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Reader Mail: New Graduate, TD e-Series, RRSP or Non-Reg?





New graduate, Mike, emailed me with some investing questions.  He’s new to the work force, and is diligently looking to find ways to invest and save money.

I am a new grad, just started working permanently last year. I have contributed every year to my TFSA (right now, it’s parked with Canadian Western Bank, which offers 3% on their Demand account). I haven’t contributed to RSPs because I haven’t earned sufficient income to justify doing so. As such, I have carried forward my totals every year.

I project that I will contribute by Jan/Feb 2013. In the mean time, I have excess funds in my account that I don’t use. Because of the lower MERs, I want to either invest in ETFs or TD E-series funds. Right now, I’m leaning towards the E-series, but will definitely consider ETFs with Questrade as I get a better handle on how to select ETFs (though your advice with this would be appreciated as well).

1) If I were to start a non-registered TD E-series fund this year, would I have to start another account next year if I were to contribute to my RSP through E-series? Or is it possible to convert my non-registered into registered?

2) How does taxes work if I were to start up a non-registered E-series fund? I assume TD would send me a T3. Can I rely on their tax slip information or do I have to keep track of additional information? I’m likely taking the couch potato strategy on this by just leaving it there without selling (unless I require the cash) and contributing every four months or so.

Before I start, I must say that new grads asking these types of questions, especially regarding index investing, are already way ahead of the pack. Second, jumping on the soap box for a moment, I believe that consumer/student debt should be paid off first before jumping into the investment game.

Now, onto Mikes scenario.  He has savings money in a TFSA, no money in RRSPs (not yet anyways), and is curious about non-registered investing with index type investments, like TD e-Series.  If there salary income in the mix, then over the long term, it’s more efficient to keep investments in tax sheltered registered accounts first.  Then, if/once the contribution room and cash get used up, then look into moving into non-registered accounts.  More about this subject in the portfolio allocation article.

Another point is that Mike mentions being in a lower tax bracket, so he doesn’t contribute to an RRSP.  One strategy that I would suggest is to contribute to the RRSP but carry forward the tax deduction to a higher income year.  That way, investing within the RRSP can start before going to the non-registered route.

Yet another benefit of putting the investments in a registered account is that it simplifies income tax filing.  No need to hold onto those T5′s and other investment slips, or track your capital gains/losses or return of capital.

Say that I’m not convincing enough, and Mike would still like to invest in his non-registered account.  To answer his questions:

1.  If investments are in a non-reg account, they can be transferred “in-kind” to a registered account, it’s not really “converting” per se.  The only issue with that is that if there are any capital gains on the date of transfer, capital gains tax will be accrued.  To add salt to the wound, capital losses cannot be claimed when transfers are made in-kind from a non-reg to a registered account.  To get around this, simply sell the shares and contribute cash to the registered account.

2. As mentioned, taxes and tracking the adjusted cost base is a real turn off when using a non-registered account.  TD, or any mutual fund would send you tax slips for any distributions (dividends, interest, etc), but the investor is responsible for tracking capital gains/losses and the adjusted cost base if he/she buys in small increments.

To be a bit repetitive here, if I was in this position, I would look at investing within registered accounts (TFSA/RRSP) before considering investing within a non-registered account.

Do you have a financial question that you would like answered?  Email me and I’ll give it a shot!

P.S. For readers of Chinese descent – Gung Hay Fat Choy (Happy Chinese New Year)!





21 Comments, Comment or Ping

  1. 1. Alex C

    Can you expand on point 2? I thought one of the advantages of mutual funds was not having to track your adjusted cost base. If I am contributing 500 a month into an eseries account, what do I need to keep track of.

  2. 2. D L

    If I contribute to RRSP but I carry forward the tax deduction to a higher income year, does that mean that the RRSP account that I started out now is still considered a tax-shield account — meaning all the capital gain/dividends are shielded from tax until I withdraw them out later? Please help clarify this… I am also new to RRSP… Thanks so much!

  3. @Alex, if in a non-reg account, you need to track if you SELL. The mutual fund itself should send you info on ROC if there is any.

    @DL, Yes, all contents within an RRSP remain tax deferred until you withdraw.

  4. 4. Sportsguy

    Very interesting article. I’m in the same boat as Mike. I haven’t contributed to my RSP b/c I always thought that we can carry forward the contribution room, but not the deduction room. Here’s a few questions:

    For point 2:
    1) How exactly do we carry forward the tax deduction we file our taxes?
    2) Is there any limit as to how many years we can carry forward the tax deduction?

    On a side note, for investing in TD e-Series, are all the distributions Canadian dividends (including US and International Index)? My line of thought on this is with the dividend tax credit.

  5. @sportsguy, when you file with software (like quicktax or studiotax), you’ll need to include how much you contributed for the year, but you can choose how much to claim in the current year. There is no carry forward limit as far as I know. Best to consult with a tax pro for the official details.

    No, not all distributions will be Canadian dividends. The TD-e Canadian index will have distribution that includes capital gains, ROC and eligible dividends. US index and international dividends will not qualify for the div tax credit. In my opinion, all international holdings should be kept in an RRSP.

  6. 6. Sportsguy

    Thanks, FrugalTrader. So would it be advisable to contribute the RSPs entirely into the US, International, and Canadian Bond Indices within the e-Series and for excess funds to be held non-registered, such as a variety of Canadian dividend ETFs? I’m trying to determine a good way to invest excess cash after I’ve maxed out my registered accounts. I want to maximize my earning potential, but minimize tax consequences (if there’s such thing).

  7. 7. BadCaleb

    Hey FT, thanks for writing your blog. I read your post on Carry Forward Deduction a few years back. My wife contributed in the first month last year to RRSP even though she had no employment income since she hasn’t gone back to work after having our kids. She didn’t deduct this on her income tax return so it’s a carry forward and won’t be used until she starts working again. Here’s another good post on the difference between contribution and deduction. http://wheredoesallmymoneygo.com/deferring-your-rrsp-deductions-to-higher-income-years/

  8. 8. Alex c

    Sorry FT, follow up to my initial comment. If I have mutual funds in a non-reg account, I track when I sell, and what the NAV of the fund on that day is. What does this information get used for? If I’m not tracking purchases how can I make an adjusted cost base? Or is it based on the dec31 value they provide you from the year before, as you are not present for the full years returns

    Thanks

  9. 9. Fit

    Just for clarification, why is he trying to get an investment with a low MER? It was never really stated in the article. I would gladly take on a high MER for a higher risk/reward return. Example: CI Signature High Income fund ran by Eric Bushell. MER 1.6 Sorry, it is just bugging me haha and don’t say “for a higher return” or “fees are bad” as that is is untrue. Fees are good if they have the right type of reward (higher return or lower risk, low oppurtunity cost, you can sleep at night, etc.)

  10. @Alex, my understanding is that if you buy/sell a mutual fund for profit (ie. capital gain), then you’ll need to track your buy and sell prices for capital gains tax purposes. If you hold a mutual fund, and they churn and incur capital gains tax, this will also flowed through to the unit holders, but you’ll be given this information before you file taxes.

    @fit, the issue is that most active mutual funds do not beat the index, esp after their fees. And if they do, it’s hard to pick which funds will beat the index going forward.

  11. 11. buff_butler

    As a simple rule you would want to contribute to your TFSA if you see your marginal tax rate rising in the future and your RRSP if you see your marginal tax rate falling however as Frugal pointed out you can “bank” your income deduction for later on so if you want you can still put money in there.

    As for holding external to your account you’ll have to look at your tax bracket. For me I keep securities that would likely see large capital gains rather then dividends. Then when you realise the gains 1/2 of that goes into the RRSP and the rest is tax free.

    Also im not 100% sure of this but if your in a lower bracket (below 40k) theres also opertunities because the effective dividend tax rates are negative in some provinces however its unlikely a new grad can use this because you would have to have other property income to use the excess dividend deduction against; ex: a distribution from a small company that you hold shares in. This would be incredibly unlikely for a new grad.

    As a word of caution stay away from REITS/Trusts in a non registered account (ie ROC) however IMO Frugals advice is best because it keeps things simple (walk before you run; the savings would be superficial at this point). Also, I’m not a tax advisor so double check things : P

  12. @sportsguy, sorry missed your comment. For proper tax allocation of portfolios, check out my post on portfolio allocation.

  13. 13. Ed Rempel

    Hi FT,

    I think you missed Fit’s point about Eric Bushell. He has managed the CI Signature High Income fund that Fit mentioned for 10 years. He beat his index in 8 of the 10 years and beat it by 8.1%/year compounded for the 10 years.

    I have met him a few times and he is intimidatingly smart. Most finance experts have trouble understanding his points sometimes. He is not on our short list of fund managers, but certainly an excellent fund manager.

    I agree with Fit that I would definitely prefer his fund to an index.

    Your comment is true about “most funds”, but not about the top fund managers. The index industry has really programmed people to believe that nobody can beat the index and it is hard to identify the top fund managers. If you know what to look for and do some real research, it is not that hard.

    The main reasons that “most funds” don’t beat the index is that most fund managers try to stay close to the index and many are index funds. If you ignore the index funds and the “closet index funds” and look only at the fund managers that have portfolios very different from the index, then the average mutual fund has beaten the index after all fees. The Yale study on “Active Share” showed this.

    Fit’s point is that MERs are not always bad. Investors should look for value for their fee, not necessarily the lowest possible fee.

    If you study the top fund managers, you get completely different conclusions than you do if you study average mutual funds.

    Ed

  14. @Ed, you’re probably right, so I guess Mr. Bushell is on your All Star list? :) So what happens when Mr. Bushell leaves or retires? Do you sell the fund?

  15. 15. Fit

    @Ed, once again my short rambling post is made eloquent by your response haha I’ve also had a chance to talk to Eric and he his basically a “mad scientist” haha one of the smartest people I have ever met or listened to.

    @FT That’s an interesting point, would I still own the fund?… who knows haha but I would have to believe that if you do your due diligence with other top funds, you can find value. I look Radlow, Swanson, and Snow running some of the new Cambridge funds. It is like they got the “band back together” haha after running the Fidelity Cdn Asst Allocation fund for years.

  16. 16. Ed Rempel

    Hey FT,

    Having your fund manager leave or retire is much more of an issue with average fund managers than the top fund managers. The best fund managers usually own their own investment firm and get contracts with mutual fund companies – so they don’t leave.

    The surprising thing is that some of them work surprisingly long, as well. They often love investing and are passionate about it. Look at Warren Buffett. He is in his 80s and still just as active as ever.

    Eric Bushell is not on our short list, but we do invest with him somewhat. He is an employee of a fund company, so there could be one move once if he creates his own firm. However, that is probably unlikely in his case. He is the top guy in a large firm with a huge, capable team.

    Eric Bushell is also only 42. It is unusual to have a great 10-year record at 42. Not many managers are lead managers by 32, and far less are on top at that age. I don’t think he will retire any time soon.

    That is part of the index propaganda. Nobody can identify top fund managers ahead of time and when you do, they quit or retire. From what I have seen, there is some truth to that with average fund managers, but not usually with the All Stars.

    Ed

  17. 17. Steven

    ETFs, mutual funds, individual stocks and bonds are all valid investments, but seeing someone going into an ETF because of low fees bothers me more than anything.

    Always understand that in life, there will always be costs to doing business. What matters is your NET PROFIT, not the fees involved. Lower fees do not necessarily translate into a higher net profit.

    A newly grad should NOT be investing in ETFs but rather be focusing on their careers and building a family. Use actively managed mutual funds. Ones that have a long and successful track record and have consistently proven to be able to beat whatever index you desire exposure to. Note that all posted returns regarding mutual funds are always NET of fees. If the TSX returns on average 10% per year over the past 50 years, and a Canadian Equity mutual fund can return 11%, you are better off with the mutual fund. These things do exist, and that’s why people still buy mutual funds.

  18. 18. kunwak

    Ed and others: I don’t buy any of this “you can predict the best performing mutual funds”.

    Hallam has a good write up about it here:
    http://assetbuilder.com/blogs/andrew_hallam/archive/2012/02/06/when-the-underdog-fights.aspx

    Granted, he is trying to promote his book which itself promotes an ETF strategy. However, I doubt that Ed or anybody else can predict the top performing funds or fund managers over the long term. So far, history has proven them wrong it seems.

  19. 19. Steven

    Kunwak,

    I do not have a crystal ball and cannot predict the best performing fund. I do know however if your child was top of the class for 8 years in a row, he is LIKELY to be a top student in his 9th year as well. No, this is not guaranteed, but statistically probable. Investing is no different.

  20. 20. Ed Rempel

    Hi Kunwak,

    I realize this “nobody can beat the index” has been hugely promoted, but when you look at it closely, it is quite ridiculous.

    I’ve been analyzing fund managers for more than 15 years and can tell you there are quite a few that I am confident have real stock picking skill and can beat the index.

    My belief in these fund managers is genuine, since 100% of my investments are in mutual funds or hedge funds with managers that I am confident will beat their index. I personally have never owned an ETF or index-type investment and probably never will.

    The studies saying nobody can beat the index are usually 5-minute studies – not done in-depth.

    I had a look at the study you mentioned and it clearly shows a bunch of fund managers that all beat the index and likely will continue to.

    I spent 15 minutes looking at the study you mentioned. When you look at them closely, I would take any of the funds on the list over the index.

    The study started just before the 2008 crash. Many of the fund on the list are more aggressive than the index. Those are mostly the ones that show lower than the index during the study, while the more conservative ones are the ones that beat the index.

    However, if you just click on the links shown on the site you mentioned, you will see that 8 funds show a chart comparing to the index. All 8 beat the index from the March/09 low until now.

    The logic supporting index investing is the “Efficient Market Hypothesis”, which “represents one of the most remarkable errors in the history of economic thought.”

    Remember, the EMH claims that:

    - investors are rational.
    - bubbles don’t exist.
    - panic selling does not exist.
    - 1999 was not a “tech bubble”. The market always values stocks correctly, so the tech stocks were worth the P/Es over 100.
    - After they fell 80%, it was because of a real decline in the value of those companies.
    - There was no panic selling in 2008. Stocks lost value because of a real loss of value of companies.

    All of these are clearly wrong.

    Academics in finance have almost unanimously agreed that the EMH is false. It was generally believed to be true in the 1990s, but the bubbles in the last decade and the rise of Behavioural Finance have clearly disproved it.

    It does take some effort to identify the All Star Fund Managers. The average fund does underperform, mainly because most mutual funds are either index funds or “closet index” funds.

    The Yale study on “Active Share” was the most in-depth study I have seen on the issue. It showed that if you filter out the “closet indexers”, then the average mutual fund beats the index after all fees – and this outperformance tends to persist.

    Now there is nothing wrong with index investments. I think that is what amateur investors should buy. Identifying skill in the top fund managers takes some research.

    However, after all the years of research I have done the top fund managers, I will continue to invest 100% with them.

    Ed

  21. 21. SST

    And after all the years of research I have done on the financial industry, including the stock market, I will continue to invest 0% with them. Instead, investing in production assets which have little or no ties with paper markets.

    That is, until the last 30 years of credit (and fraud) is cleaned out of the system and valuations return in-line with GDP. Then you’ll be able to buy really cheap APPL!

    Me thinks I’ll be waiting quite some time.

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