Why I Started Buying a New Index Fund

horizons etf

In this blog, I tell my readers that the Vanguard low cost index funds VCN, VXC and VAB are highly recommended by our investing all-stars. I personally own both VCN and VXC. However, I have recently stopped buying both and have replaced them with a relatively new product that I’d like to tell you about. It’s also important for me to explain why I made the switch and why this change made sense for me but may not for you.

Because I am a teacher, I am obligated to contribute 12.5% of my pay to my pension. My employer also contributes to my pension to the point that I am not able to set up a meaningful RRSP. As a result, almost all investing I do is done in taxable accounts, except for the $5500 TFSA. That means that any dividends or capital gains I earn are fully taxed using the rates prescribed by government. In my case, dividends are taxed at 25% and capital gains at 21%.

Instead of paying these taxes every year, I found a product that works like a low cost index fund but is able to shelter my dividends and capital gains from taxes until I sell the product. This has the advantage of allowing my investments to compound tax free while I am still in the accumulation phase. This does not avoid paying tax, it just delays paying until a later date.

The product is called Horizons S&P 500 (HXS). It’s a specialized product utilizing a type of derivative so that I don’t actually own the S&P 500, but rather a product that almost exactly mirrors the performance of the S&P 500. Canadian Couch Potato does a fabulous job of explaining the product and the risks involved with HXS.

This product does have slightly more risk than a conventional index fund but I am comfortable with the small risk because I believe that the chances of a large Canadian bank, that guarantees the product, going bust is exceedingly small. I also am limiting my exposure to HXS to about 15% of my total portfolio so if in the highly unlikely scenario that the National Bank of Canada went broke and the S&P 500 was no longer trading freely, I would lose no more than 15% of my portfolio. If this scenario came to pass, I think the least of my worries would be my investment portfolio; what Warren Buffett called CNBC has probably happened (cyber attack, nuclear, biological or chemical disaster).

It many be true that Albert Einstein said that compounding is the most powerful force in the universe. The beauty of HXS is it keeps all my money compounding for as long as I hold it. This temporary tax sheltering strategy can have a reasonably significant effect on returns in the years and decades to come.

http://canadiancouchpotato.com/2013/10/15/more-swap-based-etfs-on-the-horizon/

Leave a Reply

Your email address will not be published.