Ranking investment options for my self-directed RRSP

If the idea of handing your RRSP contributions over to a sales person (a.k.a. financial advisor) at a bank isn't appealing to you, then it is time to consider your investment choices. I am about to contribute for the first time ever into my RRSP this year. So I performed my due diligence by researching and evaluating my choices. This post is a ranking of my findings. I evaluate each investment strategy according to three criterias, in descending order of importance.

  • Risk. Will I lose sleep at night if I put all my money in it?
  • Reward. How much can I potentially gain?
  • Effort. How much time and energy do I need to spend on it?

My overall portfolio is exposed to enough risk already from my other trading activities. So my risk appetite is leaning towards a conservative approach. Also note that I factor in costs as a part of my risk assessment. I place a 40% emphasis on this criteria. Next, I consider the return of each investment vehicle using a 40% weight. For obvious reasons. Lastly, I prefer something that requires as little time and effort as possible. I weight this criteria at 20%. As I've said numerous times, I don't like the limitations in a registered account. It is like trying to invest with one hand tied behind my back. I do not want to put much effort to manage this account because I can do better in my regular trading. The resulting ranking of the six types of markets that I am considering for my RRSP (and TFSA) is as follows.

  1. Guaranteed savings
  2. Indices or sectors (through passive mutual funds or ETF's)
  3. Fixed income (using a mutual fund or ETF bond index)
  4. Gold
  5. Stocks
  6. Actively managed mutual funds

One thing of note about investing in physical gold within a registered account is that it can only be done at Questrade as far as I know. Although I doubt they are the only one. Here is the table I used to estimate this ranking. I give each category a score from 1 (bad) to 5 (good) based on my own experience and my sentiment of future market condition. So yes, it is a very crude guess at best. Nevertheless, the table shows that my best choice is to either put my RRSP money in a savings account or invest in indices using passive mutual funds (like the TD e-Series) or ETF's. However, I plan to do both. I will trade indices in my RRSP and put my TFSA money in a high yield savings account. [caption id="" align="aligncenter" width="493" caption="RRSP investment choices ranking"][][][/caption]

Posted 29 March 2010 in trading.

Considering investment options for my first RRSP

I have been fortunate enough to not have to think about taxes for the longest time. Unfortunately though, that is because of my long stay in academia plus a couple of years of a low salary research position. I didn't have to pay much income taxes, if at all. Things are different now that I am working in a full time job with a decent pay. I am reminded of the impact of our high Canadian taxes from the missing chunk on every paycheck. That is why I am looking into what to do with my RRSP contribution lately. Last month, I analyzed the cost-benefit of a Tax Free Trading Account. I concluded that a TFSA trading account is not worth my while for the moment. So I will probably just stash my TFSA contribution in a good old savings account for now. That is not the case with a RRSP. One big difference that change the whole argument around with RRSP is that any contribution that I make into it is tax deductible! I won't go into details here because I hate taxes. Refer to the Wikipedia entry on RRSP if you are unfamiliar with it. Essentially, I am guaranteed about 30% (or your marginal tax rate) of "profit" by way of tax refund for the amount of money which I put into my RRSP account. I don't know about you, but 30% is a massive return for me! And it's risk free! (Technically it's just a refund of my own money, but still) The benefit of having a RRSP is obvious. What I have been pondering about is where should I put my money in my RRSP? As I discussed in Benefits of trading in a TFSA account, there are many limitations to a self-directed registered account. Although there are certainly other options than just trading stocks in a registered account. Here are the options that I have considered.

  1. Savings account
  2. Fixed income
  3. Mutual funds
  4. Exchange traded funds
  5. Individual stocks

In my next post, I will rank my preferences for each retirement investment option.

Posted 26 March 2010 in journal.

Forex Trading: Income or Capital Gain Tax in Canada?

I've always known that foreign exchange trading is treated as capital gain tax in Canada. But just to be sure before filing my taxes soon, I've decided to double check the facts from Canada Revenue Agency. As you know, the difference between income tax and capital gain tax is substantial. Income tax is taxed at your marginal tax rate. Whereas capital gain tax is a generous half of your marginal tax rate. That works out to a 10% to 20% difference. Taxes in Canada is generally simple to do. The problem though, is sifting through the cacophony of information within the Canada Revenue Agency to find out the applicable rules. I've copy and pasted a couple of relevant excerpts from the 2010 CRA Income Tax Interpretation Bulletin for the record. Basically, forex trading can be treated as either income or capital gain tax in Canada (surprise). According to IT-95R Foreign exchange gains and losses.

  1. Where it can be determined that a gain or loss on foreign exchange arose as a direct consequence of the purchase or sale of goods abroad, or the rendering of services abroad, and such goods or services are used in the business operations of the taxpayer, such gain or loss is brought into income account. If, on the other hand, it can be determined that a gain or loss on foreign exchange arose as a direct consequence of thepurchase or sale of capital assets, this gain or loss is either a capital gain or capital loss, as the case may be. Generally, the nature of a foreign exchange gain or loss is not affected by the length of time between the date the property is acquired (or disposed of) and the date upon which payment (or receipt) is effected.

As you can see, it is very vague. That's why forex trading can be considered income or capital gain tax. It is up to you and your accountant to figure out which works for you. A noteworthy point in the above excerpt is that the holding period is not taken into account. So there's no 30-day rule like in the states whereby frequent trading would miss out the capital loss credit if they re-purchase the same asset within 30-day of disposal. Update: Looks like I have misconstrued the above article with regard to capital loss. As Olga pointed out in the comments, Chapter 5 of T4037 defines Superficial Loss. In which if you repurchase your property (e.g. stock) within 30-days after a sale at a loss, then that initial loss cannot be deducted as a capital loss. More about the Superficial Loss rules in Canada can be found at WhereDoesAllMyMoneyGo.com. Further down the page in IT-95R, we have the following bullet.

  1. A taxpayer who has transactions in foreign currency or foreign currency futures that do not form part of business operations, or are merely the result of sundry dispositions of foreign currency by an individual, will be accorded by the Department the same treatment as that of a "speculator" in commodity futures see 7 and 8 or IT-346R. However, if such a taxpayer has special "Inside" information concerning foreign exchange, he will be required to report his gains and losses on income account.

IT-346R Commodity Futures and Certain Commodities explains the tax treatment of speculation in the commodity markets.

  1. As a general rule, it is acceptable for speculators to report all their gains and losses from transactions in commodity futures or in commodities ascapital gains and losses with the result that only one-half the gain is taxable, and one-half the loss is allowable subject to certain restrictions, (hereinafter called "capital treatment") provided such reporting is followed consistently from year to year.

So there, we have it. Amateur forex traders, such as myself, can report our forex trading gain/loss as capital gains and losses. The reason being that forex trading isn't part of my business operation because I have another primary source of income (e.g. salary from another job).

Addendum via reader Lem:

I think you forgot to mention that in IT-346 bulletin it states the following,

8) If a speculator prefers to use the income treatment in reporting gains and losses in commodity futures or commodities, it may be done provided this reporting practice is followed consistently from year to year. If income treatment has been used by a speculator in 1976 or a subsequent taxation year, the Department will not permit a change in the basis of reporting. *Interpretation Bulletin CPP-3 discusses the effect of the income treatment and capital treatment on self-employed earnings for the purposes of the Canada Pension Plan.

so just like you said FOREX can be treated as a Capital or Income gains/losses. You just have to be consistent on your filing, exactly what CRA consultant told me....if you filed it as business in the very beginning yo can't change it to Capital Gains.

Posted 08 March 2010 in forex.

Is a $5000 Questrade TFSA trading account cost effective? Part 4

Alright, so I'm back from the dead. Let's finish this cost-benefit analysis before the weekend. Here are back links for Part 1, Part 2, Part 3 in case you missed them. The table below shows my expected return as derived through part 2 and part 3 of this series. As you can see, I'm only expected to break-even by risking 1% of my \$5000 TFSA trading account. Trading just for the sake of break-even isn't exactly an enviable goal. Based on my statistics, I typically say an expected return of 0.10% per trade is acceptable. Looking at the table, that would require that I risk 1.5% per trade. [caption id="" align="aligncenter" width="570" caption="TFSA Trading Cost-Benefit for Reward/Risk = 2.0 and 40% win rate"][][][/caption] So I'll have to risk 1.5% just to scrape in 0.10% of profit? The problem is obvious. Using a \$5000 trading account with \$5 commission, along with my historical trading performance simply do not justify the odds. I started this series to study the cost effectiveness of a Questrade TFSA trading account. But the conclusion which I derived is much broader. Considering that even without being taxed, a \$5000 TFSA trading account is insufficient for trading with a commission of \$5 or higher. Thus, if this is a taxed, non-registered trading account, the cost would be even more. As such, not only is \$5000 an insufficient capital for a Questrade TFSA trading account; \$5000 is simply too little money to trade any trading account with \$5 of commission per trade for me. Remember though, this cost-benefit analysis is based on my own statistics. You can input your own parameters into this spreadsheet to get your own set of results. To be fair, I must clarify that the problem isn't with Questrade. Even with their lowest trading commission in Canada (affiliate link), a \$5 trading commission for an account of \$5000 is simply too much for me. Yes, there's nothing to stop you from trading with a \$5 commission for a \$5000 account. Heck, many have claimed to be successful with less than \$5000. However, that's just not my style. I don't gamble with my hard earned money. I only trade when the odds are in my favour. If the cost is un-proportionately high, it's as if I've suffered a setback even before I begin fighting the battle. As such, I'm going to say "no thanks!" to a Questrade TFSA trading account for now. My short term plan is to look for a guaranteed TFSA savings account until I can develop a trading system for Canadian stocks that would justify the cost-benefit.

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