portfolio mix for TFSA

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steve_o
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portfolio mix for TFSA

Post by steve_o »

I have about $150,000 in RRSP and $40,000 in TFSA. I'm about 20 years from retirement.

If I need to take out $10,000 sometime in the next 2-3 years, it makes more sense to take it out of my TFSA. Therefore, the “investment horizon” on the TFSA account is shorter than the RRSP.

Based on the above, should I have a more balanced mix of bonds and equities in my TFSA (because I may need to dip into it in a few years), and in my RRSP I can be more aggressive and have much higher % of equities? Perhaps 60% equities 40% bonds in my TFSA as a less-aggressive mix?

Thanks!
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Re: portfolio mix for TFSA

Post by Canadian Saver »

You can't really treat the entire TFSA as having the same investment horizon as your short-term withdrawal.

I would look at your portfolio as being $180,000 long-term, and $10,000 short-term. Each of those will have completely different allocations. The former would be according to your investment policy statement and take into account your personal appetite for risk. The latter should likely be in cash or cash-equivalents (HISA or GIC).

If, for whatever reason, you can only change the allocation for your entire TFSA (e.g. if you have it at Tangerine and can only pick a single allocation for the entire account), then you should open a second TFSA and transfer $10,000 into it and keep it in risk-free investments.

Of course, another alternative is to direct future savings over the next 2 years to build up the $10,000 you will need and keep your existing $190,000 geared for retirement.
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Re: portfolio mix for TFSA

Post by Taggart »

I can't really tell you what you should do. All I know is I treat our taxable, RRSP's and TFSA's as three separate accounts. Both the RRSP's and the TFSA's are basically a 40% bonds 60% equities split. The RRSP's are still the same ratio, because my wife and I will be starting mandated minimum withdrawals from RRIF's starting around another six years from now. However, as per the TFSA's I'm starting to move from the original mentioned diversification to a 10% bonds, 90% equities split. We can afford to do that though. My wife and I both have pensions from our previous employment. No pension, and it may be a completely different scenario however.
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Re: portfolio mix for TFSA

Post by IdOp »

If it were me ...

I would take that $10,000 (or maybe a little more, to be on the safe side) that you need to take out of the TFSA in 2-3 years, and mentally put it in a separate "pot". There aren't many choices that you can invest it in, because there isn't time to ride out if things go sour temporarily. Equities or broad market bond funds could drop and not have time to recover. You may be stuck with a choice of cash, HISA and very short-term GICs with this money. I would only use 1- or 2-year GICs if you are certain it won't be needed for the full two years.

As for the rest of the money in the TFSA, you can invest that longer term and according to the big picture of your overall asset allocation and asset location plan.

In other words, I wouldn't let some abstract concept of TFSA mix drive what I do with this $10,000 if it's critical to have it in 2 years. I'd put that money aside so it will be ready.
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Re: portfolio mix for TFSA

Post by chufinora »

You ideally want your maximum growth to be in the TFSA. Thus I too would set aside the amount you potentially want to withdraw and keep it in a HISA account but within the RRSP. Treat both accounts as one combined portfolio. When you want to withdraw the amount set aside, let's say it is $10k, then sell $10k of equities in the TFSA and re-purchase them in the RRSP so you are withdrawing from the $10k from the TFSA.
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Re: portfolio mix for TFSA

Post by IdOp »

chufinora wrote:You ideally want your maximum growth to be in the TFSA.
Will this always be true? If the tax rate at withdrawal is (enough) less than at contribution, then wouldn't the RRSP be better?

But ok, let's suppose TFSA is better in this case anyway ...
Thus I too would set aside the amount you potentially want to withdraw and keep it in a HISA account but within the RRSP. Treat both accounts as one combined portfolio. When you want to withdraw the amount set aside, let's say it is $10k, then sell $10k of equities in the TFSA and re-purchase them in the RRSP so you are withdrawing from the $10k from the TFSA.
I'm not sure I understand the reasoning here. You keep the $10k in RRSP so that TFSA can hold more equities ("high growth"). But the high growth of equities only becomes highly probable (we hope!) in the longer term. In a short term like 2-3 years they may be down from the starting point of this excercise. And then if you sell them, you not only lock in a loss but can't claim the loss against capital gains. Perhaps I've missed something though.
EDIT: I now see the loss is not really locked in since you re-purchase in the RRSP. It seems like taking a 2-3 year risk in hopes the TFSA will be bigger (rather than the RRSP), but that might fail if stocks go down. Have I got it right?
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Re: portfolio mix for TFSA

Post by chufinora »

IdOp wrote:
chufinora wrote:You ideally want your maximum growth to be in the TFSA.
Will this always be true? If the tax rate at withdrawal is (enough) less than at contribution, then wouldn't the RRSP be better?

But ok, let's suppose TFSA is better in this case anyway ...

I'm not sure I understand the reasoning here. You keep the $10k in RRSP so that TFSA can hold more equities ("high growth"). But the high growth of equities only becomes highly probable (we hope!) in the longer term. In a short term like 2-3 years they may be down from the starting point of this excercise. And then if you sell them, you not only lock in a loss but can't claim the loss against capital gains. Perhaps I've missed something though.
EDIT: I now see the loss is not really locked in since you re-purchase in the RRSP. It seems like taking a 2-3 year risk in hopes the TFSA will be bigger (rather than the RRSP), but that might fail if stocks go down. Have I got it right?
I think so, in the long run I am assuming equity growth will by higher, thus at some arbirtary point in future you want the growth in the tax free account rather than the RRSP where you pay additional tax on the 'capital gain' withdrawal at whatever rate. In the situation described I think everyone would suggest withdrawing the $10k from the TFSA rather than the RRSP, thus the TFSA will drop by $10k regardless of whether it was holding all equities or equities plus $10k HISA. As you point out in the short term the stocks could drop, in this situation I am not sure what is better. The capital loss is a wash, I think it may depend on how quickly you can refund the TFSA to capture the growth.
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Re: portfolio mix for TFSA

Post by zinfit »

Take 10k in the TFSA and buy 10k in the Vandguard short term corporate bond ETF.
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Re: portfolio mix for TFSA

Post by IdOp »

chufinora wrote:I think so, in the long run I am assuming equity growth will by higher, thus at some arbirtary point in future you want the growth in the tax free account rather than the RRSP where you pay additional tax on the 'capital gain' withdrawal at whatever rate.
I don't agree that this will always be true. In a simple model comparing RRSP and TFSA, if one assumes the tax rates going in, and coming out, are the same then the two accounts are equivalent. If the tax rates are not the same, then one or the other account is better.
In the situation described I think everyone would suggest withdrawing the $10k from the TFSA rather than the RRSP, thus the TFSA will drop by $10k regardless of whether it was holding all equities or equities plus $10k HISA. As you point out in the short term the stocks could drop, in this situation I am not sure what is better.
I think what will happen is that the extra gain, or loss, will take place in the account where you hold the equities for the 2-3 years. If you get a gain, then you'd want that to occur in the "better account" (which will depend on the tax rates in and out), and for this example I'm willing to assume it's the TFSA just to be definite. If you get a loss, you'd want it in the worse account. Of course you can't be sure what you'll get -- equities are too unpredictable. The probability of a gain after 2.5 years may be over 50% (I don't know for sure), but there is still a notable "gamble" there, that one must be aware of.
I think it may depend on how quickly you can refund the TFSA to capture the growth.
Well, I think in making these kinds of comparisons, one has to assume everything else is equal, and just look at what happens over the 2- or 3-year period. Otherwise things will get more complicated than they already are, and with enough adjustments allowed to do this and that, one could have a chance to overcome any obstacle. The net result would be confusion and whatever could be learned from the simple example might be lost.
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Re: portfolio mix for TFSA

Post by chufinora »

IdOp wrote:
chufinora wrote:I think so, in the long run I am assuming equity growth will by higher, thus at some arbirtary point in future you want the growth in the tax free account rather than the RRSP where you pay additional tax on the 'capital gain' withdrawal at whatever rate.
I don't agree that this will always be true. In a simple model comparing RRSP and TFSA, if one assumes the tax rates going in, and coming out, are the same then the two accounts are equivalent. If the tax rates are not the same, then one or the other account is better.
The tax rate going in is irrelevant once the the accounts are funded any growth in the TFSA is tax free, any growth in the RRSP has a tax liability, therefore it is better to get higher growth of TFSA than RRSP. If you are choosing to fund either RRSP or TFSA then tax in/tax out is relevant as you are funding RRSP with pre-tax dollars.
IdOp wrote:
chufinora wrote:In the situation described I think everyone would suggest withdrawing the $10k from the TFSA rather than the RRSP, thus the TFSA will drop by $10k regardless of whether it was holding all equities or equities plus $10k HISA. As you point out in the short term the stocks could drop, in this situation I am not sure what is better.
I think what will happen is that the extra gain, or loss, will take place in the account where you hold the equities for the 2-3 years. If you get a gain, then you'd want that to occur in the "better account" (which will depend on the tax rates in and out), and for this example I'm willing to assume it's the TFSA just to be definite. If you get a loss, you'd want it in the worse account. Of course you can't be sure what you'll get -- equities are too unpredictable. The probability of a gain after 2.5 years may be over 50% (I don't know for sure), but there is still a notable "gamble" there, that one must be aware of.
Yes I agree there is always a risk due to volatility, that is why we both agree in parking the $10k in HISA.

(edit due to typo missed on preview)
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Re: portfolio mix for TFSA

Post by IdOp »

chufinora wrote:The tax rate going in is irrelevant once the the accounts are funded any growth in the TFSA is tax free, any growth in the RRSP has a tax liability, therefore it is better to get higher growth of TFSA than RRSP. If you are choosing to fund either RRSP or TFSA then tax in/tax out is relevant as you are funding RRSP with pre-tax dollars.
That's interesting ... but, what makes me uneasy about that argument is that it suggests that once an account is funded, an investor's plans for asset location that were made initially should always be thrown away and as much equity as possible put into the TFSA. So I looked
at a numerical example (below) to try to show that may not be best. The result surprized me, as it showed it didn't matter. Now, that's just one example, but still interesting I think. (Maybe
we're both wrong? :o ) I'll need to look at this more, either with algebra or a spreadsheet, to see if the example's result is more general. Though I won't have time for that today. Here's the
example:

Assume: Tax rate now is 50%, and in the future it's 20%. So the RSP is "better". An investor has $20k of pre-tax money and puts $10k into RSP, and $5k (after tax) into the TFSA now. Only 80% of the money in the RSP belongs to the investor since it will eventually be taxed at 20%. The TFSA is 100% the investor's now. Assume equities double and cash gains 20% over some period. Consider two investors, A and B.

Investor A believes the RSP is better so puts it in 100% equities, and puts the TFSA in cash. Note A's asset mix is 8:5 of equities:cash (initially) since only $8k in the RSP is his. His end result after growth and tax is:

RSP: 10k --> 20k --> 16k after tax

TFSA: 5k --> 6k --> 6k

Total: 22k

Now consider Investor B. He starts out just like A, but as soon as he makes the contributions, he decides the tax rate in is irrelevant and wants to put equity into the TFSA because high growth is not taxed. So Investor B puts all 5k of the TFSA into equity, while the RSP has 3.75k equity and 6.25k cash (total of 10k). Note that B's initial asset allocation is also 8:5 of equity:cash, because

Equity : 3.75k x 80% + 5k = 8k
Cash : 6.25k x 80% = 5k

This makes a fair apples-to-apples comparison with Investor A (as has been emphasized by adrian2 before). At the end of the period, Investor B's portfolios are worth:

RSP:
equity 3.75k --> 7.5k --> 6k after tax
cash 6.25k --> 7.5k --> 6k after tax

TFSA: equity 5k --> 10k --> 10k

Total is 22k, same as Investor A. Tax free growth in the TFSA didn't seem to help Investor B in this example, if I did it right.
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Re: portfolio mix for TFSA

Post by IdOp »

I had a chance to look at this a bit more, and it seems the result of the example -- being equal -- is more general.

First though, between the two accounts, the one with the lower tax rate is "better" in the sense that you'd put all your money in it if you could, because it will be lower taxed. In the example this account is the RSP. But you may not be able to do that due to limits, so you put your money into two accounts.

If you do that by distributing the money into various asset classes in the two accounts, but such that the after-tax asset allocation (defined in a particular way) is the same for two such distributions, then their final results will be the same. In a way this makes sense, since the difference between accounts (RSP and TFSA) is taxation, and by looking at after-tax asset allocation you've removed that factor. So each distribution has the same amount of after-tax money in various classes, that all grow at their own rates, and you get the same result. I didn't understand this clearly at the beginning of the discussion, so, awesome to get a better insight into it. :)
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Re: portfolio mix for TFSA

Post by chufinora »

:? I'm still very confused :? I don't get the bit "such that the after-tax asset allocation (defined in a particular way) is the same for two such distributions". Whilst I know there is some tax liability for my RRSP I have very little idea what level of tax it will occur over its lifetime during withdrawal. I treat all my portfolio's (Non-reg, TFSA, RSP, LIRA, LIF etc) as one regarding asset allocation.

I can also see in your example if you had two equal amounts and were either all cash or all Equity the TFSA all equity would be better:-

Investor A:- RRSP $10k Equities
TFSA $10k Cash

Investor B:- RRSP $10k Cash
TFSA $10k Equities

Using the same conditions (100% equity growth, 20% cash, 20% tax on RSP withdrawal)

I get Investor A $20k -> $28k
Investor B $20k -> $29.6k
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Re: portfolio mix for TFSA

Post by IdOp »

chufinora wrote::? I'm still very confused :? I don't get the bit "such that the after-tax asset allocation (defined in a particular way) is the same for two such distributions".
No worries about confusion, sorry about that, it is understandable since what I wrote was a very brief summary of the key ideas with all details missing, for lack of time. I will organize my scribbles better and try to post the details within the next several days to week. (Apologies also to OP if we are going too far off topic!)
Whilst I know there is some tax liability for my RRSP I have very little idea what level of tax it will occur over its lifetime during withdrawal. I treat all my portfolio's (Non-reg, TFSA, RSP, LIRA, LIF etc) as one regarding asset allocation.
Agreed. I was only referring to a generalization of this kind of example, which allows putting several asset classes into several accounts. So it's not really a real-world thing because you assume no withdrawals, and that the tax rates are known, while for an RSP of course they're in the future so you have to guess them. Still I find this sort of thing conceptually helpful.
I can also see in your example if you had two equal amounts and were either all cash or all Equity the TFSA all equity would be better:-

Investor A:- RRSP $10k Equities
TFSA $10k Cash

Investor B:- RRSP $10k Cash
TFSA $10k Equities

Using the same conditions (100% equity growth, 20% cash, 20% tax on RSP withdrawal)

I get Investor A $20k -> $28k
Investor B $20k -> $29.6k
I agree with your numbers, but the key thing to hi-lite is that in your example, Investor A only has 8k of equities in his money in the RRSP; the other 2k belongs to the gummint (they will eventually take 20%). Similarly your Investor B only has 8k of his cash in RRSP. These 8 k are each after tax amounts. In fact, the 10k's in the TFSA are also after tax, after a tax of 50% that is. Your investors started with $30k. So returning to the key thing, your Inv. A as an equity:cash ratio of 8:10 of his money after tax, while for your Inv. B it is 10:8. They aren't the same. Your Investor B has more of his money in equities, which have a higher return, and that's why s/he ends up better. In other words, if you change the asset allocation of the money that won't be taxed towards higher growth, the end result will change for the better.

All I did (I think, must check and reorganize) was generalize this cute model very slightly.

Hope that helps a bit for now.
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Re: portfolio mix for TFSA

Post by IdOp »

I've put together the details explaining generally why the results of Investors A and B turned out to be equal in my example up-thread. It's here:

ataa.pdf

The arithmetic involved is really very short and simple. I ended up putting a lot of words around it in case some may find them helpful. Comments, questions and corrections are welcome.
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Re: portfolio mix for TFSA

Post by chufinora »

IdOp wrote:
chufinora wrote:
I can also see in your example if you had two equal amounts and were either all cash or all Equity the TFSA all equity would be better:-

Investor A:- RRSP $10k Equities
TFSA $10k Cash

Investor B:- RRSP $10k Cash
TFSA $10k Equities

Using the same conditions (100% equity growth, 20% cash, 20% tax on RSP withdrawal)

I get Investor A $20k -> $28k
Investor B $20k -> $29.6k
I agree with your numbers, but the key thing to hi-lite is that in your example, Investor A only has 8k of equities in his money in the RRSP; the other 2k belongs to the gummint (they will eventually take 20%). Similarly your Investor B only has 8k of his cash in RRSP. These 8 k are each after tax amounts. In fact, the 10k's in the TFSA are also after tax, after a tax of 50% that is. Your investors started with $30k. So returning to the key thing, your Inv. A as an equity:cash ratio of 8:10 of his money after tax, while for your Inv. B it is 10:8. They aren't the same. Your Investor B has more of his money in equities, which have a higher return, and that's why s/he ends up better. In other words, if you change the asset allocation of the money that won't be taxed towards higher growth, the end result will change for the better.

All I did (I think, must check and reorganize) was generalize this cute model very slightly.

Hope that helps a bit for now.
Let me try one more time. I agree with your math, but not that the key thing is that investor A has different equity:cash ratio than investor B. IMO the key thing is that, if you have funded TFSA and RRSP, it is better to have your AFTER TAX dollars in equities and your PRE-TAX dollars in Cash. Going back to OP question I still believe it is preferable to keep his short term cash in his RRSP until he needs it (But to withdraw it when needed from the TFSA which nobody disagrees with.)
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Re: portfolio mix for TFSA

Post by IdOp »

It's a good point, and only fair to the OP, to return to the initial problem to see how our discussion-tangent applies to it. I look at it this way.

As you say, the TFSA is after-tax and the RRSP is pre-tax. So there's a tax yet to be paid on the RRSP money. Let's assume it's at 33.33% so that $10k in the TFSA is equivalent, after tax, to $15k in the RRSP ... nice round figures. :)

Base Case. As I understand it, the base case is to put $10k of the TFSA in cash, and to have $15k in equity in the RRSP.

Scenario A. You suggested an alternative of substituting the cash into the RRSP. Since $1 in the TFSA is equivalent to $1.5 in the RRSP after-tax, if you want to keep the investor's money in the same asset allocation as the base case, you have to put the whole $15k of equity in the RRSP into cash. If you work this out, the result is the same as the base case. This follows like the Claim in my pdf with details.

Scenario B. However, you suggested a different substitution, namely putting only $10k of the RRSP money into cash. This is a "dollar for dollar" substitution of the nominal amount of cash from the base case. If you do this, yes, you will come out ahead (assuming equity does
better than cash for 2-3 years). The reason for that is entirely due to the extra $5k of equity that is left in the RRSP -- which would have been cash in Scenario A. However, to achieve this improved result, it must be recognized that the asset allocation of the investor's money
(not nominally, but after tax), has been changed from the base case. It has more equity and less cash; there's no free lunch.
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