Asset allocation within RRSP and TFSA

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
Post Reply
gdogg
Contributor
Contributor
Posts: 17
Joined: 18 Feb 2017 14:50

Asset allocation within RRSP and TFSA

Post by gdogg »

Emergency funds: 3 months
Debt: Mortgage (8 years remaining)
Marital Status: Single
Provincial Residence: AB
Age: early 40s
Pensions: Defined Benefit

Portfolio Value: Low six figures. Future target percentages:
RRSP:
30% US Total Market index (some USD, some CAD)
12% Developing Market Index (some USD, some CAD)
6% Canadian Market index
4% Emerging Market index (some USD, some CAD)
15% Broad Market Bond index
5% Corporate Bond Index
5% Preferred Share Index
TFSA:
18% Canadian Market index
5% Dividend Aristocrats index

Hello board members,

I've been trying to balance out my portfolio, which was originally much messier, by coming up with a better asset allocation of index ETFs. I've been reducing risk by selling individual stocks which used to take up about 50% of the portfolio, and gradually buying more ETFs with the proceeds.

I'm using a ratio of 25/75 fixed income and equities. TFSA is all Canadian Equity. RRSP has all international equity, some Canadian equity spillover, and all fixed income. International equity is all in the RRSP to avoid foreign dividend tax withholdings. Fixed income assets are in the RRSP as they are interest bearing, with the exception of the Preferreds. About 15% of the RRSP is in USD, and I will keep those assets, but going forward I will stick with CAD investments.

But I struggle a bit with what to put where, especially the TFSA where once the stocks are sold will consist mostly of a single fund. I added a small percentage of another equity fund for flavour.

My RRSP contributions are higher than TFSA, but I am not maxing both out yet. When I max out both contributions, likely once the mortgage is paid off, I will add a taxable account and invest in more Preferreds.

Just wondering what you all think? Does the allocation and placement above make sense? Is there an over-reliance on assets in the RRSP?
2of3aintbad
Contributor
Contributor
Posts: 72
Joined: 04 Jan 2016 10:55

Re: Asset allocation within RRSP and TFSA

Post by 2of3aintbad »

What's best for the TFSA depends on your personal situation. One extreme is a married person with a stay at home spouse, children, a mortgage, and no other investments. Your case is somewhat the other extreme, single and with a defined benefit pension plan. Why contribute to an RRSP before the TFSA or mortgage, unless you are already in the highest tax bracket and likely to be lower at retirement? I would forget about corporate bonds, Canadian dividend paying stocks, and preferred shares until the time you need income. In your situation, use the TFSA for the highest potential growth investment, such as global small caps, and your existing RRSP for all the rest.
User avatar
Mordko
Veteran Contributor
Veteran Contributor
Posts: 6326
Joined: 24 Jan 2016 09:26

Re: Asset allocation within RRSP and TFSA

Post by Mordko »

When deciding how to allocate, you need to make sure you count all your assets. Given that you have a DB pension, why do you need any Fixed Income in your RRSP? Your actual allocation to the Fixed Income is far more than 50%.

TFSA is good for Canadian stocks. You lose withholding taxes if you put US/international stocks into TFSA
2of3aintbad
Contributor
Contributor
Posts: 72
Joined: 04 Jan 2016 10:55

Re: Asset allocation within RRSP and TFSA

Post by 2of3aintbad »

Mordko wrote:....
TFSA is good for Canadian stocks. You lose withholding taxes if you put US/international stocks into TFSA
I hear this reasoning often. How much withholding tax will there be in growth stocks that pay little or no dividend; ie what is the expected total return for Canadian stocks versus non-Canadian growth stocks?
User avatar
AltaRed
Veteran Contributor
Veteran Contributor
Posts: 33398
Joined: 05 Mar 2005 20:04
Location: Ogopogo Land

Re: Asset allocation within RRSP and TFSA

Post by AltaRed »

2of3aintbad wrote:I hear this reasoning often. How much withholding tax will there be in growth stocks that pay little or no dividend; ie what is the expected total return for Canadian stocks versus non-Canadian growth stocks?
You cannot know in advance which growth stocks will outperform, or which geographic location so that comment is a red herring. Where I do agree with you is that if you have low yield, or zero yield US domiciled stocks, they are as good in the TFSA as anywhere else. After all, the 'lost' withholding tax is 15% of the yield...which if tiny, or nothing, is essentially nothing.

For the OP: Depending on your personality and tolerance for risk, and the generosity of your DB plan, you may not want to have much in fixed income at this point of your investing life, or you may want to retain only a smaller portion of fixed income until you can see your DB pension coming 'in the whites of your eyes'. A quality DB pension, provided you last long enough to get solid value from it, will be your annuity, i.e. fixed income, component of your net worth/cash flow upon retirement. I am guessing based on your salary that you are quite limited in what you can put in your RRSP anyway so I wouldn't get overly stressed in having FI in it.

Case in point: I was in a similar situation with a good salary and a mediocre DB pension plan. I knew that if I could get to 55 years of age, I would have a pretty good annuity from my DB plan even if I got terminated at that time and had to take a dscounted pension. So what I did was to build up a fixed income component in my 'limited' RRSP during my 40's and early 50's as a potential safety net in case my world got turned upside down before age 55. Once I reached age 55 and became 'bulletproof', I really did not need that FI as a safety net any more. I retired almost 11 years ago by choice and my FI component (all in my RRSP) has been steadily decreasing as a percentage of my overall asset allocation as my equities in other accounts increase in value AND I age. Once I convert to a RRIF, I will be drawing down that FI through mandatory withdrawals such that at some point 10-15 years from now, I may have virtually no FI allocation left.

P.S. I don't see the point of 5% allocations in any portfolio. It is not enough to move the needle. I'd drop the preferred share index and roll that over into a good Canadian dividend ETF that yields in the 4% range....and personally I hate Emerging Markets and would drop that entirely (I also don't know what a Developing Market index is....sounds like EM to me).

P.S.S. Accelerate the buydown of your non-interest deductible mortgage. That is the best after-tax return for your money even if the interest rate is only about 3%.
Imagefiniki, the Canadian financial wiki The go-to place to bolster your financial freedom
User avatar
Quebec
Veteran Contributor
Veteran Contributor
Posts: 1645
Joined: 24 Oct 2009 16:49
Location: Quebec City

Re: Asset allocation within RRSP and TFSA

Post by Quebec »

AltaRed wrote: (I also don't know what a Developing Market index is....sounds like EM to me).
The OP probably means developed markets, i.e. EAFE, since he also lists Canadian, US and EM.

To the OP: you mention CAD and USD. I'm sure you realize that whether you buy an ETF in CAD (e.g., in Toronto) or in USD (e.g., in New York) is not relevant, i.e. it will not change your returns in CAD. What's important is whether the ETF is hedged to CAD or not.
OP wrote:TFSA... I added a small percentage of another equity fund for flavour.
For asset allocation purposes, you can treat your RRSP and TFSA together as one big portfolio. For where to place different ETFs, see tax-efficient investing.
OP wrote:...which was originally much messier
It still looks quite complex in my opinion (see also what AltaRed is saying above), especially for low six figures. Please Have a look at Simple index portfolios, in particular the parts on simplicity and How many funds.

Happy investing!
Imagefiniki, the Canadian financial wiki: a knowledge base of financial subjects written from a Canadian perspective
gdogg
Contributor
Contributor
Posts: 17
Joined: 18 Feb 2017 14:50

Re: Asset allocation within RRSP and TFSA

Post by gdogg »

2of3aintbad wrote:What's best for the TFSA depends on your personal situation. One extreme is a married person with a stay at home spouse, children, a mortgage, and no other investments. Your case is somewhat the other extreme, single and with a defined benefit pension plan. Why contribute to an RRSP before the TFSA or mortgage, unless you are already in the highest tax bracket and likely to be lower at retirement? I would forget about corporate bonds, Canadian dividend paying stocks, and preferred shares until the time you need income. In your situation, use the TFSA for the highest potential growth investment, such as global small caps, and your existing RRSP for all the rest.
Thanks for your reply! I am in the second highest tax bracket, and the DB Pension, if I take it at age 60-65, would make retirement income around 50% of current salary. I contribute more to the RRSP partially for reasons of habit. I was doing so before I had my current job with the DB pension, and before the TFSA device existed. Over time I have been contributing more to both, but the RRSP still gets the lion's share. I've considered reversing that and maxing out the TFSA first, though.

I did consider whether any fixed income was necessary at all at this point because of my age and the DB pension. I targeted 25% FI to reduce volatility in case of a 2008 situation (during which my all-stock portfolio got hammered), and spread some of it into corporate bonds and preferreds just because of greater yields at slightly higher risk.
gdogg
Contributor
Contributor
Posts: 17
Joined: 18 Feb 2017 14:50

Re: Asset allocation within RRSP and TFSA

Post by gdogg »

Quebec wrote:
AltaRed wrote: (I also don't know what a Developing Market index is....sounds like EM to me).
The OP probably means developed markets, i.e. EAFE, since he also lists Canadian, US and EM.

To the OP: you mention CAD and USD. I'm sure you realize that whether you buy an ETF in CAD (e.g., in Toronto) or in USD (e.g., in New York) is not relevant, i.e. it will not change your returns in CAD. What's important is whether the ETF is hedged to CAD or not.
OP wrote:TFSA... I added a small percentage of another equity fund for flavour.
For asset allocation purposes, you can treat your RRSP and TFSA together as one big portfolio. For where to place different ETFs, see tax-efficient investing.
OP wrote:...which was originally much messier
It still looks quite complex in my opinion (see also what AltaRed is saying above), especially for low six figures. Please Have a look at Simple index portfolios, in particular the parts on simplicity and How many funds.

Happy investing!
1. That is correct, I meant Developed markets.

2. I was originally buying US-listed ETFs for non-Canada holdings. But I got weary of the forex transaction fees and currency risk that way, especially as the CAD dollar dropped in value. So going forward I'm just purchasing TSX-listed ETFs for everything. Non-hedged as hedging tends to add cost and risk from what I've read.

3. My portfolio is admittedly still complex, particularly compared to a 3-4 fund portfolio, but nothing compared to what it was before. I'm a big believer in index investing, but I like to spice things up I guess. :)
gdogg
Contributor
Contributor
Posts: 17
Joined: 18 Feb 2017 14:50

Re: Asset allocation within RRSP and TFSA

Post by gdogg »

AltaRed wrote:
2of3aintbad wrote: P.S.S. Accelerate the buydown of your non-interest deductible mortgage. That is the best after-tax return for your money even if the interest rate is only about 3%.
I've considered this as well (not being a huge fan of debt), and have made enough extra principal payments to pay down the mortgage at least 5 years early. I never made that my number one priority though, as paying down the mortgage is really a 2.75% return, while a balanced portfolio is more like 6-10%.
User avatar
Quebec
Veteran Contributor
Veteran Contributor
Posts: 1645
Joined: 24 Oct 2009 16:49
Location: Quebec City

Re: Asset allocation within RRSP and TFSA

Post by Quebec »

gdogg wrote: I was originally buying US-listed ETFs for non-Canada holdings. But I got weary of the forex transaction fees and currency risk that way, especially as the CAD dollar dropped in value. So going forward I'm just purchasing TSX-listed ETFs for everything.
Forex fees: yes, this is a problem. One solution is Norbert's Gambit.

Currency risk: whether you buy an ETF of US stocks on the TSX or the equivalent US-listed ETF, you are exposed to both variations in the value of the underlying stock index and to CAD-USD fluctuations. Is does not make a difference which currency or which stock exchange you use when you buy the ETF. Think of buying Royal Bank shares on the TSX or on the NYSE: after one year, your return in CAD must be the same.

The same argument applies to EM or EAFE equities: even though you may be using USD for the purchase, when you express your returns in CAD, what really counts is the exchange rate between Canadian dollars and the Euro, the Yen, the Pound, the Yuan, etc. I admit that this can be difficult to accept, but try playing around with some numbers in a spreadsheet.
Imagefiniki, the Canadian financial wiki: a knowledge base of financial subjects written from a Canadian perspective
gdogg
Contributor
Contributor
Posts: 17
Joined: 18 Feb 2017 14:50

Re: Asset allocation within RRSP and TFSA

Post by gdogg »

Quebec wrote:
gdogg wrote: I was originally buying US-listed ETFs for non-Canada holdings. But I got weary of the forex transaction fees and currency risk that way, especially as the CAD dollar dropped in value. So going forward I'm just purchasing TSX-listed ETFs for everything.
Forex fees: yes, this is a problem. One solution is Norbert's Gambit.

Currency risk: whether you buy an ETF of US stocks on the TSX or the equivalent US-listed ETF, you are exposed to both variations in the value of the underlying stock index and to CAD-USD fluctuations. Is does not make a difference which currency or which stock exchange you use when you buy the ETF. Think of buying Royal Bank shares on the TSX or on the NYSE: after one year, your return in CAD must be the same.

The same argument applies to EM or EAFE equities: even though you may be using USD for the purchase, when you express your returns in CAD, what really counts is the exchange rate between Canadian dollars and the Euro, the Yen, the Pound, the Yuan, etc. I admit that this can be difficult to accept, but try playing around with some numbers in a spreadsheet.
True enough. I was also just removing an item of unnecessary complexity. Since I get paid in CAD dollars, why go to the trouble of converting them to USD, triggering either forex fees or having to do Norbert's Gambit? I just cut out the middle steps - bought ETFs on the TSX and be done with it.
User avatar
AltaRed
Veteran Contributor
Veteran Contributor
Posts: 33398
Joined: 05 Mar 2005 20:04
Location: Ogopogo Land

Re: Asset allocation within RRSP and TFSA

Post by AltaRed »

gdogg wrote:I was also just removing an item of unnecessary complexity. Since I get paid in CAD dollars, why go to the trouble of converting them to USD, triggering either forex fees or having to do Norbert's Gambit? I just cut out the middle steps - bought ETFs on the TSX and be done with it.
That works perfectly fine for the vast majority of investors. Just be careful NOT to buy the currency hedged ones if you wish to remain exposed to the USD.
Imagefiniki, the Canadian financial wiki The go-to place to bolster your financial freedom
dwarren
Contributor
Contributor
Posts: 84
Joined: 13 Mar 2015 17:06

Re: Asset allocation within RRSP and TFSA

Post by dwarren »

gdogg wrote:
True enough. I was also just removing an item of unnecessary complexity. Since I get paid in CAD dollars, why go to the trouble of converting them to USD, triggering either forex fees or having to do Norbert's Gambit? I just cut out the middle steps - bought ETFs on the TSX and be done with it.
Assuming the position in is held in the RRSP account, CDN listed US ETFs are subject to US withholding taxes. So if you're buying the S&P 500 ETF in the TSX it would be subject to a 15% withholding or about 30bps drag compared to buying direct on the US exchange. Depending on the amounts and how long you'll be holding the position, it might be worth it.
gdogg
Contributor
Contributor
Posts: 17
Joined: 18 Feb 2017 14:50

Re: Asset allocation within RRSP and TFSA

Post by gdogg »

dwarren wrote:
gdogg wrote:
True enough. I was also just removing an item of unnecessary complexity. Since I get paid in CAD dollars, why go to the trouble of converting them to USD, triggering either forex fees or having to do Norbert's Gambit? I just cut out the middle steps - bought ETFs on the TSX and be done with it.
Assuming the position in is held in the RRSP account, CDN listed US ETFs are subject to US withholding taxes. So if you're buying the S&P 500 ETF in the TSX it would be subject to a 15% withholding or about 30bps drag compared to buying direct on the US exchange. Depending on the amounts and how long you'll be holding the position, it might be worth it.
I weighed the pros and cons of that. The dividend withholding is unfortunate, but typically the yield on those funds is fairly low anyway (~2%), as most of the value is growth. Maybe worth it to avoid forex fees, additional currency risk, or intermediary steps like the Gambit. Hopefully I made the right decision.
User avatar
Mordko
Veteran Contributor
Veteran Contributor
Posts: 6326
Joined: 24 Jan 2016 09:26

Re: Asset allocation within RRSP and TFSA

Post by Mordko »

As noted above, there is no "additional currency risk" from holding ETFs with American shares in USD rather than CAD. None at all.
Post Reply