I haven’t blogged in a while and might not for some time as I’m really busy right now with work and personal things. I am waiting for one more transfer from Clearsight to E*Trade in my wife’s RRSP (yes, my wife is coming over to E*Trade as well) then I will provide an update on our portfolio allocations. Suffice to say that our combined portfolio is an all-ETF, all-index portfolio and is very low-cost. It is also very simple, with so far just 6 ETFs in total. It will remain that way for the foreseable future. I dumped all the old mutual funds after looking closely at their past performance vs. the indexes and not being overwhelmingly convinced that any of them were beating indexes.
I finally crunched the final numbers and here is how we did in 2006:
From: 2006-01-01 to 2006-12-31
TD Stuff: 14.24%
Templeton International Stock Fund: 28.79%
S&P TSX 60 Index ETF: 13.28%
E&P Growth Opportunities Fund: 5.97%
CI Value Trust Fund: 8.89%
TD Canadian Bond Fund (Wife): 8.30%
TD Canadian Bond Fund (Dave): 4.19%
Cash (Wife): 1.71%
Cash (Dave): 6.17%
I got these numbers by making a list of all the inflows and outflows; not just into the entire RRSP but into cash, into the investments, out of the investments, out of cash, and so on. Every transaction is a double-entry transaction, except for the final balance (outflow) and the cash inflows from my chequing account (inflow). I could have just looked at cash flows into my RRSP and the final balances but I wanted to see the breakdown between the different components. Once I had the cash flows for each individual investments I did an Internal Rate of Return for each individually. I also did an overall calculation for the entire portfolio (shown at the bottom). Considering that the EAFE index went up 23.47% last year, the S&P 500 went up 13.62%, and the TSX went up 14.51%, we didn’t do too well. All of the stuff there except for the “TD Stuff” we only owned since March when we switched to Clearsight from TD. So I lost to the the indexes I mentioned above. The reason is because we had a sizable bond portion of about 25% and we were also carrying around a lot of cash (not literally) this year for whatever reason. Well part of the reason was that Clearsight dumped my advisor after they were bought by Wellington West and I ceased communication with them after that as I switched to E*Trade. So I didn’t do any trading during that time and our cash pilled up a bit too much.
The reason that my cash account went up by 6.17% annualized is because the dividends from the iShares S&P TSX 60 Index ETF (XIU) do not get reinvested (ie. it’s not a DRIP) but instead go into my cash account. So the dividends show up as sort of a capital gain in the cash account. One way for me to fix this would be to aggregate the cash inflows and outflows from cash and the iShares XIU and get the annualized return for that combination. That would give the annualized return including inflation. But once I buy another dividend-paying ETF, then what? The final 12.17% annualized return takes into account all the unrealized capital gains and dividends that went into the cash account and the dividends on the TD Canadian Bond Fund that were reinvested.
I really love these calculations. It really shows how well YOU did regardless of that the mutual fund’s NAV or the ETF’s market price did. Look at the TD Canadian Bond Fund for example. My wife got 8.3% annualized on hers and I only got 4.19%. This was because I bought it at a worse time. What’s the lesson here? That you should try to time the market? NO! You can’t time the market (so give up trying). The best way in my opinion is to trade completely randomly (hard to do) or just trade at some regular interval (easy to do) regardless of what the market is doing. Too many investors panic when their investments lose value and chase performance in bull markets. These behaviours lead to lower annualized returns for your portfolio, regardless of what the underlying mutual fund or ETF’s published returns were.
I wrote about investors and their bad timing before. Here is one of the quotes from that blog post:
The results indicated that, as with most active funds, investors’ timing decisions were costly when it came to index funds. The dollar-weighted returns for virtually all large-cap index funds were worse than their official returns for the trailing 10-year period through the end of the third quarter 2005. As the table below shows, poor timing cost Vanguard 500 shareholders 2.7 percentage points of returns per year over the past decade. That’s not chump change.
So I hope to see from these calculations how good/bad my timing is. By this time next year I will have an all ETF portfolio so I will be able to compare my annualized return in index X with the return of index X over the same period.
Canadian Capitalist recently had an article discussing the “smoke & mirrors” guy’s “Myth 1: If I had a $1,000,000… I Could Retire”. I hate guys like Mr. Trahair who rant about the financial services industry and their “vested self-interest in telling people they need more” and flame about how the banks try to scare people into putting more money away for retirement. All the while ignoring the fact that the individual also has a vested self-interest in saving for retirement. It’s the stupidest reason to not invest as much as possible that I have ever heard. It’s like taking a lower salary so you can receive the GST credit.
He talks about how once you retire your expenses are much lower because you will hopefully no longer have a mortgage to pay down, no more kids’ education to pay for, etc… So what? Your expenses could go up too if you want to travel more than before you retired. You could go out for dinner more. You might want to go buy a dream house, buy a cottage, a boat, hire a maid when you are 60, hire someone to help you out when you have a stroke at the age of 70, etc… But no, Mr. Trahir tries to explain how you’ll be just fine with 40% of what you made in your 40s.
The question of how much you need when you retire is irrelevant (if you can easily satisfy your needs). The question is how much do you want? For most people, the more the better. Of course you need money now too, but no one will instinctively starve themselves now to have more money later. Nor will you ever starve yourself now by putting away too much for later. You can always take money out of later if you need it now. One thing I don’t need is Mr. Trahair telling me that I can “get by” on only 30% of my current income in retirement. I’d rather have some balance between now and later. Maybe do some travelling and enjoy the money when I am older on a boat or a condo at Whistler or on Vancouver Island. Not scrape by on 30% of my current income.
It seems his only reason in debunking this “myth” is to “start relaxing a bit.” I think saving up more for retirement than I would actually “need” is a perfect way to “relax a bit.” The stock market and/or interest rates might go through a bad slump and your investments won’t compound as much a your thought/predicted they would. Targetting 100% of your present income (in tomorrow’s dollars) in retirement is playing is safe.
The Canadian Capitalist adds “of course, those planning an early retirement need a larger nest egg.” Another perfectly good argument for saving as much as you can. The more you save, the earlier you can retire.
Smoke and mirrors “is a metaphor for a deceptive, fraudulent or insubstantial explanation or description.” Describes Mr. Trahair very well.
We just did some preliminary tax calculations and thanks to carried-over tuition/education amounts from previous years, and our RRSP contributions from last year, we will be getting a tax refund of around $9500. Sorry you can’t “act now to receive my amazing tax secrets.” We just had a lot of tuition credits to use, but we have now used up all our tuition/education amounts so that will be the last time we have that kind of a refund. We will either be putting that refund into our RRSPs, then reducing our monthly RRSP contributions over the next 12 months, thereby increasing the amount we can put down our student line of credit each month, OR putting it down on the line of credit thus reducing the amount of interest we have to pay on the loan each month, thereby increasing the amount of principal paid each month. Either way, it doesn’t really matter too much. I figure the risk-adjusted return on the RRSP compared to the line of credit is about the same. Although the student line of credit is at prime so the return there is really low.
A reader that goes by “David” provided a link to an article from AIM called “RRSPs versus non-registered accounts.” Here I quote part of his comment:
There are opinions all over the place on these calculations. A study published by AIM Trimark states that RRSP only come out ahead if the refund is also invested. IF the refund is used for other purposes then the un-registered investment is a better choice. RRSP vs. Non-Registered.pdf. This is what Martin Gale also states — you have to invest the whole $1000 (the $640 you have in hand, plus the refund you get).
This was my reply:
David, thanks for AIM link. Totally makes sense and thanks for bringing up the fact that the refund must be invested, not squandered. This is implicit in Martin Gale’s calculation, as you pointed out “This is what Martin Gale also states — you have to invest the whole $1000 (the $640 you have in hand, plus the refund you get).”
I am writing this blog post just to emphasize this point again. The reinvestment of the RRSP refund was implicit in Martin Gale’s calculations and I sort of missed it the first time I read the article. I understood how he used $1000 in the RRSP and $640 outside (pre-tax and post-tax amounts respectively) but hadn’t fully realized the significance. Remember that you are deferring your income tax until later. The government gives you back some tax that it collected throughout the year but you’ll need that for later, when you withdraw from your RRSP and have to declare it as income. So you better invest the tax you saved now to offset those income taxes you’ll be paying later. As “David” above pointed out, IF the refund is used for other purposes, like a new TV, then the unregistered plan is a better choice. And when we say better choice, we mean a better choice for the long term… but if you get a new TV now, that’s better for the short term (well, if you think TVs are a good thing). Like Jerry Seinfeld said when comparing medicines at the pharmacy “do I want to feel good now, or later?” I think it’s best to try to find a good balance of both.
I have written a lot of old articles having to do with putting your tax refund to good use, so I won’t belabour this point and further.
I am going to be buying a US ETF (like an S&P 500 ETF) and an international ETF (like an MSCI EAFE ETF) in the near future in my or my wife’s E*Trade self-directed RRSP account. I was just wondering if anyone out there has some good advice on whether I should buy the US dollar ETFs, like VTI (Vanguard Total Market) or EFA (iShares ISHARES MSCI EAFE ETF), or the Canadian-dollar hedged versions, like XSP (iShares S&P 500 ETF) and XIN (iShares MSCI EAFE ETF). Currently I have no USD investments.
Here’s the advice I have to go on so far. This might be of interest to others who are asking the same questions.
- Martin Gale seems to recommended the Vanguard funds (which are all in USD-only and traded on US exchanges) because of their low MERs. He reminds readers to “please think about where you will be when you spend your investment savings. If you are planning to live in Canada then your expenses will be paid in Canadian dollars. In that case it would be worthwhile making sure a lot of your investments are in Canadian dollars as well–perhaps by concentrating on Canadian bonds.”
- In another article by Martin Gale about the scrapping of Foreign Content rules in RRSPs, he has a long section called “Thinking About Currency.” The key message here seems to be balance. Some currency risk (ie. having some holdings in USD) is ok but make sure a significant portion of your savings is in Canadian dollars. He throws around 40% CAD in your nest egg for young people and 80% for more conservative investors, saying that “That should provide adequate protection from the whims of the swinging Loonie while still ensuring a proper global allocation.” On the other hand, too much investment in Canadian dollars is also bad thing. In another article entitled “How much US dollar investment in your RRSP is too much?” he says that “If you still have many income earning years ahead of you, but your job prospects depend on the Canadian economy (most working people’s do) then you might want to avoid Canadian investments lest your job and your savings are both lost in the same Canadian recession.”
- The Canadian Capitalist has mentioned USD currency exposure a lot in the past and in fact just re-iterated his opinion on it today, “I believe that investors with a reasonably long-term view (more than 10 years) should ignore currency fluctuations, as it is impossible to precisely predict currency movements even in the near-term.” In other words, I think what he’s saying is that the currency fluctuations will help you some years and hurt you in others but over the long term your return in CAD will probably be fairly close to the return in USD. A while back he talked about the difference between iShares and iUnits (the Canadian ones, now also called iShares). He later said he would have used the USD versions rather than the CAD versions if he were to start the Sleepy Portfolio all over.
I am leaning towards going with the USD versions since I have no US currency exposure, and to avoid the extra cost associated with the currency hedging on ETFs like XSP and XIN. Also, as Martin Gale said, the Vanguard ETFs are very low-cost, and there is more variety, compared to what we have available in Canada.
Martin Gale form Efficient Market Canada just wrote an amazing piece, laying out the case for RRSPs over non-registered investment in a growth stock, a dividend stock, and a mortgage payment. This article is a MUST READ for anyone who has every wondered if investing outside an RRSP has some advantages over investing inside an RRSP. Or if you have ever wondered if you should pay down your mortgage rather than investing in an RRSP. Here’s the set-up:
Are people really better off saving money outside of an RRSP? Some say buying and holding growth stocks that pay no dividends is another way to defer taxes, and that investments in an RRSP lose access to the dividend tax credit. Others say that it’s better to repay your mortgage than invest in an RRSP There are a lot of people out there who say things like this and they are almost always wrong. The arguments for non-registered investments generally involve a lot of handwaving and grand claims so let’s break it down and look at the numbers. First we’ll look at buying stocks in and out of an RRSP, then we’ll compare an RRSP to a mortgage payment.
This article is going to be a straight-forward proof that investments in an RRSP beat investments outside of an RRSP in terms of expected returns.
A couple notes about his calculations… As he says, “Note that if anything these assumptions bias against the RRSP because for many people the tax on withdrawals from an RRSP will be lower in retirement than the tax saved at contribution time.” He goes on to give a good reason for why this is usually the case. Another reason these calculations are biased against the RRSP is because he neglects the fact that the investments outside the RRSP might be taxed every year if you are selling your investments every year and buying new ones, for example, whereas inside the RRSP your investments will experience tax-free growth. I just did a quick back of the envelope calculation and this does make a difference.
In the end the RRSP wins out in each case, even though some simplifications in the calculations bias the calculations against RRSPs. The key reason the RRSP comes out ahead, as he explains so well, is because of double taxation outside the RRSP. Taxation on your income (off your paycheque), then taxation on the gains made off those investmentes. In the RRSP you are only taxed once, when you withdraw the entire thing, your gross income plus gains from the RRSP as income.
Almost everyone who argues that the non-RRSP is better ignores the fact that the non-RRSP payment was made with after tax dollars, in other words, they ignore the double taxation.
Around this same time last year I looked at a Phillips, Hagar, & North report that compared investing in an RRSP with investing outside an RRSP. It was called “The Retirement Savings Debate: Inside or outside the RRSP structure” and their conclusion was that
saving for retirement using a registered plan (RRSP) is more beneficial than saving in a non-registered, taxable account. There are a few exceptions to this, but for the most part, this conclusion will hold true for the majority of middle- and upper-income earners.
If anyone finds that PH&N report, let me know. That blog post also had a quote from Derek Foster, which after looking at it again, now seems like total bunk.
I also wrote about paying down student loans vs. contributing to an RRSP although I neglected a few things (see comments).
In the Globe & Mail, Dale Jackson Debunks some RRSP Myths. Overall, I thought the article was good and I liked it.
In debunking Myth #2 in the article, Dale Jackson says “There’s also a strong argument for young investors to delay making RRSP contributions until they are in their higher income years and the tax savings are bigger. The trade off would be less time to allow savings to grow tax-free. [emphasis mine]” First of all, he is confusing himself and all of us when he misuses the term “contributions” with “deductions.” He means to say “deductions” here. Let me re-write his quote the way I think it should be: “There’s also an argument for young investors to delay making RRSP deductions until they are in their higher income years and the tax savings are bigger.” I have replaced “there is a strong argument” with “there is an argument.” In a previous blog post I did some calculations to determine whether or not it is smarter to delay that RRSP contribution or not. As far as contributions go, there is a strong argument to make contributions right away without delaying, so you can take advantage of tax-free growth. ie. no capital gains and no tax on dividends or interest.
Another small detail concerning contributions and deductions. Myth #3 is: “3. You must take advantage of your maximum allowable contribution the year it is issued.” Answer: “Wrong. The difference between the allowable amount and what you contribute can be used in later years.” Although this is totally correct, you could also write a Myth #3.5 (which I think is a WAY, WAY, WAY bigger myth): “3.5. You must deduct all of your contribution the year you contributed.” Answer: “Wrong. The difference between what you contributed and what you have deducted (which is 0 if you haven’t made any deductions) can be used in later years.” Essentially, you can contribute to an RRSP when you are 16 and make the deduction when you start working full-time after university at the age of 22. That’s 6 years of tax-free compounding. Seriously, I don’t think I’ve met anyone who knew that you could contribute to an RRSP and then deduct it later. I don’t blame anyone though because it’s just not a common thing to do once you get older.
There were actually some pretty good comments in the comments section. I recommend checking it out. There are also some not-so-awesome comments but other readers are quick to point out the flaws.
One reader, Gardiner Westbound, says “. . . Modest income seniors approaching retirement should cash out RRSPs before applying for OAP, GIS and other benefits.”
Nick B. quips:
Gardiner, way to go dispensing unqualified financial advice. An individual applying for those benefits in short order should be working with their bank or advisor to determine how their finances are going to look. There may be a need to manage RSP withdrawals to create non-registered savings, but simply cashing out may well not be a good decision . . .
A long time ago I wrote about why having lots of mutual funds is a bad idea. Namely, lots of overlapping mutual funds of the same type, like Canadian equities, for example. In my case, I owned 4 TD large-cap Canadian equity funds. The punchline is that with so many funds and so many underlying stocks, I was starting to get so diversified that I was about as diversified or more so in the Canadian large-cap market than an index. But I was paying exorbitant MERs on the mutual funds, at least 1-3% whereas I could have just bought 1 index ETF and paid 0.17% MER. A 1-3% difference in performance is huge over the long term.
Tom Bradley at SteadyHand just wrote an article about the exact same thing, however, the example in his case is far more extreme: “The featured couple had registered retirement savings plans totaling $170,000 that were spread across 29 mutual funds.”
I’ll summarize his analysis:
Holding 29 funds is ridiculous whether you’re investing $170,000 or a million dollars . . . But more than anything, owning 29 mutual funds means you’re seriously over-diversified . . . If we assume that there were 45 unique stocks per fund, that’s 900 stocks plus the ones that showed up in multiple funds. Let’s say you own 1000 stocks. What you really own is a very expensive index fund.
and the conclusion/recommendation:
Through exchange-traded funds (ETFs) you could get the same market exposure for an average fee of 0.25 to 0.30 per cent a year on their management expense ratios. I hazard a guess that the couple in the article were paying in the neighbourhood of 2.5 per cent. It is no wonder they were disappointed with their mutual fund returns.
I suspect that there are many Canadians in a situation similar to the one that I was in, or similar to the one the couple above was in. My guess it that there is a subset of those people who DO look at the MERs on funds (so they are thinking about cost a little) and given two funds, will choose the lower MER one over the high MER one. But most probably fail to think about their cost relative to an index ETF and their risk-adjusted return relative to an index ETF.
Finance Minister Flaherty is still considering allowing income splitting for all (ie. not just those over the age of 65). It doesn’t sound like the benefits are that big. Well maybe one might consider them to be big; they are just smaller than I expected them to be:
The Canadian Taxpayers Federation calculates that a single-income family with a $100,000 earner would save $4,320 this year under a split-income scheme that would allow each spouse to declare $50,000.
By way of comparison, a family with one $75,000 earner and a $25,000 earner would save $1,000 if they split their declared income.
I’m glad that they have “go ahead with joint filing for pensioners and seniors with respect to pension income.” It means I don’t have to worry about spousal RRSPs at all. But would the government ever take away income-splitting for pensioners in the future? Maybe. Would the grandfather it to those with existing RRSPs? I don’t know. I mean the government can do anything if they want.