Archive | Ask the Spud

Ask the Spud: Combining e-Series Funds and ETFs

I use the Global Couch Potato with e-Series funds in my TD Waterhouse account, but I eventually want to use the Complete Couch Potato. Once my portfolio gets to $50,000 and I qualify for $9.95 trading commissions, should I move everything to ETFs? — Mark V.

If you’re a client of any other brokerage, it makes sense to use ETFs to build the Complete Couch Potato portfolio. But with TD Waterhouse you have the unique opportunity to combine the e-Series mutual funds and ETFs in the same account. For five-figure portfolios (and perhaps even much larger accounts) a hybrid approach is likely to make more sense than using all ETFs.

The Complete Couch Potato has three asset classes that are absent in the Global Couch Potato: real estate, real-return bonds, and emerging markets. There are no e-Series funds for these asset classes, nor are there low-cost index funds from other providers. But that doesn’t mean you can’t create a hybrid portfolio of e-Series funds and ETFs. It would look something like this:

Asset class

Fund name (ticker)

Canadian equity

TD Canadian Index – e (TDB900)

US equity

TD US Index – e (TDB902)

International equity

TD International Index – e (TDB911)

Emerging markets equity

Vanguard MSCI Emerging Markets  (VEE)

Real estate

BMO Equal Weight REITs (ZRE)

Real return bonds

iShares DEX Real Return Bond (XRB)

Canadian bonds

TD Canadian Bond Index – e (TDB909)



A few words of explanation.

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Ask the Spud: Should I Unbundle My ETF?

Q: What do you think of investing directly in Canadian REITs instead of buying an ETF? It may be possible to achieve similar results without paying the ETF’s management fee. – Philippe V.

ETFs promise broad diversification at rock-bottom costs, but not necessarily in every asset class. Sector ETFs, in particular, still have relatively high fees in Canada. The BMO Equal Weight REITs (ZRE), for example, holds just 18 real estate investment trusts yet carries an MER of 0.62%, including the Ontario HST. The iShares S&P/TSX Capped REIT (XRE) charges about the same for an even smaller portfolio. (Vanguard has announced it will bring out its own REIT fund later this year with a management fee of just 0.35%.)

Since indexing is all about capturing an asset class’s returns at the lowest possible cost, does it make sense to simply buy all (or most) of the REITs in these funds directly and avoid management fees altogether? If your portfolio is very large, it might. But whenever you make a decision like this, you need to do the math carefully. Then you need to consider the convenience factor.

At the most basic level,

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Ask the Spud: Does Home Bias Ever Make Sense?

Q: The Global Couch Potato has one-third of the equity allocation in Canadian stocks, but Canada makes up only about 4% of the world markets. Aren’t you guilty of home country bias? – Jeremy D.

I’m actually pleased that I’ve received this question several times in the last few months. Not long ago, it wasn’t unusual for investors to ask why anyone would invest in any country but Canada. Our domestic market was one of the world’s top performers during the first decade of the new millennium, but that’s changed: Canada has now lagged the MSCI All Country World Index by 3.4% annually over the last three years, and we’ve trailed the US over the last five.

That’s a reminder that the long-term expected returns in any developed country are more or less the same. (Since 1970, the average return on Canadian, US and international stocks are almost identical.) However, since each country’s stock market moves along a different path, a globally diversified portfolio should have lower volatility than any single country, and it should boost returns by providing opportunities for rebalancing.

It makes theoretical sense to build an equity portfolio that assigns weight to every country based on the size of its stock market.

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Ask the Spud: Investing With Multiple Accounts

Q: How do I use the Couch Potato strategy across multiple accounts?  We have a taxable investment account, my RRSP, a spousal RRSP and two TFSAs (one for me, and one for my spouse). Should we hold all of the ETFs in each account—which seems cumbersome—or treat them all as one large portfolio? — B.H.

In most cases, you should think of your assets as one large portfolio, and it often doesn’t make sense to simply hold all of your ETFs in each of your individual accounts. This just increases trading costs and complexity. However, it is often impossible to avoid at least some overlap when you’re investing across multiple accounts. Here are the important factors you need to consider as you figure out the right plan for your household assets.

The purpose of the accounts. This is the most important consideration: you should only treat your accounts as a single portfolio if they are intended for the same purpose. If you have a group RRSP through your employer and a self-directed RRSP with a discount brokerage, these are both clearly designed to fund your retirement. So you might hold all the fixed income in one account and all the equities in another,

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Ask the Spud: Should I Hold US Bonds?

Q: One of my coworkers and I recently started our own Couch Potato portfolios and we’re wondering if it would be better to have some American bonds in the mix. Wouldn’t that be another way to diversify? – Jason L.

The answer depends on whether you’re talking about government bonds or corporate bonds.

It’s usually not a good idea for Canadians to hold US or other foreign government bonds in their portfolio. In theory, because interest rates are not the same in every country, it can makes sense to diversify your bond holdings globally. However, investing in US or international bonds exposes Canadians to currency risk.

Currency risk is welcome on the equity side of your portfolio, because it can lower volatility without decreasing expected returns. That’s why I recommend using unhedged index funds and ETFs for US and international stocks. But the situation is different for fixed income. The yield differential between Canadian and US bonds is likely to be quite small, and it will be completely overwhelmed by significant changes in the exchange rate. That means adding currency risk to your bond holdings will tend to increase volatility without increasing expected returns.

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Ask the Spud: Am I Vulnerable to US Estate Taxes?

Q: I am ready to follow the Couch Potato and would like to use the US-listed Vanguard ETFs that you recommend in your model portfolios. But when I checked with my accountant, he warned me that I could face US estate taxes when I die. Is this true? — Karl W.

It’s possible, yes. Canadians with a high net worth and significant holdings in US assets (including ETFs listed on an American exchange) may be subject to estate taxes levied by the Internal Revenue Service. This tax can be up to 35%.

Before we go any further, let me remind you that I am not a tax expert, and it is essential that you consult an accountant or other qualified advisor if you think you may be in this situation. It’s also crucial to understand that US estate tax laws have changed several times in recent years (most recently in December 2010) and will likely change again after the presidential election next year: the current law is only valid until the end of 2012. It’s your responsibility to stay on top of these changes.

With that out of the way,

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Ask the Spud: RBC’s Target Maturity ETFs

Q: I just read about the launch of RBC’s family of target-maturity corporate bond ETFs. They seem like they would be an attractive option for the fixed-income portion of my RRSP. How do these products compare with more conventional bond ETFs? How do I compare their yields? And can I use them in a laddered fashion? — Karl T.

RBC became Canada’s sixth ETF provider when it launched a family of eight corporate bond funds last week. Unlike traditional fixed-income ETFs, which continually buy new bonds to replace those that mature, these new products have a “target maturity.” That means all the bonds in the fund will come due in the same year, and once they’re redeemed, the fund will be liquidated and all the money returned to investors.

ETFs like these are not exactly new in Canada: BMO launched four similar funds in January, with target dates of 2013, 2015, 2020 and 2025. However, RBC’s offerings fill in the gaps, covering every year from 2013 through 2020. Each ETF will mature on or about November 30 of the target year.

Extreme couponing

Whenever you buy an individual bond or a bond ETF,

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Ask the Spud: iShares Gold Trust

Q: The iShares Gold Trust (IGT) trades on the Toronto Stock Exchange, but I can’t find it on the iShares Canada website. Can you tell me why? — Jim O.

The iShares Comex Gold Trust is an exchange-traded product that tracks the price of gold. Like its competitor, SPDR Gold Shares (GLD), the trust is backed by gold bullion held in a vault by a custodian.

But although IGT is listed on the Toronto Stock Exchange, it is not a Canadian product. It’s simply a cross-listing of the iShares Gold Trust (IAU), which is domiciled in the US and traded on the NYSE. That’s why it isn’t included on the iShares Canada site.

If you’re not familiar with cross-listing, it’s a common practice among large corporations that want their shares to trade in more than one currency (and sometimes more than one time zone). For example, while Research in Motion is a Canadian company traded on the TSX, you can also buy its shares in US dollars on the NASDAQ. There are many other examples of companies with dual listings,

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Ask the Spud: Can You Time the Markets?

Q. Have you ever done any calculations into the optimal time to purchase index funds or ETFs based on broad market indicators? I’m essentially talking about buying during market dips and corrections, perhaps based on moving averages. — Joe S.

Canadian and international stocks are now in negative territory for 2011, and even US equities have fallen more than 5% since the beginning of May. If you’re an index investor with a global strategy, does it make sense to wait on the sidelines for opportunities like this? Can you enhance your returns by identifying the right time to buy?

Let’s call a spade a spade here: this is market timing. It is always possible to look in the rear-view mirror and identify what would have been the optimal time to buy into any asset class. But trying to spot buying opportunities ahead of time, based on moving averages or other technical indicators, is likely to be futile and costly.

Besides, the Couch Potato strategy already includes a technique for buying into asset classes when they’re “cheap.” It’s called rebalancing.

About once a year—or when your portfolio’s target allocations are out of whack by a certain amount—it makes sense to trim the best performers and use the proceeds to prop up the winners to get the portfolio back to its targets.

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