Silver Linings – Financial Planning Opportunities During the Coronavirus Turmoil
What a wild month it has been. The Dow Jones and S&P 500 peaked on February 19th and we have had the steepest correction in history over the past month. This correction has brought unprecedented volatility both up and down. We experienced the largest single day drop in history on Monday. Last week was one of the most volatile weeks in history when we had two of the largest single day gains accompanied by three of the largest single day losses in the past 10 years.
While there is plenty to talk about when it comes to investments and markets, we also want to point out some opportunities the Coronavirus downturn has created for our clients. First, market downturns open the opportunity to do tax loss harvesting. In Canada, if you had an allowable capital loss, you must apply it against your taxable capital gain for that year. If you still have a loss, it becomes a net capital loss for the year. You can use a net capital loss to reduce your taxable capital gain in any of the three preceding years or in any future year. In the U.S., if a taxpayer’s capital losses are more than their capital gains, they can deduct the difference against other income on their tax return. This loss is limited to $3,000 per year for married couples filing jointly. Tax loss harvesting refers to the practice of selling securities in a loss position to be able to use those losses against future gains, or against other income in the U.S. to reduce your future tax liability. There are limitations to this as we must avoid the “wash sale rules”. We also manage investments according to the Investment Policy Statement that has been agreed upon with the client and we have to make sure that if we go out of model it is for a short period.
Second, both short-term and long-term interest rates have dropped to historic lows. Any client who has a mortgage in the U.S. should consider refinancing and locking in these low rates. If you are currently working, we generally recommend our clients use a 15-year term as rates are considerably lower than 30-year rates. Rates around 3% are currently available on 15-year fixed rate mortgages in the U.S. Rates between lenders can vary with the current volatility and as they try to manage the rush of applications they are receiving. With rates this low, we recommend making the minimum payment only to take advantage of this cheap money for as long as possible. Since we recommend making the minimum payment only, it makes sense to pay points to lock in the lowest rate possible. The breakeven for paying one point is usually between seven and eight years.
Refinancing is less common in Canada because most mortgages carry prepayment penalties. Canadian mortgages generally have terms of up to five years but are amortized for 25 or 30 years. These mortgages have to be renewed at the end of the term and penalties apply if you pay it off early, such as a refinance. Refinancing is still possible but the difference in interest rate must be bigger to make up for the prepayment penalties. Also, it is less appealing because the rate, if it is a fixed rate mortgage, is only locked in for up to five years. Consult your mortgage professional for current loan options, and make sure to get quotes from at least two lenders. Cardinal Point can provide referrals if necessary.
Third, current market conditions have caused the Canadian dollar to depreciate relative to the U.S. dollar. This means you get more Canadian dollars when converting from U.S. dollars. Part of our mission is to help you reduce the amount of risk in your financial life. Ultimately, we recommend clients hold the currency they will need to support their lifestyle in the future. Holding a currency other than what you need to live on creates additional risk that we would like to reduce when prudent. The current exchange rate according to the bank of Canada is 1.4496 which is considerably better than we have seen in recent history. It is also approximately 18% better than the historical average exchange rate which is approximately 1.23. One of the barriers we usually face when considering currency conversion is unrealized gains that will be realized when U.S. securities are liquidated to make the conversion. Much of the unrealized gains that were previously in many people’s accounts have been reduced or eliminated with the current correction, making currency conversion transactions more appealing. U.S. retirement accounts such as IRAs cannot be held in any currency other than U.S. dollars. It is best to leave those accounts intact to preserve the tax deferral for as long as possible, unless early distributions or Roth conversions make sense from a tax perspective. Those who have taxable investments in U.S. dollars, but either live in Canada or will be moving there for retirement should consider converting some of their U.S. dollars to Canadian dollars soon. We advise against selling after a major market correction, but this is one circumstance when it makes sense.
Lastly, the most basic principle of investing is “buy low, sell high”. Times like these can be scary and the idea of putting cash into the market after seeing such losses makes many people nervous. That is part of the reason why you hire a financial advisor. Financial advisors analyze your situation objectively to provide you the best advice. One of the advantages of working with an advisor is they can help you take the emotions out of investing decisions. Market research has shown that selling after a major market correction is the worst thing to do. The best approach is to maintain a long-term perspective, remember that security prices only matter when you are buying or selling, and remind yourself that capitalism works and the market will recover. We don’t know how long that will take, which is why we don’t sell until you need the cash for living expenses or there are other financial planning considerations being made such as currency conversion. We don’t know where the bottom of this correction is, but we know equity securities are much cheaper than they were a month ago, and they are much cheaper than they will be in the future. Those with available cash or disposable income should consider purchasing equities while they are cheap.
Our investment team has done a good job communicating with our clients from an investment perspective. Our financial planners and relationship managers are doing their best to be proactive reaching out to clients and making themselves available to clients who want to talk about their portfolio and markets. If you have not heard from your relationship manager yet, you will sometime this week. Many people are concerned about how this will affect them long-term and their finances are weighing heavy on their mind. Our staff is doing our best to point out financial planning and tax opportunities to our clients, but our time is limited. If you know one of these situations applies to you, please help us be proactive and reach out to your financial planner. We want to take advantage of opportunities as they present themselves, but things can change quickly and we want to strike while the iron is hot. We are here to provide advice and guidance, and we need to work as a team in such a quickly changing environment to make sure we take advantage of all opportunities available.