Does Your Portfolio Need a Makeover?

Broad diversification is one of the pillars of the Couch Potato strategy. But getting exposure to thousands of stocks and bonds doesn’t mean you have to hold a dozen funds in your portfolio.

I recently received an email from a reader named Thomas who was concerned that his investments were getting unwieldy: “I am concerned I have ETFs with too much duplication and am not keeping it simple.” He agreed to let me use his situation as an example of how investors can make their portfolios more efficient and easy to manage.

Thomas has a pension and adequate RRSP savings, so he’s not worried about covering his retirement expenses. However, he also has about $115,000 in a taxable account and another $15,000 or so in a TFSA. “I have been looking at the taxable account and the TFSA as one overall portfolio,” he says. “I plan to use this money in one of two ways. The first option is to dip into it to renovate our home, perhaps to add a pool. Or I can just let the investments grow until I retire and fund the renovations with a line of credit, paid off in a reasonable time.”

Based on his risk tolerance and goals, Thomas is aiming for an asset allocation of 60% stocks and 40% bonds, with the equity holdings more or less evenly split among Canadian, U.S. and international. Here are his current holdings:

Taxable Account
iShares S&P/TSX Capped Composite (XIC) 16%
Vanguard Total Stock Market (VTI) 12%
Vanguard MSCI EAFE (VEA) 6%
Vanguard Emerging Markets (VWO) 6%
iShares DEX Corporate Bond (XCB) 17%
iShares DEX Short-Term Bond (XSB) 16%
Claymore Balanced Income CorePortfolio (CBD) 2%
iShares S&P/TSX Capped REIT (XRE) 5%
Claymore Global Real Estate (CGR) 3%
Claymore Natural Gas (GAS) 1%
Miscellaneous preferred shares 4%
88%
Tax-Free Savings Account
BMO Dow Jones Canada Titans 60 (ZCN) 4%
BMO Dow Jones Industrial Average (ZDJ) 4%
Vanguard FTSE All-World ex-US (VEU) 4%
12%

The diagnosis

Thomas’s portfolio is certainly diversified, but it needs some serious decluttering:

Too many ETFs. With 14 different ETFs, Thomas’s portfolio is far more complicated than it needs to be. For starters, since he is planning to use both accounts for the same purpose, he doesn’t need to hold multiple funds for each asset class. The three equity funds in his TFSA, for example, overlap with others in his taxable account. He can dramatically reduce the number of ETFs without significantly changing his overall allocation. (Unfortunately, if he sells ETFs that have gone up in price in his non-registered account, he’ll trigger capital gains taxes.)

Too many small holdings. Several of the portfolio’s holdings are random items that don’t fit into any thoughtful plan. The Claymore Balanced Income CorePortfolio (CBD), for example, holds 14 ETFs in many asset classes. It’s meant to stand on its own, not make up a tiny sliver of a larger portfolio. The 1% allocation to a natural gas ETF and the preferred shares are also misfits. “I have been inclined to add bits and pieces from time to time,” Thomas admits.

Too much tax-inefficiency. By holding equities in his TFSA, Thomas is not taking maximum advantage of the tax shelter. Canadian stocks are best held in a non-registered account, where they benefit from the dividend tax credit. Dividends from the US and international equity ETFs are fully taxable, but the yields on these funds are relatively low, and any capital gains would be taxed favourably. Thomas would save more in taxes by using the TFSA to hold the corporate bonds, which have a higher yield and limited potential for price gains.

The makeover

Before rebuilding his portfolio, Thomas will need to decide how he wants to fund his reno projects. If he chooses to use his investments to pay for the pool, he should set aside this portion in cash—the remainder can then be used for long-term growth (Option 1). If he decides to use his line of credit for the home improvements, then the whole portfolio can be considered part of his long-term strategy (Option 2).

Here’s how Thomas might rejig his holdings. Without giving up any diversification benefit, he can reduce his portfolio from 14 ETFs to just six:

Taxable Account Option 1 Option 2
Cash 25% 0%
iShares S&P/TSX Capped Composite (XIC) 15% 20%
Vanguard Total Stock Market (VTI) 10% 15%
Vanguard Total International Stock (VXUS) 10% 15%
iShares S&P/TSX Capped REIT (XRE) 10% 10%
iShares DEX Short-Term Bond (XSB) 18% 28%
 .
Tax-Free Savings Account
iShares DEX Corporate Bond (XCB) 12% 12%

.
I imagine that many investors, like Thomas, have portfolios filled with too many ingredients, many of which play no meaningful role in their overall plan. By streamlining your holdings you can reduce costs, complexity and taxes, and stay focused on your larger investing goals.

The suggestions in this post are presented as general information and should not be considered investment or tax advice aimed at any individual.

19 Responses to Does Your Portfolio Need a Makeover?

  1. J from Ottawa August 18, 2011 at 9:20 am #

    I’m curious why you recomed Short Term and Coporate Bonds in this case (versus Real Return and the iShares Universe Bond Fund as in the Model Portfolios)?

  2. Canadian Couch Potato August 18, 2011 at 9:58 am #

    @J: My goal here was to not recommend different asset classes from what Thomas wanted, just to make his chosen ones more efficient. Thomas wanted to keep his bonds short, which is fine if he wants lower volatility, and he wanted a higher allocation to corporate bonds.

  3. Greg August 18, 2011 at 10:35 am #

    How do you decide whether reducing the number of holdings is worth the transaction fees? Sell VEA, sell VWO and buy VTI. Is the simplification of the portfolio worth the $30. If so, why?

    In any event, according to Mark Cuban, diversification is for idiots. 🙂 http://blogmaverick.com/2011/01/24/wall-streets-new-lie-to-main-street-asset-allocation/

  4. Canadian Couch Potato August 18, 2011 at 10:46 am #

    @Greg: If you’re planning to hold the portfolio for many years, I think it’s worth it to spend a few bucks now to save a lot more later. You can make these changes gradually: every time you add new money, or when it’s time to rebalance, you’re going to be making some trades anyway, so you can use those opportunities to make an adjustment. It doesn’t have to be done all at once. Going forward, managing a portfolio of 14 ETFs is going to be a lot more expensive than using one with just six.

    I don’t even know where to begin on the Mark Cuban thing. 🙁

  5. Dong August 18, 2011 at 9:38 pm #

    Wondering why you placed XRE in RRSP instead of TFSA ?

  6. Canadian Couch Potato August 18, 2011 at 11:12 pm #

    @Dong: Thomas’s TFSA is maxed out at $15,000, so there is no room for XRE. But you’re right, it would be best held in a tax-sheltered account if possible.

  7. Raman August 19, 2011 at 8:58 am #

    Thanks for this post, Dan. I am having a similar issue in my handling of 5 accounts — my RRSP, my wife’s RRSP, each of our TFSAs, and our joint non-registered account. Keeping track of exactly what is in where (even with less than a dozen different holdings total) can get quite complicated. Thank god for simple spreadsheet software!

  8. sleepydoc August 19, 2011 at 10:42 am #

    This is a great article and an issue I think many of us struggle with at some point. I know that some of the holdings in my ETFs likely overlap – eg: for my CDN equity allocation I use CDZ for the higher dividend income, XCV to add a value component, and HXT to fill in the blanks. There is no doubt that this has me “overweighted” in certain holdings and sectors – but is there a tool I can use to demonstrate this? Do you know of a tool such as Morningstar’s Instant X-Ray that will work for the Canadian listed ETFs? I’d like something that gives me a better idea of the cap weighting/country/sector distribution of my entire portfolio.

  9. Canadian Couch Potato August 19, 2011 at 10:57 am #

    @sleepydoc: Advisers have access to tools like this, using services like Morningstar’s PALTrak. But I don’t know of anything available to individual investors. In terms of figuring out your country and sector weightings, that would be easy to do with a spreadsheet, since the breakdown for each ETF is published on its website. It would be a bit of work to set up, but easy to maintain.

  10. My Own Advisor August 19, 2011 at 2:02 pm #

    Nice post Dan, and good options for Thomas!

    In this case, less is certainly more.

    Most investors can probably get by with about 6 ETFs in their portfolio.

  11. Dong August 22, 2011 at 1:22 pm #

    Just converted my VEA/VWO holding to VXUS, harvested about 6,500$ tax-loss at the same time 🙂

    You should do an article on investing specific to non-registered account… explaining why it would make sense to supplement XIC/XIC with dividends paying stocks (or ETF) to profit from the tax-credit and others details specific to non-reg account.

  12. Canadian Couch Potato August 22, 2011 at 1:34 pm #

    @Dong: Great point: a market downturn is an ideal time to make changes to a non-registered portfolio, because it allows you to harvest losses that you can use later on.

    I don’t necessarily think it makes sense to use a dividend strategy rather than XIC in a taxable account. If you assume that over the long term both strategies will produce the same total return (and I realize many people believe dividend stocks will outperform), then the taxes payable will be virtually the same. And if you don’t need the income for spending today, it often makes more sense to defer the capital gains until you need the money.

  13. sleepydoc August 29, 2011 at 4:59 pm #

    @CCP: It seems actually a little more challenging than I thought to extract the data from different fund providers for keeping track of sector, cap and country weighting amongst many funds. Is there an online source that you can direct us to that keeps this information in a consist format to copy/past into one’s spreadsheet?

  14. Allen August 29, 2011 at 7:53 pm #

    @CCP: Can you explain a little more this statement?
    “By holding equities in his TFSA, Thomas is not taking maximum advantage of the tax shelter. Canadian stocks are best held in a non-registered account, where they benefit from the dividend tax credit.”

    Seems to me that any tax benefits/credits for high tax bracket individuals with be eliminated by any capital gains the equities would incur. I guess I would argue holding anything that could potentially incur taxes in a TFSA is good. No tax is no tax…

    Thanks for any clarifications that I may have overlooked or not considered.

  15. Canadian Couch Potato August 29, 2011 at 10:13 pm #

    @Allen: If Thomas is able to hold all of his portfolio in tax-sheltered accounts, then you’re right, no tax is no tax. But I’m assuming here that Thomas is forced to hold some assets outside tax-sheltered accounts because he’s maxed out his RRSP and TFSA room. If that is the case, then it is best to hold Canadian equities in the taxable account, since these are taxed most favourably.

  16. balk September 14, 2011 at 3:28 am #

    I realize that you are using his asset allocation, but even, in your model portfolios, you tend to weight can stocks higher than US or international. Why is this? The Canadian market is small globally, why not just weight it the same or less as the US or international? Larry Swedroe’s model for portfolio, that he posted on his blog, had an equal weighting (not overweight like we are doing with the smaller Canadian market) between US and international even though the US stock market makes up a huge percentage of the world market.

    Thanks,

    Balk

  17. Canadian Couch Potato September 14, 2011 at 8:33 am #

    @balk: My model portfolios do include about equal amounts of Canadian, U.S. and international equities. This is a much greater proportion to foreign stocks than most investors have. For reasons of taxation, cost and currency risk, it still makes sense to limit foreign exposure to about this much.

  18. Andrew November 11, 2015 at 2:52 pm #

    Have any free tools like Morningstar’s Instant X-Ray (http://portfolio.morningstar.com/Rtport/Free/InstantXRayDEntry.aspx) become available for Canadian ETFs?

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