Couch Potato investors hear a lot about asset allocation, but asset location is also an important consideration. Asset location refers to the type of account you use to hold the stocks, bonds, cash and real estate in your portfolio. It’s important because the growth and income from your investments are treated in different ways by the taxman:
Interest from bond funds and bond ETFs (as well as individual bonds, GICs and money market funds) are taxed at your marginal tax rate, just like employment income.
Dividends from Canadian stocks are eligible for a generous dividend tax credit from the federal government. For the 2009 tax year, eligible dividends are first grossed up (increased) by 45% and declared as income; the investor then receives a tax credit of 19% on the grossed-up amount. Some provinces offer an additional dividend tax credit.
Foreign dividends are taxed at your marginal rate. In addition, many countries (including the US) levy a withholding tax on dividends, often between 10% and 15% (this may be recoverable in non-registered accounts).
Capital gains are profits earned from selling a security for more than you paid for it. You report 50% of your capital gains as income and pay tax on that amount. Mutual funds and ETFs must also pass along their capital gains to unitholders, although index funds are usually more tax-efficient.
Here’s a table highlighting the dramatic differences in how each type of investment income is taxed, assuming a marginal rate of 22%:
Interest | Canadian Dividend | Capital Gain | |
Amount received | $1,000 | $1,000 | $1,000 |
Taxable income | $1,000 | $1,450 | $500 |
Federal tax (at 22%) | $220 | $319 | $110 |
Dividend tax credit (19%) | – | -$275.50 | – |
Total federal tax owing | $220 | $43.50 | $110 |
The tax rates above apply to securities held in non-registered investment accounts. Registered accounts offer several opportunities to defer or avoid paying tax on investment growth and income:
- If your retirement savings are in an RRSP or RRIF, you pay no tax on interest, dividends or capital gains until you withdraw the funds. At that time, you pay tax on the entire withdrawal at your marginal rate. (You can’t claim the dividend tax credit or enjoy the lower tax on capital gains.)
- With a Registered Education Savings Plan (RESP), you pay no tax until you withdraw the funds. At that time, all the growth is reported as income in your child’s hands. You pay no tax on the amount you put into the account, since contributions were made with after-tax dollars.
- In a Tax-Free Savings Account (TFSA), all the growth is tax-free, and no tax is payable when the funds are withdrawn.
So, what’s a Couch Potato to do with all this information? If you’re able to hold all your investments in an RRSP or other tax-deferred accounts, you don’t need to worry much about this at all. However, if you also hold ETFs or index funds in a taxable account, review your asset location to make sure you’re not paying more tax than you need to:
Canadian equities deliver their returns from lightly taxed dividends and capital gains. So if you need to hold some of your investments in a taxable account, start with Canadian stocks.
REITs pay generous distributions, but these are not considered dividends. The bulk of the payouts are classified as income and taxed at your full marginal rate. (The rest is usually return of capital.) REITs are therefore best held in a tax-sheltered account.
Bonds (as well as GICs and money market funds) are best held in a tax-sheltered account, since their interest is fully taxable at your marginal rate.
Preferred shares are sometimes considered fixed-income investments, but they pay dividends, not interest. For income-oriented investors who have no more RRSP or TFSA room, Canadian preferred shares may be a good choice in a taxable account because they’re taxed more favourably than bonds.
Canadian-listed ETFs that hold international stocks include the popular iShares XSP and XIN. Although these are traded on the TSX, their underlying holdings are foreign stocks, so the dividends are not eligible for the tax credit. These ETFs are best held in a tax-sheltered account. However, as Canadian Capitalist has pointed out, XSP and XIN (which simply hold US-listed ETFs in a Canadian wrapper) are still subject to the US withholding tax even if they’re held in an RRSP.
Dividends from US-listed ETFs are fully taxable in Canada and get dinged by the additional withholding tax unless you hold the funds in an RRSP. Note that you still pay the withholding tax if the fund is held in an RESP or a TFSA. The good news is that you may be able to recover the withholding tax if you hold them outside an RRSP. A taxable account also allows you to buy and sell ETFs in US dollars and avoid currency exchange fees—most discount brokers do not allow you to hold US dollars in an RRSP. (Questrade and QTrade are the exceptions.)
Pulling all this together, here’s an example of how you might divvy up an ETF portfolio across different accounts with an eye toward keep taxes to a minimum:
RRSP
Vanguard Total Stock Market (VTI)
Vanguard FTSE Developed Markets (VEA)
Vanguard FTSE Emerging Markets (VWO)
iShares Canadian Universe Bond (XBB)
TFSA
iShares S&P/TSX Capped REIT (XRE)
Taxable account (assuming no more RRSP or TFSA room)
iShares S&P/TSX Capped Composite (XIC)
iShares S&P/TSX Canadian Preferred Share (CPD)
As you can see, tax planning is complicated, so if you have a large portfolio, consider seeking help from a financial or tax advisor.
Thanks for this clarification; it has prompted me to move some funds around that will help in my taxes.
Nothing big, but it’s free money if I just do the manouver!
Hi, thanks for this piece. The question of how to optimally organize a portfolio across the various types of accounts that are available to Canadian investors is an important one and often gets ignored. Two questions:
Am I correct in understanding, then, that the distributions from my USD-denominated ETFs (e.g. VTI) will NOT get hit with the witholding tax as long as I hold them in my RSP?
Also, are you saying that investors can recover the US witholding tax on USD denominated securities if they’re held in TFSA or non-registered accounts, it’s just that paperwork is involved?
I hold VTI, VEA and VWO and recent gains in these positions have been erased by the run up in the Canadian dollar. About a year ago I had to decide how to play the US market and i chose VTI over XSP. I would have been way ahead if I’d chosen XSP. However, it’s the long term that I care about. Pretty much impossible to forecast where the CAD dollar will be relative to the USD in 25 years!
> Am I correct in understanding, then, that the distributions from my USD-denominated ETFs (e.g. VTI) will NOT get hit with the withholding tax as long as I hold them in my RSP?
You are correct. Canada and the US have a tax treaty that eliminates the withholding tax in accounts that are designated as “retirement savings.” RRSPs and RRIFs are covered, but TFSAs are not.
> Also, are you saying that investors can recover the US withholding tax on USD denominated securities if they’re held in TFSA or non-registered accounts, it’s just that paperwork is involved?
You may be able to recover it in a taxable account, but not in a TFSA (see Erick’s post below). I have to confess I have not personally had cause to do this, so I don’t know all the details. If you have significant US holdings outside your RRSP, you should ask an accountant or tax preparer about this. The amount invested would have to be significant to make this worthwhile: with US stocks paying about a 2% yield these days, the withholding tax amounts to about $30 annually for every $10,000 invested. So you can think of the withholding tax as an extra cost of 0.30%.
> Pretty much impossible to forecast where the CAD dollar will be relative to the USD in 25 years!
Absolutely. You can’t judge the success of currency hedging by what happens in a year. VTI is much less expensive than XSP, so over the very long term, assuming currency fluctuations even out, it’s likely to be the better choice.
CCP: Where would US listed Dividend ETF’s be more tax efficient: TFSA or RRSP?
Thanks for the excellent summary.
We have just pulled all our of savings out of a big bank wrap account and are transferring it to a discount broker.We’ve been giving a lot of thought to asset allocations as we basically have multiple registered accounts and a non registered in cash waiting to be invested. This post (in fact, all your posts) has been a great help.
Hey there,
Just a point of clarification on this question:
“Also, are you saying that investors can recover the US withholding tax on USD denominated securities if they’re held in TFSA or non-registered accounts, it’s just that paperwork is involved?”
If you own a U.S. dividends paying stock inside a TFSA, the withholding tax applies and you cannot claim it as a foreign tax credit or deduction on your tax return.
For non-registered accounts, you report the amount withheld when you do your taxes:
http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/ddctns/lns409-485/405-eng.html
Erick: Many thanks for clarifying this. I’ve updated the post accordingly.
As Erick points out above, TFSAs are still subject to the withholding tax, so an RRSP would be more tax efficient for US-listed dividend ETFs.
Question: this post sort of assumes all your savings are targeted towards the same goal (retirement, mostly). Does that mean your asset allocation is calculated irrespective of whether the money is in a registered account or not?
I’ve been assuming that (as a younger person) the retirement money is in the RRSP, and is fairly aggressive (long-term). Money outside the RRSP is for things like downpayments on houses, and so is less aggressive.
This means that I essentially treat each goal as a separate pot of funds, with individual asset allocation targets. Consequently, I hold some assets – like bonds – outside of my RRSP accounts. My assumption is the asset allocation offsets the tax penalties.
Should I instead treat all my savings the same, and just dip into the appropriate account as needed? This implies that the less-liquid RRSP holds the less risky investments. The problem, of course is that if I need some money for a purchase, I may have to sell some stocks at a poor time to get it.
Neil: Great questions. The post did indeed assume that all of your investments were for the same long-term purpose.
As you recognize, the key point here is that your decisions about asset allocation and location depend on what you’re going to use the money for. If you have different goals (e.g. saving for retirement and saving a down payment) then you have to think of those independently.
Even if you’re saving for a home inside your RRSP (through the Home Buyer’s Plan), you’ll likely want to earmark part of your savings for each goal and adjust the allocation accordingly. For example, a young person might hold all his retirement savings in stocks (for now), plus another portion in a money market fund for a down payment, all in a single RRSP account.
Bottom line, it sounds like you’re doing everything right.
Great article! I only wish my ‘certified financial planner’ knew half of this when he was constructing our portfolio of mutual funds over the past 20 years. Somehow he got our Canadian equity funds in our RRSPs and our foreign funds mostly in our ‘non-deferred’ account. No amount of questions during our ‘reviews’ about tax efficiency got a straight answer yet year after year, we got those slips in the mail at tax time. After all, he was a ‘certified financial planner’. Who would know better?
I hope that others reading this, even if they don’t use your couch potato strategies, will not make the same mistakes as we have and we made a lot of them. Educate yourself, even if it is just enough to know what to look for, what questions to ask and to know a ‘brush off’ when you hear it. This article is gold and very timely.
Keep up the great work!
@Doug: Thanks, and glad you found it useful. I’m surprised that a CFP would not have known this stuff. It’s covered in their training. Sometimes I think people would be better off managing their own investments and just paying an accountant for a few hours of advice each year.
what about someone with a non-registered account worth much more (say 10x) than his rrsp/tfsa, how can you be tax efficient and properly diversified at the same time ??? suppose a classic 60/40 allocation, i fail to see how things could be divided, fixed income would be all in rrsp/tfsa and taxable account would be almost 100% Canadian based ETF and/or high dividends paying stocks.
i often read that all account should be treated as one single portfolio and optimized regarding tax-returns. Any guidance regarding a situation like this ?
@Dong: There’s no magic solution to your problem. “Optimized” means keeping taxes as low as possible, but that doesn’t mean eliminating them altogether. Many wealthy retirees do hold bonds outside registered accounts. If you’re in this situation personally, I’d suggest talking to an accountant or tax advisor.
Thanks for the reply, i did some excel and further reading and came up with this:
TFSA (maxed):
50% XSB
50% XRE
RRSP (maxed):
Mix of VTI/VEA/VWO or more speculative investments (ex: individual US stocks, http://www.ndir.com/SI/articles/0110.shtml)
Non-Registered:
Mix of VTI/VEA/VWO/XSB to get proper asset allocation (ex: 60/40), of course bonds/stocks held in registered accounts are included as part of the 60/40 global allocation
This way the portfolio is treated as a single entity and tax-optimized. I also booked a meeting with a fee-only (ouch 200$/h !!!) next week to get some validation on my global strategy.
I want to personally thanks you for all the time you put in this very useful blog !
@Dong: Sounds good to me, and glad you found the blog helpful. Good luck!
I am new to this whole thing. Interested in the Couch Potato (may I say I also had difficulties with in house advisors at TD when trying to open the e-series account). Anyways, I am going to go with the 40-60 split as you suggested. I have not maxed my RRSP and want to hold long term. I just want to be clear on where to put it: TD Cdn. Index Fund, TD U.S. Index Fund, TD Int’l Index Fund, TD Cdn. Bond Index Fund. I would assume all in a RRSP? I am a bit worried because I have been reading about the pitfalls of putting everything in RRSPs.
@Roxanne: Your questions depends entirely on your individual circumstances. In general, investors who expect to have a lower income in retirement are better off with RRSPs. Those who have low incomes now, or who expect to have a generous pension or other income in retirement may be better off the TFSAs.
Just a few comments on allocation. There are no hard and fast rules on where a certain type of investment should be. Yes there are tax advantages as mentioned in the article for various locations and for various investments. You should always try to keep those in mind but…everyone’s situation is a bit different.
If you can only afford an RRSP then everything goes into that (assuming that your current tax rate > expected withdrawal tax rate otherwise TFSA is an option but has lower contribution limits) and allocation % will be based on your risk tolerance. You could be almost 100% in Bonds or 100% in equities or anything in between depending on your age and risk tolerance.
If you have additional funds that you want to invest then looking at the portfolio as a whole is the way to go. Determine your desired allocations and then administer across all the accounts. Do think about the tax implications but also think about time horizon.
For instance, you are getting close to sending your kid off to school, you may want to make that portion of the portfolio less risk adverse to ensure that you don’t see a major drop in the 2 years before you need the funds for instance. This would mean bumping up your equity portion in other parts of your portfolio so as to maintain your desired overall portfolio asset allocation.
Another example, would be if you had a large capital loss from previous years that you can use against future capital gains. You may want to have as much of your equity portfolio outside of the registered accounts to benefit from any capital gains that are triggered regardless if it is canadian or foreign. Yes with foreign outside of registered accounts you will have 15% withholding tax on dividends but most can claim that against taxes owed at tax time so I don’t see that being a big reason to not to move foreign equity outside especially if you are trying to generate lots of capital gains. Better to diversify the capital gain generation than depend on just Cdn equities for the gain generation. If your main reason is to generate capital gains, the small 15% tax on say 1/5 to 1/10 of the total annual return is minimal compared to the benefit of using the capital loss.
All to say, there are more factors involved in determining which assets go in which account other than tax implications. Risk tolerance, time horizon, current tax situation vs withdrawal tax situation, etc.. All must be taken into account but I do agree with the general rule of ” income producing assets in tax-deferred accounts and dividend / capitals gains producing assets in non-registered accounts”.
Knowing the tax implication of each type of asset in each type of account is the beginning step and then making it work for your situation is next.
I can see some comments coming on this one.
Thank you for the excellent blog. I’ve had most of my questions answered by reading it. I stumbled across this entry because I was wondering where to put everything. The only question I have now is what to do when re balancing, because you wouldn’t want to sell from the RRSP to add to the TFSA and get dinged with a big tax hit. I guess it’s not a big deal when your account is small, as you could add money, but what happens when the portfolio gets much larger?
@Tyler: Thanks for the comment. There is no easy answer to your question. You definitely do not want to be taking money out of your RRSP to add it to your TFSA. (Most people have much more RRSP room than TFSA room anyway, so this may not even be possible.) The other issue is that the two accounts may not have the same goal: the TFSA might be short-term savings rather than retirement savings. Overall, my advice would be to consider the asset allocation first, and the location second. Don’t make tax savings more important than proper risk management.
I recently came across the following website: http://www.retailinvestor.org/RRSPmodel.html, which has a very different take on RRSPs than most banks and financial advisors.
They take the position that the income you earn on your investments in a RRSP is actually tax free, because the tax that you pay when you remove the funds is just the amount the government loaned you in the form of the RRSP contribution credit plus interest. Consequently, they feel it is no different from a TFSA and that you should place the funds that will be taxed the most heavily in total dollars into the RRSP. In other words, if your going to make enough capital gains to pay more tax dollars than on the current low bond interest, then you should put your equity investments into the RRSP preferentially, even if they are Canadian, because you aren’t actually paying any tax on your portion of the RRSP, so it doesn’t matter that you can’t claim the capital gains tax credit.
In any case, they do make a fairly convincing case and have forced me to reconsider how I think about my RRSP allocation. I have a nagging feeling that there is a flaw in their logic somewhere, but I haven’t been able to find one. I’d be much obliged if you could have a read through and see if you agree with their conclusions, because if they are correct then all equity index ETFs that are being purchased with the intent to hold for the long-term should be held in RRSPs on the basis that stocks have consistently higher returns than bonds/GICs.
@Julian:
Money in my pocket = Money invested + Gains – Taxes
So, assuming “Money Invested” and “Gains” are similar(*) between the different accounts (RRSP, TFSA, and non-sheltered), the primary goal should be to minimize taxes paid in order to get as much “Money in my pocket” as possible.
Here’s an example using a $2,000 dollar investment (50% TFSA, 50% non-sheltered) with a 50% GIC/50% stocks allocation. Assume the GIC has a 2% and the stocks 8% (capital gains only) annual return. After 3 years, what happens?
(assuming 50% marginal tax rate)
Scenario 1: $1000 GIC in TFSA, $1000 Stocks non-sheltered.
– end of year 1: TFSA $1020, non-sheltered $1080 (no tax on unrealized gains)
– end of year 2: TFSA $1040, non-sheltered $1166 (no tax on unrealized gains)
– end of year 3: TFSA $1061, non-sheltered $1194 [$1259 – 65$ (taxes)]
Total in my pocket after 3 years (after taxes): $2255
Scenario 2: $1000 stocks in TFSA, $1000 GIC non-sheltered.
– end of year 1: TFSA $1080, non-sheltered $1010 [$1020 – $10 (taxes)]
– end of year 2: TFSA $1166, non-sheltered $1020 [$1030 – $10 (taxes)]
– end of year 3: TFSA $1259, non-sheltered $1030 [$1040 – $10 (taxes)]
Total in my pocket after 3 years (after taxes): $2289
So, scenario 2 wins, mostly due to less taxes paid.
(*)Note that the gains on GICs are reduced in scenario 2 (e.g. in year 3: 2% of $1020 [$20] is less than 2% of $1040 [$21]). This difference in the “Gains” part of the “Money in my pocket” formula should be taken into account in a full picture.
The long-term average annual gains of stocks and (some types of) bonds are much closer than stocks/GICs, making it preferable to hold the bonds (in preference to stocks) in TFSA/RRSP accounts in most cases.
Personally, I use an estimate of the difference in both taxes and gains over the life of an investment to guide my decisions.
My rule of thumb for putting money in RRSP/TFSA:
– the bonds part of my long-term goals goes in first
– if space remains, the stocks part of my long-term goals goes in second
– if space remains, the GICs of my short-term goals go in.
Any overflow goes in taxable accounts.
@Nathan: You’re correct about this. There is a link in the post to the CRA’s page about the foreign tax credit.
Gah, another mistake in my first comment – greater Canadian allocation reduces currency exchange risk; it doesn’t increase it. (That’s what I get for adding points while skimming through before posting!)
@CPP
Hi Dan, this site really rocks. I understand your hesitance to give specific financial advice and respect that, so let’s consider this hypothetical situation. If one was to structure a Uber-Tuber scenario with over 500k, and consider the recommended priority of ETF’s placed in registered accounts. Assuming one was to start with XSB, then XIG to max out TFSA’s and RRSP accounts, would placing the US ETF’s (PDN, PXF, PRF, VWO, VXF) in an US account be the only remaining tax efficient move? As one would get more room in the registered accounts, he or she would move some over (in a US registered account). Is there something wrong with this approach and in general would there be a better strategy taxe wise? Assume that none of these funds are needed for at least 10 years.
If one was moving from mutual funds managed by others to taking charge with DIY ETF’s, this could be a lot of fun.
Thanks for sharing your knowledge and enthusiasm of personnel finance, you are helping lots.
@ACMZ: I’m no tax expert, but your strategy seems sound to me. You’re right to shelter the least tax-efficient asset classes first (in this case, the bonds). Have a US-denominated cash account will allow you to trade the US-listed ETFs more cheaply, assuming you have US dollars to begin with, or you’re prepared to use Norbert’s gambit to convert them. This post might be interesting to you:
https://canadiancouchpotato.com/2012/02/27/a-new-way-to-sidestep-currency-conversion-costs/
Hi Dan,
Wondering if you have come across an approach to portfolio building that would addrress the following scenario? Assuming one was in the process of building a portfolio and it was heavily weighted in equities at this time. If it needed 40k of bonds ETF to balance the portfolio and the funds were available, would it be wise to commit all of it to bonds at this time? If equities are low and bonds are high because of the economic times, would it not be wise to buy the underperformer (ie. equities) and rebalance at a later date? This has a strong smells of market timing and speculation. Maybe an alternative would be to buy bonds at a slow rate in order to consider dollar cost averaging, but then this alternative would have to consider the lose on the returns from the bonds not purchased. Are you aware of this situationor something similar having been discussed somewhere? This is very interesting.
ACMZ,
No matter how you look at it you will be doing some form of market timing unless you just buy the bond portion as needed right now. That being said, personally I would invest say 1/4 today in bonds, 3/4 in high interest savings account (at least you’ll get some return while you wait). Then dollar cost average the next portions say 1/4 each month. That’ll cost you about 0.1% in commissions based on $10 comm. fees.
If that comm % bothers you then do 1/3 or 1/2 now and then equal portions later on.
Just my thoughts.
After doing a bunch more research I’ve answered my own questions with the help of Fama and French. :) Basically small and value are different risk factors from market/equity risk. Since they are not perfectly correlated, they aren’t simply additive. That’s why it might make sense to add some risk and expected return with a small or value tilt, while still having some fixed income. In fact, one can theoretically increase return while holding volatility constant or reduce volatility while holding expected return constant (or some combination) by increasing exposure to small and value stocks while decreasing the total percentage of the portfolio in equities.
Seems like you could think about over-weighting Canada in the same way. For Canadian taxable investors, Canadian dividend paying stocks (or the Canadian market in aggregate) effectively carry a premium. They also carry increased risk due to lack of diversification, compared to a worldwide market-cap weighted portfolio. The premium is a fair bit smaller than the value premium, and somewhat smaller than the size, historically, but it’s also a whole lot more guaranteed going forward, and the risk should be lower. I suppose you could plug a bunch of assumptions into an efficient frontier calculator to get an ideal over-weighting of Canadian stocks, but my guess is you’d probably end up with something like the 25-40%ish range usually recommended!
I’m not clear on the decision to put REITs in TFSA. I did this a couple of years back with XRE. I am considering moving it ‘In-Kind’ to my non-registered account but wonder if I don’t see full picture/implications?
Reviewing the distributions for 201o & 2011
2010 2011
sorry…continuing
2010 2011
Eligible Dividends: .013 .011
Income .139 .237
Cap.Gains .41 .40
Return of Capital .113 .066
TOTALs: .68 .738
Over 60% of payouts seem tax advantaged. With limited TFSA contribution room I’m unclear why XRE belongs there?
Some individual REITs payout almost entirely in Income and I can understand putting those in TFSA. Hoping for clarification….
@Jane: Thanks for the comment. The most tax-efficient type of distribution is “eligible dividends,” which as you can see, is almost no part of REIT payouts. All of the “other income” id fully taxable at your marginal rate. And while capital gains are taxed at only half the rate of regular income, most equity ETFs do not distribute any capital gains at all. So REITs are likely to be more tax-efficient than high-coupon bonds, but they are definitely more of a tax liability than dividend-paying Canadian equities.
Dan,
You separated XBB into RRSP and XRE & GICs into TFSA, just to clarify, there isn’t a difference or any benefits to put these in either RRSP or TFSA?
Thanks,
Que
@Que: There’s no significant difference between a TFSA and an RRSP for bonds. Just put them wherever you have the contribution room.
Hi,
I’m in university right now, studying to become an accountant, so I don’t have a whole lot of money to put away but I still want to start investing. I’m thinking of putting $300/month to start into an TFSA, what I’m wondering is does it matter where I put it? I’ve always used Scotiabank, but I don’t want to be at a disadvantage for my investments. Should I stay at Scotia or go to TD or another firm with cheaper trading rates?
I’d like to do the Complete Couch Potato strategy, but at such a low monthly contribution, should I still be going for something so diverse or is there a better way to do it?
Thanks, I’ve been reading as much as I can but still having trouble with some things.
@KingL: Most online brokerages charge an annual fee for small accounts (the cutoff varies), so make sure you check that out before opening an account. You almost certainly don’t want to start with an ETF portfolio because the trading commissions will erode your returns quickly. Index mutual funds are the place to start (see the Global Couch Potato options 2 and 3). A few articles that may help:
http://www.moneysense.ca/2010/05/27/become-a-couch-potato-investor-with-less-than-5000/
https://canadiancouchpotato.com/2012/07/30/comparing-the-costs-of-index-funds-and-etfs/
https://canadiancouchpotato.com/2012/03/05/some-advice-for-new-potatoes/
That was exactly what I was looking for, thank you. I will go with TD e series for sure!
One to add to Dan’s list which you might find useful, especially being an accountant…
https://canadiancouchpotato.com/2010/06/25/should-you-use-index-funds-or-etfs/
Hi Dan,
I noticed the revisions done to the Uber Tuber bond allocations from XSB to ZFM and from XIG to ZCS. Was it mainly because of MER that the changes were done or is there a change in focus also? It looks like the change removes the US influence (diversification?) in the XIG to ZCS reallocation. I am looking at adding to my portfolio and may look at revising the allocations. Thank you very much Dan.
ACMZ: The changes were to try to simplify the portfolio and reduce its overall MER. If you want to add some US corporate bonds as well, that is a reasonable addition.
Hello,
Can you please clarify where would you put Gold investments, specifically XGD? It appears to me it should be treated as “canadian equities” type investment, but I would like confirmation for that.
@VidasM: The stocks in XGD are treated the same way as any other stocks: don’t think of them as “gold investments.” They’re equity investments. The fund does not seem to have paid any dividends, which is not surprising, given mining stocks rarely do. The distributions all seem to be return of capital:
http://ca.ishares.com/product_info/fund/distributions/XGD.htm
Virtually all of the returns from a fund like this will come from capital gains. (These are taxed the same regardless of whether the stocks are Canadian or foreign.) That would make the fund quite tax-efficient, since you can control when you want to takes these gains.
Thank you very much for confirming that for the tax purpose gold (XGD ) is treated just like other canadian stock. I was not sure because in my allocation chart Gold is treated like separate investment type. Thanks again!
Hello CCP –
Would a US equity mutual fund provided through a Canadian Bank (e.g. TD US equity index) yield “foreign dividends” or are they considered “dividends from Canadian stocks”?
@Cyn: US stocks held in a Canadian mutual fund are still US stocks and the dividends are considered foreign.
@CCP: I’m still trying to wrap my head around what the Preferred Stock Index Funds characteristics are, and how, if at all, they fit into portfolios. You have said they behave a little like Bond ETF’s except they pay dividends, so they should be in non RRSP accounts. From the context, I take it that their risk (and therefore potential reward, I guess) is somewhere between Bond Index ETF’s and Canadian Equity Index ETF’s.
For instance, for someone with a largish portfolio and a 12-ish year horizon and anticipated gradual withdrawal (hopefully as dividends outside RRSP) with no anticipated new contributions to the portfolio, would the following Index ETF allocation be out of the ordinary (I am referring to the Preferred Shares component with respect to the rest of the allocation)?
20% Plain Vanilla Canadian Equity outside RRSP
20% US Equity split 2/3 Plain Vanilla inside RRSP and 1/3 Small Cap in non RRSP
20% International as VXUS outside RRSP (no room left)
10% CANADIAN PREFERRED STOCK outside RRSP
10% Canadian Real Return Bond (duration/term = 16y/20y) outside RRSP
20% Canadian Bond (duration/term = 7y/10y inside RRSP
(0% Cash in Interest-bearing or GIC’s)
Does this capture the way Preferred Stock ETF’s are generally positioned within a portfolio?
Would you characterize this as a Bond-like 30% or Bond-like 40% portfolio? Or is the Preferred Stock Index behaviour so unlike Bond Index behaviour that it is best not to lump Preferred with Bond?
@Oldie:
In my opinion (for what it’s worth!), preferred shares generally behave somewhere between bonds and equities. As a rough rule of thumb, I’d say consider them 2/3 bonds, 1/3 equities. Or if you want to be conservative, 50/50. Much more detail and analysis here if you’re interested: http://www.financialwebring.org/forum/viewtopic.php?f=29&t=115428
@Nathan: Thanks a lot for your comment — I guessed that’s how they behaved from previous comments, but I find your 2/3 – 1/3 (or conservatively 50-50) rule of thumb very helpful. Your link to Financial Webring was interesting, but the math went over my head for the time being. I did get the discussions conclusion, though, which is essentially what you said, above.
What I hoped to glean from the Financial Webring discussion, was some indication that not only was the risk different from straight bond index or straight equities index, but also that the correlation was negative to either or even both, which would be a huge factor in my adopting Preferreds in my portfolio, but I didn’t detect any indication one way or another in the mathematical treatment, such as I was able to understand it, or the discussion. Do you have any insight as to the risk correlation?
Incidentally, I can read your post in my e-mail and by clicking the link I got in my e-mail, but when I go directly to the canadiancouchpotato website “Put Your Assets in Their Place” page, and click to see all the comments, I still can’t find your comment.
@Oldie:
I don’t believe you’ll find negative correlation in the movements of a preferreds index like CPD and a Canadian equity/bond mix. You will probably see a lot of uncorrelated (random) movement of the preferreds; based on the regressions I did for that forum post, it appears that (very roughly speaking), half of movement of the preferred index could be approximated by a 33/66 stock/bond mix, while the other half is random and unrelated. (Due to the unique and concentrated nature of the preferred market.) That’s a simplification, but is probably good enough for us couch potatoes. :)
So I wouldn’t expect to get any free diversification in terms of negative correlation. The added random volatility of preferreds could be good or bad depending on the volatility of the rest of your portfolio, your rebalancing scheme, luck, etc., but personally I wouldn’t worry about it too much; I would just consider the alternatives to be putting a portion of the portfolio in preferreds vs splitting the same portion between stocks and bonds and try to estimate whether the after-tax returns of the preferreds are expected to be greater than the after-tax returns of the stock/bond mix.
Hope that helps!