Wealth

Part 22 - Stock Trading

As soon as you have some money left over from day to day expenses you will be investing. Most people save their spare cash in a bank and in normal times this is a safe way to make a modest return as the bank pays you interest. However, as of 2022 interest rate are close to zero and much less than the rate of inflation (about 5% at 2022 March) and this tiny amount of interest is taxed at your top marginal rate so in real terms you are losing money. So many people are finding other ways to get a better return on their investment. Some buy houses and this can be a good investment as house prices do tend to increase over time but the large up front costs and monthly payment for a mortgage loan can be a burden and there is a risk, as many people found out when the market value of their house dropped below the balance of their mortgage.

In Canada, the best way to invest is in a Tax Free Savings Account (TFSA) with an on-line (accessed through the Internet) stock broker. (For examples,  TD Webbroker and Questrade). The interest, dividends and capital gains inside a TFSA will not be taxed, ever, even when you take money out. There is no cost to opening a trading account but you will be charged a fee, typically ranging from $5 to $10, each time you buy or sell shares. Although there are a few brokers who do not charge a fee for trading. However, unless you are buying and selling very small amounts of stock the trading commission is typically a small percentage of the cost of the shares.

In Canada, if you were older than 18 in 2009 and have never contributed to a TFSA, you can immediately deposit up to a maximum of $81,500 (as of 2022). If you were 18 after 2009, the maximum contribution is less, depending on your age. Thereafter, the Canadian Revenue Agency allows a maximum contribution of $7000 every year (as of 2024). If you do not already have savings, you can use a windfall like the sale of property to bring your TFSA up to the maximum. You can withdraw money at any time without paying taxes and you can re-contribute the withdrawn amount within one year.

Another Canadian method of saving is a Registered Retirement Savings Plan (RRSP) which allow you to defer taxes until you withdraw money. Like the TFSA, gains inside the RRSP are not taxed and any contributions, up to the mandated limits based on your earned income, can be deducted from your taxable income in that year. However, you will pay tax when the money is withdrawn.

It is most useful for people with high incomes who pay tax at a higher rate than low income earners and expect to be in a lower tax bracket when they retire. Young people can benefit if they keep track of all income earned and wait until they reach a higher tax bracket before starting a RRSP, when they can use the total lifetime earnings to immediately reduce taxes at the higher rate.

You can find information about TFSA's and RRSP's from the Canadian Revenue Agency (CRA) or from your broker's website. If you do not want to make investment decisions yourself, many brokers offer managed funds. Questrade, for example, has a low-cost, managed ETF fund to match your risk profile and you can switch in and out at any time. Avoid mutual funds, which tend to have a high management fee and are less easily traded. Buying and selling shares (also known as stocks) of a company is now very easy for anyone with a few thousand dollars to invest and a computer or cell phone connected to the Internet.

One advantage of self directed trading is that you can decide when to sell a particular stock and thus decide when to pay any capital gains tax.  Managed funds tend to sell every year and thus you must pay any capital gain each year.  

You do not have to take big risks because some shares are inherently less risky than others. Just two examples will illustrate and you can check the history by logging onto web sites like;-https://bigcharts.marketwatch.com/ You can get the same information from many other web sites like Yahoo Financial.

Near the beginning of 2020,  5 shares of Shopify (ticker symbol SHOP) were about $600 per share for a total of $3000. The price dropped to about $450 in March with the Covid crash but recovered near the end of 2020 for $1400 each for a total of $7000 for a capital gain of $4000. (It did look like a good, but risky, bet. In 2021 February SHOP shares were over $1800 Canadian but they fell back in March). 

On bigcharts.com type ca:shop in the box before Basic Chart. ( "Ca:" means the price is in Canadian dollars on the Toronto Stock Exchange (TSE)). If you type SHOP alone, you will get a chart of the same stock on the New York Stock Exchange (NYSE) in U.S dollars. 

On the same dates,  100 shares of an Exchange Traded Fund (ETF) (ticker symbol ZUT), managed by the Bank of Montreal, that invests in electricity generation companies, like Hydro One (H) and Algonquin Power (AQN), all on the TSE were about $20 each so 100 ZUT shares,  cost $2000 Canadian. 

 The price dropped to about $16 in March but near the end of 2020 they were $24, making a total capital gain of $400. But ZUT also paid a monthly dividend of $0.07 per share which over 12 months totalled a gain of 0.07 x 12 x 100 = $84 Canadian (an annual yield of 4.2%). So the total gain was $400 + $84 = $484. And in Canada, capital gains and dividends from Canadian companies are taxed at a lower rate than interest income.

Sure, the percentage gain on ZUT was less than the gain on SHOP but it was far less risky because if the shares of one of the companies in ZUT falls, the other power generating companies are not likely to fall at the same time. The monthly dividend payments also tends to reduce fluctuations in share prices.

Caution. I am giving you two examples of good (or lucky) trades but I routinely lose money on a lot of trades. The trick is, try not to be emotional about wins or losses and try to lose less than you gain. Buy a stock when it is underpriced and likely to move up. Sell a stock that looks overpriced (overbought) and likely to fall in price.  As a rule I tend to sell if a stock drops below 15% from a local high but I frequently wait for the rebound. If you miss out on selling, it sometimes pays to patiently wait until the stock starts moving up again.