This year has been another reminder of why international equities are such an important part of a diversified portfolio: in the first 11 months of 2015 the Canadian market was down almost 6%, while international developed markets were up close to 15%.
On December 9, Vanguard Canada launched two new ETFs tracking international equities: the Vanguard FTSE Developed All Cap ex North America (VIU) and a currency-hedged counterpart that uses the ticker VI. These new funds are a welcome addition to Vanguard’s ETF lineup, but they make the choices more confusing, because there are already similar funds on their menu. So let’s try to sort it all out.
First, the background. Vanguard Canada seems to have been put in an awkward position by recent changes to their benchmark indexes. Back in June, their US parent company announced that four international equity indexes provided by FTSE would expand to include mid-cap and small-cap stocks as well as China A-shares. Those were potentially useful changes that added more diversification. However, they also announced that the FTSE Developed ex North America Index would eventually become the FTSE Developed All Cap ex US Index. That means the new benchmark will include Canada.
The changes make good sense for US investors who get their foreign equity exposure with the Vanguard FTSE Developed Markets ETF (VEA), since Canada was the only developed country missing from that fund. But they create a problem for investors who hold the Canadian ETFs using VEA as their underlying holding: namely the Vanguard FTSE Developed ex North America (VDU) and its currency-hedged version, VEF. Right now these funds are useful for Canadians who want to add western Europe, Japan, Australia and other developed markets overseas. But VEA’s index transition is complete (the timeline hasn’t been announced) Canadians holding VDU or VEF will see their home country making up part of their international equity allocation. Granted, it will be a relatively small allocation (about 7% or 8%), but it’s not ideal.
Two new spinoff ETFs
Vanguard Canada could have addressed this issue simply by making changes to VDU and VEF. They could have decided to sell the entire holding in VEA and replace it with other US-listed ETFs that don’t include Canada—Vanguard FTSE Europe (VGK) and Vanguard FTSE Pacific (VPL), for example. But that would have created a potentially larger problem: international equities have appreciated significantly since the Canadian ETFs were launched (VDU has risen in price by some 40% in four years), and such a switch would likely realize large capital gains that would be passed along to investors who hold the ETFs in taxable accounts. So instead Vanguard decided to leave VDU and VEF unchanged—though these ETFs will eventually be renamed to reflect their new index: the FTSE Developed All Cap ex US.
Vanguard Canada has also created two new ETFs that will exclude Canada: the Vanguard FTSE Developed All Cap ex North America (VIU) and the hedged VI. These will be a better option for Canadians looking for more precision in their international equity allocation.
But there’s more: the new funds will get their exposure by holding the stocks directly, rather than via an underlying ETF. This is significant because the “wrap” structure adds an additional layer of foreign withholding taxes, whether the fund is held in an RRSP, TFSA or non-registered account. Unfortunately (though not surprisingly) the ETF will use a sampling strategy for now, until it gathers more assets. That means it will hold only a portion of the 3,500 stocks in the index, which may lead to larger than normal tracking error until the index can be fully replicated.
And what should you do if you already hold VDU or VEF? In a taxable account, if you would incur a large realized gain, it is probably not worth selling your existing holding. But if it’s a registered account and you can switch without getting slapped with a tax bill, it probably makes sense to sell the older Vanguard ETFs and replace them with either VIU (or VI), or the comparable iShares Core MSCI EAFE IMI (XEF). That will allow you to clear Canada out of our international equity holdings and reduce the drag from withholding taxes at the same time.
@Llui: No plans to change the model portfolios at this time. I will be publishing the returns in early January. Yes, pretty much all Canadian equity index funds experienced negative returns in 2015.
Dan – thanks for the quick reply. What are the pros/cons of the laddered GIC approach versus one of those bond ETFs?
There’s so many etf’s now it’s getting confusing. For example what’s the difference between ishares xin and xfh ? both have the same title except for xfh which also has “core and imi ” in the title. To me both are etfs that are international equity hedged to canadian dollars. Why does ishares offer 2 ? both seem the same to me.
@Llui: “Also, this year Canadian equity was quite a disappointment and that will probably lead to negative returns this year right?”
I don’t intend to be facetious, but your comment, though technically factual, need not have been part of your bemoaning summing up of 2015, or of any year or period for that matter, for any disciplined Couch Potato (passive index investor) with a rational, well thought out, simple, diversified portfolio and a long term outlook.
Speaking (hopefully) as someone in that camp, although for academic and self-amusement reasons I sometimes pore over the varying trajectories of the individual components of my portfolio, in an overall sense I don’t have “disappointments” about my portfolio any more, and I don’t expect to in the future.
My Couch Potato approach will always be expected compare favourably to any other strategy I know of, particularly the poorly thought out “listen to your stock-broker” and/or “predict the future” approach that most people (myself included) seem to start out with.
@Jake: Yes, the variety and choices can be overwhelming, so you have to look carefully at the strategy. In this case, XIN holds primarily large cap stocks (about 900 holdings), while XFH also holds mid and small caps (about 2,500 holdings).
@Jean: This should help:
https://canadiancouchpotato.com/2015/03/27/ask-the-spud-gics-vs-bond-funds/
@oldie: I don’t mean to be facetious either, but am I correct in inferring from your comment that you have crossed the rubicon from being a dividend growth investor to that of a passive index investor?:)
@Tristan: Basically yes. To be fair, I never really was a believer that dividend growth gave more secure or higher returns. I basically fully bought into the Diversified Portfolio of Passive Index Fund idea from the moment of starting to read about it. My large “disposable” investment, i.e. the non-RRSP portion that my wife allowed me to self invest was, by default, fully taxable, and I struggled with finding a tax-friendly way to diversify the non-equity portion, and for a while I had some investments in Canadian Preferred Shares indexes, hoping that they represented some diversification separate from bond funds and equity funds, while liking the favourable tax treatment on the not inconsiderable dividend income. But eventually I liquidated them and replaced them with more plain vanilla Canadian Equity Index ETFs, ending up with rather more than one third of my Equity holdings in Canadian Equity ETFs, reasoning that I could live with this percentage, and whatever dividend I received and will continue to receive from this portion was and hopefully will continue to be favourably taxed.
My bond portion was all in BXF until a year and a half ago, at which time I replaced it all with HBB soon after it became available.
@ oldie: Can you share why you switched to HBB from BXF? I am trying to plan the fixed income side of my non-registered portfolio, and am interested in your rationale. Also, what is your opinion of using bonds versus a GIC ladder approach (see my conversation with Dan above)?
@Jean: Don’t want to hijack this thread, but briefly, (this choice has been discussed quite extensively in several posts in this blog) GIC ladder is simple, better tax than horrible situation on bond ETFs, but interest is paid at fixed intervals, so you have no choice on the tax paid, the ladders expire at fixed intervals so you don’t have as much flexibility in balancing, BXF is an ETF so you have more flexibility in balancing, tax is less, but you still have to pay it on income portion. HBB at first glance is rather opaque and intimidating for us North Americans, but apparently this sort of structure has been used for quite some time in Europe, and investors there are comfortable with it, and besides HBB was not available till lMay 2014. I have a large portfolio, and I don’t need the income to live on, so the tax hit was considerable. I own HXS (for tax reasons too, similar structure) so the choice of HBB was easier for me. No tax till sold, and then only on capital gains. My understanding from this blog is that, for RRSP at least, bond ETFs are ideal for Couch Potato portfolios, so for large taxable portfolios it would seem HBB is a reasonable substitute.
(@Jean: But you must be comfortable with the rather roundabout structure, which I am now.)
At the risk of sounding novice (which I most certainly am!) I really don’t like these Horizon ETF swap funds (HBB, HXT, HXS). I understand this style of an ETF is popular in Europe and they are “tax efficient” – since one doesn’t have to pay the tax on the distributions, or any tax at all if one is a non-resident investor – but it seems to me that one forfeits the protections of a diversified portfolio to one with promises and legalized commitments from a few key players. These few key players have little to no relationship with the actual underlying assets: The National Bank of Canada as the counterparty, the Horizons fund company, and the government regulators/regulations that are meant to ensure that Horizons doesn’t do anything fraudulent with the invested principal. I’d love to not pay the tax on the distributions. I’m a non-resident and therefore could legally avoid not paying any tax, like an infinite RRSP with no capital gains expense at the end. But then I’d have to trust the National Bank to make good on its commitment, on Horizons to ensure they don’t do anything obscene with my principal/collateral, and the government to regulate effectively. I can’t trust that those stars will forever be aligned and therefore I’d much prefer to pay the tax and own the likes of a VUN, VCV, VAB, and XEF.
Canadian Couch Potato wrote:
“@Jean: The equity ETFs in my model portfolios are fine for non-registered accounts. When it comes to fixed income, however, it is best to avoid traditional bond ETFs such as VAB in taxable accounts. A GIC ladder is often a more tax-efficient option, as long as you do not need liquidity (GICs cannot be sold before maturity).”
In 2015, a taxable VAB investor had a total (before tax) return of 3.6% due to 0.8% in price increase and 2.8% in distributions. If I subtract taxes on distributions (2.8% X 50%), I get an after-tax total return of 2.2%.
In 2014, a taxable VAB investor had a total (before tax) return of 8.8% due to 5.6% in price increase and 3.2% in distributions. If I subtract taxes on distributions (3.2% X 50%), I get an after-tax total return of 7.2%.
The annual compound return of a taxable VAB investor, since 2014, is 4.7% after tax.
GICs are safe short-term debt securities. As such, they do not benefit from the diversification of an aggregate bond ETF which contains bonds of all maturities above one year and a mix of investment-grade corporate and government securities.
Had a taxable investor used a GIC ladder since 2014 instead of VAB, he would have forfeited 75% of VAB’s after-tax cumulative growth over the period (assuming capital gains are not realized and a generous GIC rate of 2.5%).
In the total market itself, bonds are bought near their par value redeemed at par on maturity. In real life, an aggregate bond fund will approximate this, but with a few differences due to downgrades, upgrades, and ETF inflows and outflows. Therefore, an investor can expect the NAV of an aggregate bond ETF to gravitate around a set value.
If I look at the historical NAV of XBB, the oldest Canadian aggregate bond ETF, I see an increase in NAV, due in part to the tax-efficient structure of an ETF. When an ETF creates new parts, it can redistribute recent coupons over a larger set of parts and transform interest gains into capital gains. ETFs are really wonderful instruments for taxable investors.
My personal objective is maximize after-tax growth, not to minimize taxes. It’s generally a bad idea to let the tax tail wag the investment dog. I will continue to use VAB in my taxable account.
@LI: Thanks for the comment. Holding VAB in a taxable account is an example of a poor decision that happened to have a positive outcome over the last couple of years.
It is not helpful to look backward at a single two-year period when making asset location decisions. (Using this logic one may as well say you should have held bonds instead of Canadian equities in your taxable accounts, because VAB outperformed VCN over this period also.) Yes, VAB outperformed a GIC ladder over the last two years, but this outperformance was due entirely to the decline interest rates that caused bond funds to rise in value and deliver a return far in excess of their yield to maturity. Had interest rates stayed the same or risen, the GIC ladder would have outperformed, likely on both an after-tax and pre-tax basis.
The best estimate of a bond fund’s expected return is its weighted average yield to maturity, and this is just under 2% for VAB after fees. Basing an investment plan on the expectation that bond returns will be 4.7% is wishful thinking, and is tantamount to a large bet that interest rates will fall significantly lower.
Your description of how a bond ETF works is simply not accurate. Most of the bonds in VAB and XBB were purchased at a significant premium, not near their par value: this is why the fund’s average coupon is much higher than its yield to maturity. And ETFs never hold bonds to maturity: they are typically sold one year before maturity. Premium bonds are notoriously tax-inefficient because they pay a high coupon that will offset by a capital loss when they are eventually sold near maturity unless, interest rates decline.
If a fund is filled with premium bonds one should expect to see its NAV decline over time, reflecting the series of capital losses that will add up as the bonds are sold. The reason this has not happened in recent years is that interest rates have trended downward almost relentlessly for 30 years. That is the reason XBB has seen its NAV increase: it has nothing to do with the tax-efficiency of the ETF structure.
ETFs are indeed tax-efficient for many reasons: the problem here is not ETFs, but rather the premium bonds that make up the underlying holdings. At some point in the future, if interest rates rise gradually, we should expect to see the gap narrow between the fund’s average coupon and the yield to maturity. That will make funds like VAB or XBB more tax-efficient than they are now. But until that happens, traditional bond ETFs should be avoided in taxable accounts. Those who do not want to use GICs can consider ETF options such as ZDB, HBB and BXF.
More information here:
https://canadiancouchpotato.com/2015/03/27/ask-the-spud-gics-vs-bond-funds/
https://canadiancouchpotato.com/2013/03/06/why-gics-beat-bond-etfs-in-taxable-accounts/
https://canadiancouchpotato.com/2014/11/19/ask-the-spud-bond-etfs-in-taxable-accounts/
https://canadiancouchpotato.com/2014/05/08/a-tax-friendly-bond-etf-on-the-horizon/
https://canadiancouchpotato.com/2014/02/13/new-tax-efficient-etfs-from-bmo/
https://canadiancouchpotato.com/2013/06/07/why-use-a-strip-bond-etf/
The @LI sounds like a salesperson who doesn’t give you the whole story, just picks out the good points to sell you. I will stick with GIC’s and high interest savings account in my taxable account
Perhaps it would be more helpful to consider ourselves all as students, some perhaps with more insight and sophisticated judgement based upon experience and more opportunity for in-depth analysis, rather than as possible agents of nefarious intent. Surely we can learn from all, including those whose conclusions differ from ours.
For that matter, @LI “My personal objective is maximize after-tax growth, not to minimize taxes. It’s generally a bad idea to let the tax tail wag the investment dog. I will continue to use VAB in my taxable account.” I would fully concur with your first two sentences, which certainly contain pragmatic wisdom. However, I cannot reasonably follow your example as expressed in your last sentence due to my large taxable portfolio and resulting high tax cost if I were to do so.
The tax reducing alternatives all require some compromise, of course; I really struggled with this. I wonder if I glossed over the benefits of a GIC ladder too quickly. The lack of flexibility of the GIC ladder is only a real problem if you really need precision in re-balancing. As the years of self-managing a real portfolio go by, I’m wondering to myself whether this building in of flexibility/precision in balancing was really necessary. Couldn’t you just buy and hold and not rebalance? Or tolerate the imbalances until the ladder rungs mature and rebalance only at that point?
@Canadian Couch Potato: My understanding of an aggregate nominal bond index fund is accurate. The goal of the fund is to replicate the total market. Let’s ignore the small discrepancies due to selling bonds one year prior to maturity, up/downgrades, and in/out-flows, which are secondary issues to how such a fund works.
A single bond is issued with a coupon and is auctioned near its par value. Then, until it matures, its value fluctuates. At maturity, the value of the bond converges to par. There is no escaping this. This is how a bond works.
An aggregate (total market) bond fund has, as objective, to replicate the total market. It will include newly issued bonds (near par), bonds that will mature shortly (also near par), and a whole lot of other bonds in between, which are subject to fluctuations based on the shape of the yield curve. When the yield curve is steep, as it currently is, many of the in-between bonds will be valued at a premium (because their coupon is bigger than the yield). If the yield curve was to stay fixed, medium bonds would slowly lose in value until they reach par, on maturity. But, this is only half of the picture! The newly issued bonds, that are continuously added to the fund (because is has to replicate the market) will be subject to the reverse movement; they’ll increase in value, because of the steep curve. But, in real life, the yield curve is not static. So, NAV movements (which summarize the sum of all movements) are simply impossible to predict.
The future return of a total bond market fund cannot be predicted using simple measures such as yield to maturity (YTM). YTM predicts the internal rate of return of a single bond between the time it is measured and maturity. VAB sells its bonds one year prior to maturity and reinvests the capital into other bonds. Due to the shape of the total market, VAB is likely to be reinvesting the matured capital into recently issued bonds, which will have a higher YTM than VAB’s YTM in a steep yield curve environment. By the time the average maturity of VAB is reached (10.7 years), these new bonds are “expected” to have returned more VAB’s initial YTM. Actually, 67% of VAB will mature in less than 10 years, so this is more than two thirds of the furure VAB composition, in 10.7 years, that is ignored by VAB’s current YTM!
Nobody can accurately predict VAB’s (or XBB’s, or ZAG’s) future returns over any specific time frame (1, 5, 10, 20, or 30 years), plain and simple.
Getting back to the main issue. Over its limited lifetime, the (internal) total return of a single bond is due almost entirely to its coupons. There can be a small additional gain or loss in capital if the bond was bought or sold at a discount or premium. For a bond fund that replicates the total market, and held for the long term, the total return will be due almost exclusively to its coupon distributions (which excludes capital gain and return of capital distributions).
Over its 29 years of existence, Vanguard US’s Total Bond Market Index fund (VBMFX) had its NAV price fluctuate between a little less than $9 and a little more than $11 (+/- 15% of its initial $10 price). On the other hand, an initial $10 investment (with reinvested distribution) has grown to $56.60. Of this $46.60 growth, $1 is due to NAV increase and $45 is due to distributions. That’s how well-construted aggregate index bond funds/ETFs work.
A total bond fund is simply a replicate of the total market. If it was a perfect replicate (no defaults, all bonds bought at par and held until maturity, all coupons distributed, all capital reinvested), its NAV would necessarily gravitate around a fixed value, with no divergence. Mathematically, it cannot be otherwise.
Aggregate bond funds actually sell their bonds one year prior to maturity, almost always at a premium (at least historically). This can cause a small upward deviation on long-term NAV prices. The reverse could happen, too, but this will be far from the dominating factor in total returns.
I fill my registered accounts with bonds, but my bond allocation is bigger than my registered accounts space. I use VAB in my taxable accounts.
I know that I will be subject to the vagaries of the bond market; at some points, VAB will have a lower price, at others it will have a higher price. If I am lucky enough, rebalancing will lead me to buy more of VAB when its price is lower and sell some when it is higher. Over the long term, I know that the price has no choice but to remain more or less between $20 and $30, unless Vanguard decides to change the fund’s objective and stops replicating the entire market.
@LI: Your understanding of Bond ETF structure seems very sound, and as a relative novice I hesitate to question your expertise. I basically understand and agree with most of your factual presentation except for the second last paragraph of your January 3 10:28 post (OK, maybe also your seeming to justify the exceptional 2 year returns of VAB as a prudent investment result rather than as a fortuitous result of declining interest rates, a trend that is not going to be sustained):
“If I look at the historical NAV of XBB, the oldest Canadian aggregate bond ETF, I see an increase in NAV, due in part to the tax-efficient structure of an ETF.”
It is certainly true that generally the NAV increases as interest rates decline. Selling the underlying bonds would involve a capital gain, and correspondingly the ETF’s selling price if buoyed up sufficiently is likely to command a capital gain when sold. This is great when the tax on capital gains is half the marginal rate. Is this what you meant by the rest of the paragraph?
But when the reverse happens (interest rates rise, the worth of component bonds promising lower interest rates than current levels drops, NAV gets dragged down) your Bond ETF is worth less. Selling would generate a capital loss which is not eligible for any tax benefit unless you have an eligible capital gain to offset, and then only at half the marginal rate. Meanwhile, the increased number of lower yielding bonds the ETF has had to purchase to replace matured or almost matured bonds to generate current yield levels (or, bought at a premium) generates a higher interest component than you bargained for — think “tax” — without any capital loss tax relief.
At best I might accept your argument that over the very long term the NAV fluctuations will even out on a statistical basis (i.e. the gist of the 3rd last paragraph of your second post of the day), and therefore we should look only at the interest bearing “yield” component of the return. But over the interim the tax implications are asymmetrical, being taxed on capital gains, but likely not given relief for capital losses. If this scenario is correct, then the Bond ETF in a taxable situation is less efficient than, say a GIC ladder, assuming equal or comparable interest yields (which I agree would not be likely, but I think the net results in real life would still favour the GIC ladder.)
@Llui: (I assume you’re the same person) I apologise for the tone of my Dec 31 post, which upon re-reading sounds really condescending, which was inappropriate, particularly towards someone like you who obviously has a sense of a total investment strategy involving diversification. I really intended my cautionary comments for any complete novices recently tuning in to this station who often take the first thing they read here at face value and run with it, often with unintended consequences.
@oldie: Thanks for the comments.
The objective of my first post was simply to expose that choosing GICs over VAB is not a slam dunk. Comparing an aggregate bond fund to a GIC ladder is like comparing apples and oranges. Really!
Anyway, one should always compare the YTM of a fond to another, not the rate on its longest-term bond. For example, while a Tangering 5-year GIC currently has a 1.90% rate, a five-rung Tangerine GIC ladder currently has a YTM of 1.51% ((1.20% + 1.35% + 1.50% + 1.60% + 1.90%) / 5). Reasoning about the long-term behavior of a GIC ladder, calculating its yield to maturity (YTM) and NAV, and looking at the overall ladder total return over an “average maturity” (3 years) period is very helpful to understand how bond funds work, and how it is impossible to predict this total return.
Developing a preference for GICs based on the primary criterion that broad bond funds contain premium bonds (which they would have contained since the 1930s, due to the steep yield curve) is simply not logical. Surprisingly, in the US, in the 1800s and early 1900s, the yield curve was inverted. Short term bonds paid more than long-term bonds. A different world!
Your understanding of the long-term behavior of the NAV is correct. Now, bond ETFs distribute very little in capital gains; instead, their NAV increases. That was probably the main driver for XBB’s NAV increase since inception. But, unless an investor sells, he won’t have to pay any taxes on these gains (except for the few gains that escaped the ETF capture mechanism).
If interest rates finally increase (actually, they have increased in 2013) like everybody predicts, the NAV will get lower, and reinvested distributions will buy at these lower NAV prices. An accumulating investor will also get to buy more at these lower prices, lowering his the overall adjusted cost basis. If the investor is lucky, maybe stocks will go up and he’ll get to buy even more while rebalancing into bonds.
If interest rates (across the curve, not only short-term ones!) don’t increase for another while, then NAV will possibly remain stable or maybe even increase a little more. So, later drop would simply erase past gains, at first.
The main idea to retain (but it only applies to total-market bond funds, unfortunately) is that NAV is more or less anchored to a middle price (representing the “par value” of the entire bond market; the weighted average par value of all bonds). It will bounce above and below this value, but never stray too far, due to plain mathematics. As long as the yield curve remains declining (e.g. short-term yields are lower than long-term ones), NAV will remain above “par”, and thus the fund will contain premium bonds. If the yield curve was fixed, the NAV would simply remain fixed too (hypothetical, will never happen in real life), even if the fund has bonds which decline in value. Of course, in real life, other considerations add some variations to this (upgrades, downgrades, ETF inflows and outflows, sampling techniques, etc.)
Finally, a bond fund investor should always plan to hold his fund at least until duration. For VAB, this means at least 7.5 years. I don’t know anybody who can predict the future NAV of VAB in 7.5 years or more. If its NAV gets down next year, I would actually be happy as I plan to hold for more than 7.5 years. It would lower my cost basis!
On the other hand, I would worry to invest in a high-yield bond fund, which won’t benefit from all of the above discussion. Such funds tend to have a (forever) dropping NAV. If this is what Dan worries about, he is right.
@Oldie: I got one important details wrong, in my previous post.
It’s the overall shape of the yield curve that determines if a majority of bonds will be at a premium or at a discount, not the level of interest rates. If the yield curve was flat, and fixed, all bonds would be bought at par and remain at par, regardless of whether interest rates are 1% or 10%. It would make no difference.
Here’s a simple example. Imagine that rates were to go up relatively slowly, and that I had the five-rung GIC ladder of my previous post, bought today at par with 1.20%, 1.35%, 1.50%, 1.60%, and 1.90% (1 to 5 year) yields. Assume that one year from now, interest rates have gone up to 1.35%, 1.50%, 1.60%, 1.90%, and 2.30% (1 to 5 year) yields. Can you see that each GIC, if marked to market, would still be valued at par, and that the matured 1-year GIC would be reinvested into a new 2.30% GIC? This is an example of how yields can increase without causing any change to NAV. It’s really the shape of the yield curve and the speed of change that can lead to NAV variations.
@Ll: Thanks for your detailed and helpful explanation.
Hi Dan,
If you’re only concerns are that you’d like VIU ( alreacy have VDU, but need more, and prefer not to have Canadian content or extra WH fees, would you buy VIU now, or would you wait awhile, because of tracking error. If you’d wait, how would you know when to buy?
Thx,
Ros
@ros: I like to wait at last a year to see how well the ETF tracks its index. It would be different if the ETF simply held an underlying US-listed ETF that was well established. But in this case, VIU will use a sampling methodology and we can’t know how well it will track the benchmark.
Hi Dan,
I have 200 shares each of VCN, VUN, VDU, VEE, and VSC, all within my TFSA, and all
with a 25+ year time horizon. I am fully comfortable with my 80% equity exposure.
Of late, my US and INT’L ETFS have been doing well, while my CDN equity fund and my
CDN bond fund have gone nowhere. While I understand the concept behind rebalancing,
at least annually ( where necessary ), I cannot avoid wondering why I should sell my
winners ( VUN, VDU, & VEE ) in order to purchase VCN and VEE when these ETFS are
likely to be laggards for many years to come, due to a low energy and low interest rate
environment, respectively.
I do my own investing through a discount broker ( VB ), and I check my positions at least
weekly. Should I get a sense that things are going to turn, then perhaps I can make these
rebalancing adjustments at a much later date. It is not something that is going to change
overnight. I would like your thoughts on this as I very much respect your contribution to
this site and MoneySense.
Thanks,
Ross
@Ross: Thanks for the comment. You have assumed that the recent poor performance of Canadian equities is going to continue “for many years to come,” when no can possibly predict that. The poor outlook for Canada’s economy may be reasonable, but that is precisely the reason why Canadian stocks are cheap now. Stock prices reflect the market’s assessment of each company’s future prospects, so your outlook and everyone else’s is baked into the prices already.
If you make a point of never selling what has recently outperformed and never buying what has recently lagged, then you are doing the opposite of rebalancing. You will be using a strategy that systematically sells low and buys high. It should be obvious that is getting exactly backwards.
If you can’t bring yourself to rebalance, at least resist the urge to chase performance by pitting all your new money into whatever has recently done well. That strategy has spelled doom for many investors.
One more suggestion: if you have a 25-year horizon there is no point in checking your portfolio every week. That’s like planting a tree and then pulling it up every week to look at the roots.
Hope this helps.
@Ross If the steaks at his local supermarket are on sale this week he doesn’t say he will wait till next week to buy them when they are back to normal prices !!! People do funny things when it comes to investing compared to everyday behavior.
Hi Dan, I purchased shares of VIU in December 2015. I do no see any dividend paid yet. There is no information about the Q4 dividend on their website as well. Would you know why? Is it because it is a new fund and there is no payout in December?
Thanks,
Kevin
Waiting for your Couch Potato Portfolio Returns for 2015 !
@Ross: Part of this is called “recency bias”, where we tend to assume that what has happened recently will continue. It sounds like you check/watch your portfolio regularly (which may be doing more harm than helping), so you probably also read the news, check the markets, etc. All of this can not only feed your recency bias, but also listening to all the “experts” can lull you into thinking that you have some idea what the future holds, when you really do not.
Right now everyone is saying Canada is the basket case and will be for years. Two years ago, Canada was still a better bet than the US or EAFE. Two years before that, Europe was going to be in the toilet for a decade. Two years before that, the whole world was ending so you better buy gold, and two years before that we had peak oil and the Chinese economy was going to surpass the US.
The narrative will change within a year or two, like it always does. The best thing you can do is admit you have no idea where this is going, and rebalance once per year like I just did. The only thing that’s certain is that Jan 1 will come at the same time next year as it did this year. :)
@Willy: Nicely put!
@Kevin: Best to check with Vanguard directly, but it`s not surprising that the fund would elect not to pay a cash dividend immediately after launch. Note that the fund would still need to distribute to investors any dividends received during 2015, so check your T-slip: there could have been a reinvested dividend that would still be taxable.
Could you provide what is the holding of VIU ? Vanguard Canada site DOES NOT provide any information ?
Thanks
@HAT: This information will eventually appear on the Vanguard website: the fund is only a few weeks old. I would suggest holding off buying any new fund until you have all the information you need to make an informed decision. In the meantime you could look up the index on the FTSE website and see if it lists the individual constituents.
Hi Dan,
My wife and I are in the process of consolidating our RRSP’s, my LIRA and our investment account under one organization. Currently they are spread between a full service broker, discount broker (my management) and a low fee mutual fund dealer (my management). We are self-employed thru our personal service company with no other employees.
I would like to have limited control over the portfolio but I don’t feel I have the skills to totally manage the portfolio by myself. In your opinion is there any value in private client investment counselling? What would be a fair percentage fee (based on total assets) to pay for a portfolio just under 1 million dollars?
Really enjoy your blog and Moneysense articles. Keep up the good work.
@Wilkster: Not sure if you aware that I am an advisor with firm that manages portfolios this way, so I have a conflict of interest when I say, yes, there is value in paying for professional hep if you have a large portfolio you are not ready to manage on your own. Our fee is 0.88% for portfolios of $1 million, which is at the low end in the industry. A fee of about 1% is common and reasonable, though as always, it depends on what services are provided. Some firms provide only investment management, while others also include financial planning for that same fee.
Would it make sense to complete VIU with VEE ?
Would that combo give me exposure to both China and South Korea ? I see indexes providers classify theses two important countries in different ways and I am getting confused.
Also, i understand that my EM exposure should be about 25% of my international holding, is that correct ?
@sandy48: Yes, you could use VIU and VEE in conjunction to get both developed and emerging markets. And yes, holding about four times as much developed as emerging markets is about right based on global market cap.
thanks ccp !
is there any significant advantage in XEC vs VEE that I am not aware of ? VEE is more diversified and have lower MER. But many people seem to be using XEC over VEE, I am right to assume that this is simply because, until now, XEF/XEC combo was favored because XEF held stock directly.
with the introduction of VIU and his direct stock holding, VUN,VIU,VCN,VEE seem to be the best canadian 4 funds ETF combo at the moment, or maybe I am missing something.
It seem VIU+VEE+VCN is even more diversified than VXUS
VXUS = 6,010 stocks
VIU+VEE+VCN = 7,176 stocks
Add VUN and you get a staggering 10,895 stocks !
Hey CCP,
I was wondering if you could do your analysis or provide an opinion on the new line of new ETF’s from TD
TD International Equity Index ETF: TPE
TD International Equity CAD Hedged Index ETF: THE
TD S&P 500 Index ETF: TPU
TD S&P 500 CAD Hedged Index ETF: THU
TD S&P/TSX Capped Composite Index ETF: TTP
@Jon F: I will likely write something about these ETFs in the future.
VIU hold VGK and VPL. I’m guessing to help with its sampling spread? Is Vanguard likely to ease back on holding these funds as VIU’s asset volume increases?
Instead of buying 3 etfs and rebalancing them frequently, if I buy XAW or VXC. How often these fund companies rebalance their funds. How do they rebalance.
@Aslam: VXC and XAW do not rebalance. Unlike my model portfolio, they do not specifically allocate a fixed amount to US, international and emerging market equities: their holdings simply reflect the market capitalization of these regions. Right now that is roughly 54% US, 37% international and 9% emerging markets, but that changes over time.
Does the VIU only exclude Canada, or the U.S.A as well?
@Gianluca: VIU excludes both the US and Canada.
Hi, I’m 25 years old, I just switched to ETFs and I’m building my portfolio. Would it be a sensible choice of holding 50% VUN, 30% VCN, 10% VIU, 10% VEE in my RRSP account. Should I maybe expose myself more to foreign equites outside Canada and the Us. Thank you for your input!
@Ved: My usual advice is to hold roughly equal amounts of Canada, US and international equities. The international component can be roughly 80% developed and 20% emerging. So if the portfolio is all equities it would be about 33% US, 33% Canada, 27% international and 7% emerging.