My Portfolio Asset Allocation – Part 1 (VSB)

This is a multi-part series exploring in-depth each of the individual allocations I have in my B&D investment portfolio.

In today’s post, I’ll dig into VSB which is the stock ticker symbol for the Vanguard Canadian Short-Term Bond Index ETF. I’ll talk about:

  • what it is
  • the actual allocation in the portfolio
  • why I hold this in my B&D portfolio
  • fees/costs to hold it
  • the income it pays me
  • its growth potential
  • which investment vehicles (TFSA, RRSP, LIRA, non-registered account) I put this ETF in
  • Alternative ETF(s) for tax loss harvesting purposes
  • the future of it in my B&D portfolio

Information provided is considered accurate and up to date at the time this post was published.

What is it?

VSB is a short term bond fund ETF that is managed by Vanguard (Please note I have no affiliation whatsoever to them, I just hold it as part of my portfolio. Also, there are many other ETF providers out there with relatively similar ETFs to VSB. I just chose this one to invest in). They define it as follows:

Vanguard Canadian Short-Term Bond Index ETF seeks to track, to the extent reasonably possible and before fees and expenses, the performance of a broad Canadian bond index with a short-term dollar-weighted average maturity. Currently, this Vanguard ETF seeks to track the Bloomberg Global Aggregate Canadian Government/Credit 1–5 year Float Adjusted Bond Index (or any successor thereto). It invests primarily in public, investment-grade fixed income securities issued in Canada.

THE PORTFOLIO ALLOCATION

Why Hold it in my b&D portfolio?

It invests in pretty safe stuff, relatively speaking, and forms part of the fixed income component of my portfolio.

Those bonds have a short duration period which helps further. We’re currently living in a time of rising interest rates and high inflation. Shorter durations on bonds help because once the ones held in the ETF mature, they get replaced by others with higher interest rates. Currently, the longer the time for bonds to mature, the less attractive they are for investors. Longer duration bonds become more attractive than shorter ones when interest rates go down.

With that relative safety though, the returns are lower but I don’t hold this ETF for the interest payment it provides. I mainly hold it to offset some of the riskier components of my B&D portfolio and for rebalancing purposes. I also consider it to be my emergency fund (something I’ll discuss in greater detail in a future blog post).

the associated fees/costs

The one fee I always look at is the MER (management expense ratio) and the ETF provider, like Vanguard, has an obligation to provide what it is so investors understand the total cost of owning this type of investment. It’s defined as follows:

The management expense ratio (MER) is an annualized measure of the cost charged to investors, to invest in a fund. It is calculated by dividing the total of the expenses charged to manage and operate the fund by the total assets of the fund. The expenses include the management fee paid to the fund manager and operating expenses (taxes and administrative costs). The MER is calculated as a percentage of the total assets under management for the fund (AUM).

For VSB, the MER comes in at 0.11%. Therefore, for every $1,000 invested, they charge me $1.10 annually. Versus a potential MER of 2%-3% on many mutual funds translating to $20-$30, $1.10 feels reasonable.

income Received from this etf

VSB pays out interest income. That means for every dollar earned, you will be taxed. For context, it’s the same as taxing every dollar earned for employment income. The only exceptions are if the interest income is tax sheltered or tax deferred. The investment vehicle (e.g.: TFSA, RRSP, LIRA, non-registered/cash/margin account) that houses the ETF will determine which tax situation applies.

Growth potential for this etf

VSB is a low growth ETF. As can be seen in the chart below, it doesn’t grow much.

Placement in Investment vehicles

I’m a Canadian with tax residency in Canada so investment vehicles and tax treatments are related to Canada. I currently have a TFSA, RRSP, LIRA, and a non-registered account which is also known by many as a cash account or a margin account

Legally minimizing and/or deferring the greatest amount of taxes possible is the primary criteria I use to decide which investment vehicle to house an ETF. Since I have a TFSA, RRSP, LIRA and a non-registered account, I use a 3 level filter which is below.

PRIMARY: TFSAs are for investments with the highest capital growth potential as it offers tax-free compounding and any withdrawals made are tax free as well. 

SECONDARY: The non-registered account takes up any of the surplus that doesn’t fit in the TFSA. Also, any investment income that has preferential tax treatment such as capital gains (as I write this, only 50% of capital gains are taxable) or is eligible for the Canadian Dividend Tax Credit should be going in this account.

TERTIARY: RRSPs/LIRAs take up any of the surplus that doesn’t fit in the TFSA and the non-registered account. Therefore, the lowest growth investments would be found here  as well as investments with the heaviest taxable income generated (in most cases, that would be bonds). The benefit of an RRSP/LIRA is that any income taxes owing are deferred until I decide to withdraw from them. The full amount withdrawn is taxable in the same way as employment income. Any taxes paid at withdrawal are based on whatever tax bracket I fall into for that particular calendar year. Therefore, compounding can occur tax free until then.

Based on the above criteria, in which investment vehicle(s) do I currently have VSB? 

Since VSB is a low growth ETF, I have it sitting in my RRSP and LIRA.

tax loss harvesting strategy

Tax-loss selling (or tax-loss harvesting) occurs when you deliberately sell a security at a loss in order to offset capital gains in Canada. You can then use these losses to offset your taxable capital gains. This applies to the non-registered account only. The other investment vehicles (TFSA, RRSP, LIRA) are not eligible for this.

In Canada, the last day in a calendar year for tax-loss selling is typically the third to last business day of the year (not counting any statutory holidays that could happen between then and the end of the year). If you sold at a loss on or before that date, you’re able to deduct your loss against your gains in that calendar year. However, you can also carry your loss back for the previous three years to offset capital gains or carry it forward indefinitely to offset future capital gains.

Also, beware causing a wash sale. This can also be called the superficial loss rule. What this means is that if an investor buys back a security within 30 days of selling it, then they are not permitted to claim the capital loss for tax purposes. Failing to obey the 30-day rule will result in the capital loss being disallowed for tax loss harvesting. To avoid this, I would buy an ETF similar to the one sold but measured on a slightly different index. A wash sale can also occur if you sell in one investment vehicle (e.g.: your non-registered account) and buy that same ETF in another (e.g.: your TFSA) so be careful to not do that within the 30 day period.

As mentioned earlier by Vanguard, VSB tracks the Bloomberg Global Aggregate Canadian Government/Credit 1–5 year Float Adjusted Bond Index. 

Therefore, I would consider XSB which is a short term bond fund ETF that is managed by iShares (I also have no affiliation whatsoever to iShares). It tracks the FTSE Canada Short Term Overall Bond Index. 

Graphed against each other just below, VSB and XSB are a very close match.

 

Lastly, tax loss harvesting does not apply for VSB in my situation as it is held in my RRSP and LIRA (not the non-registered account) however I will discuss the potential for tax loss harvesting for each of my holdings regardless for illustrative purposes.

The future of this etf

Central banks in Canada and the rest of the world are currently continuing to raise their interest rates to fight inflation (if you have not noticed the cost of living rising in your area, please let me know where you are and I’ll come stay there for a while). As rates rise, that means longer term bonds such as an aggregate bond ETF like VAB or long term bond ETF like XLB will continue to suffer more than VSB has (see the graphs for VAB and XLB below For their YTD losses). By holding VSB, I suffer less capital loss and maintain my ability to reduce volatility in my portfolio while also giving me the chance to rebalance as needed.

Once interest rates have peaked or get near to that, I’ll be considering swapping out VSB from my B&D portfolio in favour of something like VAB or XLB. For now though, it will stay put as a part of my portfolio.

Summary

So that’s my overview of the ETF VSB that currently holds an allocation in my B&D portfolio. Please let me know what you think. Was the overview useful? Was anything missing? I’m happy to hear all feedback.

About the picture: I snapped this on June 24th, 2022 in the Haute-ville of old Quebec City. It’s an art installation part of the Passage Insolites public art circuit. Still trying to figure out if it’s a dragon, a centipede, or something else. 

After further research…it’s supposed to be rotifers. I guess you learn things all the time.

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