Q: Can you share your thoughts about the BMO Discount Bond (ZDB) and the Horizons Canadian Select Universe Bond (HBB) as long-term holdings in a taxable account? – D. F.
Earlier this year BMO and Horizons both launched bond ETFs specifically designed for taxable accounts. These two funds have very different structures, and each has its strengths and weaknesses. So let’s dig more deeply into each fund to help you decide which might be right for your portfolio.
Before we discuss these specific funds, let’s review the problem with holding traditional bond ETFs in non-registered accounts. Most bonds these days trade at a premium (higher than their par value), because they were issued when interest rates were higher. Premium bonds are perfectly fine in your RRSP or TFSA, but they are notoriously tax-inefficient and should not be held in non-registered accounts.
 Do you want a discount or a swap?
The BMO Discount Bond (ZDB), launched in February, is similar to traditional broad-market bond ETFs, such as the iShares Canadian Universe Bond (XBB), the Vanguard Canadian Aggregate Bond (VAB) and the BMO Aggregate Bond (ZAG). All of these funds include about 70% government bonds and 30% corporate bonds (VAB has slightly less in corporates), and they have an average maturity of about 10 years, a duration around seven years, and a yield to maturity in the neighbourhood of 2.35%.
The difference is that ZDB specifically selects bonds trading slightly under par. That means its average coupon (that is, the amount of interest paid out in cash) is lower than its yield to maturity. So while ZDB can be expected to post similar pre-tax returns to the ETFs mentioned above, it would likely come out ahead on an after-tax basis because of those lower distributions.
The Horizons Canadian Select Universe Bond (HBB) has a completely different structure. It’s also designed to mirror the characteristics of the broad-market funds mentioned above, but rather than holding bonds directly it gets exposure through a total return swap. (For more about HBB works, see this post.) The ETF pays no distributions at all: the swap is designed to deliver the total return of a diversified bond index, and all of the growth is reflected in price changes. Investors in HBB won’t have any tax liability until they ultimately sell their shares, at which point any growth would be taxed as a capital gain.
What’s your priority?
So if you need to hold bonds in a taxable account, which ETF should you choose?
Let’s begin by comparing costs. The BMO fund has a management fee of 0.20%, while the Horizons ETF has a management fee of 0.15% plus another 0.15% payable to the swap counterparty. So ZDB is about 10 basis points cheaper. But if HBB performs as expected, it seems clear it would have the edge after taxes, at least for high-income earners. By eliminating cash distributions the ETF could allow investors to defer taxes indefinitely. Moreover, future capital gains would be taxable at half the rate of interest income, and you’d have the flexibility to choose when to realize them.
However, HBB has a couple of additional risks. The first is the possibility—inherent in any swap-based product—that the counterparty will fail to meet its obligation. Granted, this seems like a very small risk: the counterparty is National Bank, and Canadian banks have a long track record of stability. There’s also a collateral arrangement in place to ensure that even if the counterparty did default, the loss to unitholders would be no more than 10%.
The second risk is that the good people in the Ministry of Finance may one day take a dim view of swap-based investment products. It’s impossible to know how likely that might be. The government famously changed the rules on income trusts back in 2006, and in 2013 it put an end to mutual funds and ETFs that recharacterized interest and dividends as capital gains. Swap-based ETFs do not recharacterize income in this way, but one can never ignore the possibility that tax-advantaged products are at the mercy of our elected officials.
What would happen if swap-based ETFs did eventually fall victim to a zealous finance minister? Chances are the funds would be liquidated, which could force investors to realize capital gains they had deferred to that point. That could result in a hefty tax bill you weren’t counting on all at once. But even if that were to happen, it’s possible you’d still come out ahead had you been able to benefit from the fund’s tax advantages over several years.
In the end, your decision comes down to which you prefer: the maximum tax deferral of a total-return swap with some additional risk, or the more transparent structure of a discount bond ETF with less tax-efficiency.
@CCP: Do XBB, VAB, or ZAB distribute capital losses? If not, then what’s the big deal with the apparent tax problem?
In other words, as a long-term couch potato investor buying a broad bond ETF, why should I care about the fact that the ETF holds premium bonds that it will probably sell at a premium 1 year before maturity, or if there’s a loss, it will be used to offset such gains internally within the ETF?
Is it really prudent to reduce one’s exposure to only the few available discount bonds (ZDB), or to assume the risk of a single party like if one was holding a single corporate bond (HBB)?
Dan, Thanks for answering my question!
One follow up please: Doesn’t National Bank have to pay the taxes on the distributions of the bonds they hold for this swap arrangement? If so, how are they able to not pass that cost on to the investor? Surely the taxes generated by these bonds will be higher than the 0.15% fee we would pay them?
@ccpfan: Mutual funds and ETFs cannot distribute capital losses: they can only use them to reduce distributed capital gains at the fund level. And a fund filled with premium bonds will only experience capital gains if interest rates fall significantly.
Investors can harvest capital losses on bond funds in their own accounts, but these can only be used to offset capital gains, not interest income, which is taxed at twice the rate. That’s why premium bonds are a non-issue in registered accounts (the capital loss is entirely offset by the extra interest) but not in taxable accounts.
Whether it is prudent to use either of these ETFs is really a personal decision. I think most people would find the diversification in ZDB to be adequate: it holds about 57 investment-grade bonds.
@Daniel: One of my concerns about swaps is that no one seems know exactly how the counterparty handles the tax liability. The assumption is that there is a kind of tax arbitrage: i.e. as a corporation they may be able to take advantage of deductions not available to individual investors. Dan Hallett did a good job of explaining this when HXT first came out, but it’s not clear how this might apply to bonds:
http://thewealthsteward.com/2010/10/a-closer-look-at-betapros-dirt-cheap-etf/
@CCP: As far as I know, a broad bond ETF experiences capital gains (or much smaller capital losses) by selling bonds at a premium 1 year before maturity.
If interest rates were to spike, a couch potato would load up on discount bonds, not sell bonds, due to rebalancing into cheaper bonds. This would lower the cost basis. So, in a very long term view, I see no capital losses due to bonds in the couch potato investor’s portfolio.
As for discount bonds, they are more attractive, so market theory tells us that they are probably more expensive than premium bonds. Isn’t this what you usually teach us? What’s different, this time?
@ccpfan: Assuming interest rates stay the same, the price of a premium bond will gradually fall as it approaches maturity, so if you buy a five-year premium bond today and sell it in four years you will suffer a small capital loss.
You can see this in laddered bond ETFs like CBO and CLF, all of which sell their bonds with about a year to maturity. They have suffered significant price declines over the last few years. In tax-sheltered accounts these are offset by their very high coupons, but in a taxable account they are a real problem. For example:
https://www.pwlcapital.com/en/Advisor/Toronto/Toronto-Team/Blog/Justin-Bender/May-2013/2012-Negative-After-Tax-Return-on-CLF
https://www.pwlcapital.com/en/Advisor/Toronto/Toronto-Team/Blog/Justin-Bender/February-2012/Can-You-Earn-a-Negative-After-Tax-Return-on-a-Bond
If rates spike and bonds fall in price, you are right that rebalancing would dictate buying more. But in this context I’m talking about tax-loss harvesting: you could sell a bond ETF that has declined in value to harvest the capital loss and replace it with a different ETF. This would allow you to offset gains elsewhere in your portfolio, but it cannot be used to offset fully taxable interest income.
Discount bonds are not more attractive than premium bonds: the latter have higher yields and a lower duration that some investors may find attractive. Witness the enormous popularity of funds like CLF and CBO. The advantage of discount bonds depends on the investor’s particular situation.
First of all, I would like to congratulate for you blog !
I bought a new bond etf to reduce my tax : First Trust Advantaged Short Duration High Yield Bond Fund (FSD.UN)
It’s seems to good to be true : short duration + high yield + tax advantaged and a 7% yield !
Could you tell where is the catch if you compare with HBB and ZDB ? Thanks
@Romain: It’s important to understand that high yield and short duration go hand-in-hand, so that’s not too good to be true. But unless I am missing something I don’t see any tax advantage with this fund. On the contrary, those big distributions are likely to be fully taxable. High-yield bonds, in general, are among the least tax-efficient of all asset classes.
@CCP. Thanks for your reply. FSD.UN distributions are return of capital distributions only.
@Romain: Sorry, I was looking at the similarly named First Trust Short Duration High Yield Bond ETF (FHY). The fund you mentioned uses a derivative called a forward agreement, which is exactly the type of instrument that was targeted in the 2013 federal budget:
https://canadiancouchpotato.com/2013/04/02/how-the-2013-budget-will-affect-etfs/
According to a press release from First Trust issued after the budget announcement: “Based on its review to date, FT Portfolios Canada Co., the manager, believes that these changes will not affect First Trust Advantaged Short Duration High Yield Bond Fund (TSX: FSD.UN), or the tax treatment of its distributions, until the expiration of the Fund’s forward agreement in May 2016.”
So it sounds like this advantage will be coming to an end eventually. The iShares funds that used similar structures have already changed their mandates:
https://canadiancouchpotato.com/2014/03/03/ishares-advantaged-etfs-where-are-they-now/
Why wasnt BXF mentioned?
Arent ZDB, BXF, HBB all designed to reduce the amount of tax in a non-registered account?
What are the ranks for each?
The yield to maturity on both HBB and ZDB is so low (~2.2%) that after fees I don’t think they are any better than GIC’s other than having better liquidity. As a longer term investor I have been laddering 3,4 & 5 year GIC’s quarterly in my taxable account and feel I am getting as good or better returns than either of these ETF’s without the tax issues related to premium bonds. Am I missing something here?.
@CharlieF: I didn’t mention BXF because the reader didn’t ask about it. Strip bonds are a specific type of discount bond, though BXF is all short-term bonds and it’s mostly provincials, so it’s exposure is quite different from broad-market funds like ZDB and HBB.
https://canadiancouchpotato.com/2013/06/05/a-new-etf-of-strip-bonds/
https://canadiancouchpotato.com/2013/06/07/why-use-a-strip-bond-etf/
@Duncan: You’re not missing anything at all: GICs are an excellent choice if one needs to hold fixed income in a taxable account. But the liquidity issue you mention is often significant. A bond fund can be more useful for investors who may need to access the money in the next couple of years, those who are adding money to the portfolio regularly, those with a relatively small fixed income holding, and those who want some flexibility when rebalancing.
Hello Dan,
I’m a young investor planning to start investing $50-100/month into a RRSP account.
I plan to open a self directed group RRSP at RBC (affiliate with my company) tomorrow.
Is it a good choice? If so, which index fund with low MER will you advise me to choose?
Thanks for help.
@Bryce: Putting $100/month into your RRSP is a great choice, but I can’t recommend specific funds for you. Have a look at the Global Couch Potato for some guidance:
https://canadiancouchpotato.com/model-portfolios/
Thanks for your quick feedback Dan :).
When I look at Global Couch Potato, Option 3 seems to suit my need for index fund except that the overall MER 0.71% is higher compare to TD’s.
Is it safe and tax-efficient to hold both equities and bonds as for option 3 in a RRSP account?
Thanks.
Ps: Plan to invest for the long term 10-20 years
Hello Dan. Does the availability of HBB, with its tax advantage, change your March 6, 2013 post conclusion that, ” if you’re a long-term investor, who needs to hold fixed income in a taxable account, GICs are likely to be a better choice.”
I have 40% of my non-RRSP holdings in cash, and I am considering investing 50% in HBB and the other in a laddered GIC (with current returns ranging from 2.4% for one year to 3.05% for a five year GIC).
In respect to laddered GICs, given the possibility of rate hikes in a year or so, would you suggest keeping the ladder to the 1-3 year range, or would equal amounts over a five-year ladder still be Ok?
Thank you and best regards.
@Bryce: Unfortunately the TD e-Series funds are available only from TD. If you are investing with RBC you won’t have access to them. Maximizing your tax-efficiency and minimizing MER are not all that important at this stage if you are starting from zero. They will become much more important as your portfolio grows. This may help:
https://canadiancouchpotato.com/2012/03/05/some-advice-for-new-potatoes/
@Grant: To echo my comment to Duncan, liquidity is an important consideration in the decision between GICs and ETFs. Your suggestion for keeping half in each is probably a good compromise. As for keeping your ladder shorter than five years, well, that’s just another way of asking whether I think interest rates will rise. I have no idea. But if the yield curve is very flat (i.e. a five-year GIC pays only a tiny bit more than a three-year GIC) then there’s some justification for staying shorter.
@Romain
I don’t know if First Trust Advantaged Short Duration High Yield Bond Fund qualifies as junk bond fund, but it does say this in the “Fund Profile” (http://www.firsttrust.ca/ContentFileLoader.aspx?ContentGUID=5740d9b9-5459-4734-ac23-a43c76465a3f):
“Under normal circumstances, the Sub-Advisor will invest at least 70% of the Portfolio’s total assets in below investment-grade North American debt securities, comprised primarily of U.S. dollar-denominated debt securities. ”
So, one of the reasons for the high yield is likely the below investment-grade holdings. I believe the other bond funds being discussed are investment-grade.
Also, due to being US dollar-denominated, you would be subject to currency risk.
CCP wrote: “Discount bonds are not more attractive than premium bonds: the latter have higher yields and a lower duration that some investors may find attractive. Witness the enormous popularity of funds like CLF and CBO. The advantage of discount bonds depends on the investor’s particular situation.”
That makes a lot of sense. I had not thought about that.
Yet, I’m still not convinced of the value of a discount bond ETF over a total-bond-market ETFs such as XBB, VAB, and ZAG for a long-term couch-potato investor. When I look at the NAV of these funds (or, better, of an old one such as Vanguard’s VBMFX fund), the NAV seems to be attracted to a stable value over time, sometimes getting higher, sometimes getting a lower, but always coming back toward this value. It’s not like the NAV of high-yield bond funds (going down over time). So, the effect on a buy and hold (and rebalance) long-term investor should be a cost basis near NAV, meaning there won’t be much capital gains or losses.
Dan, some time back, if I remember correctly, your colleague, Justin, commented here that he thought that GICs would likely be more tax efficient than BXF. Now that BXF has been on the market for nearly 18 months, has that turned out to be the case?
Thank you very much for this excellent article. Your site is far more informative and the best (and only) source I know of for these more advanced topics.
@Tristan: I haven’t looked at the after-tax returns of BXF, but that would be a good future blog post! It’s easiest to make comparisons when you have a full calendar year of returns, so this will be a good one for early January.
@David McKenna: Thanks for the comment:much appreciated.
@Bryce, @CCP
Based on previous comment from Bryce – “self directed group RRSP at RBC (affiliate with my company)”
If I am correct about this, then I am in a very similar program and the following likely applies:
1. You can only chose from a select number of RBC mutual funds. RBF556, RBF557, RBF559 are equity funds that are probably RBC’s best index funds – at least your best bet to start looking.
2. Your employer matches a percentage of your contributions, up to a defined limit. If you are delaying a decision worrying about a .5% MER difference, you are making a serious mistake considering the employer contributions (up to 100%) you are missing out on.
You are probably right @Bryce and @CCP.
I will open the RRSP account tomorrow, invest in the RBF556 to start (hope it’s a good choice) while taking advantage of my employer’s contribution.
Thanks for your precious help.
I don’t agree with the statement that Treasury debt should be held in Registered accounts – especially when priced at a premium.
The authors have written this before. The first argument they used was that historical data proves their point. But they ignored the difference between today (when Bond interest rates have no where to go but up …. and the past 30 years when interest rates fell 10%-15%, creating Bond rates of return to rival the returns of Equity.
It is the assets’ rate of return that is the most important factor in deciding which asset benefits the most from the profit-sheltering of Registered accounts. In the past 30 years Treasury Debt’s returns equaled Equity’s, so the deciding factor was the tax rate. Debt’s higher tax rate meant that IN THE PAST it benefited most from the profit-sheltering.
But at today’s low interest rates, the low returns from Treasury debt means it should be the LAST asset to use a Registered account. This can be proved. Compare two assets – a stock and a treasury bond, both held 5 years before capital gains/losses are triggered, The owner is in the 2nd tax bracket using the Federal rates grossed up 50% for the provincial portion. He re-balances yearly a 50:50 AA.
Stock:
2% dividend taxed at 14%
6% capital gain taxed at 17% which the 5 yr delay makes = 15.4%
8% total return taxed overall at 15.1%
bond
4% coupon yield taxed at 33%
-1% capital loss taxed at 17% which the 5 yr delay makes = 16.7%
3% total return taxed overall at 38.4%
After 30 years with either one or the other in a Registered account, the larger ending wealth results from putting the stock in the Registered account, and the Debt in the taxable account. It is the rate of return that makes the most difference, NOT the tax rate or whether there will be capital losses.
Use the spreadsheet http://www.retailinvestor.org/Taxburden.xls The tabs called “Year By Year”, “Effective Capital Gains Rate” and “Weighted Avg Tax Rate”.
@RetailInvestor: Did you rebalance the portfolio all along, to keep the AA in check? My guess is that the difference for a rebalanced portfolio won’t be huge. If the difference is small, sticking to the traditional recommendation (bonds in registered) would be the correct thing to do for an investor that does not wish to make predictions about future returns.
re: HBB vs ZDB
HBB is the logical choice for the rational investor.
First, what is the possibility of the counterparty (National Bank) defaulting ? 0.0001% ? If National Bank go bankrupt it is because Canada economy is in utter despair and then, all Canadians have bigger problems than a (maximum) 10% swap lost. In the future, we can also expect Horizon to add more counterparties to further minimize this risk
Second, what is the possibility that CRA end the swap-ETF “advantages” ? This is a remote but real possibility. There billions and billions of $$$ under swap agreement so this will require proper planning and probably a couple warnings shot before legislation are put in place.
But more importantly, what is a consequence of a CRA action ? You simply sell your HBB position and realize your capital gain earlier than expected. As CPP say “it’s possible you’d still come out ahead had you been able to benefit from the fund’s tax advantages over several years.”
And this is the important part.
Ask yourself the question: do you refer to take the risk of realizing early capital gains or to pay tax on years and years of unwanted interest distributions ?
For anyone without any need for yield, this a no brainer. For investor with a need for a monthly (taxable) paycheck, ZDB might be more appropriate.
Happy investing :)
Disclosure: held ZDB briefly, now hold HBB.
Instead of holding HBB, you could hold National Bank bonds, and you would get a higher yield than total-market yield. So, the counterparty risk should be compensated by higher expected returns (after tax, in this case). It looks, to me, as a simple risk-reward equation. I prefer to take my risk on the equity side.
re: ccpfan
National Banks bonds would be taxable which is exactly what i try to avoid by holding HBB :)
Re: ccpfan’s …” Did you rebalance the portfolio all along, to keep the AA in check? My guess is that sticking to the traditional recommendation (bonds in registered) would be the correct thing to do for an investor that does not wish to make predictions about future returns.”
The whole point of tracking what happens year by years with re-balancing is to re-balance AA. So yes, the chosen AA is kept.
Re-balancing actually does make a lot of difference. It greatly dilutes the impact of the Asset Location AL decision. It also reduces the difference in ending wealth, and it increases the time frame necessary for the benefit-lines to cross when the tax$$ in year1 are higher with a low Rate of Return asset, than the tax$$ in year1 of a high RofR asset. See the first graph at http://www.retailinvestor.org/rrsp.html#taxfree . The result is that once re-balancing is assumed, the AL decision becomes really a waste of time because the outcomes are so little different.
If you want to compare the outcome WITHOUT the re-balancing assumption use the opening tab of the same spreadsheet http://www.retailinvestor.org/Taxburden.xls . Change the variables to the same used above.
Stock
8% return
15.1% effective tax rate
30 years
30% tax rate for both contributions and withdrawals.
$1,000 gross wages
RESULT = $2,006 benefit from Registered accounts.
Debt
3% return
38.4% effective tax rate
30 yearss
30% tax rate for both cont and draws
$1,000 gross wages
RESULT = $487 benefit from Registered accounts
This difference in outcomes, as a percent of the $1,000 starting wages (2006 – 487 / 1000)= 150%
There really is no argument that justifies the ‘Debt in Registered accounts” argument.
So assuming the returns are the same for ZDB, HBB, BXF, VAB.
For tax efficiency, it’ll go like HBB>ZDB>BXF>VAB?
If there’s no tax, I’d just go with ZRR or XLB for the returns.
Sigh…this tax thing adds another layer of complexity to all of this…
@Retail Investor: Thanks for the clarification.
@CharlieF: “So assuming the returns are the same for ZDB, HBB, BXF, VAB.
For tax efficiency, it’ll go like HBB>ZDB>BXF>VAB?”
I wasn’t sure if your question mark was real or rhetorical — were you stating your opinion? If so how do you arrive at the conclusion that ZDB is more efficient than BXF? I must say I didn’t fully understand the tax treatment of the various components of the BXF yield.
@retailinvestor: Thank you for keeping up the good fight on this point — I appreciate the detailed analysis/simulation on your site.
@Oldie
Real question. ZDB and BXF are both bonds which are suppose to save on taxes, but since HBB is pure capital gains, HBB is best. I dont understand the details of ZDB and BXF so I kinda just put those two randomly.
~~
Another thing I’m curious about is HBB. Since all interest is converted to capital gain in the price of the ETF, wont the cost of buying that ETF eventual rise to infinity?
Like right now it’s $41. The bonds pay interest and the price rises to $42. Repeat. Isnt it better if I buy them asap so I’d get more distribution per share?
I know that’s assuming no one sells their share of HBB, but whoever that buys HBB is most likely in it for the long-term so wont it be likely that HBB will cost lke $50 per share by 2025?
@CharlieF: Any ETF that is expected to deliver capital gains would be expected to see its share price rise: that would include every stock ETF as well as HBB. If the share price doesn’t rise then your return would be zero. (For the record, if HBB rises from $41 to $50 in 11 years that would be an annualized return of about 1.8%.)
I imagine HBB would do a stock split well before reaching $50. E.g. at $30 a 3 for 2 split would result in a $20 share price.
FWIW, In my largish taxable account I held BXF briefly, then switched to HBB in total once it became available, and once I understood how it worked, i.e. late July. Still don’t understand how the BXF distribution will be taxed — have to wait for my tax slips. But the introductory rate on BXF till July 1st was 0% :)
Any plans to put a model portfolio together for taxable accounts?
Would be helpful to see your advise come to life in the form of a model for us that have maxed out tax sheltered accounts.
Thank you for everything you have done for myself and others.
@Ryan: If you have both registered and non-registered accounts then the issue becomes one of asset location. You can still use any of my model portfolios, but there are some decisions to be made about where each asset class should go, and about the specific products you should use.
For example, if you’re holding fixed income in taxable accounts, the ETFs mentioned above are preferable to the bond ETFs in my models. GICs are also a more tax-efficient choice.
If you are holding US or international equities in taxable accounts, then it’s often preferable to use Canadian-listed ETFs rather than their US-listed counterparts.
https://canadiancouchpotato.com/2013/12/09/ask-the-spud-when-should-i-use-us-listed-etfs/
@ CCP Excellent article, it has really got me thinking about the benefits of HBB.
I started doing some math to compare HBB to a less liquid GIC, please let me know if I have missed anything.
HBB’s current average yield to maturity = 2.28%
subtract 0.15% for management fees = 2.13%
subtract 0.15% for swap fee = 1.98%
To factor in the income tax I would subtract this number from the following (assuming that I earned $70K in Manitoba)…
…multiply by combined MB & fed captial gains tax (for Manitoba 19.7% x 1.98% =0.39% tax loss)
(for tax rates see http://www.taxtips.ca/taxrates/mb.htm)
Thus, total yield (after fees and taxes) in Manitoba for $70K income would be 1.98% – 0.39% = 1.59%
Compare GIC which has a combined fed and Manitoba tax at 39.4%
In order to beat HBB’s 1.59% the GIC would need to be more than 2.55% (or a 54 month GIC at the local credit union)
Is this an accurate comparison? Have I overlooked anything here?
Thanks!
@Solanum tuberosum (love it!): I think one should also consider that yield to maturity is the best estimate of a bond fund’s expected return, over any period the annual returns are not likely to look anything like that. A GIC’s return, by contrast, is entirely predictable. Remember, too, that the capital gains on HBB do not need to be realized every year: they can be deferred indefinitely. The interest on a GIC is taxed every year.
@ CPP
So I think I understand the difference now. Unlike GIC’s which requires you to both pay interest annually and pay at a high rate of tax, HBB allows yearly compounding of interest and a lower rate of tax when the time comes to sell and the liquidity to sell at any time (the price being affected by interest rates).
I’m still trying to wrap my head around bonds and bond yields. Given that HBB’s weighted average duration is 7.21 years, would it be reasonable to assume that one could expect to get 2.28% (the average yield to maturity) in about 7 years time? If so, then would a fair comparison be to a 7 year GIC (that is taxed annually)?
Thanks
@CCP. Great article as always. I’ve learned a lot from your website over the years. Thanks.
I have a defined benefit pension, and I’m open to taking on more risk since I’m in my 30s. Therefore my asset allocation across all accounts is heavily weighted to equities. I have a low allocation to bonds (10%) in my RRSP and TFSA. I’m thinking of restructuring and placing all bonds in HBB in my non-registered account. I figure that the tax sheltering space is better served for equities due to the higher return. I pretty much want to avoid my RRSP given the future tax implications, so I figure these horizons etfs (including HXT and HXS) are a better bet instead of an RRSP. Anything wrong with this thinking?
@Solanum: Understanding the expected return on bond funds can be very confusing. The key idea is that a bond index fund maintains a more or less constant exposure: if HBB’s average term to maturity is 10 years, that’s not the same as buying a 10-year bond and holding to maturity. It’s more like buying a 10-year bond and selling it every year and buying a new 10-year bond. That’s why you can’t just assume that if you hold a bond fund for a period equal to its duration you will get a return equal to its yield to maturity. That would only happen if interest rates never changed, which of course is impossible.
That’s why it’s not possible to compare a GIC to a bond fund without making a lot of assumptions.
@George: I would separate this into two different questions. The first is whether it makes sense to ignore your RRSP altogether because you have a DB pension. If you’re in your 30s you should probably consider the possibility that this situation could change between now and your retirement. If you do decide to hold all your assets in TFSAs and taxable accounts, then it may indeed make sense to keep your fixed income holdings in the non-registered account and use the TFSAs for higher growth investments.
The second question is whether to use swap-based ETFs for all your non-registered holdings. That depends on your comfort level with these products. The alternative would be to use low-coupon bond ETFs or GICs for the fixed income and plain vanilla index ETFs for the equities.
I think my concern is the payout per share.
If I had $400, I’d own 10 shares @ $40 each.
If the cost is $50, I’d own only 8 shares.
Since they pay (for example) $1 per share, I’d get less if I bought shares in the future (when it rises higher).
Like, what’s so good about HBB in the future, when it costs more, if my payout is lower since I own less shares cause each share costs more?
@CCP: In George’s situation, his query was largely regarding location of allocation in relation to taxation. But, assuming that he was talking about juggling the location, without changing the overall 10%/90% Bond/Equities distribution ratio, my understanding is that even for a self described risk tolerant investor, not only does the volatility decrease as bond percentage rises, but also the expected long term return actually initially rises as the bond percentage rises from 0% to some low percentage, after which, indeed, the expected yield actually starts to diminish as one would have expected initially. I was not sure of the location of this percentage inflection point, but I seem to remember that it was not quite as low as 10%; perhaps it was about 20%?
I understand the risk if the counterparty (national bank) defaults- loss of up to 10 percent of gains for the horizon swap agreement Etf’s, but is there any risk of losing the pool of cash held by horizons in the unlikely event of horizons itself collapsing? Is ones investment at risk in HBB if more than 100k is invested? (CDIC ‘s limit/fund). Is this money that is sitting there (collecting interest that is paid to the counterparty) insured?