Super Tax Efficient Bonds

When held outside of a registered investment account (TFSA and RRSP), interest revenue is the most heavily taxed form of investment income. In fact, interest income is taxed added to your employment and other income and taxed at your full income tax rates in the province where you live.

We know income tax rates are pretty steep in Canada at the higher ends of the income curve. For a $100,000 income, interest income will be taxed at rates ranging from 36% in Alberta to 45.7% in Quebec. That is correct, nearly half of your interest income will be funneled right back to the government. Perhaps not ironic considering governments are also the largest debt issuers, so Canadians who own bonds are likely to own are large number of government bonds.

It's no wonder that bonds have not been a very attractive investment in the recent past. Not only are interest rates very low (a sub-3% yield on most major bond ETFs), the net returns after the huge tax hit shrink the returns down well below 2%. That is nicely below the current 2.3% inflation rate.

Although a 1.7% or 1.8% net yield might give you the illusion that you are coming ahead a little bit when holding bonds, with inflation factored in you are actually achieving a negative investment return. All while taking on the risk of investing your money. It's certainly unlikely that our governments will default on their bonds any time soon, but if you hold corporate bonds that is a very real possibility.

Avoid Interest Income with HBB.TO

Given the high penalty of earning interest income in the current financial and taxation environment, any investor who invests in bonds through their non-registered investment account should avoid holding bonds or ETFs which generate interest income.

Thanks to a unique swap structure (contractual arrangement between two parties), Canadians have access to an increasingly popular ETF which invests in bonds but provides no interest income. Instead of distributing interest income as is common in a standard bond ETF, a swap-based ETF will simply apply that interest income to the Net Asset Value of each ETF unit behind the scenes.

The bond ETF I'm talking about trades on the Toronto Stock Exchange as HBB.TO. It is swap structure ETF which tracks the total return of the Solactive Canadian Select Universe Bond Index. It generates similar results as the more popular XBB.TO (sold by iShares Canada) and VAB.TO (sold by Vanguard Canada) which also track nearly identical Canadian Universe Bond indices.

The management fees on this Horizons Bond ETF (HBB.TO) have recently been reduced again to 0.09%. There is an additional embedded swap contract fee up to 0.15% per year (it was 0.1448% in 2017). However, for that fee you have zero distributions, the fund incurs no taxes, there are no other behind the scenes transaction costs, and the ETF tracks the total return of the bond index perfectly.

In a way, you could think of the swap fee as a sort of tax as it represents an additional drag on the returns of the ETF that the more conventional ETFs (XBB.TO and VAB.TO) do not have. But that fee should not scare you as it is a very cheap fee.

Swap Costs vs. Tax on Interest

To keep the math when comparing the two categories of ETFs simple, we'll assume that the underlying indices of the various bond ETFs will perform the same over long periods of time.

Although the Solactive Index is new, the holdings are very similar to the more popular FTSE TMX Bond Index (used by XBB.TO and ZAG.TO) and the Bloomberg Barclays Bond Index (used by VAB.TO). Each index allocates around 70% to governments, 10-12% to financials, and 9-10% towards energy and utilities. The remaining 10% is allocated to telecoms, consumer stores, real estate, and industrials.

Since there are no distributions of any sort with HBB.TO, there are no taxes along the way. Instead, there is a simple deferred capital gain and the swap fee which is not charged by the conventional bond ETFs. Let's see how that swap fee compares to the tax costs on interest income from the conventional bond ETFs.


Regardless of the income level, the additional fees on HBB.TO are multiples cheaper than the income taxes on other bond ETFs. The higher your personal income is, the higher the savings will be.

Over time, the savings on taxes will have a big impact on your total portfolio. If you invest $100,000 and achieve a 3% return, your portfolio will grow to $245,000 over 30 years. The same amount having an after-tax return of 2.1% will grow to just $187,000. A difference of $58,000, or 24% of your total return.

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The Unattainable

Is Early Retirement the real goal?

I discuss the topic of Early Retirement quite extensively on this blog. While it is not always at the forefront, it definitely lurks in the background. Spending, saving, investing... the accumulation of financial assets.

Early Retirement often evokes a bad image. To some, it suggests a capable person who is so incredibly lazy they want to be deliberately unproductive. To a neo-Marxist, an early retiree is the capitalist exploiter controlling means of production and living off the stolen labour of others.

Honestly, it is neither of these things and those who criticize Early Retirement from these broad positions either don't understand what Early Retirement actually is, or they deliberately choose to attack the idea because it is easier to attack another than discipline yourself.

Early Retirement is the pursuit of personal independence from the financial perspective. It is esacping from the necessity to work and do the bidding of others who actually have the ability to control. It is exactly what every capitalist, socialist, communist, individualist, collectivist wants: freedom. (However you define that word).

The difference is those who are willing to exercise great control over their personal lives and take calculated risks with the resources they've earned don't have it in their nature to complain about the success of someone else. When you don't worry about others, you can focus on bettering yourself.

Individuals who achieve Early Retirement standards by their own hard work and pursuit of a solid understanding of risk and investment are not going to sit in a hammock for decades and whither away like a discarded zucchini. The creativity and hard work required for personal financial success somehow tends to propagate more success in further ventures.

The great thing about Early Retirement is that it is entirely possible to achieve. That is precisely why I discuss the strategies in detail, track our own path and share that online, and continuously pore over tens of thousands of numbers in massive spreadsheets searching for better ways to invest money.

Canadians are way better off that we like to admit and we have massive potential to save, invest, and retire early without absolute reliance on government benefits. We just need to stop spending like fools.

No new vehicles, smaller houses, less furniture, less utilities, less restaurants, less convenience services, less clothes, less shoes, less household trinkets, less less less. The irony of course is that having less also means less stress which means a drastically better life overall.

The Investment Savings Rules

Lets talk truth when it comes to saving, investing, and Early Retirement.

If you plan to retire around age sixty where you expect some government benefits to come your way in the near future, you need to have invested an amount of money equal to at least 20 times your annual spending. That's $1,000,000 if you are spending $50,000 a year.

If you plan to retire earlier, you need to have invested at least 25 times your annual spending. That's $1.25 million if you are spending $50,000 a year.

If you want to be extra safe, never needing to work again, and are retiring young, you need to have invested 30 times your annual spending. That's $1.5 million if your are spending $50,000 a year.

Summed up, for the typical Canadian couple renting a house, you need to save and have invested between $1 million and $1.5 million. The amount would be around $300,000 less if you own a paid-off house.

Over a million dollars is a lot of money, so how do you get there?

The Importance of Early Discipline

Time and investment returns are a huge factor. The earlier you start saving and investing in productive assets, the better off you'll be and the easier it is. Also, the higher your investment returns are, the faster you will hit your goals.

While not impossible, it is not always easy to invest for higher returns. It requires even greater discipline and I view it as more of a bonus rather than a reliable factor in financial planning.

Assuming more standard 6% net returns after inflation, here are the monthly saving numbers required to make a comfortable retirement at age 55 happen.


The older you start, the more difficult it is. If you start saving after you are thirty years old, you will likely never retire early barring amazing investment returns or some other financial windfall. Realistically there's only so much you can save when the typical household in Canada earns around $80,000 per year.

Some Advice for the Young(er than me)

The math, the power of compounding gains over time, clearly shows that the earlier you start saving and investing that money the better off you will be. This kind of thinking ahead can put you way in front of peers who follow conventional wisdom.

The destructiveness of acting like a teenager with your finances when you are well into your twenties or thirties cannot be made more clear by this chart. The exponential financial damage is huge. It ruins your personal freedom in ways that can't be totally computed.

I'm personally a huge fan of skipping university and picking a trade or apprenticeship educated career instead. If you graduate from high school and go directly into a trade, you can be a ticketed journeyman in your early 20s earning $30 to $50 per hour. You avoid student debt and the lavish lifestyle expectations that often come along with working in a field that is full of people with degrees. Trades careers present business ownership opportunities and specialization opportunities that you often can't find in many degree requiring fields.

But even if you do decide it is worthwhile for you to go to university, or if you are already on that path, it's not too late to make sure you are doing it correctly. Live how a student used to live (ie. poor). Work hard in the summer. Avoid student debt at all costs. Get a job right away, even if the pay isn't what your academic advisor promised it would be. Choose a degree in business, sciences, or engineering. Learn how to code or at least be savvy with tech stuff beyond simple user knowledge.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.