DIY investor’s windfall requires unique advice

This article appears in the February 2022 issue of Advisor’s Edge magazine. Subscribe to the print edition, read the digital edition or read the articles online.

The situation

Mario Dussault* has always considered himself a gambler. Growing up in Gatineau, Que., he started playing blackjack at the Casino du Lac-Leamy as a teen. Starved for entertainment during the 2004–05 NHL lockout, he got into online poker and won enough to cover his university tuition. In 2013 he invested in a cannabis company and bought a two-bedroom condo in Hull when he sold his shares.

When the Covid-19 pandemic hit, Dussault, 33, temporarily lost his job as a manager at a luxury hotel in Ottawa. Idling away another pandemic afternoon, he clicked on an Instagram ad for an online broker. As markets roared back to life, his investments in tech stocks and Bitcoin went #tothemoon; soon he was trading leveraged products and taking out a home equity line of credit (HELOC) to buy meme stocks. By the middle of 2021, he had turned his $20,000 initial investment into almost $400,000.

Now, as he returns to work, Dussault is considering professional advice to manage his windfall. This is partly at the urging of his new wife, Aida Sellassie*. Dussault began dating 28-year-old Sellassie, an aide to a federal cabinet minister, at the pandemic’s onset and they moved in together in the spring of 2020. Last summer they were married in a small outdoor ceremony, and they’re expecting a baby in the spring. Dussault will admit that his circumstances require a more nuanced approach to risk than he had while betting his way through university. But he also prides himself on his investing knowledge and mistrusts the wealth management industry. He’s not going to abandon his YOLO ethic all at once, especially after the success he’s had.

Dussault earns $70,000 per year at his job, which is still unstable as the tourism sector struggles. Sellassie earns $155,000 per year, with little job security working in politics. She has $40,000 in a TFSA.

Sellassie’s brother has an advisor he likes, and she convinces Dussault to have a meeting. How should the advisor pitch the couple?

* These are hypothetical clients. Any resemblance to real people is coincidental.

The experts

Brianne Gardner Wealth and investment advisor, Raymond James in Vancouver

Gabriel Leclerc Financial advisor, Edward Jones in Arnprior, Ont.

Zoran Vranjkovic CPA, Welch LLP in Ottawa

Experts’ answers have been edited for length and clarity

Advice for DIY clients

Gabriel Leclerc (GL): He’s done a great job building wealth and turning $20,000 into $400,000. But we need to identify his short-, medium- and long-term goals for those funds, especially as a growing family.

Brianne Gardner (BG): Mario should keep in mind that he did well during a very strong bull market, and the easy money period is likely over. The higher-risk investments he used to achieve his returns tend to be more volatile. Low fees are an important factor, but there can be a lot of extra value from a financial advice expert.

Without a solid risk management plan to protect his profits, he may see his hard-earned growth disappear. I’m not suggesting he abandon all his old investment methods — just take most of the profits and go with a slightly less aggressive approach to achieve more consistent, less volatile returns.

GL: We always try to work with the client’s goals in mind, with their experience in investing. When we look at high-risk or leveraged products or high-volatility products, we [try to get clients to focus on] high-quality investments with a proven track record that will provide a consistent return over time.

BG: I suggest two parts to his portfolio: a conservative one (the majority) and some “play money” for higher-risk opportunities.

His family’s financial situation means he shouldn’t be taking too much risk. Mario may not be aware that the S&P 500’s long-term returns are around 10%. There are certainly years where 15% to 20% returns are achievable, but those are rare.

I’d explain that a 2,000% return, which he experienced, is not normal. I would show him charts that illustrate how deep losses can take years to recover from. By targeting double-digit returns, he has to be prepared for significant volatility.

I’d suggest setting aside $5,000 to $10,000, or 2.5% of his assets, for higher-risk investments. He might be hesitant and want to have at least $20,000, but I’d explain that to take the amount of risk he did originally, he’d have to be prepared to lose money because it’ll be much harder to repeat those returns. He shouldn’t let greed or emotions creep into his investing. Use rules and stick to a proven strategy.

For his main investments, I’d suggest an income growth or growth portfolio targeting 6% to 8% annualized return. A basket of ETFs will be a lot less volatile than buying just one underlying security. He’d still have exposure to Tesla and other innovative, up-and-coming ideas.

There are so many ETFs to choose from now and some of them are so specialized that they carry more risk than you might assume. That’s why working with an advisor is important.

If he invested the “play money” inside a TFSA and maintained his [previous] luck and performance, he could grow that money tax-free. But if the market pulls back significantly and experiences volatility, he doesn’t get to write off the capital losses, which would be a benefit of having the play money in a non-registered account.

Also note that Bitcoin and other cryptocurrencies can’t be held directly inside a registered account since they are not qualified investments. However, there are now cryptocurrency ETFs that allow exposure to the asset classes inside TFSAs and RRSPs.

He can sell the crypto in his non-registered account, which would trigger the gains on it, and buy the ETF version (depending on which crypto he’s holding) inside his TFSA.

I would suggest he sell most of the crypto and diversify the portfolio. If he really wanted to hold some, I’d recommend no more than 5% to 10%.

We also need to consider other debts aside from the HELOC, which he may not need to pay off right now. That’s because rates are at historic lows. If he’s earning more in his investment account than the interest rate on the HELOC, he should keep his money invested in the market. If rates start to go up, then I would re-evaluate. They are calling for four rate hikes in 2022, but it won’t be anything drastic.

Then, we would look at spending goals and an emergency fund, especially since both their jobs are still unstable because of Covid.

Tax considerations

Zoran Vranjkovic (ZV): We would want to ensure the family’s income is taxed efficiently and not skewed more to one individual than another. Income splitting might be an option. They could consider a prescribed-rate loan structure, which allows a loan to a family member, spouse or minor child. That loan has to be interest-bearing with a minimum rate equal to the prescribed rate of interest at the time the loan is made.

That rate can fluctuate quarterly but, once you make the loan, you’re locked into that prescribed interest rate. Right now, it’s at a historical low of 1%.

BG: Aida is in a higher tax bracket, so we would also look at adding to her RRSP to help bump her income down. Also, max out both of their TFSAs, which will help shelter some of that future growth of the $400,000.

ZV: It’s not clear what the underlying gain at this point is on that $400,000. But, right now, only one-half of capital gains are subject to tax, which reaches a maximum rate of 26.76% at the top end. If the government increases the inclusion rate for capital gains, that would push the tax rate up to over 40% at the high end on capital gains. So if they are reallocating the assets and diversifying, now might be a good time to do so while the capital gains rates are certain.

Also consider that if his HELOC was taken out to invest in crypto, the interest might not be tax deductible. That’s because, while borrowing has to be for the purpose of earning income, capital gains are not considered income.

GL: With a growing family, there are a lot of objectives. They should also think about estate planning and life insurance. This is the right approach, to partner with [professionals] and get the right advice. They’ve got a leg up already, so starting early will really help them long term.