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Discussion Starter #1 (Edited)
Hello everyone,

I met with a couple "financial advisors" few months ago to explore differents options for a non-registered account. I am pretty much settled on using ETF in a passive/index strategy and follow a "buy and hold" approach.

While i finally opted for ETF and index/passive strategy one of the financial advisor sent me an email few days ago with some infos regarding how active is better than passive and how active perform better in bear market, etc etc. However, to my surprise he also attached some rather-obscure (for me at least) data about how mutuals funds are more "tax efficient" than ETF for non-registered account. Most of the references i consulted state that ETF are much more tax efficient so this is puzzling me....

Anyone can shed some light on this data and provide an explanation or external references ?

Here is the email tidbit:

Taxation: The products you listed are held in trust (referring to ETF), a structure not fiscally advantageous. When you will want to make movements in the portfolio for these Non-RRSP accounts, it'll cost you dearly in taxes! Fidelity offers a structure for funds company (french: fonds en société, not sure if the translation is correct) that not only allows transfers between funds without immediate tax provision, but this structure will maximize the returns on bonds. In no case, will you receive a distribution as interest, even if your portfolio is heavily invested in bonds. This is an invaluable and incalculable benefit to the customer. In other words, you decide when you want to pay the tax structure unlike ETFs or you will have to pay tax even if there is no provision.
Here is the two scenarios (mutual funds vs etf):
SCENARIO 1: Fidelity Canadian Balanced Class
Starting account value $ 500,000
Ending account value $ 889,789
Starting ACB $ 500,000
Ending ACB $ 548,635
Cumulative tax exposure
Capital gains tax on holdings $ 78,465.48
Tax on re-invested distributions $ 11,185.94
Total $ 89,651.42
Assumed marginal tax rate 46%
Net after tax benefit
After tax market value $ 811,323
tax on re-invested distributions $ (11,186)
Total $ 800,137

SCENARIO 2: Canadian Balanced ETF
Starting account value $ 500,000
Ending account value $ 850,167
Starting ACB $ 500,000
Ending ACB $ 780,525
Cumulative tax exposure
Capital gains tax on holdings $ 16,017.85
Tax on re-invested distributions $ 98,826.89
Total $ 114,844.74
Assumed marginal tax rate 46%
Net after tax benefit
After tax market value $ 834,149.49
tax on re-invested distributions $ (98,826.89)
Total $ 735,323

Source: ca.ishares.com and Fidelity Management and Research Company. The performance of ETFs Canadian balanced and the tax consequences are based on a combined index that consists of the iShares Canadian Composite Index (XIC) to 50% and the bond index Canadian iShares (XBB) to 50% with monthly rebalancing. Assume that the monthly rebalancing between the two ETFs did not lead to tax consequences. The units have not been redeemed for payment of annual taxes due. The performance and the tax consequences of the Fidelity Canadian Balanced Class are based on an investment in Series F. Assumes a marginal tax rate of 46% and an initial investment of $ 500,000.
Here is the actual graph provided:



Quick links for the products mentionned:

Mutual fund:
http://www.fidelity.ca/cs/Satellite/en/public/products/mutual_funds/asset_allocation/cdn_asset_allocation/bl

ETF:
http://www.ishares.ca/product_info/fund_overview.do?ticker=XBB
http://www.ishares.ca/product_info/fund_overview.do?ticker=XIC
 

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I can only assume that the data was cherry-picked to prove their point.

One issue is that class "F" is the type that doesn't pay any trailer fees to the advisor, so the MER is lower. However, I would assume that your advisor would be either putting you in a different class or charging a percentage of your portfolio which would raise the cost a bit.

That doesn't answer your question - I'll have to think about it some more.
 

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Anyone can shed some light on this data and provide an explanation or external references ?
Is it possible for you to post the exact text you received from your FA? It is hard for me to figure to out what I'm looking at.

The FA is wrong on index funds versus ETFs. The references are correct. ETFs are more tax efficient due to their structure.

If I were you, I wouldn't hold any bonds in a taxable account. If possible, I'll hold bonds in a tax-deferred account and Canadian stocks in a taxable account. IMO, balanced funds are not suitable candidates for taxable accounts due to their high fixed income weightings.
 

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Discussion Starter #4
Is it possible for you to post the exact text you received from your FA? It is hard for me to figure to out what I'm looking at.

The FA is wrong on index funds versus ETFs. The references are correct. ETFs are more tax efficient due to their structure.

If I were you, I wouldn't hold any bonds in a taxable account. If possible, I'll hold bonds in a tax-deferred account and Canadian stocks in a taxable account. IMO, balanced funds are not suitable candidates for taxable accounts due to their high fixed income weightings.
Here a quick translation of the relevant part of the email he sent:

Taxation: The products you listed are held in trust (referring to ETF), a structure not fiscally advantageous. When you will want to make movements in the portfolio for these Non-RRSP accounts, it'll cost you dearly in taxes! Fidelity offers a structure for funds company (french: fonds en société, not sure if the translation is correct) that not only allows transfers between funds without immediate tax provision, but this structure will maximize the returns on bonds. In no case, will you receive a distribution as interest, even if your portfolio is heavily invested in bonds. This is an invaluable and incalculable benefit to the customer. In other words, you decide when you want to pay the tax structure unlike ETFs or you will have to pay tax even if there is no provision.
Thanks for helping !
 

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Discussion Starter #5
I can only assume that the data was cherry-picked to prove their point.

One issue is that class "F" is the type that doesn't pay any trailer fees to the advisor, so the MER is lower. However, I would assume that your advisor would be either putting you in a different class or charging a percentage of your portfolio which would raise the cost a bit.

That doesn't answer your question - I'll have to think about it some more.
Yes i also noticed he was referring to Class "F" and that the simulation is doing ... MONTHLY portfolio re balancing...

I am also pretty sure that the data was cherry picked but however, tax implications are very important in my case since its a non-registered account.
 

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As I have stated here before, I am a simple man and I like to invest simply and cheaply and, after much research and mountains of reading on the subject, I simply prefer either a diversified portfolio of individual dividend paying stocks or a diversified portfolio of broad-based ETF's along the lines of the sample portfolios shown at www.canadiancouchpotato.com

Whenever advisors start suggesting anything else, I become cynical and can't help but wonder what is in it for them as the financials services industry is ripe with potential conflicts of interest.

What seem on the surface to be rather insignificant fees can really add up over the years and have a devastating long term effect on your retirement portfolio.

Keep your fees as 'little' as possible!! That is one life lesson that I have learned from the school of hard knocks.:cool:
 

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The reason why your advisor talks about tax efficiency is that any fees you pay are deductible. But why pay a dollar when you can pay a dime? Both are deductible and the former provides a bigger tax deduction but at your expense.

In terms of a family of funds, this is a common argument proferred by the industry. You can switch between members of the same funds family without incurring extra charges. But the price of such flexibility is that you have to pay the higher MER for the fund family.

Think of ETFs as wholesale products in this context. Buying wholesale usually requires a critical mass of purchases. Once you reach such a level, mutual fund families no longer are cost effective.
 

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Discussion Starter #8
The reason why your advisor talks about tax efficiency is that any fees you pay are deductible. But why pay a dollar when you can pay a dime? Both are deductible and the former provides a bigger tax deduction but at your expense.

In terms of a family of funds, this is a common argument proferred by the industry. You can switch between members of the same funds family without incurring extra charges. But the price of such flexibility is that you have to pay the higher MER for the fund family.

Think of ETFs as wholesale products in this context. Buying wholesale usually requires a critical mass of purchases. Once you reach such a level, mutual fund families no longer are cost effective.
thanks for your input, really appreciated.

Regarding tax efficiency, i am waiting for CanadianCapitalist info's regarding 'not holding any funds in a taxable account'. My taxable account is 10x worth what my registered accounts are!

However for the moment, i am 100% cash while i finish my asset allocation and portfolio creation.

Bottom line is, from what the FA said, he seem to imply that mutuals funds are more 'tax efficient' for bonds when used in a taxable account.
 

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...
Bottom line is, from what the FA said, he seem to imply that mutuals funds are more 'tax efficient' for bonds when used in a taxable account.
Yes that is the line that they use. Sure you can deduct the fees in a taxable account. So you get to deduct 2.5% versus an ETF fee of just 0.5% (e.g.). Your tax deduction is much higher but so is your effective cost.

This is the kind of doubletalk that makes my blood boil about "the industry".

The term we used to use in sales (not FA) was "bullshit baffles brains"!
 

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Anyone can shed some light on this data and provide an explanation or external references ?
I believe the advisor is suggesting a "corporate class" mutual fund in this case. There can be tax deferral advantages that "may" have them further ahead of an ETF in the long run. You would be able to theoretically capture dividends and reinvest them without taxation, (until much later when the funds are sold, and only capital gain applies in most cases). As well, one can switch between funds without having to formally sell the fund. The tax deferral is the main benefit of such a fund, but must be weighed against the often astronomical MER.

I've thought about and researched corporate class funds for the non-registered account within my CCPC, but decided that it is less of a headache to be self-directed (and not be stuck with one bank or investment company).
 

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Hello everyone,

I met with a couple "financial advisors" few months ago to explore differents options for a non-registered account. I am pretty much settled on using ETF in a passive/index strategy and follow a "buy and hold" approach.

While i finally opted for ETF and index/passive strategy one of the financial advisor sent me an email few days ago with some infos regarding how active is better than passive and how active perform better in bear market, etc etc. However, to my surprise he also attached some rather-obscure (for me at least) data about how mutuals funds are more "tax efficient" than ETF for non-registered account. Most of the references i consulted state that ETF are much more tax efficient so this is puzzling me....

Anyone can shed some light on this data and provide an explanation or external references ?

Here is the email tidbit:



Here is the two scenarios (mutual funds vs etf):


Here is the actual graph provided:



Quick links for the products mentionned:

Mutual fund:
http://www.fidelity.ca/cs/Satellite/en/public/products/mutual_funds/asset_allocation/cdn_asset_allocation/bl

ETF:
http://www.ishares.ca/product_info/fund_overview.do?ticker=XBB
http://www.ishares.ca/product_info/fund_overview.do?ticker=XIC
just a quick advice, avoid 2x, 3x and inverse etfs. It is just a machine to make $ for the fund and not you. Essentially you are short gamma.
 

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Agree completely with Mike59.
An "advisor" I had ran into a few years ago was really pushing for these corporate class funds.
From what I recall, that was Fidelity too (gee, they must pay great commissions)

I researched into it and decided against it (thanks to some good advice on the old MS forum).
The MERs and DSC are huge.
You will not make any money with these funds.
The fees hurdle is too steep to overcome, esp. with bond funds.
 

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thanks for your input, really appreciated.

Regarding tax efficiency, i am waiting for CanadianCapitalist info's regarding 'not holding any funds in a taxable account'. My taxable account is 10x worth what my registered accounts are!

However for the moment, i am 100% cash while i finish my asset allocation and portfolio creation.

Bottom line is, from what the FA said, he seem to imply that mutuals funds are more 'tax efficient' for bonds when used in a taxable account.
Okay. I understand your dilemma. Since your taxable investments dwarf your registered accounts and you want to hold some fixed income, you are looking for tax efficient ways to do it.

If I were you, I'd explore a product like Claymore Advantaged Canadian Bond ETF, which employs derivatives to provide returns in the form of ROC and capital gains instead of interest. However, you might want to look into whether counterparty risk is acceptable to you.
 

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Discussion Starter #14
Okay. I understand your dilemma. Since your taxable investments dwarf your registered accounts and you want to hold some fixed income, you are looking for tax efficient ways to do it.

If I were you, I'd explore a product like Claymore Advantaged Canadian Bond ETF, which employs derivatives to provide returns in the form of ROC and capital gains instead of interest. However, you might want to look into whether counterparty risk is acceptable to you.
thanks for the info, i will look it up in more details

Generally speaking, what is the general opinion regarding the most efficient/common sense way of splitting a portfolio into different account where there is a huge difference between the registered and non-registered parts ?

For the sake of simplicity, lets take a 100k portfolio with target allocation of 60% in equities and 40% in bonds target, the $$$ allocation is divided like that:

TFSA 10k
RRSP 15k
non-registered 75k

Lets also consider that all account have the same target, long term investing

My take:

TFSA = 100% in XBB or GIC
RRSP = US Stocks/ETF
non-registered : split evenly between ishares/vanguard ETF to attain the 60/40 target while also taking in consideration the percentage already in the others account

I would be very interested in getting input regarding this.

Also, I understand the logic of putting bonds in the TFSA but since its a 'tax free' account, isn't the TFSA also the best place to put the most 'risked' investment and not something as plain as ... bonds ?

ps: pardon my not-so-perfect english folks, hope everyone understand me well :)
 

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Yes that is the line that they use. Sure you can deduct the fees in a taxable account. So you get to deduct 2.5% versus an ETF fee of just 0.5% (e.g.). Your tax deduction is much higher but so is your effective cost.

This is the kind of doubletalk that makes my blood boil about "the industry".

The term we used to use in sales (not FA) was "bullshit baffles brains"!
Am I missing something? I wasn't aware that MERs were tax-deductible.
 

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MERs are not tax-deductible. (Stated more completely, the management costs are already deducted by the fund company and reduce your realized returns - you cannot claim the same expenses twice.)

I just read through this whole thread for the first time. The biggest red flag for me is that the advisor says the benefits of tax deferral are "incalculable."

No, they are entirely calculable - if there is a financial benefit, it is measured in dollars and cents, which you can count.

For goodness sakes, if you are going to make a numbers argument, don't suggest you "can't calculate" the numbers.
 

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The whole discussion on tax efficiencies of different investments is very rich (literally and metaphorically).

I have three studies to share: the first, from the National Bureau of Economic Research (in the U.S.) studied U.S. mutual funds from 1963-1992 and found that the differences between the before- and after-tax rankings (assuming middle- and high-income investors) were dramatic. For example, one fund that ranked in the 19th percentile on a pretax basis ranked in the 61st percentile on an after-tax basis for an upper-income investor (i.e., the fund that seemingly performed worse than 81% of its peers on a pre-tax basis actually beat out 61% of those peers when the after-tax return was considered for an upper-income investor).

A similar study in Canada found similar results: two different funds that had relatively similar performance on a pre-tax basis had a whopping 46% change their ranking was reversed on an after-tax basis.

The classic paper on this topic is "Is Your Alpha Big Enough to Cover Its Taxes?" published by two well-known money managers. If you are interested in learning more about this topic (and you are a finance geek), this is a great place to start.
 

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Holding instruments that provide returns in the form of ROC in a non-registered account would require you to carefully track your ACBs.
If your non reg. portfolio is 75% of your total portfolio (and if it's around $75k as you suggested) and you invest in several such funds, you would have to carefully track ACBs for each investment.
Not a bad thing, just something extra you have to do.
Holding such investments inside RRSP or TFSA means you don't have to track ACBs.
You need to track investment performance, of course.
 

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Am I missing something? I wasn't aware that MERs were tax-deductible.
They are not if the MER is claimed by the fund (normal) but for a class of funds, part of the MER is remitted to the broker and this portion is deductible (Accuity funds for example).
 

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Discussion Starter #20
Holding instruments that provide returns in the form of ROC in a non-registered account would require you to carefully track your ACBs.
If your non reg. portfolio is 75% of your total portfolio (and if it's around $75k as you suggested) and you invest in several such funds, you would have to carefully track ACBs for each investment.
Not a bad thing, just something extra you have to do.
Holding such investments inside RRSP or TFSA means you don't have to track ACBs.
You need to track investment performance, of course.
seem a bit too complicated for me.

i will stay with 'standard' etf, vanguard, ishares, etc
 
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