Why I don't like earning interest
I said elsewhere that I'd told the reason elsewhere so wouldn't repeat, but to write me, which someone did and someone else asked on that thread and I forget where the original comment was, on a thread related partially to a different topic, so here goes.
Twenty years ago as I began work as a personal financial advisor, a number of people recounted to me with great satisfaction how they'd got 19% on their Canada Savings Bonds in 1981 (rates vary from year to year). Reported with a big smile, and even a bit of a chortle, one might say. An expression on their face sort of like, as Dad used to say, the face of the cat that swallowed the cream (but without any white residue, of course).
I said that, while the 19% shows up nicely in their savings account book when they deposit the cheque, so makes a substantial impact on their memory, that's not the end of the story.
The Income Tax people want to talk to us every year about all of our earnings in the previous year. If the owners of the Canada Savings Bonds were in a 25% income tax bracket, that would reduce the 19% to under 15% after-tax return.
The Canadian Income Tax rate is highest on our income as employees, or interest that we earn on our investments. And at an equal rate, with a small tax credit, on our income as retirees from our private pension plan. The types of income that most Canadians have.
We don't have tax-free municipal bonds in Canada. Every type of interest earning that I know of is taxable here. So, as the disclaimer always says on ads about mutual funds, " ... your experience may differ".
If I own Canadian stocks, which pay me dividends, those dividend rates are often somewhat lower than the rates of interest that an equal amount invested might produce - so I have a smaller amount of current income to report to the income tax people, this year.
If I, a Canadian resident, own U.S. or other foreign stocks which pay me dividends, I must pay income tax at the same rate as though I earned interest, here or elsewhere. So if that dividend rate is lower than the rate of interest that I might earn, I pay less tax now, though at an equal rate to that which I'd pay on interest income.
Also, the income tax rate on some other types of income is much lower - the types more commonly owned by more wealthy people.
Those dividends paid by Canadian stocks are taxed at a much lower rate.
If I have been skillful enough to have purchased some quality stocks, as the value of those stocks increased, the amount of dividends that they pay annually usually increases, as well. If a stock priced at $10.00 pays 2%, that's 20 cents, but if the value increases to $20., 2% of that is 40 cents.
Some stocks, especially in fairly new companies which have a good product or service and want to expand, pay no dividends at all. I own several like that. Some have not done well, so the price of their stock has not advanced as much as though I'd put that amount out to earn interest. I have lost on such stocks, of course.
But a number of them have grown, some quite substantially, so that the value of the shares is several times the amount that I paid.
That's fine with me - and I haven't had to pay the income tax people a cent related to my investment in that stock, so far.
As I've said to a number of people over the years, I don't have to answer to the Canadian Revenue Agency until I either sell those stocks ... or die ... and I don't plan to do either, this week or next.
Suppose I hold the stock for twenty years, its value increased, then decreased, then increased some more, then slipped some more, went up again, etc. and I sell it for three times what I paid for it.
I don't have to talk to the income tax people about the increased value throughout the time that I own it. When I sell it, I deduct the amount that I paid to find the capital gain.
Only then, at the end of the twenty years of fluctuating prices, must I report the growth in value of that asset over those twenty years to the income tax people.
Instead of facing all of my tax liability as I go, I like to defer it when I can.
Not only that - after I've calculated the capital gain on that stock at the end of that twenty year holding period, I am required to pay tax on half of it, but can keep the other half free of tax.
I prefer tax-free income when I can get it.
Furthermore - I have a choice as to when I sell a stock, so need to report the income - which I may choose to do in a year when my income from other sources is lower (and when, as a matter of fact, I might like to have the money).
When I lend my money to a financial institution (or an individual, for that matter), they guarantee that they'll return every dollar that they borrowed at the end of the agreed period (but the guarantee is a little less solid on loans to individuals).
There's another guarantee that they never mention - they won't pay one dollar more than they borrowed, either. So, apart from the rent on the money, that's the only return which you'll ever receive on that chunk of money for that period of time.
So, the only income that that asset will ever develop related to that year is ... right then. So, all of your return on that asset for that period will always be fully tax-liable at the time that you earned it.
You would agree, I'm sure, that $10,000. won't buy as much now as it would 10 years ago.
So, if the asset that you rented out to earn interest can't grow, you'd better take part of the annual income that it produces to increase the amount of the asset, so that you can now afford the the car that cost $10,000. ten years ago and now costs $16,000.
If the $10,000. that you had 10 years ago hasn't grown by the rate of inflation, more or less, you may have the same number of dollars - but you're losing ground.
Did they know what the rate of inflation was in 1981, I asked them and most had only a vague idea.
It was running at 12% - so when they deducted that amount from the better than 14% after-tax return on their vaunted Canada Savings Bonds, they had a real rate of return of somewhat over 2%. If their top marginal rate of incometax was 25% - if it was higher, their net amount left in hand after allowing for tax and inflation would have been even less.
How would you like to have a real rate of return for a year of just over $2,000.00 on an investment of $100,000.00?
Sometimes in recent years it has ben negative.
If you choose not to add part of your interest earnings to the basic asset annually, or at least from time to time, at the beginning your $100,000. stays $100,000. through the first period ... then the second ... then the third, etc.
So your interest earnings will be based on the same amount of asset, at the going rate each time when you invest the asset.
That seems to be enough for now - should get a good discussion going.
Hope you'll come back later, for I have some more to add that may be of interest.
Good wishes to all for conducting an examination of the way that you live, your habits, etc. from time to time.
Sort of stretches the mind, so to speak.