It's been several weeks since I looked at the Q&A inbox and a lot of mail has piled up. So let's get right to it.
Why keep bonds?
Q – Why keep bonds in a portfolio when we anticipate interest rates to go up in 2017? – Peter M.
A – Reduced risk is the primary reason. Fixed-income securities like bonds provide a safety net in the event of a stock market crash. A portfolio that is 100 per cent exposed to equities is going to experience heavy losses if the market crumbles. Quality bonds rarely produce a negative total return in any given year and when it happens the losses are usually small.
When interest rates are rising, as we expect in 2017, short-term bonds are the best option from a risk perspective. The market price of issues with long maturities will be hit harder when rates go up. Of course, any bonds held to maturity will be redeemed at par.
One more point –winter predictions don't always translate into reality, as I know from long experience. Last year, for example, bond prices rallied strongly in mid-year when interest rates unexpectedly declined. They lost most of those gains in the fall but bonds still ended 2016 in the black. The iShares Canadian Universe Bond Index ETF (XBB-T) was up 1.36 per cent last year and had a three-year average annual compound rate of return of 4.28 per cent. – G.P.
Q – I have a good dividend paying stock and would like to move part of it into a TFSA where I have accumulated a few years of contribution room and the remainder into my self-directed RRSP, to which I haven't contributed for years. If my intention is to reinvest the money back into the same company, but under both the TFSA and the RRSP umbrellas, am I making a sensible move or should I leave things as they are? I'm 60 years old and drawing a pension. My spouse won't retire for another five years and we manage well with our combined incomes for now. – Monica D.
A – For starters, you don't have to sell the stock to make the transfers. You can contribute it in kind, assuming you have self-directed plans.
If you move the stock into either plan, it will be deemed a taxable event by the Canada Revenue Agency and you will be taxed on any capital gain. The same will apply if you sell the shares. You should take that into account before you act.
If you decide to proceed, your dividends and capital gains will be fully sheltered in the TFSA. The RRSP will give you a tax deduction when you contribute but you'll be taxed at your marginal rate when you make any withdrawals, including on the original contribution. – G.P.
Q – Can a privately owned company be the possessor of a TFSA account and can each member of a family contribute their TFSA annual contributions to this single fund? – Samuel C.
A – No. Tax-Free Savings Accounts are the personal property of an individual. No company can open one and no other person can contribute to your account, not even your spouse. – G.P.
Mutual fund MERs
Q - Here is a question related to mutual fund MERs.
Hypothetically, let's say there are two mutual funds in a portfolio. Fund A has a MER of 2.5 per cent and Fund B has a MER of 1.5 per cent. Both funds report exactly the same return for every year after fees and expenses.
My question: In this hypothetical example why should I care about mutual fund MERs if the net return is the same? Actually, why would I care about MER at all? Should I only focus on the return? - Minh T.
A – I'm glad some people understand what I've been saying for years. The only number that should matter when judging mutual funds is the net return to you. If a mutual fund with a 2.5 per cent management expense ratio returns 10 per cent a year after expenses and an ETF with a 0.5 per cent MER gains just 8 per cent, which would you choose? Clearly, the mutual fund puts more money in your pocket than the ETF, even if its costs are higher. This is not to suggest people should ignore costs. However, judge them against returns before deciding. – G.P.
Q – I am putting all my RRSP into a RRIF to start in June 2017. My royal bank planner says I should put it into RBC Select Conservative Portfolio as I told him I want low risk. The money is in GICs right now. They will charge me 1.8 per cent (MER). Is this a good fund? – Gordon S.
A – This portfolio invests in 25 Royal Bank and Phillips, Hager & North mutual funds. It's a global balanced fund with an emphasis on the fixed income side (53.5 per cent of assets). Performance is below average for a fund of this type. The portfolio gained 4.1 per cent in 2016 compared to 4.8 per cent for the category as a whole. The five-year average annual compound rate of return is 6.2 per cent versus 6.8 per cent for the group. The fund hasn't lost money in any year since 2009 but it isn't completely safe. It dropped 13.8 per cent in the 12 months to the end of February 2009. Overall, I'd rate it as average for its type. – G.P.
Q – You have recommended holding any cash reserves in U.S. dollars. Do you recommend any particular vehicles to hold this cash, such as money market funds, savings accounts, etc.? I could not find any listed on your USD recommended lists. – Don M.
A – Unfortunately, you aren't going to earn much interest on U.S. cash (or on any cash for that matter). The recommendation was based on my expectation that the loonie will decline in value against the greenback this year, which would give you a capital gain on any U.S. cash you hold. (Of course if the loonie rises, you'll lose.)
All the big banks offer U.S. dollar accounts and some come with a variety of bells and whistles such as a U.S. currency credit card, cheques, favourable exchange rates, etc. What they don't offer is respectable interest rates. For example, you would have to deposit at least US$25,000 with TD Bank in order to earn a miserly 0.10 per cent. If you have over $100,000 (U.S.) you can earn 0.25 per cent with HSBC.
A good U.S. dollar money market fund may offer a better return. For instance, the CIBC U.S. $ Money Market Fund returned 0.7 per cent over the year to Jan. 31. The average for the category over that time was 0.31 per cent.
You can find better rates with some smaller U.S. banks, however they may require a U.S. address. You can search for details at www.bankrate.com/partners/sem/savings-accounts-mma-v3. – G.P.
GIC in an RRSP
Q - I am holding a GIC in my RRSP. Do I have to pay income tax on the interest I get from it? I know that there are taxes on any money taken out of the RRSP, but what if you do not take money out? – George V.
A – No investment earnings are taxed inside an RRSP or RRIF. Tax is assessed only at the time money is withdrawn and then at your marginal rate. – G.P.
U.S. citizens and TFSAs
Q - My husband has dual citizenship with Canada and the U.S.; because of that we have topped up my TFSA and now have money to contribute to his. To keep things simple for US income tax filing purposes, does it make sense to buy Canada stocks in U.S. dollars in this fund? The intent is to withdraw profits yearly to fund our southern winter vacation every year and after the initial purchase not have to worry about the exchange rates. I would appreciate any ideas that you have. – D.M.
A - I assume you are aware that the U.S. Does not recognize TFSAs under the Canada-U.S. Tax Treaty. Therefore all investment income earned in the plan will be taxable when your husband files his U.S. tax return. Since all U.S. returns have to be in U.S. dollars, yes it would make sense to have the assets held in U.S. dollar denominated securities. - G.P.
If you have a financial question, send it to me at firstname.lastname@example.org and write "Globe question" in the subject box. Sorry, but I cannot guarantee personal answers, although I try my best.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.
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