You can't afford to earn interest

The Advocate, November 6, 1996

Can you afford to earn interest? I can't, even at 10 or 12%. I have no investments that earn interest such as mortgages, GICs, savings accounts (except T-Bill Money Market Funds), no Canada Savings Bonds, or notes and loans to other people. The reason being, I can't afford to lose purchasing power each year. It has always surprised me that most people when putting their savings to work, look at only one thing, and that is rate of return. If it's 12%, they think they will have 12% earnings to spend.

But will they? The second thing to look at is net rate of return after taxes. That's a very important point. Finally, the third thing to look at is inflation. Those last two points, in the past several years, have made it a "losing proposition" for me to "earn interest". Let's look at it! If you were to earn 12% a year in interest (remember the good old days?) and have a taxable income of $30,000 you would be in a combined federal and provincial tax bracket of 41.9% on any earnings in addition and that includes interest at the full tax rate. The next tax bracket below that would be 27.4%. The next bracket above would be 44.9%. Anything over $59,181 is 50.1%. Therefore, even at a lower bracket of 41.9% a 12% rate of return would be reduced by 5.2% leaving an after-tax return of 6.8%. Inflation averaged 5.97% from December 31, 1967 to December 31, 1995. That means your after-tax, after-inflation "real" rate of return is less than 1%

. If you are in the 50% or higher tax bracket even that meagre amount is wiped out. At current rates of 6% and less you are effectively lowering your standard of living, especially if you are relying on that as part of your income. True, you have more dollars, but they buy less. (See my September 1994 article "A Dollar on a Loaf of Bread" or call me for a copy.) Many people want these guarantees because they consider them safe. However, earning interest under the above conditions is not really safe, in fact, it is a guaranteed way to lose.

Now let's suppose you were to earn 12% in capital gains and dividends. If you were in the $6,759 to $29,590 tax bracket your dividends would come to you practically tax-free. You would be able to keep $926 out of $1000 in dividends. Because of the dividend tax credit you would also be able to save taxes on your other earned income. Capital gains on the other hand are 25% tax free. Only 75% are taxable. In other words, on a capital gain of 12%, only 9% would be taxable at whatever rate you pay. I would prefer to have a 10% gain in dividends and capital gains than 12% in interest because (thanks to inflation) I would have more to spend after taxes. Remember, it's your after-tax return that you can spend at the store.

That's the bottom line! I have heard many people say: "How come no one has ever shown me before the difference taxation makes in various types of return?" I think the answer is quite simple. Most institutions that we deal with day after day, such as banks, trust companies, credit unions, deal primarily in one kind of return, and that is "interest".

You may have noticed recently in my ad in the professional directory that I no longer offer GICs. I firmly believe if I were to continue to offer them even as a service to my clients, I would be doing them a dis-service. I am a firm believer in "ownership". As I have explained several times before, investing in the right equity mutual funds gives you this ownership which produces dividends and capital gains and a superior rate of return.

"Own or loan" is the saying I use to demonstrate this point. (See my November 1993 article "Owning vs. Loaning" or call me for a copy.) I also have charts and tables that show the after-tax retention of $1,000 in the various tax brackets plus the inflation rate per year from 1967 to 1995. They are yours for the asking.

If you have any questions, please call Reg Borrow at (519) 855-6639. He is an Independent Financial Consultant with Regal Capital Planners Ltd.

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Created: Mon Sep 23 10:30:50 1996
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