Archive | Dividends

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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Ask the Spud: Why Do ETF Yields Differ?

Q: The Vanguard S&P 500 (VFV) currently has a dividend yield of 1.44%, but the US-listed version of the same ETF has a yield of 2.01%. How can these two funds have such different yields when their underlying holdings are exactly the same? – Lindsay

The US and international equity ETFs from Vanguard Canada do not hold their stocks directly: they get their exposure by holding a US-listed ETF. The Vanguard S&P 500 (VFV), for example, simply holds the Vanguard S&P 500 (VOO), which trades on the New York Stock Exchange.

Since the underlying holdings of VFV and VOO are identical, you might expect the two funds to have the same dividend yield. Yet if you visit their respective websites you’ll find the published yields actually vary by 57 basis points. What gives?

More than one way to do the math

Turns out there are several ways to calculate a fund’s yield. Vanguard Canada uses the trailing 12-month yield, which it defines as “the fund’s cash distributions over the past 12 months divided by the end of period net asset value.” The last four quarterly distributions from VFV totaled $0.52905 per share,

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The High Cost of High Dividends

In our recent white paper, Asset Location for Taxable Investors, Justin Bender and I argue that most investors are better off keeping their bonds in an RRSP, while equities should be held in a taxable account (assuming, of course, that all registered accounts have been maxed out). At the end of the paper, however, we noted one exception: investors who use high-dividend strategies may well be better off sheltering their equities in an RRSP.

Stocks can be relatively tax-efficient because much of their growth comes from capital gains, which are taxed at just half the rate of regular income and can be deferred indefinitely. Canadian dividends also receive a generous dividend tax credit that benefits low-income investors in particular: a retiree in Ontario whose only other source of income is the Canada Pension Plan and Old Age Security might be able to collect more than $20,000 a year in eligible Canadian dividends and pay no tax.

Getting paid taxed to wait

But if you’re still working and earning a good income, a dividend strategy may come at a high cost, especially if your taxable portfolio includes foreign equity ETFs.

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Inside the RBC Quant Dividend Leaders ETFs

In January, RBC launched the Quant Dividend Leaders ETFs, a family of dividend-focused funds covering the Canadian, U.S. and international markets. I recently had a chance to speak with Bill Tilford, Head of Quantitative Investments at RBC Global Asset Management, to learn more about the new ETFs:

RBC Quant Canadian Dividend Leaders (RCD)
RBC Quant U.S. Dividend Leaders (RUD/RID.U)
RBC Quant EAFE Dividend Leaders (RID/RID.U)

The funds do not track a third-party index: rather, the portfolios are built using a rules-based methodology. Unlike the popular S&P Dividend Aristocrats indexes, which focus on past dividend growth, Tilford says the RBC ETFs try to be forward-looking. So in addition to screening for stocks with above-average dividend yield, the strategy also looks at three measures of financial strength to determine the sustainability of the dividends.

The first is called the Altman Z-score, which has been used since the 1960s to estimate the probability of a bankruptcy. “It also does a great job of forecasting dividend growth,” says Tilford. The other factors are the volatility of the firm’s return on equity (ROE) and the amount of short interest.

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Why Has VRE Outperformed Its Rivals in 2013?

It’s been a marvellous year for equities, but 2013 has not been kind to real estate investment trusts. Like other income-producing investments, REITs are sensitive to rising interest rates, and the sharp increase in the middle of this year hit them hard. But the three Canadian ETFs in this asset class have shown significant differences in performance. Notably, the Vanguard FTSE Canadian Capped REIT (VRE) has outperformed its iShares and BMO rivals by a wide margin. Here are the year-to-date returns of the funds as of December 18, according to Morningstar:

Vanguard FTSE Canadian Capped REIT (VRE)
–2.47%

iShares S&P/TSX Capped REIT (XRE)
–7.81%

BMO Equal Weight REITs (ZRE)
–6.72%

REISs pieces

Whenever you see variance among funds in the same asset class, it’s important to determine why. In this case, the main reason is a significant difference in the underlying indexes. Shortly after VRE was launched, I wrote a detailed post describing its benchmark, the FTSE Canada All Cap Real Estate Capped 25% Index, which is quite different from those tracked by the iShares and BMO funds.

Like XRE,

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Looking for Value in Canadian Equity ETFs

Monday’s post about factor analysis was, I admit, too technical for most readers’ tastes. At least that’s the conclusion I drew when the two most enthusiastic comments came from a professor of statistics and an astrophysicist. But the brave few who managed to read to the end saw my promise to put all this in context. What can factor analysis teach us about where an ETF’s returns are really coming from?

Two decades of research has shown that the returns of a diversified equity portfolio can largely be explained by its exposure to three factors: the market premium, the value premium, and the size premium. A broad-market index fund like the iShares S&P/TSX Capped Composite (XIC), by definition, should be neutral in its exposure to the value and size premiums. And as we saw in my previous post, it is: the value and size coefficients for XIC are negligible. So, on to the next step.

Let’s now take a look at the iShares Dow Jones Canadian Value (XCV) and the iShares S&P/TSX Small Cap (XCS).

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ETF Dividend Dates Explained

This post is excerpted from The DIY Investor’s Handbook, coauthored by myself and Justin Bender, and available exclusively to clients of our DIY Investor Service.

Occasionally when you buy an ETF you won’t be eligible to receive the fund’s next dividend payment. At other times you’ll sell an ETF only to be paid a dividend a few days later. This is confusing for many investors, so let’s look at some important dates surrounding dividend payouts.

When a fund announces a dividend (or other distribution, such as an interest payment from a bond ETF), it will declare a record date and a payment date. For example, it might announce it will pay a distribution of $0.10/share to investors who own the ETF on January 15 (the record date), with the payment to be made on January 18 (payment date). In this case, if you sell your shares on January 16, you will still receive the dividend two days later, even though you no longer own the fund.

Two business days before the record date, the ETF will begin trading ex-dividend (“without dividend”).

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Why You Should Avoid DRIPs in Taxable Accounts

Last week’s post about calculating your adjusted cost base with ETFs drew some interesting comments. It’s clear that many DIY investors who use non-registered accounts were unaware of how much work is involved in accurately reporting capital gains.

Careful record-keeping is an unavoidable burden for taxable investors, but you don’t need to make it any more difficult that necessary. Yet as one reader pointed out (hat tip to Jas), some investors complicate their lives by using dividend reinvestment plans in non-registered accounts.

DRIPs allow you to receive ETF distributions—whether stock dividends, bond interest, or return of capital—in the form of new shares rather than cash. You can only receive whole shares, so if the ETF is trading at $20 and you’re eligible for $87 in distributions, you’ll receive four new shares plus $7 in cash. These plans are extremely popular with do-it-yourself investors, and they can be beneficial, since you pay no trading commissions on the new shares and your money starts compounding immediately rather than sitting idly in your account.

But although they are convenient in RRSPs and TFSAs, dividend reinvestment plans are usually not a good idea in taxable accounts.

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Calculating Your Adjusted Cost Base With ETFs

Being a DIY investor is easy when all your accounts are tax-deferred. As the April 30 tax deadline approaches, pretty much all you need to do is gather your RRSP contribution slips. But if you have nonregistered accounts, things are more complicated, even if you’re a Couch Potato who uses ETFs and index funds.

To begin with, you need to report any income you received during the year. This part is relatively easy: in February or March you should receive a T3 slip that includes a breakdown of the type of income you’ve received from your mutual funds or ETFs: dividends, reinvested distributions, and interest income. Just enter these amounts in the appropriate boxes on your tax return and your software—or your accountant—does the rest.

If you hold US-listed ETFs, you’ll receive a T5 slip from your brokerage: Box 15 contains the amount of foreign dividends you receive, and Box 16 will indicate the amount of foreign tax paid. Dividends from US and international companies are fully taxable as income, but you can recover the withholding tax by claiming the foreign tax credit on your return.

But there’s more to the story than simply reporting income.

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