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The Mighty TFSA

Tax Free Savings Accounts (TFSA)

Many of you are probably familiar with the saying: “the only sure things in life are death and taxes.” Well, as of January 2009 there’s been a little ray of hope as far as those taxes are concerned. In February of 2008 the Canadian Minister of Finance (Jim Flaherty) announced a new program would start in 2009 that would forever change how Canadians can choose to save their hard-earned money.

Before the TFSA was introduced, if you saved or invested your money(the money you would have already been taxed on) you would then go on to be charged more taxes if those savings or investments made money. Many Canadians felt that they were being punished despite trying to do the right thing by saving or investing. While many of those same rules are still in place, the reason a TFSA is so innovative is because it gives Canadians an option to save and grow their money without having to pay any taxes on it. Sounds like a great option to us.

What is a TFSA exactly?

A TFSA is a special type of account that enables Canadians to grow the money in the account tax-free. Whether the money is in cash or is invested in allowable products (such as stocks or GIC’s) any money made within a TFSA account will not be taxed. For example, when most people saved money in a bank they generally put the money is a savings account. Aside from keeping the money safe, there was the added bonus of gaining some interest for parking your money there. The consequence of earning some interest is that it can be taxed as income by the government. In a TFSA, however, any money earned in the TFSA is not taxable by the Canadian government – ever.

How it works?

Most large Canadian banks as well discount brokerage firms offer a TFSA. Opening a TFSA is generally as simple as opening any other account at these institutions. In order to qualify for getting a TFSA however you have to meet the following criteria:

  1. You have to be a Canadian resident
  2. You have to have a Social Insurance Number
  3. You have to be 18 years of age or older

The government has set a limit on the amount of money you are able to contribute into your TFSA in any one year. In the first year of the program (2009) the amount was set at $5000 and every subsequent year this amount increases according to the inflation rate.

The good news is that you are able to carry forward any unused contribution room to future years so even though you might not have opened a TFSA in 2009, you have accrued the contribution room since that time. The CRA will provide the contribution room figure on your income tax statement (called the Notice of Assessment).

To help understand better how a TFSA works, let’s walk through an example. Suppose you had $1000 to save in the first year (2009) and you decided to put that $1000 into a TFSA. Your contribution limit for the year was $5000 but since you only used up $1000, you’re left with $4000 of extra room for that year. As of January 1st the following year your contribution room would increase by $5000 plus any unused contribution room from the prior years ($4000) bringing your grand total of contribution room to $9000. The exact amount of contribution actually is slightly more than $5000 each year because of inflation. Your personal amount can be found on your tax return or via Canada Revenue Agency’s “my Account” website [http://www.cra-arc.gc.ca/myaccount/] .

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A falling knife in real time

Today was a great opportunity to witness the raw power of stampede for the exit on a stock.  Focus Media Holding was at the centre of a report released by controversial investment firm Muddy Waters alleging fraudulent business practices.  This is the same company that has made headlines in the past by obliterating stock prices of the companies they feature.  Because Muddy Waters usually sells short (e.g. they take a bet that a stock is going to fall in price) many of the names they feature, if the stock drops they stand to profit.

While not illegal, it is controversial.  Muddy Waters has exposed several cases of improper or fraudulent activity from Chinese companies listed on American and Canadian stock exchanges (such as Sino-Forest – to read more click here). While some of these claims have turned out to be true, others have been refuted.  Regardless, what happened today with a stock price losing over 50% of it’s price in less than 30 mins in the middle of the trading day is not something you typically get a chance to see.

Even though the video does not have sound you can see how quickly the prices fall (this video catches the sell off into the day low) and that anyone trying to get a “bargain”  at $12 ends up having to ride this stock well down underneath $10 and not really knowing how much further things will go. This kind of falling stock is usually called a “falling knife” because even though the price is dropping, trying to catch it on the way down can be very dangerous.  One of the scariest moments if you own/trade a stock is when the stock exchange intervenes and halts trading activity because it’s really anybody’s guess as to what happens next. Luckily for FMCN shareholders this halt was lifted and trading resumed about 10 minutes later only to be halted another time as the price rose dramatically from the day low.

The take home lesson: even if you do your homework on a stock, there are opinions out there that can move the perception on what something is worth.  When opinions go negative though, the results are often dramatic, emotionally driven drops in price and stampedes for the exit. Markets always try to “price in” (i.e. factor in the ‘cost’ ) certain scenarios and this video shows you how fast and volatile that process can be.  Enjoy!

 

 

 

 

 

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Playing both sides of the market

This is a great interview with Kyle Bass (Hayman Capital) that captures two things really well: approaching opportunity and how media sometimes approach trading.

The first compelling point of this video is that is shows viewers how successful traders approach opportunities and the calculated fashion in which they “speculate”.  While it is true that there is risk in what traders undertake, you can see how entirely rational Mr. Bass’s assertions about the world are.  If you listen very carefully to what is being said you will hear that in spite of his very negative outlook on the world in 2006, he still had positions (i.e he owned stocks) that believed the market would go up AND positions that the believed that the market was going to go down.  In simple terms, the cost to take the bet against the market was so low, and the potential reward so high that even though his ‘negative’ bet was “wrong” for a year and half while the markets still rose, when that negative bet paid off, it did in a big way.   Despite having both lost and gained money, his gains exceeded his losses and in the end that is what makes your trading portfolio grow.

The second really interesting part about this interview is that it highlights the way in which the media/press sometimes sensationalize issues at the expense of being accurate. In other words, they try to shock viewers rather than inform them. While the questions were pointed, Mr. Bass’s responses were often unfairly interrupted and in spite of the interviewer trying to construe Mr. Bass and traders like him as the source of problems in the markets, he did an excellent job of pointing to the real causes of the financial mess, and most importantly how to think through hedging against what could be around the corner.