PLACE: Southern Ontario
TFSA TOTAL: $70,000
STRATEGY: A unique strategy of Canadian dividend paying stocks transferred “in-kind” to and from his unregistered account annually
Philip’s TFSA holdings
|Bank of Nova Scotia||19.70%|
|Corby Spirit and Wine – A||31.90%|
|Inter Pipeline Ltd.||12.60%|
|Plaza Retail REIT T/U||7.50%|
Philip is 66 years old and lives in southern Ontario. He used to be a computer programmer but has since retired and hopes to one day own a cottage in Ontario. “We moved here from B.C. a few years ago and wanted to live in a small city in Central Canada,” says Philip. “We chose Peterborough and enjoy it here.”
Philip hasn’t always been a fan of TFSAs. “Well, to be frank, when they just started I didn’t see much use for them,” says Philip, who’s changed his mind since then. “I maxed out me and my wife’s RRSPs each year and added to my son’s RESP so there was little left for TFSAs and there just didn’t seem to be a great benefit.”
After investing in a couple of stocks his first year—and losing 10% of his investment that year—Philip wasn’t too impressed with their ability to generate wealth. “It was a Eureka moment for me,” says Philip. “I had realized I had really lost money that I could never use as a deduction, and lost room in my TFSA I could never recover. It looked like a path to the poorhouse, and it made me feel angry and guilty for losing family money.”
That’s when Philip decided to set down some ground rules and develop his own unique TFSA investing strategy. First, Philip focuses on choosing companies he understands—Canadian stocks. He also knows that Canadian dividend stocks in a non-registered account can save on taxes, and he avoids having any U.S. investments in the TFSA. “About 90% of my TFSA is made up of Canadian stocks,” he says. Right now, he’s also holding some cash.
Here’s Philip’s investment strategy in a nutshell:
- Never buy a risky stock in a TFSA account if there’s a likelihood it may lose value. “I vied to hold those in my unsheltered account so the loss is tax deductible,” says Philip.
- Buy strong stable stocks that appreciate slowly and steadily over time, such as bank stocks, utility companies, REITs, and Telcos
- Buy stocks that return dividends that also go up over time
- If the stock does not have a DRIP (reinvestment option) take the dividends out as they accrue each month or quarter to use for whatever you want and keep track of the amount taken out since this adds room to the TFSA next year
- Before the end of the year transfer “in kind” any stocks in the TFSA that went up and look hard at those that did not to see if selling is a good step or if holding on is better. Remember, they still generate dividends and most stocks like these do go up and down with the dividend cycle
- In the new year, you can add all the dividend income back plus all the worth of the appreciated stocks transferred out and the next chunk of allowance ($5,000 or more)
- Now you have expanded the room in the TFSA and doing this every year quickly increases the TFSA value so it is a worthwhile account that can also shelter a lot of income and capital gains
- Philip never buys and sells stocks inside the TFSA since the commission just eats at the total value. Similarly, he doesn’t own mutual funds or assets with high fees, or ones that he can’t transfer in-kind or convert to stocks like ETFs can.
The hardest part of Philip’s strategy? “Co-ordinating the year-end transfers and bookkeeping on the TFSA values. A lot of the self-directing brokerages now have added the “transfer in kind” feature from one account to another so there’s not a long and tedious phone call to make to a broker.”
With this strategy, Philip has improved the value of his TFSA account from the allowed $57,500 to about $70,000 at year-end. “I believe, like compound interest, if you can accelerate the growth curve in an account early, it gives you the flexibility to hold or buy premium investments sooner.”
Next year, with this same strategy, Philip plans to move 90% to 95% of this money into an investment account in December and then back into the TFSA in January with the $3,000 in dividends and $5,500 of new allowance as new, “in-kind” stock transfers. “There is another benefit to taking the stock out in December,” explains Philip. “The stock price and a number of stocks will adjust the average cost base for the same stock held in an investment account and will reduce capital gains when the stock is transferred back to the TFSA or sold. This is my method, and it seems to work with little stress or effort.”
Philip’s end goal? To have the TFSA reach $100,000 (his wife’s too) and then he plans for each of them to take a big chunk of money out for a trip, then put it back into the TFSA until the unregistered investment account reaches zero.
Tips from the pro
“It seems Philip has been smitten by a strategy that has worked for him in the recent past,” says John DeGoey, a portfolio manager with Industrial Alliance Securities Inc. “That’s not too surprising—people generally don’t resist their own ideas. Of course, virtually any strategy—successful or unsuccessful—can have short-term results that are not indicative of what one might experience in the long run.” Here are further comments by DeGoey on Philip’s strategy:
In essence, Philip is saying he’s found a way to “book” or “lock in” his gains by taking things out of the TFSA one year and then putting the money back (with additional contribution room—both from the realized appreciation and with new annual room) the following year.
With due respect, upon close examination, Philip’s strategy doesn’t hold up. If one could reliably sell stocks once they have gone up (i.e. before they drop), then whether that is done with or without a TFSA withdrawal is neither here nor there. The net impact is identical. The timing of the buys and sells and the switching of securities held in the TFSA (either within the account or by buying new securities with the money that replenishes previous withdrawals) leaves the investor in the same place at the end of the day. Re-balancing and picking different stocks could be done either way. Keeping the cash in the TFSA might even be a bit easier, administratively.
I also find the term, “premium investments” amusing. The holdings Philip is using are Canadian large cap stocks. Please allow me to take a moment to rebut a few of his initial comments:
- All of the securities he’s buying are “risky” in that they could very easily lose money in the short to medium term. The fact that it hasn’t happened yet is not evidence that it isn’t possible.
- He says he buys stocks that “always” appreciate slowly. There are no stocks that always appreciate (at any pace). If there were, why would any rational person buy anything else?
- Merton Miller and Franco Modigliani have shown that rational investors should be indifferent to a company’s dividend policy. What matters (especially in a TFSA) is total returns.
To be clear, I’m not suggesting the strategy is bad or doesn’t work. All I’m saying is that the results would be either virtually identical or exactly identical if he used the same securities without taking the trouble to move money out of his TFSA every December and then put it all back in (plus an extra $5,500) in January. It’s six of one; half dozen the other.
John De Goey is a Portfolio Manager with Industrial Alliance Securities Inc. and the author of The Professional Financial Advisor IV. Industrial Alliance Securities Inc. is a member of the Canadian Investor Protection Fund. The opinions expressed herein are those of Mr. De Goey alone and may not be aligned with the opinions and values of Industrial Alliance Securities Inc. or any of its affiliated companies.
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