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Here’s why investing in an RRSP does make sense for many Canadians

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Jamie Golombek: An RRSP can allow you to save for retirement on an effectively tax-free basis, and no, that’s not a typo

Let me try to un-muddy the waters by suggesting that RRSPs are likely the best way for many Canadians to save for retirement. After all, an RRSP, just like a tax-free savings account (TFSA), allows us to earn effectively tax-free investment income. And, no, that’s not a typo: tax free, not merely tax deferred.

For decades, some readers have tried to convince me that RRSP investment income is merely tax deferred since you must pay tax on the funds when they are withdrawn from the RRSP, or, ultimately, from its successor, the registered retirement income fund (RRIF).

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But if you go back to basics, and really think about what’s happening with an RRSP contribution, you will soon realize the investment return on your net RRSP contribution is mathematically equivalent to the tax-free return you could achieve with a TFSA, ignoring, for now, changes in tax rates. And, provided the time horizon is long enough, RRSPs can beat non-registered investing even if your marginal tax rate is higher in the year of withdrawal than it was when you contributed.

Let’s start with a basic example. Sarah has three choices when it comes to investing $1,000 of her 2023 employment income for her retirement: a TFSA, an RRSP or a non-registered investment account. Her 2023 marginal tax rate is 30 per cent, and she expects to be able to generate an annual rate of return of five per cent on her investments.

If Sarah wants to contribute $1,000 of her income to a TFSA, she first needs to pay tax at her marginal rate of 30 per cent on that income, leaving her with $700 to contribute. Using a five-per-cent annual rate of return, her TFSA will grow to $1,857 at the end of 20 years, and, because it’s in a TFSA, the entire $1,857 can then be withdrawn tax free. Her after-tax rate of return of five per cent is, naturally, equivalent to her pre-tax rate of return because the funds are withdrawn tax free.

Now, let’s say Sarah chooses to invest that $1,000 by making a tax-deductible contribution to her RRSP. Because of the tax deduction, she can put the full $1,000 to work. Keep in mind that 30 per cent (assuming her tax rate doesn’t change upon retirement) of the funds in her RRSP account effectively belong to the government by way of deferred taxes that will apply on both her initial contribution and on the sheltered income and growth in the RRSP.

Both an RRSP and TFSA will beat a non-registered account if your tax rate today is the same as the tax rate in the future.
Both an RRSP and TFSA will beat a non-registered account if your tax rate today is the same as the tax rate in the future. Photo by Getty Images/iStockphoto

Applying the same annual rate of return of five per cent over the next 20 years, with no annual taxation, Sarah will be able to accumulate an RRSP worth $2,653. But, alas, not all the RRSP funds are hers to spend. The piper must be paid. When Sarah withdraws the $2,653 from her RRSP, and assuming her marginal tax rate is still 30 per cent, she will pay $796 in tax, netting her $1,857 after tax from her RRSP. This is equivalent to a five-per-cent annual after-tax rate of return on her $700 net initial investment ($1,000 contribution less $300 in deferred taxes on that initial investment).

In other words, Sarah’s after-tax rate of return of five per cent is exactly equal to her pre-tax rate of return, meaning she essentially has paid no tax whatsoever on the growth of her initial $700 net RRSP investment for 20 years. The RRSP allowed her to save for retirement on an effectively tax-free basis.

Now, if Sarah instead invests that $1,000 in a non-registered investment account, she will first need to pay tax, leaving her with $700 to invest. If this $700 earns five-per-cent income annually that’s taxed at a rate of 30 per cent, her non-registered account at the end of 20 years will be worth only $1,393 — significantly less than the $1,857 in her TFSA or RRSP.

These examples clearly show that both an RRSP and TFSA will beat a non-registered account if your tax rate today is the same as the tax rate in the future. If, however, your future tax rate is lower than it was in the year of contribution, you will get an additional advantage when using the RRSP because you can deduct your contribution at a high rate, but pay tax at a lower rate when you take it out. Conversely, if your tax rate is low now, but expected to be higher in the future, then the TFSA will produce the better result.

Some commentators have suggested that building up too much money in an RRSP or its successor, a RRIF, could very well be a bad thing because of the potentially high tax rate associated with withdrawals as well as the potential loss of government benefits, such as Old Age Security.

 

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18 Mutual Funds with Clearly Defined Investment Processess – The Globe and Mail

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What are we looking for?

Top-rated mutual funds with top-rated investment processes.

The screen

When investors look at the performance of mutual funds, they are likely looking for something simple – are those performance numbers positive or negative? Considering why those numbers are positive or negative is also important. Why a fund performs a certain way can be the direct result of its investment philosophy and process. An understanding of these components can help investors better gauge if performance results are expected given the goal and method applied. This can be particularly helpful during periods of volatility, such as the one we have experienced since the collapse of Silicon Valley Bank earlier this month. A strong investment process is well-defined and consistently executed, and generally able to withstand short-term market shocks and reward investors over the long term.

A fund’s investment process can be nuanced. To help guide investors, Morningstar’s manager research team assigns ratings to Canadian funds and ETFs that include an explicit component focused on understanding their investment philosophy and process. We refer to this component as the “Process” pillar and rate each asset manager as either Low, Below Average, Average, Above Average or High, depending on the efficacy of their practices. To highlight a few great mutual funds available to Canadians with top-rated investment processes, I used Morningstar Direct to screen more than 3,400 Canadian-domiciled mutual funds and ETFs to find a selection of options to consider. The criteria include:

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  • A Morningstar Quantitative or Analyst Process Pillar rating of High, indicating the fund has a clearly defined investment process and performance objective that is repeatable and implemented effectively.
  • A Morningstar star rating of five stars. The star rating is an objective look back at a fund’s after-fee, risk-adjusted returns relative to the category to which the fund belongs. Though the measure is backward-looking, Morningstar’s research shows that over time and on aggregate, five-star funds continue to outperform four-star funds, three-star funds, etc., after receiving the rating.
  • A top quintile category rank month-to-date indicating the funds selected have outperformed their peers since March 1, 2023.

*Data as of March 23, 2023

What we found

Mutual Funds with Clearly Defined Investment Processes

Name Morningstar Category Annual Report Management Expense Ratio (MER) Morningstar Quantitative Rating Morningstar Analyst Rating Total Ret MTD (Daily) CAD Total Ret % Rank Cat MTD (Daily) Total Ret 1 Yr (Daily) CAD Total Ret % Rank Cat 1 Yr (Daily) Total Ret Annlzd 3 Yr (Daily) CAD Total Ret % Rank Cat 3 Yr (Daily) Total Ret Annlzd 5 Yr (Daily) CAD Total Ret % Rank Cat 5 Yr (Daily)
Dynamic Active Canadian Dividend ETF Canada Fund Canadian Dividend & Income Equity 0.84 Gold -3.20 20 -4.28 11 23.26 44 10.88 2
Fidelity True North Sr F Canada Fund Canadian Equity 1.08 Silver -2.29 13 -4.55 17 21.84 67 9.89 2
Fidelity Greater Canada Sr F Canada Fund Canadian Focused Equity 1.11 Silver -0.19 14 1.93 5 33.26 1 19.20 1
PH&N Inflation-Linked Bond Fund F Canada Fund Canadian Inflation-Protected Fixed Inc 0.37 Gold 2.28 1 -5.20 48 0.74 10 1.36 1
RBC Canadian Mid-Cap Equity I Canada Fund Canadian Small/Mid Cap Equity 0.71 Gold -3.00 18 -9.41 34 31.67 16 10.65 7
Fidelity Floating Rate Hi Inc F Canada Fund Floating Rate Loans 0.90 Silver -0.26 11 11.26 1 8.63 26 4.08 6
Manulife Global Equity Class F Canada Fund Global Equity 1.08 Gold 1.48 16 3.09 12 16.28 40 9.58 6
Dynamic U.S. Balanced Class Ser F Canada Fund Global Equity Balanced 1.08 Silver 3.87 1 -3.74 65 12.47 39 10.15 1
Dynamic Blue Chip Balanced F Canada Fund Global Neutral Balanced 1.11 Silver 1.60 3 -1.73 28 9.39 38 6.41 5
Manulife US Balanced Val Priv Trust F Canada Fund Global Neutral Balanced 0.91 Silver 1.34 6 -3.02 58 14.87 3 8.11 1
Manulife US Monthly High Inc F Canada Fund Global Neutral Balanced 1.13 Bronze 1.33 7 -3.24 64 14.62 4 7.91 1
Fidelity NorthStar Sr F Canada Fund Global Small/Mid Cap Equity 1.13 Silver 0.36 9 3.55 7 18.40 28 6.26 9
Dynamic Global Real Estate Series F Canada Fund Real Estate Equity 1.22 Gold -7.12 16 -15.14 12 12.92 30 5.27 8
RBC Life Science & Technology Fund F Canada Fund US Equity 0.94 Gold 6.31 1 -0.51 21 18.91 49 14.53 3
Canoe Defensive U.S. Equity Port Cl F Canada Fund US Equity 1.25 Silver 1.09 18 7.22 2 17.25 66 11.70 12
Fidelity US Focused Stock F Canada Fund US Equity 1.10 Silver 0.86 20 -8.19 78 16.35 75 12.03 9
RBC U.S. Mid-Cap Growth Equity Fund F Canada Fund US Small/Mid Cap Equity 0.93 Gold -1.73 1 -2.10 22 19.26 59 10.78 1
Dynamic Active U.S. Mid-Cap ETF Canada Fund US Small/Mid Cap Equity 0.78 Gold -5.70 17 2.33 4 17.79 66 7.55 24

Morningstar

The list above highlights funds from 13 different mutual fund categories (as defined by the Canadian Investment Fund Standards Committee) from six different asset managers, indicating strong processes are not confined to a specific asset class or investment style. Although not explicitly screened for, each of these funds also earned a Bronze, Silver or Gold Morningstar Analyst or Quantitative Rating indicating a forward-looking view of the fund’s ability to outperform its peer group and/or relevant benchmark on a risk-adjusted basis over a full market cycle. Every fund on the list has delivered, with all but two ranking in the top decile of their respective categories over the past five years.

Note that the management expense ratios listed here are reflective of the f-share class. In the table, f-class (also known as fee-based share classes) shares exclude the cost of advice and are held in fee-based accounts where the adviser charges separately for advice.

This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.

Danielle LeClair, MFin, is director of manager research, Canada for Morningstar Research Inc.

Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.

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For the ultimate in cheap investing, check out the Freedom .08 ETF Portfolio

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Fee competition in the exchange-traded fund business is driving down the cost of investing to new lows.

A simple little ETF strategy I call the Freedom .08 Portfolio proves it. Some previous names for this portfolio included Freedom 0.15 and Freedom 0.11. The numbers are based on the aggregate management expense ratio for the portfolio, which has fallen ever lower through the years. That’s how we get to Freedom .08 in early 2023. That’s 8 cents in fees for every $100 you have invested.

Here’s how the Freedom .08 Portfolio is put together using a 70:30 asset mix of stocks and bonds.:

-30 per cent in the Desjardins Canadian Universe Bond Index ETF (DCU-T): The MER for this fund is 0.08 per cent, which is at the low end for aggregate bond ETFs covering the broad Canadian market for government and corporate bonds. It tracks the Solactive Canadian Bond Universe total return Index, which is a relative newcomer to the Canadian market. You can compare returns to competitors using the bond fund installment of the 2023 Globe and Mail ETF Buyer’s Guide, but they’re very similar to more established indexes.

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-30 per cent in the iShares Core S&P/TSX Capped Composite Index ETF (XIC-T): The MER for this fund is 0.06 per cent and the underlying index is the ultimate benchmark for Canadian stocks.

-20 per cent in the Franklin International Equity Index ETF (FLUR-NE): The MER here is 0.1 per cent, which is strikingly low for the international equity category. That’s markets outside North America, by the way. Solactive is again the index provider. In doing your research, compare returns against international equity ETFs tracking the more traditional MSCI EAFE index.

-20 per cent in the Vanguard S&P 500 Index ETF (VFV-T): The MER is 0.09 per cent and the index is one you know and love, the S&P 500.

ETFs trade like stocks, which means you’ll need a digital brokerage account to build a portfolio. For extreme frugal investing, consider the zero-commission brokers Wealthsimple, National Bank Direct Brokerage, and Desjardins Online Investing. CI Direct Trading and Questrade offer ETF purchases at no cost, but you pay the usual commission to sell.

A final point of comparison for the Freedom 0.08 Portfolio is a popular kind of exchange-trade fund called the asset allocation fund. You can buy these fully diversified portfolios with MERs of 0.2 to 0.24 per cent.

— Rob Carrick, personal finance columnist

This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.

Stocks to ponder

Bombardier Inc. (BBD-B-T) The plane maker is generating cash, paying down debt and raising its financial targets. Investors are paying attention, too: The share price has rallied more than 250 per cent over the past eight months. David Berman asks: Has the stock become relevant again?

WELL Health Technologies Corp. (WELL-T) After this health-care company reported record quarterly financial results last week, the share price rallied nearly 16 per cent on high volume. Analysts believe this positive price momentum will continue. The average one-year target price implies a 61 per cent potential gain for the stock. Jennifer Dowty takes a look at the investment case.

The Rundown

Banking woes, Fed keep investors on edge in nervous stock market

Investors are settling in for a long slog in the U.S. stock market in coming months, braced for more tumult in the banking sector and worries over how the Federal Reserve’s tightening will ripple through the economy. As David Randall of Reuters reports, many worry that other nasty surprises are lurking as the rapid series of interest rate hikes the Fed has delivered over the past year dry up cheap money and widen fissures in the economy.

Grocery REITs are a safe harbour in the market storm

Feeling gouged by high grocery prices? Bummed out by bank runs? Sick of stock market volatility? With inflation and rising interest rates creating turmoil in the economy and financial markets, these are tough times to be a consumer – or an investor. John Heinzl is here to offer some help by profiling some real estate investment trusts in the grocery sector. The goal: put some of that grocery money back in your pocket while enabling you to sleep better even as markets gyrate.

Throw caution to the wind with the Free Cash portfolio

It’s time to catch up on the value stock race. Norman Rothery pitted 14 popular measures of value against each other in the U.S. market. Each measure was used to form a tracking portfolio containing the cheapest 10 per cent of the stocks in the S&P 500 index based on that measure. The 14 tracking portfolios were equally weighted and rebalanced annually. So far, the trend favours investors who keep an eye on debt while hunting for bargains.

Read more from Norman Rothery: Portfolios for Value and Dividend Investors

Canadian bank stocks may not be quite as special as we think

Canadians are used to thinking of bank stocks as a safe, nearly guaranteed way to bet the market. They may want to think again. As Ian McGugan tell us, investors would be wise then to consider the prospect of a future in which Canadian banks no longer churn out market-beating results with clockwork regularity.

Strength in megacap stocks masks broader U.S. market woes

Investors are relying on an old strategy to navigate the current tumult in asset prices: buying shares of the massive U.S. companies that led markets higher for years. Shares of the top five companies by market value — Apple , Microsoft, Alphabet, Amazon and Nvidia — have gained between 4.5% and 12% since March 8, when troubles at Silicon Valley Bank set off banking system worries. In that period, the S&P 500 has fallen 0.5%. Lewis Krauskopf of Reuters tells us more.

Others (for subscribers)

Monday’s analyst upgrades and downgrades

Globe Advisor

Where investors put their money in this year’s RRSP season

How to play the demand for microprocessors as chatbots, robots and EVs disrupt sectors

Are you a financial advisor? Register for Globe Advisor (www.globeadvisor.com) for free daily and weekly newsletters, in-depth industry coverage and analysis.

Ask Globe Investor

Question: Harvest Healthcare Leaders has units that trade in U.S. dollars on the TSX. For tax purposes, is the income considered foreign income or Canadian? For example, can donations to registered charities in the U.S. be deducted against the income from HHL.U? – Michael K.

Answer: Only a small amount (9.26 per cent) of the income from this ETF was classified as foreign income in 2022, according to the Harvest Funds website. Most of the distributions (about 94 per cent) are treated as return of capital. So, you won’t get much help here for U.S. charitable contributions.

–Gordon Pape (Send questions to gordonpape@hotmail.com and write Globe Question in the subject line.)

What’s up in the days ahead

Bond markets are suggesting interest rate cuts loom for this summer in both Canada and the U.S. But central bankers are dropping few hints. Who should we believe? Veteran bond fund manager Tom Czitron will provide some insight.

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Online investment fraud increasing in Manitoba

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Manitobans are being warned about the rise in fraudulent online investment websites, which have exploited some Manitobans out of more than $200,000.

During the Manitoba Securities Commission’s (MSC) ongoing investigation into cryptocurrency fraud, the agency uncovered 66 victims in Manitoba who were scammed through 34 separate online platforms. These Manitobans had transferred money to offshore crypto exchanges based in Lithuania and Bulgaria.

According to Jason Roy, MSC senior investigator, the initial investments were smaller amounts of money as the fraudsters know if they ask for too much money right off the bat, then people are more likely to decline the offer.

“They start with these small amounts and then show you fake trading results and get you excited about putting more money in,” he said in an interview with CTV Morning Live on Monday.

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The victims’ losses ranged from $306 to $206,000, with the total losses coming to $710,000.

Roy said there are likely a lot more investment fraud victims in Manitoba, but they may feel too embarrassed to report what happened to them.

“Really, only five to 10 per cent of victims actually report being victimized,” he said.

For those who come across an online investment website, there are certain things to look out for to ensure it is legitimate. Roy recommends ensuring that you are dealing with a company that is registered to do business in Canada. Checking a company’s registration can be done online.

Other common attributes of the investment fraud websites uncovered in the MSC investigation include:

  1. Targeting victims on social media;
  2. Promoting cryptocurrency or Forex trading;
  3. Promising an unreasonably high or quick return on investment;
  4. Victims being unable to withdraw their initial investment or fake returns;
  5. Operating offshore, but telling investors they have offices in Canada;
  6. Requesting investors to convert funds to cryptocurrency; and
  7. Getting investors to provide remote access to their computers or phones.

Those who are solicited by a fake trading website, which can appear to be legitimate, are asked to report the incident by calling 1-855-372-8362.

– With files from CTV’s Katherine Dow.

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