Archive | Taxes

Ask the Spud: Should I Switch All at Once?

In Episode 8 of the Canadian Couch Potato podcast, I answered the following question from a listener named Remy:

I want to move away from my stocks and mutual funds in order to build a Couch Potato portfolio with ETFs. What is the best way to do this? Should I sell everything at once and pay all of the taxes this year, or should I sell my assets over a longer period, like two to three years?

Many investors in Remy’s situation have made that all important first-step: committing to an indexed strategy. But now they’re unsure about how to liquidate their existing portfolio and build the new one. Should you clean house and do it all at once, or take a more gradual approach?

This is an easy decision if all of your investments are in RRSPs and TFSAs. Since there are no tax consequences to selling your existing holdings, you should just liquidate all the holdings right away. But Remy is investing in a non-registered account, and if he’s held his stocks and mutual funds for several years, he’s probably sitting on large unrealized capital gains,

Continue Reading 24

A New ETF Structure for Accumulators

ETF launches are generally unexciting these days: most new products focus on increasingly narrow niches or exotic strategies. But last week BMO unveiled an innovative ETF structure that may just have some lasting appeal. They launched a new share class of four existing short-term bond ETFs: called “Accumulating Units,” these new funds do not pay their distributions in cash like traditional ETFs. Instead, they reinvest all the interest payments immediately and increase the net asset value (and market price) accordingly.

An example will help. Consider a bond ETF with a unit price of $15 at the beginning of the year. Over the next 12 months it pays out 3% in interest and falls in price by 1%. The fund’s one-year total return would therefore be 2% (the 3% interest minus the 1% capital loss). If this ETF were available in both the traditional and Accumulating Units structure, both would report the same performance. But they would arrive there in different ways:

Traditional ETF
Accumulating Units

Unit price at beginning of year
$15.00
$15.00

Cash distributions (3%)
$0.45
$0

Reinvested distributions (3%)
$0
$0.45

Capital loss (1%)
-$0.15
-$0.15

Unit price at end of year
$14.85
$15.30

Value of ETF unit + cash
$15.30
$15.30

One-year total return
2%
2%

What they’re not

The idea of reinvested distributions is not new,

Continue Reading 25

Ask the Spud: Can I Make Taxable Investing Easier?

In Episode 4 of the Canadian Couch Potato podcast, I answered the following question from a listener named Jakob:

I’m currently investing with all my ETFs in RRSP and TFSA accounts. This year, however, I’ll finish paying off my mortgage, so I will have more surplus cash and will have to start using taxable accounts. I have been reading your blog posts about adjusted cost base, and they’re helpful, but it still sounds like a pain to track and calculate. I’d consider paying some extra fees for help with this. What options do I have?

Investing in a non-registered account involves a lot more hands-on work than RRSPs and TFSAs. While there’s no such thing as a maintenance-free taxable portfolio, you can certainly make your life easier with a few simple strategies:

1. Consider alternatives to ETFs. Make no mistake: ETFs are generally tax-efficient and they can be a great choice in non-registered accounts. But if you’re a novice index investor, consider other good products that require a lot less recordkeeping. Mutual funds, for example, track your adjusted cost base at the fund level,

Continue Reading 94

Podcast 4: Charles Ellis and the Index Revolution

For the latest episode of the Canadian Couch Potato podcast, I was privileged to have the opportunity to interview Charles Ellis, who has been called “Wall Street’s wisest man.”

Mr. Ellis’s best-known work is Winning the Loser’s Game, a book that had a big impact on me when I was beginning my education on index investing. After spending decades as an analyst and consultant for pension and endowment funds, here was Ellis arguing that individuals—and even many institutional investors—would be better off simply using index funds. And while that seems like a familiar argument today, Ellis first made it some 42 years ago, in a hugely influential article called The Loser’s Game. That paper appeared in The Financial Analyst’s Journal in the summer of 1975, a few months before John Bogle launched the first index fund at Vanguard.

In our interview, Mr. Ellis and I discuss his latest book, The Index Revolution, which looks back over his long career and concludes that, alas, things haven’t changed very much. The financial industry still behaves as though the data in favour of indexing doesn’t exist—or at least doesn’t apply to them.

Continue Reading 32

Making Sense of Capital Gains Distributions

Imagine you’re part of a group of 10 friends at a restaurant to celebrate the holidays. Everyone else arrives on time and enjoys cocktails, appetizers and a main course, while you get stuck in traffic and barely make it in time for dessert. At the end of the meal, the server brings 10 separate bills, each for the same amount. “But I only had a slice of pie!” you complain. “Why am I paying for a full meal?”

If you’re an ETF or mutual fund investor who makes a large purchase in December, you may end up feeling the same way. That’s because some funds distribute capital gains at the end of the year, and you’re on the hook for the taxes whether you’ve held the fund for a couple of weeks or the full 12 months. (Note this only applies to non-registered accounts: you don’t need to worry if you’re using only RRSPs and TFSAs.)

Giving them the slip

Let’s back up and review why this happens. Mutual funds and ETFs occasionally sell investments that have increased in value, resulting in capital gains. Over the course of the year, a fund may also do some tax-loss harvesting to realize losses that can offset some or all of those gains.

Continue Reading 27

Tangerine Expands Its Lineup

The Tangerine Investment Funds have long been part of my model portfolios, as they’re a simple way to build a broadly diversified index portfolio with a single product. With a management expense ratio (MER) of 1.07% they are not the cheapest option, but they offer a lot of convenience for investors who aren’t ready to manage a portfolio of individual index funds or ETFs.

This month the Tangerine family grew for the first time in five years with the launch of the Tangerine Dividend Portfolio.

As with the existing members of the Tangerine lineup, the Dividend Portfolio includes a mix of Canadian, US and international equities. But whereas the older funds track traditional indexes of large and mid-cap stocks, the new one is focused on yield. It tracks three MSCI indexes that screen for companies with dividend payouts at least 30% higher than average, as well as “quality characteristics” that suggest these yields will be sustainable.

The MSCI Canada High Dividend Yield Index currently holds 22 stocks, including the usual suspects such as Fortis, TransCanada, Telus, and the big banks.

Continue Reading 35

How Foreign Withholding Taxes Affect Returns

In our newly revised white paper, Justin Bender and I explain the hidden cost of foreign withholding taxes on US and international equity ETFs. I gave an overview of the most important points in my previous blog post. Now let’s look at one of the more subtle ideas: how those taxes affect your personal rate of return.

Meet Julie, an investor who is looking to hold US equities in both her RRSP and non-registered account. After reading our paper, Julie knows the US imposes a 15% withholding tax on dividends paid to Canadians, and with US stocks yielding 2% these days, that would result in a drag of about 0.30%. So she decides on the following:

In her RRSP, Julie uses the Vanguard Total Stock Market ETF (VTI), because this US-listed fund is exempt from withholding taxes.
.
In her taxable account, Julie uses the Vanguard U.S. Total Market Index ETF (VUN), the Canadian-listed equivalent of VTI. This ETF is denominated in Canadian dollars, which makes it cheaper and easier to trade. Although the fund is not exempt from the foreign withholding taxes in a non-registered account,

Continue Reading 63

Foreign Withholding Taxes Revisited

Justin Bender and I have just completed the second edition of our popular white paper, Foreign Withholding Taxes: How to estimate the hidden tax drag on US and international equity ETFs.

Originally published in 2014, the paper explains how many countries impose a tax on dividends paid to foreign investors—most notably a 15% levy on US stocks held by Canadians. When the first edition appeared, foreign withholding taxes were not well understood by many investors and advisors, and even the ETF providers rarely discussed them. In the two years since, the issue seems to be getting more recognition. Both Vanguard and iShares, for example, have made changes to their international equity ETFs to make them more tax-efficient. That’s great news, though it also made the first version of our paper somewhat dated.

In this new edition, we’ve made some significant changes. First, we’ve removed corporate accounts from the discussion and focused on personal accounts only. We’ve also used some different ETFs in our examples, including the Vanguard U.S. Total Market (VUN), the Vanguard FTSE Developed All Cap ex U.S. (VDU) and the iShares Core MSCI EAFE IMI (XEF).

Continue Reading 93

Cost Versus Convenience in “ex Canada” ETFs

I used to own one of those one-piece cutlery tools designed for hiking and camping—the kind with a knife, fork and spoon that all fold into a single unit. It was hardly ideal for eating, especially if you needed the fork and knife at the same time. But it was more convenient than trekking around with three individual pieces of flatware that might tear your pack or get left behind on the trail.

As investors we often make similar trade-offs. Consider the Vanguard FTSE Global All Cap ex Canada (VXC) or the iShares Core MSCI All Country World ex Canada (XAW), which both offer one-stop global diversification by holding thousands of US, international and emerging market stocks. But as with folding cutlery, you give up something to get that convenience. These two “ex Canada” funds get at least some of their exposure by holding underlying US-listed ETFs rather than holding their stocks directly. This structure can result in additional foreign withholding taxes on dividends.

In a recent blog post, Justin Bender estimated the impact of foreign withholding taxes on RRSP investors who hold VXC.

Continue Reading 61