By Jonathan Chevreau
After Robb revealed his “conversion” and I appealed for other readers with similar stories, readers started to come out of the woodwork. In one of the cases, the “confession” appeared first at MoneySense and now here and the Hub.
In addition to the two readers profiled in the MoneySense blog, I’ve already started to receive more emails from other “pure” readers. Please let me know by emailing me at email@example.com. Hopefully, we’ll discover that there are a lot more than the half dozen I’m so far aware of.
I’ve republished the original version of the blog below and included photographs of the two readers that were not included in the MoneySense version:
Pure indexers step forward
Early in January, popular blogger and fee-only financial planner Robb Engen announced on Twitter and his Boomer & Echo site that he had finally bitten the bullet – he’d liquidated his portfolio of individual dividend-paying stocks in order to become a 100% “pure” indexer.
As he subsequently revealed in a blog at the Financial Independence Hub, he “felt like a part of me died,” but nevertheless manned up and sold off his 24 stocks, $100,000 worth of them. He replaced them with just two Vanguard ETFs that happen to be MoneySense ETF All-stars: the All World ex-Canada ETF (VXC) and Canada All Cap Index ETF (VCN) and “that’s it.”
Click on the link for the full story but the rest of this blog is about two young investors who responded to my request for similar dramatic Damascene conversions. It had seemed to me that Robb’s heroic conversion was unique although the pages of MoneySense’s magazine and books have occasionally been graced by a similar tale from Millionaire Teacher Andrew Hallam.
Embracing the Global Couch Potato
Jason St. Hilaire (@TcommeFinance on Twitter) is 31 and lives in Quebec City. The medical physicist started to invest seriously in December of 2011, when he put the ING Direct Balanced Fund in his TFSA and ING Growth Equity Fund in his RRSP. His early research made the case for index investing, so he put four TD e-Series funds in his TFSA (the Global Couch Potato portfolio).
“At some point I even bought some Bitcoins. You can see that I was all over the place.” Then, like Robb Engen before his dramatic turnaround, in the summer of 2012 St. Hilaire discovered the Canadian Drip Primer and the DRiP Investing Resource Center.
“I figured I could try my hand with good dividend stocks with nice yields …I built myself a 10-stock portfolio with no real investing plan whatsoever. I would buy what I would feel like buying.” By 2013, he and his partner were raising cash to buy a home, liquidated the index funds and transferred the stocks to their brokerage account. They still have three stocks: “I see the stock market going down and can’t help but tell myself to wait until my positions recover. Can you say ‘behavioral bias?’ “
Unable to stay completely out of the market, early in 2015 he restarted his Global Couch Potato portfolio in his TFSA, adding $200 every other week. “The dividend stock experiment was fun, but I don’t want to spend so much time researching companies and trying to find bargains. In my situation, going with market returns with a simple portfolio is appropriate. I just need to get over my own non-sense to finally become a pure, 100% index investor. And now that I just confessed this to someone, I might just do that.”
“Pure” since 2011
Another young investor who contacted me was Pat McIver (@mrpatmciver on Twitter.) After a brief fling picking individual stocks, he and his wife became “100% pure indexers” in 2011. They use only index-tracking ETFs for their RRSPs and TFSAs, and even for their toddlers’ RESPs.
“I had a professor at Carleton University tell me back in 2003 in his 3rd-year finance class that I shouldn’t bother trying to pick stocks, market time, or waste energy on trying to beat the market. He said the smartest thing we could ever do as investors was buy index funds (ETFs or mutual funds), and hold them.”
Despite this, after graduating, he dabbled in Nortel, RIMM, BMO, and CP but held them for only short periods and neither made or lost money. “I realized early on I was somewhat a risk-averse investor when it came to picking individual securities, and never had the confidence that I was able to identify the ‘winner’ fund or the ‘loser’ stock.”
With prescient timing, they withdrew funds from their RRSPs in August 2008 to buy their first home, and started to reestablish their RRSPs in January 2009 (also great timing!). They owned Altamira Canadian Index, TD International Equity Index Currency-Hedged and US Index and the actively managed TD Canadian Bond. They departed from this only to buy a few shares of Canadian Pacific.
In January 2011, after reading various blogs, including MoneySense, he switched his wife’s RRSP into iShares ETFs (25% XBB, 25% XIU, 10% XCS, 20% XSP, 15% XIN and 5% XEM.) Then Pat ditched the CP shares and a few mutual funds to go “all-in with index ETFs: 20% XBB, 35% XIU, 25% XSP and 20% XIN. “This past summer, I reduced the holdings in my wife’s RRSP from six to four.”
Pat says the blended annual cost is 0.31%. “We also switched our XSP for VUN and switched XIU for XIC to broaden our diversification in the US and Canadian markets, respectively.” They rebalance once a year.
“When we started investing again in early 2009, I decided we would go with a mostly-index-based portfolio. In 2011, I decided we might as well go on in and once our allocation weightings were set, just leave it and let it ride until we retire in 2036 (the earliest date we can retire as federal government civil servants).
As a busy family man with a two-hour daily commute, Pat is happy “knowing I have a broad-based diversified portfolio that is low-cost and contains minimal funds gives me great comfort (and no sleepless nights) that I don’t have to worry about whether I am “winning” or “losing” vis-a-vis the market. I doubt I would ever go back to being an active investor ever again.”
So, counting Hallam and a handful of advisors I know, I’m aware of half a dozen truly pure indexers. Anyone else out there? Email me at firstname.lastname@example.org.
… contributing as much as $5,500 to your TFSA (Tax Free Savings Account) if you’re Canadian. Launched at this time in 2009 and behaving somewhat like America’s “Roth” IRAs, it’s hard to believe this is already the seventh time you can contribute. By my calculations, that means $36,500 of collective contribution room plus any investment growth. That’s four years at $5,000 and now three years at $5,500: the maximum was boosted by $500 as an inflation adjustment for calendar 2013.
So if you’re one half of a couple, that means $73,000 in joint contribution room, even if you left it in interest-bearing investments paying almost zero. If you’ve been investing mostly in equities (either stocks or equity ETFs), it’s likely your TFSA had reached $40,000 or more by year-end, so it’s quite conceivable that some couples now have close to $100,000 invested in TFSAs between them.
Thursday, Jan. 1 was of course a holiday. While Friday, Jan. 2, 2015 is likely to be a quiet day for most, there’s no reason why you can’t contribute the next $5,500 to your TFSA that day, particularly if you use online banking and/or discount brokerages.
Good place for equity ETFs
What to invest in? In retrospect, those who invested in US investments with unhedged exposure to the US dollar would have done best up till now. Our daughter’s TFSA is more than half invested in US tech stocks and broader ETFs and the exposure to the greenback has boosted her TFSA to several thousand more than our own TFSAs with more exposure to the loonie.
Generally, I think a Couch Potato approach to investing in TFSAs makes the most sense, using broadly based ETFs from firms like Vanguard or iShares. Those closer to retirement may want a healthy exposure to Canadian dividends: foreign dividends will lose a bit of withheld tax in a TFSA and are better held in RRSPs for that reason. But for younger investors it may make sense to hold non-dividend paying US tech stocks in a TFSA for both the extra growth potential and the exposure to a strong US dollar that is showing no signs of weakening.
I still say the TFSA and Roths are the best games in an over-taxed town. While it’s true that many had hoped the 2015 limit would be more than $5,500, remember that unlike RRSPs, you can continue to contribute to TFSAs well past age 70 or 71: in fact, if you live that long you could still be contributing if you’re a hundred or more.
The key is to get the money in there as soon as you can and let it grow. And that means early January each and every year. While I think the benefit is particularly powerful for the young, they should balance the growth potential with debt repayment. There’s not much point in paying close to 20% a year in credit-card interest if you’re only earning 2% interest in a GIC or cash equivalent contained in a TFSA.
Why? Mister Canadian Couch Potato himself, Dan Bortolotti — now also an investment advisor for PWL Capital Inc. — explains the behavioural investment quirks that makes the simple complicated in my Wednesday blog at MoneySense.ca.
My latest MoneySense blog on robo-advisers can be found here.
If you’ve been listening to the news lately, then you’ve noticed that low-cost automated investment services are making the leap from the U.S. market to Canada. While in the U.S. they’re called robo-advisers, a better word for the Canadian versions might be semi-automated “light advice” services.
Recent issues of MoneySense have talked about the arrival of NestWealth, WealthSimple (which has just received regulatory approval) and WealthBar Financial Services. WealthBar’s website says it will be arriving “soon” and is registered as a portfolio manager in British Columbia, Alberta and Ontario. As well, SmartMoney—owned by Money Capital Management—is also about to launch in Canada. Most of these use exchange-traded funds (ETFs) as the underlying investment vehicle. That means investors can expect to pay either a monthly subscription fee or an asset-based fee of about 0.5% a year. Even adding in the management expense ratios (MERs) of the underlying ETFs, the total cost should come in at less than half what actively managed Canadian mutual funds or wrap accounts charge.
Apart from these startups, you can also expect to see more established firms reinventing themselves with similar models. Take ShareOwner Investments Inc., of Toronto. Since 1987, it’s been the place knowledgeable Canadian investors have bought individual stocks through DRIPS (dividend reinvestment plans). Last May, ShareOnwer announced the launch of a new portfolio building service that’s based now on individual stocks but—you guessed it—ETFs.
As with its DRIP program for individual stocks, ShareOwner’s ETF portfolio service is very cost-efficient. Contributions and distributions are automatically invested in all the ETFs in one of the five model portfolios chosen by the retail investor. As with the other services, asset allocations are reviewed and rebalanced to ensure they stay with agreed target levels. For instance, if Canadian equities are supposed to be weighted at 20% of a portfolio, the service won’t let the allocation dip below 17.5% or above 22.5%, says ShareOwner president and CEO Bruce Seago. (Previous ShareOwner head John Bart, is now retired.)
Clearly, long-standing ShareOwner customers own individual socks but many are now also using ETFs as the core of index part of their portfolios, particularly for international exposure outside North America. ShareOwner has about 500 Canadian and U.S. stocks. There are no commissions to buy or sell but a fee of 0.5% of assets is charged on the portfolio value, billed monthly, and capped at $40 a month for any account over $100,000. As an example, an investor may want to add $500 a month to portfolios holding between eight and 12 ETFs. The $500 will be spread among all those ETFs automatically with each payment, in the correct proportions and with no trading costs. Similarly, any cash from dividends will also be deployed and fractional shares can be accommodated.
Because the emphasis is on core, broadly diversified ETFs, the funds are mostly from BMO, BlackRock Canada’s iShares and Vanguard Canada, Seago says, although oehters are available for those who want custom portfolios. He adds that even if clients want to invest in both individual stocks and ETFs, they would maintain separate accounts for them. For the most part, the model portfolios stick to the major asset classes or stocks, bonds and cash, but those who want to do so can get previous metals or gold exposure through ETFs—one that holds mining stocks, the other that holds bullion—directly.
While the service is aimed at do-it-yourself investors, personal human advice is provided for those who feel they need help choosing an appropriate portfolio. “Building a portfolio does require thinking about risk tolerance,” says Seago. “Once you know how much risk to take, you can pick one of our portfolios—most of which usually match up with the needs of our investors. We are adding a human element on top.”
You may have heard the phrase “robo-adviser” but as implemented in Canada, the phrase “light advice” may be more appropriate.
Read more here in my column in the Financial Post.
For purposes of continuity and “one-stop-shopping” I’ve included the piece below, and added the minor clarification that Wealth Simple has now received regulatory approval.
The term robo-advisor has come into widespread use in recent months, with a handful of firms starting up in Canada.
The model for this is Palo Alto, Calif.-based WealthFront, founded in 2008. It describes itself as an “automated investment service.” It assembles portfolios of passively managed exchange-traded funds (ETFs), matching client investment objectives and risk tolerance to the ETF selection, with appropriate asset allocation and regular rebalancing.
The fees are low: nothing on accounts below US$10,000 and after that it bills clients monthly at a rate equivalent to 0.25% annually of assets under management (plus the fees of the underlying ETFs, many of which are from Vanguard).
Subscription-based Couch Potato service
One of the first Canadian equivalents is Toronto-based NestWealth.com, launched by Randy Cass starting in Ontario and set to roll out nationally this year. I call this a “subscription-based Couch Potato service.” Cass got the idea from watching his son watch the subscription-based Web TV service, Netflix.
For $80/month (or $40/month for those under 40) customers can “subscribe” to a service that chooses and monitors a portfolio of ETFs — selected from Vanguard Canada and Black Rock Canada’s iShares families. As with similar services, NestWealth will worry about asset allocation and rebalancing.
Wealth Simple now approved
Awaiting regulatory approval — now received — is Michael Katchen’s WealthSimple, a “light advice” model that takes a more traditional approach of levying an annual asset-based fee of 0.5%, which will be above and beyond the underlying fees of the ETFs themselves. Fees taper down with higher amounts of wealth.
SmartMoneyInvest.ca about to launch
Also about to launch is another Toronto-based firm called Smart Money Capital Management, which will operate on the web as www.smartmoneyinvest.ca. Founder and managing director Nauvzer Babul told me in an interview that “no one in this space calls themselves robo advisors. The term was coined in the United States, where everything is very automated. My goal is to be between that and where we are in the Canadian investing space, where there is advice and a person to meet with. Clients can speak with live people who try to understand their risk tolerance and understanding, then develop a portfolio around that. There’s definitely human interaction.”
At least in the Canadian model, “light advice” seems a better description than “robo-advisor.” In any case, fees will be higher than what do-it-yourself (DIY) investors would pay buying their own ETFs at discount brokerages (perhaps aided by some fee-for-service advice from a human financial planner). On the other hand, fees of these automated or semi-automated portfolio management systems should come in well below “wrap” programs offered by major Canadian financial institutions and certainly below the Management Expense Ratios (MERs) of most actively managed retail mutual funds sold in Canada.
In other words, a DIY investor might pay just the MERs of the underlying ETFs, meaning somewhere between about 0.10% and 0.55%, depending on the products chosen. Wraps and DSC mutual funds typically come in between 2.5% and 3% or a tad above that. So you can figure a typical robo-advisor or light advice service should come in somewhere between 1% and 1.5%, including the MERs of the underlying ETFs.
In the case of Babul’s firm, the annual asset-based fee charged is 0.45%, on top of the underlying ETFs, so the total portfolios should come in around or slightly below 1%, all in.
Retail investors take on too much risk picking stocks
What kind of value can investors derive from such a service? Babul provides an interesting response, drawing on his 13 years of investment banking experience at BMO Capital Markets, which he left three years ago. In managing its derivatives business, Babul developed an intimate understanding of risk management. He noticed that retail investors tend to take on more risk than institutional investors. “I believe individuals picking individual stocks are taking on too much risk. Many institutional investors are more index-based than stock-pickers because they don’t want to be exposed to undue systematic risk.”
Babul’s goal is to invest clients in diversified global portfolios of ETFs. “We’re not trying to beat the market, but just create a diversified portfolio that adequately manages their risk tolerance.”
I ask whether there was a time when Babul ever believed in market timing and stock-picking.
“I saw my portfolio’s performance.”
Today’s blog headline (minus the suffix I added) is also the subtitle of a free new investing booklet titled If You Can by William J. Bernstein. This is a terrific and short (16 pages) document that I wholeheartedly recommend be read and absorbed by today’s millennial generation. For that matter, it should be read by just about any investor at any age.
But a warning: if you’re in the financial services industry, you’re not going to like the content. The author is a neurosurgeon who learned the hard way how to invest his own money, and has written a few books along the way. If you’re not in the financial services industry, you may be merely amused by his depiction of most full-service stock brokerages and mutual fund salespeople as the equivalent of “hardened criminals” or “self-deluded monsters.”
At the outset, Bernstein promises to lay out an investment strategy that any 7 year-old could understand and will take just 15 minutes of work per year. Yet he promises it will beat 90% of finance professionals in the long run, but still make you a millionaire over time. The formula will be no surprise to MoneySense readers familiar with the Couch Potato approach to investing in index funds or ETFs. Simply, Bernstein advocates saving 15% of one’s salary starting no later than age 25 into tax-sheltered savings plans (IRA or 401(k) in the U.S., RRSPs or Registered Pension Plans in Canada), and divvying up the money into just three mutual funds: a U.S. total stock market index fund, an international stock market index fund and a U.S. total bond market index fund.
Bernstein a big fan of Vanguard and John Bogle
In Bernstein’s view, the index funds should be supplied by the only financial services company he seems to trust: the Vanguard Group (which sells both index mutual funds and ETFs).
Bernstein is addressing young Americans just embarking on their working careers but the basic idea would apply to Canadian millennials too. Judging by recent Portfolio Makeovers we’ve run showing ETF-based Couch Potato portfolios, the equivalent mix would be 20% each of Canadian, U.S. and international equity index funds or ETFs, and 40% of a bond ETF. And as I’ve written before, don’t even wait till age 25: if you can get your parents to match your savings starting at age 18, the TFSA is the place to put in place these bedrock principals of investing.
And the 15 minutes of work? That would be an annual rebalancing exercise to get the proportions of the three or four funds back to their starting levels.
Millennials can’t count on employer pension plans
Despite this, Bernstein warns younger people that they’ll have a hard go of it because the traditional defined benefit employer pensions of previous generations probably won’t be around much longer. This is pretty much what I wrote in the Editor’s Note for the April issue of MoneySense: that we’re all forced to be our own pension managers these days.
Bernstein says the operative word in his booklet’s title is “If,” because following his simple recipe for wealth (I’d call it financial independence of course) involves a very big “if.” He lays out five hurdles. Number one is excessive spending, second is understanding the basic principles of finance and investing, third is learning and applying market history, fourth is overcoming yourself: the biggest enemy being your face in the mirror; and hurdle five is the conflicted financial industry that is supposedly there to help you with your financial goals. He goes so far as to declare, “The financial services industry wants to make you poor and stupid.” Fighting words, indeed! I might not go that far but it’s certainly a way of looking at the world.
Bernstein’s homework assignments
Bernstein assigns some “homework” to his young readers. They have to read his document twice and read a few books, starting with Thomas Stanley and William Danko’s The Millionaire Next Door and John Bogle’s Common Sense on Mutual Funds. He’s too shrewd to plug his own books but I’ll name one on his behalf that I’ve reviewed positively in the past: The Four Pillars of Investing.
The fact that Bernstein has gone out of his way to give away the booklet should tell you a lot. You can find the link for a PDF here. If you act quickly (today, May 5) you may also be able to get the Kindle version free rather than the 99 cents Amazon.com normally would charge.
To parents of millennials, I’d urge you to download and print this document and hand it over to your kids, perhaps after highlighting the passages you feel to be most relevant. You could give them the link but you know how distracted they tend to be with all the social media noise that abounds these days. Sure, they may say they want to get rich some day but to paraphrase the old saying, “We all want to go to heaven, but no one wants to die first to get there.” For millennials, saving 15% of salary is the financial equivalent of dying, which is why Bernstein titles his document “IF you can.”
What I call the “Findependence Day Model” dervived from the book is simply the combination of three things.
All three deal with cutting investment costs or brokerage costs. The first is using a discount brokerage to make your own trades, typically at $10 per transaction. The second is to take advantage of broadly diversified, tax-efficient and low-cost exchange-traded funds (ETFs), which can also be purchased at a discount brokerage.
And the third is to use a fee-for-service financial planner, that is, a planner whose services are billed either by time (usually by the hour) or by the project (as in a one-time financial plan) but NOT via annual fees levied as a percentage of client assets under management. The problem with the latter is it gets prohibitively expensive as wealth grows, unless the fees are tapered down accordingly. I recently heard from a reader complaining that a 1% fee on a $4 million portfolio cost $40,000 a year — an amount many people could live on. Clearly in such case, you should negotiate a lower fee: say 0.5% for starters, or look for another firm that will negotiate, or go the DIY route described in this blog and find a true fee-for-service planner.
What the heck does “fee-only” really mean?
Note there is much confusion over the term “fee-only.” As Preet Banerjee writes in the current issue of MoneySense — here — the term fee-only does not necessarily mean fee-for-service. All that fee-only means is that it is NOT old-time commission-based, levying commissions per transaction. In fact, commission-based is not that bad a deal, particularly if you’re a buy-and-hold investor.
Sadly, many journalists and even advisers themselves have used the term “fee-only” when they really were referring to fee-for-service. As a result of the definition used in the US NAPFA, an asset-based financial planner (like the one charging our reader 1% of a $4 million portfolio) is well within their rights to refer to themselves as “fee-only.” Fee-only can mean EITHER fee-for-service OR asset-based financial planning, rendering it almost meaningless. And mea culpa, even in the two editions of Findependence Day, I use the term fee-only when I should have used “fee-for-service.” Future editions will fix that and editions of MoneySense magazine will going forward make this distinction clear.
MoneySense’s new Fee-for-Service online directory
Because of this, we at MoneySense have revamped the previous online directory of “fee-only” planners. Click here for the new directory, or rather TWO directories: one for true fee-for-service (i.e. by hourly or project billing) and one for financial planners who are primarily asset-based (at least 60% of revenues) but who do offer clients the option of time-based or fee-for-service billing.
I might add that other aspects of the Findependence Day model have also been rolled out in MoneySense throughout the year 2013. Our Feb/March issue on RRSPs introduced the ETF All-.Stars, which will be revisited in the Feb/March 2014 issue. And our June 2013 issue introduced MoneySense’s first survey of Canada’s best discount brokerages, a second version of which will run next summer. Both features were written by MoneySense editor at large Dan Bortolotti, more about which can be found below.
For those who missed those two issues of the magazine, here’s a tip. It costs only $20 a year to subscribe to MoneySense magazine (7 issues), which also gets you free access to the web site at MoneySense.ca PLUS the iPad edition. We recently went behind a paywall (or technically a pay fence) but the iPad edition also gives you the back issues, including the ones mentioned above and in fact all the issues since I became editor starting with the June 2012 issue.
Upcoming iShares educational event in partnership with MoneySense
Finally, those in the greater Toronto area may find an event coming Saturday, November 16th of interest. Dan, mentioned above and pictured on the left, will be talking about ETFs and portfolio construction along with “Ask MoneySense” columnist and broadcaster Bruce Sellery, and various iShares ETF experts from BlackRock Canada . Dan will be taking readers through some of the concepts I’ve described above, as outlined in the book he authored for the magazine: the MoneySense Guide to the Perfect Portfolio, copies of which will be given away at the event, along with the current issue of the magazine, parking and breakfast. (more than recouping the $25 charge).
I might add that Dan is in the process of becoming a financial planner himself. He is already working with PWL Capital, whose firm is listed in the new directory as primarily asset-based. Dan himself is in the fee-for-service camp.
Details for the iShares/MoneySense event can be found here.
A belated Happy New Year to all readers and a reminder that every adult Canadian can take a big step this week towards their ultimate financial independence. I refer of course to the fact we can all contribute another $5,500 to our Tax Free Savings Accounts (TFSAs), bringing the total cumulative room to $25,500 (going back to the program’s launch in 2009). For the benefit of any American readers, Canada’s TFSA is the equivalent of the U.S. Roth plans, albeit with different rules.
In other words, if you acted at this time each year, you’d have contributed $5,000 in each of 2009, 2010, 2011 and 2012. Now that it’s 2013, the annual limit has been raised to $5,500, the first time the limit has been adjusted to accommodate inflation.
Of course, assuming you invested wisely in each of those years, your balance should by now be well north of $25,500, and in some cases may have grown past $30,000.
TFSAs a particular boon for young people
I truly believe that maximizing the TFSA is the single biggest step Canadians can take in their quest for financial freedom. As we noted in Julie Cazzin’s “Make Your Child a Millionaire” feature in the current issue of MoneySense, the TFSA is especially a boon to young people because they have such a long investment time horizon ahead of them.
Unlike RRSPs, which require earned income the prior year, an 18 year old can qualify for the full TFSA $5,500 limit this year (they may need parental assistance to come up with the money, but that’s permitted by the rules. Think of it as a tax-effective early inheritance!). Not only that, but they can contribute to TFSAs well into old age, unlike RRSPs, which end after age 71. You better believe that half a century of maximizing TFSAs and investing wisely will mean multi-millions down the road.
Do this right from the get-go and you may not even have to worry about RRSP contributions, although those in higher tax brackets should probably do both.
But how to invest wisely? For the young in particular, but also older people seeking income, I think equities are the only way to go in TFSAs, especially with interest rates being so low as they are now.
I’m all for international investing but if you already have lots of RRSP contribution room, I’d use the RRSP for US dividend-paying stocks, since the tax treaty shelters Canadians from the 15% foreign withholding tax.
Despite the “tax-free” moniker, TFSAs won’t stop you from being dinged by that tax on foreign securities. For this reason, I like TFSAs for Canadian dividend-paying stocks. Yes, I realize the dividend tax credit makes Canadian dividends a good choice for non-registered (taxable) accounts, since the tax is roughly half what it is on interest income. However, Canadian dividends also result in the annoying “gross-up” calculation come tax-time, and such phantom dividend income can ultimately hurt you on the OAS clawback. And to me, zero tax is preferable to even a “low” rate of tax, especially if you plan to reinvest those dividends.
Canadian Dividend ETFs are my choice
For all these reasons, my personal choice for TFSAs this year are Canadian dividend-paying ETFs. A year ago, when it was part of the Claymore family, I publicly stated that the iShares S&P/TSX Canadian Dividend Aristocrats Index Fund (CDZ/TSX) was a tempting choice, at least for those who already have plenty of exposure to the big Canadian banks. To be included in that index a stock has to be a common stock or income trust listed on the TSE and have increased dividends for at least five consecutive years.
This year, there is a valid new alternative from Vanguard Canada: the Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY/TSX). The management fee on VDY is just 0.30%, half the 0.60% of CDZ. (MER is 0.67%, we don’t yet know what VDY’s MER will be). But keep in mind that VDY amounts to a big bet on the major banks: a whopping 59% of the ETF is in Canadian financials and in fact the top four holdings are all the big banks. CDZ has much less exposure to financials (just 21%) and minimal exposure to the big six banks in particular.
Half and half is one compromise
One way to go might be to split your contribution between both ETFs: say $2,750 in each. Remember, though, this assumes you have plenty of US and foreign stock exposure in your RRSP. Younger people for whom the TFSA comprises the lion’s share of their wealth should strive for plenty of US and foreign stock exposure through similar types of ETFs. We’ll be looking in depth at these in the next issue of MoneySense, currently in production.
How ironic that as criticism of high Canadian mutual fund fees focused on Investors Group the last week — see Do We Really Care About Fees? — Tuesday marked the first day of trading of the first six ETFs from Vanguard Canada on the TSX.
The six ETFs average fees of 0.24%, according to Vanguard Canada managing director Atul Tiwari, who briefed financial advisors at a session at the Royal York in Toronto Tuesday afternoon. That’s roughly eight times less than the MER of the average mutual fund sold in Canada, he said.
There are three ETFs providing exposure to the U.S., EAFE and Emerging Markets, plus three domestic ETFs built expressly for Canadian investors covering Canadian equities and fixed income. All six can be considered “core” ETFs for portfolio construction.
For now, there are no plans to provide Vanguard index mutual funds in Canada, Tiwari said. Distribution appears to be the challenge there.
Pictured is Charles Ellis, author of Winning the Loser’s Game, who addressed advisors with a talk similar to one he delivered to portfolio managers in November, reported in this blog here. In an interview, Ellis told me he’s personally invested mostly in Vanguard ETFs, except for a small position in Berkshire Hathaway. He also told the audience that going back a decade, he was mostly invested in Emerging Markets, a trade that worked out well until his wife said she wasn’t comfortable with the risk. He switched to large household name American blue chips and he remains happily married, he quipped.
For more details, see Vanguard Canada’s web site here.
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As noted in my Wealthy Boomer blog here, American indexing guru and author Charles Ellis [seen in photo on left] gave Canadian money managers both a history and arithmetic lesson on Tuesday. His point in a nutshell is that annual mutual fund Management Expense Ratios (MERs) of 2.5% or so (in Canada) are “terrible” but even the investment counselling fees of 1% (plus or minus 50 basis points) are also excessive.
These numbers may seem small when expressed as a percentage of assets but Ellis said the way to look at it is as a percentage of the return generated by active managers. So even if the active manager could generate a pre-fee return of 10%, the 2.5% fee takes that down t0 7.5%, so amounts to a 25% reduction of the return: or ten times the 2.5% figure that seems so insignificant. If returns are more likely pre-fee 6 or 7%, then a 1% fee takes it down to 5 or 6%, and amounts to a 15% reduction of return, he said.
Ellis himself prefers market-cap weighted index funds or ETFs of firms like Vanguard Group (which recently set up shop in Canada.) Investors can buy the “market” for as little as 10 basis points (0.1%), which long ago was a figure that customers of money managers were accustomed to pay. But as he related in his Monday talk in Toronto, customers didn’t balk when one firm hiked it to 25 beeps, others followed suit and eventually even a full 1% didn’t seem out of line.
This cost-conscious approach consistent with Findependence Day model
None of this should surprise readers of this blog, since the Findependence Day model cuts costs to the bone by emphasizing use of discount brokerages to cut commission costs, and then implementing trades of ETFs or index funds, the fees of which will range from about 8 or 9 beeps to 55 beeps for most mainstream ETFs, and perhaps a bit more for some esoteric ones. Of course, you can also try and pick your own individual securities, although Ellis would probably call that the “loser’s game,” as per the title of his book, Winning the Loser’s Game.
The third point is that you can still benefit from good advice by engaging a fee-only financial planner who charges by the hour, month, quarter or year, or perhaps by the project (which might be a financial plan or portfolio assessment). You can also go the fee-based route but keep in mind that a 1% fee will be on top of the underlying MERs of the ETFs, which could easily run 1.5% or so. For some investors, especially buy-and-hold investors who don’t trade frequently, a traditional commission-based full-service advisor could make sense from a cost perspective, at least relative to a high-fee-based alternative.
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