Ever since the advent of the Tax-Free Savings Account, or TFSA, I’ve been quite dead set against investors putting anything other than cash and cash equivalents into one of these neat little containers. However, as 2010 comes to a close, I’m open to rethinking that position a little bit. It’s one New Year’s resolution I might be able to keep.
No question, when TFSAs were first announced in the 2008 federal budget – they became reality at the start of 2009 – I was a bit worried about the substance behind the product. It’s a natural reaction to anything that was hyped and lauded the way TFSAs were, as if they were the best thing since sliced bread, or at least since the introduction of the RRSP, to suspect whether this is really a good product for clients to have, or whether it’s just a good product for the banks to market.
But I quickly got over that, and determined that a TFSA was actually an excellent container to hold money in, and I have recommended ever since that virtually everyone should have one and load it up. Okay – not if they have a ton of credit card debt to pay off first; but everyone else should have a TFSA.
But as much as I’ve been endorsing investors use this product, I also have had a bias on how to use it. I’ve advocated that you should use only cash and cash-like securities – GICs, term deposits, T-bills – in a TFSA, not money market funds, and not securities such as stocks, bonds, income trusts, or mutual funds.
Here’s the rationale behind that. The tax benefit of a TFSA is not the $5,000 per year you can sock away. The tax benefit is not the $200 or so in interest that you can make on that $5,000 per year, if you’re lucky.
The tax benefit is the $100 or so in tax that you can save, assuming you’re in a 50% marginal tax bracket and you make $200 in interest on the $5,000 you contributed.
A tax benefit of $100. That’s it. Or less, if you’re in a lower marginal tax bracket. If that’s all you’re saving (compare what you’d save if you put the same $5,000 in an RRSP!), then I don't see a lot of sense in putting securities into a TFSA.
Putting securities into a TFSA means paying commissions, plus possibly an annual admin fee, to get the same benefit you can get for free with a simple high-interest savings account or GIC. Remember, the government gave this tax benefit to you. Why would you turn around and give it to your bank or your investment dealer? You get few enough tax breaks as it is. My recommendation has always been to keep this particular one for yourself.
Of course, one might argue that you could put an income trust or a stock into a TFSA and get a return that is incrementally higher, after both buy and sell commissions are factored in, and admin fees on the TFSA, than you can get on a GIC or a savings account.
I would ask such a person where, if not in a TFSA, they’re holding the cash portion of their portfolio. And if they consider the stock or income trust in their TFSA to be their “cash” component (because they can cash it at any time if they have liquidity needs), I would argue that their TFSA doesn’t have the risk-reward profile of cash, and they shouldn’t therefore be calling it cash.
Bottom line: There are numerous good tax-advantaged containers in which to hold securities: RRSPs, RESPs, and so on. There’s only one that’s good for cash, and that’s a TFSA.
That’s been my position since before TFSAs were launched in 2009, but as I said, I’m open to rethinking it. As 2011 approaches, the opportunity to put another $5,000 into your TFSA – i.e., $15,000 total – is approaching with it. At $15,000, that might be too much cash to hold relative to your overall portfolio. If that’s so, I could maybe see holding a low-fee ETF in your TFSA alongside your cash. Hey, it’s not a big concession, but it’s a concession.
Speaking of low-fee ETFs, I’ve just been looking over some that I follow as the year-end results start closing in. Faithful stalwart is on track for another good year in 2010. But even better, it has made its investors a lot more than it has made for itself.
I like to use a measure I call MER Coverage, which measures how much an investor makes on a fund relative to what the fund makes. For example, if the fund’s MER is 0.15% (as it is for this fund) and the fund makes you 1.5% in a year, the one-year MER Coverage is 10 times.
With the iShares S&P/TSX 60 Index Fund, in 2010 its one-year MER Coverage is 77.7 times. Its three-year MER Coverage is just 1.1 times, meaning the fund barely made more in returns for its investors than it did in fees, but its five-year and 10-year MER Coverages are 45.2 and 38.9 times respectively. You’d be hard-pressed to find another Canadian equity index fund that beats that performance-for-fee record.
David West, CFA, FCSI, has more than 25 years’ experience in the financial services industry as an adviser, trainer, writer and commentator. He is a columnist for The MoneyLetter and Canadian Business Online among others, and is a regular contributor to the Fund Library
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