Rob McClelland | Founder of The McClelland Financial Group»
Twenty-Five Years of Financial Insights
Part 7: Tax-Efficient Investing Essentials
 You can't judge a book by its cover … or its title. "Storyselling for Financial Advisors*" doesn't sound like much of a read for the general public, but this compilation of quotes and anecdotes actually contains a lot of good ideas, like this one:
"The long-term goal of investing is to multiply the eggs in our basket. Most people are very focused on producing more eggs … but pay little attention to the fox that perpetually robs the hen house. … That fox is taxation."
This brings me to the next important financial insight in our series of 25-year reflections. Tax-efficient investing (or lack thereof!) can have way more influence on your end returns than you might think. If you're not doing everything you can to protect yourself from the sharp bite of taxes, you're losing money that would otherwise have been yours to keep.
Your Tax-Efficient "Hen House"
When it comes to tax planning, there are a number of nuances to know when making choices that make the most sense for you and your unique financial circumstances. Since this overview would quickly become overload were we to cover every possibility, we strongly recommend consulting with a tax professional before you invest.
But, here's the good news: Whether your investment portfolio is modest or grand, there are tax-efficient construction strategies you can employ to your advantage.
Your Starter Portfolio: How To Build It
Most investors start saving for retirement or other major milestones by opening a Registered Retirement Savings Plan (RRSP), Tax-Free Savings Account (TFSA), or both.
The money you put into an RRSP is tax-deductible when you make the contribution (up to an allowable limit). Once the money is stashed in your RRSP, it grows tax-free, until you withdraw it. At that point it is taxed as regular income.
In contrast, contributions to a TFSA are not tax-deductible upfront, but both your initial investments and any gains are tax-free while they grow and when you withdraw the funds.
As you might expect, additional rules and restrictions apply. One rule I like is that, if you withdraw an amount in a given year, you can re-invest it in full the next calendar year. If you are diligent about "paying yourself back" with the reinvestment, this allows you to effectively "borrow" money from your TFSA when needed, without doing any serious damage to your long-term, tax-sheltered savings.
Your Starter Portfolio: How To Invest It
Once you've stashed some tax-sheltered money into RRSPs, TFSAs or similar registered accounts, the next step is to invest it. Otherwise, just as taxes can slink away with your wealth, inflation can attack it like a virus, sapping away its vital spending power.
If all of your savings are held in registered (tax-sheltered) accounts and your total savings are modest (say $100,000 or less), you've probably already done all you can to tax-manage your investments. That makes your next steps relatively simple.
- Balance your investments among stocks, bonds and real estate, as we've described in earlier 25-year insight installments, like this one on diversification.
- Do so as efficiently and cost effectively as possible.
For this scenario, a low-cost, low-fuss balanced fund may be the best way to get the job done. Especially if you're continuing to contribute to your accounts on a monthly or regular basis, having your contributions all flow into a single balanced fund helps you readily achieve effective diversification without having to continuously fuss over your investment decisions. It's less work, and gives you an easier way to stay on track toward your long-term goals. Enough said.
Next-Level Tax-Efficient Investing
While an investment "starter plan" offers ease and simplicity, I certainly hope for your sake that your wealth will outgrow it – and sooner than later! Once you've exceeded your capacity to tax-shelter assets in registered accounts, you'll want to open non-registered (taxable) accounts in which your savings can continue to flourish.
Then what? Here's where you can begin to employ additional tax-planning strategies that are admittedly more complex, but that can further safeguard your total, after-tax returns – i.e., the money that counts as your own. In my next piece, we'll cover ways you can take your tax-efficient investing to the next logical level.
Rob McClelland
Senior Financial Planner and Branch Owner
The McClelland Financial Group of Assante Capital Management Ltd.
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