One of the most gratifying things about writing this blog is getting emails from young people who are just getting started in Couch Potato investing. “Without you,” a 23-year-old wrote this week, “who knows what I would have continued to do with my money.” I wish I could say I got started that young.
“New Potatoes” are often full of questions about the ideal asset allocation (“Should I include 10% in emerging markets?”) and how they might save a few basis points by choosing Vanguard ETFs instead of the TD e-Series funds. But when it comes to new investors who are starting small, I think these decisions are almost immaterial.
If I could send one message to young people who are just beginning their investing journey, it would be this: stop worrying about squeezing out incrementally higher returns and concentrate on saving more money. Because when your portfolio is small, the size of your monthly contributions has a much a greater effect than your rate of return.
When savings are more important than costs
To illustrate this idea, let’s look at two investors at different stages of life. Christopher is in his early 20s and has just started his first full-time job. He’s saved $5,000 in his RRSP and plans to sock away another $100 a month. Christopher is trying to determine the perfect asset mix and keep his fees as low as possible. But what if instead of trying to optimize his portfolio he instead made an effort to increase his monthly contribution to $150, or even $200?
Starting value $5,000, contributions for 10 years
| Rate of return | $100/month | $150/month | $200/month |
|---|---|---|---|
| 1.5% | $18,151 | $24,464 | $31,717 |
| 2% | $19,400 | $26,047 | $32,694 |
| 3% | $20,756 | $27,760 | $34,765 |
| 4% | $22,228 | $29,615 | $37,002 |
| 5% | $23,828 | $31,624 | $39,421 |
| 6% | $25,567 | $33,802 | $42,037 |
| 7% | $27,458 | $36,162 | $44,867 |
| 8% | $29,515 | $38,723 | $47,931 |
| 9% | $31,753 | $41,502 | $51,250 |
As you can see in the table, at $100 a month and a rip-roaring annual return of 9%, Christopher would have $31,753 after 10 years. But if he increased his contribution by 50% to $150 a month, he would only have to earn 5% to wind up with the same amount. If he were able to dig deep and double his monthly contribution to $200, he wouldn’t even have to take any market risk: a savings account earning just 1.5% would leave him with an almost identical $31,717.
It seems clear that at this stage of his investing career, Christopher is far better off finding an extra $50 to $100 in his budget rather than trying to get an extra percentage point out of his portfolio’s performance—let alone 10 or 20 basis points by choosing ETFs instead of index mutual funds.
When low costs are paramount
Now let’s consider Nicole, who is in her 50s and has accumulated $200,000. Nicole is well along in her career and is now contributing $500 a month to her account. She wants to get an extra 1% out of her portfolio to ensure that she retires with a comfortable nest egg, and she is considering making some changes that will lower her costs by that amount. She wants to compare this cost savings to the alternative of raising her monthly contribution to $750, or even $1,000:
Starting value $200,000, contributions for 10 years
| Rate of return | $500/month | $750/month | $1,000/month |
|---|---|---|---|
| 4% | $372,036 | $408,972 | $455,907 |
| 5% | $407,367 | $446,349 | $485,331 |
| 6% | $446,229 | $487,403 | $528,578 |
| 7% | $488,980 | $532,503 | $576,027 |
| 8% | $536,011 | $582,052 | $628,093 |
Because Nicole’s portfolio is so much larger than Christopher’s, lower costs (or higher investment returns) now mean thousands of dollars every year. Increasing her returns by one percentage point over 10 years would have a greater effect than increasing her monthly contribution by 50%. And two percentage points—the approximate MER difference between a typical portfolio of actively managed mutual funds and ETFs—accomplishes more than doubling her contribution. It adds up to about $100,000 over 10 years.
Keeping costs low and choosing an appropriate target rate of return are important at every age. But the truth is, if you’re a young investor these factors matter a lot less than you think. In your 20s, it’s better to focus on spending less than you make and saving the difference. Once you have built significant wealth—and you will—then those basis points become much more important. Lay a foundation of good habits and by the time you enter your peak earning years you’ll be primed for success.
@newbie: Yes, you will still pay a withholding tax on US dividends if the ETF or index fund is held in a TFSA. Withholding taxes are levied by the US government, which does not recognize the TFSA’s tax-free status. (However, the US and Canada have a tax treaty making RRSPs exempt from this tax.)
Note, however, that this does not apply to capital gains. These are not taxable in a TFSA.
@SterlingF and Marc: Here’s the answer from RBC. To clarify the first point, early redemption fees can be charged by the brokerage or by the funds themselves. RBC Direct Investing (the brokerage) does not charge early redemption fees, but RBC Asset Management (the index fund provider) does. It should be noted that other brokerages and other index fund providers will have different rules. These rules are quite a bit more generous than most.
Many thanks to RBC for the clear and prompt reply.
What??? That is the worst advice I’ve ever heard. Obviously Chris should be trying to do both. Get the best returns he can and save his money. In your example he’d have 50k+ if he could do both. They are mutually exclusive. Chris should focus more on eating vegtables and less on savings money… Does that not sound stupid too. He should do both!!
@Mark: I’d appreciate it if you’d keep comments more respectful. I’ve never claimed that it’s impossible to maximize your savings and minimize costs. But if you received the amount of investor email that I do, you might have a different perspective. You might be surprised how many young investors pay little or no attention to saving, choosing instead to focus all of their energy on portfolio optimization that will have very little effect on their results. It’s also important to remember that Chris can’t just go out and get 9% returns. We cannot control our rate of return, but we can control our contribution amounts.
@Canadian Couch Potato. I think you are contradicting yourself. “But what if instead of trying to optimize his portfolio…” (from the article) (implies he can change his rate of return) ” We cannot control our rate of return”(from your comment)
“Lay a foundation of good habits and by the time you enter your peak earning years you’ll be primed for success.” This I agree with. Make good habits of maximizing returns AND savings.
I agree savings is important, but it is completely unrelated to maximizing return.
I didn’t mean to offend and I apologize.
@Mark: Thanks for the reply. You can control expected returns by tweaking your asset allocation and by lowering your costs, and this is what I meant by portfolio optimization. But unless you stick to GICs and the like, you cannot know your absolute rate of return. You can tilt more of your portfolio to stocks or reduce your costs by 50 basis points, and both of these actions raise your expected returns, but they offer no guarantees. Saving more money has no effect on your expected returns, but it does guarantee that you will end up with more money.
I have spoken with many financial planners and advisors who have told me they regularly deal with clients who are so focused on their investment returns that they forget that if you’re not saving enough money, nothing else really matters. Very few people get wealthy because they are outstanding investors. They’re more likely to accumulate wealth by spending a lot less than they earn, and then wise investing allows them to preserve and grow that wealth.
I just would have worded more like that in the article instead of saying that people should “stop worrying about squeezing out incrementally higher returns”
Instead say, worry about incrementally higher returns but it is also important to save more money.
I’ve read around the site some more. It looks very good.
I would want to if there a way to build a good portfolio with all the free trade ETF availible on virtual brooker (100 ETF), Qtrade(50 ETF) and scotia Itrade(40 ETF). If yes you should add this new portfolios to your list and call the The ComFree Patato ;)
@Francis: In general, I don’t recommend making this the primary driver of your decision. The lineup of free ETFs at Virtual Brokers, iTrade and Qtrade is quite limited, and most of the products are narrow sector ETFs, commodity ETFs, etc., with few options for the core asset classes. Claymore’s ETFs are well represented, but many of these funds have higher MERs than index mutual funds. So it makes little sense to use these funds simply because they trade without commissions. If you are a believer in fundamental indexing, however, then this is a good opportunity.
In terms of core asset classes, you might consider CLF and CBO for short-term bonds, HXT and XMD for Canadian equities, and HXS for US stocks (as long as you don’t mind currency hedging).
@Canadian Couch Potato: thank you so much for following up with the reply from RBC. It sounds like the plan will work: use an index mutual fund as a “bucket” to collect monthly contributions without incurring fees and then every year “empty the bucket” into ETFs (allocating as required to balance the portfolio) making sure to leave enough units in the mutual fund to avoid the early redemption on the last month’s contributions.
@Marc: You’re welcome, and good luck with the plan.
@CCP – was digging through your old posts – your site is truly a “gold mine” of information. You certainly convey your passion for this, and it is quite motivating. Reminds me of the book “The Richest Man in Babylon” which is a great read for anyone trying to build wealth.
Now for a real question – I just saw your comments on iTrade and Virtual Brokers’ free ETF trades, but with limited selection. Fast forward to today, and Questrade is now offering free purchases for ANY North American ETF. Do you have any thoughts on this? Is this not a great alternative to the TD E-series funds as people can contribute regularly without taking a hit? (I think ECN fees still apply though..)
Thoughts?
@Kevin: Questrade is probably a good option for investors who are bent on ETFs, but in my opinion the TD e-Series funds are still the best place for small accounts:
https://canadiancouchpotato.com/2013/02/19/why-index-mutual-funds-still-have-a-place/
I am 25 and working as a an engineer. I have about 15k saved right now, and can put away almost 40k a year, which I have excess of all my living expenses. I was looking at opening a TFSA and filling it with index funds and capping it each year, as well as investing the rest of this excess money each year.
If I would be looking at using this money in the next year or two to purchase a new car, and maybe 5 years down the road purchase a house. Can a TFAS retroactively be filled (can I fill it for 2013/2012/2011 etc), such that the rest I can put into a RSP (the amount in a TFSA would be more than enough for a car if I can do this), or would I have to look at filling up the TFSA each year and just setting up a mutual fund account if I’ll need to withdraw it in the next year or two for a car. I was looking to fill these accounts with index funds (TD e series or ING).
Thank you for this blog and articles. I have a learned a lot reading these posts, and it has really motivated to invest my money instead of letting it sit stagnant in a ridiculous low interest savings account.
@Matt: Yes, you can retroactively fill a TFSA. Even if you have never opened an account, your contribution started accumulating in 2009, when the TFSA was launched, as long as you were 18 years old. So in your case, you should have $31,000 of room if you have never made any past contributions.
The bigger issue is your suggested strategy. If you plan to use the money in the next year or two (or even the next five), it should not be invested in index funds (except perhaps a short-term bond fund). Stocks and (many) bonds are long-term investments that can lose value over shorter periods. The only appropriate place to stash savings for one to five years is a savings account or GICs.
https://canadiancouchpotato.com/2010/08/16/lunch-is-still-not-free-even-if-its-potatoes/
https://canadiancouchpotato.com/2010/11/10/ready-willing-and-able-to-take-risk/
I just signed up for a questrade account. I am still trying to understand why one shouldn’t invest in ETFs with less than $50,000? Is it ok to start with them since it doesn’t cost anything to buy them and if I plan on getting my investments to that amount in the next few years?
@Rachel: The $50K limit is just a guideline, not a rule. If commissions are zero on the ETFs that clearly changes the situation. However, I do like to remind investors that trading ETFs properly takes some experience and there are still many advantages to using index mutual funds on smaller portfolios.
https://canadiancouchpotato.com/2013/02/19/why-index-mutual-funds-still-have-a-place/
I have just shy of $20,000 sitting in a chequing account. I am starting university this coming year, and would like to put my money away somewhere for the future. I have no investment experience, but I am very interested in the stock market.
I was looking to invest in index funds (for long term; 7-10years) and GIC’s and TSFA’s for shorter term (within the next 3-5years). I already have a web broker account with TD, but there e-series funds would charge me annual account fees for not having the minimal amount of $25,000 to invest.
What would be an sensible spit of my total cash value?
How much (%) into index funds?
How much (%) into GIC/TSFA accounts?
I am looking for an opinion or advice to help determine where to start. Investing through TD web broker would be easiest since I already have an account set up, and I do my banking through TD. But if there are alternatives with lower/no fees I would look into that instead. (I believe Tangerine investment funds has no annual fees).
I also noticed that the MER for TD e-series funds are significantly lower than any other funds. Tangerine, along with most others I come across, have an MER of around 1.07% .
I am running into one pretty fundamental challenge as a new potato, and it’s not savings power. Basically, I find it very hard to set financial goals and targets as a single, unattached 25 year old! It’s possible that I will want to buy a condo in five years, if I find the right place or partner. Then again, maybe I won’t, and I am happy to continue renting for the foreseeable future… Given such uncertainty, how should one split current assets and future savings between a Couch Potato portfolio and a GIC ladder or HISA approach? I tried working out how much I would need for a down payment in 5 years and whether I end up paying more in interest on the mortgage then I am making in returns with a Couch Potato portfolio, but then again, who knows what rates and property prices will be by then (let alone my salary / savings ability)!
The other confusing aspect are the tax implications. I will have enough to max out my TFSA already. Can you even contribute to the same discount brokerage account beyond your contribution limit if you opened it as a TFSA (I am assuming you’d be taxed only on the portion in excess of your contribution limit)? Or do I need to open separate discount brokerage accounts for an RRSP (in which case, do I need to consider total asset allocation between both accounts, or simply for each individual account)? And beyond that, I am not sure I ever expect to make less in retirement than I am making now, so I am wondering if RRSP is even an appropriate choice to begin with, as opposed to a personal investment account.
My info: I have about $20K in blue chip stocks, which have been doing well, and $25K sitting in a HISA as a TFSA simply because I haven’t been able to decide on a strategy. I also have a generous defined benefit pension (though who knows if I will spend my entire career in the public sector). At the moment I am considering selling my stocks and transferring my HISA to a discount brokerage account to max out my TFSA and contribute to a separate RRSP account, both with the Global Couch Potato portfolio, possibly with a view to using the Home Buyers’ Plan on my RRSP in five years if I want to buy property.
@Frank: First let me say you are well ahead of most 25-year-olds when it comes to saving and planning, so kudos for that. I worry you might be overthinking things a little too much. At this stage of life, as long as you continue to save and think a few years ahead you don’t need to agonize over the details of your long-term investing decisions. A few words of guidance:
– I would probably avoid GICs longer than two or three years, because GICs are usually not liquid. If you lock up a lot of money in five-year GICs and then decide you want to use it as a down payment it may not be available. So use cash and one- or two-year GICs for any money you might need imminently.
– “Can you even contribute to the same discount brokerage account beyond your contribution limit if you opened it as a TFSA (I am assuming you’d be taxed only on the portion in excess of your contribution limit)?” I’m not sure I understand this comment. You can open multiple accounts with the same discount brokerage (TFSA, RRSP, non-registered) but you absolutely should not overcontribute to your TFSA. You are not just taxed on the excess amount: you’ll pay a 1% penalty per month.
– It sounds like maxing out your TFSA first is the right move, and once you have done that you probably should consider an RRSP. Remember that you do not have to claim the RRSP deduction in the year that it’s made: you can carry it forward indefinitely. If you expect your income to be higher in the future, you can defer claiming the deduction until then. Meanwhile, your money grows tax-free and you have a nice disincentive to withdraw it and blow it on a trip to Vegas.
– For now I would just try your best to divide your savings into two piles: one for the next five years or so and one for long-term retirement savings. Keep the first pot of money in cash and short-term GICs, and then keep the other in a diversified portfolio that includes as much in equities as you can stomach. (Just be aware that you probably have no idea of your risk tolerance because you’ve never endured a bear market, so err on the side of caution.)
Good luck!
Hi, I’m 25 and recently started a government position paying around $55K Gross. I currently live with my parents and will continue to do so for at least 1-2 years, therefore my expenses are very low.
I have opened a Tangerine TFSA investment account (Balanced Growth) and I have up to $36.5K TFSA room available. I also opened a RRSP balanced income account. I’m looking to start contributing with my new salary – I have no previous investments.
My questions are the following:
1) Given that I can contribute anywhere between 50-80% of my monthly salary to investments, should I put it in all in the Tangerine accounts, or also open another brokerage account and purchase other funds or ETFs? I know that you recommend $25K+ for ETFs but, am I “missing out” on ETFs, given that I can invest around $25-$30K within the next 2 years?
2) should I care about how the market is doing, or just set up a automatic contribution to the funds ( I was thinking at least bi-weekly or weekly).
3) I want to take advantage of the fact that my living expenses are low as much as possible – but Is putting a large % of my salary in investment fund even a good strategy, or should I also leave a portion in a normal savings/or GIC? I am medium to high risk tolerant (at least for the current year) given my circumstances.
Thank you everyone for your guidance, any other advice/tips is greatly appreciated !
I have been reading your articles for a couple years now and I feel as though you have made me want to invest. I am currently a 19 year old university student and have around $5000 for an initial investment, and can contribute around $200 per month into the account. I just wanted to ask you what the best strategy is to start off investing. My goal is not short term growth, but I want to have an account that earns between 2-5% annually that I would keep in for around 10-15 years. If you could help me out that would be greatly appreciated!
@CPP
I’m hoping you can provide some guidance, my goal is to save for my retirement, 20+ years from now.
Currently I have $14k in a RBC Select Conservative portfolio with a Group RSP, contributing $1000 monthly via pre-authorized contribution but without employer contribution.
Because I’m financially illiterate, my plan is to transfer everything to Tangerine Balanced Growth Portfolio and increase my contribution to $2000, while I educate myself to make better choices.
My questions:
1.) Would the move be worth it, or should I set up my RBC as per the funds mentioned in the “RBC Revamps Its Index Fund Lineup” article? I.e.
* RBC Canadian Index Fund 20%
* RBC U.S. Index Fund 20%
* RBC International Index Currency Neutral Fund 20%
* RBC Canadian Bond Index Fund 40%
2.) About educating myself, do you have any suggestions for someone who just want to know enough to not be dangerous? Here is what I planned to read:
i. Personal Finance For Canadians For Dummies (5th edition)
ii. The Money Class: Learn to create your new American dream
( I wanted to read “The MoneySense Beginner’s Guide to Personal Finance”, but it might be dated, it still refers to ING Direct)
Thank you for any guidance you can provide.
@Marius: I think the decision to use a simple solution like Tangerine is good one: it’s much simpler than using individual funds at this stage of your investing career. Check out my Resources page for some reading suggestions.
@CCP: Thanks for your quick reply – putting to an end a month of indecisiveness.
Thanks so much for all this useful info! I am new to this, so it’s a lot to take in but I’m prepared to go with the TD e-series; however, my question is about how you suggest allocating among my RRSP, TFSA and regular/taxable accounts. Do you allocate differently in an RRSP/TFSA compared to a non-RRSP/non-TFSA within the eseries? I am 40yrs old but am but will have a great government pension when I retire, so I was thinking at least for my RRSP (and maybe) TFSA accounts that i could do 90% equities and 10% bonds, but for the other cash account to do 30-40% bonds and 60-70% equities. Does this make things too complicated? Or do you suggest that across all accounts I select my appropriate allocation and not have it specific to type of account and if so, how do you divide it up among all three? Or, would it be a good idea to place my RRSP and TFSAs in the TD eseries and then do my other account with Questrade, therefore keeping my non-taxable and taxable ones separate? Thank you!
@Jessica: I can’t suggest anything too specific, as I don’t know the details of your account setup. But I would strongly encourage you to keep things as simple as possible. I would use two brokerages, and I would not use a combination of e-Series funds and ETFs. Choose one or the other.
For most DIY investors, managing an asset allocation across multiple accounts will prove difficult and frustrating. If you’re comfortable using ETFs, your best bet is likely to use a single asset allocation ETF (see my Model Portfolios) and just hold it in each of your accounts. This is never “optimal” but striving for optimal often backfires. I’d suggest getting everything set up this way, and then somewhere down the road if you are more comfortable managing the portfolio you could consider making a few tweaks.
Hello, just to clarify my original question, I am looking at setting up the TD e-series index funds (not the ETFs). My main question was weather I should set up a TD e-series index fund to include my TFSA, RRSP and cash account and then whether I should apply my selected allocation across all three accounts or within each separate account. Secondly, is there any advantage to setting up my TFSA and RRSPs in the TD e-series index fund and setting up a cash account in Questrade (or vice versa) or is it best to keep the accounts all together? Thanks!
@Jessica: To answer your first question, it is certainly easiest to maintain the same asset allocation in all three accounts. I’m not sure I understand the second question. Why are you considering opening an account at a different brokerage for the cash accounts? I had assumed you mentioned Questrade because its most attractive feature is that it allows you to buy ETFs for free.
Thank you for such an informative website! There is one thing I cannot find and would love some advice on. I am about to receive a fairly large amount of money through commuting my pension. A portion ($132K) will be put into a LIRA which I have opened through Questrade. Given I cannot add funds to it, I think that following one of the model ETF portfolios makes the most sense…I am 40 years old so have some time for it to sit and grow. Does that make sense?
@Sonya: I think a an asset allocation ETF is ideal for a LIRA. As you note, you will not be able to make contributions, so you won’t be able to rebalance with new cash. So you can just choose the appropriate one-ETF portfolio, use a DRIP, and you may be able to leave it alone for many years.
@CCP: Thanks! Appreciate your response.
Hey there! We appreciate you so much. Thanks for helping this new potato out. I’m definitely planning to keep up the discipline of saving. I’m also going to create a QTrade account (TFSA) and buy ETFs. I currently have: TD Chequing – $22k ; TD Mutual Fund TFSA – $34k ; TD Mutual RRSP – $12.5k. I’m considering buying ETFs using the Model Portfolios you suggested (Vanguard or iShares, 70% equities) with my chequing account — starting small with $2000, and deposit more monthly. I’m thinking of keeping the TD TFSA as is, for purchasing a property (down payment) in the near future. My QTrade is for longer-term, and I’m 28 years old. My questions are:
1) Is there any risk of putting all ETFs into just Vanguard or just iShares (eg. is it even possible for Vanguard to crash and burn)? Should I be diversifying by buying both Vanguard + iShares, or even other ETFs (eg. XAW, ZAG)?
2) In your Vanguard Model Portfolios, I notice some ETFs include U.S. and global markets (eg. VBG). Does this mean I will need to pay a withholding tax? (I’m opening a TFSA account.) Or, as long as the ETF has “.TO / TSX” beside it, I am fine to purchase it without paying taxes? Some non-Canadian ETFs I’ve also been looking at were ICLN, ARKG, EWY, EWT, etc.
@Helene: There is no risk in using only one ETF provider, such as Vanguard or iShares. Even if one of these firms were to become insolvent (a vanishingly small risk), investors in their ETFs would not lose their investments.
There will be foreign withholding taxes on some of the foreign equity funds inside the asset allocation ETFs. However, if you are investing in a TFSA there is no way to avoid this, expect to avoid investing in foreign equities. This is absolutely not a reason to avoid using the asset allocation ETFs.
Thanks CCP! Final question: If I decide to go with an all-in-one asset allocation (eg. XGRO), and I change risk tolerance/portfolio (eg. to XBAL) 20 years from now, what are the negative implications, if any? Am I better off to just get XBB and XEQT now (instead of XGRO) so that it’s easier for me to re-jig my portfolio?
@Helene: Switching from one asset allocation ETF to another in an RRSP or TFSA takes two trades and about five minutes. I’d encourage you not to anticipate problems that might come up 20 years from now. Just focus on getting a good plan in place now.