Archive | February, 2011

How Often Should You Rebalance?

In my previous post, I looked at the reasons why investors should occasionally rebalance their portfolios. When a portfolio contains both fixed-income and equities, rebalancing is mostly about risk management: if it also results in higher returns, that’s a secondary benefit. Having a disciplined rebalancing schedule also helps you control your behaviour and resist the pressure to chase performance.

That’s the theory behind rebalancing. But it doesn’t answer the most common question: “How often should I do it?” Like so many aspects of investing, the answer depends a lot on your situation. There are at least three strategies to consider.

1. Rebalancing by the calendar

Perhaps the most common rebalancing strategy is to make adjustments once a year. There’s nothing magical about that one-year interval. Indeed, many academic studies have tried to determine the optimal rebalancing period — monthly, quarterly, semi-annually, annually or even every two years — but the research is inconclusive. Since there’s no clear benefit to rebalancing more frequently, once a year should be fine for most investors.

If you’re using a tax-sheltered account, it doesn’t really matter which date you choose, but there are some practical reasons for rebalancing early in the year.

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Why Rebalance Your Portfolio?

An important part of the indexing strategy is that you occasionally rebalance your portfolio back to its target asset allocation. I get a lot of questions about rebalancing, so I felt it was time to put together a series of posts about the idea.

For those who are new to the concept, we’ll start with a primer on what rebalancing is. One of the most important decisions investors will ever make is their asset allocation—the percentage of stocks, bonds, cash and other asset classes in their portfolio. For example, a mix of 60% stocks and 40% bonds is common in a balanced portfolio.

The problem is that asset allocations don’t stay constant. As the markets move month by month, your portfolio’s stock-bond mix will change, sometimes dramatically. If you had a 60-40 portfolio in mid-2008, the stock portion fell to about 45% by March 2009. If you were at 60-40 when the market bottomed, then your mix would be close to 80% equities today.

That’s why investors should occasionally adjust their portfolio to get it back to its target. You can do this by adding new money to the underperforming asset classes,

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More Income ETFs from BMO

When Bank of Montreal rolled out ten new ETFs earlier this month, no one should have been surprised that six of them were aimed at income-oriented investors. In my last post, I looked at the four target maturity bond ETFs, and today I’ll pop the hood on the other two. And to reward you for sticking with me to the end of the post, I’ll also give readers a chance to win free tax preparation software from H&R Block.

Let’s start with the least complicated of the new BMO products. The BMO Monthly Income ETF (ZMI) is a portfolio of 10 other high-yield exchange-traded funds, covering real estate investment trusts (REITs), corporate bonds (both investment grade and junk), emerging market bonds, and dividend-paying stocks. In this respect, it’s nothing revolutionary. It’s similar to other ETF wraps like the Claymore Balanced Income CorePortfolio (CBD) and the relaunched iShares Diversified Monthly Income Fund (XTR).

The other new product, however, is unique in Canada: the BMO Covered Call Canadian Banks ETF (ZWB) holds shares in the Big Six banks and sells call options on these stocks to generate additional income.

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BMO’s Target Maturity Corporate Bond Funds

One of the criticisms of bond funds is that they have no maturity date. If you buy an individual 10-year bond, you know you’ll collect fixed interest payments twice a year, and you know you’ll receive the face value of the bond when it matures in a decade. But if you invest in a bond fund, you can’t be sure what its value will be in 10 years. That uncertainty can make financial planning more difficult.

Earlier this month, BMO launched a family of four new target maturity bond ETFs designed to solve this problem. They are modeled on the same principle as other target-date investment products, such as BMO’s LifeStage Plus funds (for retirement savings) and RBC’s Target Education Funds (for RESPs). Target-date funds are designed for investors with a very specific time horizon. The funds’ asset allocation starts out aggressively to maximize growth, and then get increasingly conservative as preserving capital becomes more important.

Moving from bonds to cash

While traditional target-date funds use a mix of equities and fixed-income, the new BMO ETFs use only investment-grade corporate bonds, gradually shortening the maturities as the target date approaches.

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The U Portfolio

I recently received the following article from an investment advisor in western Canada. It contains a proven strategy for achieving outstanding returns, and the advisor has agreed to share it with readers of Canadian Couch Potato:

Recently, a small group of investors has unlocked the secret to investing success. It is called the U Portfolio. People who use this strategy invest only in stocks that start with the letter U.

Although stocks that start with the letter U comprise only a tiny fraction of the world’s equity markets, by a strange twist of fate they primarily include energy, materials (gold, copper, zinc, etc.) and financials.

Because of these fascinating qualities, investors in stocks that start with the letter U have enjoyed some of the best equity returns over the last eight years. It is true that in January 2000 gold was hovering around $280 an ounce and oil was averaging $11 dollars a barrel, and since then the price of gold has increased by five times, and oil by eight times. In addition, the banks in the U Portfolio did not to have exposure to the US housing market, though we cannot determine if this was mere luck or a function of their relatively small size.

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Under the Hood: Vanguard Total International Stock (VXUS)

This post is part of a series called Under the Hood, where l take a detailed look at specific Canadian ETFs or index funds.

The fund: Vanguard Total International Stock ETF (Nasdaq: VXUS)

The index: The ETF tracks the MSCI All Country World ex-USA Investable Market Index, which includes virtually every country with a significant stock market, except the United States. This covers 44 developed and emerging markets in Europe, Asia, South America and Africa, as well as Canada.

What sets this index apart from other all-world benchmarks is that it includes small-cap stocks as well as large and mid-cap stocks. As a result, it’s made up of an astounding 6,435 companies. If there is a larger equity index in the world, I’m not aware of it.

The cost: The fund’s MER is 0.20%.

The details: This ETF was designed as one-stop shopping for US investors who want to hold international equities in their portfolio. The rough country breakdown is 43% developed markets in Europe, 25% developed Pacific markets (mostly Japan and Australia), 25% emerging markets, and 7% Canada. The fund includes 54% large-cap stocks,

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Finding an Index-Friendly Advisor

Since launching Canadian Couch Potato a year ago, I’ve received a number emails from readers who are interested in index funds and ETFs, but who are uncomfortable handling their own investments. Some want a full-service advisor, while others just need a planner who will review their current portfolio and help them create a roadmap for the future. So I’m pleased to announce a new feature called Find an Advisor, a national directory of index-friendly professionals.

Advisors listed in the directory must meet certain criteria. First, they must offer their clients ETFs, index mutual funds, or asset-class funds such as those offered by Dimensional Fund Advisors (which are not available to DIY investors). Financial planners who do not manage portfolios are also included, as long as they have the expertise to help their clients set up a passively managed portfolio.

Second, the advisors must work on a fee-only or fee-based compensation model. If they do receive commissions from products in their lineup (such as Series A mutual funds or advisor-class ETFs), this must be openly disclosed in the listing.

It’s not easy to find an advisor who embraces indexing. I hope this service will help match budding Couch Potatoes with a like-minded financial professional.

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Debunking Dividend Myths: Part 6

This post is the sixth (and last) in a series exploring the myths and misunderstandings about dividend investing. The goal of the series is to argue that many investors following a dividend-focused strategy may be better off with broad-based index funds.

Dividend Myth #6: Investors who follow a dividend growth strategy will eventually beat the market on yield alone.

I was hoping to wrap up this series on dividend myths after Part 5, but I bumped into another fundamental misunderstanding that I just couldn’t ignore. It’s proclaimed on Tom Connolly’s website DividendGrowth.ca, and I’ve heard it cited several times by other investors. According to Connolly: “With dividend growth investing, after a few years (maybe a decade) of dividend growth, you can beat the market with yield alone.”

This would be a very compelling argument in favour of a dividend growth strategy — if only it were true. Unfortunately, it’s just terrible math. Here’s an example of the logic that investors use to arrive at this spurious conclusion:

In 2000, I bought 1,000 shares in Phil’s Nails for $20 each. The stock’s yield was 4%,

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