Archive | 2014

Understanding ECN Fees

The promise of commission-free ETFs has steered many index investors toward independent brokerages such as Questrade and Virtual Brokers. These deep discounters have a lot to offer, but before you sign on, make sure you understand the details of their pricing.

Orders at these brokerages may be subject to fees that originate with the exchanges and networks that match buyers and sellers. This includes the big boys such as the Toronto and New York Stock Exchanges, as well as a host of lesser-known electronic communication networks (ECNs) and alternative trading systems (ATSs). Though it’s not technically accurate, you’ll often hear all these costs lumped together as “ECN fees.”

ECN fees are applied on a per-share basis. They vary slightly depending on the brokerage and the specific exchange, but they’re always fractions of a cent. At Questrade, for example, the cost is $0.0035 on Canadian stocks and ETFs, while Virtual Brokers charges $0.0039.

It’s a very small cost—less than $2 on an order of 500 shares—but ECN fees are irritating because it’s hard to understand when and why they apply. So let’s dig a little deeper.

Staying liquid

ECN fees do not apply on every trade: they are only charged when a buy or sell order “removes liquidity.” What does that mean?

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The Limits of Limit Orders

For some time now I’ve been suggesting that ETF investors use limit orders—never market orders—when placing trades in their accounts. A market order will be filled (usually immediately and in full) at the best available price. A limit order allows you to specify the maximum price you’ll pay when buying, or the minimum you’ll accept when selling. But judging from some of the comments I’ve received recently, many investors are not clear on the reasons for this advice.

Some seem to believe that placing limit orders will allow them to get a “better price” than they would have obtained with a market order. But if the exchange functions the way it’s supposed to, that’s not true. Using limit orders is not like haggling with a salesman on a used car lot: you can’t get a good deal just because you drive a hard bargain.

Consider three ETF investors—Mark, Cheryl, and Barney—who want to buy 100 shares of the Vanguard Canadian Aggregate Bond (VAB). They get the following quote from their brokerage:

Because they’re placing a buy order, our three investors look at the ask price,

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Decoding International Equity ETF Returns

How have international equities performed over the last year? If you research the returns of index funds in this asset class, you may wind up with more questions than answers.

I recently received an email from David, a reader who wanted to know why the recent performance of three international equity index funds looked so different. It’s an excellent question, because unless you understand what’s going on here you’re liable to make a poor decision when choosing one for your portfolio. Exhibit A, their returns over the last year (period ending December 4), according to Morningstar:

TD International Index Fund – e (TDB911)
7.66%

iShares MSCI EAFE Index ETF (XIN)
10.21%

iShares MSCI EAFE ETF (EFA)
1.80%

All of these funds have the same benchmark: the MSCI EAFE Index, which covers developed markets outside North America, including Japan, Europe and Australia. In fact, XIN uses EFA as its sole underlying holding, so the two funds have identical stock exposure. Why, then, is their performance dramatically different?

Peeking over the hedge

Let’s begin with the TD International Index Fund,

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The Couch Potato Goes Abroad

Andrew Hallam’s Millionaire Teacher remains one of the best introductions to index investing. When I reviewed it three years ago, I stressed that Andrew writes with authority because he follows his own advice.

In his new book, The Global Expatriate’s Guide to Investing, Andrew shares more of his first-hand knowledge about managing an indexed portfolio outside your home country. Andrew left Canada in 2003 and spent years as a teacher in Singapore before settling (at least for now) in Mexico earlier this year. So he knows all about the challenges—and the surprising benefits—of being an expat investor.

Most of his book’s advice applies equally to homebodies: the first several chapters lay out the case for using a passive strategy, whether with plain-vanilla ETFs, a fundamental index strategy, or the Permanent Portfolio. Then he explains how expats can put these ideas into practice. I asked Andrew to elaborate on some of the key points for Canadians living abroad.

What are the most important tax issues that Canadian expat investors need to be aware of?

AH: So much depends on where the expat is living.

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Ask the Spud: Bond ETFs in Taxable Accounts

Q: Can you share your thoughts about the BMO Discount Bond (ZDB) and the Horizons Canadian Select Universe Bond (HBB) as long-term holdings in a taxable account? – D. F.

Earlier this year BMO and Horizons both launched bond ETFs specifically designed for taxable accounts. These two funds have very different structures, and each has its strengths and weaknesses. So let’s dig more deeply into each fund to help you decide which might be right for your portfolio.

Before we discuss these specific funds, let’s review the problem with holding traditional bond ETFs in non-registered accounts. Most bonds these days trade at a premium (higher than their par value), because they were issued when interest rates were higher. Premium bonds are perfectly fine in your RRSP or TFSA, but they are notoriously tax-inefficient and should not be held in non-registered accounts.

 Do you want a discount or a swap?

The BMO Discount Bond (ZDB), launched in February, is similar to traditional broad-market bond ETFs, such as the iShares Canadian Universe Bond (XBB), the Vanguard Canadian Aggregate Bond (VAB) and the BMO Aggregate Bond (ZAG).

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Tax Loss Harvesting Revisited

No one likes to see their investments plummet in value, but it’s going to happen many times over your lifetime. If you’ve got a strategy for tax loss selling, you can make the best of the situation by harvesting capital losses that can be used to offset capital gains. That gives you an opportunity to reduce or defer taxes in the future, or even recover taxes you paid in past.

In a blog post on September 26, I noted that Canadian equities had fallen by about 5% since the beginning of the month, which could have triggered one such opportunity. (A useful rule of thumb, courtesy of Larry Swedroe, says a security should be sold when the loss is at least 5% and at least $5,000.) If you had recently made a large purchase of the Vanguard FTSE Canada All Cap (VCN), for example, you might have sold it that week to realize a capital loss and then repurchased the iShares Core S&P/TSX Capped Composite (XIC) or a comparable fund. As long as the replacement ETF tracks a different index you’ll maintain your exposure to Canadian stocks while also steering clear of the superficial loss rule.

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Do You Have the Advisor Six-Pack?

When people criticize the financial industry in Canada, the target of their wrath is usually high fees and underperformance. These are huge issues and, of course, they go hand-in-hand. But the more I work with new clients who arrive after using other advisors, the more I’ve come to appreciate a different problem. I can’t understand why so many mutual fund advisors seem incapable of building a portfolio with a coherent strategy.

This seems almost ridiculously easy. Is it so difficult to pick one fund for each of the major asset classes (bonds, Canadian stocks, US stocks, international and emerging market, real estate) and then assign a target weight to each? Instead I see what I’ve dubbed the “advisor six-pack.” No, not the guy at Investors Group with the ripped abs. I’m talking about the portfolio built from a half-dozen mutual funds thrown together randomly. It’s like the advisor swallowed the Morningstar database and then threw up in the investor’s account.

“Hmm, how about a few thousand bucks in the Mackenzie Growth Fund (the sales rep just visited and gave me Leafs tickets), a few more in the CI Canadian Investment Fund,

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Three Reasons to Ignore Market Downturns

“Long-term investors shouldn’t worry about daily or weekly blips in the markets.” How many times have you heard that? It’s true of course, but most investors don’t heed the advice. And to be fair, it’s hard to ignore the financial markets when there’s non-stop commentary in the news and on social media.

Since markets began falling early last month—the S&P/TSX Composite Index shed more than 11% in the six weeks following September 3—some investors are starting to get spooked. As one wrote to me recently: “A word of encouragement would be appreciated for those of us who recently began the Couch Potato plan and are now seeing our ETFs going down.”

Words of encouragement are helpful, but “don’t worry, be happy,” doesn’t cut it. So here are three specific reasons why a falling stock market shouldn’t shake your confidence in a balanced index portfolio.

1. Downturns are ridiculously normal. A reasonable expected rate of return for a global equity portfolio might be about 7% to 8%. But this is an annualized average over the very long term. In any given year, equity returns are likely to be much lower or much higher.

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An Interview With Wealthsimple: Part 2

Earlier this week I published an excerpt from my interview with David Nugent, portfolio manager of the online investment service Wealthsimple. In this second part of our interview, Nugent goes into more detail about the firm’s investment strategies, including the individual funds they use in their portfolios.

Let’s say you’ve determined an investor’s appropriate asset mix is 60% equities and 40% fixed income. Can you describe how you would divide that across various asset classes?

DN: Our asset classes are Canadian equities, US equities, foreign developed market equities, emerging markets, dividend stocks and real estate, and then there is a component of tactical stocks. The fixed income piece is Canadian investment-grade corporate bonds, Canadian government bonds, US high-yield bonds and cash.

When it comes to choosing ETFs, we try to get the broadest exposure in each asset class. We’re looking to try to capture large caps, mid caps and small caps because we believe that over the long term there is value in having some exposure to that small cap space: they tend to outperform large caps over extended periods. So for Canadian, US, foreign developed and emerging market equities we use total-market cap-weighted ETFs.

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