The Canadian Money Roadmap
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The Canadian Money Roadmap
Your Q's Answered: Portfolio Building, TFSAs, and Navigating Capital Gains Tax
In this iteration of listener Q&A, we'll kick things off by discussing the concept of selling winners and buying losers, and why maintaining a target allocation is crucial to avoid overexposure to a single risk. We also explore the unpredictability of country performance and the importance of diversification when building a portfolio of stocks.
Dive deeper into the benefits and risks of holding individual stocks within a Tax-Free Savings Account (TFSA). We reveal why it's best to have these stocks in a non-registered account and address the complexity of transferring investments between account types. As we unravel the confusion surrounding capital gains tax, you'll gain a greater understanding of how the Canada Revenue Agency (CRA) taxes capital gains, how capital losses can offset future gains, and even how donating these assets can become a valuable tax planning strategy.
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Hello and welcome back to the Canadian Money Roadmap Podcast. I'm your host, evan Newvilt. Today we are answering some of your questions, so I've got some of these from my email very recently and some a couple months ago, and some from clients of mine as well. We're going to be looking at topics like TFSAs, capital gains, diversification and where's my Twitter account? First of all, i want to give a big hello to anyone that's a new listener. I've had thousands of new listeners this year, which is crazy to say out loud. So if you're new to the podcast, welcome here. Doing an episode like this is something I try to do a couple of times a year, where I kind of go through a bunch of the emails that I've received and I pull through some of the questions that I get from you listeners and I answer them for everybody on the podcast. If you want to send me an email, my contact info is always in the show notes of every podcast, but you can reach me at hello at evannewfieldcom. Again, that link is in the show notes of every episode and, yeah, glad to answer some of your questions. First one here comes from Dave and Dave's asking about diversification regarding an episode that we talked about before and he was wondering what I meant by the idea of selling your winners and buying more of the losers. He says that makes no sense to me for long-term investing, because if they're winners, why not hold on to them for the long-term and offload the losers? And I say fair enough, good question. I gave Dave a better answer in an email here, but I'll just touch on this briefly. The main idea with diversification and having some winners and losers in your portfolio is that the challenges that we never know what the winners of tomorrow will be. And so when you build a portfolio that hopefully is well-diversified, the mix between your different components should largely stay the same, assuming there's a reason for having it in the portfolio in the first place, beyond just having a hunch that it might do well based on what you think. So generally, when I talk about diversification, i'm talking about pretty boring old, broadly diversified portfolios as opposed to buying individual stocks. Because, yeah, there's definitely some winners and definitely some losers when you're looking at building a portfolio of individual stocks. So in this regard, my answer, i guess, is maybe a little bit different depending on how you've built your portfolio in the first place. But let's just say, hypothetically, you're using broad market indexes for different countries. So say, you've got some Canada, you've got an ETF that tracks the US market, something international, something maybe emerging markets and maybe a bond one. So if you have a portfolio that's split in that way, inevitably some years some will do better than others. For example, the last 10 years the US has been the best place to invest, broadly speaking, whereas the previous 10s over from 2000 to 2009,. If you had only invested in the US market, you actually would have lost money over that decade. And so I've got I call it a quilt chart here that I sent to Dave, but I'll try to describe it for you. So what I'm looking at here is a chart that shows the performance of about 25 different countries, and at the top is the winner, at the bottom is the loser and everything in between, and it looks like a patchwork quilt because all of the different countries show up in different orders all the time. There is no discernible reason for it. It is essentially random as to which country will outperform in a given year, and so in some cases the disparity between the winners and losers can be pretty significant. But it can also be from the same country. So, if I go back to 2016, canada was the best performing country that year out of the ones that are listed, and then the following year, canada was the second worst, and then in that 2017 year, austria was the best performing And the following year, austria was the worst. In 2018, finland was the best, and I'll let you guess. Guess which country was the worst the next year? It was Finland. So there's a lot of leapfrogging that happens, and so in this case, maybe my advice before buying the losers and selling the winners is a little simplistic, but it comes more so down to rebalancing, to a target allocation every year or every quarter or whatever you've decided to do, so you maintain that same exposure that you want, regardless of what did well recently. Okay, so this country, a patchwork quilt is also really applicable for different sectors of the market. If you're doing that individual stocks the returns can be completely random, for sure. So, again, the reason that you want to have diversification and a rebalancing strategy and again rebalancing means that if you have something that has outperformed for a long time now, it inevitably makes up a larger percentage of your total portfolio You want to sell some of that and buy something else so that you can get back to your target allocation. So you're not necessarily exposed to tomorrow's losers by accident. You're in a diversified portfolio. You're always going to have some winners and some losers, and so if you just keep holding on to the things that were winners recently, you really over expose yourself to one singular risk. So that is my rationale. Therefore, potentially selling some of your winners, buying some of your losers. Again, that totally depends on how you're building your portfolio in the first place, but I recommend aiming for globally diversified portfolios that has a relatively static allocation and rebalancing back to that allocation every year or every quarter. Next question comes from Ryan, and Ryan says where's the Twitter account? I'd love to see more content. He sent me some other questions too, but I wanted to address this one specifically. So for now, no, i don't have a Twitter account. I have a personal one, but it's mostly for just lurking and retweeting NBA or baseball related content, so you're not going to get a whole lot of interesting stuff from me there. But for me, i found that Twitter I would probably just become too consumed with being a well actually, guy you know, like the person that's correcting mistakes or you know that kind of thing like. That's not really adding a lot of value in my opinion, and, truth be told, i just wouldn't want people spreading inaccurate things in my replies if I'm posting stuff on there. It's kind of why I like this podcasting medium, because it's just me, i can say what I feel, i can say what has merit, and I don't have to spend a lot of time debunking things that are public, like you would have to do on Twitter. Lots of people are really good at running Twitter accounts. Here in Canada, previous guests Mark McGrath and Aaron Hector have really good Twitter presence, so you can look out for them, but for me, i think, as it is now, it would probably be too much of a time sink just for how my personality is and how I use social media. So I will say, though, that I am looking to add more content in a written medium, but I'm going to do that through a regular newsletter. The newsletter is called Fully Invested and it's going to start later this year. I don't have a firm start date for it yet. I'm just in the process of kind of ironing out a few of the details and providers and all that kind of stuff, and in my personal life I'm actually moving and I've got a lot on my plate right now. So what you can do is join the list so that you'll get all of it when it's ready to go. You can find that link in the bottom of the show notes. Just look for the Fully Invested newsletter sign up. And also on that note, big thanks to everybody that's already signed up for it. I'm actually shocked at how many people have signed up for the newsletter. I'm really excited to be able to share more content with you. The concept for the newsletter is it's a little bit more specific than the podcast here. The podcast is more general personal finance content, whereas the newsletter is going to be more specifically about evidence based investing for Canadians. If that sounds interesting to you, i'd love to have you on the newsletter list. All right. Next question comes from Mike And Mike. He asked a few questions, but this one I wanted to address. He asked some questions specifically about his mom's investments in a fund. He describes her age and what he was suggesting. I'm not going to give specifics there just to protect Mike's details, but I wanted to address this question because I wanted to give a reason why I can't give specific investing advice to use a podcast listener or an e-mailer and someone who is not a client. So here's a few reasons why, in no particular order, but There's just a lot of information that we need as investment advisors before we can make good recommendations. So whenever I see a YouTube account or a Twitter account saying this is how everybody should be investing and whatever it's like, i think we have to be really careful about that. Maybe call me old-fashioned or low risk or whatever the case may be, i just don't think it's appropriate to be giving blanket investment advice And it's also against our regulations. So, because I'm regulated in the advice that I give, i cannot be giving specific investment recommendations to people without knowing who they are and what their situation is. So again, here's a few reasons why I can't give specific advice. So in this case, i don't know this person. I don't know her, so I don't know why she has this fund in the first place. Could be a great fund, could match her goals, but it maybe was a bad recommendation in the first place. So I don't know if it weren't a change necessarily. Another thing I don't know what they consider low risk. So Mike describes her investment fund as a low risk fund. That could be a literal low risk fund in terms of how the fund is categorized, or it could be something that someone feels is a low risk fund, or how it was described to them, and because I don't know what the fund itself is in its specifics, i cannot actually determine what she currently has besides just that description of low risk mutual fund. Ok, so beyond that, there's some things that we would need to know as well, like is this account all of her assets or is this just a small portion? Maybe she has a multimillion dollar portfolio, but this is just her TFSA. I'm not sure Investment recommendations would change based on what the investment represents for that person's financial life. In that same vein, does she have any income sources? Is she living off of this income, or is this just part of her portfolio That's kind of earmarked for the future and perhaps even for estate purposes? So does she have a goal or specific purpose for this money now? Or what about after she's passed away? Is she in good health today? Is she familiar with any of the investment terminology or concepts? Are she a relatively new investor? Are you power of attorney acting on her behalf, or are you just a helpful son? All those sorts of things, would there be tax implications for moving these funds? And so if it's in a non-registered account, there could be capital gains. I'm going to get to capital gains in a second with another question. But if there's capital gains there, if you move to something like a GIC which is what the original question involved there might be tax implications of making that change. Also, if it is a non-registered account and a GIC, is she aware of how GIC interest is taxed compared to how investment returns in her fund might be taxed? That could be very, very different. Also, is she aware of how access to the money could be restricted in a GIC? Maybe she has a deferred sales charge on the mutual fund which I'm not aware of, or there could be a penalty for her to switch. There's so many things that go into an investment recommendation. So if you're hearing people give out blanket investment advice online or on YouTube and Twitter, whatever, i would say be very, very cautious of someone that's willing to do that, because there's so much information that they don't know. That goes into making a sound recommendation for you. So, mike, i hope this came across the right way and I gave you hopefully a better answer through the email, but I just wanted to highlight this as a reason why sometimes I cannot give podcast listeners great answers to their very, very specific investment questions, because you're not a client of mine. Okay, next question comes from Gavin, and Gavin had a question about TFSA. He had been listening to some of my podcasts about TFSAs and how I recommend people use that as a TFRA, like a tax-free retirement account. In his case, he has a what he calls a cash account Some I would usually call it a non-registered account for purchasing stocks, and he is worried about capital gains tax in the future. And so he asks is there potentially a way to transition my account from from his trading account to a TFSA trading account? And yeah, hopefully I'm answering or understanding the question here, but anyways, as far as a TFSA is concerned, i highly recommend that the investments that you hold in your TFSA are the ones in your portfolio that have the highest odds of success. The evidence says that trading individual stocks, even in a buy and hold basis, is incredibly difficult to make money over the long term, let alone outperform a diversified portfolio. So I would say, based on what the evidence says, if you're going to own individual stocks, it would probably be best done in a non-registered account where you can use the capital losses against any future capital gains. This is not an insult to the person asking the question here By any means. I'm just playing the odds that, by and large, when you own individual stocks, the most likely outcome is not a capital gains problem in the future, and so if you can count yourself among the lucky few that make money doing this, i'm going to say not every one of your holdings will be a winner. So in that case, if you have it in a non-registered account, your losers can help offset the capital gains tax owed because you can actually use those capital losses against capital gains. I'm going to clarify these capital gains questions again in a second. But that's why I don't really like using individual stocks in a TFSA, because if you have any situations where stocks go to zero or you have significant losses there, you cannot get that contribution back. So I spoke to someone recently and this is not the first time I've heard this, but I spoke to someone recently who lost $80,000 trading stocks in their TFSA, all in companies that literally went to zero, and these were companies that were on the TSX Venture Exchange, so that these are up-and-coming companies with. They've got the greatest stories around, coolest technology, whatever, and they're trading for six cents a share or whatever the case is. The story is always the same. It's, you know, bought it for six cents, went up to $2.45, and then the company went bankrupt. I'm not saying every company that's listed on the Venture Exchange goes bankrupt, but when I hear these stories, that's almost exactly how it happens all the time. Every company looks great, every idea looks great, every stock looks cheap. Be extremely careful when I would say, avoid it altogether, because in this case you lost $80,000 and you cannot get that room back because the only room you get back from your TFSA is on money that you withdraw from it, not on money you lose in it. Okay, so you get that contribution room back if you make a withdrawal and in this case a loss on the stock is not a withdrawal. So in this case he lost 14 years of TFSA room and all of the tax-free compounding benefit that comes along with that evaporates. It's gone. That is way too valuable for someone to just be okay with losing it. I would say you should be begging to pay capital gains tax before you even consider the real risk of losing your TFSA contribution room. So anyways, that's kind of my little rant on that one. So I would say, if you already have stocks in a non-registered account and they've got a capital gains position, just leave it, you're probably fine. But if you want to start investing in your TFSA as well, just open a different account and you can start fresh there. Because if you already have investments in a non-registered account, you can technically transfer them to a TFSA, but you cannot shelter your current gains from future taxes. So what happens there is, if you transfer your stocks or your ETFs or your mutual funds from a non-registered to a TFSA, what CRA says is that those shares have been deemed to have been sold on that day and thus incurring capital gains tax. If you're going to gain position or capital loss, if you're in a loss position, and so there's no benefit of doing that, you might as well just sell it and move the cash over instead of having the complexity there, necessarily, unless you want to own those specific units in your TFSA, but you can just rebuy them at that point, so it doesn't really matter. Hopefully that answers that question there regarding the TFSA and trading and capital gains potential and transferring existing funds to a TFSA. So, finally, what are all these capital gains? I mentioned capital gains a few times and I don't know if I've spent enough time talking about it, but there's a lot of confusion about capital gains tax. I got this from a client recently who had some questions about it, so I'll try to highlight some of the things that often come up. If you're looking about capital gains tax online, you'll probably run into some US terms and situations, because the US has something with the short term and long term capital gains tax. Honestly, i have no clue how it works because it's not applicable here and I'm not a US tax specialist by any means. So if you're hearing anything about short term or long term capital gains tax, that is not applicable to us as Canadians. Capital gains a capital gain and that's all you need to worry about. So capital gain is when you sell something that is increased in value. However, for the vast majority of us Canadians and many of you listening your capital gains are not applicable. If you're investing in an RSP, capital gains do not apply. In an RSP. Capital gains do not apply in a TFSA. Capital gains do not apply when you sell your primary residence. For the vast majority of us, capital gains will not really come up very often. But if you have a secondary property or if you are like the previous listener, who has stocks or investments in a non-registered account or a cash account or an open account, whatever you call it then you have to worry about capital gains Because in those environments the CRA standard of if you make money, we want a piece of it, applies. Capital gain is a situation where it is increased in value and you have to pay some tax on that increase. Let's give a hypothetical example here. Say you buy some stock for 100 bucks and then over time it increases to 120. Then at that time you want to sell it and buy something else, or sell it and spend the money whatever you want to do. So in this case you bought it for 100, sold for 120, and so the capital gain in this case is $20. However, in Canada you only pay tax on half of the gain, so only $10 is included in your taxable income. So if you have employment income or maybe you're receiving a pension or something like that, all of that it pools together into your taxable income And in this case the $10 of the taxable capital gain gets included in that and you pay it at your marginal rate. So if you're in the 33% tax bracket, in that case you would owe $3.30 on that $20 of capital gain. Let me run through that example again. You bought something for 100 bucks. You sold it at 120. 20 is your capital gain, 10 is taxable income. But the tax you owe is based on your marginal rate and hypothetically that would be about $3 for this person. If you're in the 50% bracket, then you'd owe $5, and so on and so on, as it relates to your personal situation. Now, the opposite is also true. Whereas if you buy something for 100 bucks and you sell it for 80, now you have a $20 loss. Now what you cannot do is use a capital loss to offset your income not yet anyways. So capital losses can only be used to offset capital gains. However, if you have a loss, you can carry it forward for the rest of your life to the point where eventually, hopefully, you have some gains that you can use it against. But if you make it to the end of your life and you still haven't used those capital losses in the year that you pass and the previous year, you can use your capital losses to offset any source of income. Don't worry about this. Your executor is going to be the one dealing with all of this. But having a capital loss is always something that sits on your tax record as an asset that can be used against capital gains now or anytime in the future, and against income in the year that you pass away or the previous year. So there's plenty of tax planning that can go into a situation of capital gains. Another way that you can get rid of capital gains is by donating those shares or units of a mutual fund or ETF to a charity of your choice, and in that case your capital gains actually evaporates to. You get a tax credit for the entirety of the charitable gift. So there's some cool things there. I've done a couple episodes about charitable giving in the past. If you have questions about that, i'd love to have that discussion with you too. But that's just a brief overview of how capital gains works. Again, if you're in an RSP, if you're in a TFSA, if you're in a pension plan I guess I didn't mention that one And if you own a primary residence, capital gains will not apply. So you don't have to worry about that. Again, if you've heard anything about the US and how they've got short term and long term capital gains tax and a bunch of other things that do not apply. Really make sure that when you're looking for tax specific content, that it's Canadian, because what we do here is very, very different than what we do in the US. Anyways, thanks so much again to all of you who asked questions and for those of you that I didn't answer on the podcast here, i hope that my email responses were sufficient for you. I really appreciate all the view who do reach out and I look forward to doing this again in a few months. Thanks so much for listening. We'll see you next time. Thanks for listening to this episode of the Canadian Money Roadmap Podcast. Many rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Neufeld is a certified financial planner and registered investment fund advisor. Financial funds and ETFs are provided by Sterling Mutuals Inc.
