Hands down, asset location is the topic I receive the most questions about from readers, and with good reason. It’s easy to get bogged down in the details and lose sight of the actual target.
Specifically, asset location is about improving your overall portfolio’s tax-efficiency by being deliberate about where you’ll locate your overall stock vs. bond allocations across your various accounts. In other words, what stock/bond ETF mixes will you hold in your TFSAs vs. RRSPs vs. taxable accounts?
To answer this seemingly innocent question, we first need to master the key concepts involved. Then we can build from there.
And, by the way, merely minimizing foreign withholding taxes by holding U.S.-based foreign equity ETFs in your RRSP doesn’t count as asset location. That’s a helpful tax-management technique as well, but that’s more about tax-efficient product selection than actual asset location.
Asset Location “Light”
If you’ve dropped by the blog before, you may recall our 2020 posts on Light, Ludicrous, and Plaid asset location strategies … or basic, moderate, and advanced, if you’re not a Spaceball nerd like me.
Essentially, you can manage asset location the easy way, or the hard way. For 99% of you, I recommend taking the easy way out by simply holding a single asset allocation ETF across all your accounts and calling it a day. It doesn’t get much lighter than that, and it can still be pretty darn tax-efficient!
Still, some of you may want to see what harder ways have to offer, which we’ll discuss in more detail throughout this series.
Key Concept #1: Your RRSP Is a Lot Like a TFSA
To set the stage, if you take one thing away from this series, here it is:
Part of the money you stash in your RRSP isn’t really yours, at least not for asset location purposes. From the moment you put it in there, it helps to think of that part as belonging to the government.
This perspective will help you master what most investors never quite grasp about asset location.
Most investors think of their RRSP as a tax-deferred account. You pay no annual taxes on the earnings. But both your original contributions and any earnings are fully taxable when you withdraw them.
For example, let’s say you’ve contributed $100,000 to your RRSP, and invested it all in stocks earning 6% annually for 10 years. At the end of the 10-year period, your RRSP would be worth $179,085. But assuming a tax rate of 40% on withdrawal, your after-tax RRSP value would be $107,451.
Now, let’s look at this scenario from a slightly different perspective. Rather than seeing your RRSP as a single tax-deferred pile of before- and after-tax money, what if we think of it as two piles?
Pile #1 – Your Money: The first pile is the after-tax portion, where both your contributions and your earnings are tax-free, even on withdrawal. This money is yours, to have, hold, and asset locate as you please.
Pile #2 – Their Money: The second pile is the taxable portion, where both your contributions and earnings will eventually belong to the government. Like a dark star, this money is dead to you from the get-go.
Continuing with our example, since your $100,000 RRSP will eventually be taxed at 40%, your “tax-free” contribution is really only worth $60,000. The 6% annual return on this $60,000 will also be tax-free.
From this perspective, your pile of your $100,000 RRSP is similar to a $60,000 tax-free savings account, earning 6% tax-free returns. The government’s pile is the $40,000 taxable portion, along with its 6% growth. They’re effectively using you as their unpaid portfolio manager.
So, what is each pile worth after earning 6% for 10 years? The $40,000 government portion grows to $71,634, and your $60,000 portion ends up being worth $107,451. If you’ve got a sharp eye, you’ll notice that’s the same, after-tax RRSP figure we calculated in our first, single-pile example.
In other words, whether you think of your money as one big tax-deferred pile, or two separate tax-free + taxable piles, what you get to keep and what eventually goes to the government remains the same. That’s why it’s okay to think of your $100,000 RRSP as really only representing a $60,000 tax-free account for purposes of asset location.
Key Concept #2: Your RRSP Allocations Aren’t What You Think They Are
To recap, here’s what we’ve learned so far:
- The after-tax, “tax-free” portion of your RRSP acts like a TFSA. The initial after-tax value and any growth both accrue to you tax-free.
- The taxable “government-owned” portion of your RRSP and any of its growth is dead to you. It’s just along for the investment ride.
What does this mean to you?
If you figure in the taxable, “government-owned” portion within your asset allocation, you are assuming you own more stocks than you effectively do. In other words, choosing to hold stocks in your RRSP (before holding them in other account types) will make your portfolio’s after-tax asset allocation more conservative than your before-tax asset allocation.
Likewise, choosing to hold bonds in your RRSP (before holding them in other account types) will make your portfolio’s after-tax asset allocation more aggressive than your before-tax asset allocation.
Either way …
By holding stocks (or bonds) in your RRSP, you’ll have less invested in stocks (or bonds) than you may think.
Key Concept #3: What Looks Like Asset Location Is Often Asset Allocation in Disguise
That was the warm-up. Is your brain ready for the main event? As we’ll see in our next examples, deciding whether to first locate stocks in your RRSP or TFSA can impact the after-tax asset allocation of your portfolio. This will also have an impact on your future after-tax portfolio value.
Let’s walk through five asset location scenarios to illustrate. To keep things (relatively) simple, we’ll use just one TFSA and one RRSP, with these assumptions across all five scenarios:
- The initial TFSA value will be $60,000.
- The initial, before-tax RRSP value will be $100,000, and your tax-rate is assumed to be 40%. As we just covered, that means the after-tax value of the RRSP will also be $60,000.
- Once again, our measurement period will be 10 years … with no rebalancing.
- We’ll assume a 6% annual return on your stock ETFs and a 2% annual return on your bonds.
- Last, we’ll target an initial before-tax asset allocation of 50% stocks and 50% bonds
Asset Location Scenario #1: Identical Asset Allocation Across the TFSA and RRSP (aka, “Asset Location Light”)
By far, the most common asset location set-up is to hold the same asset allocation across both your TFSA and RRSP. This ensures your before- and after-tax asset allocations are always equal.
For example, in our RRSP, if we allocate $50,000 before-tax equally to stocks and bonds, the after-tax value for each will be $30,000, calculated as follows:
$50,000 x (1 – 40% tax rate) = $30,000
And because the TFSA is always tax-free, its before and after-tax values will be the same. So, it makes no difference whether we’re viewing this initial portfolio from a before- or after-tax basis. It will always be 50% stocks and 50% bonds.
This Asset Location Light set-up takes the least amount of effort to manage, especially now that commission-free asset allocation ETFs are readily available at many discount brokerages. As I mentioned at the beginning, this means you can simply hold the same asset allocation ETF across all account types, and call it a day.
Now, we’ll let this 50/50 portfolio do its thing for the next 10 years, without even bothering to rebalance it back to its original targets. Check out what happens to the after-tax RRSP value after 10 years:
It’s no coincidence that the after-tax RRSP value drops to the same figure as the before- and after-tax value of the TFSA. Remember, the before-tax RRSP value started at $100,000, and our tax rate is 40%, so its initial after-tax value was $60,000—the same as our initial TFSA value. And since they both have the same after-tax asset allocation, they both grow to the same after-tax portfolio value of $90,295. Once again, the after-tax value of your RRSP behaves just like a TFSA. At the end of the 10 years, they create a combined, after-tax value of $180,591.
Asset Location Scenario #2: Holding Stocks in the TFSA First, with a 50/50 Before-Tax Asset Allocation
In our first, “TFSA first” scenario, we’ll ignore the after-tax asset allocation and focus only on before-tax figures. Since the total before-tax portfolio value is $160,000, we’ll allocate $80,000 to stocks and $80,000 to bonds for our before-tax 50/50 mix. We’ll first allocate as much of our stock allocation as we can to the TFSA, and then allocate any “spillover” to the RRSP.
As we have $60,000 to invest in the TFSA, and $100,000 to invest in the RRSP, we would purchase $60,000 of stocks in the TFSA first, $20,000 of stocks in the RRSP, and $80,000 of bonds in the RRSP. This arrangement will provide our before-tax 50/50 asset mix.
Assuming a 6% annual return on stocks, a 2% return on bonds, and no rebalancing, the TFSA, RRSP and total portfolio would grow to $107,451, $133,337 and $240,787 respectively. But after the RRSP has been taxed at 40%, its value would drop to $80,002, resulting in a total after-tax portfolio value of $187,453. This is higher than the $180,591 after-tax portfolio value from our first example, where we simply held the same asset mix across both accounts.
At first glance, it would seem as if holding stocks in the TFSA first and the RRSP second is a better asset location strategy than holding the same 50/50 mix across both accounts. However, looks can deceive, because, as we proposed as Key Concept #3 above …
It’s actually your after-tax asset allocation—NOT the asset location—that is driving the outcomes.
The portfolio started out with a more aggressive after-tax asset allocation of 60% stocks and 40% bonds. It’s this riskier, after-tax asset allocation that explains the higher after-tax portfolio value after 10 years, not the asset location strategy of holding stocks in the TFSA first.
If you’re a skeptic, here’s how it pencils out. If we adjust our RRSP values downward to account for the 40% government-owned portion of the RRSP, its after-tax stock allocation is only worth $12,000. This is calculated as follows:
$20,000 x (1 – 40% tax rate) = $12,000
We also find that the after-tax bond allocation in the RRSP is only worth $48,000:
$80,000 x (1 – 40% tax rate) = $48,000
So, in the overall after-tax portfolio, we end up with $72,000 invested in stocks and $48,000 invested in bonds … i.e., a 60/40 mix.
Asset Location Scenario #3: Holding Stocks in the TFSA First, with a 50/50 After-Tax Asset Allocation
Still don’t quite believe me? Let’s test the claim by still holding stocks in the TFSA first, but maintaining a 50/50 after-tax asset allocation. To do so, we would start by multiplying the $120,000 after-tax value of the total portfolio by 50%, giving us $60,000. Since we want to hold stocks in the TFSA first, and the cash available in the TFSA is $60,000, the entire TFSA would be made up of stocks. As we don’t need to purchase any additional stocks in the RRSP, we can invest its entire $100,000 into bonds. Remember, since the RRSP will be taxed at 40%, the bonds in the $100,000 before-tax RRSP are only worth $60,000 after-tax, so we now have an after-tax asset allocation of 50% stocks and 50% bonds.
The before-tax percentages on our account statements will obviously look different. The before-tax total portfolio value will be $160,000. The before-tax value of stocks vs. bonds will be $60,000 and $100,000 respectively, resulting in a before-tax asset allocation of 37.5% stocks and 62.5% bonds. Clearly, this is more conservative than a 50/50 asset mix … but that’s from a before-tax perspective.
If we let this more conservative, before-tax portfolio ride for the next 10 years without rebalancing, the TFSA, RRSP, and total portfolio would grow to $107,451, $121,899, and $229,350 respectively. After the RRSP was taxed at 40%, we would find its value would drop to $73,140, resulting in a total after-tax portfolio value of $180,591. This is the exact same after-tax portfolio value from our first example, where we held a 50/50 asset mix in both the TFSA and RRSP accounts.
Voila! Our asset location choices had no bearing on our portfolio outcomes. Once again …
It was the after-tax asset allocation (not the asset location) driving the portfolio returns.
This makes intuitive sense. As we discussed earlier in this video, the government portion of the RRSP never accrues to us, nor does any of its investment growth, so both can be ignored entirely.
Asset Location Scenario #4: Holding Stocks in the RRSP First, with a 50/50 Before-Tax Asset Allocation
Because it’s better to have too much proof than not enough, let’s now swap the account location of the two asset classes, holding stocks in the RRSP first. For this first scenario, we’ll ignore after-tax asset allocation, and simply build a 50/50 before-tax portfolio. If you want to skip the exercise entirely, it’s going to once again demonstrate that it’s your after-tax asset allocation, not your asset location, that impacts the majority of your future after-tax portfolio returns.
Since the total portfolio value is $160,000 before-tax, we’ll again want to allocate $80,000 to stocks and $80,000 to bonds to achieve a 50/50 before-tax asset allocation. This time, we’ll first allocate as many of our stocks as we can to the RRSP.
With $100,000 of cash in the RRSP, and $60,000 in the TFSA, we would purchase $80,000 of stocks in the RRSP first and then $20,000 of bonds. We’d finish by purchasing $60,000 of bonds in the TFSA. This arrangement will provide us with our 50/50 before-tax asset mix.
Again, assuming a 6% annual stock return and a 2% annual bond return with no portfolio rebalancing, the TFSA, RRSP and total portfolio would grow to $73,140, $167,648 and $240,787 respectively. After the RRSP has been taxed at 40%, we would find its value would drop to $100,589, resulting in a total after-tax portfolio value of $173,728. This is lower than the $180,591 after-tax portfolio value from our initial example, where we simply held the same asset mix across both accounts.
But once again, if we adjust our RRSP values downward to account for the 40% government-owned portion of the RRSP, we find our overall, after-tax portfolio has only $48,000 invested in stocks and $72,000 invested in bonds. This results in a more conservative after-tax asset allocation of 40% stocks and 60% bonds. So, once again, we would suggest it’s this less risky, after-tax asset allocation that has resulted in a lower after-tax portfolio value at the end of 10 years—not the specific asset location strategy of holding stocks in the RRSP first.
Asset Location Scenario #5: Holding Stocks in the RRSP First, with a 50/50 After-Tax Asset Allocation
For our final example, we’ll continue holding stocks in the RRSP first but target a 50/50 after-tax asset allocation. To do so, we would start by multiplying the $120,000 after-tax value of the total portfolio by 50%, giving us $60,000. Since we want to hold stocks in the RRSP first, and the cash available in the TFSA is $60,000, the entire TFSA would be made up of bonds. As we don’t need to purchase any additional bonds in the RRSP, we can invest the entire $100,000 of cash into stocks. Remember, since the RRSP will be taxed at 40%, the $100,000 before-tax stock allocation in the RRSP is only worth $60,000 after-tax, so we now have an after-tax asset allocation of 50% stocks and 50% bonds.
The before-tax percentages on our account statements will once again look different. The before-tax total portfolio value will be $160,000. The before-tax value of stocks and bonds will be $100,000 and $60,000 respectively. The result is a before-tax asset allocation of 62.5% stocks and 37.5% bonds, which is more aggressive than a 50/50 asset mix.
If we set this riskier, before-tax portfolio on auto-pilot for the next 10 years, and don’t rebalance, the TFSA, RRSP, and total portfolio would grow to $73,140, $179,085 and $252,224 respectively. After the RRSP has been taxed at 40%, we would find its value would drop to $107,451, resulting in a total after-tax portfolio value of $180,591. This is the exact same after-tax portfolio value from our first example, where we held a 50/50 asset mix in both the TFSA and RRSP accounts. It is also the exact same after-tax portfolio value of the example where we held stocks in the TFSA first but targeted a 50/50 after-tax asset allocation.
Five Scenarios, One Compelling Conclusion
In case I’ve not yet made my point painfully clear, here it is:
First, regardless of the asset location decision, after 10 years, each of our portfolios targeting the same after-tax asset allocation had the exact same after-tax portfolio value: $180,591. So long as the after-tax asset mix of each portfolio was the same, it didn’t matter whether we held the same asset mix across both accounts, or located stocks first in our TFSA or RRSP.
Second, holding stocks in your TFSA first while targeting a 50/50 before-tax asset allocation did result in a higher after-tax portfolio value of $187,453 at the end of our 10-year measurement period. But this was not due to any tax efficiencies. Rather, the portfolio had a more aggressive after-tax asset allocation of 60% stocks and 40% bonds.
Likewise, when we held stocks in our RRSP first, while targeting a 50/50 before-tax asset allocation, we ended up with a lower after-tax portfolio value of $173,728 at the end of our 10-year measurement period. This was again not due to a bad asset location decision. It was simply the result of investing in a more conservative after-tax asset allocation of only 40% stocks and 60% bonds.
The grand conclusion: Your after-tax asset mix drives most of your after-tax returns, not your asset location decision.
If you made it this far, congratulations are in order. These asset location concepts are not easy. Feel free to take a break and re-read this material later.
After that, if it’s still not sticking, that’s okay too. To be a successful investor, you don’t really need to understand this stuff. You can simply opt for Asset Location Light by holding a single asset allocation ETF across all your accounts. You’ll still have one of the best asset location solutions around.
However, by now, you may be wondering whether asset location matters at all. The answer is, yes, it can! But it takes some extra work to make it happen. In our next two posts, we’ll build on today’s key concepts, and provide practical advice on how to implement a Ludicrous or even Plaid Asset Location strategy in your DIY portfolio.
Just how far can we take this asset location stuff? Keep an eye out for our next two posts, and you’ll soon find out for yourself.
I don’t undestand where your assumption of a 40% tax rate for the RRSP comes from. According to the CRA’s own website, the witholding tax on RRSP withdrawals is onle 30% for amounts over $15,000.
Someone with a taxable inome of $50K only pays $6,791 (federal) and $3106 (provincial) which is LESS than even 30% so if they were taking out $50K from their RRSP they would be getting a refund come tax time.
Source: https://ca.talent.com/tax-calculator?salary=50000&from=year®ion=Ontario
Thank you very much for these posts. This clarifies many questions that I had and will orient my DIY investment strategy.
Hi Justin,
Slowly working my way through your posts. Tons of quality information cheers!
Question: Why wouldn’t one want to view their three accounts as separate entities when it comes to portfolio construction? For example:
RRSP: Only U.S listed ETF’S for U.S, emerging, International developed at 60%/20%/20%
TFSA: All CAD listed ETF’S for U.S., CAD, International developed at 60%/15%/25%.
Taxable account, VEQT for the SM.
Rebalancing them on a per account basis. Is that advisable or would I run into some issues?
Thanks!!
Hi Justin,
I am looking at VGRO and if I understood the above article correctly I would match my asset allocation between my RRSP and TSFA to 50/50 between both accounts. I would need to calculate the after tax value of my RRSP in order to actually get an after tax 50/50 split between the two accounts ? I would buy the same ETF and hold it in both accounts 50/50 ? If I’m in a low tax bracket would I be better off just using the TSFA ? or use the RRSP contributions to get a tax refund and invest that refund in my TSFA ? Im just having a hard time selling myself on the benefits of an RRSP when I generate a low income and don’t owe income tax each year. Being in my late 20’s my short- medium term goals are to buy a house and long term to save for retirement.
4,000 RRSP – 40% = After tax value of 2,400
TSFA = 2,400
= after tax 50/50 ratio between the two accounts
Thanks for the help !
@Caleb – This article is not meant to help you choose between a TFSA and RRSP. If you’re just starting out, you can ignore these “asset location” articles and simply hold the same asset mix across all accounts.
If you’d like to read about whether to invest in an RRSP or TFSA, you can check out this article:
https://www.youngandthrifty.ca/tfsa-vs-rrsp/
These examples work because only registered accounts are being used. Registered accounts tax any kind of income or gain at the same rate, whether it be 0% (TFSA) or your marginal tax rate (RRSP).
However, I wonder if we would arrive at the same conclusion with taxable accounts thrown in the mix. In taxable accounts, there would be a difference in taxation between dividends from Canadian stocks, foreign dividends, interest from bonds and capital gains, which should make it more profitable to hold highly taxed items (interest or foreign stocks) in registered accounts and lower taxed items (Canadian or high-growth/low-dividends stocks) in taxable accounts.
@Anthony – It’s a three-part asset location blog/video series. The other two blogs/videos throw taxable accounts into the mix (but the main tax concepts are the same as those found in Part 1).
Hi Justin,
If you’re basing asset allocations on after-tax amounts in RRSP accounts, by the same logic shouldn’t you also be taking unrealized capital gains into account in taxable accounts?
For example, if you have stocks in a taxable account with a market value of $100k, and a book value of $50k, then the government “owns” part of your investment. At a 40% marginal tax rate and 50% inclusion rate for capital gains, the government owns $20k ($100k * 40% * 50%) of your investment, and your $100k is really only worth $80k after taxes.
If that’s the case, then investors with large amounts of unrealized capital gains in taxable accounts have portfolios that are less aggressive than they might think.
Thanks for your videos and blog posts – they’re extremely useful.
@pjb – You are absolutely correct! :)
Although this example focused on just a TFSA and RRSP, investors with taxable accounts with large unrealized capital gains will also need to make an additional adjustment to calculate their after-tax asset allocation.
Thanks for the response!
I tried this on my own accounts, and it made some difference, but not a huge one. Compared to using pre-tax amounts, at the next rebalancing I’ll have to sell more of some TFSA investments and less of some taxable investments with high capital gains.
(There’s a mistake in my original post. Obviously, only the $50k in capital gains is taxable, not the whole amount. So, the government owns $10k of the $100k investment (= $50k * 40% * 50%), not $20k.)
Thanks for your videos. The presentations are very clear and make a complicated subject somewhat easier to understand.. In these examples, have you figured in the tax credits received for contributions to an RRSP in the overall return of the investing account allocations?
@Herschell Sax – I’m glad you’ve been enjoying the videos :)
These examples do not include any assumptions about tax deductions on RRSP contributions (they take place after the contribution decisions have taken place, and now the investor is wondering what to do with the cash in each account).
Hi Justin,
Thank you very much for sharing your knowledge and training us. I have learned and advanced a lot by watching your videos and reading your articles. I sold my MFs and decided to become a DIY:)
I managed to complete my RSP with XBB/XIC/VIU/VUN (I hope it is a good pick), but I am still wondering about my TFSA:(
I have read so many things that I feel overwhelmed and cannot finalize my TFSA (60K). I am planning to hold various fixed income ETFs in my TFSA (I want income). I prefer to use index ETFs with low volatility and MERs. I would like to combine different bond ETFs in a way that when one goes down the other goes up. It would be a great help if you suggest fixed-income ETFs that can be matched this way for my TFSA.
Thank you very much.
Sara
@sara – Thanks for checking out the videos (and reading the blog)!
Are you saving in your TFSA for retirement, or are the funds earmarked for a shorter-term goal?
Hi Justin,
Thank you very much. I am saving in my TFSA for retirement (won’t touch it for around 25-30 years).
Sara
Hi Justin,
Thank you very much. I am saving in my TFSA for retirement (won’t touch it for around 20-25 years, so sorry made a math mistake!! in my previous post).
Sara
@sara – If you don’t require the funds until retirement, you could consider holding a single asset allocation ETF across both your TFSA and RRSP. Here’s a video Shannon created on how to choose the most appropriate asset allocation for your portfolio: https://www.youtube.com/watch?v=JyOqqtq12jQ
Thank you for adopting the ‘not all your money’ understanding of the RRSP. May I suggest for a future article you revisit AL yet again, this time covering the 4th point made in the article I linked to my name?
Thank you for adopting the ‘not all your money’ understanding of the RRSP. May I suggest for a future article you revisit AL yet again, this time covering the 4th point here https://www.advisorperspectives.com/articles/2019/06/26/asset-location-irrelevant
Thanks so much for these posts and videos. Really awesome that you take the time to do this charitably.
I follow the Couch Potato / Index investing 100%, for more than a decade now, and (at the risk of being over confident) I generally think I “get it”. To be honest though, this is one concept that I never quite got the “so what” of.
I understand all the math as you and others have presented it. And while mathematically I understand the point about how, on an after-tax basis, you are taking more risk if you don’t calculate the government-owed portion of the RRSP, as a matter of practical implementation I don’t see why it matters. My questions really is as follows:
To follow this process, you have to make a calculation today with an assumption about the RRSP withdrawal rate later. But that assumption is subject to so many “what ifs”. Changes in tax rates, other government rules. Fundamentally, each individual has some control over it, at the “end” moment of withdrawal, right? Like, I can choose to retire early (or not), or take out more (or less) or turn a bunch of knobs to manipulate that rate (and ideally lower it as much as possible) when I withdraw the funds. So if I assume and calculate based on 40% today, isn’t it all just for not anyway because of the (likely) different rate when I withdraw?
(I am not a super wealthy guy, maybe the problem is my frame of reference, but I can see a path to having my marginal rate in retirement being much lower than it is with my earnings today – maybe someone with loads of $$$ can’t assume that?)
So I guess to me, we say it’s “proper” to consider after-tax or else you could theoretically be taking more risk. Yet the whole thing hinges on a multi-decade assumption of future tax rate that is very likely to be wrong anyway, rendering the whole thing kinda futile?
And then, I guess even if one accepts the premise that using Before Tax allocation results in a higher-risk allocation (assuming Bonds in RRSP), I guess again I have the fundamental “so what?” question? With normal / modest account size assumptions, you end up with a slightly more risky portfolio – maybe 70/30 instead of 60/40. This is probably GOOD for you over the long term, no? The main down-side of highly risky portfolios *in the long term* I think is the propensity of psychological freak-outs and panic sells at the wrong time. 70/30 is unlikely to be dramatically different from 60/40 and anyway in this case I think it is even LESS likely because the person is still visualizing the portfolio as 60/40 “Before Tax”, so there’s really no argument for increased “bad effects” of the riskier after-tax allocation.
Hopefully that all makes sense. I myself use a roughly 60/40 allocation but use Before Tax calculations. I concede theoretically the increased risk argument but practically, given all the assumptions & variables, I just don’t see why I would even bother with the calculation!
(Bonus Question – if one also has an Unregistered account in addition to TFSA/RRSP, then technically we have to add a fudge-factor for After Tax allocation there as well, right? Because any growth in the account over time has some portion of tax owing. And if so, aren’t there even MORE degrees of freedom and necessary assumptions there because of all the ways that tax rate might be lowered via planning?)
@ Dwilly
Yes, no one knows what the exactly tax rate will be on eventual RRSP withdrawals. But there is no necessity that you be exact. Any rough estimate is better than none at all. Even if you end up drawing at the bottom tax rate, that is still 20% different from a 0% assumption.
The necessity to discount the RRSP’s $value for the AA calculation is not because you would be ‘taking more / less risk’. It is because without the discount you are simply calculating your AA wrongly. You would have actually implemented a different AA.
Once you have corrected the AA calculation, you will probably find that the conclusions for AL reverse… resulting in bond being the FIRST to get kicked out of RRSP / TFSA ‘s. When you locate the high risk/return asset inside the RRSP, you are correct that the larger $$ holding stocks (because includes the gov’t share) magnifies the $$ losses during a downturn.
In any situation with AL there will be more than one account, so it is where you sum up the account totals that (necessary only during a crash) that you play games to control your emotions. Subtract the RRSP account’ gross up from the total sum of all accounts. Mark it on your statement (or Excel, etc). Then do the same next month … and you will see the correct reduced % and $$ losses more clearly.
Hello Justin. I wonder why you have chosen a tax rate of 40% when the usual strategy would be to make withdrawals at a far lower average tax rate. For instance, my average annual tax rate is 18% across all my current sources of income, including RIF income. I can only assume the choice is for illustrative purposes in a blog with the primary target group being accumulators. Doesn’t the supposition of a 40% tax rate at the time of withdrawal skew the results? I wonder how much the scenarios change when withdrawals are made when average tax rates are much, much lower as is one, if not the major objective of RRSP investment.
@Curt – I chose the 40% rate as it made the percentages more “tidy” (i.e., the 50/50 portfolio was a 60/40 or 40/60 portfolio after-tax in certain scenarios). For purposes of understanding these key concepts, the tax rate, asset allocations and account values are irrelevant (they are just random figures chosen while writing the post). However, most investors concerned with tax-efficiency tend to be investors in higher tax brackets (otherwise, the benefits of any tax-efficient strategy are not as worthwhile for their specific situation). If you’re in a lower tax bracket, this is yet another reason not to complicate your asset location (and simply hold the same asset mix across all account types).
The concepts in the article will remain valid no matter what input assumptions you make. To Asset Allocate correctly, you must discount the value of the RRSP account …. because it is not all ‘your money’.
You can discount the RRSP by whatever estimate of your effective tax rate at withdrawal you like.
Another great article, Justin – much appreciated :-)
@Terry O’Malley – I’m glad you liked it! :)
Hi Justin,
I just hold VGRO in all my accounts – TFSA, RRSP, taxable and corporate.
It has been so simple and I really don’t care about any extra costs.
Because now it is something that I can take care of forever.
Thank you for reminding many of us that sometimes simple is better.
@Stephanie – I’m so glad to hear you’ve decided to keep your asset location simple! :)
Hi Justin,
Here is my solution for asset location. Once we exclude non-registered accounts (and we should, since adjusting them for asset location can trigger negative tax consequences), there are really only 2 asset location scenarios to consider. TFSA > RRSP and RRSP > TFSA. I propose we select asset location to reduce complexity and minimize foreign withholding taxes. In both cases, we throw Canadian ETF (VCN) and Canadian Bonds (ZAG) in the TFSA. We put US-listed ETFs for US Market, International Developed, and Emerging markets into our RRSP.
Then for overflow, if RRSP > TFSA, we put our overflow units of ZAG and VCN into the RRSP in a proportion to give us our desired asset allocation. Alternatively, if TFSA > RRSP, then we instead put overflow units of Canadian-Listed ETFs for US Market, International Developed, and Emerging Markets into our TFSA.
Other accounts such as non-registered or RESP are excluded and should have their own independent asset allocation.
What do you think?
@Mark H – I’m unfortunately not following your asset location logic. Perhaps wait for the next two videos to be released, and these might help to clear things up.