Tax Aware Investing
Cutting-edge and potentially contentious tax shelters can be tempting, but I’ve seen the pitfalls of overzealous tax minimization strategies.
Tax Alpha
Great to see you again, I’m Jeff van der Maden, Senior Wealth Advisor and Portfolio Manager.
The late Charlie Munger, former vice-chairman to Warren Buffett at Berkshire Hathaway once stated that “trying to minimize taxes too much is one of the great standard causes of really dumb mistakes”. A pretty reasonable assessment if you ask me.
[image of Warren Buffett with text “trying to minimize taxes too much is one of the great standard causes of really dumb mistakes”]
The prospect of cutting-edge and potentially contentious tax shelters can be tempting, but over my 20+ years in this industry I’ve seen the pitfalls of overzealous tax minimization strategies and how they can lead to the dumb mistakes that Charlie was eluding too.
If you hold investments in a taxable account like a personal non-registered account, a Holdco or a professional corporation I have 5 tips that you should consider.
Before I do though, let’s take a quick look at how investment income is taxed in Canada, using an Ontario resident with personal taxable income of $100,000. Here you can see that capital gains and Canadian eligible dividends are taxed at a much lower rate, while interest that you earn on bank accounts, GICs and bonds as well as ineligible dividends will be taxed at your normal tax rate.
{example of tax rates on $100K of taxable income. Comparing average vs. marginal tax rate and applying marginal rate on dividends, capital gains, foreign dividends, and interest]
Now, here are a few ways to increase the real rate of return on your investments;
[Image of 5 tips: #1 Hold your Canadian stocks in your taxable account. #2 Focus on low-dividend stocks. #3 Replace your GICs with discount bonds. #4 Consider replacing your GICs and bonds with preferred shares. #5 Take advantage of simple and proven tax structures.]
#1, hold your Canadian stocks in your taxable account. Although capital gains on all stocks are taxed the same, Canadian eligible dividends are taxed at a lower rate than the dividends you earn from U.S. and international stocks.
[Image of 5 tips: #1 Hold your Canadian stocks in your taxable account. #2 Focus on low-dividend stocks. #3 Replace your GICs with discount bonds. #4 Consider replacing your GICs and bonds with preferred shares. #5 Take advantage of simple and proven tax structures.]
2nd, focus on low-dividend stocks. Stocks that pay little to no dividends tend to earn more of their return in the form of capital gains, which defers the tax you pay until you actually sell the position. This can be more efficient than having to declare higher amounts of annual taxable income.
[Image of 5 tips: #1 Hold your Canadian stocks in your taxable account. #2 Focus on low-dividend stocks. #3 Replace your GICs with discount bonds. #4 Consider replacing your GICs and bonds with preferred shares. #5 Take advantage of simple and proven tax structures.]
Next, replace your GIC’s with discount bonds. Interest income in Canada is fully taxed so by buying bonds that trade at a discount to par you can turn some of your fixed income return into capital gains, where only half to 2/3’s of the return are taxable.
[Image of 5 tips: #1 Hold your Canadian stocks in your taxable account. #2 Focus on low-dividend stocks. #3 Replace your GICs with discount bonds. #4 Consider replacing your GICs and bonds with preferred shares. #5 Take advantage of simple and proven tax structures.]
The 4th idea, consider replacing your GIC’s and bonds with preferred shares. Shifting some of your credit exposure to preferred shares helps you turn some of your interest income into Canadian eligible dividend income.
[Image of 5 tips: #1 Hold your Canadian stocks in your taxable account. #2 Focus on low-dividend stocks. #3 Replace your GICs with discount bonds. #4 Consider replacing your GICs and bonds with preferred shares. #5 Take advantage of simple and proven tax structures.]
And last, take advantage of simple tax structures such as corporate class mutual funds and liquid alternative funds. These healthy alternatives to traditional mutual funds and ETF’s will ensure that more of your returns stay with you.
There is a significant difference between reckless tax evasion and the strategic pursuit of tax alpha within a portfolio. These five tips only scratch the surface. If you have any questions about these concepts, please don’t hesitate to reach out to us for a conversation.
Until next time.
Oh, Canada
Is overconcentration to Canadian markets weighing down your portfolio return?
Oh, Canada
Good day, I’m Jeff van der Maden, Senior Wealth Advisor and Portfolio Manager.
In a recent commentary I highlighted the fact that Canada’s largest pension plan, the $600 Billion CPPIB, has only 12% of their portfolio allocated to Canadian content. This is no surprise to us, over the past 20 years we’ve witnessed a steady reduction in allocation to domestic markets by Canadian pension plans. Back in the early 2000’s Canada’s largest pension plans held around 28% of their assets here at home, by the end of 2023 that number was down to less than 4%.
The direction of domestic holdings by pension plans is not being mimicked by the average Canadian investor. A recent report shows the portfolio of the average Canadian holding a significantly disproportionate amount of domestic equities. On average, Canadian investors have allocated 50% of their total equities allotment to Canadian stocks, this despite the fact that Canadian stocks account for less than 3% of global equity markets.
If you think this is a safer bet, holding an excessive amount of domestic stocks, consider that as of April 30th the top ten companies on the Canadian market made up more than 36% of the index. Clearly the Canadian stock market is top-heavy.
Another risk to being over-loaded with Canadian stocks is sector over concentration. More than half of our stock market is in financial companies and companies that take resources out of the ground. Little to no exposure to the technology sector, health care, consumer goods and services or commercial real estate.
Look, we do understand why Canadian investors might favour home-grown companies. It’s comfortable to own companies that you’re familiar with, companies that you might be a customer or client to. Another reason would be the removal of currency risk in your portfolio. Or maybe you’re investing in a taxable investment account, where you have to declare your investment income as it’s earned. In this case you would prefer the beneficial tax treatment on eligible Canadian dividends. These are all valid reasons.
But ultimately, as an investor you’re missing out on a world of diversification opportunities, investment options that could serve to reduce your portfolio volatility and risk, and ultimately drive greater returns. If Canada’s most successful pension plans can post the returns they do while having only a marginal amount of their portfolio invested in Canadian content, maybe you should too.
To learn more about the benefits of pension-style investing, reach out to us.
Thanks for watching, have a great day.
https://www.newswire.ca/news-releases/oh-canada-canadian-investors-still-have-high-levels-of-home-bias-in-their-portfolios-but-are-increasing-global-diversification-891239201.html
To Be Successful, Copy Success.
Investment lessons from one of the largest pension plans in the world.
Thanks for tuning in, I’m Jeff vanderMaden, Senior Wealth Advisor and Portfolio Manager with Kom vanderMaden Advisory Group of CIBC Private Wealth.
Hot off the press, the Canada Pension Plan Investment Board (also known as the CPPIB) recently released their Fiscal 2024 results.The CPPIB has over $600 Billion in assets under management (yes that’s billion with a B), making it one of the 10 largest pension funds in the world. For fiscal year 2024 which just wrapped up on March 31st they generated a one year nominal investment return of 8.0%.
Why might this be of interest to you? It’s fair to say that almost every Canadian adult is impacted by the CPPIB, either as a contributor or a recipient of benefits. So it wouldn’t hurt to keep tabs on the financial health of this plan.
Why are the details of this plan important to us? Our years of research into the composition of some of the largest pension plans in North America has led us to the development of our own Pension-Style Investment Management process.
In a later video I’ll address the many and exceptional responsibilities of a successful pension plan, at this time though I want to draw your attention to two observations I made from the CPPIB year-end portfolio disclosure.
The first, is that our very own Canada Pension Plan has only 12% of its portfolio invested in Canada. This is a stark contrast to the portfolio of the average Canadian where we’ve seen domestic allocations as high as 100%.
The second standout is that the CPPIB allocates only 42% of the portfolio to publicly traded stocks and bonds. That leaves 58% of the portfolio invested elsewhere, and spoiler alert, that elsewhere is not cash or GIC’s.
Most of the remaining allocation has been steered into Private Investments, meaning direct investment in assets that don’t trade on a public exchange like the stock market. In addition to their Private investments, they covet an investment class called Real Assets which refers primarily to infrastructure and real estate. Airports, cell towers, data centres and toll highways to name only a few.
If this alternative method of managing an investment portfolio works for the $600 Billion CPPIB, why wouldn’t it work for you? To find out how your portfolio could look and act more like a successful pension plan, reach out to us.
Thank you for watching, see you soon.