On May 10, I hosted an AMA (“Ask Me Anything”) on Reddit, the online discussion forum, and over 90 hectic minutes I answered as many questions as I could from investors. This week, in two separate blog posts, I’ll present a lightly edited transcript of the discussion, along with some additional comments and links I didn’t have time to provide during the live AMA.
vbally101: I’m newly financially stable, 31, single female, own my home and car. Finally in a full-time job with a salary and benefits and have paid off my debts (with the exception of my car and mortgage). Current annual salary is $90K before taxes. I have about $13K in savings.
My new company has a defined contribution pension plan (7% individual contribution; 6% company matching). I have no other investments and am not sure where to begin. I’m trying to look to the future, but there is so much information I don’t know how to sort through it all.
CCP: Sounds like you’re off to a great start! Taking full advantage of your workplace plan is the place to start, especially if the plan offers low-cost index fund options (most do). You could consider making additional contributions to that plan: your RRSP room will be 18% of your previous year’s salary and it sounds like you’re doing 13% now.
If you still have surplus cash after maxing your RRSP and keeping some aside for emergencies, consider making additional mortgage prepayments: that’s a risk-free, tax-free way to increase your net worth that requires no investment knowledge.
princessdianasauce: I haven’t been investing long enough to have endured the 2008 financial crisis or any extended bear market. However, I have been very disciplined during the market volatility in the last 3 months, and for the entirety of my DIY experience. Do you think that is sufficient evidence to increase my risk tolerance? I am 28 years old, currently using 75% equity, 25% fixed income, but I am considering 85% to 90% equities.
CCP: The market volatility we’ve experienced in the last several months is not a gauge of an investor’s tolerance for loss. Not even close. The true test is when you have lost at least 30% to 40% of your portfolio. In 2008–09, it was closer to 50% in six months. Few people can endure that without panic. You might well be able to stomach a portfolio of 90% equities, but I would make that decision after the next ugly bear market rather than before.
derekcanmexit: What is your opinion of Horizons total return ETFs, which use swaps to deliver index returns in a low cost and tax-efficient manner. Are you recommending these ETFs to clients? They seem too good to be true, and I am afraid I am missing something in the details.
CCP: We’re not currently using these swap-based ETFs with our clients, but I don’t have any objection to them as long as investors understand the additional risks, which I’ve written about a fair bit. Certainly they have done an outstanding job of delivering on their promise of matching their index returns minus fees.
One concern we have is that the government may eventually stop allowing this structure (as they have done with other tax-advantaged products), which could cause investors to sell the funds and realize all of the accrued gains in a single year.
p0u1337: For someone with a defined benefit pension plan that uses up most of my RRSP room, as well as a maxed TFSA, what are some options for the CCP model in unregistered accounts? Currently with HXT and HXS for the simplicity until I figure it out!
CCP: Investing tax-efficiently across multiple accounts can tie people in knots, so I’d urge you not to look for an “optimal” solution, because there probably isn’t one.
In general, I agree with your decision to hold Canadian and US equities in the non-registered account: Canadian dividends can be very tax-efficient, and yields on US equities are generally low these days, so there’s little taxable income. Whether you use HXT/HXS or plain-vanilla ETFs is a different topic, but either is likely to be fine.
If you hold cash or GICs, a non-registered account can also be appropriate, as the interest income is relatively low and therefore little tax would be payable. I would not, for example, hold low-growth, low-income assets like this in a TFSA while holding higher-growth, higher-income assets in a taxable account.
[Note: While my model portfolios are generally more appropriate for tax-sheltered accounts, my colleague Justin Bender offers a model ETF portfolio for non-registered accounts that includes the BMO Discount Bond ETF for fixed income.]
falco_iii: If I can max my TFSA and RRSP and have some left over for a taxable account, where should I put the ETF assets? Can you include that in the next model portfolio? There is an older blog entry but it does not have the current ETFs or TD e-Series funds.
CCP: As mentioned in the reply to p0u1337, above, asset location across multiple accounts is probably the most difficult part of DIY investing. There are very few hard and fast rules, so a full understanding of the situation is essential.
How big are the accounts relative to one another? Where is most of the new money being added? Do you need liquidity? What tax bracket are you in? Are you using index mutual funds or ETFs? Are you willing to use US-listed ETFs or only Canadian?
If you’re simply asking which assets should be the first to go in the non-registered account, it’s hard to go too far wrong with Canadian equities.
Titanmowgli: In terms of rebalancing one’s portfolio consisting of an RRSP, TFSA, and taxable account, do you recommend factoring in that the government owns a certain portion of your RRSP upon withdrawal? Will doing it one way or another affect the level of risk that one is taking on?
CCP: Another common question that doesn’t have an easy answer. The short reply is, no, we don’t manage portfolios that way because it is hopelessly impractical. There are also behavioural issues to consider. If you lost half of the value of your RRSP, would it make you feel better to know that 30% would have gone to taxes in retirement anyway? I doubt it. So I don’t disagree with this idea in theory, only in practice.
[Note: To clarify the background here, some people argue that, for example, if you hold $75,000 in equities in a TFSA and $75,000 in bonds in an RRSP you don’t really have a 50/50 asset mix. Because some percentage of those RRSP dollars will be taxed upon withdrawal, you own less in bonds than you think. Therefore, you should consider after-tax dollars when setting your asset allocation.
The most vocal advocate of this strategy is the author of the Retail Investor website. If you feel you can apply these insights to managing your own portfolio, I welcome you to do so, but I suspect it will defeat most DIY investors. For professionals managing portfolios for multiple clients it is close to impossible, and I am not aware of any firm that does so.
I also encourage you to read a this new article at Holy Potato, authored by John Robertson, who recently appeared on my podcast. John is a very smart guy who understands the math of after-tax asset allocation as well as anyone. But at the end of his blog he concludes that “all these optimization games can bring is a few basis points of extra return,” and the added complexity is not worth it. “My default suggestion is that it’s best to just replicate the same allocation in all your accounts.”]
throw0510a: Someone recommended that instead of putting bonds into non-taxable account, that they should be put into a taxable instead. The reasoning is that since returns are so low with bonds lately that it’s not worth try to save on them with regards to tax-efficiency. The claim is that it is better to put equities in the non-taxable accounts so that one can keep as much of the returns as possible for oneself. How crazy is this idea?
CCP: This idea is not crazy at all. Fixed income can be perfectly appropriate in a taxable account. However, some bond ETFs are particularly tax-inefficient, so if you hold fixed income in a taxable account it’s important to use the right products (i.e. GICs or tax-efficient ETFs).
derekcanmexit: I’d like to know your thoughts on factor-based ETFs? Would you recommend them as a complement to any CCP strategy?
CCP: This is another theory vs. practice issue. I think many of the premiums (value, size, momentum) are real. I just think that in practice they are very hard to capture with an index fund, and the additional costs can easily overwhelm any premium that does exist.
I also worry that once you go down the road of looking for the best way to capture factor premiums you create new behavioural problems. You may find yourself perpetually looking for something better instead of settling into a long-term strategy.
[Note: I wrote a long series of blog posts about factor-based, or “smart beta,” ETFs in 2016. I concluded by arguing that most investors are better off sticking to plain-vanilla index funds.]
I would like to ask how you view low cost active management. A primary argument against active management is the high fees will erode your returns. What if you followed a low cost active management strategy? Below is an example.
The person has a smaller portfolio and makes regular contributions. This is most young people. MAW104 seems ideal for this. You will not pay any fees to buy/sell and it will cost you 1% annually. A strict couch potato would say you could drop the active management and use Tangerine Balnced (INI220) instead and achieve the same effect. You could also use the ETF’s that are free to trade at discount brokers and lower your costs further. This would require you to re-balance. I don’t believe there is a balanced ETF that allows for free trades.
I know this will be controversial, but I feel as though MAW104 has a good chance of outperforming INI220 into the future.
Do you think there are other instances where an investor could be successful with active strategies?
CCP, wrt to vbally101’s question, what do you think of putting surplus cash in a TFSA before making extra mortgage payments?
An interesting behavioural advantage, to having bonds in your RRSP and equities elsewhere, is that because the government owns a portion of those bonds, you actually have a riskier portfolio than you thought (therefore giving you a higher expected return), so are, in effect, using the government owned bonds to trick yourself into a having a higher equity allocation without the higher volatility. I think that’s kind of neat!
@rgz: I don’t think your comment is particularly controversial. As you say, the primary (though certainly not the only) advantage of passive investing is lower cost. A prudently managed active fund that charges a similar fee to an index fund doesn’t have a very high hurdle to overcome. Indeed, if you had the option of a free and well-managed active fund (in an employer sponsored plan, for example) or an index fund that charged 1%, it would be hard to make a good argument for the index fund. The superiority of indexing is not about ideology.
It’s worth noting, however, that this argument has been made many times before on this blog and elsewhere, and virtually everyone making it references the Mawer fund specifically. It’s a fund with an excellent track record, but it’s more of an outlier than a typical example of how low-cost active funds are likely to beat their benchmarks.
@Grant: Circumstances vary, but I usually suggest prioritizing debt repayment over TFSA contributions. Paying down a mortgage offers a risk-free return, and for people with little investment experience it’s usually the best choice. You can always use that TFSA room later in life when your debt is paid off.
My comment would be controversial around here because:
1. I’m suggesting active management can beat out passive management
2. I’m suggesting that I can select in advance a particular active strategy that will be outperform indexing
A strict indexer would suggest INI220 is a better choice than MAW104 given the similar cost and asset allocation. They are effectively passive and active equivalents and I’m advocating for the active option.
“This is another theory vs. practice issue.”
In theory there is no difference between theory and practice. In practice there is.
Thanks for doing this Dan, always appreciate the content you provide us. The questions about taxable investing are helpful as I am in that exact spot right now. I think i am going to go with SP500 and Canadian bonds @ MER of .18 and MSCI EAFE @ Mer .32 in my DC pension as they are the lowest cost. Ill round out the bond and TSX allocation to the right target in my RRSP and then go 100% equites in my TFSA. Then invest in TSX and US market in my taxable in 5-10k increments as i accumulate cash in a high interest savings account.
Also @Kevin: great comment
With regards to non-taxable accounts, if one is fortunate to max out RRSP and TFSA room, would it perhaps be practical to use (e-Series?) mutual funds in the taxable funds and ETFs in the shelter accounts?
While not completely “MER efficient”, it would simplify taxes with adjusted cost base (ACB), since most mutual funds handle ACB for you in most cases (especially if one avoids DRIP).
@throw0522a: Nothing wrong with using a combination of e-Series funds and ETFs if that makes your bookkeeping easier.
Hi CCP
Thank you for putting this together, very informative. In your reply to p0u1337 you mentioned that “I would not, for example, hold low-growth, low-income assets like this in a TFSA while holding higher-growth, higher-income assets in a taxable account.” Do you consider a broad-based bond ETF such XBB a low-growth low income asset?, (Currently I have all my bonds in the TFSA and all my equities ETFs in a taxable account -I don’t use RRSP). If so, do you think I should move my bonds to a taxable account and then move international equities into the TFSA? Will I trigger capital gains if I do something like that? Thank you very much for your help,
@Carl: In most situations it makes sense to keep low-yield fixed income in a taxable account and equities in the TFSA. High-growth assets allow you to take greater advantage of the permanent tax shelter the TFSA offers. However, traditional bonds such as XBB are not a great choice in taxable accounts: there are more tax-efficient choices for fixed income, such as GICs and/or specialty bond ETFs:
https://canadiancouchpotato.com/2015/03/27/ask-the-spud-gics-vs-bond-funds/
https://canadiancouchpotato.com/2014/11/19/ask-the-spud-bond-etfs-in-taxable-accounts/
If you sell equities in your taxable account to make the switch, you could indeed trigger taxable gains.
[quote]Note: To clarify the background here, some people argue that, for example, if you hold $75,000 in equities in a TFSA and $75,000 in bonds in an RRSP you don’t really have a 50/50 asset mix. Because some percentage of those RRSP dollars will be taxed upon withdrawal, you own less in bonds than you think. Therefore, you should consider after-tax dollars when setting your asset allocation. [/quote]
This reminds me of your dissection of the yield-on-cost fallacy.
Suppose I had the allocation above, and wanted to be 50/50. What should I do? For the cost of four trades I could rebalance both accounts to be 50/50, and voila, suddenly even though I have the same amount of money allocated to both asset classes,, I’m now 50/50 when I wasn’t before. Of course, the accounts will now grow differently over time, but presumably the difference in growth expectations is why you had your asset classes separated to begin with.
I’m confused by the vgro asset allocation. When I looked on the vgro site, it said 29.7% allocation to us total markets (vun) and 24.3% to VCN. When I scrolled down the page, it said “top market alocation exposure, % of equities,” Canada 57.1% and USA 31.8%. Can you explain this to me? I was under the impression that vgro was more heavily weighted in the US and International markets. Perhaps I misunderstood? Thanks in advance for clarifying this for me.
@Jill: This is just a confusing aspect of how Vanguard is reporting its exposure. All of underlying holdings that are Canadian-domiciled ETFs are being reported as “Canadian” exposure, even if they hold international stocks. Just ignore that section on the fund’s web page and look instead at the “Allocation to underlying Vanguard funds” to understand what the ETF actually holds.
Hi CPP
My company has an employee stock plan and after many years it’s grown to about $45000 or 1000 shares in my TFSA account every year after the vestment period was up I would move $5000 into the TFSA. The stock pays a dividend of 0.48¢ -0.49¢ quarterly. I was looking at the ETF Aggressive portfolio and its 1 year return of 12.29%. Doing some quick math I am getting about $2000 a year in dividend auto reinvested by the ESP into more shares and its %100 stock and very little capital gain. With the Aggressive ETF portfolio it would about to be around $5500 Gain. My question is does it make sense to transfer the ESP account to a discount broker and invest it in a Couch potato Aggressive portfolio that does hold some stock and bonds? Thoughts
Hello Dan,
I was just wondering if you’re going to write an article about the new Vanguard mutual funds, and you think it will be beneficial to hold any of those funds in a ccp portfolio ? I was interested in the VIC 200 but It’s not offered through TD direct investing .
Thanks .
Hi Dan,
I just began investing in ETFs and created a small portfolio. I was wondering if there is any value in research companies like 5i Research? As their annual subscription fee is under $200.
Thanks.
@Seth: If you’re interested index investing, as opposed to picking stocks, then you don’t need to pay for research. If you’re interested in stock picking, I’m the wrong person to ask!
Hi, I am 27 years old. I have busted my tail and kept my expenses very low for several years. I have managed to put together a portfolio of approx 250,000. I have been invested for a couple years now. I am invested exactly how you suggest on your other website. I have a cash account, RRSP and a TFSA. A lot of my funds are up, especially my US etfs. Now my question does scratch the surface of timing the market. Do you ever move to cash? Or sell off some of your investments? If you think there might be an election, interest rate rise or something that is obvious to affect an extremely long bull market? Because even if your estimate was within a year or even two and the market dropped 50 % and you had a surplus of cash to invest then you could potentially do whichever the rebound would be which could be 50%. Is that a pragmatic move for the current conditions? Anyway Something that’s on my mind.
@Brennan: Kudos to you for dong such an excellent job in saving an investing. I would urge you now to blow up your plan my trying to time the market. It’s futile, and while you can occasionally get lucky, you are more likely to fall into the trap of constantly trying to pick the “right time,” which of course can only be identified in hindsight. If the market does crash when you’re fully invested (and it will eventually), just rebalance and stick to your plan.
Thank you for taking the time. I appreciate the reassurance.
I am a convert and keep the bulk of my money in TD eIndex funds as you suggest.. THe only change is that I prefer the TD e NASDAQ fund to the International one, and that fund has done really well
Question–I keep some funds in an everyday account and more in a TD savings account–switching money between the two is hardly,worth the wear and tear on my fingers, with interest rates at 0.1%. Is their money Mkt account a better option??ly
@Dr Mike: It’s worth pointing out that substituting the NASDAQ e-Series fund for the international equity fund is a decision to double down on large-cap US stocks (companies in the NASDAQ 100 are almost all in the S&P 500 as well) and exclude all countries outside North America. Yes, this would have worked out well over the last several years. But this is just performance chasing rather than prudent diversification.
As for where to hold cash savings, I’d agree with you that it’s not worth the hassle of moving money around to take advantage of tiny differences in interest rates. Money market funds are effectively useless these days: they have been all but replaced by ISAs (investment savings accounts), but even these pay very low rates now. TDB8150, for example, pays 0.25%. Unless you’re holding very large amounts, the different options probably don’t amount to more than a few dollars.
while interest rates have increased greatly over the last few months, the monthly dividend paid by ZAG remains at four cents. i had thought that the dividend would increase as ZAG’s older bonds mature and are replaced with higher-yielding bonds. do you think the dividend will increase any time soon?
@lou cornelis: This is a great question that I think will trip up others as well. Remember that even though the dollar amount of the distribution from ZAG has not changed, the yield (expressed as a percentage) is much higher now. You are paying much less to get that four cents per share than you were a year or two ago.
Think of this in terms of buying a single bond rather than an ETF. If a 10-year bond is trading at par with a yield of 2%, you would pay $1,000 to receive $20 per year in interest. If prevailing rates then rise to 3%, the price of that bond will fall, but the $20 annual interest payment remains the same.
If you were to buy that same bond today, when equivalent new bonds are yielding 3%, you would pay much less than $1,000 in order to receive that $20 of income. (If we do the math, it works out to about $914). And when the bond matures, you will also benefit from a capital gain, because the bond will mature at its face value ($1,000) even though you paid only $914. The “yield to maturity” of the bond (which includes all the interest payments plus that capital gain) will be approximately 3%, even though the bond has not changed the amount of interest it pays.
To return to ZAG, yes, it is still paying the same dollar amount of interest (four cents per unit) as it has for several years. But today each unit costs about $13.40, compared with about $16.50 back in mid-2020. That’s almost 19% less.
This is a tricky concept, and it’s one many investors struggle to understand. The key point is that when you buy a bond ETF like ZAG today, following a period of rising rates, you should not necessarily expect more income per unit (at least not for some time), but you should expect more income per dollar invested. And over the long term you should also expect some capital gains, as most bonds are now trading at a discount to their face value.
many thanks for your reply. i guess patience is the key!