Part of my investment strategy is index investing. I use Exchange Traded Funds (ETFs) for this approach. If you think my investing approach using dividend stocks is boring you haven’t seen anything yet. Using ETFs for retirement planning is downright lazy.
I index part of our portfolio to:
- Achieve market performance less minuscule management fees.
- Obtain great diversification.
- “Set and forget” part of my retirement portfolio. I honestly don’t even think about it.
I think indexing using ETFs can work for the majority of investors. I believe most investors would do well to own any combination of up to three (3) equity *ETFs:
- XIU or XIC or VCN for Canadian equity
- VTI or VUN for U.S. equity
- VXUS or VXC or VDU for International equity and worldwide exposure.
*I own some of these ETFs above.
We will use some indexed products in our registered accounts for retirement planning. This is in addition to our passive dividend income goal: to earn about $30,000 per year from Canadian companies. When we reach this goal, hopefully by the end of 2023, we’ll likely retire.
My Indexing Approach:
I believe investments in a few low-cost ETFs will help us on our journey to financial independence, providing long-term capital appreciation and growth.
- I only buy low-cost, established ETFs.
- I reinvest all distributions paid by these ETFs.
- I try to avoid selling any ETF units regardless how far the stock price falls. If anything, I buy more when prices tank.
My Asset Allocation Strategy
Diversification is great but it comes at a cost unless you put your ETFs in the right location. This is because many countries levy taxes on ETF distributions paid to foreign investors. Here is a summary of what I’ve learned and how I try and manage my portfolio using ETFs to keep taxes in check.
Currency Hedging or Not
I try to avoid currency hedging. Hedging eliminates currency risks from your portfolio and you’ll pay higher fees because of this avoidance. I think you want currency exposure. If you want exposure to foreign currencies then you’re looking for unhedged ETFs.
Heard of withholding taxes? Let’s look at some examples in case you haven’t…
A Canadian ETF that holds international stocks
example: Vanguard Canada VEE
VEE trades in Canadian dollars. VEE is not a hedged product. VEE is the Canadian version of U.S. version VWO. Using VEE in a non-registered account withholding taxes will apply (15%) but they are recoverable when investors file their tax returns. In an RRSP or TFSA withholding taxes apply and you cannot claim a credit for this. This makes the true cost of this ETF inside your RRSP or TFSA more than double the posted MER of about 0.30%.
A Canadian ETF that holds US stocks
example #1: Vanguard Canada VFV. VFV trades in Canadian dollars. VFV is the Canadian version of U.S. VOO. Using VOO in a non-registered account withholding taxes will apply (15%) but they are recoverable when investors file their tax returns. In an RRSP or TFSA withholding taxes apply and you cannot claim a credit for this.
If you don’t have much to invest, it’s probably best to invest with a Canadian ETF that holds international or US stocks and simply pay the higher MER; the higher MER associated with withholding taxes. This way you don’t have to worry about any currency conversion from Canadian to U.S. money to buy your U.S.-listed ETFs.
example #2: Vanguard Canada VUS. VUS trades in Canadian dollars. VUS uses currency hedging and is the Canadian version of U.S. version VTI. Using VUS in a non-registered account withholding taxes will apply (15%) but they are recoverable. In an RRSP or TFSA withholding taxes apply and you cannot claim a credit for this. With the currency hedging and the withholding taxes to pay for inside your RRSP or TFSA, the MER is close to 0.50%.
When it comes to withholding taxes I prefer to own U.S. stocks or U.S. ETFs in my RRSP only.
A US ETF that holds US stocks
example: Vanguard VTI. Disclosure: I own this ETF.
This ETF makes the most sense in an RRSP because U.S. listed ETFs like VTI held inside an RRSP escape withholding taxes of 15%. It’s worth reminding you foreign dividends are taxed at your marginal rate. With U.S. listed ETFs the Internal Revenue Service will take a 15% withholding tax on all dividends received.
The other key point is that Canada has tax treaties with the US and many other countries. Those tax treaties waive withholding taxes on U.S. stocks or U.S. ETFs in registered accounts like RRSPs, RRIFs and Locked-In Retirement Accounts (LIRAs). TFSAs don’t apply to these tax treaties, it is not considered a retirement account (even though I do). In a TFSA you must pay 15% withholding taxes on a U.S. ETF like VTI or U.S. stocks like Coca-Cola.
A US ETF that holds international stocks
example: Vanguard VWO. This ETF would make the most sense inside an RRSP. A U.S. listed ETF like VWO is subject to withholding taxes but these withholding taxes do not apply in an RRSP, RRIF or LIRA.
You can learn more about Foreign Withholding Taxes in these great articles here:
Finally, check out my Archives page for some of my favourite ETF products. I try and update these every year.