In the preceding post, I reviewed the rules for using an FHSA and how to make the most of the tax benefits. The FHSA is an account type, but the next question is what to put in that account. The answer depends on your situation, risk tolerance, and preferences. Learn more about the options and how to weigh them to aim for the best returns while also likely having the money available when you need it.
What Can You Hold in an FHSA?
Where You Open The Account Matters
If you open a HISA FHSA at your bank or credit union, you can only hold cash in it. Similarly, if you open a mutual fund FHSA at your bank, you can only hold the bank’s products in it. Those are usually high-fee mutual funds that transfer more of your money to the bank compared to using a low-cost all-in-one asset allocation ETF.
To use ETFs, stocks, bonds, or GICs, you are best off opening an FHSA through a brokerage. That could be a discount brokerage if you are going to DIY invest. I use Qtrade for my kids’ FHSAs. If you are using an advisor, you could use their brokerage, but that will add to their fee. If they are a good advisor, they will have asked you about your goals (like buying a home) and already suggested an FHSA, if you qualify. You can choose whether to do that with them or to open an FHSA at a discount brokerage and manage this account on your own.
It is usually a good idea to avoid having multiple FHSAs at different institutions. If you have multiple FHSAs, consider having your brokerage transfer funds or cash from the others to consolidate them. It avoids hassles for you and can be done tax-free if it is a direct FHSA-to-FHSA transfer by the brokerage. Do not take money out yourself and move it. That would be a one-way tax-triggering move.
What You Cannot Hold in an FHSA
Most of the assets that you cannot hold in an FHSA are not what you would want to use to invest anyway. You cannot directly hold crypto or gold in an FHSA. That is probably a good thing, given their volatility. However, if you really wanted to, you could indirectly hold them through an ETF. You also cannot hold a private equity investment in an FHSA. That is not a problem since it is unlikely to outperform a small-cap value factor ETF, and the money is usually hard to access.
You cannot directly hold real estate or collectibles (like art, watches, action figures, etc) in an FHSA. You could hold shares of a publicly traded real estate investment trust (REIT) or an ETF holding multiple REITs. However, that would constitute placing a concentrated bet on the real estate sector relative to a more diversified investment.
How Much Risk Can You Afford to Take?
Investment Risk & Return
When you are considering investments, risk and return are related. There is no way around this. If you expect a high return on an investment relative to the risks, you are not accounting for some of those risks. That has historically worked out as shown in the chart below.
At one end of the spectrum, stock markets have higher expected returns over the long run. You are buying into a company’s future profits. Because the future is uncertain, the amount paid for it is discounted. The more uncertain or further into the future those profits are (like with small caps above), the larger the discount. If the future unfolds as expected, the price rises as uncertainty decreases, and you eventually sell at a profit.
The same principle applies to bonds. Longer-duration bonds (like 20-year U.S. Treasuries) are riskier. There is a longer period for the bond issuer to default. Plus, your money is tied up longer, and if inflation and/or interest rates rise more than expected, you will have less buying power than you planned for. Short-term bonds are less risky, but also barely keep pace with inflation over the long run.
Importantly, the above applies to broad markets. The risks are much higher when buying a small part of the market or a few stocks. Even worse, there is no expected increased return for taking that risk. “Specific risk” is an unpriced risk. Historically, the return of the average individual stock in the S&P 500 was worse than a treasury; only 4% of stocks accounted for the increased market return, and you must have owned them before they emerged as the winners. This is why you would want to use a broad market fund (buy the haystack rather than hoping to find the needle).
Your Time Frame Matters
How long between now and when the money is needed is the most common limiter for an FHSA. Not having the money when you need it is a serious risk. While riskier stocks have the highest returns over decades, they fluctuate a lot in the short term (months & years). Commonly 10-20%/yr, but occasionally and unpredictably much more than that. If the stock markets are down by 40% at the time you want to buy your home, then you will have a lot less money available than you hoped for.
On the other hand, if your purchase is 5-10 years away or more, you may be able to take on more risk. Below is a chart showing the depth and duration of some historical market drawdowns. Consider whether you could handle having that much less money or waiting long enough for it to recover. An all-equity portfolio may take a decade to recover. However, most of the recovery occurs within the first 5 years.
If you take more investment risk, you must be able to accept a bad outcome, as illustrated historically above. However, if you can, the odds do favor a good outcome the longer you are invested. For example, a high-risk investment like the S&P 500 has produced positive returns in most time periods from 1926 to 2017. The odds of a positive outcome increased as the rolling time period length increased. Even short periods, like 3 months, were positive 69% of the time. Still, you wouldn’t want to be on the wrong side of that 69%, and down by 20 or 30%, if you needed the money.
I am not suggesting a narrow investment like the S&P 500 above (I favor global diversification), but it does provide an extended historical dataset to consider. A globally diversified portfolio would have a lower drawdown and a quicker recovery than if your investments were concentrated at the epicenter of whatever crisis underlies the drawdown. For example, the “lost decade” (2000-2009) of the S&P500, sparked by the dot-com bubble, looked very different for more diversified equity investors. It wasn’t a lost decade for diversified investors.
How Much Flexibility Do You Have?
Adjusting Over Time
One important thing to consider is the amount of time that money you invest today has to grow before you is not static. It changes. As you get closer to needing the money, the time frame shortens. For example, if you plan to buy a house in five years, you could possibly take on some equity risk now. You may start aggressive and then shift to mostly fixed income over a few years.
You could do that by selling some of your ETFs and buying lower-risk ones, if you are not making new contributions. Alternatively, if making new contributions and/or receiving dividends, you could buy a bond ETF as you invest new money. As the time you need the money becomes shorter than 3 years, you would likely move to fixed income only. Still, making those adjustments over time would allow for taking some extra risk early on. The odds favor a result that yields more money, but that is not guaranteed. You must also accept that you could get unlucky with some of those early investment dollars.
Consider Other Sources of Money
Other investments or sources of money that may become available as your house purchase approaches can also influence how you invest. For example, you might start your FHSA and take on a high level of investment risk with the $8K/yr added to it. That is pretty risky if you plan to purchase in the next few years. However, you may feel okay doing so because your income will increase dramatically between now and your home purchase. You can also add money to your TFSA and RRSP that you can access. You may take less risk in those accounts as you add more to them closer to your deadline.
For example, if you added $8K/yr to your FHSA as an all-equity ETF, you could also add $7K/yr (or more if unused room) to your TFSA. You could have a close to 50:50 stock-to-bond allocation if you put GICs or a money-market ETF in there. You may also add up to $30K/yr to your RRSP and access up to $60K through the Home Buyers Plan. That rapidly shifts you towards a conservative allocation overall if you use that to buy GICs or a money-market ETF. Consider all the accounts or income sources you plan to access when allocating your assets. Not the FHSA in isolation – that is mental accounting.
How Flexible Are You on Price & Timing?
Another factor to consider is what you would do if there is a market downturn when you want to buy a home. If you are flexible and willing to put it off if you get unlucky or perhaps compromise and buy something less expensive, then you could take more risk. Some people are willing to take more risk and trust the odds that favor a better outcome, but are also willing to compromise if risk comes home to roost at a bad time. However, those people are pretty rare when it comes to housing decisions. A house purchase is usually steeped in emotional and social pressures. Plus, their partner has to feel the same way if they are married and want to stay that way.
Another reality of how the universe works in terms of timing is that bad stuff usually clusters together. If you are waiting for some calamity to make houses more affordable, it is likely that the cataclysm (if it materializes) will also be bad enough to affect other high-risk investments (like equities) at the same time. A less costly house, but less money available to buy it, if you were aggressively invested. That said, equity markets tend to fall and bounce back much more quickly than real estate does. Real estate prices are sticky due to the high transaction costs, emotional attachment, and anchoring bias to previous market prices. Below is a chart of the inflation-adjusted price of houses in Canada with previous corrections highlighted. You can also see how Canadians went nuts after 2007/8 while the rest of the world saw some moderation.
How Much Volatility Can You Ignore?
Even if you can probably handle taking investment risk in your FHSA from a financial standpoint due to your timeframe, flexibility, and other sources of money, your emotional risk tolerance may limit how much risk you can take. Our emotional risk tolerance is part of our psyche. It is also piqued by larger price swings (volatility).
We are wired to want things when they are popular (and more expensive), and shun them when they are not (and cheaper). The larger the price swings, the stronger it stokes those emotions. That can cause us to deviate from our plan. For example, if prices rise sharply, you might get FOMO (greed) and buy more at the top, using a loan or a leveraged ETF. Then magnify the loss on the way down, selling near the bottom when you can’t stand the pain anymore (fear). We tend to project recent trends into the future, and that can be devastating to your real-world performance.
Taking investment risk has a higher expected return. However, your behavior is not priced into that. If you performance-chase or sell because you listened to one of the never-ending narratives about why the end is nigh, then that may easily overpower the benefits of taking investment risk. The average investor trails their benchmarks by ~2%/yr on average. That may be lower with a simple automated plan and no access to internet news. However, it is commonly higher for those investing in exciting volatile areas of the market.
Risk Tolerance Questionnaires
Emotional risk tolerance is quite complex. It is influenced by genetics, previous experiences, culture, the people you interact with, and your environment. Still, some questionnaires are commonly used to provide estimates. For example, the Missouri Risk Tolerance Assessment gives a score based on hypothetical scenarios. It is less about risk capacity and more about risk tolerance. The score is based on where you stand relative to the general population. The Vanguard Questionnaire is short and asks about a mix of risk tolerance and risk capacity to spit out a stock:bond asset allocation.
A risk tolerance questionnaire is quick and straightforward. However, I have also created a more comprehensive set of exercises to supplement that if you want to.
How Can You Improve Your Risk Tolerance?
The environment and the people you interact with can impact your risk tolerance. So, there are some things that you can do to avoid challenging your self-discipline. First, spend some time understanding how efficient markets work and why they are hard to beat. Know that whatever story you are hearing is priced in. Be aware of the common investing stories we tell ourselves and avoid expensive self-talk.
Understanding common pitfalls and how markets work helps. However, that requires you to pause and think calmly and rationally. It is our reflexive emotional brain that is the most dangerous and gets us in the moment. There are a few ways that you can help yourself. Avoid watching business media or reading investment news. The odds of whatever you are hearing about coming to pass are already priced in. Plus, the media gets paid for eyeballs, and scary or emotionally provoking stories attract more eyeballs. Similarly, use the chatter from your friends, family, neighbors, or colleagues about their investments for entertainment only. Hopefully, you have better things to talk about. And it is all priced in anyway.
Don’t check your portfolio regularly. That gives you more opportunities to provoke an emotional decision. Check your portfolio when you are doing something. Like buying or selling. Even then, the more you can automate that process, the better. Using an advisor or a robo-advisor can be fully automated, but is more expensive. Setting up automatic contributions and using an all-in-one asset allocation ETF or a money-market ETF is the next most automated option. You have to log in and buy more of the same investment when you have money, which can be simple and take under five minutes. The main challenge is having the discipline to remember and do it.
What if you get your risk tolerance wrong?
If you find you may not have estimated your risk tolerance correctly, adjust gradually. Also, make sure that it is because you have gained experience or your situation has changed – not in reaction to some news item. At least sleep on it – a few times. If it is a minor adjustment, start making adjustments as you add new money. You’ll rarely have gotten it majorly wrong, like oscillating between 100% equity vs 100% cash. If you find yourself contemplating that type of change, it may be a sign that you are trying to market time, unless it is a planned adjustment due to a shortening timeline.
If you are unsure of your risk tolerance, err on the side of a more conservative investment approach, especially if you are new to investing. The risk is lower, and it is easier to ratchet up risk as you gain experience than to sit tight when you realize you have exceeded your risk tolerance in a downturn. Experiencing a downturn really helps you to understand your risk tolerance the best. Reflect on how you feel when markets drop. Or if there was a significant correction, and you managed to ignore it all because you were following the suggestions in the preceding section, and living your life instead.
Putting It Together: Your Risk Ceiling
In summary, when considering what to buy in your FHSA, you must consider how risk you can afford to take and how flexible you are. Except over very short and rigid time frames, taking some investment risk is likely to generate more money. However, if you do that, you must also be able to handle a significant, unfortunate negative outcome by injecting additional funds into your housing purchase or making compromises. Most people are not willing or able to do that when it comes to housing. That is the ability to take risks (risk capacity). Even those who can afford the financial risk, may not be able to tolerate the volatility of a higher-risk investment without deviating from the plan by buying or selling at inopportune times (risk tolerance).
The lower of your risk capacity and risk tolerance should set the ceiling of the amount of risk you can take. The final factor is the willingness to take risks. Some people simply prefer a predictable, safe outcome rather than more risk and potential return. That may be particularly important if the timing of a home purchase is uncertain and may be sooner than you think. Once you start talking seriously about buying a home and looking, it is hard to resist the marketing and social pressures at work for very long.
What I Would Buy For Common Scenarios
I am not an investment advisor. Even if I were, you would have to play an active role in deciding what to buy for your own FHSA. I cannot give you specific advice or recommendations. As you hopefully realize after reading this article, there are many variables specific to your situation, personality, and preferences to consider. You must also do your own due diligence to understand any investment that you buy. Still, I will share some common scenarios and what I would do in those situations.
Impending Purchase That Will Hoover Our Savings
We are actively looking for a house or plan to buy within the next year or two. After a few years of living in our city, we are sure we want to stay here, and in which neighborhood. We may have to jump at the opportunity if the right home comes up. Having earned a good income relative to our spending for a while, we also have some money in our RRSP, FHSA, and TFSA. However, we plan to use most of those funds (limiting the RRSP withdrawal to our HBP) to make our down payment. Making a larger down payment helps us avoid paying higher CMHC insurance premiums. With the short timeline and the annual maximum contributions, we are not adding much more money to our registered accounts before purchasing. Together, these circumstances give us very little risk capacity.
We have a high tolerance for investment risk emotionally because the only financial media we partake in is The Loonie Doctor. We have previously invested in 100% equity using ZEQT, VEQT, or XEQT. However, our risk capacity is now the limiting factor with the impending need for cash. So, I would sell my equity ETF and buy a cash equivalent for the amount I plan to use. I need liquidity and stability. So, I would use a money market ETF like ZMMK rather than a GIC.
Purchase In The Next 3-5 Years. Probably.
Let’s say that I have the same very high behavioral risk tolerance, but my planned home purchase is a bit further off, and I am somewhat flexible about price and timing. I could potentially take some investment risk.
If I am flexible on timing and price, I could potentially buy an equity ETF this year, maybe even the year after. Historically, there would be an >80% chance of a positive outcome, and I am flexible if I get unlucky. Plus, I would be adding money each year. So, the 100% equity will rapidly decrease as I add more fixed income in later years. If I had a large drawdown in the first two years, I would stay invested to ride that back up. Conversely, if I had been lucky those first couple of years, I would have moved to fixed income by year three.
If I were not adding significant new money each year or was not willing to compromise on price or timing, I would be more conservative from the get-go. With a 3-5 year timeline, I might consider a slightly higher risk than a cash equivalent, such as a short-term bond ETF (e.g., VSB/XSB/ZSB). They hold bonds – so there is a slightly higher risk and return relative to cash equivalents. However, they also have a weighted duration of about 3 years. So, not crazy relative to my timeline. Still, when I get within 2-3 years of needing the money, I would shift to a money market fund.
Purchase In The Distant Future. Maybe.
This is what we are actually doing ourselves. We do not qualify for an FHSA, but our kids did when they turned 18. We have opened and funded FHSAs for them. They have 15 years (to age 33) to use the money tax-free to purchase a home. Even if they do not, they get the tax deduction to use when advantageous, tax-sheltered growth, and can add that to their RRSP to continue tax-deferred growth for decades more.
They have a high-risk tolerance with me sitting at their shoulder, and a long time frame. There is nothing even on the foreseeable horizon for them to need the money for. So, we have them invested in XEQT and ZEQT. Vanguard recently lowered the VEQT management fee to be competitive with those options as well.
New Investor or Nervous
The above scenarios were investors with a high risk tolerance. They understand how markets work enough to know they should ignore the noise and adopt a simple, effective plan that they can stick to. It is even better if they have invested through some scary times, so they know what that feels like in real life and how they reacted. That is not a prerequisite. We are all noobs at some point. A humble new investor who has taken the time to learn, accepted that markets work, and maybe even had some mentorship, could be fine. Hopefully, The Loonie Doctor has helped. Investing the time to learn is very valuable. However, for those who are early or unsure should err on the side of more conservative investments until they gain knowledge and experience.
The FHSA can be one of your most valuable investment accounts. I would avoid using it to speculate or gamble, thinking it is investing. Again, even if you have a timeline and risk capacity that suggests you could take on more investment risk, you should not exceed what you can comfortably handle from an emotional and behavioral standpoint. That can inadvertently turn a good investment into a speculative one.
Great content, per usual, Dr. Soth!
Thanks. This post will also apply for other accounts people are using for intermediate term goals.
Mark