Archive | September, 2014

After-Tax Returns on Canadian ETFs

When you invest in a non-registered account, you need to be concerned about more than just your funds’ performance: you also need to know how much of your return will be eaten up by taxes. Unfortunately, while regulators are strict about the way ETFs and mutual funds report performance, fund companies in Canada have no obligation to estimate after-tax returns—something that’s been required in the US since 2001.

To help address this problem, Justin Bender spent the last several months creating a calculator for estimating the after-tax returns on Canadian ETFs. He was inspired by Morningstar’s US methodology, but he made many significant changes to adapt it for Canada. The new methodology is fully explained in our latest white paper, After-Tax Returns: How to estimate the impact of taxes on ETF performance. We have also made our spreadsheet available for free download so DIY investors can experiment on their own. (The spreadsheet is protected so the formulas cannot be altered. However, we have included detailed descriptions of these formulas in the appendix to the white paper.)

The methodology is quite complex, but here’s an overview in plain English:

We begin by recording the ex-dividend dates for all the cash distributions an ETF made during the period being considered.

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Is It Time for Tax Loss Selling?

Last October, Justin Bender and I published a white paper on tax loss selling with ETFs. It explained how index investors can harvest capital losses while maintaining a consistent exposure to the equity markets. We were proud of the paper (which was even adapted as a continuing education course for advisors) but it proved to be rather useless during the subsequent year. Indeed, it would have been irrelevant during much of the last three years, as the charging bull market never stopped to catch its breath. There were simply no capital losses to harvest.

Well, it may be time to dust off the paper. September has been a difficult month for stocks, especially in Canada, and investors with large portfolios might now have their first tax-loss selling opportunity since 2011.

No gain, no pain

Let’s start with a refresher on how tax-loss selling works. In a non-registered account, when you a sell a security that has declined in value, you realize a capital loss. You can use these to offset any capital gains you’ve incurred in the current year, which can reduce your tax bill. Moreover,

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Foreign Withholding Taxes in International Equity ETFs

It seems Canadian ETF providers are paying more attention to foreign withholding taxes these days. Not so long ago, you rarely heard anyone discussing this hidden drag on returns. But last month BlackRock announced a significant change to its iShares Core MSCI EAFE IMI Index ETF, ticker symbol XEF, which makes up the international equity component of my Global Couch Potato portfolio. The change was made specifically to reduce the impact of foreign withholding taxes.

When the fund was launched in April 2013 it simply held a US-listed ETF, the iShares Core MSCI EAFE (IEFA). That was a convenient way of getting exposure to the 2,500 or so stocks in this large index. Over the last three weeks, however, XEF has gradually bought up the individual stocks in the index and now holds them directly. According to BlackRock:

“XEF will generally no longer be subject to U.S. withholding taxes. While foreign withholding taxes will continue to apply to dividends paid on certain international equity securities included in the XEF Index, it is expected that the change in investment strategy implementation will reduce the overall amount of withholding taxes borne directly or indirectly by XEF.”

A refresher course on foreign withholding taxes

A few words of explanation will help here.

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