Archive | Ask the Spud

Podcast 9: Finding Common Ground

Does the whole “active versus passive” debate miss a key point about what leads to successful investing? Why do investors focus on “mutual funds versus ETFs” when neither structure is inherently superior? These are some of the topics I discuss with Tom Bradley in my latest podcast:

Tom is the co-founder and president of Steadyhand Investment Funds, based in Vancouver. Steadyhand believes strongly in active management: they even call themselves “undex funds,” because their goal is to look like nothing like the benchmarks. But if you spend any time reading Tom’s articles in the Globe and Mail, MoneySense, and on the Steadyhand blog, you’ll notice there a surprising amount of overlap in our messages. I noted this some six years ago when Tom released the first edition of his book, It’s Not Rocket Science.

Tom and I both understand that, whatever your specific strategy happens to be, the fundamental ingredients of a successful plan are low cost, broad diversification and a disciplined strategy you will adhere to over the long term.

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Ask the Spud: Should I Switch All at Once?

In Episode 8 of the Canadian Couch Potato podcast, I answered the following question from a listener named Remy:

I want to move away from my stocks and mutual funds in order to build a Couch Potato portfolio with ETFs. What is the best way to do this? Should I sell everything at once and pay all of the taxes this year, or should I sell my assets over a longer period, like two to three years?

Many investors in Remy’s situation have made that all important first-step: committing to an indexed strategy. But now they’re unsure about how to liquidate their existing portfolio and build the new one. Should you clean house and do it all at once, or take a more gradual approach?

This is an easy decision if all of your investments are in RRSPs and TFSAs. Since there are no tax consequences to selling your existing holdings, you should just liquidate all the holdings right away. But Remy is investing in a non-registered account, and if he’s held his stocks and mutual funds for several years, he’s probably sitting on large unrealized capital gains,

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Ask the Spud: Can I Make Taxable Investing Easier?

In Episode 4 of the Canadian Couch Potato podcast, I answered the following question from a listener named Jakob:

I’m currently investing with all my ETFs in RRSP and TFSA accounts. This year, however, I’ll finish paying off my mortgage, so I will have more surplus cash and will have to start using taxable accounts. I have been reading your blog posts about adjusted cost base, and they’re helpful, but it still sounds like a pain to track and calculate. I’d consider paying some extra fees for help with this. What options do I have?

Investing in a non-registered account involves a lot more hands-on work than RRSPs and TFSAs. While there’s no such thing as a maintenance-free taxable portfolio, you can certainly make your life easier with a few simple strategies:

1. Consider alternatives to ETFs. Make no mistake: ETFs are generally tax-efficient and they can be a great choice in non-registered accounts. But if you’re a novice index investor, consider other good products that require a lot less recordkeeping. Mutual funds, for example, track your adjusted cost base at the fund level,

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Ask the Spud: Reverse Share Splits in ETFs

Q: I noticed the unit price of some iShares ETFs changed radically last week. For example, the iShares MSCI Singapore ETF (EWS) shot up from around $10 to $20 overnight on November 7. Another fund went from $14 to over $28. What’s going on here, and how would it affect investors? — Chris

If you wake up to find the unit price of your ETF doubled overnight, you might be tempted to think you just scored a 100% return while you slept. But unless you’re an eternal optimist, you’ll probably realize that isn’t the case. What’s happened here is called a reverse share split, or consolidation. Although the price per share of these iShares ETFs doubled (or in some cases quadrupled), the total value of each investor’s holding hasn’t changed, because they now own correspondingly fewer units.

If you’ve ever traded stocks, you’re probably more familiar with a regular stock split, whereby a company increases its number of outstanding shares by some multiple, reducing the price of each share by a proportional amount. A company with one billion shares trading at $100 might undergo a 4-for-1 split, creating four billion shares trading at $25.

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Ask the Spud: Switching From e-Series Funds to ETFs

Q: “I currently have $30,000 invested in the TD e-Series funds. When the time comes to move to ETFs, what is the best way to do this while still making automatic contributions? Should I put my biweekly contributions into a money market fund and then make ETF purchases four times per year?” –  C.D.

Too many investors think of the TD e-Series funds as little more than a stepping stone, and they can’t wait to “graduate” to ETFs. The appeal is understandable, since a portfolio of ETFs will typically carry a management fee of about 0.15%, compared with about 0.45% for the e-Series funds. But when I get this common question, I encourage the investor to think carefully before making the leap to ETFs, especially if their portfolio is small and they’re making automatic contributions.

For starters, management fees don’t tell the whole story. Index mutual funds are more investor-friendly than ETFs, and while the cost difference can be dramatic on large portfolios, the gap is narrower on smaller accounts. A fee difference of 0.30% shaves off just $30 annually per $10,000 invested, and that will be reduced—perhaps eliminated—by $9.95 trading commissions,

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Ask the Spud: Is It Time to Hedge Currency?

Q: “I use non-hedged ETFs for US and international equities, which worked out well as the Canadian dollar tanked. But the loonie is now so low that I wonder if it makes sense to move to the hedged versions. My thinking that there is limited risk from the loonie falling much further, and a bigger risk from its recovery.” – B.G.

It’s hard to believe it was just three years ago that the loonie was at par with the US dollar. Since 2013 our currency has trended steadily downward, reaching a low of $0.68 USD in late January, a level not seen since 2003.

My model portfolios recommend US and international equity index funds that do not hedge their currency exposure. That means when the loonie falls in value relative to the US dollar and other foreign currencies, these funds get a boost in returns. That was particularly dramatic in 2015, when US and international equities posted only modest returns in their native currencies but netted close to 20% for Canadians on the strength of the currency appreciation.

Expecting a repeat of that performance is foolishly optimistic.

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Ask the Spud: My ETF Is Shutting Down

Q: I received a notice that an ETF I own will be closed within the next few months. Is it better to sell it now or wait until the termination date? – S.H.

ETFs are now available for just about every niche sector and exotic asset class, so it shouldn’t be surprising when some of these fail to attract investor dollars. If an ETF cannot attract enough assets to be sustainable within a couple of years, the provider may decide to shut down the fund.

ETF closures have been relatively uncommon in Canada, but this year has seen several death sentences. In June, BlackRock announced it will be shuttering six products, including the iShares Broad Commodity (CBR), the iShares China All-Cap (CHI), iShares Oil Sands (CLO) and the iShares S&P/TSX Venture (XVX). Earlier in the year Horizons also terminated its broad commodity ETF as well as couple of its leveraged ETFs.

What should you do if you learn that an ETF you own will soon be shut down? To help answer this question, I reached out to Mark Noble,

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Ask the Spud: GICs vs. Bond Funds

Q: I would appreciate it if you could write an article contrasting the advantages and disadvantages of holding bond funds versus GICs. – A.R.

All of my model Couch Potato portfolios include bond funds, and I’m frequently asked whether a ladder of GICs would be a good substitute. In many circumstances the answer is yes. Indeed, our clients at PWL Capital often hold a combination of bond funds and GICs in their portfolios, because these two investments each have strengths and weaknesses. Let’s look at the relative advantages of each.

When GICs are preferable to bond funds

Higher yields. As of March 25, the yield on five-year federal bonds was 0.75%, while you can easily find five-year GICs paying over 2%. Normally higher yield means higher risk, but both federal bonds and GICs are backed by the Government of Canada: GICs up to $100,000 are insured against default by the Canadian Deposit Insurance Corporation.

Tax efficiency. These days just about all bond funds are filled with premium bonds, which are notoriously tax inefficient. Premium bonds pay a lot of taxable interest and then suffer capital losses when they mature.

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Ask the Spud: Should I Use Global Bonds?

Q: I was surprised to see a Vanguard infographic pointing out that international [non-US] bonds are the largest asset class in the world. Do you have any thoughts on why Canadians have not embraced international bonds in their portfolios? – A.M.

While stocks grab all the headlines and dominate the conversation among investors, the bond market is vastly larger. Yet while a diversified index portfolio can include 10,000 stocks from over 40 countries, chances are your bond holdings are entirely Canadian.

There are some good reasons for a strong home bias in bonds. The main one is currency risk. Exposure to foreign currencies benefits an equity portfolio by lowering volatility (at least for Canadian investors), but taking currency risk on the bond side is usually unwise. Because currencies are generally more volatile than bond prices, you’d be increasing your risk without raising your expected return. That’s a bad combination.

It also gets to the heart of why few Canadians have international bonds in their portfolios: there just aren’t many good products offering global bond exposure without currency risk. iShares and BMO have a number of ETFs covering US corporate and emerging markets bonds.

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