Adapting the Lazy Portfolios for Canada

In Monday’s post, I had some fun at the expense of Paul Farrell, the MarketWatch columnist who champions index investing while at the same time forecasting the coming apocalypse. What got lost in the discussion was that Farrell’s Lazy Portfolios are actually worth a look. They’re all built with an eye toward rock-bottom cost and broad diversification.

There are loads of other model portfolios out there, too. The Oblivious Investor, a US blog that advocates indexing, lists 8 Lazy ETF Portfolios of its own. (Some are the same as Farrell’s.) The site’s creator, author Mike Piper, also includes links to the original sources of these portfolios, many of which include historical returns. Or you can shuffle over to Asset Builder, an advisory firm run by Scott Burns, creator of the original Couch Potato. His site is also packed with model portfolios.

The problem for Canadians is that all of these portfolios are designed for Americans. They typically include about two-thirds of the equity allocation—and all of the fixed income—in US funds. The good news is that adapting them for Canadian investors is quite easy. To show you how, let’s use an example. This is the Coffeehouse Portfolio, created by Bill Schultheis:

10% iShares S&P 500 (IVV)
10% Vanguard Value (VTV)
10% Vanguard Small-Cap (VB)
10% Vanguard Small-Cap Value (VBR)
10% Vanguard FTSE All-World Ex-U.S. (VEU)
10% Vanguard REIT (VNQ)
40% Vanguard Total Bond Market (BND)

Step 1: The bonds

Holding your fixed-income investments in a foreign currency is almost always a bad idea. (A small allocation to US or global bonds is fine, but the currency should be hedged.) So the first step is to replace the Vanguard bond fund with a similar broad-based Canadian bond ETF. iShares DEX Universe Bond (XBB) will do the trick nicely.

Step 2: The real estate

The 10% allocated to REITs is also easy enough to Canadianize. You can simply swap the Vanguard fund with iShares S&P/TSX Capped REIT (XRE), or BMO Equal Weight REIT (ZRE).

If you have a large portfolio and don’t mind a little added complexity, you could add a foreign REIT component. You might put half in the iShares or BMO fund, and the other half in the Vanguard REIT fund or in Claymore Global Real Estate (CGR).

Step 3: The equities

The Coffeehouse Portfolio is half equities: 40% in US stocks and 10% in a global equity fund that includes all developed and emerging markets outside the US. This doesn’t make much sense for Canadians, especially in a taxable account, where you’d be subject to withholding tax and would not be eligible for the dividend tax credit.

There’s no hard and fast rule about how much of your equity allocation should be in Canada, but approximately one-third is reasonable. So we could go with something like 15% Canadian, 15% US, and 20% to the rest of the world.

The Coffeehouse Portfolio gives added weight to small-cap and value stocks, which isn’t as easy to do in Canada. Slicing and dicing Canada’s small market into three or four ETFs is also unnecessarily complicated. To keep things simple, we could put 10% in Claymore Canadian Fundamental (CRQ), since this large-cap ETF has a value bias. Or if you just want large caps at the lowest cost, you can’t go wrong with iShares S&P/TSX 60 (XIU). We can round things off with 5% to iShares S&P/TSX Small Cap (XCS).

US-listed ETFs are impossible to beat for low cost and minimal tracking error, and they’ll do just fine for the US and international components. IVV is great for the S&P 500, but the Vanguard Total Stock Market (VTI) is probably even better, as it covers the entire US market.

Finally, the Vanguard All-World Ex-U.S. ETF that Schultheis recommends includes Canada, which would be redundant in our version. It’s cheaper and neater to split the international component of our portfolio, putting 15% in Vanguard’s Europe Pacific (VEA) and 5% in Vanguard’s Emerging Markets (VWO).

Step 4: Putting it all together

Now it’s time to assemble our Canuck version of the Coffeehouse Portfolio:

10% Claymore Canadian Fundamental (CRQ) or iShares S&P/TSX 60 (XIU)
5% iShares S&P/TSX Small Cap (XCS)
15% iShares S&P 500 (IVV) or Vanguard Total Stock Market (VTI)
15% Vanguard Europe Pacific (VEA)
5% Vanguard Emerging Markets (VWO)
10% iShares S&P/TSX Capped REIT (XRE) or BMO Equal Weight REITs (ZRE)
40% iShares DEX Universe Bond (XBB)

In honour of everyone’s favourite Canadian coffeehouse, let’s call this the Tim Horton’s Portfolio. Make mine a double-double.

14 Responses to Adapting the Lazy Portfolios for Canada

  1. Marz August 12, 2010 at 10:05 am #

    That looks like a much more complicated (I believe “diversified” is the euphemism used) portfolio than the Global Coach Potato portfolio. Is it really that necessary? The only addition I see is the REIT ETFs you’ve included.

  2. Peter August 12, 2010 at 10:13 am #

    2 questions

    1) Some of the recommended Canadian ETF’s have very low daily volumes which acares me. What are your thoughts?

    2) What is wrong with having the fixed equity component is USD? Specially now that the exchange rate is almost 1:1

  3. Canadian Couch Potato August 12, 2010 at 10:16 am #

    @Marz: The Global Couch Potato is a great starting point, and for a small account it’s all you really need. As your portfolio grows, however, it’s usually worth adding other asset classes. Emerging markets and REITs, for example, are absent from the GCP and should be part of a truly diversified portfolio. The value and small-cap funds are probably less important, though they do have higher expected returns than the overall equity markets.

  4. Canadian Couch Potato August 12, 2010 at 10:34 am #

    @Peter: Which ETFs have trading volumes that scare you?

    As for holding bonds in USD, remember, we’re talking about a long-term investment. We all have such short memories. The loonie was worth 77 cents in the spring of 2009, which means a Canadian with his bond holdings is USD would have lost 20% that year on the currency. Bonds are supposed to reduce volatility in a portfolio, so exposing them to that kind of risk makes little sense.

  5. Peter August 12, 2010 at 11:55 am #

    I like ETFs with high volume. For example the BMO REIT. In general, for long term I like volumes of 500K or more. Maybe this is too much.

  6. Canadian Couch Potato August 12, 2010 at 12:09 pm #

    @Peter: That’s definitely setting the bar too high in Canada. You wouldn’t be able to buy any bond or REIT funds, and only a few iShares equity ETFs have anything approaching that much trading volume.

    Low trading volume is definitely something to watch for with an ETF, but it’s not as important as it is for individual stocks. As long an ETF trades a few thousand shares a day, its market price should stick pretty close to its NAV.

  7. Larry MacDonald August 12, 2010 at 12:12 pm #

    There are a fair number of home-grown Canadian “Lazy Portfolios” too. Some have been around for awhile too, as can be seen in this article.

  8. Peter August 12, 2010 at 12:18 pm #

    Assuming we have a portfolio like the one proposed where some are in USD and some in CAD. When we reach re-balancing time, the % allocated to each ETF might have changed due to the performance of each ETF and the excahange rate between USD and CAD. How does that play into the rebalance formula? What if one ETF now represents a much higher (or lower) % of my target allocation but as a result of changes in the exchange rate other than the performance?

    I also wonder for those of us contributing monthly to the portfolio, if we should buy the ETF which % allocation decreased the most until we reached the quota and then the next one? What strategy should we use if we are planning on contributing on a monthly basis? I know about the benfits of buying less ETF each month to save commision but not sure what criteria to use to determine which ETF to buy each month

  9. Canadian Couch Potato August 12, 2010 at 2:05 pm #

    @Larry: Thanks for posting the link. Wow, how times have changed. The Easy Chair portfolio (20% cash, no international equities) looks like a relic today. I also like Canadian Capitalist’s original Sleepy Portfolio, which has evolved a bit, too.

    All these portfolios sounds like the Seven Dwarfs: Sleepy, Lazy, Easy. I’m working on Dopey Portfolio for a future post.

  10. 50plusfinance August 12, 2010 at 11:29 pm #

    I like to rebalance by just using my monthly ETF purchases. I usually keep allocations in the proper percentages this way. I’m using the no-fee Schwab ETF’s to accomplish this. Keeping expenses low.

  11. Canadian Couch Potato August 13, 2010 at 12:05 am #

    @50Plus: Unfortunately, Canadian investors do not have access to commission-free ETFs:

  12. StatRunner August 13, 2010 at 12:56 pm #

    I recently moved my savings from mutual funds to a BMO InvestorLine account. I had no idea how to proceed and was considering the Lipper portfolios. Fortunately, googling led me to your comments about Lipper. Thanks for the warning. I have found your blog a great help in setting up my portfolio. I like your Tim Horton’s portfolio because it largely confirms my choices. Confirmation bias feels gooood! The main differences are related to asset location and risk, which you dealt with in earlier postings. I just retired and so put 60% in less volatile investments (Claymore short-term bond and preferred share ETFs). I have a defined benefit pension, so most of my savings are in the taxable account. I put the Canadian bond and stock ETFs there, the three Vanguard ETFs in the RSP, and BMO REITs in the TFSA.

  13. Canadian Couch Potato August 13, 2010 at 1:19 pm #

    @StatRunner: Glad you found the blog helpful. One suggestion: if you have room in your RRSP or TFSA, either would be a better location for your bonds. Bonds are the worst thing you can keep in a taxable account:

  14. Financial Cents August 13, 2010 at 3:44 pm #

    Hey Dan.

    Another quality post about indexing, I like the Timmys portfolio. However, surprised to see so little of XIU!? I do like your weighting in XBB though.

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