12.Jan.2010 A passive Canadian’s portfolio

After years of procrastinating, I’ve finally got my finances in order and done my homework on investment. I thought I’d write up a bit of my strategy for anyone interested or wiser than me.

I was relatively uninvested during the Fall 2008 credit crisis, and saw an ideal opportunity to get in and make some money. It was a dangerous time to learn the ropes and I only put money in slowly, with no expectation of “timing” the market’s true low point. As a result, I made nothing off the huge March 2009 dip – but no matter.

I’ve taken a fairly conventional asset allocation strategy – I’m young, and can afford a lot of risk, so my target is to have a high amount in stocks:

  • 70% Equities
  • 25% Fixed income / bonds
  • 5% Cash

I have zero interest in active investing and paying regular attention to this. Therefore, I’ve adopted an entirely passive approach. (Read Fact and Fantasy in Index Investing from U of T finance prof Eric Kirzner if you want to learn more. Many thanks to Eric for first telling me about index funds.) I’m using ETFs for the stocks, since they have lower fees than index funds.

My equity portfolio is aimed at global diversification, weighted by the national/regional allocation of capital:

  • 42.3% VTI (USA)
  • 40.4% VEA (Europe / Pacific developed)
  • 7.3% VWO (Emerging markets)
  • 10.0% XIC (Canada)

I’ve increased the weight on Canada from 3.3% (its share of global market capital) to 10% to account for the relative cheapness of investing in Canada for me – no currency exchange fees, dividend tax benefits, etc. This entire strategy was derived with much help from efficientmarket.ca’s Globally Efficient Equity Portfolio page (and its recent update).

For fixed income, I chose to go entirely with short-term Canadian bonds, emphasizing government bonds but with some corporate bonds. I’ve gone with an ETF as the instrument since I don’t have enough money (or energy…) to do a laddered bond system, and bond mutual funds apparently have terrible fees. I might add a GIC ladder at some point if I can figure out the relative merits, particularly with respect to interest rate risk.

The result for now is dead simple:

  • 100% XSB

This single ETF essentially does what I want, at least from what I understand so far. I’m grateful to The Radical Guide to Bonds for teaching me about the different types of bonds, and to efficientmarket.ca’s article on XSB for giving some useful Canadian context.

So what are the results? Well, including capital gains, dividends and management expense ratios, but excluding trading fees and taxes, it looked like this for the calendar year of 2009 in Canadian dollars (after accounting for US$ fluctuations):

Weight Return Asset
Weight
Equities
VTI 42.3% 11.2%
VEA 40.4% 10.2%
VWO 7.3% 49.7%
XIC 10.0% 34.1%
Subtotal 15.9% 70%
 
Fixed income
XSB 4.2% 25%
 
Cash 0.0% 5%
Total 12.2%

A total return of 12.2% on a tumultuous year, for very little effort. We’ll see what it looks like going forward.

A few final notes:

  • Trading fees seem to add up to about 1% of the portfolio value on buying and another 1% when selling, largely due to ~1.5% currency exchange on the US$ ETFs. With a buy-and-hold strategy over several years, it’s not too much.
  • As someone who first invested in GICs, I’m actually particularly enamoured with XSB. It gave a 4.2% annual return with very high liquidity in a year when buying a new GIC would pay only 1-2%.
  • See also: canadiancapitalist’s sleepy portfolio and its performance for several years.

There are 32 Comments to "A passive Canadian’s portfolio"

  • Your portfolio allocations look good and about the only suggestions I have are for you to consider bumping up your Canadian stock component mainly because Canadian dividends get much better tax treatment and you don’t have currency fluctuations to worry about. You may also want to consider adding REITs and real-return bonds.

  • drpritch says:

    Thanks for the feedback! Most of my investments are sheltered, so I haven’t had to design for tax treatment… yet. Once I’ve had the chance to do the research, I’ll definitely take your suggestions on XRB and REITs into account – I just haven’t had the time to do the reading on those (more exotic) subjects yet. I notice that your sleepy portfolio also includes some Canadian small-caps – also something I should dig into.

    Thanks for your various posts and website – somewhere along the way, I noticed that a lot of what I learned about Canadian investing came from you and efficientmarket.ca – it’s a great resource.

  • e says:

    Great post David, thanks for writing it. My own strategy is very similar, though I only arrived at it after learning some expensive (and humbling) lessons about my stock-picking skills. I’m currently much more North American-centric, but I’ll be changing that once I re-enter the workforce.

  • h says:

    Thanks for sharing. I’ll be checking out those links. My strategy so far is still 100% cash. I’ve been procrastinating from doing any investing. And yet I managed to loose something like 15% by keeping money in USD rather than converting to CAD right away. I finally at least applied for a BMO Investorline account recently. What broker are you using?

  • drpritch says:

    Glad it’s useful. I’m using TD Waterhouse for my trading, mostly just for three reasons:
    – convenience with my existing banking account
    – alleged ability to do “wash” trades – sell one US$ equity and buy another immediately without doing a US$->C$ and C$->US$ conversion and losing 3% of my money. Honestly, I’m not likely to juggle my portfolio often enough for this to matter, though.
    – alleged decent currency exchange fees – I’d guess TD is charging me 1.2-1.5% for currency exchange. (No one publishes their currency exchange fees, but you can infer them from looking at your records and looking at intraday exchange rates at the time a sale was made.) This is by far my largest trading expense.

    My main complaint is the lousiness of their online trading platform, especially with US$. For some inane reason, they often report the value of my portfolio by assuming that the US$ / C$ exchange rate is always 1.0.

  • a says:

    Awesome Dave, Ed and I have some money invested in many of these funds, but have been lazy at doing any regular interval investing (missing many boats I’m sure). Question – how often did you invest? Quarterly? Or more often?

  • drpritch says:

    I’ll probably be moving new income to investments roughly quarterly, and I’ll try to do it in a strategic way to keep the portfolio balanced. I’ll probably only do any rebalancing via selling annually, given the trading costs involved with moving between US$ and C$.

    From what I understand, though, the one key thing to do regularly is keep the equities/bonds ratio close to the target level. I can see how that helps deal with market cycles and forces you to adopt a sort of “buy low, sell high” strategy with equities. For example, while equities were going crazy over 2005-08, this strategy would have sold some of the gains and moved them into bonds before the crash.

  • b says:

    Thanks for posting.Just read “Random Walk Down Wall Street” last month and am feeling extremely passive myself.

    Didn’t most market indexes kick ass in 2009? S&P500 +23%, TSX +31% … Not that I got anywhere near those returns.

  • drpritch says:

    You’ve got to account for the US$ fluctuations – sure S&P was up, but US$/C$ was down 13% over the same time – so from a Canadian perspective the net effect of US markets was only a ~13% rise.

    But yeah, 2009 was of course an anomolous year.

  • e says:

    “only” 13%. Ha! We should be so unlucky every year!

  • b says:

    I see, good point David. A long time ago I had set up Microsoft Money with Canadian dollars as the base currency, and that’s the result I look at.

    So my portfolio’s actually doing better than I thought, especially when measured against USD (not so much against GBP; CAD has ‘only’ gained 6% vs. GBP).

  • s says:

    Interesting timing on this post – I just met with my fincnial counsellor, and though I’m up about 20% from last year, it looks like overall I’ve lost about $6,000 since 2002. I don’t really know anything about investing (which is why we have this guy). Do you think offhand that I should be concerned?

  • c says:

    Thanks for posting this David. If I may pose a few questions:

    1) Why invest outside of Canada?

    2) Why not go 100% equities at this stage in your life?

  • drpritch says:

    @b – yeah, I’m kind of annoyed about most financials tools’ treatment of currency. If you’re spending $C, you want to know variation relative to fluctuations $C – and most tools (even Yahoo Finance or Google Finance) don’t let you see the world through that lens. (e.g., a European stock may be rising in $US, but only because the US dollar is falling – it may be falling in $C.)

    @s – a good “passive” investment strategy should be able to achieve much better returns than that over a boom period like 2002-2009. The “sleepy portfolio” I linked to at the end of the article above made about 19% returns over 2005-2009, including the 2008 crash.

    From what I’ve read, many financial advisors look out for their interests, not necessarily yours – e.g., suggest investments that earn them a commission. You might want to find a “fee-only” financial advisor who does not sell financial products or earn commissions from them.

    My approach has been to read a lot, but it does take a bunch of math and time to make sense of it all.

    @c –

    1) My strategy is based on high diversification – across asset classes, sectors and countries. The theory is that different assets/sectors/countries’ returns are less correlated – and the average of a wide range of assets/sectors/countries will more reliably produce high returns over the long run. Canadian index funds (e.g., TSX index) are too small to allow good diversification across sectors. The Canadian economy could also be derailed for some political reason – imagine you were a Japanese investor in the 1990s while their economy tanked from a banking crisis – so exposure to a wide range of countries mitigates this risk.

    2) I’ve asked this question of myself, to be honest. I don’t really need any of the investment money, and I could imagine taking a 100% equities approach. (Is that your strategy?) I’ve heard it argued that equities and bonds are relatively uncorrelated – bonds can do well when the stock market is doing badly – and that’s part of the rationale for some mix. Some argue that a mixed portfolio gives better overall returns than a pure-equities portfolio. Check this article out for example: http://www.efficientmarket.ca/article/Stocks-Or-Bonds

  • c says:

    Additional diversification is a good reason. I invest little outside of Canada because I consider currency fluctuation to be another form of volatility and investing abroad typically entails greater costs.

    I do go 100% stocks (via mutual funds – low-cost TD index e-funds) for my monetary assets. For better or worse, most of my net worth is equity in our house (lower return but less volatile than stocks – a bond substitute?).

    I do buy and hold on the index funds but I also keep an eye on valuation. If the market is too overpriced, I put new money into paying off the mortgage instead of buying into an overpriced stock market.

  • drpritch says:

    C – Interesting to hear your thoughts. I’d be concerned with currency fluctuation if I only had US stocks (I’m not optimistic for that currency over the short term), but with a basket of global stocks (and hence global currencies) I’m not very worried. As for costs, it isn’t actually very expensive if you find a good ETF that trades on a North-American exchange.

    The real-estate component of a portfolio is interesting – I still haven’t found any satisfactory explanation of how to think about it. It’s lower return, lower risk, much lower liquidity; but there are tax advantages (no capital gains tax!), and the mixed blessing of leverage.

  • z says:

    Just a quick comment about currency exchange with TD Waterhouse. You can open a US trading account and just keep all your money in US$ all the time so you don’t have to worry about fees when you sell. It should be free to do.

    Also, I’ve been quite passive with my investments. I just did a quick check of my Canadian stock portfolio for 2009. I didn’t make any changes to my portfolio since Feb and by end of Dec it was up a whopping 41%. Although I think it was simply recouping the whopping losses of 2008 (I’m too afraid to calculate what I actually lost).

  • drpritch says:

    Z – Good point – I haven’t used the US$ TD account. Do you know if they do US$ RRSP and TFSA accounts?

    Interesting about your portfolio performance. FYI, the term “passive” usually refers to an index-based investment strategy rather than a “buy stocks and hold” strategy.

  • jordan says:

    Some thoughts:
    – If you’re at TD already, you might save a bundle on fees by looking at their e-series funds. Unless you’re over the 100k mark in assets, their fees are pretty ridiculous compared to most discount brokers, but the e-series mutual funds will let you buy in with smaller amounts and will be cheaper or comparable in fees until your assets get to a critical mass.

    The eseries funds can match most of your asset classes with an MER less than the Commission + MER you would pay at TDW.

    – On the topic of being easy to move funds around, a number of cheaper brokerages will make it pretty simple – for example with Scotia iTrade (formerly e-trade canada), you can do a simple bill pay to move money in, and just as easily get it out, with no transfer fees either way and much cheaper commissions (they are $9.99 at 50k assets for example)

    – On tracking in native currencies, if you create a portfolio in Google Finance set to CAD (on finance.google.ca), it will tell you your returns in that currency, so you can see track your progress. There is definitely a lack of currency-adjusted charts available though.

    – If you want Europe/Asia exposure, and you want to keep to balanced against the US, you might consider VT vs. holding VTI and VEA. I don’t hold much in the way of developed Euro/Asian markets, as the returns haven’t been compensating for the diversification when I looked back, but VT would make rebalancing easier/cheaper as it will rebalance globally at it’s 0.3% MER. (There is a small Canadian component, so you might want to take that into consideration if you’re concerned about being overweight Canada)

    – To the posts above, there are quite a number of books and articles that recommend (often with math/backtesting) that young investors should focus on 100% equities, if not more. York’s Moshe Milevsky ‘Are you a Stock or a Bond?’ covers this topic quite well.

  • drpritch says:

    Jordan –

    1) My approach has heavily optimized for MER and I’ve wound up paying quite a bit in commissions and currency exchange fees to enter that position. (Given that I’ll want some of this money back for a mortgage soon, that was a mistake.) For short term investments under five years, the TD e-series funds do indeed look like a better choice for some parts of the portfolio. The U.S. indices they track seem to be less broadly based – e.g., S&P 500 or DJIA 30, but not a “total market” 4400 company index comparable to VTI. Their international equity e-series funds seems to track the same index as VEA, though, and the Canadian fund looks good as well.

    2) Good points on the other trading platforms. Are in-kind transfers between accounts reasonable at Scotia? (e.g., cash account to TFSA, etc.)

    3) Tracking in native currencies – I tried Google Finance, and it doesn’t do what I want, actually. If I own US stocks in a Canadian portfolio, it correctly translates the current value to $C. However, the “cost basis” is translated using *today’s* exchange rate, not the rate at the time I bought the stocks. This means that all of the returns reported are from a fictional perspective where the US/CAD exchange rate has always been the same as it is today. I want the cost basis at the historical rate. Ditto with the stock charts. Google Finance seems to have spotty dividend data, as well (no data on VEA, for example).

    4) I went with VTI+VEA due to the lower MERs (~0.1% each) compared with VT (0.3%). I really don’t understand why this difference exists.

    5) Interesting to hear your thoughts on the stocks-vs-bonds issue. I clearly haven’t researched this one enough!

    6) What do you do with the cash part of your portfolio? I’ve haven’t really researched the money market funds so far, but the fees don’t always sound very friendly.

  • p says:

    David, I wish I could share my thoughts on passive investing but I know zilch. (Outside of having read Naked Economics—a really good book—and Niall Ferguson’s book, The Ascent of Money.) For someone who aims to think about money as little as possible, can you recommend a couple good books from your reading?

  • c says:

    I am an e-funds investor and I would need to have 400k invested in a Waterhouse account to break even on fees (in a given year) with my current investing strategy of twice a month contributions (and assuming there are no other fees than a $10 commission when buying).

  • s says:

    I figured it out today, and in one of my mutual funds I’ve made 3% profit from 1998 to 2009. Is that horrible?

  • drpritch says:

    P – I’m afraid I don’t have any book recommendations; I’ve done all my research on the web, and I’ve shared my best sources here. Anyone else?

    C – As discussed, I think the TD e-funds are good. The best ETF index funds only outperform if held for more than 10 years and invested in chunks around $5,000, when the lower annual fees can pay off (e.g., 0.15% annually for VTI versus 0.48% annually for TD US e-fund). Even then, the difference over 35 years adds up to less than 8% – it’s not worth worrying about. As long as the annual fees are below 0.5% and the fund tracks the index well, call it quits.

    S – it depends on your whole portfolio. While 3% sounds poor, 1998-2009 was an extraordinary period – especially the +50% rise of the Canadian dollar. (Canadian index funds made about 85% over that period inc. dividends, while a Canadian holding a US index fund likely lost money.) I don’t have historical info for my exact portfolio, but I’d guess that the stock component probably would have lost money while the bond component would have gained money, and it probably would have made close to 0% over 10 years.

  • jordan says:

    Re: 1, As a fellow wage earner, I suspect you’re also going to be adding additional funds – again the transaction fees there are going to kill the benefit from your MER as you add in new fees (interestingly enough Claymore’s ETFs allow you to buy more units without a transaction fee if you’re at a participating broker)

    Re: 2, In-Kind, meaning moving stocks from one account to another? The platform doesn’t do it, but an email to them and they’ll do it for you for free. Are you familiar with the rules for doing that? For most cash -> registered accounts (RRSP or TSFA) transfers you are basically treated as if you sold and then re-bought the shares for tax purposes, which might trigger capital gains.

    Re: 3, Hmm – good point, I hadn’t noticed that, and I’ve only been tracking my USD accounts in USD. Definitely a gap.

    Re: 4. VT holds more than VTI + VEA (well, different) – it also holds some Emerging Markets, some Canada. Full details here: https://personal.vanguard.com/us/funds/holdings?FundId=3141&FundIntExt=INT

    Re: 5, I’m sure you know the basics here, and I’m not much more sophisticated than that. I don’t keep much in bonds, and in the current interest rate environment, they aren’t very attractive. I experimented with buying actual bonds, which have done pretty well, but as they mature I’m doing what you’re doing and putting the funds into XSB/XBB – I’m considering Claymore’s Laddered Bond ETF too.

    Re: 6, As a mortgage holder, I don’t really have a Cash portion – every spare dollar goes to paying down the mortgage. The guaranteed return of not paying interest is better than anything I can get in a cash account. I wouldn’t get into Money Market Funds – you can get better rates at High Interest savings accounts or laddered GICs

  • jordan says:

    Re: Book recommendations:

    – Random Walk Down Wall street is a classic for getting into the passive state of mind.
    – The Four Pillars of Investing is quite good too
    – The Wealth Barber is a (kind of dated) Canadian Classic
    – For a more sophisticated look at over all investment, I like ‘Are you a Stock or a Bond?’

  • ma says:

    Hmm my first useful thing to come across Google Buzz :) I just made the plunge into investing as well, though probably with less research than you! Will definitely have to check out your links :)

  • drpritch says:

    Cool, hope it’s useful. The book Jordan recommended in the comments is also a good thought piece, especially the first half.

  • [...] post last year on my passive portfolio generated a lively conversation, so I thought I’d follow up with a few further thoughts on [...]

  • blin says:

    Hi David, thanks for sharing. I think I’m doing poorly, but I’m not sure – Microsoft Money hasn’t been tracking my rate of return very well. It’s really difficult to tease out how it does its calculations, and the purchase price seems wrong all the time.

    Also, it suffers from the same problemyou mentioned upthread – historical purchases in a foreign currency are converted to $CAD using today’s exchange rate.

    Couple of questions for the crowd:

    – Why do we talk about ‘currency risk’ like it is a bad thing? Isn’t there an equal chance that currency fluctuations will help us, rather than hurt us?

    – Your broad-based index funds, how do they compare to the narrow-based ones? The last time I looked at, the difference was in a fairly small tail of the smallest cap stocks (almost by .definition). Still, maybe that’s where the exciting differences are?

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