Alternative Investment

Alternative investments hold a certain appeal for many people today, because of the downturn in the financial markets. Investors are disillusioned with large banks and brokerage houses and want someone who can offer them better returns without having to sacrifice safety.

To qualify as an alternative investment, any of the following may be used: equity, real estate, hedge equity fund and a private equity fund.

Alternative investments are exempt from the normal income rules that apply to RRSPs and RRIFs. These include capital gains tax on realized profit and dividend withholding tax. Dividends paid on some equity investments may also be eligible for a dividend tax credit. The amount of any realized loss can generally be carried forward to offset future capital gains, or deducted from taxable income in the year the loss occurred.

Alternative investments do not have a great deal of liquidity because investors are locked into their investment for a period of time. Exiting early will result in a penalty fee.

Another risk is that equity investments are often volatile due to factors such as economic recession, high inflation or market sentiment. To manage this risk it’s best to invest in equity funds rather than individual equity shares.

Many investors are reluctant to invest in alternative investments because they need the money at some point within the next 5 – 10 years. For the same reasons, equity investments are illiquid, which means you can’t get your money back until the investment is sold or matures.

However, equity funds have a number of advantages over individual equity shares. Funds are diverse portfolios of equity securities that are professionally managed by portfolio managers who will include all types of equity classes such as equity, equity mutual funds, equity exchange traded fund, equity index fund and equity strategy. The portfolio managers can invest in equity securities that fall outside of the conventional definitions of equity markets.

If you’re comfortable holding onto your alternative investment for at least four years (the minimum term mandated by many equity funds) this may be an excellent way to take advantage of equity returns while deferring capital gains tax.

In addition, equity investments offer a number of other benefits that RRSPs and RRIFs do not. They include:

– Low correlation with equity markets – Equity funds can reduce the volatility in a portfolio because they don’t rise and fall in value at the same time as equity markets.

– High expected equity returns – Equity funds tend to offer consistent equity returns over the long term, which means you might be able to retire earlier than you thought.

– Tax deferral on realized capital gains – When equity fund units are sold, any increase in value is considered a deferred gain and taxed at the time of sale (no refund of withholding tax) instead of when the fund is purchased. This means equity funds are taxed at lower rates than equity trades, especially for high-income earners.

– Professional management by investment advisors – Funds will be managed by experienced portfolio managers who invest in equity securities with strong potential for capital appreciation or stable income generation. They may also hold cash equivalents to hedge equity risk.

– Ability to reinvest capital gains – Capital gains can be automatically reinvested in the equity fund, resulting in compounding growth over time. Many equity funds also offer monthly distributions that are eligible for the dividend tax credit.

– Ability to claim other deductions – There are strict rules about claiming deductions on your income tax return for RRSPs and RRIFs. Only equity trading fees are deductible for these registered plans. Equity funds can reduce taxable income, resulting in tax savings you might not be able to get through your other investments.

– Access to equity markets – By investing in equity funds rather than individual equity shares you have access to equity markets across the world without the need for foreign exchange conversions or international trading costs.

The equity fund alternative may be right for you if you’re risk-averse with a high equity allocation in your portfolio, don’t need to access your money for at least four years (and not likely to want it back within the next five) and are looking to take advantage of the equity returns equity funds have to offer.