Tag Archives: tax efficiency

By James Gauthier, CIO, Justwealth

Special to the Financial Independence Hub

When investors run out of contribution room in their tax-sheltered investment accounts such as RRSPs and TFSAs, they often continue investing in a non-registered account that does not have the same automatic benefit of avoiding or deferring taxes. Managing investments in a taxable portfolio then becomes a much more complicated exercise: one that attempts to maximize wealth on an after-tax basis instead of a pre-tax basis, which is how investments would be structured in a registered account.

Any investment income that is earned in a non-registered account is subject to taxation annually and can therefore be thought of as a “fee,” similar to the annual fees charged by your financial institution or advisor. As a robo-advisor that provides low-cost investment options for investors, we devote much time and resources to educating investors about the negative impact that investment management fees can have on their overall wealth. But unlike management fees, which are generally easy to identify and compare amongst different investment options, it is virtually impossible to find after-tax rates of returns for making apples-to-apples comparisons between various products and providers.

Most investment providers, including robo-advisors, use the exact same portfolio recommendations for their clients’ non-registered accounts as they do for their registered accounts, as long as the “risk” level is deemed to be the same. To illustrate the true cost of tax inefficiency, we can show how altering a portfolio recommendation, without materially altering the risk level or other characteristics of the portfolio, can improve the after-tax return of the portfolio.

Consider an investor in the top marginal tax bracket who is considered to have an “average” risk tolerance and is invested in a Balanced portfolio of 40% bonds, 20% Canadian equity, 20% U.S. equity and 20% international equity. A reasonable long-term expected annual rate of return on this portfolio, on a pre-tax basis, is 5.6%. Applying tax rates to the interest, dividends (Canadian and foreign) and a conservative estimate for capital gains, the after-tax return on the portfolio is reduced to 4.0%.

By making some minor changes to the portfolio’s asset allocation, such as emphasizing asset classes that receive more favourable tax treatment and finding investment vehicles (ETFs in our case) that are innovatively structured to receive more favourable tax treatment, we can create a new portfolio that is very similar from a high-level asset allocation and risk perspective. The expected pre-tax return on this new, tax-efficient portfolio is slightly lower at 5.5%, but after taxes are applied, the return is a more favourable 4.5%.

 

The difference of 0.50% in after-tax returns should be considered the MINIMUM cost of tax inefficiency, since we have not yet addressed any other tax-inefficient practices. Extending the analysis across our entire range of investor risk tolerances (from Conservative to Aggressive) shows that the cost of tax inefficiency can vary from a low of 0.40% up to 1.00%. In most cases, the cost exceeds our 0.50% management fee, meaning that you would be better off paying our fee rather than having your assets managed for FREE at any another institution that does not use tax-efficient portfolios!

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Weekly Wrap: Horizons escalates ETF price war, Questrade expands active ETFs, CSA to review robo advisers

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PRICE WAR red Rubber Stamp over a white background.

Three significant developments in the ETF and robo-adviser space late this week, the full recap of which can be found in my new Weekly Wrap that may run online Fridays in the Financial Post.  You can find the link for the first one here.

Horizons ETFs has rejigged fees on its popular Canadian equity fund, Horizons S&P/TSX 60 Index ETF [ticker HXT,] to just 0.03% or three basis points (plus taxes, down from the previous 0.05%. Previously the low-fee threshold was 0.05%, shared with three other providers.

Meanwhile, Questrade Wealth Management launched two actively managed ETFs, a global equity fund plus a fixed income ETF  subadvised by institutional money manager, Jarislowsy, Fraser Ltd. These expand the lineup of six Questrade Smart ETFs launched in March.

On Thursday, the Canadian Securities Administrators (CSA) issued CSA Staff Notice 31-342 directed at portfolio managers providing online advice, popularly known as robo advisers.   The CSA says it may conduct compliance reviews of online advisors within one or two years following launch, particularly as operations become more complex than the first generation that had basic ETFs or mutual funds as its underlying  investments, and “uncomplicated” asset allocation models.