Pay lower taxes by investing in Index funds

Celebrating Christmas with my friends.

Taxes is our biggest expense

Our biggest expense is neither food, nor housing, nor transportation. No, our biggest expense is taxes.

Here in Canada, we have many privileges not found anywhere else in the word. We have a stable government, low crime, acceptable medical service, job opportunities, etc. But we pay dearly for all those benefits, we pay some of the highest taxes in the world.

There are ways to pay less taxes

The first thing is to take advantages of all the tax shelters offered by the Canadian government. Some of those tax shelters are RRSPs, RRIFs, RESPs and TFSA. We will talk about each one of those in future posts, but in general, you can eliminate completely, or postpone for many years, taxes on the money earned within those tax shelters. The biggest problem with those tax shelters is that there is a limit on how much money you can put in them. For example, I can only put $5,500/year in my TFSA.

How can we invest the money that can not be protected from taxes?

Stay away from bonds or any kind of interest revenue. This kind of revenue is taxed as regular income. You pay more taxes on $1 earned from interest income that in $1 earned from dividend income of capital gain income.

The income which is taxes at the lowest rate is capital gain income.

Then problem arrives when you buy actively managed mutual funds. Those mutual funds have a lot of buying a selling within them, and you the investor, you are responsible for paying for those capital gains. This is surprising for most investors because as far as they know, they are not actively buying and selling, they are buying and holding. It is very unpleasant to see a tax bill at the end of the year.

The best way to lower your tax bill or  is to invest in Index of ETFs.

Index funds are highly tax efficient because there is not an active manager constantly buying and selling securities. The index fund represent a basket of stocks which mostly stay the same.

For example, the Index fund which represent the 60 biggest Canadian companies is composed of the 60 biggest Canadian companies. The Index fund which represents the Dow Jones industrial Average, always has the same 30 companies. There is no much change in one of those indexes from one day to the other, for the most part, the index fund, never buys and never sells.

Index Funds and ETF not only offers the highest returns in the stock market, when compared against mutual funds, but also offer the most tax efficient way to invest in the stock market.

I think that we should forget completely about actively managed funds and embrace completely Index funds.

Do you own any actively managed funds? Any index funds? Let me know in the comments.

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