After two years with no changes to my Couch Potato model portfolios, the 2017 edition comes with an update to the ETF version.
Before I get to the details, I feel compelled to stress that if you’re currently using the older ETF portfolio, there is absolutely no reason to change. The funds I’ve swapped here are a wee bit cheaper, but the cost of selling your existing ETFs and buying the new ones almost certainly outweighs the benefits. And if the transactions would involve realizing taxable gains, then making a switch is downright nutty. To put this in perspective, the new portfolios will reduce your management fees by 0.03% annually, which works out to 25 cents a month on every $10,000 invested.
I’ve also updated my model portfolios page with historical returns to the end of 2016. As always, we’ve used actual fund performance wherever possible: for earlier periods we’ve used index data, subtracting the fund’s current MER to account for costs.
With that out of the way, here are the changes.
Zigging over to ZAG
First, I’ve replaced the Vanguard Canadian Aggregate Bond Index ETF (VAB) with the BMO Aggregate Bond Index ETF (ZAG). BMO’s aggressive cost-cutting has made ZAG the cheapest bond ETF in the country, with a management fee of just 0.09%. (Don’t be fooled by the old MER of 0.23% that still appears on the BMO website: the fee reduction took place in June 2016 and the fund needs 12 full months before it can report its updated MER.)
Another benefit of using ZAG is that it has a companion fund, the BMO Discount Bond Index ETF (ZDB), designed for taxable accounts. So if your portfolio includes bonds in both registered and non-registered accounts, you can use ZAG and ZDB to get similar exposure in both accounts with maximum tax-efficiency.
One small point to be aware of: VAB and ZAG have slightly different risk exposures. The Vanguard ETF is roughly 80% government bonds and 20% corporates, while ZAG is closer to 70% government and 30% corporates, which explains its slightly higher yield to maturity.
Worlds apart
The second change replaces the Vanguard FTSE Global All Cap ex Canada Index ETF (VXC) with the iShares Core MSCI All Country World ex Canada Index ETF (XAW). These funds cover the global equity markets outside Canada: they’re both about 55% United States, 35% international developed markets (Europe and the Asia-Pacific region), and 10% emerging markets.
XAW was launched just weeks after I launched my simplified ETF portfolios in 2015, and two years later it has emerged as a slightly better choice than its Vanguard counterpart. The lower fee is the most obvious advantage: with an MER of 0.22%, the iShares fund it’s five basis points cheaper. Less obvious is XAW’s tax advantage.
Although both of these funds hold several underlying US-listed ETFs, the iShares version uses a Canadian-listed ETF for international developed markets. This difference in structure means the Vanguard ETF will be subject to a greater amount of foreign withholding taxes. According to Justin Bender’s detailed analysis, this amounts to a drag of about 0.10% in an RRSP or TFSA (the difference would be smaller in a taxable account). Add that to VXC’s higher fee and the cost difference becomes significant in registered accounts.
Which option is right for you?
I haven’t made any changes to the other two model portfolio options, though I have stopped including performance data for the Tangerine Equity Growth Portfolio. This fund, which is 100% stocks, recently changed its target asset mix: it was previously 50% Canadian, 25% US, and 25% international. As of last November, it now holds equal amounts of all three asset classes. I think this makes it a more diversified fund, but the change makes its historical performance meaningless for anyone considering the fund today.
One of the age-old questions I get from readers is, “How do I know which option is right for me?” Many new investors look only at the differences in MER and immediately gravitate to the ETF version, even though one of the index mutual fund options would be more appropriate.
To help answer this question, I recently wrote a feature in MoneySense magazine that walks you through the decision-making process. It even includes a selector tool that asks you to describe your preferences and then suggests one of the three options. Both the article and the quiz are now linked on the model portfolios page.
I have RSP, TFSA and LIRA accounts?. Should I just duplicate the same portfolio to all 3 accounts? For example, using model portfolio: ZAG/VCN/XAW.
sorry Dan for the confusion
i just wondered if its wise to reduce the number of ETF’s currently held ( 10 ) down to the recommended 3 ??
because it would cost money to sell old and buy new positions
are we trying to get to the cheapest MER and simplified level in our holdings ??
or is your advice for new portfolios ??
thanks
@nicholas: My general advice is to keep things simple, and I would not suggest that investors use portfolios with 10 ETFs. However, since your portfolio is already in place, there will be taxes and costs to pay to make the change. Only you can decide whether that is worth it. The decision also depends on how comfortable you are managing 10 ETFs, and again, only you can answer that. I’m not trying to be evasive, but please understand that the model portfolios are not a one-size-fits-all solution, they are just a starting point.
Hello,
I’m holding VAB in a non-registered account and it’s in a loss position. Would there be value in selling VAB and purchasing ZDB?
Thanks!
To C,
I’ve gone through the same decision making process and I’ve come to the conclusion that replicating the asset mix in all three accounts is a poor choice for several reasons.
1) Too many holdings to manage (3 x 3 = 9)
2) More trading costs due to above
3) Can’t fully take advantage of DRIP
My final decision is to generally follow these rules:
1) Fill TFSA with Canadian equities since they are likely to grow faster than bonds. You won’t be taxed on anything you take out.
2) Fill RRSP with US-listed ETFs (VTI, VXUS, etc) for lower MER and not be hit with 15% withholding tax.
3) Fill the rest of RRSP/LIRA with bonds
This advice is similar to Dan’s reply on Jan 14 11:19am:
“In general, it usually makes sense to keep bonds in your RRSP rather than your TFSA: since the TFSA offers tax-free growth indefinitely (as opposed to tax deferral, like the RRSP) you’re likely to be better off keeping the highest-growth assets there, and that would be equities. Otherwise the differences are not meaningful.”
Hi dan, reviewing my holdings before i make this years contributions and am wondering if using vxus is still recommended for global equity as a us $ option in an rrsp? Is there a better alternative? Currently in rrsp xbb, vcn, vti, vxus. Large once a year contributions, comfortable with norberts gambit, aware that vxus contains some Canadian equity, like all cap, and appreciate that it has emerging markets.
Thanks phil
@phil: VXUS is still a good choice in an RRSP, and it’s probably the best single-fund option for non-US equities. We often use the combination of IEFA and IEMG, but of course this means two trades instead of one.
@Brett: This situation is quite different from those who are just switching because of small MER differences. Traditional bond ETFs like VAB are a poor choice in a taxable account, so there is a much stronger argument to be made for switching to a more tax-efficient option.
Hi ZHZ,
Thank you for your advice. I guess to make things simple, I can start with the following?
ZAG – LIRA
VCN – TFSA
XAW – RRSP
Thanks again.
@Jerry: Yes, I will definitely need to revisit the asset location discussion at some point. The basic principles in that older post are still valid, but there are a lot of subtleties that one only appreciates over time!
Hey Dan,
My TFSA and RRSP are maxed out (index funds: equities in TFSA and bonds in RRSP).
My plan was to start investing the extra cash in a Non Registered Account in 2017 with a Lump Sum in ETFs (5 ETF model with the BMO Discount Bond ETF for the fixed income portion).
Unfortunately, the markets being at all times high and the political situation south of the border being what it is (…), it looks like right now would not be the best time to invest in Equities, especially with a large Lump Sum.
I am really not trying to time the market, but investing right now and having a market crash in a few weeks scares me a bit.
Would you recommend a DCA approach given the exceptional circumstances?
I am not a big fan of DCA because of the EFT commissions and also the fact that many studies show that a Lump Sum approach is superior to a DCA approach over a long term period. It will also add complexity when it comes to keep track of my investments in this taxable account.
So I d rather invest with a Lump Sum.
What are your thoughts on this topic?
Thanking you in advance for comment on this.
If using a dollar cost averaging approach would it make sense to buy these newly updated ETFs going forward as opposed to the previous recommendation or should I just stick with the old recommendation?
Hi Dan,
In a rising interest rate environment, would it not make sense to buy a bond ETF with a shorter average duration (like XSB)?
@Solomon: It is true that if interest rates rise, short-term bonds will lose less than longer-term bonds. Let’s just remember there is no such thing as a “rising rate environment.” There is only an environment where a most people believe that interest rates will rise. We’ve been in that environment since 2009 and rates have mostly moved downward since then.
https://canadiancouchpotato.com/2015/05/18/how-changing-interest-rates-affect-fixed-income/
@Jacky: Are these really “exceptional circumstances”? I certainly understand the anxiety around investing a lump sum, but if you think it’s hard to invest when markets have been strong, you probably will be just as anxious if they head sharply down. I don’t think I have heard anyone say, “This is really a great time to invest a large amount of cash.” It’s an inherently difficult thing to do because the outcome is always uncertain.
https://canadiancouchpotato.com/2013/02/07/scary-when-theyre-down-scary-when-theyre-up/
https://canadiancouchpotato.com/2015/08/24/is-a-pullback-really-a-buying-opportunity/
It’s pretty clear that DCA should not be expected to increase your returns: the studies consistently show that investing the lump sum works out better about two-thirds of the time. But this is not a math question. If investing gradually makes you less anxious and more likely to execute your long term plan then it is better than the alternative, which is trying to be a market timer.
https://canadiancouchpotato.com/2013/05/28/ask-the-spud-should-i-buy-in-now/ (Note the “all-time high” comment in this question: that was four years ago)
https://canadiancouchpotato.com/2013/05/31/does-dollar-cost-averaging-work/
Hi C,
If using XAW, my understanding is that TFSA/RRSP/LIRA doesn’t make a difference in terms of withholding tax. (Dan can confirm this). If you use US-listed ETFs, the clear winner in terms of withholding tax is RRSP.
Assuming that having bonds only in your LIRA satisfy your asset allocation, I believe it doesn’t matter which other account XAW or VCN goes into. Just choose the one with enough room to match your asset allocation.
For example, 40% bonds, 20% Cdn Equities, 40% International Equities.
LIRA: $40K, ZAG
TFSA: $40K, XAW
RRSP: $20K, VCN
But your accounts could be like this:
LIRA: $40K, ZAG
TFSA: $20K, VCN
RRSP: $40K, XAW
Or even this:
LIRA: $20K, VCN
TFSA: $40K, XAW (keep equities in TFSA)
RRSP: $40K, ZAG
But please, confirm that from a withholding tax perspective, XAW is the same in each account.
@ZHZ: Yes, foreign withholding taxes would be the same for XAW in a TFSA, RRSP or LIRA.
@Aleks: Thanks for the comment. If you are comfortable using US-listed ETFs you could substitute XAW for a roughly equal mix of VTI and VXUS. Another option is 50% VTI, 40% IEFA and 10% IEMG. Remember that using US-listed ETFs generally only makes sense in an RRSP.
https://canadiancouchpotato.com/2013/12/09/ask-the-spud-when-should-i-use-us-listed-etfs/
Hi ZHZ and Dan,
Thank you both for you advise, I appreciate your time.
I inherited a large windfall of cash after the death of my mother, after paying off debts and taxes I’ll have more than $500k to invest. I’m 36 years old and I’ve struggled financially for basically my entire adult life.
Are simple 3 ETF portfolios appropriate for investments that large?
@Brian: The three-fund portfolio is certainly appropriate for a large portfolio. My bigger concern is that it may be difficult to manage a large, taxable ETF portfolio if you have no experience with investing. I encourage you to be thoughtful and take the time to make sure you take the appropriate amount of risk. A financial planner might be able to help.
@Brian: I’d suggest a fee-based financial planner to start; someone you pay by the hour. He/she could advise you on how to proceed (pay off mortgage? Buy a home ? Invest ?), and you could try to figure out if you’re cut out for investing independantly. Some people just aren’t and that’s ok.
I can tell you that once you have a 3-etf portfolio spread out over multiple accounts (RRSP, TFSA, etc.), it’s not as simple as you’d expect.
I’d also be wary of any investments that come with fixed costs (like, say, a large home or cottage with taxes, maintenance or condo fees). You don’t want to wind up house-poor (ie, cash-flow issues because all your cash-flow goes to maintaining your home).
I’m looking to re-balance about $75000. I was looking at your Model ETF Portfolio but VCN and XAW are near 52 week highs. Do you suggest waiting for these to hopefully come down a little before switching?
Quick question, does it make any difference to invest in XIC / VCN? The MER looks the same.
Hi Dan. Thanks for all of the information you have provided over the years. I have a taxable account and I am going to create an etf portfolio using the model you provided in the pdf using ZAG, VCN and XAW.
Since it’s taxable should I exchange ZAG for ZDB? Is that the only change that should be made? I have a portfolio with Mawer that’s similar should it all be CCP? I know that’s a matter of opinion but I thought I would ask anyways. :) Thanks!
@Kevin: The whole point of rebalancing is undermined if you start adding a market-timing element. If you have along-term target for your asset mix, then it’s best to simply stick to those targets.
@Tripp: Thanks for the comment. Yes, if you are using a taxable account then ZDB is a more tax-efficient choice than ZAG or similar traditional bond ETFs.
As you anticipate, I can’t advise you on whether you should switch out of your Mawer funds. There may be capital gains to pay, etc., and perhaps you find their service helpful. You can certainly do a lot worse than Mawer, which is a prudently managed firm with relatively lost-cost funds.
@C: VCN and XIC track different indexes but are effectively identical. Take your pick.
In fact, I think ZCN may be a choice as well, at least the share price is lower than both VCN and XIC.
@C: Lower share price might mean paying more in terms of bid-ask spread.
My tie-breaker would be which ones have DRIP through your broker, since not all brokers allow DRIPs for all ETFs.
Hi Dan,
Great website. An article I read in the globe and mail seemed to suggest that index funds with equal weighting seem to have performed better than those that are weighted based on market cap. The author suggests that when these funds rebalance, it ensures that you sell high and buy low and the gains are magnified because of the equal weighting. I am interested to hear your thoughts about this.
Thanks
Hi Dan,
I built my portfolio last year with VAB, VXC and VCN ETFs. I understand your reasoning behind not switching to ZAG and XAW immediately due to costs. But moving forward would it make sense to purchase XAW and ZAG as I invest more money and preferably sell VAB and VXC if it becomes necessary to sell either for rebalancing purposes or if I require the cash?
Thanks
@Greg: Totally up to you but it seems unnecessarily clunky to have two funds covering the same asset class in the same account.
I’m on the fence of reinvesting more than a 1M cash starting next week.
I will stick with the 40/60 split with a maxed out RRSP of 325K which will contain 100% of ZAG ETF.
The remaning 75K for bond allocation will be ZDB in a taxable account.
I am still not sure for the equity portion since I want to see what will happen after tomorrow.
Maybe a 18% canadian, 24% US and 18% international makes more sense to me.
In any cases, for the equity portion, all studies show that I should reinvest the remaining 600K at once but it is easier said than done.
How does ZDB compare to HBB?
@Alex: https://canadiancouchpotato.com/2014/11/19/ask-the-spud-bond-etfs-in-taxable-accounts/
Hey Dan,
In a previous response to another message today, you said “My bigger concern is that it may be difficult to manage a large, taxable ETF portfolio if you have no experience with investing. I encourage you to be thoughtful and take the time to make sure you take the appropriate amount of risk.”
Could you elaborate? What exactly would make a large taxable ETF portfolio difficult to manage?
Are you talking about the ACB, dividends and interests to report and keep track of?
I am asking as I am myself in a similar situation (large lump sum to invest in a 5 ETF portfolio in a taxable account). My overall allocation will 70/30.
Thank you!
Having experienced the labour and hassles of managing a classic 5 ETF old style CP tax sheltered portfolio I am coming around to the simplicity and elegance of replacing the US, Rest of the world Developed Markets and Emerging Markets ETFs with XAW as you have suggested. But the nagging doubt of “if it’s so simple, what’s the catch?” keeps me wondering.
Particularly on the issue of re-balancing, which I realize has more to do with managing risk tolerance than with locking in profits, what happens when one of your components in XAW significantly outperforms the others after you build your portfolio (for instance if US outperforms the other developed nations and Emerging Markets). Does the market capitalization formula of the index take the place of the rebalancing (between US, Rest of World Developed Markets and Emerging Markets) that you would otherwise need to do yourself with individual ETFs? Is the current ratio of 55%US, 35% Other Developed Markets and 10% Emerging Markets going to be maintained, or will it float in future to match whatever changing market capitalization ratio evolves?
@Jacky: “Are you talking about the ACB, dividends and interests to report and keep track of?” Yes, that’s a big part of it. If you’ve never invested in a taxable account before the required recordkeeping can come as a surprise. Product selection also becomes more important: I still see investors with traditional bond ETFs in taxable accounts, unaware that there are far better alternatives. Your mistakes have bigger consequences in taxable accounts, too.
I have a question regarding the MER for BMO-ZAG as you mention that BMO has lowered the MER mid year 2016 to 0.09%. ZAG is an etf that holds a basket of BMO etfs (9 in total according to the 09-2016 quarterly portfolio disclosure) with various MERs. If ZAG is charged the underlying fees of the etfs it holds and then adds an additional fee for managing this basket, how can it be less expensive than an etf like VAB where the etf physically replicates the index and hold the securities directly?
Are products like ZAG (an etf built with etfs) a way to hide fees from consumers? BMO makes no mention of the fees on the etfs it hold except in a footnote in their documentation.
I look forward to hearing you thought.
Regard
@Aaron: Don’t worry, investors are not double-charged on management fees if the fund provider uses a wrap structure. BMO rebates the fees of the underlying funds and investors pay only the 0.09%.
Agreed with all the above. Simplicity is very important.
I will buy 325K of ZAG to max out my RRSP, fill my TFSA with VCN and will buy the remaining VCN in my TD DI taxable account as well as 400K of XAW. For the remaining 75K fixed income allocation, I have finally decided to go with a short term (1 year) taxable GIC since I am not sure about that part of my portfolio in the long term.
At the end of next week, this portfolio will include only 3 ETFs and 1 GIC. Can’t be simpler than that for recordkeeping I think.
I have a question about the 2016 year end capital gains distribution for the Vanguard Global All Cap Ex Canada (“VXC”) ETF. The Vanguard Canada website states it was a cash distribution of $0.180469 per unit and was paid on Jan 8, 2017. I use BMO Investorline and I was not paid this amount. I received the other year end dividend of $0.142 per unit that was paid on the same day but no capital gain. Was this reinvested in more units? I don’t see any transactions in my account to support this. Thanks. Love your blog!
@kevin
That is a capital gains distributions, will show on your tax slip if you hold VXC in a taxable account, if not then you won’t see anything anywhere.
I have a quick question about buying 400K worth of XAW. With a bid ask spread of 22,02-22,16 (can change anytime) I am looking at a transaction cost of around 7 cents per share (marketable limit order buy).
That’s roughly 1260$.
The MER of XAW is 0,21% while the combined MER of the TD equivalent eseries funds (TDB902 and 911) is 0,43%, a difference of 0,22% or 880$.
Am I correct in assuming that XAW will be more expensive to own than the equivalent eseries funds in the first 18 months of ownership ? Of course over the long run, that’s another story.
About 4 years ago, I sold all my expensive mutual funds to become a DIY investor. At first, I became obsessed with the stock market, reading about it for large part of my days, trying to figure out what to do with my money. The obsession stopped when I found your web site: with a bit of practice, I became a perfect couch potato.
Since then, I have been extremely happy with my couch potato portfolio. Did not think I could find a better way tot invest! But this morning, I watched this TEDx video from this Montreal women, Milla Craig:
https://www.youtube.com/watch?v=xrHTKzb13bc&feature=youtu.be
She speaks about sustainable investing. And now, I would LOVE to turn my couch potato portfolio into a SUSTAINABLE couch potato portfolio! Might you have any inputs into how to get this done?
@Alex: Are you looking at the spread when markets are closed? I would be surprised if there was 14-cent spread.
@Soso: SRI is not my area of expertise. You find this site helpful:
http://www.sustainableeconomist.com/model_portfolios
@Kevin: As Jake points out, this “distribution” is really just a declaration for tax purposes. No cash would have been paid into your account. This blog may help:
https://canadiancouchpotato.com/2016/12/13/making-sense-of-capital-gains-distributions/
Hi Dan
Thanks so much for your info over the years. As a doc, I have found investing to be alot easier with your model portfolios. I know you can’t give specific advise but I had some questions regardless.
I have been following your CCP recommendations in my medical corporation account, as VXC/VCN/VAB, just to keep things simple. Given that I have close to 500k, is that enough to be selling and re buying (VXC for XAW and VAB for ZAG)? Should I just stick to my current allocations and just keep buying the same funds to keep things simple?
After reading the comments in this update, I just realized I probably should not have the bonds part in VAB to begin with in this taxable account. Would it make sense to switch to ZDB as you recommended to someone before?
My goal is to keep things simple primarily. Thanks for your time!
Yes that’s the spread after closure. Will follow closely during the day on monday because 14 cents of spread seems a little bit high.
Good post!
What are your thoughts on ETF VIU? I know it is a relatively new fund and may have a tracking error as it hasn’t grown enough yet. However even if it is diversified in only 10% of the index, this is still a lot of companies. As long as the MER is low, a small tracking error could be just as easily a small positive as a small negative. What is for sure, is that you won’t be hit by double foreign withholding tax.
Why is there no international bond exposure? I take it you have no concerns having your entire bond portion in Canadian assets? …. <5% of the global economy and only 1 national government.
We spend so much time trying to allocate between Canada, USA, International and Emerging for equities and then on bonds it's all in on Canada. Seems odd.