I am retired and I manage my own portfolio of stocks. I have to be a bit aggressive because the total potential income isn’t enough for my retirement, so I turn 5 to 8 percent of gambling on startups. I originally bought these stocks in my tax-free savings account with the expectation that the substantial profit, if lucky, would be tax-free. However, I did not take into account the other edge of the sword, namely that losses cannot be claimed. Do you have an opinion on where best to keep it?
If it were my retirement money, I wouldn’t gamble on startups at all. The risk of losing all or part of your investment is too great. According to Statistics Canada, only 63 percent of new businesses stay in business after five years, and the survival rate drops to 43 percent after 10 years. Even among the companies that make it, many lag behind for years and never achieve the ambitious goals of their business plans.
But many investors cannot resist the appeal of a high score and pile up in start-ups, “story” shares and IPOs.
“A wealth of research shows that IPOs generally generate lousy returns with very high risk,” writes investment advisor and author William Bernstein in his book The Investor’s Manifesto. But investors still flock to them because “IPOs are the investment equivalent of a lottery ticket”.
This is proven by the data. Of the 8,286 US IPOs from 1975 to 2015, nearly 60 percent had negative returns after five years, according to data from University of Florida professor Jay Ritter. Of these, around 70 percent lost more than half of their value, based on the closing price on the first day of trading. Only 1 percent of the IPOs achieved 5-year returns of 1,000 percent or more – the proverbial “ten baggers” that investors dream of.
Do you really believe that with odds like this you can reliably determine the winners and avoid companies that are out of money, squashed by the competition, or turn out to be fraudsters? Unless you have a specific knowledge of a particular company, it’s like throwing darts at a dart board. Limiting your startup investments to 5 to 8 percent of your portfolio helps control your risk, but that doesn’t make it a good idea.
However, there is a relatively safe way to get exposure to these rare stocks with great returns. Rather than buying individual companies, consider holding broad exchange-traded funds that own a slice of indices like the S&P / TSX Composite, S&P 500, Nasdaq 100, or Russell 2000. And you avoid the risk of one of your picks exploding in your face.
You mentioned that you want to generate more income in retirement, but startups aren’t helping because they don’t pay dividends. Another option is to invest in blue-chip dividend stocks – like banks, utilities, power producers, telecommunications, and real estate funds – that will increase your cash flow without unduly increasing your risk. Many of these stocks increase their dividends on a regular basis, increasing your retirement income and protecting your purchasing power from inflation. (You can find examples in my model of the Yield Hog Dividend Growth Portfolio at tgam.ca/dividendportfolio.)
As for the tax impact of gambling on startups, you are right that losses in a TFSA cannot be used to offset capital gains for tax purposes. But you invest with the intent to make money, not to lose it. If you expect to lose money overall investing in unproven companies, don’t do so in the first place.
On the flip side, if you expect startups to make a big profit – that is, you are confident that your profits from some home runs far outweigh the potential losses of the others – then it would make sense to keep your stocks in a TFSA . That way, if you’re “lucky” and one of your stocks goes to the moon, you won’t have to pay capital gains tax on your net profits. The problem with this is that deciding where to hold your risky stocks depends on how they perform, and that is not known.
After all, you shouldn’t just rely on your portfolio to make ends meet in retirement. When money is tight, look for ways to cut your spending. This could include small things like switching to a cheaper cable or cellphone package, or major changes like downsizing your house. These things are under your control, as opposed to the returns on risky startups.
Bottom line: if you’re trying to play your way to a happy retirement, you might endanger it instead.
Email your questions to [email protected] I can’t reply to emails personally, but I choose certain questions to answer in my column.
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