This post is the fifth in a five-part series outlining the primary benefits of the Couch Potato strategy.
All investors have to deal with the erosion of their returns by fees and taxes. The first post in this series explained how using ETFs and index funds can cut your costs by 90% or more. Now let’s look at how index investing can also cut your tax bill.
Fair warning: this subject is rather technical and it may leave beginners baffled. The good news is that if all your investments are in registered accounts—RRSPs, RRIFs, RESPs or Tax-Free Savings Accounts—you don’t need to worry about it. But if you’re investing in a taxable account with actively managed mutual funds, you may want to settle in. It just might save you some money.
Most mutual funds are structured as open-end trusts, which enables them to avoid paying taxes. Instead, funds pass along any interest, dividends and capital gains to their unitholders. (Mutual funds incur a capital gain any time they sell stocks, bonds or other securities at a profit.) Usually all of these distributions are reinvested rather than paid in cash, but unitholders are still responsible for paying tax on them: that’s why you get that T3 slip in the mail every year.