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Terry Ritchie on Unraveling Cross-Border Financial Planning

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Terry Ritchie

Snap Projections, a financial planning software company, recently featured Cardinal Point’s Partner and Director of Cross Border Wealth Services, Terry Ritchie, on their Growing Your Financial Advisory Practice podcast. Given Terry’s more than 30 years of experience in cross-border financial, investment, tax, and estate planning, it’s no surprise that Snap Projections chose to tap into his insight for this primer directed at financial planners who want to serve US-Canada clients.

From the factors driving clients to move between Canada and the US (hint: politics, healthcare, family, and lifestyle all play a role) to the intricacies of visas, green cards, and US income tax, the podcast highlights Terry’s wealth of knowledge and passion for cross-border work.

Here’s everything discussed in the one-hour episode:

  • Why people move between Canada and the US.
  • Why Terry thinks cross-border work matters.
  • What you MUST know about visas and green cards.
  • Important elements of US income tax.
  • Limitations on Canadians who invest in the US.
  • Estate planning for cross-border clients.
  • The biggest cross-border planning mistake advisors make.
  • How to grow a financial planning career you really love.

The Politics of Investing

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We all know politics is an uncomfortable topic for many people. In fact, a recent research paper from the University of Nebraska found that politics was making Americans physically sick. According to the study, nearly 40% of Americans reported that they were stressed out by politics, while 20% said they were losing sleep over politics. In recent conversations with clients, politics is certainly on many people’s mind and is hard to avoid.

With upcoming elections this month in Canada, both the Liberals and Conservatives have proposed budgets that would in varying degrees add to annual deficits in the near term. With a decent chance neither party will win a clear majority, more compromises will probably be needed, and the outcome will not be that dramatically different from the status quo.

While the Canadian election cycle is a concise 40 days, the U.S. election cycle never seems to end. When we see pitches and policies floated in the media on a daily basis with more than a year to election time, it’s natural to wonder what impact, if any, they will have on our investments. It’s also nearly impossible to avoid articles or pundits who are absolutely certain that if candidate X wins, the market will drop by Y%. While politics may be making us physically sick, does it also impact our investing habits?

A recent academic study from Professor Kemph of The Booth School of Business at the University of Chicago and Professor Tsoutsoura of the SC Johnson Colle of Business at Cornell University (“Partisan Professionals: Evidence from Credit Rating Analysts”) showed that bond credit analysts of both parties typically let their political biases impact their corporate bond ratings. The researchers found that analysts who voted for the opposite party of the president, tended to lower their bond ratings during that presidency.

This isn’t surprising when we view investing through the many lenses used in behavioral finance, such as confirmation bias – one’s tendency to search for, interpret, favor, or recall evidence that confirms one’s already existing belief. In other words, if you disagree with one political party, you probably look for reasons for why that party gaining or staying in power would be bad for your investments.

These are highly educated professional analysts who still had trouble disentangling their political persuasions from their day-to-day job of assessing the credit ratings of entirely unrelated companies. What hope does the average investor have?

Let’s take a step back from the political squabbling of 2019 and soon-to-be 2020 and realize that the medium- to long-term returns we see on most investments are likely to be impacted far more by the direction and strength of economies and company earnings than by an election result. Even if – hypothetically – the U.S. economy were headed for a 2020 recession, it likely doesn’t matter who wins the election since they will be jumping into the captain’s seat of a massive ship to which the president can only make minor changes of speed or direction.

Think back to 2008 and 2012, when it was common to hear investors worrying that an Obama presidency would wreck the stock markets and be the end of capitalism. In 2009, The Wall Street Journal ran an op-ed warning that “Obama’s Radicalism is Killing the Dow”, virtually at the bottom of the bear market – the time you would have benefited the most from being invested. Similarly, many investors had agonized that the Trump presidency would quickly send the economy into recession or worse. On election night, as S&P 500 futures were plunging, everyone was forecasting financial disaster as soon as he stepped into office. Investors who stayed invested over the last 10 years, regardless of who was in office, have been generously rewarded.

We tend to exaggerate the impact that any politician can have on the long-term value of companies. How much impact will the next Prime Minister’s or President’s policy decisions have on the future value of all the hamburgers McDonald’s will serve worldwide over the next 50 years, or parkas sold by Canada Goose?

Election results will soon be known in Canada, and whichever Democratic nominee emerges in the U.S. will shed a bit more light on what the range of U.S. policy differences may be after the 2020 election. In any case, we’d expect there to be some moderate shifts on both sides of the border regarding issues like tax rates and estate planning. The only constant in financial planning is change. No investment plan is meant to be stagnant over decades but should always be viewed as a living document – a document that incorporates changes in the investment and tax environments as well as your own unique circumstances. An investment plan ensures that your overall asset allocation is still the appropriate mix to meet your long-term goals.

The few investment changes that Cardinal Point has made over the last year have all been with the aim of making our portfolios more robust to potential stock market declines, regardless of whether those were to occur due to election results, geopolitical surprises or a further slowdown in economic growth. While we closely monitor global financial markets, speculating on the latest tweet is not a sound way to reach your long-term investment goals.

 

The Key

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I don’t care too much for money, money can’t buy me love
-Paul McCartney

My typical days the last 16 years may involve some combination of reading the latest academic research paper, running different scenarios of minor adjustments to a model portfolio or keeping tabs on the newest investment vehicles available to clients- all in the hopes of trying to eek out a few extra basis points of return. When this far in the weeds, it can be easy to forget the reasons we invest our money in the first place.

Growing up in the Bay Area of California, I frequented the Oakland and San Francisco zoos with family or during school field trips. While I was grateful for the time outside to play and admire the amazing animals, there was always something I was envious of: those other kids who had the cash to buy a zoo key.

A zoo key is a silly little plastic ‘key’ shaped like an elephant that allows you to play a recording at designated areas that gives background on the animal you were looking at. It probably cost $2.00 back then. It wasn’t even the recording that I was excited about, it was what that key symbolized. Having a key meant you were one of the cool, rich kids for which money was no obstacle. It was like the Tesla Model X  for an eight-year-old in the 1980s.

thezookeyphotoLast month we took a family trip to the Oakland zoo with our two young children. The following is a picture of my 2 year old son turning a key into the same recording box at the Giraffe exhibit that I wished I could have all those years back.

It hit me- does this mean I’ve made it in life? Because I can afford these minor luxuries that were beyond my family’s modest reach a generation ago, does that make us wealthy? After all, the couple dollar purchase won’t keep me up at night. My money worries center more around funding 529 plans for the kids, determining the right neighborhood for the next house we buy, or helping our parents prepare for their retirement.

This seemed to bridge the gap in my mind between money and meaning.

Perhaps these thoughts were heavy on my mind because I had just finished reading The Geometry of Wealth by Brian Portnoy, a fantastic book that prods the reader to evaluate their relationship with wealth and how it can help them live a more meaningful life- whatever that means to each individual.

An old saying came to mind at this moment- that money can’t buy you love. But in some ways it can help free you up to be able to enjoy experiences that make you happy, like going to the zoo with your children whenever you’d like. The end goal of earning wealth over time wasn’t the ability to invest in a hedge fund or own a vacation house. The goal was to have the financial freedom to enjoy those experiences with the ones we hold dear.

Financial planning expert Michael Kitces wrote, “The fundamental problem with goals-based investing… is that we don’t really have any real clue what our goals actually are”. This rung true to me, as 10 years ago I had no notion of what feelings I would have as a parent. 10 years from now I might feel strongly about a certain charitable cause or want to pick back up with the global travel we often did before having children. What being financially successful, or wealthy, meant to me in the past is likely to change over time.

The book mentions four C’s that wealth may be able to be employed towards in order to bring deeper meaning to one’s life.

  • Connection: Social connections
  • Control: The ability to direct and define your life
  • Competence: Being good at something you care about
  • Context: attachment to something bigger than ourselves

What are you investing for? What ability do you hope to have in the future that you don’t have today? If you hit the lotto tomorrow- what would you do with your time? Where would you live?

Using the framework of the four C’s above can help formulate goals. For example, it may be something like, “I enjoy volunteering for a certain nonprofit, and the ability to spend more of my time using my skills to help them is going to bring great satisfaction to me.” Or “I’d like to get to the point where I could pursue that architecture interest I’ve always had by taking some college courses.”

The author summarizes the book with the statement: “The ability to underwrite a meaningful life is achievable for anyone who combines the right mindset and the right plan.”

We at Cardinal Point couldn’t agree more.

While I spend most of my days ensuring we have an investment strategy that is grounded in academic research that can be tailored to our clients’ evolving and complicated cross border needs, we believe working with clients to help understand how we can best position their assets to help meet those future aspirations and needs is the foundation of a successful financial advisory relationship.

In my distant future that might simply mean the ability to bring grandkids to the zoo, and maybe even splurge for a plastic zoo key.

Why Invest Internationally?

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Diversification is the most important concept in investing, but also perhaps the least exciting. If anyone knew for sure exactly which one company or country would have the highest return in the coming year, there would be no reason to hold anything else. But while being able to predict markets with any certainty sounds great in theory, in practice nobody has been able to consistently outsmart the market. So what do you do if you can’t know for sure if Pepsi or Coke, or the US or Canada will be the best performer in the coming year? You diversify. This is especially important when it comes to financial planning.

While we may plan to retire in one country or have our peak earnings years in another, having broad-based global diversification can help you over the long run, even though in any give year or time period it can feel like it’s not benefiting you.

Stock Market Returns 2003-2006Let’s take an example of a Canadian investor who had a CAD account and was watching returns in the early 2000s. Between the start of 2003 and the end of 2006, the Canadian market far outpaced the US. You can see from the chart on the left that the annualized returns (in CAD) for Canadian markets was nearly triple the returns for US markets over that period.

Besides Emerging Markets, it would have been hard to see much reason to allocate any investments outside of Canada. And in fact, that’s much of what the Canadian and US investing media was telling you at the time- dump your US stocks, and buy Canadian and Emerging Markets! Yet moving to those markets solely and out of the US and International Developed markets would have been particularly painful shortly after in 2008, when  Canadian and Emerging Markets holdings would have underperformed compared to US markets, when viewed in CAD.

Stock Market Returns 2015-2017More recently, if we look at 2015-2017, Canada has delivered just half the performance of the US on an annualized basis, and well below the returns experienced in  International Developed and Emerging Markets.

As we can see on the chart below, the order of returns by region each year is essentially random. Trying to guess in advance each year which country or market segment will outperform will likely lead to simply buying what’s been hot in the last year and will often result in  disappointment. One area might do well for a number of years, as Emerging Markets did in the early 2000s, only to fall hard in 2008. US stocks did much better than Canadian stocks for 6 of the previous 7 calendar years, but underperformed significantly in 2016, and have experienced steeper declines this October.

Returns by Region
Diversification blog chart
*2018 YTD is Jan 1 – Oct 27

Instead of guessing which country or region is going to outperform next, astute investors can realize many benefits by spreading their assets across the group of global stocks. Doing so  allows you to capture the returns of whichever market is doing best in that time period, and ensures you’re never exposed to just one market or currency. As you can see on the chart, a blended exposure to the different regions means you can reduce your year to year volatility, and this is before the introduction of bonds or other asset classes that may move differently than stocks.

Over the last 15+ years, each region we looked at had strongly positive returns. Standard deviation measures how much those investments went up or down over the years, with  Emerging Markets being the most volatile. The Sharpe Ratio measures how efficient each investment was by comparing the magnitude of the returns  to the amount of volatility experienced. US stocks looked pretty good during this time period, but they don’t beat the blend when it comes to reward per unit of risk.

US stocks 15years

Looking back to the chart of annual returns above, we can’t know what region will have the strongest returns over the coming week, month or year. Yet, when we look at the blended result, which made no predictions at all but simply followed a long-term asset allocation between the four regions, we saw the lowest volatility and a healthy return , resulting in the highest Sharpe ratio.  This indicates that the blended portfolio is a  more efficient stock allocation than holding any one region individually. This blog looked at these regions from the Canadian Dollar point of view, but the results and theory are similar from the US Dollar perspective.

The downside of diversification is that you will never be the best performer. There will always be some particular stock or area of the market that will do better than the whole of your portfolio. But by having a globally diversified portfolio, you’re likely going to be capturing some of those gains. At some points, like 2008 or recently in 2018, all markets may see losses, however diversification ensures that you’re not taking unnecessary risk by having all of your exposure in any one company, sector, or country.

Thinking back to the financial plan that is crucial to the ability to meet long term goals, the long-term growth rates assumed are already factoring in ups and downs along the way. Nowhere in a prudent investment plan is the need to try and predict or out guess markets, but key to the plan is being able to capture those market rates of return wherever and whenever they do occur.

Source: Morningstar Direct 2018. Canada returns represented by S&P/TSX 60 TR CAD, US returns represented by S&P 500 TR CAD, International Developed represented by MSCI EAFE NR CAD, Emerging Markets represented by MSCI EM GR CAD. Blended mix represents 33% in Canada, 33% in US, 23% in Intl Developed and 10% in Emerging Markets, rebalanced annually. Indexes are unmanaged baskets of securities that are not available for direct investment by investors. Index performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. All investments involve risk, including the loss of principal and cannot be guaranteed against loss by a bank, custodian, or any other financial institution

Don’t Settle: Choose wisely when selecting a cross-border wealth management firm

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Your whole life you have done things correctly: worked hard, saved and prudently invested your money. Then one day, out of the blue, you receive a letter from your U.S. investment management firm saying they no longer want to work with you because you reside outside of the U.S. Worse yet, they give you 90 days to transfer out your account or risk having your holdings liquidated. Whether it is a taxable or tax-deferred investment account, a forced liquidation and closure of your account can have  severe tax consequences. Furthermore, it can have a devastating effect on your long term retirement and savings goals. While the above scenario sounds  dire, it does not mean you should make a rushed decision and simply partner with the first firm that confirms they can take over the management of your account(s). Instead, take the opportunity to rethink what advisory firm would best serve your long-term interests as a non-resident. In other words, seek out a true cross-border wealth management firm that can not only deliver on the investment management piece but also provide ongoing value added cross-border financial, tax and estate planning solutions. The last thing you want to do is work with another firm that does not specialize in working with non-residents of the U.S., only to find out down the road you are once again being terminated from their platform.

So what characteristics should you be looking for in a true cross-border wealth management firm? The following checklist is a good starting point for selecting a company that’s right for you:

Cross-border platform – Make sure the firm and its advisors are legally licensed and registered in the jurisdiction you reside. Confirm they are not restricted on how your investment account can be managed based on your non-resident status.

Fiduciary vs. Suitability – It is important to confirm that the firm’s advisors operate under the fiduciary standard of care, which is a legal requirement that an advisor act in the best interest of his or her client. The fiduciary standard helps eliminate conflicts of interest. In contrast, the less stringent suitability standard adheres to a rule in which recommended investments must merely be “suitable” for but not necessarily in the best interest of a client. Most large investment brokerages, banks and wire houses operate under the suitability standard.

Fee-only – Finding an advisory firm that is fee-based and is not compensated by commissions, trading fees or financial products can eliminate conflict of interests between the advisor and the client.

Business Model – You cannot be all things to all people. Advisors who claim they work with four or five different categories of clients (retirees, small business owners, professionals, divorcees, expats, etc.) fall back into that “generalist” category. If you want to be an expert in what you do, focus on your niche. A financial firm with a business model of working exclusively with cross-border clients is typically better suited to handle expats or non-residents of the U.S.

Credentials, Experience and Education – Just because an advisor has a certain credential, doesn’t mean that they are an expert. That being said, when looking to partner with a cross-border financial advisory firm, make sure to review the bios of the individuals working at the company.  Have they been working with cross-border clientele for a long time? Do they have education or credentials in certain areas that focus on assisting cross-border clientele?

Cross-border Team – When building and preserving wealth, you’re only as strong as your weakest link. In other words, you may find a firm that can deliver on the investment management piece, but can they provide the ongoing cross-border or expat financial, tax and estate planning services you require? Look for a cross-border team that has dedicated portfolio managers who specialize in managing money for expats, and has international or cross-border tax experts and cross-border financial planners. All of these individuals have unique skill-sets that complement one another. Finding a firm that can provide comprehensive cross-border financial planning services in an integrated and coordinated fashion ensures no stone is left unturned when reviewing your situation.

Understanding of Tax – Understanding the tax rules and regulations of the jurisdiction in which you reside is extremely important when providing investment management services to non-residents. Further, if you are a U.S. citizen living abroad, you must also ensure the investment management strategy is tax managed based on U.S. tax rules. For example, the Passive Foreign Investment Companies (PFICs) rules will impact almost all foreign-traded mutual funds and ETFs. Ensuring you are not subjected to the punitive tax rules associated with holding a PFIC is critical. Make sure the firm you choose has a strong understanding of tax rules impacting non-residents and expats.

While no one wants to be faced with a surprise “move your investment account or else” deadline, don’t feel pressured to move your account to the first firm you speak to. Do your homework. Look to partner with a true cross-border wealth management firm that is positioned to provide long term value in addressing your unique and ongoing cross-border financial planning requirements.