I received an email from a reader questioning how to properly setup the Couch Potato Portfolio for maximum tax efficiency.  I have written about this topic before in my tax optimized portfolio allocation article, but I neglected to name specific examples.

What is the couch potato portfolio?  It’s a simplified index investing strategy that composes of 4 investments.  The 4 parts are made of a Canadian index, US index, International index and a Bond index.  To keep it extremely simplified, you have the option of keeping every investment in equal proportions.  To me, the bond allocation should be adjusted based on your risk tolerance – the higher your risk tolerance the lower bond allocation and vice versa. After the bond allocation is chosen, the remaining equities are divided equally.  At least that’s how I do it.

As index investing can be with mutual funds or ETFs (or a combination), a good example of a low cost mutual fund couch potato portfolio would be with the TD e-Series funds.  For arguments sake, lets assume a 40% TD-e bond index allocation, which means 20% would be the TD-e Canadian Index, 20% TD-e US Index, and 20% TD-e International Index.  If ETFs are your fancy, then a low cost ETF portfolio would be 20% XIU, 20% VTI, 20%, 10% VEA, 10% VWO, and 40% XSB.

What is porfolio allocation?  It’s how to optimally place various types of investments for the highest tax benefit.  For example, foreign dividends may face a withholding tax depending on which account it is held in.

For example, if you are an indexer, a simple portfolio may consist of globally diversified index funds/ETFs, bonds and cash.

Here are some possibilities on how to minimize your investment taxation providing that your tax sheltered accounts are maxed out:

RRSP:

• Fixed Income/Bonds/GIC’s
• Foreign Equities
• Income Trusts
• REITs

TFSA

• Fixed Income/Bonds/GIC’s
• Income Trusts
• REITs

Non-Registered:

• Canadian equities

As I mentioned above, if you have the contribution room in tax sheltered accounts (RRSP/TFSA), then it’s most tax efficient to keep your investments in those accounts.  However, if you decide to use your TFSA, then keep the foreign holdings (ie. US/international equities) within an RRSP as foreign dividends will face withholding tax (15%) in a TFSA.

However, if you don’t have the contribution room, then simply follow the guideline quoted above.  Here are some specific examples on tax efficient accounts to place your couch potato components:

RRSP:

• Fixed Income/Bonds/GIC’s – TD-e Bond Index, iShares Short Term Bond Index (XSB)
• Foreign Equities – TD-e International Index, Vanguard Total Stock Market (VTI), Vanguard Europe Pacific (VEA), Vanguard Emerging Markets (VWO)
• Canadian Equities – TD-e Canadian Index, iShares Canadian Index (XIU)

TFSA

• Fixed Income/Bonds/GIC’s – TD-e Bond Index, iShares Short Term Bond Index (XSB)
• Canadian Equities – TD-e Canadian Index, iShares Canadian Index (XIU)

Non-Registered:

• Canadian Equities – TD-e Canadian Index, iShares Canadian Index (XIU)

Not to beat this topic to death, but assuming that you use your tax refund wisely, simply keep everything in your RRSP.  If your savings exceed your contribution room, then move some of the fixed income or Canadian equities to your TFSA.  If you don’t have enough room in your TFSA, then move your Canadian Index to your non-registered account.

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