Investing in taxable accounts
Should you consider investing in taxable accounts?
I think you should, but with some caution. Read on for my take.
Hybrid investing 101
Fans of this site will know I take a “hybrid” approach to investing:
- Approach #1 – we own a number of Canadian dividend paying stocks for income and growth. We own nearly 30 different Canadian stocks within our non-registered account and across our Tax Free Savings Accounts (TFSAs). We own these stocks because we believe buying and holding our DIY bundle of Canadian dividend-paying stocks will, over time, provide some steady monthly income for future wants and needs in retirement.
- Approach #2 – we’re owning more units of low-cost ETFs over time. While dividend paying stocks are great, we believe this is smart because we’re investing abroad beyond Canada’s borders. In doing so, we’ll add growth and diversification to our portfolio. While we still own some Canadian stocks and some U.S. stocks inside our RRSPs, (names like Procter & Gamble and Johnson & Johnson to name a few) we’re buying more (and holding more) ETF assets over time.
So, with those approaches in mind – you should know we strive to max out contributions to our registered accounts (i.e., x2 RRSPs + x2 TFSAs) before making investments inside our taxable investment account*
*I do hold some investments inside my taxable account but I’ve also long since maxed out my personal TFSA and RRSP.
Recently, in the My Own Advisor mailbox, I’ve received a few reader questions about taxable account investing. Some of those questions go like this:
I really enjoy your site and your journey. I’ve been investing for a bit and getting more comfortable with investing. Recently, I even transferred my full/out of contribution room mutual fund RRSP account to a self-directed RRSP account. I’m going to review what lower-cost ETFs I should buy for that account based on your site in the coming weeks!
However, how should I invest in a taxable account? I would like to minimize taxes in the future!
I read all your dividend income updates like this one. Congrats so far! It seems as though you invest in Canadian dividend paying stocks with your unregistered account. I’m learning that anything that pays a dividend, even low-dividend-payers, can incur taxation even at modest account sizes. How are you going to manage this? Also, what do you make of the Horizon’s swap-based ETFs? Thanks!
Thanks for your questions readers. Lots to unpack there – so let’s get at it!
- Considerations for any account – TFSA, RRSP, non-registered, other!
I think it goes without saying but to answer these questions above from readers – there are far more considerations than just what ETFs to own.
For any account (TFSA, RRSP, taxable, or even your kids’ RESPs) I think you should consider the following questions:
- Is my approach diversified? Do I understand the investment risks I’m taking on for any potential return or even returns that could be below market performance?
- What is my desired asset allocation? Meaning, in general, how much equities to bonds to cash do I want to hold? Why?
- What are my investing objectives? How long do I intend to invest? (Remember: I believe plans for your money should come before products!)
- Should my TFSA + RRSP + RESP + taxable be managed as “one big portfolio? (Me: yes, I think it should!)
- And more and more and more…
Ultimately folks, you should strive to own assets that met your investing objectives; don’t just buy ETFs for the sake of buying ETFs. Know why…
You might also wish to consider tax efficiency as part of asset location.
General rules of thumb on that go like this: put the most tax-efficient assets in the taxable account (because of the Canadian dividend tax credit and capital gains treatment) AND put the least tax-efficient assets in your registered accounts, more specifically your RRSP.
- How should you invest in a taxable account?
That could play out in soooo many ways, given there are never any hard and fast rules for everyone. That said, here are some starting considerations for asset location and tax efficiency based on what I’ve learned and do:
|· Canadian stocks
· U.S. stocks
· Real Estate Investment Trusts
· Canadian or U.S.–listed ETFs
· Bond ETFs
|· Canadian stocks
· Canadian Real Estate Investment Trusts
· Canadian-listed ETFs
· Bond ETFs
· British American Depositary Receipts (ADRs)
|· Canadian stocks
· U.S. stocks that pay little to no dividends
You won’t find international, U.S. dividend paying stocks or any U.S.-listed ETFs under my “TFSA Assets” column because withholding taxes on dividends earned will apply to the tune of 15%.
Best to keep U.S. stocks and your low-cost U.S. ETFs inside your RRSP.
As a general rule of thumb, I believe it makes sense to maximize contributions to your registered accounts before non-registered investing. I mean, why not use tax-free (TFSA) and tax-deferred (RRSP) accounts to your advantage first?
To help you minimize taxes in the future (when it comes to taxable investing), consider owning the following, again just examples:
- Canadian stocks (that apply for the Canadian dividend tax credit),
- Canadian ETFs (like XIU) that are very tax-efficient, OR
- Stocks that pay little to no dividends – since capital gains when you incur them are – all things considered an efficient form of taxation.
So, your potential portfolio could look like this…as a totally hypothetical example only!
|Any one or more of the following:
· Canadian stocks (BMO)
· U.S. stocks (JNJ)
· Real Estate Investment Trusts (CAR.UN or ZRE)
· Canadian or U.S.–listed ETFs (VCN, XIC, XIU, VTI, VYM, XAW, VXC)
· Bond ETFs (VAB)
|Any one or more of the following:
· Canadian stocks (FTS)
· Canadian Real Estate Investment Trusts (HR.UN or XRE)
· Canadian-listed ETFs (ZCN, XIC, XIU, XEI)
· Canadian Bond ETFs (ZSB)
· British ADRs (BP)
|· Canadian stocks (CNR) (or tax efficient ETFs like XIU)
· U.S. stocks that pay little to no dividends (BRK.B)
I think most investors, who are wary of any individual stock selection, could easily hold 3-4 ETFs and be done with it.
Alternatively, should you feel 3-4 ETFs are too much to rebalance or monitor – could consider these simple but very effective all-in-one funds. One fund, across many accounts, and be done!
- What I do – Canadian dividend stocks in my taxable account
As mentioned above, I’m going to keep investing using Canadian dividend paying stocks in my taxable account for the foreseeable future. The downside of this is – as my income might rise over time, dividends are not as efficient as capital gains. So, I’m actually not buying any more stocks within this account short-term.
I’m not doing this for a few reasons: 1) the more employment income I make, the more I’m taxed even with the Canadian dividend tax credit. 2) while my own TFSA and RRSP accounts are out of contribution room, we have debt. So, we’re focused on paying down debt in the coming years prior to semi-retirement which will hopefully occur in 5-10 years. 3) We’ll work on maxing out my wife’s RRSP account soon too (before she intends to stop full-time work in the next 5-10 years).
Those are plenty of good priorities for now…
What do I make of these Horizon’s swap-based ETFs?
I think these are interesting products for sure…using agreements as part of their fund structure so investors only pay capital gain taxes when they sell the ETF units down the road.
Great for taxable investing or use in your TFSA, RRSP/RRIF and more as well.
Investing in taxable accounts summary
How to invest, what to own where, why and for how long are all very simple questions with some complex answers. Besides, personal finance and investing will always be personal.
For what it’s worth, for anyone new to investing, I would focus on understanding the merits of registered investing using your RRSP and TFSA (and the RESP as well) first before even considering investing in a taxable account – certainly knowing what I know now.
For more seasoned investors, I would consider investing inside a taxable account only when RRSPs, TFSAs, and RESPs are full of contribution room.
Even then, your focus should likely be on debt repayments and killing a mortgage if those accounts are full.
If and when you find yourself in a very enviable financial position where you have no debt, all registered accounts are maxed out, I hope you return to this blogpost for any assistance in growing your wealth. I will be certainly one of the first people to say “congratulations” if that’s where you are financially – good on you!
Happy investing and thanks for reading!