Liquid Independence

Liquid is the main editor of the Freedom 35 Blog.

Jul 072015
 

Determining which account (Tax Free, Retirement, or Taxable) to hold different investment types in

Today’s post is targeted specificity at Canadians and assumes the reader is already familiar with the TFSA, RRSP, and regular taxable accounts.

There are two parts to every investment decision we make; the investment itself, and the type of account to hold that investment in. Asset allocation is important because we don’t want to put all our eggs in one basket. But asset location is also important because different types of investment incomes are taxed at different rates. Thankfully we can hold our investments in special tax advantaged accounts to shelter our profits so we don’t pay more tax than we have to. 😉

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In an ideal world all of our investments would be bought inside tax advantaged accounts such as a TFSA or RRSP. There’s little reason to use a non-registered (taxable account) if there is still contribution room remaining in our tax free or registered retirement accounts. However its possible to purchase more investments than what our tax advantaged accounts will hold. If that’s the case then investment income that is typically taxed at higher rates should take priority inside a TFSA or RRSP. So with that in mind let’s get down to the nitty-gritty. :)

Which Investment Vehicles to use: TFSA, RRSP, or Non-Registered

Where is the best place to put stocks, bonds, mutual funds, and ETFs? Should they go in an RRSP or a TFSA? There is no categorically correct answer but here are some general guidelines that I follow.

  • Use RRSPs for interest producing investments and U.S. dividend paying companies.
  • Use non-registered accounts for Canadian dividend paying companies and preferred shares.
  • Use TFSAs for everything else.

For a deeper look, below are two charts that go into specifics. The first chart shows how different types of investment income is taxed in different kinds of accounts for someone in the 31% marginal tax bracket. The second chart suggests the best accounts to buy different types of specific investments in. 😀

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Additional notes to consider:

  • If we hold U.S. dividend stocks in a taxable account we’ll pay the 15% U.S. withholding tax off the top. But we can claim a foreign tax credit on our tax returns to recover some or all of this amount. However we’ll pay tax at our marginal rate on the full amount of the U.S. dividend. The net result is that U.S. dividends held in a non-registered account will be taxed at the same rate as interest income.
  • Dividend income from U.S. dividend stocks in a Tax Free Savings Account (TFSA) is also subject to the 15% withholding tax, however this tax is non-recoverable. But the remaining dividend and any capital gains is not taxed.
  • Dividend income from U.S. stocks in an RRSP are exempt from the 15% withholding tax. But this only applies if we directly hold a stock or ETF traded on a U.S. exchange. If the U.S. stocks are held in a Canadian mutual fund or ETF, we will need to pay the unrecoverable 15% withholding tax on the dividends.
  • Keep in mind that although many investment incomes are tax efficient while being held in an RRSP, any money withdrawn from the RRSP or RRIF later on will be subject to income tax at the full marginal rate and could trigger claw-backs for income tested government benefits like OAS.
  • Tax efficiency should not be the only factor when deciding which account to put an investment into. Simplification of record keeping, personal financial situation, risk tolerance, and retirement goals all have to be considered.
  • For most intents and taxation purposes RESPs behave the same way as TFSAs. RRIFs and LIRAs behave similar to RRSPs.

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Jul 042015
 

Greece is holding a referendum tomorrow, Sunday, on whether or not they want to accept the bailout terms from their creditors. I’m not great at economic forecasts but I feel like the majority will vote yes for better or for worse.

[Edit] The result is out. Greeks voted No, lol. This is why I’m not an economist. [/Edit]

In other news it hasn’t been a very good month for global markets. Both the U.K. FTSE 100 and the French CAC 40 indices are down about 4% for the month of June. But China experienced the most dramatic loss. The Shanghai Stock Exchange Composite Index fell by 25%. Sufferin succotash! 😲 A whole bunch of millionaires in China just lost 1/4 of their wealth in the span of 30 days.

Here in Canada our stock market index dropped 3.5%, not as bad as other countries, but still enough to wipe out any gains it’s accumulated so far in 2015. As a result my net worth is down for the first time in years, lol. This means my portfolio is finally large enough that my change in wealth is determined more by the fluctuations in the market than by my savings rate.

*Side Income:

  • Part-Time Work = $600
  • Dividends = $500
  • Interest = $0
*Discretionary Spending:
  • Fun = $100
  • Debt Interest = $1500

*Net Worth: (MoM)15-06-networthiq_chart

  • Assets: = $897,400 total (-5000)
  • Cash = $2,500 (-2000)
  • Stocks CDN =$93,600 (-1300)
  • Stocks US = $65,100 (-200)
  • RRSP = $51,200 (-1500)
  • MICs = $15,000
  • Home = $259,000
  • Farms = $411,000
  • Debts: = $508,100 total (-4300)
  • Mortgage = $193,500 (-400)
  • Farm Loans = $200,700 (-500)
  • Margin Loan CDN = $29,600 (-1900)
  • Margin Loan US = $25,800 (+100)
  • TD Line of Credit = $26,000  (-1000)
  • CIBC Line of Credit = $10,000
  • HELOC = $18,200
  • RRSP Loans = $4,300 (-600)

*Total Net Worth = $389,300 (-$700 / -0.2%)
All numbers above are in $CDN. Conversion rate used: 1.00 CAD = 0.80 USD

This is why it’s important to understand our financial decisions. Warren Buffett said “if you understood a business perfectly and the future of the business, you need very little in the way of a margin of safety.”

For example, when I look at my assets listed above I know what purpose each line item plays in my financial plan to reach early retirement. I know why I have $2,500 in cash right now, not more, not less. When I look at any of my investments I know why it’s in my portfolio. As another famous investor Peter Lynch once said, “know what you own, and know why you own it.” 😀

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Jul 012015
 

The European debt crisis is so confusing, it’s like Greek to me. lol 😀 As of yesterday Greece became the first developed country to default to the International Monetary Fund (IMF) to the tune of €1.6 billion. Overall Greece owes about €300 billion to all its creditors.

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A referendum in Greece will be held this upcoming weekend to decide if the Greek people would like to stay in the European Union and continue using the Euro, or exit the EU and revert back to their old national currency. What happens next is the million-euro question. A Greece exit (Grexit) should not have a large direct impact on other countries. But here are some lessens we can take away from the predicament facing Greece right now.

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Jun 282015
 

Earlier this month I blogged about my plan to help make this world a greener place by supporting renewable energy initiatives. One way to do this profitably is to invest in green companies. On Thursday this past week I purchased 50 shares of Brookfield Renewable Energy, (BEP.UN) for $38.05 CAD each for a total cost of roughly $1,900. It also trades as BEP on the New York Stock Exchange for interested investors in the U.S.

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This is my first investment in a pure-play renewable energy company. Brookfield Renewable develops, owns, and operates renewable power generation facilities. It’s one of the largest and most diversified publicly traded green companies in the world. BEP has a diversified portfolio of high quality assets and over 100 years of power generating history. :)

The Business of Brookfield Renewable Energy

I’ve always like the idea of investing in B.C. Hydro or Ontario Hydro because the idea of creating electricity through the power of nature itself (water and gravity) and then selling that electricity to make money sounds like a great business model. The profit margin must be very profitable because once a hydro dam is built it doesn’t cost much to maintain it. But there’s no practical way for me to invest in crown corporations and government operated hydro facilities. Luckily, Brookfield Renewable has the solution. :)

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BEP has over 7,000 MW of installed capacity, predominantly from its large hydroelectric portfolio. This means I can invest in water dams via BEP. :) 80% of the company’s assets is hydro projects, the highest quality renewable asset class. The other 20% is split between solar farms and wind farms with a compelling total return profile. In total Brookfield Renewable has $20 billion of assets under management (AUM,) mostly in North America, as the map below shows.

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Investment Returns

But ultimately what I really want to know is will this company be profitable in the future. First let’s look at its historical returns. Thanks to the experienced management team at the Brookfield Asset Management company (BAM), the parent company of Brookfield Renewable, BEP was able to return to its investors 16% compounded annualized return since inception in 1999. Hey not bad at all! 😀 It outperformed both the Canadian and U.S. stock market indexes.

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Jun 252015
 

Some people may think of me as frugal, but that’s actually not entirely true. For example, I spend a lot of money (over $2,000 every month) on interest payments. 😉 It’s fun to find out how much other people spend on their hobbies. But in the end it’s pointless to judge their behavior because money contains different meaning to different people. This is because our real wealth is time. Money is merely a means to maximize the enjoyment we get out of our time in this world.

This is why some people who make $30,000 a year can live a happier, more fulfilling life than others who make $300,000 a year. The income gap between the rich and poor gets a lot of attention, but from a broader perspective most people have roughly the same amount of real wealth in this world, which is measured in years, not dollars. The truly unfortunate are those who are so poor that all they have is money, lol. If all my financial assets disappeared overnight I’d be fairly upset. But if I knew I only had a few more months to live I’d be devastated. 😱 I don’t blame Walter White for what he did. Dire times call for extreme measures.

So if our goal is to enjoy life to its fullest using our limited financial resources then we simply have to allocate the right amount of money for each block of time we spend living. This means if we watch more than 10 hours of live sports a week then spending $3,000 on a new 60 inch 4K Ultra HD LED TV is totally justified. 😀 After seeing a football or soccer match in 3840 x 2160 resolution there is no going back. 😉 But on the other hand if we use those 10 hours a week to play PC games then we should spend $3,000 on a new kick-ass gaming computer instead. :) The point is to choose what our interests, passions, and values are in life, and spend our money with the purpose to maximize our happiness in mind. This way, we’re less likely to second guess ourselves and regret our purchases.

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