3 Proven Ways to Increase Investment Returns
For most investors the central goal is to try and earn the highest return possible, while also minimizing risk of losses. While this is pretty obvious conclusion, the less obvious thing is how to best accomplish it.
There are a myriad of investment strategies, tips and trends available at any given time in the markets – but how often do these really pay off in the long run? For most investors the big payouts are few and far between. Profitable trends eventually reverse themselves without warning, and hot stocks can take tumbles. There is simply no way of controlling it, and unfortunately no crystal ball.
So this article will take a refreshing look at what we CAN control with our investments, and how we can apply these ‘levers of control’ to maximize our returns. Specifically, you will learn the 3 proven ways to increase investment returns:
- Lowering income taxes paid on investment returns.
- Asset allocation and portfolio diversification.
- Lowering investment related costs and fees.
The best part is that each of these is proven, and very simple to get started with. You don’t need an MBA in Finance. With the information you’ll learn in this guide, you will be well on your way to higher, more stable long term returns on investment.
Lowering Income Taxes Paid on Investment returns
Taxes are the biggest expense we have in life, and no matter how good your returns on investment are – the government will want its piece of the pie. Thankfully taxes are one of the things we can lower, to help us realize a better AFTER TAX return on investment. How do we do this?
- RRSPs: An RRSP (Registered Retirement Savings Plan) is not an investment, but a government sponsored account that allows you to hold a wide range of investments, including socks, bonds, mutual funds and ETFs, tax free. In other words, you do not need to pay income tax on the money invested in an RRSP structure, so in many cases where income tax has already been deducted from pay, it is returned or refunded at tax time when an RRSP is purchased. If this tax refund is then invested, due to the effects of compounding, the return can be quite impressive. With this said, the party is over when you are required to pay income tax on ALL deductions from an RRSP (unless you are using the first time buyers plan or lifelong learning plan).
Top RRSP Investment Tips: If your marginal income tax rates are much higher during working years than retirement, RRSP investing is an excellent choice. If you have interest paying bonds, fixed income investments or American investments – consider holding these in your RRSP first!
- TSFAs: A TSFA (Tax Free Savings Account) is another type of government sponsored investment account. While it does not allow you to deduct investment amounts from income in the year, and thus receive a tax refund – it allows all of all money invested up to a yearly limit, to grow tax free. In other words, when you sell the investment within a TSFA you do not need to pay taxes on the growth. Having this kind of tax free growth is very rare, and is generally the most important investment tax opportunity to take advantage of, no matter what your income level is.
Top TSFA Investment Tip: Because you are not taxed on the gains made in a TSFA, during retirement the withdrawals will not lower your Old Age Security and other government benefits. This is hugely important and is the reason why TSFAs are preferred ahead of RRSPs for most Canadians.
- ETFs: Unlike RRSPs and TSFAs which are accounts that hold investments, the ETF is an investment itself that is similar to a mutual fund. The tax benefit of an ETF is that there is typically very little stock trading that happens within an ETF, so at the end of the year you will not be faced with a potentially high capital gains tax bill like is often the case with mutual fund investments.
Top ETF Investment Tip: If you are looking at holding some investments outside of an RRSP or TSFA, the ETF can especially make sense do given its proven tax efficiencies.
Asset Allocation and Diversification
The single most important factor that will affect the amount of investment returns you earn over time is how your portfolio of investments is structured, or ‘allocated’. Asset allocation refers to the fixed % of a portfolio that is invested in a particular area, such as stocks, bonds and cash. For example, a portfolio with 50% stocks and 50% bonds has achieved an asset allocation of 50/50 stocks and bonds.
If stocks went up in value and were now 60% of the portfolio, more money would be invested in bonds (or stocks sold and bonds bought) to return to the 50/50 asset allocation.
Asset Allocation is completely controllable. But a lack of control of the allocation is the biggest culprit for investment losses over time.
Why? Because when one type of investment, for example oil related stocks are preforming poorly, instead of balancing out the allocation by purchasing more oil stocks, usually the poor preforming investment, or oil stock in this case, is sold. Then when the poorly preforming investment rises, and the well preforming investment drops – the allocation and risk is completely out of balance, and returns are far less than they could have been.
Top Asset Allocation Investment Tip: Discover your own risk based asset allocation and stick with it. Take the emotion and effort out of it with regular investments into an automatically rebalancing portfolio, such as those found with robo investors.
Lowering Investment Costs
When it comes to controllable factors that will affect your investment returns over time, the close second to Asset Allocation is Investment Fees – specifically (but not limited to) the yearly investment management fees. In some brutal cases, almost half of an investor’s portfolio can be deteriorated over time due to the compounding effects of these management fees. Let’s take a look at an example to illustrate the effects:
- Initial sum invested (with no additional money over time): $100,000
- Growth rate: 8% per year.
- Number of years invested: 20
The 2.5% fee category represents a common yearly management fee for a mutual fund, and the 0.25% fee category represents a common yearly ETF fee.
||2.5% Yearly Fee
||0.25% Yearly Fee
|Ending Value with NO Fees
|Total (-) Effect of Fees
|Annual Fees Total
|Growth Forgone (due to fees)
|Ending Value WITH Fees
|Reduction of Returns due to Fees
The $162,426 difference in ending values is HUGE, in favour of the 0.25% category. This is a 37% total portfolio improvement in the low fee category, when compared to the higher fee category. Why would anyone pay the higher fee? For higher returns? It doesn’t quite work out that way.
It has been proven time and time again, that professional mutual fund money managers who charge these higher fees to not perform any better than the total stock market average, or index in which they are invited. An ETF or Exchange Traded Fund matches the return of the index by automatically investing in the entire index. Because ETFs automatically invest in the entire market average/ index, and there is no stock picking, they are able to change much lower fees. For more information on this click here, but for now its safe to say that by controlling the costs of your investment, a much higher return can be achieved.
Your biggest financial goals, including retirement depend not on gambling, or making investment managers rich – but a carefully thought, well executed strategy. By following these three controllable steps well, you will likely achieve higher returns than most Canadian investors, and ultimately reach your goals sooner.