Asset Location vs. Asset Allocation

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You should have already received your Assante 2017 year-end statement. These statements will provide calendar year and annualized rates of return for each of your individual accounts and a weighted-average considering all accounts as a total portfolio.

What you may notice, is a discrepancy between individual account rates of return. Why is that?

As you know, we attempt to provide the most tax efficient investment experience as possible, while still staying true to your individual risk tolerance, investment objective and time horizon.

Most of our clients have a combination of registered and non-registered accounts. This provides the opportunity to direct specific investments into different types of accounts.

Let’s take for instance a client who has a 40 year life expectancy and can tolerate a medium degree of risk in their investment portfolio. A 70% equity and 30% fixed income portfolio is suitable and appropriate for this client. As you may be aware, the type of investment income earned on equity investments (stocks) is typically capital gains or dividends. These types of investment income are taxed more favourably in Canada. Whereas the investment income earned on fixed income investments (bonds) is typically interest income. This type of investment income is taxed more harshly.

With this in mind, we can take advantage of a tax saving opportunity by moving more equity investments into the non-registered accounts and fixed income investments into the registered accounts. Why would we do this?

The investment income earned in a non-registered account is taxable and must be reported on your tax return. If we can, we would like the investment income that is taxed more favourably in these accounts.

Conversely, the investment income earned in a registered account is either tax free or tax deferred and does not have to be reported on your tax return in the year it is earned. If we can, we would like the investment income that is taxed more harshly in these accounts.

Therefore, we move as much of your equity investments into the non-registered accounts and move more of your fixed income investments into the registered accounts. All the while still staying within the original 70% equity and 30% fixed income asset allocation. This would mean that your non-registered accounts would have a different asset allocation than the registered accounts.

We know that risk and return is related. More risk equals potential for more gains or losses. Less risk equals less gains or losses. Equity investments are higher risk and fixed income provide the safety (less risk). Therefore, in an increasing market, the non-registered accounts would have a higher rate of return than the registered accounts because it has the investments that will provide a higher return. The opposite would be true in a decreasing market.

When you look at the portfolio as a whole (all accounts), your rate of return will be different than the individual accounts (weighted according to the size of each of the accounts in the overall portfolio).

If each individual account maintained the same asset allocation (percentage of equities and bonds), then each account would have the same rate of return, and would match the overall portfolio weighted return. In this scenario, the total portfolio weighted rate of return would end up being less due to the increased tax implication of having interest income in a non-registered, taxable account.

Therefore, by directing certain types of investments to certain types of accounts (asset location), you can decrease the income tax impact on your investment income earned on your overall portfolio (asset allocation).

Contact our office (905) 771-5200 for further clarification or for more details.

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