Your Complete Guide to Index Investing with Dan Bortolotti

A Mutual Fund Refugee

2018-06-16T10:13:36+00:00March 19th, 2010|Categories: Indexing Basics|15 Comments

I hear from a lot of investors who are mutual fund refugees: they’ve abandoned their overpriced, inappropriate funds and the advisor who sold them, and they’re trying to move ahead on their own. Darren, a reader in British Columbia, recently wrote to me with his story and gave me permission to share it.

Darren and his wife, Sarah, are in their 60s and have been retired for seven years. Until last year, most of their RRSP savings were in mutual funds handled by a adviser they thought was trustworthy. Only after the markets plunged in 2008–09 did they fully understand their situation: the adviser had all of their savings in equities. Not only did they lose a huge chunk of their nest egg, but when they went to sell their funds in disgust they faced the added insult of deferred sales charges. “After that episode we have become rather jaded with financial advisors,” Darren says.

A year later, he and Sarah are still sitting on $283,000 in cash, plus $57,000 in stocks from Darren’s former employer, a telecom, which he does not want to sell. They’re ready to get back into the market and want to build an ETF portfolio they can manage themselves. Unlike their adviser, they understand that 100% in stocks is too risky for retirees. “We want a portfolio focused on preserving principal, while at the same time providing a fair level of growth and income,” Darren says. “We don’t plan on dipping into any investments for at least two years.” They feel comfortable with 40% in bonds, 20% in cash, and 40% split between stocks, preferred shares, REITs and gold.

The problem is that the couple’s cash is spread between several accounts: two RRSPs and a taxable account. They also have two Tax-Free Savings Accounts they’re using to hold some of the telecom stocks.

When Darren first contacted me, he wasn’t sure whether he should treat all of the accounts as a single portfolio, or whether he should make sure each account included 40% bonds and 20% cash. I explained that since all of their money will be used for the same purpose, they can think of it as one big portfolio: as long as the overall allocation is on target, the asset mix in any one account doesn’t much matter. However, he should strive to keep transaction costs and taxes to a minimum. Ideally, none of the ETFs should be duplicated, and most importantly, he should pay careful attention to his asset location. That means putting all the bonds, cash, REITs and foreign stocks in registered accounts, while using the taxable account for Canadian stocks and preferred shares to take advantage of the dividend tax credit. (Since gold pays no distributions, it’s also fine in a taxable account.)

So Darren sat down with a spreadsheet and came up with this portfolio:

Claymore 1-5 Year Laddered Government Bond (CLF) 20,000 6%
Claymore 1-5 Year Laddered Corporate Bond (CBO) 20,000 6%
iShares Real-Return Bond (XRB) 48,000 14%
iShares Canadian REIT (XRE) 10,000 3%
Laddered GICs 10,000 3%
Cash 7,000 2%
iShares Canadian Long Bond (XLB) 40,000 12%
iShares US High-Yield Bond (XHY) 7,500 2%
Laddered GICs 7,500 2%
Cash 5,000 1%
Telecom stocks 20,000 6%
Telecom stocks 37,000 11%
Vanguard Total World Stock Market (VT) 17,000 5%
Vanguard Total Stock Market (VTI) 7,500 2%
Claymore S&P/TSX Canadian Dividend (CDZ) 14,000 4%
Claymore S&P/TSX Canadian Preferred Share (CPD) 14,000 4%
Claymore Gold Bullion (CGL) 17,000 5%
GICs 33,500 10%
Cash 5,000 1%

“We’re asking for some critical feedback on our plan,” Darren writes. “Please don’t be shy as we’re learning a lot here.” Readers are welcome post their comments below.

Thanks for sharing your experience, Darren, and good luck with your investing!


  1. The Rat March 19, 2010 at 9:47 am

    A very interesting thread.

    In terms of providing feedback, my thoughts are the following:

    The taxable account is great for dividends because of the favorable tax treatment but keep in mind you can also by some REITs directly (such a REI.UN.and BEI.UN)within your non-registered account that will provide good distributions and increase your cash flow stream. In addition, a lot of REITs will be exempt from the new tax implications coming on stream with trusts in 2011.

    You may want to consider not going with a laddered (presumably 5-year) GIC right now and instead go with a one year. Yes, you’ll get a lower interest rate but it looks as though rates will be climbing in the months to come. I locked into a 5-year GIC at about 3.75% last fall, and from what I can gather, right now, a 5-year GIC wont’ offer much more than 3% at the moment. I do feel however, it’s good to see a sizable chunk of your portfolio in safety vehicles such as this. This component of your portfolio will NEVER go down in value.

    With interest rates poised to rise, we are starting to see bonds become less attractive and my own thoughts would be to maybe scale down the 40% on bonds and perhaps throw some of that in Canadian banks. When I got my annual report in the mail from BMO the other day, I noticed it was their 192nd report. It doesn’t look like the banks are going anywhere soon and their dividend history speaks for itself. You can diversify withing banks by buying positions directly with CM, BMO, LB, BNS, TD, NA and RY and minimize the bond allocation if you wish. Or, you could get a fund that gives more exposure to banks.

    Aside from that, there seems to be a nice collection of investments you have planned. I like the gold bullion component.

    Best of luck. Trust my comments prove to be helpful in your pursuits!

  2. Canadian Couch Potato March 19, 2010 at 10:08 am

    Rat: Welcome to the blog, and thanks for the input!

    It’s important to note that distributions from REITs are mostly “other income,” which is fully taxable like interest and not eligible for the dividend tax credit. So holding them in a non-registered account can lead to a big tax bill. REITs really are better in a tax-sheltered account, if possible.

    I’d agree with your caution about moving a lot of money into bonds right now (especially long bonds), but the Couch Potato in me doesn’t like the suggestion of buying individual bank stocks as a substitute. If the investor wants 40% bonds, he should buy 40% bonds: swapping bonds for individual bank stocks violates a basic rule of the Couch Potato strategy. Keep the bonds short, sure, and maybe move into them gradually, but stick to the asset allocation you planned. Even in retirement, you’re investing for the long term, not the next six to 12 months.

  3. Canadian Couch Potato March 19, 2010 at 1:27 pm

    A couple of clarifications:

    The TFSAs are maxed out ($10K each per spouse), so they can’t move anything from the taxable account. They could start moving a bit each year as the contribution room grows, however.

    The idea that individual bonds offer principal protection, but bond funds do not, is an illusion. Here are couple of good articles that explain this:

    In any case, building your own ladder is fine for short and maybe intermediate bonds, but it’s much harder to do with long bonds (10+ years to maturity). It’s impossible with real-return bonds because there are not many issues, and some have maturities longer than 20-25 years. XRB is so much easier and at 0.40%, it’s hard to beat.

  4. DM March 19, 2010 at 12:54 pm

    Hi Darren, congrats on making the jump over! Here are my thoughts:
    1. Can you consolidate the spousal RSP with Sarah’s individual RSP? Most discount brokers will allow you to do this.

    2. Consider XBB instead of XLB.

    3. Consider dumping XRE. Real estate returns are in fact highly correlated with the broader equity market. You still get some exposure to them as well through CDZ.

    4. Why the overweight of telecom stocks? I would consider changing this to a basket of dividend paying stocks, across three or four defensive industries in Canada: banks, pipelines, utilities.

    5. Why the taxable account? Can you transfer these positions in kind to TFSA?

    6. Bond funds are great for diversification but recognize that your principal is not guaranteed. Consider changing XRB and XLB to direct bond ownership. You would want a 5 year ladder, similar to GIC ladder.

    7. Personally, I would scrap CGL and plough it into CDZ.

    How often do you plan to rebalance? I think once a year should be adequate.
    GOod luck!

  5. The Rat March 20, 2010 at 9:38 am

    Hey there CCP, thanks for the prompt reply.

    Despite the fact that most REITs get treated as ‘other income’, my emphasis was mainly having REITs in a taxable account for enhancing one’s income stream. Stating that they’re ‘better’ in a tax-sheltered account is subjective indeed (maybe not as it relates to the couch potato strategy) and by investing on this premise exclusively, one’s cash flow stream can be compromised. There will be less liquidity for the investor when too much is tied up exclusively in RRSPs. One of the biggest problems people have when they retire is that too much is tied up in registered accounts.

    It’s inevitable – the tax man/woman will come, and when it’s time to start drawing on RRSPs, it gets treated as income. Not only that, regardless of one’s income, there will be withholding taxes on withdrawals. If you’re income is low enough, you’ll eventually get refunded, but that’s not too good if you need the cash.

    My thoughts are that a good strategy entails an asset allocation that embraces a more balanced approach to both non-registered and registered accounts.

    I’m actually in the process of reading up on your Model Portfolios section of your site as I’m interested in possibly adding index funds and ETFs for my own portfolio.

    Regarding one’s preferences however, I’m with you. If an investor wants 40% in bonds and that’s what makes them sleep at night, by all means – let it ride. My example of providing banks as an alternative was mainly to highlight the idea how some of the dollars allocated for bonds could go elsewhere. My intent was not to violate the terms of the couch potato strategy, just to add some critical feedback and alternatives as asked.

    Nice thread. Looking forward to spending more time on your site. I like what I see.

  6. Canadian Couch Potato March 20, 2010 at 12:00 pm

    Excellent points, Rat. Thanks for sharing your insights and hope you’ll stick around on the blog.

  7. Chris March 22, 2010 at 11:03 am


    In regards to #6, please explain what you mean by “in bond funds, your principal is not guaranteed”. Ignoring the fact that your principal is never actually guaranteed even with direct ownership (default is always a possibility), I’m not sure that I understand.

    Bond Funds hold bonds to maturity (ignoring the redemptions of others). Assuming that you’re planning to hold bonds to maturity, how exactly is the behaviour of your entire bond ladder different from the price of the fund? The only issue I see is if you plan on making a withdrawal; it’s possible that interest rates have gone up (fund value has dropped) and the value of the weighted average of your units is less than the face value of the ladder rung about to mature.

    Come to think of it, with a long time horizon, why bother with an explicit bond ladder (e.g., CLF) when diversification and higher gains are more appropriate (e.g, XBB)? With a short time horizon, why use a bond latter fund (CLF) when you require a yearly withdrawal (principal or interest) and want to avoid selling low.

    Come to think of it, why bother with CLF at all? It seems to me that the benefits (e.g., better prices at purchase due to economies of scale — CLF can likely buy at lower fees than I could from my broker’s inventory) are nearly wiped out by interest rate risk over the short term.

    Or am I missing something about how CLF operates? Are gains distributed or reinvested? Can you receive funds back from the rung that just matured without triggering a sale from the other 4 rungs?


  8. Canadian Couch Potato March 22, 2010 at 11:13 am

    Chris: Bond funds don’t necessarily hold bonds to maturity: in fact, if I understand the literature about CLF, it never does: it sells all its bonds as soon as the maturity is less than one year away. Its interest payments are distributed in cash.

    I think it may be time for a post about bond funds and ETFs, as many readers seem confused about how they work. Will get to it as soon as I can!

  9. DM March 22, 2010 at 10:57 pm

    Hi Chris,
    What I was getting at is that in a rising interest rate environment, the price of bond ETFs (and bonds for that matter) will decline. But if I’m holding bonds directly with no intention of selling, I am not concerned about interest rates. As for principal protection, yes there is the risk of default. But assuming that doesn’t happen, which is not so crazy for me as I buy only high grade corporates (e.g. canadian banks, pipeline companies, etc.), the principal is effectively guaranteed if I hold to maturity. I am intrigued by comments of Canadian Couch Potato though (maybe we can say CCP for short). There are definitely advantages to bond ETFs that I might be underestimating (e.g. liquidity, ease of managing, etc.)

  10. […] Couch Potato talks about the folks that they met that are Mutual Fund Refugees, sounds like the Mutual Fund business may take a hit soon (we can only […]

  11. Dale March 27, 2010 at 12:40 pm

    Given the state of low interest rates these days and with the real prospect of nowhere to go but up (ie, BoC Governor recent hints), I’m wondering if 40k of XLB (and perhaps XRB as well) might be the wrong device to use in this portfolio. And given that sometime soon this portfolio will need to fund a good portion of retirement, returns may be nil to poor when long term bond investments are used.

    The big elephant in the room continues to be: Market Uncertainty, more than ever before.

    Perhaps another approach could be as taken from a suggestion by National Bank’s Andy Filipiuk who suggests a way of hedging against the big four investment uncertainties: inflation, deflation, recession and prosperity, by incorporating the following into an all-inclusive portfolio:

    25% XSB, 25% XRB, 10% CPD, 20% XIN, 20% GLD

    Of course this doesn’t entirely address interest rates rise, and seems rather risk aggressive as it relates to a Retiree and his limited time horizon. Perhaps some sort of modification may bring it into spec? The original blog post’s Retiree portfolio example seems to incorporate several of these features. However, again long bonds may become a problem for future income sourcing.

  12. Easter Links and Money Links Oh My! | Squawkfox April 3, 2010 at 12:38 pm

    […] A Mutual Fund Refugee | You’re not alone! […]

  13. Ross October 6, 2014 at 12:09 pm

    I am relatively new to the indexing and unfortunately I still have some mutual funds with an advisor. When I asked him about redemption of these funds he told me that it would cost 3% of my principle in order to sell these mutual funds. Currently the combined MER of these funds is 2.55% with of course a trailing commission that goes to him (who knows how much that is). Is it worth while to cash everything in and invest it into index funds or should I wait until the redemption percentage is lower? I think I have about 2-3 years left since he locked me into DSC series funds (which I should add I was never aware of).

  14. Canadian Couch Potato October 6, 2014 at 8:17 pm

    @Ross: If you’re planning to dump your advisor and become a DIY investor then it is usually best to simply make a clean break and eat the DSCs. You will immediately cut your MER by 90% and it won’t take long at all to recoup those costs. If you’re planning to move to another advisor who uses index funds and charges a transparent fee, then sometimes it makes sense to move the funds in kind and have the new advisor sell them gradually to keep DSCs to a minimum or even eliminate them altogether. We sometimes so this with clients at PWL:

  15. Alain Guillot May 4, 2018 at 7:58 am

    Let’s imagine this scenario.

    Scenario 1

    $100,000 invested in bonds, with an average return of 2%. The taxable gain is $2,000 at a 40% tax rate, Daren would pay $800 in taxes.

    Scenario 2

    $100,ooo invested in stocks. Average capital gain of 8%. Taxable gain is $8,000 X 50% = $4,000, at a tax rate of 40% = $1,600.

    Even though interest revenue is 100% taxable, I would keep them in a taxable account and let them be taxed 100%. I would still pay fewer taxes than by paying only 50% taxes on my capital gains.

    With this mathematics in mind. I will put my bonds in the taxable account and my stocks in the registered account.

Leave A Comment