Asset Location, Location, Location
Investors hear plenty about asset allocation and asset diversification but in my opinion not so much about asset location.
Why is that? Why is asset location often overlooked? I know I used to, but no longer, and here’s why…
Asset location refers to the type of account(s) you use to hold your stocks, bonds, ETFs, GICs, real estate investment trusts, cash or other investment products in.
I think asset location is equally important because owning all the right investments in the world does little good if you’re always taxed on them.
Taxes, bad. Keeping your money in tax-advantaged locations, good.
Here’s a very brief overview of what I do when it comes to asset location and the assets we hold:
Interest Income – from bond funds, bond ETFs, GICs and money market funds. If you own any of these in unregistered accounts you are taxed at your marginal tax rate. You probably don’t want that.
Dividends – from eligible Canadian stocks. I own Canadian dividend paying stocks. If you own Canadian dividend paying stocks like I do, in a non-registered account, you’ll receive a dividend tax credit from many of those stocks.
Foreign dividends – from U.S. stocks, for example, are taxed at your marginal tax rate. I own U.S. dividend paying stocks but not in a taxable account. With my U.S. holdings, I don’t have to sit back and get taxed at my marginal rate: U.S. stocks held inside my RRSP and LIRA – I don’t pay withholding taxes.
This is much better because:
•U.S. stocks held inside any RESP or TFSA – you pay 15% withholding taxes.
•U.S. stocks held in unregistered accounts – you pay 15% withholding taxes PLUS tax at your full marginal rate (ouch).
Capital gains – from selling a stock or security for more than you paid for it – you made a profit. We sold our condo last year but I don’t intend to sell my stocks. You need to report 50% of your capital gains as income and pay tax on that amount in the year gains were realized.
Other Income – from Real Estate Investment Trusts (REITs) or income trusts. I own REITs. These investments (sometimes) pay healthy distributions. Be mindful that “tax friendliness” varies from REIT to REIT since these companies provide returns in terms of distributions, return of capital and income. If kept unregistered in a taxable account income received from REITs and trusts are taxed at your marginal tax rate.
I certainly don’t advocate you need to follow my lead, I’m no personal finance or tax expert, but I know I don’t like paying tax any more than I have to.
My asset location general rules:
Rule # 1 – I keep many of my Canadian dividend paying stocks in a non-registered account (in a taxable investing account) and within my Tax Free Savings Account (TFSA) once that is fully contributed to. Why? I want that dividend tax credit, I want the favourable “tax treatment” that comes with Canadian dividend paying stocks. Our multi-year goal is to make some healthy income from dividend income.
Rule # 2 – I keep all my U.S. dividend-paying stocks and U.S.-listed Exchange Traded Funds (ETFs) inside my/our Registered Retirement Savings Plans (RRSPs) or my Locked-In Retirement Account (LIRA). I don’t want to lose any dividends paid to me. I want to reinvest all dividends and distributions received. Besides, my U.S. dividend-paying stocks don’t get the same (great) tax treatment as my Canadian dividend-paying stocks do in a taxable account.
Rule # 3 –
I keep Canadian bond ETFs in my RRSP and TFSA. Interest income, just like employment income, is taxed at the highest possible rate. If I were to own bond ETFs (I don’t anymore) I would use registered accounts such the RRSP to defer tax on bonds respectively. (Note – updated since 2015 I don’t own any bond ETFs anymore!)
I intend to use a “cash wedge” approach in retirement and so I don’t think I’ll ever own any bond ETFs again.
Rule # 4 – Outside of a few U.S. dividend-paying stocks I like to follow a lazy, low-cost investing approach inside my RRSP. Why? I don’t have to think about the markets this way – I can ride what the market returns. I own U.S. ETFs and Canadian ETFs inside my RRSP/our RRSPs for stock market growth.
Rule # 5 – I keep Canadian REITs in my RRSP and TFSA only. Why? I don’t want to bother with all the funky calculations that go with return of capital, interest, distributions and more in a taxable account. Why make income tax filing each year more complicated than it already is?
When in doubt just simplify and use the same ETFs or stocks across your accounts.
Final asset location thoughts
As always, buyer beware, do your own research, other investing disclaimers apply.
When in doubt, ask questions from knowledgeable people. Nobody learns about asset location or investing in a vacuum. I didn’t. I learned from books and I also learned from trial and error. I know I haven’t covered all the “rules” of tax-advantaged investing above but I’ve described what I’ve learned that applies to me so hopefully it can help you too.
I became a better investor in recent years thanks in part to better asset location. I hope to become more knowledgeable over time, as I mature as an investor and learn more. Death and taxes will never go away. At least for the latter you can do something about it.
Got other ideas about the best locations to hold investments, and why?
Do my rules go against yours?