The right TFSA asset allocation

How’s my TFSA asset allocation?

This reader wants to make sure his TFSA asset allocation fits his risk tolerance and that he’s not running into any tax issues


Q: My goal is to maximize returns and grow my TFSA over the long term, not necessarily only for retirement, but also as a reserve fund. I have all Canadian ETFs in it to avoid any tax complications as I believe holding anything but Canadian ETFs in a TFSA leads to tax issues.

This is my current allocation:

ZDV.TO 15.3%
ZRE.TO 9.8%
XIU.TO 15.3%
XRE.TO 9.8%
XDV.TO 15.1%
VAB.TO 19.2%
VCN.TO 15.4%

Please lend your expertise and advise if I’m on the right path with this allocation or if it requires tweaking. I’m open to taking risk and would label myself a moderate to liberal risk taker.—Harpaul

A: You’ve asked some good questions. Let’s start with asset allocation and your question about whether it’s appropriate. I’m going to give you one of my favourite answers, “it depends.”

First off, I’m leery about 35-year-olds having TFSAs. More often than not, I think they shouldn’t have them. When I diagnose most 35-year-olds’ finances, they tend to suffer from conditions like RRSP room, debt, kids who are going to go to university, a lack of proper insurance coverage, no wills or powers of attorney and so on. Some of these options may be better places to invest than in your TFSA. TFSAs are good in the right situations, but to be frank, they’re overrated for the average Canadian.

You’ve got 81% in Canadian equities and 19% in fixed income. I’d consider this a growth portfolio best suited to a long-term investor. So, given that you are contemplating using this as a reserve fund, I think you need to be cautious about how aggressively you invest in equities.

As you mentioned, your equity exposure is entirely Canadian. Depending upon the rest of your investment portfolio, you might be missing out on 97% of global equities by focusing on Canada. In particular, the Canadian markets are notoriously lacking exposure to sectors like health care and technology.

You own four broad Canadian equity ETFs that invest in similar large Canadian stocks and then two more that focus specifically on Canadian REITs. I think do-it-yourself investors have to be careful about getting too fancy and buying lots of investments just for the sake of it, or because it only costs $4.99 to buy and sell them. I’d prefer to see one Canadian equity ETF and then, if you really want to focus in on REITs, buy one REIT ETF as well.

It’s also important that you understand the difference between the different styles of ETFs you own. I’m not going to go into all the differences here, but whether you’re a professional money manager or a DIY investor, strategy is important.

The bond ETF you own is forced to hold long-term bonds because it replicates a broad bond index. Forty-three per cent of the holdings mature in under 5 years, but the balance are 5 years and over. A whopping 22% of the holdings mature in 20+ years. Bonds can go down when interest rates go up and long-term bonds are even more susceptible to this inverse relationship. So if you’re holding this ETF for safety, know that it may be less safe than you might otherwise think.

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Ask a Planner

Leave your question for Jason Heath in the comment section below or email [email protected] and he may answer it in an upcoming column.

Next, let’s tackle your tax question. Holding foreign equities in a TFSA can result in a bit of tax leakage since foreign dividends are generally subject to a 15% withholding tax before they hit your TFSA, so your yield is slightly lower than it might otherwise be.

This applies to both foreign ETFs as well as Canadian ETFs that invest in foreign stocks, as well as foreign stocks.

It doesn’t mean you shouldn’t hold foreign investments in your TFSA ever—it just means that if you’re going to hold foreign investments, you should look for the best account to hold them in and often it’s going to be an account other than your TFSA.

I think your primary concern here needs to be if you should have a TFSA in the first place. Trying to figure out how to invest your TFSA savings may be putting the cart before the horse.

READ: The savings struggle: RRSP vs. TFSA »

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products.