Tuesday, December 8, 2015

Reader Question about Non-Registered Accounts

A reader, R.V., asked the following thoughtful question about investing in a non-registered account:
“As I approach maxing my registered accounts, I need to start thinking about perhaps opening up a non-registered account.

At present, I do the following:
TFSA: TD e-series funds (25% each of Bonds, CAD Index, US Index, & Int'l Index)
RRSP: 70% VXC and 30% VAB via a brokerage account

For Non-reg, I was thinking of HXT. Benefits of a swap-based ETF is no dividend to worry about and only need to be capital gains tax upon selling.

Do you have any comments and/or recommendation on some non-reg ETFs? What do you normally buy for your non-reg account?”
To start with, R.V. is obviously handling his finances very well given that he has maxed out his RRSP and TFSA. He has also chosen good diversified low-cost index mutual funds and ETFs. If he can stay invested and not tinker too much with his asset allocation, I’m optimistic about his future.

I don’t give financial advice directly for a couple of reasons. For one, I don’t know R.V.’s situation well enough to be certain of what’s best for him. Another reason is that I’m a big believer in learning the right answer yourself instead of just trusting experts. However, I can describe the way I invest my own money and why I do it that way.

I split my money into short-term and long-term savings based on whether I’ll need it within the next 5 years. My short-term savings only go into safe investments that come due when I need them like GICs, government bonds, savings accounts, and cash. From here, on, everything I discuss applies to my long-term savings.

I treat all of my long-term savings as a single portfolio with a single asset allocation. I don’t mind having skewed asset allocations in each account if the whole portfolio mix is as I want it. I use VCN for my Canadian stocks and I fill up my non-registered accounts as much as possible with VCN to get the preferred tax treatment on Canadian dividends. It’s still better to have VCN in an RRSP or TFSA, but when there’s no room left, Canadian stocks are better in a non-registered account than non-Canadian stocks.

Some people choose to put their bonds in a non-registered account because they expect bonds to have lower returns than stocks. Bonds get poor tax treatment in a non-registered account, but this has to be balanced against the higher expected returns of Canadian stocks. I haven’t had to make this decision because I don’t own bonds in my long-term portfolio.

HXT is potentially a good choice for a non-registered account because the swap arrangement causes dividends to get turned into deferred capital gains instead of paying taxes on the dividends every year. I’ve chosen not to use swap-based ETFs because I’m uneasy with the counterparty arrangement. There are experts who say that counterparty risk is very low and that even if there is a default, the losses would be modest. Another potential risk is that the government could change tax rules for these swap-based ETFs. I’ve just decided that I don’t need these risks in my life.

I consider it more important to maintain my portfolio’s asset allocation than to focus solely on minimizing taxes. So, I’m content to have some U.S. and international stocks in my non-registered accounts even if it results in paying some taxes. Right now, my portfolio’s total costs (commissions, spreads, MERs, other fund costs, and foreign withholding taxes) are below 0.2% per year. Trying to save another basis point or two by distorting my asset allocation would be letting the tax tail wag the investing dog.

Whatever strategy R.V. settles on, it’s important to avoid tinkering too often. Our instincts can lead us to buy high and sell low. When we have intelligent-sounding reasons to modify our strategy, it’s often just fear keeping us from buying low and greed pushing us to buy high.


  1. Michael, You and Canadian Couch Potato inspired me to treat all of my accounts as a whole. We are in a situation we can hold all of our US and International stocks in our RRSP and Canadian stocks in TFSA, RESP and non-registered while being in line with our A.A. target. This way, we are tax efficient, fees are low and we only have 9 holdings in 6 accounts! It's very simple to manage. I even try to buy only once a year in each account when possible.

    1. @Le Barbu: My mix is a little more complicated than yours, but I try to do some of the same things for tax efficiency while maintaining my overall asset allocation. One difference is that I use threshold rebalancing with a signal coming by email from my spreadsheet. In theory, I never have to look at my portfolio because my spreadsheet monitors it.

    2. The date I buy in each account is planned months(years) ahead. For the small trades, I try to match the subsidy (RESP) or dividend* payment to avoid cash iddling in the account. For bigger one (like my RRSP), I usualy buy just after my tax refund wich is about 50% of the ammount of my total contribution.

      *some of my ETFs are not elegible to DRIP

  2. Just don't look (except when you are scheduled to look) is a good credo in these situations. People love to tinker, and folks who have had a degree of success seem to want to tinker more with things, not sure why.

    If it is working, why do you need to tinker with it?

    1. @Big Cajun Man: I agree it's important to avoid tinkering. It's hard not to want to buy more of what's been doing well recently.

  3. I agree that there are more important considerations than taxes, such as behaviour, asset allocation and fees, but the tax deferral of HXT is worth considering. HXS is the same structure and tracks the S&P 500, so is an option for US equities. There are always trade offs.

  4. Michael mentioned two things that, in my mind, come together into one change R.V. might consider: where to hold the different assets.

    R.V.'s TFSA is 25% bonds, and his RRSP is 30% bonds.

    Michael mentioned:
    1. treat[ing] all long-term savings as a single portfolio with a single asset allocation
    2. recognizing the different expected long term returns of bonds vs. stocks (applied to registered vs. non-registered)

    For me, that means when considering long term portfolio spread across TFSA and RRSP, I'd prefer to have all my bonds in RRSP and none in TFSA.

    Simply because: there will be tax to pay on all growth in the RRSP (when withdrawing), and no tax to pay on the growth in TFSA; and I expect stocks to have more growth in the long term than bonds. Both grow tax-sheltered, but overall I *expect* that change to reduce taxes on draw-down in the future.

    1. @Daryn: The one element of your analysis you're missing is the RRSP tax refunds. Because of these refunds, you're able to save more in an RRSP than you can in a TFSA, even for the same out-of-pocket contribution. When you take this into account, the growth in an RRSP that eventually gets taxed is not actually a problem. I explain this in much more detail in a previous post:


    2. Hmm. I would like to gently push back on that and get your feedback. Your comment and linked post talk about tax effects of new contributions being the same between RRSP & TFSA. E.g. $6000 available to go into TFSA vs contribute to RRSP is the same, except for marginal tax rate changes between contribution & withdrawal.

      But what I was suggesting was regarding R.V.'s situation where he has got *both* RRSP & TFSA, and the fact that he's holding bonds in both of them.


      (Trying to imitate your awesome ability to boil down to concrete examples...)

      Suppose Adam and Bob each have $100K long term savings, split $50K each in RRSP and TFSA. (In reality if R.V. has worked many years, his nearly-maxed RRSP is much larger than his TFSA, but that should affect the illustration's intent). Both Adam and Bob have decided on an asset allocation of 50% stocks and 50% bonds.

      Adam decides to hold all his stock allocation in his RRSP, and all his bonds in his TFSA; Bob does the opposite.

      Suppose that after a number of years stocks have grown 100% and bonds 40%, and to make my math easy they never rebalanced (tsk! tsk!).

      Then Adam would have $100K in his RRSP and $70K in TFSA, while Bob would have a $70K RRSP and $100K TFSA. When withdrawing funds, Bob is way ahead from a tax perspective.

      That's what I was trying to suggest to R.V. Ignoring the fact that rebalancing would reduce the difference a little bit, is that analysis fundamentally flawed in some way? It seems to make sense to me, so I'm really interested if my intuition is mixing up the reality...

    3. @Daryn: Good example. The fundamental difference between my assumptions and yours is that I discount the value of my RRSP for the purposed of calculating my asset allocation. So, with this view, Adam and Bob have different starting allocations because the after-tax value of the RRSP is less than $50k.

    4. Aha! Your response made me wonder if that's what you do! I had never heard of doing that before.

      My first thought would be to wonder if that is necessary, since when you have to sell something unregistered or withdraw from RRSP, you can rebalance...
      ... but knowing that you're doing it that way, I have very high confidence that you've crunched the numbers thoroughly!

    5. @Daryn: I just see the portion of my RRSP that will ultimately be lost to taxes as belonging to the government right now. That way I base my asset allocation on just the money I'll be able to spend. For this reason, I discount my non-registered account somewhat as well.

    6. In your example, if you do it as $100 gross to invest and split it 50/50 and you keep the income tax rate the same at the beginning and end of the investment period then they should come out to the same total money at the end. If your tax rate will be lower in retirement then really you should keep more of your stock allocation with a higher expected return in your RRSP accounts.