One Fund or Very Simple Portfolio for a New Early 20's Investor

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
ig17
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Re: One Fund or Very Simple Portfolio for a New Early 20's Investor

Post by ig17 »

Hyperborea wrote: 29 Oct 2017 19:27 Ok, I was thinking it would be the other way around. The GIC interest is fully taxable and so in a TFSA he won't pay tax on it. The dividends from the equity fund will get special treatment for the part that is for a Canadian company (so maybe 20-30% of his funds). The dividends on the other funds will have tax deducted in the country of origin and will give a tax credit/deduction against the dividends. He won't get either of those from within the TFSA. Finally, the capital gains from selling the equity funds will get special tax treatment (only 50% taxable) that he won't get from within the TFSA. That seems to suggest to me to go the other way - GICs in the TFSA.

It's been over 20 years since I filed a Canadian tax return and there were no TFSAs back then. Am I wrong? Thanks.
Your argument ignores the rates of return. The conventional wisdom used to be that you should always shelter your fixed income because dividends and capital gains get preferential tax treatment. That conventional wisdom went out the window when interest rates dropped to historical lows. The dollar amounts subject to tax should be part of your analysis.

I will use Ontario tax bracket between $74K and $84K in my example.
http://taxtips.ca/taxrates/on.htm

Marginal rates on the full amounts received, 2017 tax year:

Other Income: 31.48%
Capital Gains: 15.74%
Eligible Dividends: 8.92%

Invest $1,000 for one year.

GIC rate: 2.5%
Interest earned: $25
Tax: $25 * 31.48% = $7.87

Equities: 4% capital gain, 2% dividend yield
Tax on capital gains: $40 * 15.74% = $6.30
Tax on dividends: $20 * 8.92% = $1.78
Total tax: $8.08

In this example, you would be better off sheltering equities and exposing GICs. The difference becomes more pronounced if you assume a higher rate of return on equities or/and a higher tax bracket.
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adrian2
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Re: One Fund or Very Simple Portfolio for a New Early 20's Investor

Post by adrian2 »

ig17 wrote: 29 Oct 2017 22:28
Hyperborea wrote: 29 Oct 2017 19:27 Ok, I was thinking it would be the other way around. The GIC interest is fully taxable and so in a TFSA he won't pay tax on it. The dividends from the equity fund will get special treatment for the part that is for a Canadian company (so maybe 20-30% of his funds). The dividends on the other funds will have tax deducted in the country of origin and will give a tax credit/deduction against the dividends. He won't get either of those from within the TFSA. Finally, the capital gains from selling the equity funds will get special tax treatment (only 50% taxable) that he won't get from within the TFSA. That seems to suggest to me to go the other way - GICs in the TFSA.

It's been over 20 years since I filed a Canadian tax return and there were no TFSAs back then. Am I wrong? Thanks.
Your argument ignores the rates of return. The conventional wisdom used to be that you should always shelter your fixed income because dividends and capital gains get preferential tax treatment. That conventional wisdom went out the window when interest rates dropped to historical lows. The dollar amounts subject to tax should be part of your analysis.

I will use Ontario tax bracket between $74K and $84K in my example.
http://taxtips.ca/taxrates/on.htm

Marginal rates on the full amounts received, 2017 tax year:

Other Income: 31.48%
Capital Gains: 15.74%
Eligible Dividends: 8.92%

Invest $1,000 for one year.

GIC rate: 2.5%
Interest earned: $25
Tax: $25 * 31.48% = $7.87

Equities: 4% capital gain, 2% dividend yield
Tax on capital gains: $40 * 15.74% = $6.30
Tax on dividends: $20 * 8.92% = $1.78
Total tax: $8.08

In this example, you would be better off sheltering equities and exposing GICs. The difference becomes more pronounced if you assume a higher rate of return on equities or/and a higher tax bracket.
But the 4% capital gain on equities can be deferred for a long time (until they get sold).
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“It doesn't matter how beautiful your theory is, it doesn't matter how smart you are. If it doesn't agree with experiment, it's wrong.” [Richard P. Feynman, Nobel prize winner]
ig17
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Re: One Fund or Very Simple Portfolio for a New Early 20's Investor

Post by ig17 »

adrian2 wrote: 30 Oct 2017 13:40 But the 4% capital gain on equities can be deferred for a long time (until they get sold).
1. Sure. I wanted to keep the example simple, to prove that fixed income placement is not an automatic decision. Cap gain deferral complicates the comparison.
2. I'd rather shelter the entire cap gain than defer it, and hope that the gov't doesn't change the inclusion rate in the interim.
3. If I ever find that my allocation is sub-optimal, I can easily shift fixed income from the taxable account to the TFSA; there is no tax penalty for doing that. The opposite change (fixed income out, equities in) has a tax cost.

As always, there is no one right decision that fits everyone. YMMV.
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Re: One Fund or Very Simple Portfolio for a New Early 20's Investor

Post by Hyperborea »

Thanks for the details on the taxes. It looks to be a close call in your example. One thing I don't see is credit for foreign taxes paid on foreign dividends. Funds holding foreign stock are going to have to pay tax on the dividends in the country where the stock is. If my nephew holds the funds in a taxable account he should get credit for those taxes against his Canadian taxes. I'm going to guess that he won't get credit for them when the funds are in a TFSA. That should probably be enough to swing the answer over to holding at least the non-Canadian stock funds outside the TFSA.

Am I right in my guess that you won't get credit for foreign taxes paid by funds holding foreign stock in your TFSA? That's the way that it works in the US for funds held inside tax deferred retirement accounts.
ig17
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Re: One Fund or Very Simple Portfolio for a New Early 20's Investor

Post by ig17 »

Hyperborea wrote: 30 Oct 2017 19:38 If my nephew holds the funds in a taxable account he should get credit for those taxes against his Canadian taxes.
Yes, if he chooses his funds carefully. Look for funds that hold the stocks directly. Avoid wrap ETFs.
https://www.pwlcapital.com/pwl/media/pw ... _Taxes.pdf

Am I right in my guess that you won't get credit for foreign taxes paid by funds holding foreign stock in your TFSA? That's the way that it works in the US for funds held inside tax deferred retirement accounts.
Correct. Estimate the drag as (foreign stock yield * foreign witholding tax) and add it to the MER. Reduce your expected return accordingly.
ig17
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Re: One Fund or Very Simple Portfolio for a New Early 20's Investor

Post by ig17 »

Hyperborea wrote: 30 Oct 2017 19:38 It looks to be a close call in your example.
I picked a middle tax bracket. The gap is wider in the higher brackets.
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Re: One Fund or Very Simple Portfolio for a New Early 20's Investor

Post by beachcomber »

Well I enticed my kids into Altamira back in those days, for both their investment and RRSP accounts by matching their contributions. Then I matched their contributions if they left Altamira for PH&N. In recent years I have encouraged them from PH&N/RB into Vanguard funds - no longer matching ;-), as they are all doing fine and several have FAs and no longer listen to me. However, they have given me 10 grandchildren to fret about, two of which have their degrees and are poised for investment - I think :-) But being a geezer I have some difficulty in understanding these millennials - and I'm sure they regard me as a neanderthal. They are vegans and anti-pipeliners!

Get your young relative into Vanguard asap. It's not an irreversible move.
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