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Parlay a $25,000 inheritance from a rich uncle into a legacy you can share with the whole family? Sounds like a job for the banks.
Banks sell a wide variety of wealth management products, all of them designed to make lots of money for … the banks. That's why the $25,000 inheritance is going not into bank products, but into bank shares.
The biggest no-brainer move in Canadian investing is to buy bank shares and hold 'em as close to forever as you can get while you scoop up your quarterly dividends and watch your shares climb in value. But even with the short one-year time horizon we've been given for growing the $25,000, the banks still make a lot of sense.
The reasons have something to do with the increasingly temperamental stock market. Late September and early October have been typically treacherous for stocks and, after a long bull market, it's not out of the question for a serious correction to take hold. Then again, some commentators are calling for the S&P/TSX composite index to hit 13,000 or 13,500, which would represent an increase from the beginning of October of as much as 15 per cent. The way ahead is far from clear, but bank stocks should be a rock no matter what happens.
Here's why. Interest rates have reached a plateau and there's a growing consensus that slowing economic growth will, sometime next year, make the next central bank move on rates a cut. A flat to declining rate environment is good for bank stocks, although falling rates are best. As long as the economy doesn't stall out completely and send loan losses soaring, the banks should do well. This applies if oil prices hang in there and the TSX motors on, and if oil prices fall and pull the TSX down as well.
The banks have already had a fairly good year, with gains for the first nine months of the year ranging from 4.9 per cent for Bank of Nova Scotia to 12.7 per cent for Canadian Imperial Bank of Commerce through the beginning of October. Still, the dividend yields of these stocks remain attractive (rising share prices pull down dividend yields) at 3-per-cent-plus for all of the Big Five banks except for Toronto-Dominion Bank, which is around 2.8 per cent. These yields, while not sky high by historical standards, should be attractive enough to keep investors interested in bank shares regardless of the overall market conditions. Bank shares can still fall, without question. But those yields are good enough to provide a kind of floor that keeps bank stocks from plunging.
Putting money in bank shares is all about total-return investing, which means a combination of dividends and share-price appreciation. Let's conservatively estimate the average dividend yield for the year ahead at 3 per cent. How much of a capital gain can we expect on top of that? Let's estimate something like 12 per cent, which means a total return of 15 per cent. That would be enough to add $3,750 to the $25,000 inheritance in a very tax-friendly way. Remember, the dividend tax credit is on the way to being improved so that treatment of dividend income is almost as favourable as capital gains.
There's one last matter to decide, which bank shares to buy. That's an easy one — buy them all. With $25,000 to invest, this is a simple matter of putting $5,000 in each of the Big Five banks. How do you grow an inheritance? Entrust it to the money people — the big banks.
Rob Carrick has been writing about personal finance, business and economics for more than 12 years.