Archive | Index funds

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)
MER

Canadian equity
20%

TD Canadian Index – e (TDB900)
0.33%

US equity
15%

TD US Index – e (TDB902)
0.35%

International equity
10%

TD International Index – e (TDB911)
0.50%

Emerging markets equity
5%

Vanguard MSCI Emerging Markets  (VEE)
0.55%

Real estate
10%

BMO Equal Weight REITs (ZRE)
0.62%

Real return bonds
10%

iShares DEX Real Return Bond (XRB)
0.39%

Canadian bonds
30%

TD Canadian Bond Index – e (TDB909)
0.51%

100%

0.45%

A few words of explanation.

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Another 5 Underrated Index Funds

Last week I presented a list of five Canadian ETFs I feel are underused compared with their billion-dollar competitors. Here’s are three more ETFs and a couple of index mutual funds I’d put in the same category.

1. PowerShares FTSE RAFI Canadian Fundamental (PXC)

The iShares Canadian Fundamental (CRQ) has been a high-profile ETF since it was launched in 2006, and it has outperformed the S&P/TSX Composite Index by more than 1% a year for the last five, despite a relatively high fee of 0.72%. This new PowerShares ETF, launched with little fanfare in January 2012, is tied to the exact same index as CRQ, but with a significantly lower management fee (0.51% including HST). Assuming it will track the index well and overcome the problems associated with low trading volume—and it’s too early to tell—it may be a compelling alternative for investors interested in fundamental indexing.

2. BMO Low Volatility Canadian Equity (ZLB)

I’ll start by saying I’m agnostic about low-volatility ETFs, as I’m still looking deeper into the research. But there is some evidence suggesting stocks with low beta—that is,

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Foreign Withholding Tax: Which Fund Goes Where?

My previous post on foreign withholding taxes included a lot of information for investors to puzzle over. But unless you’re an accountant, you probably don’t care too deeply about the finer details. Most investors just want to answer a simple question: which fund should I put in which account?

Recall from the earlier post that there are five broad categories of funds you can use for US and international equities:

A. Canadian mutual fund or ETF that holds US or international stocks directly.
B. US-listed ETF that holds US stocks.
C. US-listed ETF that holds international stocks.
D. Canadian ETF that holds a US-listed ETF of US stocks.
E. Canadian ETF that holds a US-listed ETF of international stocks.

To help you make the most tax-efficient choice for each type of account, see the tables below. I’ve specified which of the above fund categories are the most tax-efficient, and which ones carry the largest withholding tax burden. Then I’ve included some comparisons of specific funds. In each case, the pairs track the same index and use the same currency hedging strategy. Once again, a big thanks to Justin Bender at PWL Capital for helping me sort through these details.

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Foreign Withholding Tax Explained

The Couch Potato strategy calls for a significant allocation to US and international stocks. When you live in a country with a small, poorly diversified stock market, global diversification is extremely important. But it does carry a price in the form of foreign withholding taxes.

Many countries levy a tax on dividends paid to foreign investors: the rate varies, but for US stocks it is 15%. (Foreign withholding taxes do not apply to capital gains.) With broad-based US index funds now yielding about 2%, the withholding tax amounts to an additional cost of 30 basis points. As you can see, the impact of withholding taxes can be far greater than that of management fees, which get a lot more attention.

To learn how much tax is withheld by your fund, click the “Distributions” tab on its web page and look under the heading “Foreign Tax Paid.” Here’s what the table looks like for the iShares S&P 500 (XSP). Notice the amount of tax paid for 2011 ($0.04388 per share) is approximately 15% of the foreign income received ($0.26866):

Investors and advisors are often unaware of how foreign withholding taxes affect returns,

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Comparing the Costs of Index Funds and ETFs

[Note: This post was updated in May 2014 when the ING Direct Streetwise Funds changed their name to the Tangerine Investment Funds.]

The growing popularity of index investing has a lot to do with the increasing number of ETFs available, and that’s largely a good thing. ETFs generally have lower management expense ratios (MERs) than index mutual funds in Canada, so they are usually the best choice for large portfolios, especially if you make infrequent lump-sum contributions.

But ETFs carry additional costs that are often ignored by beginning investors. Trading commissions are the most obvious: it typically costs $10 to buy or sell ETFs, while index mutual funds can be traded for free. (Some brokerages do offer a limited selection of commission-free ETFs, and a few independents offer trades for less than $10.)

Are index funds or ETFs right for you?

All of which is to say that as marvelous as ETFs are, they are often inferior to index mutual funds for investors with small accounts. My rough minimum for using ETFs is $50,000, but the actual cut-off varies a lot depending which specific ETFs or index funds you use,

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Inside the DFA Global Balanced Fund

Long-time readers will know that I’ve written before about Dimensional Fund Advisors, an innovative investment firm that builds low-cost, widely diversified funds. I enjoy keeping an eye on DFA, because their strategies are based on academic research (there are a few Nobel laureates in the family) that all investors can learn from.

The one downside of Dimensional funds is that they’re not available through discount brokerages: the only way you can get them is through a small number advisors who have been schooled in DFA’s strategies. This helps the company control fund inflows and outflows from performance-chasing retail investors that would make executing those strategies impossible.

But that doesn’t mean Couch Potatoes can’t pop the hood on these funds and take a look. Just shy of a year ago, the firm launched the DFA Global Balanced Fund in Canada: it’s a fund of funds that includes the standard 60% equity and 40% bonds. [Note: This fund's name has been changed to the DFA Global 60EQ-40FI Portfolio. There are now also versions with different allocations to equity and fixed income.] The I thought it would be interesting to compare it to my own Complete Couch Potato.

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ING’s Streetwise Fund v. TD e-Series

The humble Global Couch Potato portfolio, first recommended by MoneySense eight years ago, is an excellent way to get started with indexing. So when ING Direct launched its Streetwise Balanced Fund in 2008, I thought it would be perfect for new investors, since it’s a single fund with the same target allocation: 40% Canadian bonds and 60% equities, divided equally between Canadian, US and international.

The one problem with the Streetwise Funds was cost: with an original MER of 1% (now 1.07% with HST added) they were more expensive than I would have liked. After all, banks already offered index mutual funds with fees in that neighbourhood, and the TD e-Series Funds are dramatically cheaper: you can build the Global Couch Potato for a total cost of just 0.37%.

But four years after the launch of the Streetwise Balanced Fund, it’s worth taking a closer look at how it fared in comparison with the with TD e-Series. Here are the returns:

TD e-Series
Streetwise

2008
-14.22%
-14.13%

2009
12.00%
10.72%

2010
8.02%
6.52%

2011
0.68%
0.30%

Annual
1.10%
0.40%

As you can see,

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An Interview with the Original Couch Potato

“Allow me to introduce the Couch Potato Portfolio, a surefire formula to invest your money, enjoy a return that will put you in the top half of all professional investors, but expend virtually no effort or thought.”

That’s how Scott Burns began his column in the Dallas Morning News on September 29, 1991, and the Couch Potato strategy was born. Index funds, of course, had existed for some 15 years by that time, but it was Burns who helped popularize them with Joe and Jane Investor in countless articles that followed. In 2006, Burns left the newspaper to found AssetBuilder,  a firm that helps investors build low-cost, passively managed portfolios inspired by the original Couch Potato.

I recently had the opportunity to chat with Scott Burns about the early days of index investing. Here’s an excerpt from our interview.

During the 20 years since you created the Couch Potato portfolio, we’ve seen an enormous evolution in index investing. Can you take us back to 1991 and describe the investing climate back then?

SB: Let’s go back a little further. I have been writing about personal finance since the late 1960s.

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A Chat With Vanguard Canada: Part 2

Here’s another excerpt from my recent interview with Atul Tiwari, Dennis Duffy and Joel Dickson of Vanguard. These questions focus on the types of products we might see from Vanguard in the future. You can read also read Part 1 of the interview here.

Your first family of ETFs have all been plain vanilla funds that track major third-party indexes. What new products are on the horizon?

AT: We’re in the development and design stage for the next suite of ETF products that we’ll launch next year. Before we make any decisions about what those will be, we want to be in the market, talking to clients, talking to advisors, and then we will try to reach a conclusion about the next tranche.

The interesting thing that we have come across in terms of how to bring passive investing to Canada is that the index mutual fund market in Canada is pretty small. It’s concentrated in a few issuers and products that really don’t get much prominence. So we have seen indexing growing in Canada, but clearly the vehicle of choice is ETFs. The growth in the ETF market has been 30% or 35% per year,

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