When you invest your hard-earned money, you should make sure you do your due diligence on what you are actually investing in. Most Canadians invest in things such as real estate, stocks, bonds, mutual funds, GICs, T-bills, etc. A select few invest in things like private companies and tax shelters.
When you invest your money, your primary goal should be to make money on your investment. You make money in one of two ways. First, on any income the investment produces such as rent, interest or dividends. Second, you would like to have capital appreciation on that investment, especially over the long term. Another element which is desirable is the degree of control you have over the investment.
Private Companies
Let’s look at private companies and how they stack up as an investment possibility.
Most private companies do not pay dividends to minority shareholders so there is usually no income component to them. Since private companies do not trade on an exchange, liquidity is a huge concern. Who will buy your shares if and when you decide to sell? Unless you own over 50% of the voting shares of a private company, you will not be in control of that entity. This means you have to rely on the business acumen of others for your investment.
This brings us to Capital Appreciation, which is generally the main reason that people invest in private companies. One thing you must remember is that in order to realize a capital gain on an investment, you must first find someone to actually buy the shares from you at a higher price than what you paid.
The problem here is finding that person willing to buy your shares. Even if a private company is hugely successful, you may have serious problems trying to find a buyer. The reason is any potential buyer will eventually have the same problem as you, trying to find someone to sell their shares to. Another issue is the lack of control. If someone else is calling the shots and they make some bad decisions, it will have a large negative impact on your ability to sell your shares.
Unless you are setting up your own private business or your own professional corporation (and thus are in control), we highly recommend you seek second and third opinions from us and/or your accountant before investing your hard-earned dollars.
h3>Tax Shelters
Tax shelters are advertised generally to high income earners in Canada as a way to save taxes. Some advertise that you can save up to 70% of the cost on the investment in income taxes if you buy the tax shelter inside your RRSP.
Generally speaking, tax shelters invest in junior companies which are either start-ups or not yet fully established in their fields. Various entities using various structures basically bundle up a number of these junior companies into a form of mutual fund which they market to the public (especially high income earners) as a way to save taxes and invest in young entrepreneurial businesses in Canada. Two things they often fail to tell you up front is that you have to hold the investment for eight years in order to keep the tax benefit and two, most of the businesses you are investing in need financing because they are losing money.
Let’s look at an example:/p>
Let’s say you invest $5,000 into a tax shelter and save 70% of tax right away so the net cost to you is $1,500. Yes, you saved $3,500 in income taxes but you also spent $5,000 to save that $3,500 so you are still out of pocket $1,500.
That $1,500 is locked in for eight years into businesses that are generally losing money right now. They may make money in the future, but who knows.
Now, eight years have passed and you decide you want to sell these mutual fund units. Guess what, there may not be a market for those units. There may not be people willing to buy those shares. Why? Because now there is no more tax incentive to buy the units in a mutual fund of junior companies which are losing money.
So, at the end of the day, you lost $1,500. Sure, you saved $3,500 in income taxes but you’re still out $1,500.
Investing solely to save taxes is never a good idea.
At the end of the day, investing in entitites which produce income, in which you have control and which are liquid are the best, safest way to invest your money. Private companies (in which you hold a minority investment) and tax shelters are lacking most, if not all, of the qualities of sound investments.