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Cutting up a 3-ETF Portfolio Into a 5-ETF Portfolio in an RRSP Account

In my last blog post, we worked out the approximate asset class weights for US, international and emerging markets stocks targeted by the iShare Core MSCI All Country World ex Canada Index ETF (XAW). Now that we’ve got our breath back and our allocations in order, let’s sharpen our scissors and start running through what it would take to slice up a 3-ETF portfolio holding a single global XAW fund into a 5-ETF portfolio holding the same positions in individual ETFs. 

For example, a balanced 3-ETF portfolio (such as 20% Canadian stocks, 40% global stocks and 40% Canadian bonds) could be recreated into a 5-ETF portfolio by multiplying the 40% global stock target asset allocation by each of the US, international and emerging markets stock allocation weights that we calculated in our previous blog. This would lead us to invest 21.37% of the portfolio in US stocks, 13.89% in international stocks and 4.74% in emerging markets stocks.

Money Makes the World’s ETFs Go Round

Do you remember why in the world we’d want to create a more complicated handful of holdings out of your simple three-part portfolio to begin with? The simple answer: money. In an RRSP account, there can be noticeable foreign withholding tax and product cost savings to be had by breaking up with your global stock ETF. The larger your portfolio, and the higher your allocation to global stocks, the greater the potential savings. 


By moving to a 5-ETF portfolio, you can potentially save $100s if not $1,000s per year.


Have I got your attention? Now to the logistics. 

Breaking Up for Fun and Profit

Here are what the allocations described above look like in table form: 

Stock Asset Class XAW Weight
Global Stock Portfolio Allocation
Balanced Portfolio Allocation
(A × B)
US 53.43% 40% 21.37%
International 34.71% 40% 13.89%
Emerging Markets 11.86% 40% 4.74%
Total 100.00%   40.00%


So if you were managing a $100,000 balanced portfolio, you would allocate $20,000 to a Canadian equity ETF ($100,000 × 20%), $21,370 to a US equity ETF ($100,000 × 21.37%), $13,890 to an international equity ETF ($100,000 × 13.89%), $4,740 to an emerging markets ETF ($100,000 × 4.74%) and $40,000 to a Canadian bond ETF ($100,000 × 40%). 

Intentionally Familiar Turf

I’ve included the portfolio weights for other asset allocations below (as of September 30, 2017). If you’ve already noticed that these portfolios closely resemble my 5-ETF model portfolios, give yourself a gold star, because this is no coincidence. My model portfolios are meant to approximate these asset mixes, albeit with fewer decimal points to clutter the view.

As of September 30, 2017

The Not-So-Fine Print 

There’s a catch, of course.  Isn’t there always? To score the cost savings that make the exercise worthwhile, you will need to purchase US-listed ETFs in your RRSP account. This requires mastering the Norbert’s gambit strategy for converting your loonies to dollars as cheaply as possible. (I’ve posted step-by-step Norbert’s gambit YouTube tutorials to help with this task.) 

If you feel intimidated by the process and would rather stick with your easier 3-ETF portfolio, that’s certainly your call. But before you dismiss the idea entirely, remember: The savings can be as much as the management expense ratio (MER) you’re already paying each year. For example, a balanced 3-ETF portfolio has an MER of 0.14%. The foreign withholding tax and product cost savings of a 5-ETF portfolio in an RRSP account is also about 0.14%. Are you sure you want to leave that much money behind? 

To help you decide, check out the table below, showing estimated tax and cost savings for a 5-ETF portfolio. If you have less than $50,000 in your RRSP account, a very conservative asset allocation, or both, you may decide the potential savings – about the cost of a modest meal – just isn’t worth the extra complexity. At the other end of the spectrum, if you can feast on major money spared, you may want to go for the gusto.

Estimated Annual Tax and Cost Savings: 5-ETF Portfolio vs. 3-ETF Portfolio 

RRSP Value ($) 100% bonds 20% stocks
80% bonds
30% stocks
70% bonds
40% stocks
60% bonds
50% stocks
50% bonds
60% stocks
40% bonds
70% stocks
30% bonds
80% stocks
20% bonds
100% stocks
$50,000 $0 $22 $35 $47 $57 $69 $81 $91 $116
$100,000 $0 $45 $69 $93 $114 $138 $162 $183 $231
$150,000 $0 $67 $104 $140 $171 $207 $243 $274 $347
$200,000 $0 $90 $138 $186 $228 $276 $325 $366 $463
$250,000 $0 $112 $173 $233 $285 $345 $406 $457 $578
$300,000 $0 $135 $207 $280 $342 $414 $487 $549 $694
$350,000 $0 $157 $242 $326 $399 $483 $568 $640 $810
$400,000 $0 $180 $276 $373 $456 $552 $649 $732 $925
$450,000 $0 $202 $311 $420 $513 $622 $730 $823 $1,041
$500,000 $0 $224 $345 $466 $570 $691 $811 $915 $1,157
Cost/Tax Savings (%) 0.00% 0.04% 0.07% 0.09% 0.11% 0.14% 0.16% 0.18% 0.23%


Number crunching

So now that you’ve seen the potential cost savings and you understand what’s involved with managing a 5-ETF portfolio, are you considering making a change? Feel free to leave your comments below about your experience managing a 3-ETF or 5-ETF portfolio, and why your chosen number works for you.

By: Justin Bender | 8 comments

Where Does Your Global Stock ETF Weigh In?

Before BlackRock Canada created the iShares Core MSCI All Country World ex Canada Index ETF (XAW) back in 2015, we had no decent way to test our lung capacity. Can you say the entire fund name in one breath? ETF investors also were forced to strain their mental muscles, deadlifting a combination of several US, international and emerging markets ETFs and wedging them into one unwieldy portfolio.

These days, investors have it easier with XAW’s broad stock market exposure to over 8,000 companies around the globe. It excludes Canadian companies, so you’ll need an additional ETF for those, but the fund is still a welcome addition to most modest-sized portfolios.

Then again, the easy route isn’t always the best route for everyone. For example, tell your personal trainer you don’t need those sit-ups because you already did some last week. As your portfolio increases in size, it may be cheaper and more tax-efficient to switch back to the old-school way of doing things (i.e. buying separate ETFs for your US, international and emerging markets exposure).

But how do you get started with a new portfolio fitness regime, once you’ve gotten so used to working with a single global equity ETF?

Sweating the details

As with any bundled product, it can be difficult to understand what you’re actually buying. Reviewing the ETF’s website is a good starting point, but to really get it, I recommend rolling up your sleeves and checking out the index that the fund tracks (as well as the individual US, international and emerging markets equity sub-indices).

Working out with the weight of the world

XAW follows the MSCI ACWI ex Canada IMI Index. “ACWI” stands for “All Country World Index,” which means that it includes companies in both developed and emerging markets. “IMI” stands for “Investable Market Index,” which means that it tracks large-, mid-, and small-sized companies.

The MSCI ACWI ex Canada IMI Index can be broken down further into three sub-indices:

  • The MSCI USA IMI Index (which tracks US stocks)
  • The MSCI EAFE IMI Index (which tracks stocks in developed markets, excluding North America)
  • The MSCI Emerging Markets IMI Index (which tracks stocks in emerging markets)

To determine how much weight each of these sub-indices represents in the overall parent index, we’ll follow these steps:

Step 1: Download the index fact sheet for the MSCI USA IMI Index and obtain the market capitalization in US dollars. (As of September 29, 2017, this figure was $25,959,263.89 million.)

Note: Instead of using MSCI’s search function on their site, I tend to just Google the name of the index, followed by “fact sheet”.


Step 2: Download the index fact sheet for the MSCI EAFE IMI Index and obtain the market capitalization in US dollars. (As of September 29, 2017, this figure was $16,867,756.65 million.)


Step 3: Download the index fact sheet for the MSCI Emerging Markets IMI Index and obtain the market capitalization in US dollars. (As of September 29, 2017, this figure was $5,761,814 million.)


Step 4: Add together the market capitalization figures from steps 1–3, which should equal $48,588,834.54 million. This is the market cap of the MSCI ACWI ex Canada IMI Index. (To double-check this figure, download the index fact sheet for the MSCI ACWI ex Canada IMI Index.)


Step 5: Divide the market cap of each sub-index by the market cap of the parent index. For example, to determine the weight of the MSCI USA IMI Index in the MSCI ACWI ex Canada IMI Index, divide $25,959,263.89 by $48,588,834.54, which equals 0.5343, or 53.43%. The MSCI EAFE IMI Index and the MSCI Emerging Markets IMI Index account for the remaining 34.71% and 11.86% of the MSCI ACWI ex Canada IMI Index, respectively.

Composition of the MSCI ACWI ex Canada IMI Index

Index Asset Class Number of Companies Market Cap (USD Millions) Allocation %
MSCI USA IMI Index US Stocks 2,446 $25,959,263.89 53.43%
MSCI EAFE IMI Index International Stocks 3,178 $16,867,756.65 34.71%
MSCI Emerging Markets IMI Index Emerging Markets Stocks 2,667 $5,761,814.00 11.86%
MSCI ACWI ex Canada IMI Index Global Stocks (ex Canada) 8,291 $48,588,834.54 100.00%

Source: MSCI index fact sheets as of September 29, 2017


Now that we know the weights of the various asset classes that XAW tracks, we can select the Canadian-listed and US-listed ETFs that most closely resemble the sub-indices:

Sub-Index Canadian-Listed ETF US-Listed ETF
MSCI USA IMI Index iShares Core S&P U.S. Total Market Index ETF (XUU) iShares Core S&P Total U.S. Stock Market ETF (ITOT)
MSCI Emerging Market IMI Index iShares Core MSCI Emerging Markets IMI Index ETF (XEC) iShares Core MSCI Emerging Markets ETF (IEMG)

Putting the program together

In my next blog post, I’ll show you how you can replace your XAW ETF holdings with a combination of these ETFs, to potentially pump up the money you might save on fees and foreign withholding taxes.

By: Justin Bender | 0 comments

Corporate Taxation: Terminating Your Tax-Free Capital Dividends

Cue ominous action-adventure music: Bah-da-bum-ba-dum (Pause) Bah-da-bum-ba-dum (Pause) … Open to a darkened alley, just past midnight. Chain-linked, foggy, foreboding. You’re all alone. Bah-da-bum-ba-dum (Pause)

Just a fantasy scene from one of the Terminators? (Five so far, and counting.) Think again. Our own government may not be satisfied with just axing the refundable taxes in a corporation. They also have their sights set on mostly terminating your corporation’s tax-free capital dividends.

You may recall from my past blog that your company’s capital dividend account is where the non-taxable portion of your corporate capital gains are tracked. If there is a positive balance in the account, tax-free dividends can be paid to shareholders.

It’s tax-free now, anyway. Bah-da-bum-ba-dum (Pause) …

If the government’s current proposal is enacted, it will disallow the non-taxable portion of capital gains to be paid out as tax-free capital dividends. They’ll instead effectively tax the “non-taxable” portion of capital gains at the shareholder’s ineligible dividend tax rate when the funds are withdrawn from the corporation.

At first glance, this doesn’t seem fair at all, as individual investors are only taxed on half of their capital gains. Then again, just as in the Terminator series, the good guys and bad guys (and gals) aren’t always immediately obvious. Especially if they’re like Arnold Schwarzenegger and they get reprogrammed between movies.

So what gives? Is there some method to the seeming madness?

The government’s reasons for proposing a tax-free capital dividend ban are similar to why they have proposed eliminating corporate refundable taxes. Small business owners initially pay less tax on their active business income than individual taxpayers do on their regular salary income. It’s as if the government has loaned the small business owner extra cash at 0% interest for investment. So if both types of taxpayers invest their after-tax income in an investment portfolio, the small business owner will end up ahead (due to their initially higher investable income).

By taxing the non-taxable portion of a corporation’s capital gains once it’s distributed to shareholders, the government believes this will rectify the current corporate advantage. Is the new tax form equitable as proposed? Or is it like one of those shape-shifting cyborgs that aren’t what they seem to be? Let’s tear into the numbers and see for ourselves.

Rise of the corporations

In the example below, we’ll once again compare three Ontario taxpayers:

  1. An individual taxpayer
  2. A corporation taxed under the current (capital dividend / refund) system
  3. A corporation taxed under the proposed (no capital dividend / no refund) system

I’ve assumed that the individual earns an additional $100,000 of income. (That is, they are assumed to have already earned $220,000 of other income, so the additional $100,000 is taxed at Ontario’s top personal marginal tax rate of 53.53%.) The after-tax amount of $46,470 [$100,000 × (1 – 53.53%)] is then invested in a portfolio that yields 6% of unrealized capital gains each year. At the end of 10 years, the capital gains are realized, and the 50% taxable portion of capital gains is taxed at 53.53%.

In similar vein, both corporations are assumed to earn $100,000 of active business income, which is initially taxed at Ontario’s small business income tax rate of 15%. The corporate after-tax amount of $85,000 [$100,000 × (1 – 15%)] is then invested in the same sort of portfolio, yielding 6% in annual unrealized capital gains. At the end of 10 years, the capital gains are realized, and the 50% taxable portion of capital gains is taxed at 50.17% (which is the tax rate on passive investment income earned in an Ontario corporation). Any taxable dividends paid from the corporations to their shareholders are then taxed at 45.30% (Ontario’s top personal tax rate for ineligible dividends).

A final caveat: Like a Hollywood producer, I’ve rigged these assumptions a bit to make the calculations easier to follow. Your own, real-life returns probably wouldn’t end in such nice, round numbers.

Judgement day

After 10 years, the individual investor realizes capital gains of $36,751 and pays $9,836 in taxes ($36,751 × 50% × 53.53%), leaving $26,914 of after-tax investment income ($36,751 - $9,836).

Note: For all you investment-bots out there, you can quickly calculate the capital gains realized over the 10-year period by using your financial calculator:
Individual: N = 10, I/Y = 6, PV = - 46,470, PMT = 0. Solve for FV (answer should be $83,221), and then subtract the starting portfolio value of $46,470 from the answer, which should equal $36,751 of capital gains.
Corporations: N = 10, I/Y = 6, PV = - 85,000, PMT = 0. Solve for FV (answer should be $152,222), and then subtract the starting portfolio value of $85,000 from the answer, which should equal $67,222 of capital gains.


The corporation under the current system realizes capital gains of $67,222. Part I federal refundable taxes of $10,308 are paid ($67,222 × 50% × 30.67%) as well as $2,689 of non-refundable taxes ($67,222 × 50% × 8%). Ontario than snags an additional $3,865 of provincial taxes ($67,222 × 50% × 11.50%). This corporation ends the 10-year period with $50,359 of after-tax corporate investment income.

The corporation under the proposed system also realizes capital gains of $67,222 and ends the measurement period with $50,359 of after-tax corporate investment income. Same math then … BUT, under the proposed system, that $10,308 of refundable taxes becomes non-refundable.

Return on investments in year 10 Individual Corporation: Current System Corporation: Proposed System
Starting portfolio $46,470 $85,000 $85,000
Earn: 6% capital gains each year $36,751 $67,222 $67,222
Deduct: Federal/provincial personal tax ($9,836) - -
Deduct: Part I federal tax – refundable - ($10,308) NA
Deduct: Part I federal tax – non-refundable - ($2,689) ($12,997)
Deduct: Provincial taxes – non-refundable - ($3,865) ($3,865)
Equals after-tax investment income $26,914 $50,359 $50,359


Hasta la vista, baby

After paying all tax liabilities, the individual investor is left with $73,384 ($46,470 + $26,914).

The current-system corporation is left with a portfolio value of $135,359 at the end of the 10-year period. Once we exclude the non-taxable portion of the $33,611 in capital gains ($67,222 × 50%), and we add back the refundable taxes of $10,308, we end up with $112,057 in taxable dividends available to distribute to shareholders. The shareholders will then pay $50,767 in taxes on these ineligible dividends ($112,057 × 45.30%). They can also receive a tax-free dividend of $33,611, which is the non-taxable portion of the capital gain from the capital dividend account balance.

Once the car-chase scene has ended and the explosions are in a slow burn, corporate shareholders are left with a net worth of $94,901 ($112,057 - $50,767 + $33,611). That’s $21,517 more than the individual taxpayer’s $73,384.

Now let’s look at a corporation under the proposed system. Here too, we’re left with a portfolio value of $135,359 at the end of the 10-year period. But with the termination of refundable taxes and tax-free capital dividend distributions, the entire $135,359 is taxable when it’s distributed as a dividend to shareholders. The shareholders then pay taxes of $61,324 on the ineligible dividends ($135,359 × 45.30%), leaving them with a portfolio value of $74,035 at the end of the 10-year period.

If you’re watching all the action, that’s only $651 more than the individual taxpayer. As you can see, the government’s proposals would get us awfully close to perfect tax integration.

The results are included in the table below (along with an accompanying chart showing the differences over 10, 20 and 30 years).

  Individual Corporation: Current System Corporation: Proposed System
Portfolio value after 10 years $73,384 $135,359 $135,359
Deduct: Non-taxable portion of capital gains   ($33,611) NA
Add: Refundable taxes - $10,308 NA
Equals: Taxable dividends available to distribute - $112,057 $135,359
Deduct: Personal tax on dividends - ($50,767) ($61,324)
Add-back: Non-taxable portion of capital gains - $33,611 NA
Equals: Net Worth $73,384 $94,901 $74,035


I’ll be back

So, yes, the government has issued a couple of Terminators tasked with killing off two favorable corporate tax breaks. But not unexpectedly, there are those out there staging a Resistance as we speak. I’ll be sure to keep you posted on how any unfolding changes may impact you, your tax planning and your investments.

Bah-da-bum-ba-dum (Pause) …

By: Justin Bender | 4 comments

Corporate Taxation: Tax Gain Harvesting – “Crazy Like a Fox” Tax Planning

Following up on last week’s post, we’re not yet done exploring the wild world of capital gains taxation. Today, we’ll take a look at tax gain harvesting.

Say what? Isn’t that supposed be “tax loss harvesting”? Well, that exists too, and is more familiar to most investors. Since harvesting a gain incurs taxable income, it may at first seem kind of crazy to want to voluntarily reap what you’ve sown. But if you’re a corporate investor, it can actually be a smart, “crazy like a fox” thing to do.

Tax loss harvesting: Losing to win some tax breaks

First, a quick reminder of how tax loss harvesting works (a.k.a. tax loss selling). Say you buy an investment like a stock ETF, and a few months later the stock market plummets. Your ETF is now at a significant loss, so you sell it, realizing a capital loss. Even this may sound a bit nutty, like an infamous buy-high, sell-low strategy. But there is a critical difference. Immediately after selling the ETF, you buy back a similar, but not identical fund to retain your original market exposure (because all evidence suggests that the market is expected to eventually recover and continue bearing beautiful fruit if you stay the course).

Think of tax loss harvesting as promptly replanting your harvested “field” with a similar “crop,” instead of leaving it barren. Once the dust settles, you’ve generated a capital loss to offset taxable capital gains (in the current year, past prior three years or indefinitely into the future), without substantially altering your investment landscape.

Tax gain harvesting: Winning to lose some tax burdens

Now to tax gain harvesting. Why would anyone want to pay capital gains taxes earlier than necessary?

As an individual investor, about the only (relatively unusual) time it might make sense to harvest gains early is if you are in a lower tax bracket than you expect to be in the future.

But the corporate landscape is different. Here, the optimal time and place for harvesting gains isn’t as straightforward. It’s going to be easier to show you an example of why that’s so than to tell it to you in theory, so here we go …

Reaping the harvest: An illustration in action

To illustrate the potential tax deferral benefits of realizing corporate capital gains taxes, let’s compare two scenarios.

  • Corporation 1 will harvest a $20,000 capital gain and distribute to its shareholders the non-taxable and taxable portion of the gain (after corporate taxes have been paid and refundable taxes have been returned).
  • Corporation 2 will not realize any gains. It will instead distribute enough taxable dividends so that their shareholders end up with the same amount of personal after-tax cash as in the first scenario.

Which strategy wins? Not to ruin the suspense but this is, after all, to illustrate capital gain harvesting in action. So, as you might expect, Corporation 1 ends up with more money to invest after the distributions have been made, resulting in a greater tax deferral benefit. If you don’t believe me, here are the calculations involved.

Corporation 1: Harvesting a $20,000 capital gain

This example is identical to the one from last week’s post. The $10,000 taxable portion of the capital gain is subject to $1,950 of non-refundable taxes ($800 federal + $1,150 provincial). That leaves $4,983 of after-tax corporate income, plus $3,067 of refundable taxes to distribute to shareholders and be taxed in their hands at 45.30% (the highest marginal tax rate in Ontario for ineligible dividends). After paying $3,647 in personal taxes ($8,050 × 45.30%), the shareholder has $4,403 of after-tax cash.

But this isn’t the entire story. The corporation can also distribute a $10,000 tax-free dividend to its shareholders ($20,000 × 50%). Quick refresher from last week: The capital dividend account has a positive balance for the same amount, due to the non-taxable portion of the $20,000 capital gain.

In the end, shareholders have received $14,403 of after-tax cash, while the corporation is out $20,000 ($1,950 non-refundable taxes + $8,050 taxable distribution + $10,000 tax-free distribution).

General Formula Amount Calculation
Taxable portion of capital gain $10,000 $20,000 × 50%
Part I tax – non-refundable
($800) $10,000 × 8%
Part I tax - refundable
($3,067) $10,000 × 30.67%
Provincial or territorial tax – non-refundable
($1,150) $10,000 × 11.5% (Ontario)
After-tax corporate income
$4,983 $10,000 - $5,017
Refundable taxes
$3,067 $10,000 × 30.67%
Amount available to distribute as a taxable dividend
$8,050 $4,983 + $3,067
Personal tax on dividend
($3,647) $8,050 × 45.30%
After-tax cash (excluding the non-taxable portion of capital gain)
$4,403 $8,050 - $3,647
Non-taxable portion of capital gain
$10,000 $20,000 × 50%
After-tax cash
$14,403 $10,000 + $4,403


Corporation 2: Distributing all-taxable dividends

The calculations are a lot easier in this scenario, but the costs are a lot steeper. Without realizing the capital gain, the corporation must instead distribute only taxable dividends to its shareholders, which are taxed at 45.30%. In this example, a whopping $26,331 must be withdrawn from the corporation to yield $14,403 of after-tax cash [$14,403 ÷ (1 – 45.30%)]. This leaves Corporation 2 with $6,331 fewer dollars to invest, compared to Corporation 1 ($26,331 - $20,000).

General Formula Amount Calculation
Amount distributed as a taxable dividend $26,331 $14,403 ÷ (1 – 45.30%)
Personal tax on dividend
($11,928) $26,331 × 45.30%
After-tax cash
$14,403 $26,331 - $11,928


The early bird doesn’t always get the worm

Before you conclude that corporate capital gain harvesting is the bee’s knees every time, let me rush to assure you that you never know. I’ve deliberately cherry-picked this harvest to show you the potential benefits of tax gain harvesting, but there are plenty of other scenarios in which a gains harvest could lead to a higher tax liability and no tax deferral benefit.

So here are two “thou shalt” rules to abide by every time: First, don’t forget to consult with your friendly neighborhood accountant before you implement anything. Second, be sure any plan you embark on is customized to your own corporate and personal tax situation.

Oh, wait. There’s one more rule to add: Whatever works today, may not work tomorrow. In my next post, we’ll look at what the government has in store for corporate capital gains taxation.

By: Justin Bender | 2 comments