A holding company serves to house your excess cash, especially from your operating business, so you can invest it in other businesses and collect the profits. In other words, it can be your future retirement fund – if it is set up and planned properly.
Since there are virtually limitless options available to business owners, here are 3 simple tips for those who want to grow their net worth in the stock market.
1. Choose stocks over other securities
If you have a long investment horizon and are able to tolerate fluctuations, it is generally more advantageous to invest in stocks rather than in income-producing securities. The expected return is higher, and the tax liability when you make a profit is lower since only half of the gain is taxable. This is comparable to an individual who personally invests outside of an RRSP or TFSA, for example. Also, the capital gains realized in the company allow the creation of a capital dividend account (CDA) which ultimately allows the shareholders to receive tax-free dividends when the company realizes capital gains. This strategy should be discussed with your accountant.
2. Invest in stocks that you expect to keep for a long time
Since the capital gain is only taxable when it is realized, in other words, when a security is sold at a profit, an investment methodology of “buy and hold” allows for a much longer deferral of tax liability than someone who frequently buys and sells the securities in their portfolio. The latter will likely have to pay higher taxes each year and will have to generate a higher return to obtain the same after-tax return.
3. Avoid mutual funds with in-fund fees and those with high fees
Management fees charged within mutual funds may or may not be deductible from their distribution, unlike management fees paid directly to your advisor. If there is interest and/or other income, the management fees are offset against such income before determining the taxable distribution. However, if a mutual fund has only dividends, foreign income or capital gains, there is nothing to offset the management fee. It depends on the nature of the income or gain distributed and the fee structure you are offered. If this is not possible because the fees are collected within the mutual funds and cannot be deducted against its distribution, you should consider changing your fee structure or advisor altogether.
Funds with high management fees should be avoided in all circumstances and this is no different for the individual who invests through a management company. The larger the amounts, the more significant a difference in fees, even 1%, can be. For example, a 1% difference in fees on a $500,000 portfolio represents $5,000 per year. If you would like to learn more about holding companies or know someone who could benefit from the information, don’t hesitate to contact us directly.