Let’s make it great in 2008

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Welcome to the New Year! Hopefully the holiday season didn’t drain your piggy banks because it’s time for your annual financial physical. It’s a useful exercise and it helps to organize your records for the tax man in April.

The first step is to create a balance sheet and list all of your assets and all of your liabilities. Review the rates of return on your financial assets and record the interest costs of your liabilities. Are you paying too much interest on your debts? Perhaps you should look at consolidating those high interest expenses at a lower rate. Talk to your financial institution if you need help.

Call your accountant. Let him know where you stand this year and ask him if there are any new deductions or tax credits that might be available to you, but you might have to act quickly. The most common ones are RRSP contributions, childcare expenses, pension income tax credit, while the more exotic ones are venture capital corporation credits and deductions from limited partnerships. While these are not for everyone, a fifteen-minute phone call could save you thousands on your income tax return. For RRSP contributions and VCC tax credits, the deadline is usually 60 days after December 31, so don’t delay.

The next step is to contact your financial advisor and see you how did in 2007. Hopefully it was a profitable year for you, but how much did it cost you in fees, interest charges, and commissions? It takes a little bit of time and, sometimes, detective work, but it will give you a clearer picture of the cost of managing your investments. Remember, these costs are reducing that nest egg you are building for your future. If you are investing primarily in managed funds, take a look at the management expense ratios and add them to the costs of managing your investments. Don’t be afraid to ask questions. If you find that your advisor is making more than you are, then it might be time to get a second opinion elsewhere.

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This might also be a good time to review your investment philosophies. Are you a conservative investor or an aggressive trader? Are you exposing yourself to undue risks by jumping on the latest tip heard at the office water cooler? On the other hand, are you sitting on a mediocre mutual fund or investment portfolio that is not only underperforming its peer group but the market averages as well? Perhaps it’s time for a change.

One of the newest products to hit the marketplace is the exchange traded fund or ETF. Exchange traded funds allow investors to purchase one security that will mimic the performance of a specific stock market index such as the S&P/TSX 60 Index or the S&P 500 hedged to the Canadian dollar. The extensive diversity of ETFs allows investors to participate in a wide range of assets like bonds, stocks, and commodities with minimal entry costs and maintenance costs. It is a passive investment strategy that is gaining in popularity.

What are the risks? First, the performance of your portfolio will now be primarily dictated by the asset allocation strategy developed by you and your advisor. In other words, if you decide that you want to have all of your portfolio in a long-term bond ETF and interest rates unexpectedly and dramatically rise, your portfolio will drop dramatically and you will need a couple of aspirins each time you look at your statement.

Second, at certain points in a stock market cycle, some indices can become dominated by one industry and a decline of just a few stocks can dramatically hurt the performance. Remember the technology bubble and its impact on the Canadian stock market? Many of the stock market leaders like Nortel still have not recovered. At other times, an exogenous change can dramatically impact an index and the associated ETF. Examine, for example, the sudden shock and change in value to the S&P/TSX capped income trust index fund after the October 31, 2006 announcement by the Canadian Minster of Finance. The ETF fell 17% in one week!

Can you minimize these impacts? Yes. Investing is a dynamic process that requires monitoring and rebalancing. Setting realistic financial goals and creating diversified portfolios will help reduce the impact to both exogenous shocks and single industry domination within an index. For those investors with an aggressive bent, but not wanting to bet the farm on the next water cooler tip, using ETFs can allow them to overweight a specific sector such as gold or energy and, hopefully, still sleep at night.

For more information on ETFs, ask your financial advisor or you can reach Steve at www.tsx.ca.