Wealth Your Way

Thinking about starting your own business? One of the first things to consider is what form of business structure best suits your interests. CIBC Private Wealth US Senior Wealth Strategists, Ryan Coulson and Halsey Schreier, walk through the features and benefits of sole proprietorships, partnerships, corporations and limited liability companies (LLC).

Converting traditional IRAs (individual retirement accounts) into Roth IRAs has been a hot topic of conversation for people of all ages in recent years. Whether taking advantage of the current low income tax rates, or making the smartest choices in estate planning, many investors are turning to Roth conversions when planning their retirements. Ryan and Halsey discuss how this move can minimize the taxes owed on your retirement savings and maximize the money for both you and your inheritors.

An administration change typically leads to a change in our nation's tax laws. But the legislative process for this is complex, and may lead to less sweeping changes than expected. Ryan and Halsey explore this process together and discuss what to look out for when it comes to your personal finances.

Are you curious about crypto? 

There’s been a tremendous amount of hype about how cryptocurrencies are the “next big thing” in the digital revolution, and how they have the potential to transform not just traditional financial services, but also other industries. 

A number of high-profile celebrities have endorsed both cryptocurrencies and crypto companies. There are also watercooler stories that most of us may have heard, such as the one about the crypto millionaire who made a fortune overnight, and then lost it all just as quickly. Even the president of El Salvador had his crypto moment in the spotlight when he declared Bitcoin would be legal tender in his country. 

But as many new crypto investors have learned, cryptocurrencies are extremely complex and difficult to understand, which can make them especially challenging for potential investors. 

As with any investment, we recommend starting with the basics, which is why we’ve put together an overview of some of the essential cryptocurrency concepts to help you get started. 

What are cryptocurrencies?

Bitcoin, the first cryptocurrency, was created by Satoshi Nakamoto, which is a pseudonym for the person or team who wrote about the technology in a 2008 whitepaper. The basic concept is relatively simple: Bitcoin is a form of digital cash that allows for secure and seamless peer-to-peer transactions across the internet. 

Cryptocurrencies are not issued by a government, and there is no central authority providing oversight. Instead, cryptocurrencies are managed by peer-to-peer networks of computers, which run on free, open-source software. 

While Bitcoin is the oldest, largest, and most established cryptocurrency, there are now thousands of others. Some have a similar design and purpose as Bitcoin, while others are based on different technologies or were created with other functions in mind. For example, Ethereum is a cryptocurrency that can be used to run applications and create contracts. 

The blockchain ledger

The blockchain is an essential feature of many cryptocurrencies. It is similar to a bank’s balance sheet or ledger because it keeps a record of every on-chain transaction. However, unlike a bank ledger, the blockchain is distributed across the entire network of computers. 

The mining process

Most cryptocurrencies are mined through a decentralized network of computers. With Bitcoin and many other cryptocurrencies, miners collectively work to verify and record new transactions and create new units of cryptocurrency by solving complex mathematical equations using specialized computers known as mining rigs. 

Determining consensus and securing the blockchain

Because cryptocurrencies operate without a central authority processing transactions, they must ensure that the same unit of cryptocurrency can’t be spent twice. They do this with a system called the consensus mechanism, which allows all of the computers in the network to agree on which transactions to include in the blockchain. 

Proof of work and proof of stake are the two major consensus mechanisms that cryptocurrencies use to verify new transactions, add them to the blockchain and create new tokens. 

Proof of work

Proof of work is the protocol used by Bitcoin and is proven to maintain a secure and decentralized blockchain. With proof of work, miners compete to solve complex mathematical puzzles. The winner gets to update the blockchain and is rewarded with cryptocurrency. However, proof of work requires a significant amount of energy and can be difficult to scale.

Proof of stake

Proof of stake generally relies on a network of validators who contribute or stake their own cryptocurrency in exchange for the chance to validate new transactions and earn a reward in a process that is similar to that of proof of work. However, because proof of stake blockchains do not require miners to perform energy-intensive, duplicative processes (competing to solve the same puzzle), the networks require substantially less energy to operate. 

Where do cryptocurrencies get their value?

The economic value of cryptocurrency is based on supply and demand. Supply refers to how much is available. In the case of Bitcoin, there is a finite supply—there will never be more than 21 million Bitcoin available. Conversely, demand refers to how much people want the cryptocurrency, and what they are willing to pay for it. The value of a cryptocurrency is determined by a balance of both of these factors. 

Cryptocurrency risks

There are many risks associated with cryptocurrencies, especially for investors. Cryptocurrency prices have historically been volatile, and wild price fluctuations can result in significant losses and stress. 

Cryptocurrency transactions cannot be reversed, unlike bank transactions. This means if you make a mistake and enter the wrong amount or address, you could risk losing your cryptocurrency and may not be able to get it back again.

It is also important to note that cryptocurrencies are relatively new, and there are many nuances that are not widely understood yet. Issuance and trading are not well regulated, which means additional oversight and regulation is likely in the future. 

Should you invest in cryptocurrencies?

Bitcoin and other cryptocurrencies are speculative investments and don’t fit within traditional asset allocation models. They are not a commodity (such as gold), nor are they a traditional fiat currency, backed by a government. Additionally, cryptocurrencies are difficult to value as most traditional valuation metrics don’t apply. 

Though some traders have been successful taking advantage of the changes in prices of Bitcoin or other cryptocurrencies, we believe most investors should treat cryptocurrency as a speculative asset class to be traded outside of a traditional long-term portfolio. 

As the Covid-19 pandemic seems to be in its final phase, the world in its wake is a much different place. How will this affect our investments moving forward? ESG factors are helping companies adapt to a tumultuous year. Environmental and health-conscious business models are the new norm, and diversity in leadership and representation has begun to dominate corporate priorities. Will the trials of 2020 lead to sustainable change? Or do the grand gestures of today fade away to "business as usual" tomorrow? We're joined by the Head of ESG and Impact Investing John Tennaro to discuss.

The debate between active vs. passive investing is often framed within the context of which is better. But advocating one approach over the other isn’t necessarily helpful for new investors. Instead, what is often most helpful to these investors is a discussion that helps them understand the differences between each approach, as well as when and how it makes sense to utilize them in a portfolio. 

 

Once you’ve established the right asset allocation mix for your risk tolerance, time horizon, and investment needs and goals, the next step is implementation — choosing your investments. 

 

When selecting investments for your portfolio, one of the first decisions you’ll make as an investor is deciding between active vs. passive investment strategies. Understanding the potential advantages and disadvantages of both investing styles, as well as the importance of having a diversified portfolio, can help you determine whether to deploy an active or passive investment approach, and when to do so.

 

Here are some of the key differences between active and passive investing strategies:

 

Active investing
 
The goal of active investing is to “beat the market,” or outperform a given benchmark. Active investment decisions are often based on rigorous research and analysis of an asset. Other factors that can influence an active investor’s decision to buy or sell a particular investment include market trends, the economy and political climate.  

 

Unlike an index fund, which is designed to mirror the composition and returns of an index, an actively managed mutual fund will seek to generate returns that are different than those of the benchmark. 

 

Advantages of active investing:

 

Flexibility: With active investing, portfolio managers and investors aren’t required to hold certain stocks and bonds, which means they not only have a wider opportunity set to select from, but they can also benefit from short-term trading opportunities. 

 

Risk management: Unlike passive strategies, which ebb and flow with a market, active investors can manage their exposure to risk by avoiding or selling certain holdings and market segments. In addition, some active managers can use short sales, put options and other strategies to hedge against risk.

 

Tax management: Actively managed strategies can be tailored to particular investor needs, such as tax efficiency. For example, an actively managed portfolio can harvest tax losses by selling underperforming investments to offset the capital gains tax on outperforming ones. 

 

Actively managed portfolios generally have higher fees than passive portfolios. This is because you’re paying for the expertise of a professional money manager to pick investments and monitor your portfolio. 

 

However, even small fees can chip away at returns and have a big impact on performance. This makes it harder for actively managed funds to consistently outperform their benchmarks: It isn’t enough for an active manager to just beat the index; the fund must also outperform by a margin that is wide enough to cover the expenses. 

 

A major difference between active vs. passive investing is that, with active strategies, investors have a wider range of potential returns. As an active investor, if you make good investment choices, you could potentially see a much higher return than you would with a passive investment. On the other hand, if your investments perform poorly, you could also lose more money. 

 

Active management can really shine in times of volatility and in certain niche markets, such as emerging market and small-company stocks, where information is limited and assets are illiquid.

 

Passive investing

 

The goal of passive investing is to match the performance of an index or benchmark, rather than outperform it. Passive investing is more of a buy-and-hold approach with limited turnover, which keeps costs low. 

 

One of the most common ways to invest passively is to buy index funds, which are designed to track the performance of a particular index. Passive managers simply seek to own all of the underlying assets in a given market index, proportionate to the index. 

 

Passive strategies have grown in popularity over the last few years as research shows that a passive benchmarked strategy can deliver solid returns, but with lower fees and less effort than an actively managed approach.

 

Advantages of passive investing:

 

Low fees: Fees are generally lower for passively managed funds because there is less overhead.  Nobody is actively picking investments, and there is no need to analyze benchmark holdings. 

 

Transparency: Investors typically know which stocks or bonds are held in an indexed investment. 

 

Tax efficiency: Most index funds do not trigger a large annual capital gains tax because they do not trade often. 

 

However, one of the main drawbacks of passively managed portfolios is that you have less control over your investments, because you’re usually investing in a predetermined selection of securities. This means you won’t be able to make adjustments if certain sectors or companies become too risky or are underperforming. 

 

With passive investing, you earn whatever the market earns, based on the benchmark you pick. This means you participate fully in a market upturn, but you also fully participate in the losses when the market declines. 

 

Passive strategies are generally recommended if you have a lengthier time horizon or are in a situation where you want to minimize fees. 

 

Neither active nor passive investment strategies are mutually exclusive, so you may have a combination of each in your total portfolio. 

Year-end is typically when many people start thinking about taxes. But waiting until the year is over may result in a scramble or the inability to implement certain time-sensitive strategies, which can make tax planning less effective. Often, people look back on the previous years’ filings and think of all the things that could have been done differently to help lessen their tax bill. 

 

Taking a proactive approach by planning for any income tax burdens throughout the year could be the key to lessening some of those tax-related anxieties. Doing so may also be the key to lowering tax bills and generating significant tax savings—catapulting many into a more stable financial future. 

 

Why tax planning is important

 

Many young adults are on the cusp of pivotal milestones in life—such as graduating from college, entering the workforce and building careers, starting to save and invest, buying their first homes, getting married and having children. Navigating these major life events is not easy, especially in an uncertain financial and economic environment. In addition, tax laws can be complicated, which is why it is especially important for young professionals to understand the potentially fluid nature of their circumstances and the possible impact on their tax obligations. 

 

It’s easy to overlook important deductions or credits that could make a big difference in how much is owed or how much someone can get back when it’s time to file. 

 

This article clarifies some fundamental things young professionals should be aware of when preparing their tax returns.

 

Types of taxable income

 

There are two types of income: earned and unearned. Earned income includes wages from an employer or income received from self-employment, as well as tips, unemployment benefits and sick pay. Unearned income includes interest, dividends, royalties and capital gains from the sale of assets. Income at the federal level doesn’t include gifts or inheritances. 

 

The amount of tax owed is based on how much you earn. To determine your tax rate, the Internal Revenue Service (IRS) uses a series of ranges, also known as brackets, that represent incrementally higher amounts of income. The tax system is designed to be progressive so that people who earn more pay a higher percentage. However, taking advantage of various tax benefits may reduce tax liabilities. 

 

Standard vs. itemized deductions

 

Tax deductions lower one’s income, so taxes are paid on less earnings. The IRS allows employees to claim the standard deduction, which is a fixed amount based on their filing status. Professionals may also itemize their deductions, which means selecting various deductions allowed by the IRS, including charitable contributions, mortgage loan interest, some medical and education expenses, as well as business-related expenses, though there are limitations on the ability to deduct in all of these categories. 

 

The Tax Cuts and Jobs Act of 2017 increased the standard deduction and made itemizing tax deductions less beneficial for many taxpayers. But if an individual has the ability to itemize his or her deductions, it can make a significant difference on their tax liability. 

 

Maxing out tax credits

 

While deductions are subtracted from one’s income and lower the amount that they are taxed, tax credits reduce what is owed. After all deductions have been claimed, some people may still owe taxes. However, it is possible to reduce the amount owed or even erase tax debt with tax credits. 

 

Nonrefundable tax credits are only valid in the current reporting year and cannot be carried over to future years. A nonrefundable tax credit can reduce tax liability to zero, but cannot be used to provide a tax refund. Examples of nonrefundable tax credits include credits for adoption, the lifetime learning credit, the child and dependent care credit, the saver’s tax credit for funding retirement accounts, and the mortgage interest credit. 

 

Refundable tax credits entitle taxpayers to the full amount of the credit. If the refundable tax credit reduces the tax liability to zero, the taxpayer will receive a refund for the credit. Examples of refundable tax credits include the Earned Income Tax Credit for low- to moderate-income taxpayers who meet certain criteria based on income and number of family members, and the premium tax credit, which helps individuals and families cover the cost of purchasing health insurance through the health insurance marketplace. 

 

With a partially refundable tax credit, if a taxpayer has a zero tax liability before using the entire amount of the tax credit, the remainder may be taken as a refundable credit, up to a certain amount. An example of a partially refundable tax credit is the American opportunity tax credit for post-secondary education expenses. 

 

A note about student loan interest

 

Subject to certain income phase outs and limitations, student loan interest may be deducted, regardless of whether the taxpayer itemizes their deductions or chooses the standard deduction.

 

Getting the most from tax-advantaged retirement and health savings accounts 

 

Funding a retirement account with pre-tax dollars lowers taxable income, so if an employee is not participating in an employer’s 401(k) plan or depositing money into an individual retirement account, he or she are likely missing out on some key tax advantages. 

 

Another recommendation is to consider a Health Savings Account (HSA) if it is an option with an employer’s insurance plan. Any amount deposited into an HSA is deductible and does not have to be itemized in order to take advantage of this tax break. 

 

A good strategy is key

 

Having a good tax strategy can reduce tax liability and related anxieties. For help with tax planning, consider working with a financial advisor—someone who can explain deductions, qualified credits, and tax-advantage accounts that are most beneficial for particular financial situations.  

CIBC Private Wealth’s Wealth Your Way podcast series is an educational offering for clients and their children, and demonstrates our commitment to developing the rising generation.

CIBC Private Wealth’s Wealth Your Way podcast series is an educational offering for clients and their children, and demonstrates our commitment to developing the rising generation.

CIBC Private Wealth’s Wealth Your Way podcast series is an educational offering for clients and their children, and demonstrates our commitment to developing the rising generation.