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.
At the end of our discussion, I mention Mr. Ellis’s book The Elements of Investing, co-written with Burton Malkiel (author of his own landmark book from the 1970s, A Random Walk Down Wall Street). I reviewed this approachable volume when it was released back in 2010. Although it’s written for a US audience it contains the essence of both authors’ wisdom in a short read.
ETFs in taxable accounts
In the “Ask the Spud” segment of the podcast, I answer a question from Jakob, a listener who has been investing with ETFs in his RRSP and TFSA and is just getting started with a taxable account. He wanted some help with the additional record-keeping.
In his question, Jakob references As Easy as ACB, a white paper co-authored by Justin Bender and me back in 2013. The paper explains how taxable investors can keep track of their ETFs’ adjusted cost base (or book value) so they can accurately report capital gains and losses when they eventually sell their funds. This involves a lot more than simply recording all of the buys and sells:
- When an ETF distributed return of capital, you need to adjust the cost base downwards, which will increase your eventual capital gain (or decrease the loss) when you sell the holding.
- When an ETF distributes a reinvested capital gain, you need to adjust the cost base upwards or you may end up paying tax twice on the same gain.
Here’s a case study of how we did this calculation for a client and saved her an estimated $500 in taxes.
My first tip for Jakob was to consider using AdjustedCostBase.ca, an excellent free service that does the calculations for you—though you still need to keep careful records and make your inputs carefully.
One of the most difficult parts of the process is determining exactly how much return of capital and reinvested capital gains your ETF is spitting out. It’s not obvious from the ETF providers’ websites. To get accurate information you need to use the CDS Innovations tax breakdown service. (The process is explained in our white paper.)
The good news is that since our paper appeared, AdjustCostBase.ca has started offering a premium service that includes access to a database of these tax breakdowns for all Canadian ETFs. All you need to do is enter the ticker symbol and the year, and the return of capital and reinvested distributions are imported automatically. The premium service also allows you to import your brokerage’s transaction history from a spreadsheet so you don’t have to key in all of the entries. If you have a large taxable account with ETFs, the service is a bargain at just $49 per year.
In the podcast, I also make five suggestions for making your life easier with taxable accounts. I’ve summarized that advice in a separate blog post.
If I remember correctly, “The Loser’s Game” was on the CFA curriculum in 1989.
Nick de Peyster, CFA
http://undervaluedstocks.info/
Thanks for the info on AdjustCostBase.ca – my wife and I will soon need to utilize an unregistered account for about 1/3 of our portfolio before hitting the retirement button, so this will be very handy.
http://business.financialpost.com/investing/trading-desk/reagan-years-may-be-a-trade-template-for-markets-under-trump?__lsa=b63d-5d28
and with what is coming for us, I think that it makes sense to tweak the traditional 40-20-20-20 portfolio to something with less canadian equities (15-17% ?) in favor of US equities,
@CCP
Very nice Dan. I was not expecting to hear from one of the indexing Godfathers like Mr. Ellis on your blog. To me the most interesting one yet.
Also, very much looking forward to the next one since I am a big fan of Mr. Hallam’s first book and recommend it to everyone as a great introductory 101 type volume.
An idea for a future guest: Ben Carlson. I know you are familiar with his work and he does podcasts with other bloggers.
With regards to the ACB in taxable accounts, do the big banks not do a good job of tracking this for us already? I have looked at mine with BMO investorline and it seems that their math is correct so I do not bother to continually check it all every year. Are you able to comment on any particular brokerages that have been problematic, and others that you have seen to be accurate?
@Shaun: Glad you liked the podcast!
The bank-owned brokerages seem to be doing a better job than they once did, at least with return of capital. RBC, for example, has been pretty reliable. Last time I checked a Questrade account it wasn’t done properly. But these are just anecdotes: I can’t offer any definitive analysis. With USD accounts, every brokerage gets it wrong.
@Alex
You might argue for a lower Canadian % in the CCP portfolio in general, and you’re free to adjust it, but base such a change on your underlying (hopefully permanent) portfolio philosophy, not market conditions.
The analysts have already driven prices exactly to where they think the Trump administration will lead the market. Not to mention, with NAFTA and everything else up in the air, that outlook is changing quickly. Perhaps the writer of that article, and anyone choosing to follow its advice, are in the minority who have special insight that was better than everyone else’s. Anything is possible, of course.
Ever since discovering the couch potato (and indeed even becoming a couch potato) I have a sense of calm whenever I see links to stories about market outlooks. I often don’t even bother clicking them. Nothing in them will ever tell me anything actionable, since I’m already too late. There’s simply nothing that anyone could write that’d get me to log on and change my AA according to a forecast.
Hi,
I tried using your link “CDS Innovations tax breakdown service” and following your instructions on the white paper. When I tried to download the spead sheet neither excel nor quatropro loads it. When I click on the direct link “ISHARES S&P/TSX CAPPED REIT INDEX FUND” this just takes me to the generic iShare website.
Am I doing something wrong?
John
Thanks Dan – another great podcast and blog post.
I found the discussion on calculating ACB very helpful, especially your 5 tips. Unfortunately, I have failed to follow tips 3 and 4. I have 6 ETFs in my non-registered account, but they generally track only 3 categories: Canadian stocks (XIC/ZCN), US/International stocks (VTI, VXUS and VXC), and bonds (through HBB). VTI and VXUS are in USD.
I would dearly love to harmonize these into 3 ETFs and eliminate the 2 in USD, but of course I do not want to trigger any capital gains. I understand, however, that if you sell like for like, a capital gain is not triggered. For example, as XIC and ZCN track the same thing, I could sell ZCN and immediately use the proceeds to buy XIC and not trigger a capital gain. Is that correct?
I expect the situation is a bit different for my US/international holdings, where I want to sell a fund tracking US stocks (VTI) and a fund tracking international stocks (VXUS) and replace it with a single ETF that tracks all of that (VXC, which unlike the other 2 is in CAD).
Any thoughts you have are greatly appreciated.
@Mike: Very important misunderstanding here: if you sell an ETF and buy back an identical property (for example, XIC and ZCN) then you cannot claim a capital loss. This is the “superficial loss” rule. But you absolutely will be on the hook for any capital gain.
Hi Dan, I am using HXT, HXS, and HBB (waiting on an equivalent international) in my non-registered and corporate account to keep the ACB calculation very easy. There should be no distributions of any kind so only buying and selling will change the ACB. Is there a problem with this? Am I missing something?
(My RRSP/TFSA are maxed out with your model portfolio ETFs but with more international to keep my entire portfolio 25/25/25/25%)
@Pat: I think HXX can be a decent international proxy, despite not being very diversified.
With limited registered room, I’ve gone for HXT (non-registered)+XMD (registered) for Canadian large cap and then small/mid-cap, a similar approach for US equities, and would suggest HXX with a similar ETF for international small/mid-cap.
@Brendan: Well put, fellow Spud. Amen to every point you make.That cocoon of calm you describe in your last paragraph is the huge bonus that comes after the intellectual rigour involved in making the pivotal leap into Couch Potatohood.
About the “use mutual funds and not ETFs in taxable accounts”: I’d love to see some section of the podcast (or a blog entry) discussing what are the cheap mutual fund options available out there. Would you recommend using a cheap online broker (I am thinking Questrade) to purchase mutual funds, if the amounts are in the order of 10K to counter the fees?
Hi Dan. Glad I came across your podcast! Great to hear Charles Ellis on ‘passive’ investing and particularly liked his thoughts on the challenges faced by professional investors.
I’m a DIY investor, now retired, managing my portfolio for better or worse. In my previous life I launched and ran BNN and I continue to be hooked on the markets.
Best
Jack
Hello Dan,
What do you think about Wealth Simple instead of Tangerine? They say .5 management with ETFs at .2
I am currently stuck with a local company for my TFSA. I never really understood what MER was. I am paying them more than I make in interest since it is 3.16% after the TER and their .5%. Your website and podcasts have taught me a lot.
Thanks,
Arthur
As usual, great podcast and this is probably the best one so far!
Loved the interview with Mr Ellis! Mr Jack Bogle next? =)
Thanks for the piece on the ETFs in taxable accounts, exactly what I needed.
Question: can you confirm that XAW is a good choice in a Non Reg account?
Thank you,
@ Alex
How quickly we flip flop. Recall that on election night every new media outlet was reporting that the stock markets around the world were crashing on the surprise news of the Trump victory. There were many articles like this at the time that were all doom and gloom if he won:
http://fortune.com/2016/11/08/donald-trump-stocks-crash/
But that didn’t happen so far so now pundits get on board the other train and say he is great for the economy.
An important fact to be aware of is that experts don’t know s#%t and there are piles of very large studies that prove this fact.
Here are a few blogs on how experts’ record is laughable:
http://www.investresolve.com/blog/bold-confident-wrong-why-you-should-ignore-expert-forecasts/
https://canadiancouchpotato.com/2015/01/01/the-folly-of-forecasts/
http://theirrelevantinvestor.com/2015/12/02/can-stock-market-forecasters-forecast/
The future, certainly the short term (few years or less) is unknowable to everyone including “experts” so don’t listen to them, all they do is distract you from focusing on what you can actually control.
Another thing to be aware of is how the current valuations has been shown by many to be a decent long term (10+ years) predictor of returns. By all traditional measure, the US looks very expensive relative to the world and Canada and those who believe in valuations are predicting the US to be one of the worst performing countries in the next 10 years or so.
Personally I believe in sticking to your asset allocation through it all regardless of the valuations, and definitely regardless of the experts predictions. I do however like to be aware of the valuations as it often shows that the recent best performers have the lowest future expected returns, and the recent poor performers have the highest future returns. This knowledge makes rebalancing and buying into loosers easier for me to swallow.
A couple sites that attempt to predict future long term returns based on current valuations:
http://www.starcapital.de/research/CAPE_Stock_Market_Expectations
https://www.researchaffiliates.com/en_us/asset-allocation/equities.html
@ Oldie
I always like to see the replies from long term readers like yourself. Your have a buttery way with words that often makes me smile.
@JMM: The list of index mutual funds I recommend is very short: the TD e-Series. These are only available through TD Direct Investing, unfortunately.
@Pat: I specifically avoided getting into a discussion of swap-based ETFS here. I’ve written extensively about them on the blog, and I think they’re fine if you’re comfortable with the risks. But I would say a desire to avoid making ACB adjustments is the wrong reason to use them.
Dan,
I was wondering if you could expand on your thoughts about why one should pay off a mortgage before investing in a non-registered account. The consensus seems to recommend investing and taking advantage of low mortgage rates.
Thanks.
@James: Oops, I probably shouldn’t have opened that can of worms. :) Might be a good topic to address in the future. The short answer is that once you account for fees and taxes, you would need to take significant risk to earn an investment return comparable to the interest rate on your mortgage. It’s certainly possible, and some people have done it successfully. I just don’t recommend it. It comes down to this: I have never met anyone who said they regretted paying off the their mortgage. I have met many who regretted taking too much risk with their investments.
Thanks Dan! There’s a lot of good information in there, definitely helpful to me and hopefully also to some other followers of your blog/podcast :)
@James: My rationale was mainly that paying off the mortgage before going into taxable investing is that it simplifies things. Less risk, less stuff that I have to manage at the same time, for presumably not too much of a difference on after-tax return on investment. Instead of juggling many different concerns at once, I get peace of mind and more focus on the one main task at hand – first, getting rid of debt (with some extra RRSP/TFSA savings), then, saving for retirement.
I also like that once regular mortgage payments disappear, it feels much more feasible to take a sabbatical or pursue a career change and have less expenses to worry about. Sure those could be paid from the investments that you make instead, but the threshold feels much higher if the money I take out depletes my savings for retirement. The way I do it now, I know that whatever goes into retirement savings will stay in there, and I can still reward myself with a perception of progress and freedom along the way.
I’m sure it’s possible to get a higher return if you don’t mind keeping track of lots of stuff. In my case, I feel what I’m getting is good enough and the opportunities don’t justify the extra risk & effort. Getting rid of worries one after another is a great source of satisfaction, and likely more rewarding for me than keeping them all around until much later for a few extra dollars. Obviously, where to draw this line depends on everybody’s willpower and priorities.
Good interview. Nice to hear his take on the current investment environment and the continued value of index investing.
@Shaun: I just saw your comment. Thanks. “…long term readers like yourself..?” Gee, I never thought of myself as a long term reader, but I guess, first stumbling upon this site in 2012 as I nervously prepared for retirement would make me one.
It was a life-changing experience for this life-long “get phoned by the stock-broker every few months for yet another gut-wrenching heart-stopping experience” type of “investor”. But it shows you how even an absolute know-nothing investor can learn every thing he needs from this one powerful site and its resources and also from judicious listening to its wiser and less wise commenters. Within 2 weeks of intensive reading of this blog (including back issues) the scales had fallen from my eyes and I was hooked on the underlying principle. It took me a few months further following to be confident enough to rearrange my rather large non-registered portfolio, followed by an overarching rearrangement of my total investing strategy, but I tend to be a cautious over-planner, anyway, and it turned out to be easier than I feared. With continued following of this site (and frequent back-searching) I get even more confident of the underlying facts and how to use them; but of course, every now and then I am still learning huge valuable pearls of wisdom here. Like I said, it’s a goldmine. And the real gold is not the expectation of the best possible probability of benefit for your risk level, but rather the absolute life serenity that comes with your confidence in the underlying process.
Hey Dan,
Really enjoying the podcasts. My only criticism is that much like today’s social media the podcast is an echo chamber for ideas I already agree strongly with. Due to the current political dramas playing out I’ve realized it is important to seek out and understand opinions that you don’t necessarily agree with. I don’t think the information is bad or misleading, but you’re only presenting the pro index side. It would be interesting to hear from guest who has differing investing opinions than yourself.
@Timmay: Thanks for the comment. I agree it’s important to seek out other opinions: I just don’t see it as my role to present them. The overwhelming majority of financial commentary is contrary to the ideas I present, so the differing opinions are widely available from the Globe, Financial Post and BNN. My goal with both the blog and the podcast is to present a clear and consistent message, and to support that effort with other voices who share a similar message.
Great podcast. I particularly appreciated the five recommendations regarding ACB in taxable accounts. As a result I have a question regarding the ACB in a taxable account. If the account is held jointly is any taxable capital gain split equally by the account holders. Would you recommend that spouses have their own taxable accounts or is it okay to have a joint account? What advantages or disadvantages are there to either joint or separate accounts?
Also regarding your point about keeping ETF holdings simple in a taxable account – would VCN and XAW be appropriate and sufficient? …with bonds held in registered accounts.
@Darby: Taxes should be reported by whichever spouse contributed the cash to the account. If you both contributed equal amounts, then you can each report half of the income and gains. But it is often a good idea to set up joint accounts for estate planning purposes:
http://financialplanners.td.com/public/projectfiles/2d7f55dc-b7c2-431e-9a24-8e2c1187809c.pdf
Sure, two ETFs in a taxable account sounds quite manageable.