discount broker.

This article was written by John Heinzl from The Globe And Mail and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to

Edited on 20 June 2017 by 

Three advisers shed light on how their wealthy clients invest

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Canada’s richest people are a small but growing group that’s on track to control almost 70 per cent of personal wealth in the country. With at least $1-million each to plunk into a portfolio, these individuals tend to take a different approach to investing than the other 95 per cent of the Canadian population.

A recent survey by Tiger 21 LLC – a North American peer-to-peer network for investors with at least $10-million in investable assets – sheds light on how the wealthy are growing and preserving their money these days. Last year, according to the survey, Tiger 21 members allocated the biggest chunks of their investment portfolios to three asset classes: 28 per cent in real estate, 21 per cent in private equity and 19 per cent in public equity.

Fixed income and cash or cash equivalents each made up 12 per cent of members’ portfolios, while hedge funds and commodities accounted for the remainder.

“When you combine those top three asset classes, you’re looking at almost 70 per cent allocation to what I call equity, because we consider real estate as a form of equity risk,” says Michael Sonnenfeldt, founder of Tiger 21.

“If you look at a [historical] model where you have a 60-40 split of equity and bonds, what the survey results are telling us is that our investors have the highest exposure to equity that we have on record – a result of the current low-interest-rate environment where you really have to work your assets.”

How else do high-net-worth investors stand apart from those with fewer zeroes in their accounts? Three financial-services professionals who work with the country’s top 5-per-centers provide some insight into how the wealthy invest.

Jay Nash, vice-president, investment adviser and portfolio manager, National Bank Financial Wealth Management, London, Ont.

“Those who have created the most wealth over time have been, from my experience, able to maintain their investments through market cycles. They’re often invested directly in stocks but are able to detach themselves from the emotions of market gyrations. They have that ability to buy when the market is weak, and because they don’t foresee a need for that money in the short term, they have the ability to do this more than others.

“The investing styles of highnet-worth individuals tend to be characterized by a greater attention to the downside risk of investments than perhaps some others would be. Their interests tend to lie in larger-cap securities, and they want to know that the companies they own are going to be around. Those with some investment acumen will tend to favour direct ownership of equities versus something like an exchange-traded fund (ETF).

“Their core portfolios tend to be made up of large-cap North American stocks. Then we build around that, adding international exposure and fixed income to the degree that each client requires.

This is where it becomes very much dependent on their individual circumstances and timeline.

With a small portion of their wealth they’ll often take a risk, but it’s usually a calculated investment – they aren’t particularly interested in the flavour of the week.”

Daniel Nolan, certified financial planner, IPC Securities Corp., Ottawa “For people of average wealth, their first priority might be growth, second might be preservation and third might be income. With high-net-worth investors, preservation of their money – or the bulk of it – is paramount.

“But I wouldn’t say they’re conservative. Because they’ve got large chunks of wealth, they can divide up those assets. One chunk could be moderately managed, and they would still have a chunk that allows them to continue to make money. One of my top clients buys up other businesses and properties, but we also make sure he chunks up assets in a very modest-risk investment account.

This is where he’ll pull out future income.

“What do wealthy peoples’ portfolios look like? Stocks and bonds for sure – you typically see a nice mix of blue-chip, dividend-paying stocks along with a reasonable risk bond portfolio. Real estate tends to play a part, whether it’s personal or corporately owned.

“Fully transparent costs are important to high-net-worth investors so they can judge value, and this value has to be apparent and typically tax deductible.”

Tom McCullough, chairman and CEO, Northwood Family Office, Toronto “The issue really is not what people like or what their investing styles are but rather what they need. For a wealthy family that plans to spend a lot of money each year – maybe they have several university-age kids studying in the United States and they plan to build a cottage or start another business – we would focus a good portion of their investments in something that’s not locked up for several years, so maybe cash or short-term bonds.

“For investors who are spending less and want to build legacy money to leave their children, there’s more room for illiquid investments with higher returns, such as private equity, infrastructure and real estate.

“High-net-worth individuals are definitely interested in investments that are intriguing, but the question we ask them is: Is your portfolio for entertainment?

Sometimes, we have to talk them down from things that are fun, or we designate 5 per cent of their portfolio as play money.

“Sometimes, they come in expecting a 25-per-cent return on their portfolio – similar to the return they got from their business. The reality is you can’t get significant capital growth out of the markets these days, so people have to be reminded that if they want to grow capital significantly they should try to start another business, or we should build a portfolio full of direct investments in businesses. We have some clients who have done this, and we’ve helped them find a private-equity manager to stay on top of these investments.”

Responses have been edited and condensed.

This article was written by Marjo Johne from The Globe And Mail and was legally licensed through the NewsCred publisher network.

The Real cost of stock transactions

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Commission is the only cost that’s really visible when you buy or sell stocks. However, every stock transaction involves other costs that can be harder to spot, and even harder to predict. 

The cost of buying or selling a stock or exchange-traded fund (ETF) is transferred to the client through their broker in the form of a commission. You can identify this cost in your transaction reports.

But the way the stock market operates means that by its very nature, the price paid or received for a stock includes costs that are invisible to the client. Did you know that?

The discrepancy between the purchase and sale price, identifiable before a transaction

The cost, which is often significant, is not completely invisible: you can calculate it by looking at a detailed market quotation. Also, for each security the market quotation lists not one price, but two:

  • The Bid, or the price at which buyers are ready to buy it, and
  • The Ask, or the price at which sellers are prepared to sell a security

The Bid (purchase price) is always lower than the Ask (sale price). The term “bid-ask spread” is typically used to identify the difference between these two prices.

An investor who buys a stock and then resells it immediately would incur a loss equivalent to the bid-ask spread – even if they weren’t paying a dime in commission.

This discrepancy between the sale and purchase price is used to compensate the market maker, in other words the organization that ensures that purchase orders and sale orders match, thus allowing transactions to happen.

For example, if a buyer wants to buy 125 shares of a security, the market can’t wait for a seller to decide to offload exactly 125 shares, while at the same time there are three sellers waiting to sell 50, 50 and 25 shares respectively. A market maker must therefore, at all times, buy shares from sellers to make them available to buyers. At the end of the day, it’s from this intermediary that buyers are purchasing securities, not other investors.

The market maker assumes the cost of temporarily holding the securities and of carrying out the transactions to buy and sell. Most importantly, they take on the financial risk of purchasing securities and potentially having the stock price drop before they can sell them.

To compensate themselves and cover their risk, the market maker buys for less than they sell, and inversely the investor buys for higher than they can sell.

For an investor interested in long term investments, the cost of the bid-ask spread is usually minimal, but for a more active investor who buys and sells securities frequently, it can become significant.

Additionally, the bid-ask spread is usually greater for less traded stocks, notably those from smaller companies that attract a lower number of investors.

Two other minimal costs for the majority of individual investors

When a transaction order is for a number of securities that is large in comparison to the number of securities available for transactions at that same time, the very fact of placing the order can change the value of the security to the detriment of whoever placed the order.

So, if there are few effective sales orders for a security, a buyer who turns up with a large purchase order will “wake up” securities holders who weren’t ready to sell at the current price, but who would be interested in selling a little higher. To be able to get all the securities they want, the investor will end up paying more than the price at the time they placed their order.

The inverse is also true: an order to sell that’s disproportionate to the liquidity of a security will force the price down, and the seller won’t be able to get the price they were expecting.

The cost of this impact on prices is generally negligible or non-existent for small investors negotiating small quantities of stocks in large companies.

But it can be considerable for institutional investors, when they decide to trade a significant proportion of a company’s share capital. It might also be substantial for individual investors who want to buy or sell a large amount of a less liquid security.

That might be a reason to divide one big transaction into several smaller transactions, so that each one is more discreet and blends better in the market. Also, the investor can protect themselves by placing an order at a fixed price (minimum or maximum, depending on the case).

In the end every investor needs to assume a certain opportunity cost related to the delays involved in each transaction. From the moment an order is given for a purchase or sale, the cash amount or number of securities in play is blocked until the transaction is complete. This cost is practically negligible for individual investors targeting the long term, but could be major for very active investors.

Smart management of costs is an important part of maximizing the performance of your portfolio. Every investor should therefore have an interest in thoroughly understanding all the transaction fees involved when setting up an investment strategy.