If your investment plan includes long-term goals like a comfortable retirement, minimizing the amount of taxes you pay on your investments can have a considerable impact on your portfolio returns over time.
The chart below shows how tax can have a varying effect on the different types of investments in non-registered accounts. Treasury bills and bond income are taxed the most, since interest income received from these types of investments is 100% taxable at the investor’s highest marginal tax rate. Equities on the other hand receive the most favourable tax treatment. This is because only 50% of capital gains resulting from the sale of equities is subject to income tax and dividend income is generally taxed at a lower rate than interest income.
It's important to think about how to keep your investments growing with the impact of inflation on returns. From a portfolio perspective, this often means holding an appropriate amount of equities. This is because long-term stock returns are typically well ahead of the rate of inflation.
On the other hand, assuming an inflation rate of 2%, T-Bills providing interest income of less than 2% would actually deliver negative "real" after-inflation returns. Additionally, bond returns of 4% would see half of their "real" returns lost after accounting for inflation.
Click to see the impact of tax and inflation on investment returns
Tax impact
Tax + inflation impact
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Key points
- Taxes reduce T-bill income the most, since interest income is 100% taxable.
- Equities receive the most favourable tax treatment, since only 50% of capital gains are subject to tax.
- Relying only on cash and bonds may not be as safe as it seems. Ask your advisor if adding equity investments to your portfolio is right for you.
Key points
- The hidden risks of inflation and tax can take a significant bite out of your investment return, especially from interest-bearing investments.
- After taxes, and inflation, long-term returns from Bonds and T-bills are typically lower than returns on Equities.
- To help limit the impact of taxes and inflation on your investment portfolio, talk to you advisor about building a diversified portfolio, one that includes an appropriate mix of cash, fixed income and equities based on your investment objectives.
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