National Post (National Edition)
Sell your losers, avoid dividends
There are always disagreements in investing; in fact, every single trade that takes place on the market represents equal and opposing sides. Buyers think a stock is good and destined for greatness; sellers either need the money, or think the stock is going down.
But one thing every investor can agree on is taxes. No one likes them. They are part of investing, but there are ways to at least keep them as low as possible. Here are five tips:
TAX-FREE SAVINGS ACCOUNT
Seriously. Max it out. It is the only true tax-free account we have in Canada. Forget the word ‘savings’ in the title: make sure you put growth stocks inside the account, not GICs. You want large gains to maximize tax benefits. Think of Amazon (AMZN on Nasdaq) or Alphabet (GOOG on Nasdaq). You don’t want super-high risk, but you want growth. You can withdraw money anytime for emergencies, and put the withdrawn funds back in the following year.
DON’T OWN ANY STOCKS THAT PAY DIVIDENDS
This may be a tough suggestion for investors to wrap their heads around, because most investors just simply love their dividends. In addition, this suggestion is the exact opposite of the next one, but each is valid, as we will see. If you have no dividend income, and own stocks, then you will be only paying capital gains taxes on your investments. Capital gains tax, for most investors, is the lowest form of tax. Depending on your tax rate and province, the net tax on incremental dividends is about 30 per cent, and the net tax on capital gains is about 24 per cent. But owning non-dividend stocks can help offset the tax burden in other ways: suppose you own 10 stocks. It is likely that, in any given year, three or four of those will decline. You can sell your losers to offset your winners, and, depending on the amounts of losses, may not pay ANY tax. Either way, your losing investments will lower your overall tax burden.
ONLY OWN CANADIAN STOCKS THAT PAY DIVIDENDS
This seems to contradict the prior point, but it works wonders for certain types of investors. If dividends are your only source of income, you can earn about $48,000 (in Ontario) completely tax-free, through the wonders of the dividend tax credit. Many individuals, if their house is paid for, can live relatively well on that amount. Once this threshold is met, you can still invest for the future in non-dividend stocks, so you can still have good growth and inflation protection over time, even if your reported net income is relatively low. At the current tax-free income level, and the TSX yield of 2.9 per cent, you need a bit over $1.6 million in Canadian dividendpaying stocks to get the maximum tax-free income benefit.
SELL YOUR LOSERS
Similar to the point discussed above, you should make it a regular habit to crystallize your capital losses as much as possible. Losses can be carried back three years, or carried forward indefinitely. Not only does this strategy substantially reduce your tax burden, but it will also likely help improve your overall portfolio investment performance. Most investors keep their losers far too long. Getting rid of them for tax purposes at least gets rid of them.
CONSIDER SPECIALIZED ETFs THAT CONVERT DIVIDENDS INTO CAPITAL GAINS
ETF provider Horizons offers several funds that use derivative swaps to convert dividend income into capital gains. These ETFs pay no distributions, but still rise in value with dividends received from their underlying investments. This structure means unit holders only have a taxable event when units are actually sold. For example, Horizons Canadian High Dividend Index ETF (HXH on TSX) converts Canadian dividend income into capital gains. Fees are low at 0.11 per cent, and the potential tax savings can be significant. Obviously, if you require ongoing dividend income for expenses then these funds may not be for you, but for others they are worth checking out in a taxplanning strategy.
You might notice we haven’t even mentioned RRSPs here. That’s because income coming out of an RRSP is taxed as regular income, the highest rate. If you plan on being a long term successful investor — and you should — you should also plan on always being in a high tax bracket. RRSPs are great for growing your money over time, but they are not so great when it comes to taking money out.
Peter Hodson, CFA, is Founder and Head of Research of 5i Research Inc., an independent research network providing conflict-free advice to individual investors ().