Millionaire Teacher

by Andrew Hallam

  **Full Disclosure. I write for AssetBuilder.com.

  Intelligent Investing Firms for Canadians

  Canadians are nice. Sure, there’s a cross-section of folks who drop the F bomb and the gloves when they get knocked against the boards. But most Canadians are known for their politeness. They say please, thank you, and sorry a lot.

  Kindness is a strength. But Canada’s financial institutions take advantage. They charge Himalayan costs for their actively managed funds. Canada’s banks also have their own brands of index funds.

  I don’t recommend that you buy the index funds offered by Canada’s banks (with the exception of TD’s e-Series indexes). But I bring them up to show you something about Canada’s banking culture. I want to explain why you shouldn’t walk into a Canadian bank and say, “Please build me a portfolio of your index funds.”

  First of all, most bank-sold index funds aren’t cheap—as far as index funds go. True, they cost less than half of what the banks charge for their actively managed products. They also make the banks’ active funds look silly. For the Globe and Mail I wrote a series of articles comparing the banks actively managed mutual funds to their index funds. In each case, overall, the indexes won.

  But the smiling folks at the Canadian Imperial Bank of Commerce, the Royal Bank of Canada, or the Bank of Montreal aren’t your buddies.

  The banks make much more money when they sell actively managed funds. Millions of investors get the shaft.

  In 2016, I joined a Facebook page for owners of a condominium complex in Victoria, British Columbia. I posted the following message:

  I’m looking for four people who will each walk into a different Canadian bank. I’ll pay you each $50. I would like you to book an appointment with a financial adviser and ask him or her if they could build you a portfolio of index funds.

  Four Generation Xers jumped at the offer. Within a week, I had received details of visits to the Canadian Imperial Bank of Commerce (CIBC), Royal Bank of Canada (RBC), Toronto Dominion Bank (TD), and the Bank of Montreal (BMO).

  Some took a pencil and paper to write notes. Others recorded the conversations with their iPhones. None of the advisers wanted to build a low-cost portfolio with the bank’s index funds. They offered actively managed funds instead. On average, the funds that they offered cost 2.2 percent per year—more than double the cost of the bank’s index funds. The advisers’ lack of knowledge and disclosure shocked Tim Godfrey.

  Tim, an economics and finance graduate of Dalhousie University, was my first keen reporter. A few years previous, he had worked at the Australian Treasury. “I was advising the government on the regulation of financial advice,” he said. “We were determining how investment fees should be disclosed to clients.”

  I had hit the jackpot. Without knowing it, I had recruited Sidney Crosby for a beer league game. “The adviser said that index funds are riskier than actively managed funds,” said Tim. “That surprised me. After all, risk has nothing to do with whether a fund is active or passive [indexed]. Portfolio allocation is what determines risk.”7

  Tim is right. Take two portfolios. One is comprised of actively managed funds. It’s split four ways between Canadian government bonds, Canadian stocks, US stocks, and international stocks. In other words, 25 percent of the portfolio is invested in Canadian government bonds and 75 percent is invested in global stocks.

  Compare that to a portfolio of index funds. If it contains 40 percent in Canadian government bonds, with the remaining 60 percent invested in global stocks, such a portfolio would have a far lower risk profile than an actively managed portfolio with 25 percent in bonds.

  Deborah Bricks, a 36-year-old events planner, was my second reporter who headed to the bank. She chose the Royal Bank of Canada (RBC). “I asked if she [the adviser] could build me a portfolio of index funds,” Deborah says. “But she dismissed that idea pretty quickly.”

  Deborah already owned RBC’s Select Balanced fund in her RRSP portfolio. It’s an actively managed fund that charges 1.94 percent per year. The adviser suggested that she keep it.

  “An index fund just holds a single market,” said the adviser. “If you did buy an index fund, you would have to figure out which one to buy. Do you want a US index fund or a Canadian one? RBC’s Select Balanced fund is more diversified. It’s better because it’s actively managed.”8

  Deborah spoke to an adviser who didn’t have a clue. The adviser didn’t seem to understand that she could build a diversified portfolio with the bank’s index funds.

  Marina McKercher is a 30-year-old dental hygienist who walked into the Canadian Imperial Bank of Commerce (CIBC). A great saver, she had $20,000 sitting in cash, ready to invest. The adviser immediately showed her CIBC’s Balanced Portfolio fund and CIBC’s Managed Income Portfolio fund. “He had data sheets on each of these two funds already printed out,” she says. The management expense ratios for the funds were 2.25 percent and 1.8 percent per year, respectively.

  The bank’s index funds charged expense ratio fees that were less than half those amounts. Marina asked about the bank’s index funds instead. “The higher fee balanced funds are worth the extra costs,” said the adviser, “because the money is managed. The index funds would just sit there, not doing much of anything.”9

  Dan Bortolotti, an Associate Portfolio Manager with PWL Capital says, “I’m not surprised many advisers have no clue about how to properly build a portfolio of index funds or ETFs. The way advisers are educated and trained presumes that their job is to beat the market by analyzing stocks and picking winning funds. The idea that an adviser might add value in other ways is foreign to them.”10

  So far, there hasn’t been a revolution. Nobody has stormed Canada’s banks or mutual fund companies, armed with a hockey stick, demanding that they change.

  That’s good. There’s no need to break noses. Evolution, instead of revolution, is a lot more Canadian. Canada’s Intelligent Investment firms give a nod to Darwin.

  Would You Like a Tasty Tangerine?

  In 2008, online banking firm Tangerine (formerly ING Direct) offered something sweet to the Canadian public: diversified portfolios of index funds wrapped up into single products. They cost just 1.07 percent per year. That isn’t cheap, by DIY standards. But it’s a great deal for investors who want a diversified portfolio of indexes. Unlike DIY investors, those with Tangerine don’t have to rebalance their portfolios. Tangerine does it for them.

  That appeals to Katie Dixon. The 19-year-old from Kamloops, British Columbia, is far ahead of her time. “My high school offered the opportunity for some students to finish their graduation credits early,” she says. “Instead of attending high school for my senior year, I finished my high school graduation credits one year early [by grade 11] and enrolled in a six-month Health Care Assistant program.”

  Katie graduated from the six-month program three months before most of her other friends finished their final year of high school. “The demand for care aides is high,” she says. “So I got a great job right away.” Katie will eventually study to become a nurse. Until then, she adds, “My work as a care aide pays a lot better than a typical summer job.”

  When Katie was 18, she started to track her daily expenses with an app on her iPhone. “Keeping track of what I spent helped me to free up some money,” she says. That’s when she decided to commit to investing.

  “I opened a high-interest savings account with Tangerine. I added $150 a month. It comes automatically out of my savings account. When I turned 19, I was eligible to open a TFSA account. I switched the accumulated cash over to Tangerine’s Equity Growth portfolio. Every month, I keep adding money to it.”11

  Like I said, she’s way ahead of her time.

  Tangerine is perfect for Canadians who are just starting out, want to invest small sums regularly, and would prefer to have a company build and rebalance a portfolio of index funds for them.

  Katie’s portfolio is geared for growth. It contains a Canadian stock index, a US stock inde
x, and an international stock index. Once a year, Tangerine rebalances the fund’s holdings.

  Each of Tangerine’s three other funds would work well for investors with different time horizons and tolerances for risk. You can see them in Table 7.4

  Table 7.4 Tangerine’s Index Fund Portfolios

  Fund Best Suited For

  Canadian Bonds

  Canadian Stocks

  US Stocks

  International Stocks

  Tangerine Balanced Income Very conservative investors

  70%

  10%

  10%

  10%

  Tangerine Balanced Moderately conservative investors

  40%

  20%

  20%

  20%

  Tangerine Balanced Growth Investors looking for high growth with some stability

  25%

  25%

  25%

  25%

  Tangerine Equity Growth Young or aggressive investors

  0%

  50%

  25%

  25%

  Source: Tangerine.ca.

  WealthBar

  WealthBar offers five portfolio options for Canadian investors. They help clients determine their risk tolerance before they select a ready-made, diversified portfolio of ETFs. WealthBar does all the lifting. They offer full financial planning for those whose financial circumstances aren’t too complicated. They also build and rebalance client portfolios. All investors need to do is add money to their accounts.

  The firm charges between 0.35 percent and 0.60 percent per year, depending on each account’s size. That’s WealthBar’s take. Investors pay a further 0.20 percent (approximately) to the separate ETF provider. Investors with accounts valued below $150,000 pay total fees of about 0.80 percent per year. Investors with account sizes between $150,000 and $500,000 pay 0.60 percent in total fees. Those with more than $500,000 pay just 0.40 percent.

  To get started, new clients create a login password at wealthbar.com. As soon as they do so, a message appears.

  Hi Andrew, I’m David, a financial adviser at WealthBar. I’m here if you have any questions about investing with WealthBar.

  I’m generally available to chat between 9am-5pm PST M-F. You can schedule a call to discuss anything you like or contact me online through your WealthBar dashboard.

  David, the financial adviser, isn’t WealthBar’s Siri. He’s a real person. Neville Joanes is WealthBar’s Portfolio Manager and Chief Compliance Officer. As he explains, “Everyone who logs in to WealthBar gets assigned a financial adviser.”12

  The advisers look at each client’s long-term financial needs, based on their goals, savings rates, investment time horizons, insurance needs, as well as different tax-deferred account opportunities.

  Investors can request a plan to be reviewed at any time, either online, or over the phone. Before doing so, investors fill in some easy-to-follow online questionnaires. They ask for information such as current savings rates, investment assets, types of accounts owned (if any), risk tolerances, and salary. Based on client-entered responses, they show a model of a suitable portfolio. Investors with questions can speak to an adviser.

  WealthBar isn’t the only low-cost Intelligent Investing firm in Canada. I’ve listed others in Table 7.5. Each will build and maintain a portfolio of index funds. In each case, the firm will also rebalance the holdings at least once a year. That’s an important element that helps to reduce risk.

  Table 7.5 Intelligent Investment Firms in Canada Build Portfolios of Index Funds

  Intelligent Investment Firm Rebalances Index Holdings Portfolios May Be Rebalanced Based on Market Forecasts* Minimum Account Size Annual Fees for a $5,000 Account** Annual Fees for a $50,000 Account** Annual Fees for a $200,000 Account**

  BMO SmartFolio Yes Yes* $5,000 $74 = 1.5% $487 = 0.97% $1,850 = 0.92%

  NestWealth Yes No None (but fees are ridiculously high on small accounts) $347 = 6.9% $415 = 0.83% $1,360 = 0.68%

  Questrade Portfolio IQ Yes Yes* $2,000 (but fees are ridiculously high on small accounts) $131 = 2.6% $545 = 1.1% $1,980 = 0.99%

  WealthBar Yes No $5,000 $12 = 0.25%*** $430 = 0.86% $1,710 = 0.85%

  WealthSimple Yes No None $12 = 0.25%*** $353 = 0.71% $1,472 = 0.74%

  *Be skeptical of market forecasts.

  **Annual fees include costs charged by the investment firm, plus the expense ratio costs of the index funds (ETFs).

  ***WealthBar and WealthSimple don’t charge fees for accounts valued below $5,000. Investors would just pay the expense ratios fees of the index funds (ETFs).

  Some of the firms, however, adjust their portfolios based on market forecasts. That might sound sophisticated in a marketing brochure. But most market forecasts tend to be wrong. Statistically, firms that don’t adjust a portfolio’s position, based on forecasts, should perform better over an investment lifetime.

  Intelligent Investing Firms for British Investors

  Vanguard UK’s Target Retirement Funds

  In 2015, Vanguard UK introduced its Target Retirement Funds. These are complete portfolios of indexes, wrapped up into single funds. They represent diversified baskets of UK and global stock and bond index funds. In other words, if you buy one of these, it’s all you really need.

  Each fund has a designated date in the name. For example, investors who wish to retire in 2020 could buy Vanguard’s Target Retirement 2020 fund. Those who wish to retire in 2050 could buy Vanguard’s Target Retirement 2050 fund. There’s no obligation to hold these funds for any given period of time. Unlike many UK-based fund companies, Vanguard doesn’t charge penalties if investors choose to sell the fund after their initial purchase.

  How Does Each Target Fund Differ?

  Each target retirement fund has the same components. But the short-term risk and growth potentials differ. For example, in Table 7.6, you can see that investors who choose Vanguard’s Target Retirement 2050 fund would have higher stock allocations than investors in Vanguard’s Target Retirement 2020 fund. Younger investors can usually afford to take higher risks. When stocks fall, they have more time to wait for stocks to recover.

  Table 7.6 Longer Time Horizons Warrant Higher Stock Allocations

  Fund % In Bonds

  % In Stocks

  Target Retirement 2020 Fund 41.3%

  58.7%

  Target Retirement 2050 Fund 19.9%

  81.1%

  Source: Vanguard UK, as of June 16, 2016

  Conservative young investors, of course, could still buy Vanguard’s Target Retirement 2020 fund. Adventurous older investors could do likewise with Vanguard’s Target Retirement 2050 fund. Neither of the funds “expire” on any given date. Investors can remain invested long after the date in each respective fund’s name.

  There’s another reason I like these funds. Vanguard rebalances the indexes in each of their target retirement funds once a year. Some investors might ask, “Why would I bother having Vanguard rebalance a portfolio of index funds for me? I could build and manage a portfolio of index funds on my own. It would also cost me less.”

  These Target Retirement funds cost 0.24 percent per year. A DIY portfolio of Vanguard’s indexes or ETFs would cost slightly less.

  But investors who build their own portfolios don’t usually perform as well. Morningstar’s studies report that DIY index fund investors usually underperform their funds because they often purchase high, sell low, and speculate on market news. Investors, who let Vanguard do the rebalancing, usually perform better (see Table 7.2 and the explanation that precedes it).

  Annual rebalancing reduces risk. It can also boost returns.

  What’s more, Vanguard increases each Target Retirement fund’s bond allocation over time. As investors get closer to their retirement dates, the funds become more conservative.

  I’ve listed Vanguard’s Target Retirement funds in Table 7.7. Their annual expense ratios include all rebalancing. Vanguard also has a habit of reducing its fund expenses over time. By the
time you read this, fees could be even lower.

  Table 7.7 Vanguard’s (UK) Target Retirement Funds

  Fund Annual Expense Ratio

  Target Retirement 2015 Fund 0.24%

  Target Retirement 2020 Fund 0.24%

  Target Retirement 2025 Fund 0.24%

  Target Retirement 2030 Fund 0.24%

  Target Retirement 2035 Fund 0.24%

  Target Retirement 2040 Fund 0.24%

  Target Retirement 2045 Fund 0.24%

  Target Retirement 2050 Fund 0.24%

  Source: Vanguard UK

  What’s the Only Problem with These Funds?

  In the United States, Vanguard’s Target Retirement funds require a minimum $3,000 initial investment. But if you want to buy one of these funds from Vanguard UK, you’ll need a lot more money than that. The initial investment for a direct purchase through Vanguard is an eye-watering £100,000.

  This doesn’t mean that I’ve sent you down a rabbit hole. If you buy a Vanguard Retirement fund through a participating broker, you need far less money. Such intermediaries (or financial advisory firms) charge fees for you to buy these products. But it’s still a lot smarter than buying actively managed funds.

  Vanguard UK lists its participating brokers on its website. But be careful. Some of the firms charge a percentage of the investors’ assets. Over time, this can be expensive. If a brokerage firm charges 0.45 percent and Vanguard’s expense ratio is 0.24 percent, investors would pay 0.69 percent per year for a Vanguard Target Retirement Fund. On a £50,000 account, that would be £345 a year. On a £100,000 account, it would cost £690.