Maximizing Returns: The Asset Location Advantage

The term “asset allocation” is one you may have heard if you’ve participated in financial planning or long-term investing. It’s a term that gets thrown around a lot in the investment world.

Simply put, this is how investors divide (or allocate) their total investments to different types of assets, such as stocks, bonds, preferred shares, or GICs.

The term “asset location” however is less commonly used but remains a critical piece of the investing puzzle when it comes to retaining investment growth and increasing your net worth over time.

What is It?

“Asset location” refers to how different types of investment assets are distributed to your various accounts.

What Does It Achieve?

Asset location strategies can significantly reduce how much tax you pay, both now and later in life. The degree to which these strategies can increase net worth over time can be easily overlooked in a world where investors are often singularly focused on their investments’ rate of return.

Why & How is it so Important?

Quite simply, because different investment assets and the income they generate are taxed in different ways. And so are the subsequent withdrawals.

Let’s look at few examples.

Example 1 – Interest Income

Some investments pay interest, like bonds or GICs. Interest income does not receive favourable tax treatment. In fact, when paid to a regular taxable account, it is taxed at your full marginal tax rate, which could be as high as 53% in BC, depending on your bracket.

Regardless, these types of investments remain an integral component of many diversified portfolios due to their stability and reliable income.

With that in mind, a common asset location strategy ensures that these investments are held in tax-deferred accounts such as an RRSP or a locked-in RRSP. That way, the interest received isn’t subject to taxation until funds are withdrawn, generally much later in life during the retirement phase, which often coincides with being in a lower tax bracket.

Example 2 – Eligible Canadian Dividends

Eligible Canadian dividends on the other hand, unlike interest from bonds, are taxed much more favourably – Canadians can claim a dividend tax credit on eligible Canadian dividends. For this reason, savvy investors will hold the Canadian dividend paying investments in their non-registered, or taxable, account.

Example 3 – Withdrawal considerations

Growth and capital gains considerations further guide asset location strategies.

Withdrawals from Tax-free savings accounts are – you guessed it – free from taxation.

For this reason, a common asset location strategy emphasizes holding growth-oriented investments in your TFSA. Realized capital gains are not taxed. Subsequent withdrawals are also free from tax, regardless of when withdrawals are made.

Key Takeaway

Asset location strategies are often interconnected.

Choosing investments is one thing – understanding how to ‘locate’ these investments to your respective accounts can ensure you maximize your net returns.