In fact, the indexes swept the actively managed funds in seven straight categories. They included Canadian, US, International, Japanese, and European stock funds. I also compared Canadian bond funds and balanced funds (using the bank’s Investors Series fund because they don’t have an e-Series equivalent).
On average, they beat their actively managed counterparts by 0.77 percent per year. Over an investment lifetime, such a compounding difference would buy a lot of beer and pretzels—as well as a Maserati.
An Aerospace Technician Uses TD’s Best Kept Secret
Félix Rousseau is a 25-year-old corporal with the Royal Canadian Air Force. He works as an Aerospace Telecommunication and Information Systems Technician (ATIS Technician) in Comox, British Columbia.
He also figured out one of TD Bank’s best kept secrets. Investors who open an account with TD Waterhouse can purchase the bank’s e-Series Index funds. Such investors don’t pay commissions to buy or sell. They can reinvest their dividends for free. These are the lowest cost index mutual funds in Canada.
Many investors pay lower fees if they purchase ETFs (exchange-traded index funds). But such investors can’t always reinvest their dividends for free. They can’t buy or sell without paying commissions. Nor can they set up direct automatic purchases each month. Félix can do all of these things with TD’s e-Series indexes.
“My portfolio is relatively small for now,” he says. “It’s worth approximately $20,000. I would need to have about $50,000 before a portfolio of ETFs made economic sense.”4
TD offers 11 e-Series index funds.5 Investors require just four of them to build a low-cost diversified, global portfolio. They include the Canadian bond index (TDB 909); Canadian stock index (TDB 900); US stock index (TDB 902); and the International index (TDB911).
Investors might be tempted to look at which funds have performed best in the past. But don’t. Last decade’s winners can become next decade’s laggards.
“I follow Dan Bortolotti’s aggressive model portfolio,” says Félix, referring to the portfolio models at the Canadian Couch Potato blog.
That means Félix has 10 percent of his portfolio in Canadian bonds, 30 percent in Canadian stocks, 30 percent in US stocks, and 30 percent in international stocks.
I listed Dan’s portfolio allocation models in Table 6.46 The Aggressive and Assertive portfolio models are best suited for younger investors, adventurous investors, or those who will be earning a guaranteed defined benefit pension when they retire.
Table 6.4 Canadian Couch Potato Model Portfolios: TD e-Series Index Funds
Fund Name Fund Code
Conservative
Cautious
Balanced
Assertive
Aggressive
TD Canadian Bond Fund-e TDB 909
70%
55%
40%
25%
10%
TD Canadian Index Fund-e TDB 900
10%
15%
20%
25%
30%
TD US Index Fund-e TDB 902
10%
15%
20%
25%
30%
TD International Index Fund-e TDB911
10%
15%
20%
25%
30%
Weighted Average Management Expense Ratio .047%
0.45%
0.44%
0.42%
0.41%
Source: Canadian Couch Potato Blog
The Balanced and Cautious portfolios are well-suited to investors who are in their mid-30s or older. The Cautious or Conservative allocations are well-suited for retirees. However, these are just rules of thumb. Consider your risk tolerance. Also consider whether your portfolio will make up the bulk of your future retirement income or whether it will be icing on a guaranteed defined benefit pension cake. Investors with such pensions can afford to take higher risk, if they can psychologically handle their portfolios’ higher volatility.
Just remember to rebalance your portfolio once a year. That means selling some of the indexes that have performed well and adding the proceeds to the indexes that haven’t. Investors should maintain their original allocation—but slowly increase their bond allocation as they get older.
A Canadian Couch Potato Strips Down Costs
Dan Bortolotti is a Renaissance man. He has published books about blue whales, tigers, auroras, humanitarian aid, and baseball. But the 47-year-old father of two might be best known as the creator of the Canadian Couch Potato blog.
He launched it in 2010. It’s now the best online source for Canadian index fund investors.
Dan began investing in his 20s. But like most Canadians, his money languished in actively managed mutual funds. “I didn’t have much money at the time,” he says, “so my mistakes didn’t cost me much.”
In 2008, he was writing for MoneySense magazine when his editor asked him to cover a project called the “7-Day Financial Makeover.” The magazine had asked readers to write in and explain why they deserved a week-long financial boot camp. More than 200 readers applied.
The magazine sifted through the applicants, looking for financial train wrecks. They finally settled on three couples and one single person. “Our goal was to discover whether it’s possible for people to change their financial personality,” the magazine explained. “Can an impulse shopper become a bargain hunter? Can a couple who always argues about money live happily ever after?”
Dan’s job was to follow one of the couples and write about their experience. But during one of the workshops on investing, he had a revelation. “The presenter talked about the difference between investing in high-cost funds versus low-cost ETFs,” says Dan. “I had read about the merits of the Couch Potato strategy in MoneySense for years, but I always thought it sounded too good to be true. That was the beginning of my real education. Something inside me clicked.”
Dan began to read everything he could on the subject. In August 2008—just weeks before the beginning of the global financial crisis—he started his first ETF portfolio. Within six months, stock markets were down close to 50 percent. “It might have been the worst timing in history,” he recalls, “but I was lucky I’d read as much as I did. Everything I had learned primed me to hang on. I knew that there was nothing wrong with the strategy.”7
Dan started his blog to help other Canadians become DIY index investors. Then he took a step further. PWL Capital, a wealth management firm in Toronto, soon approached Dan about putting their skills together. In 2014, he became a licensed financial adviser. Now an associate portfolio manager and Certified Financial Planner at PWL, Dan and his colleagues build ETF portfolios for their clients. He continues to maintain the Canadian Couch Potato blog and write regularly for MoneySense.
ETFs make sense for investors with portfolios valued above $50,000. But they might not suit everybody with $50,000 or more. Unlike TD’s e-Series index funds, brokerages charge commissions for investors to buy ETFs; investors aren’t always able to reinvest dividends for free.
To purchase an ETF, an investor has to open a discount brokerage account. In June 2016, MoneySense magazine listed their top picks.8 Four of their favorites were Scotia iTrade, Qtrade Investor, BMO InvestorLine, and Questrade. Many investors like the convenience of dealing with a brokerage that’s aligned with their bank. Such brokerages include CIBC Investor’s Edge, HSBC InvestDirect, National Bank Direct Brokerage, RBC Direct Investing, and TD Direct Investing.
Commission fees differ. But it’s a competitive market and fees keep falling. Today’s major online Canadian brokerages start at less than $10 per trade. Many of the brokerages charge a flat fee. RBC Direct Investing, for example, charges a flat $9.95 per trade. It’s the same, whether somebody invests $1,000 or $10 million.
Expense ratio fees for ETFs have also dropped. When I wrote the first edition of this book in 2011, Canadian ETF expense ratios usually cost between 0.25 and 0.50 perce
nt per year. Vanguard Canada shook things up in late 2011. They introduced a variety of lower cost ETFs. Since then, iShares and BMO have slashed their ETF’s expense ratio fees as well.
Table 6.5 shows Dan Bortolotti’s sample portfolios with Vanguard’s ETFs.9 Dozens of other ETF combinations could get the same job done. Don’t sweat the small stuff. There’s genius in simplicity. With just three ETFs per portfolio, investors have fewer moving parts. That makes rebalancing easier. Note that I’ve made just one change to Dan Bortolotti’s portfolios. I’ve opted for a short-term bond market index. For an explanation on how such an ETF might be safer, see Chapter 5.
Table 6.5 Canadian Couch Potato Model Portfolios: Vanguard ETFs
Fund Name Ticker Symbol
Conservative
Cautious
Balanced
Assertive
Aggressive
Vanguard Canadian Short-Term Bond ETF VSB
70%
55%
40%
25%
10%
Vanguard FTSE Canada All Cap ETF VCN
10%
15%
20%
25%
30%
Vanguard FTSE All World ex Canada ETF VXC
20%
30%
40%
50%
60%
Weighted Average Management Expense Ratio 0.15%
0.16%
0.17%
0.18%
0.19%
Source: Canadian Couch Potato Blog
Vanguard’s Canadian Short-Term Bond ETF (VSB) contains about 335 government and corporate bonds. Vanguard’s FTSE Canada All Cap ETF (VCN) contains 216 Canadian stocks of various sizes (small caps, mid caps, and large caps). Vanguard’s FTSE All World ex Canada ETF (VXC) is made up of about 8,100 stocks. Almost half of them are American stocks. Developed world international and emerging market stocks make up the remainder.
Whether you buy the e-Series index funds or build a portfolio of ETFs, you’ll beat most professional investors—if you can harness your emotions.
That said, many Canadians don’t want to spend even an hour each year thinking about investing. They would prefer to have somebody do it for them. In the following chapter, I list some low-cost firms that build and manage portfolios of index funds.
Indexing in Great Britain
England’s national football team is about to play Germany at Wembley stadium. But a team of imposters shows up in their place. They all wear the uniform. On right wing, you can see your postman. Your former science teacher is the goalie. Your milkman plays midfield. Most people would have a pretty good laugh—before demanding that the real team take its place.
The United Kingdom’s financial institutions play a similar trick. But they aren’t doing it for kicks. Many offer “index funds.” But they’re just high-cost imposters who wear the official kit. Richard Branson’s Virgin Money was the first.
In his autobiography Losing My Virginity, Sir Richard says, “After Virgin entered the financial service industry, I can immodestly say it was never to be the same again. . . . We never employed fund managers . . . we discovered their best kept secret: they could never consistently beat the stock market index.”10
Virgin created its own index tracker funds. But they aren’t cheap. The company’s FTSE tracker fund costs 1 percent per year.11 Such costs are low, compared to actively managed mutual funds. But it’s a stratospheric cost for a single index fund. In contrast, Vanguard UK’s FTSE equity index, when it was first introduced, cost just 0.15 percent. It costs even less today.
Vanguard charges low fees because, unlike Virgin, its investors (everyone who buys its funds) actually own the company. It’s run much like a nonprofit firm. Tracking errors are also low because the company is an experienced index fund builder. If the stocks in the FTSE All Share Index rise by 10 percent, Vanguard’s tracking index should earn roughly 9.85 percent, trailing the market by its 0.15 percent management fee. If it earned a result lower than 9.85 percent, in this case, the fund managers would be to blame. Any additional performance discrepancy would be called “tracking error.”
Virgin Money’s equivalent product would lag the market by at least its 1 percent annual fee. Any tracking errors committed would reduce profits further. Over time, high costs and tracking errors are compounding problems.
Virgin’s FTSE All Share UK index earned 19.7 percent in 2013. Vanguard’s FTSE UK Equity index earned 20.7 percent. They each track the same market. But Vanguard’s index cost 0.85 percent less. As such, Vanguard’s index should have beaten Virgin’s index by 0.85 percent. But this wasn’t the case. Vanguard outperformed Virgin by a full percentage point.
Virgin, living up to its name, lacks Vanguard’s experience. Accurately tracking an index requires skill that Vanguard has honed over many years. Virgin has had a few years to practice. But they’re still disappointing investors. And 2013 wasn’t a one-off miss.
As seen in Table 6.6, between 2010 and 2015, Virgin’s UK stock index underperformed Vanguard’s by an average of 0.97 percent per year.
Table 6.6 Virgin versus Vanguard, 2010–2016
Year Virgin’s FTSE All Share UK Index
Vanguard’s FTSE UK Equity Index
2010 +13%
+14.4%
2011 –4.7%
–3.5%
2012 +11%
+12.2%
2013 +19.7%
+20.7%
2014 +0.2%
+1.1%
2015 +1%
+0.9%
Source: Morningstar UK
Such differences look small. But over an investment lifetime, paying more for the same product has costly compounding consequences. In 2016, Vanguard reported even lower costs for its FTSE UK Equity Index. Costs dropped from 0.15 percent to 0.08 percent per year.
Virgin isn’t the only UK index fund provider with high expenses and poor tracking records. Kyle Caldwell, writing for The Telegraph, reported the UK stock market grew by 132 percent for the decade ending 2013. But the typical UK stock market index suffered zombie-like rigor mortis. Halifax’s UK FTSE All Share Index tracker earned just 92.6 percent. It lagged the market by nearly 40 percent for the decade. Scottish Widows UK tracker earned just 94.8 percent. It underperformed the market by nearly 38 percent over 10 years.12
Paul Howarth won’t trust his money to a poor index tracker. Nor does he want his money in actively managed funds. When he first started to invest he signed up with a Friends Provident Pension scheme. HSBC offered him the product. “I was advised to use the HSBC World Selection Funds,” he says. “I didn’t know about the many layers of fees involved. When I found out that I was paying more than 3.5 percent a year in fees, I jumped out.”13
Paul opened a brokerage account and invested 30 percent of his money in an iShares global bond ETF (SAAA) with the remaining 70 percent in Vanguard’s global stock ETF (VWRL). Vanguard and iShares both offer excellent index funds.
Once a year, Paul rebalances the portfolio. If global stocks rise, he sells some of his global stock index. He adds the proceeds to his bond market index to ensure that he gets back to his original allocation.
Originally from Manchester, Paul now lives in Dubai. He isn’t sure where he wants to retire, so his portfolio represents full global representation without a home country bias.
Most UK-based investors, however, will pay their future bills in pounds. For that reason, it pays to have a home country bias. In Table 6.7, I’ve listed some model portfolios for British investors, based on different risk tolerances.
Table 6.7 British Couch Potato Model Portfolios: Vanguard ETFs
Fund Name Invests In
Fund Code
Conservative
Cautious
Balanced
Assertive
Aggressive
FTSE 100 UCITS ETF 100 of the largest UK companies
VUKE
10%
20%
25%
25%
30%
FTSE 250 UCITS ETF 243 mid-sized UK companies
VMID
5%
5%
10%
15%
30%
FTSE All World UCITS ETF 2,900 companies over 47 countries
VWRL
15%
20%
25%
35%
40%
UK Gilt UCITS ETF 39 UK government bonds
VGOV
70%
55%
40%
25%
0%
Source: Vanguard UK
As investors age, many prefer balanced and cautious allocation models with higher bond market exposure. Such portfolios don’t tend to perform as well, over long periods of time, but they are less volatile.
Those who expect a secondary source of retirement income (think sole heir to a millionaire’s estate) might choose to invest in a higher risk portfolio, regardless of their age.
The financial website Monevator published the following blog post, “Compare The UK’s Cheapest Brokers.”14 They continue to do a great job comparing and updating brokerage costs. It’s an excellent source for UK-based investors who are looking for a brokerage.
Some investors, however, don’t want to build their own portfolios. In the following chapter, I introduce some low-cost financial services companies that build portfolios of indexes for UK-based investors. They rebalance the holdings as well.
Millionaire Teacher Page 16