After two years with no changes to my Couch Potato model portfolios, the 2017 edition comes with an update to the ETF version.
Before I get to the details, I feel compelled to stress that if you’re currently using the older ETF portfolio, there is absolutely no reason to change. The funds I’ve swapped here are a wee bit cheaper, but the cost of selling your existing ETFs and buying the new ones almost certainly outweighs the benefits. And if the transactions would involve realizing taxable gains, then making a switch is downright nutty. To put this in perspective, the new portfolios will reduce your management fees by 0.03% annually, which works out to 25 cents a month on every $10,000 invested.
I’ve also updated my model portfolios page with historical returns to the end of 2016. As always, we’ve used actual fund performance wherever possible: for earlier periods we’ve used index data, subtracting the fund’s current MER to account for costs.
With that out of the way, here are the changes.
Zigging over to ZAG
First, I’ve replaced the Vanguard Canadian Aggregate Bond Index ETF (VAB) with the BMO Aggregate Bond Index ETF (ZAG). BMO’s aggressive cost-cutting has made ZAG the cheapest bond ETF in the country, with a management fee of just 0.09%. (Don’t be fooled by the old MER of 0.23% that still appears on the BMO website: the fee reduction took place in June 2016 and the fund needs 12 full months before it can report its updated MER.)
Another benefit of using ZAG is that it has a companion fund, the BMO Discount Bond Index ETF (ZDB), designed for taxable accounts. So if your portfolio includes bonds in both registered and non-registered accounts, you can use ZAG and ZDB to get similar exposure in both accounts with maximum tax-efficiency.
One small point to be aware of: VAB and ZAG have slightly different risk exposures. The Vanguard ETF is roughly 80% government bonds and 20% corporates, while ZAG is closer to 70% government and 30% corporates, which explains its slightly higher yield to maturity.
Worlds apart
The second change replaces the Vanguard FTSE Global All Cap ex Canada Index ETF (VXC) with the iShares Core MSCI All Country World ex Canada Index ETF (XAW). These funds cover the global equity markets outside Canada: they’re both about 55% United States, 35% international developed markets (Europe and the Asia-Pacific region), and 10% emerging markets.
XAW was launched just weeks after I launched my simplified ETF portfolios in 2015, and two years later it has emerged as a slightly better choice than its Vanguard counterpart. The lower fee is the most obvious advantage: with an MER of 0.22%, the iShares fund it’s five basis points cheaper. Less obvious is XAW’s tax advantage.
Although both of these funds hold several underlying US-listed ETFs, the iShares version uses a Canadian-listed ETF for international developed markets. This difference in structure means the Vanguard ETF will be subject to a greater amount of foreign withholding taxes. According to Justin Bender’s detailed analysis, this amounts to a drag of about 0.10% in an RRSP or TFSA (the difference would be smaller in a taxable account). Add that to VXC’s higher fee and the cost difference becomes significant in registered accounts.
Which option is right for you?
I haven’t made any changes to the other two model portfolio options, though I have stopped including performance data for the Tangerine Equity Growth Portfolio. This fund, which is 100% stocks, recently changed its target asset mix: it was previously 50% Canadian, 25% US, and 25% international. As of last November, it now holds equal amounts of all three asset classes. I think this makes it a more diversified fund, but the change makes its historical performance meaningless for anyone considering the fund today.
One of the age-old questions I get from readers is, “How do I know which option is right for me?” Many new investors look only at the differences in MER and immediately gravitate to the ETF version, even though one of the index mutual fund options would be more appropriate.
To help answer this question, I recently wrote a feature in MoneySense magazine that walks you through the decision-making process. It even includes a selector tool that asks you to describe your preferences and then suggests one of the three options. Both the article and the quiz are now linked on the model portfolios page.
Thanks for updating the portfolios! You’re having a positive impact on many Canadians.
Is subbing in (VUN, XEF, XEC) for XAW still a reasonable option? (a la Justin Bender) For those who don’t mind a bit more effort of course.
The simplicity and passivity of VUN (very Bogle-ish) clicks with me a bit more than how XAW seems to be composed of S&P 500, midcap, small cap funds. Hopefully, those are built not to overlap, and presumably XAW would hold them in a strictly market-cap fashion? I’m also unsure how IEMG (the one held in XAW) compares to XEC.
Excellent post as usual. As time goes on, I find the real education comes more from following your analytical process rather than digesting the raw recommendations given at the end. Keep up the good work!
Could you advise on the relative (lifetime) cost and merits of using ZDB vs HBB as the bond portion in a taxable portfolio.
Thanks for the information! I’m learning the Couch Potato method, and hoping you can review my math here. I currently invest with Sunlife Financial through a group plan, through a DCPP and RRSP, with ~$50,000. I’m able to invest in index segregated funds, and I think because it’s a group plan, the annualized fee percentage I have averages 0.22% across the different indexes I chose (based on your asset allocation recommendations). I do bi-weekly contributions. I’m reviewing my options with ETF’s, Tangerine, and E-Series. Is it possible that the group rate fees are this competitive and being with these Mutual Funds is currently my best option? Could I be missing something? Thank you very much for any insights. Here is a snapshot of the fees.
Fund Management Fees As Of: 31 Dec 2016
Fund Annualized Percentage
BLK Bond Index Fund 0.19 %
BLK S&P/TSX Comp Index 0.19 %
TDAM Intl Equity Index Fd 0.27 %
BLK US Equity Index Reg 0.19 %
@Oldie: Thanks for the kind words. A comparison of ZDB and HBB would require a whole lot of assumptions: rate of return on the index, your personal tax rate, how often you realized the capital gains, whether you could take advantage of tax-loss selling, etc. I think it’s safe to say that HBB would outperform after taxes in most scenarios, which is likely to true of all swap-based ETFS versus their plain vanilla counterparts. In a low-yield environment, however, the benefits of HBB are more muted. Not sure if you have seen Justin’s take on this:
http://www.canadianportfoliomanagerblog.com/hbb-vs-gics/
@Sean: Yes, it is certainly possible to get access to funds with fees this low in a group plan. If you work for a large company, your employer may cover a large part of the administration fees paid to the plan provider. I have seen group plans with fees close to zero because the employer picked up the whole tab. You should probably take full advantage of this workplace plan for as long as you can: it’s likely to be even cheaper than a DIY portfolio built with ETFs. And it looks like you have chose the right funds for an index portfolio.
For the record, don’t be confused by the term “segregated fund” in this context. In a group RRSP this term has a different meaning from the other type of segregated fund, which is actually a very expensive and dubious insurance product.
@Brendan: Sure, it’s fine to substitute the three individual funds for XAW if you want added flexibility. This post may be of interest:
https://canadiancouchpotato.com/2016/06/20/cost-versus-convenience-in-ex-canada-etfs/
XAW’s decision to use three funds for US equities instead of one is pretty trivial. The indexes don’t overlap: they combine to track the S&P 1500, a broad market index which is likely to perform very similarly to VUN’s index. (Though I am not sure why they didn’t just use ITOT.)
IEMG is the underlying holding in XEC.
Hi Dan,
Great post as usual! I’ve been following your blog for years now and your investing style has simplified my life. I have encouraged some family members to take a look and start an ETF portfolio as well. Do you have a go to article from your blog (or otherwise) that someone who is first discovering the advantages of ETFs should read as a starting point?
Thank!
Hi bud,
can you explain please how them world index funds have had ~55% US weight for the past 10 years while the US market has increased 150% and the US currency has increased too while the other global constituents seem to have stood still? how come they arnt 60/40 at least by now? Thanks for the input if you have time!
Great post again! Really enjoying your podcasts as well! Quick question as an educated (but by no means expert) DIY investor.
With RRSP/TFSA contribution room maxed, I have started purchasing funds in a taxable account for a couple of years now. Is the difference between ZAG and ZDB worth cashing out ZAG and repurchasing them as ZDB? With this most resent post, the tax and capital gain/loss implications and value of this are confusing at best.
Are there any tax or legal issues when selling losing positions of VAB in a TFSA and then using the proceeds to immediately purchase ZAG?
Hi Dan,
Great article. I’m wondering how you would recommend splitting a three-ETF CP portfolio between a RRSP and TFSA to achieve optimal tax efficiency.
Thanks,
Chris
If you’re a us citizen the switch to XAW likely isn’t worth it. XAW holds XEF which means when you file the 8621 for the pfic you’d have to file two of them (XAW and the underlying XEF)
Justin,
Thanks for the new update. Just wondering how you would allocate your model portfolio In non-taxable accounts for a model $100000 portfolio. Let’s say you had $50000 for your RRSP and $50000 for your TFSA? Would you put more of a certain ETF in one account or the other?
Are there any alternatives for etfs that are more tax efficient than the ones suggested in your model portfolio? i.e. 1 for CDN equity, 1 for US equity, 1 for international/emerging equity.
Bonds, you already mentioned ZDB is a better counterpart to ZAG for non registered accounts.
@Jeffery Ha: The only way to potentially improve the tax-efficiency of equity ETFs would be to use swap-based funds. These are fine if you understand the details, but they are not my first choice for a model portfolio:
https://canadiancouchpotato.com/2011/06/06/understanding-swap-based-etfs/
@CP: You make me blush when you call me Justin. ;)
In general, it usually makes sense to keep bonds in your RRSP rather than your TFSA: since the TFSA offers tax-free growth indefinitely (as opposed to tax deferral, like the RRSP) you’re likely o be better off keeping the highest-growth assets there, and that would be equities. Otherwise the differences are not meaningful.
Hi Dan,
Great post, and glad you are constantly re evaluating your recommendations! In the preamble you mention switching funds will only amount to a .03% savings, but it appears if you factor in the foreign withholding tax XAW actually saves .15%? I am not too concerned with switching out of VAB but your post has made me consider selling my VXC to buy XAW, or at least buying XAW for all future purchases. This is all in tax advantaged accounts. Can you comment as to whether or not this would be a good idea?
Great post as always! I an ETF investing newbie and have a question about TFSA caps that I would be thrilled if you or anyone on the blog could help with.
I have the previous model portfolio (VAB, VCN, VXC) in a TFSA account with Virtual Brokers that’s at my maximum TFSA contribution. For the sake of understanding: If I were to switch my VAB shares to ZAG and my VXC shares to XAW (I know you said this probably isn’t necessary), my broker fees would be ~$15 and I’d lose a bit on the bid-ask spreads, but does it have any impact on my TFSA room?
I.e. will selling shares count as removing money from my TFSA, or does it have no effect since the money won’t leave the TFSA; it just became cash in the account instead of an ETF holding?
Thanks in advance!
@Chris D: See my reply to CP above.
@Don: There are no tax consequences to selling securities in a TFSA, i.e. you cannot harvesting a capital loss.
@Chris: While I do not recommend switching ETFs to save a tiny amount in management fees, it probably is a good idea to switch from ZAG to ZDB if you hold the former in a taxable account. Traditional bonds like ZAG are a really poor choice in taxable accounts: we’re no longer talking about saving a few basis points.
@papwhiskeytango: I’m not sure I have a ready answer, but a few comments: I’m not sure the mix has been 55% US for the last 10 years. It was less than several years ago. The international developed and emerging markets have not “stood still” over the last decade: they have certainly underperformed the US, but they’ve grown considerably. Finally, a country’s market cap can increase without rising prices: that is, there can just be an increase in the number of public companies that get added to the index. This has certainly happened in China, and probably in many other emerging countries.
@Scot: Transactions made within a TFSA (i.e. not involving money moving in or out of the account) have no effect on your contribution room. But I still would not switch the ETFs you mentioned. At least wait until the next time you make a large contribution or you need to rebalance.
@Devin: Remember that swapping VXC and XAW would only save that 0.10% on the global equity part of the portfolio. If 40% of your portfolio is global equities, the savings would represent 0.04% on the entire portfolio. For every $10,000 in global equities, that’s $4 a year.
I would appreciate your thoughts on a market-timing question. I’m mostly in cash and have been for more than a year. I’ve held about 5-10% gold for that period and last fall, because of your comments I’ve allocated a further 20% to short term bonds. Not a good move as of today but I think wise in the longer term.
But it brings me to my question; what are your thoughts on buying new equity or bond positions today?
Equity markets are hugely over-priced and at the far end of the bull cycle. Perhaps they are some fairly priced names but any index reflects an historically high PE.
The best the bond market can hope for is continued extension of historically low rates but it seems more likely to see a push to higher rates and inflation seems a likely spectre in the near future.
I am a ‘cautious-conservative’ investor and am happy to wait for the equity markets to adjust but it seems an awfully expensive time to be buying into any kind of investment today. How do you suggest one should evaluate a re-allocation strategy over the next few months? What rational would one use to move out of a 2% hi-interest savings account into a fixed income position? Of course, all these questions assume that I can stay comfortably on the couch and not managing my portfolio on a daily basis.
Thank you so much.
Hi Dan,
Based on your post, would you recommend buying ZAG and XAW moving forward with new money added to my portfolio or would that make rebalancing more complicated?
Thanks.
hi Dan
I have a balanced portfolio of ETF’s .. 60/40 non registered account … 500k value
about 10 ETF’s .. ( and TFSA . with 6 ETF’s all positive )
should i sell them to move into a 3 ETF model like you suggest ??
half are in minus and half in positive ..
so there are capital gains and losses to consider also
thanks
I was comparing the small cap exposure of the indexes behind XAW (MSCI ACWI IMI) and VXC (FTSE Global All Cap). I couldn’t find data on the ex-Canada versions so the data below includes Canada, but I think that’s OK for this rough comparison.
MSCI:
Number of constituents = 8628
Average market cap = $5,045M USD
Median market cap = $947M USD
FTSE:
Number of constituents = 7725
Average market cap = $5,557M USD
Median market cap = $1,147M USD
Is it safe to interpret this as ‘MSCI ACWI IMI reaches about 900 companies deeper into small cap territory than FTSE Global All Cap’? And therefore XAW has slightly greater small cap exposure than VXC?
Hi Dan,
BMO usually has MER 0.03-0.04% higher than their ETF’s management fee. Do you know the new MER of ZAG?
Thanks
@zwlife: The MER is generally about 10% (not 10 percentage points!) higher than the management fee due to taxes. So if the management fee is 0.09% I would estimate the taxes to add about one more basis point, thus the 0.10% estimate.
I didn’t check your model for a while and I see that you remove the non-td index fund option. I was using your model for my kid resp because it was uncovinient for me to open a resp with td. I am a bit dissapointed that you drop the ball for updating the best options outside td E-Series.
Thanks for all your hard work. It’s great to have a real-life benchmark to compare myself to. Also, it’s always interesting to see that the products can change yearly, but the approach doesn’t. I haven’t had much in common with the model porfolios in years yet my returns must be extremely similar.
Hi Dan,
If I understand correctly, XAW’s US portion is only 1500 holdings compared to 3600+ in VUN.
How does it compare to VXC?
Other than simplicity of using a single fund it seems that VUN-XEF-XEC combo provides more diversification? What about tax implications inside TFSA? Does it make any difference that S&P1500 funds are US listed in XAW vs VUN (vs VXC)?
Great post as per usual. Thank you for putting out this information week after week! Would you suggest that investors who are now rebalancing their portfolios purchase ZAG over VAB. Or should we stick with VAB to take advantage of DRIP type programs through discount brokerages like Questrade
@Anton: For US equities, VXC holds two underlying US-listed ETFs: the large-cap VV (~600 stocks) and VB (~1,400 stocks) so the exposure is roughly the same as in XAW. Holding the three individual ETFs (VUN, XEF, XEC) provides no meaningful diversification benefit. Whether you hold XAW or VUN in a TFSA, the withholding taxes on the US equities are lost in both cases.
Justin,
Awesome post. In the VXC vs XAW debate (RRSP here), I am a bit confused by the wording as to the exact savings cost.
You mention 5 basis points difference in MER between the two. You then talk about the tax efficiency of XAW for using CDN domiciled ETFs as opposed to US-based like VXC which yields 0.10%.
Is this 10 extra basis points making a total difference of 15 basis points or is this already taken into account in the original 5 basis point calculation?
In a 100k portfolio, even 5 basis points yields a 50$ difference. Assuming we’re using Questrade like a lot of folks here do, it will cost you roughly 10$ (+ ECN fees) to sell and nothing to re-acquire XAW. Sounds like a win-win to me.
Hoping I’m making sense.
Here’s a little aside about ETF choices…. for amusement, in each sector of my portfolio I hold two ETFs, each from different companies. For example, for ex-North Americal exposure I hold both XEF and VIU. On any particular day (today for example) you can see one of these ETFs is up .6% and the is other down .6% but their components don’t seem different enough to explain that divergence. What else would?
@Jerry: It’s hard to know exactly what’s going on here: it could be a number of things related to trading activity (which could temporarily affect the market price of the ETF without affecting its NAV), the timing of dividends coming in or being paid out, cash flows in or out of the fund, and so on. And the holdings of these two funds are actually somewhat different: VIU includes Korea, while XEF does not (MSCI considers Korea an emerging market).
The latest VXC quarterly portfolio disclosure document lists only VV (US Large-Cap ETF) as a holding for US exposure. It doesn’t list VB or any US mid- or small-cap fund. Only US large-cap exposure?
https://www.vanguardcanada.ca/individual/mvc/loadImage?country=CAN&docId=4156
The Europe, Pacific, and EM funds are All-cap funds.
@Greg: The addition of VB was quite new and should be reflected in the next quarterly disclosure. See the fact sheet for VXC dated November 30, 2016: “VXC invests primarily in the U.S.-domiciled Vanguard Large-Cap ETF, Vanguard Small-Cap ETF, Vanguard FTSE Europe ETF, Vanguard FTSE Pacific ETF, and Vanguard FTSE Emerging Markets ETF. The information displayed represents VXC’s exposure to these underlying ETFs.”
One of my frustrations with Vanguard Canada is that their website does not clearly disclose the US-listed ETFs held in funds like VXC: they list the underlying stocks and then add a footnote: “For any Vanguard ETF that primarily invests in an underlying US domiciled Vanguard fund, the information displayed belongs to the corresponding US domiciled Vanguard fund.” You have to go hunting around for the details. iShares is more transparent in this regard.
Hi Dan,
I switched over to the CPP last March, and at the time was debating between VXC & XAW for my Global exposure. I went with VXC, and have watched both closely since… maybe too closely.
I am considering switching out my VXC for XAW the next time I add to my TFSA later this year, and buying XAW for all future Globsl buys.
Other than trading fees and bid/ask spreads, there shouldn’t be an issue with this switch in my TFSA … right Dan?
Finally:
I realize it’s just one day, but with US markets closed today for MLK day VXC is up 1.15% at 3:28PM EST, and XAW is up 3.12% at 3:29 EST. These figures are off the Globe and Mail website. I have never scene this big a spread unless distributions were involved.
What would cause such a huge difference?
Thanks Dan for the blog and now the podcast.
Cheers,
Brian
@Brian: The cost of switching is trading commissions plus bid-ask spreads, correct.
I can’t explain the odd behaviour of VXC and XAW today, though it probably has something to do with stale NAVs caused by the closure of the US markets today. They will likely converge by tomorrow. It might also have to do with the huge selling pressure caused by millions of CCP readers who are stampeding out of VXC and gobbling up XAW. :)
@CPP
Dan, did BMO cut the MER on ZDB as well or just on ZAG?
@Shaun: Both. ZDB also has a fee of 0.09%.
Hi Dan,
I seemed to be a bit confused–not the first time…I would have thought that VXC in more efficient when it comes to foreign withholding tax than XAW because VXC actually owns the component companies, over 9000 in total, where XAW is a fund of funds. What are your thoughts.
As always, thanks for all your work!
@Jamie: Actually VXC doesn’t hold any stocks directly: it’s all US-listed ETFs. But you can be forgiven for not realizing this: as I mentioned in my reply to Greg, above, Vanguard lists the individual stocks in the holdings section on its website and it is less than explicit about explaining that these stocks are held indirectly. I think it would be less misleading if they did what iShares does, which is list the ETFs first and then separately listing the “Underlying Aggregate Holdings.”
hi Dan
just wondered if you could reply to my post above
i am new here and not sure how this works
@nicholas: I didn’t mean to ignore your comment, but I cannot give you advice on whether you should sell the ETFs in your portfolio and change strategies.
Dan, sorry I missed the “@Gregg” above– I have noticed over the years that you very patiently go over things you have previously covered. Thanks again.
Thanks for the reply to my question earlier. I was looking over my CP files and I found an excellent post you made six (!) years ago concerning where assets should be placed (taxable/RRSP/TFSA). Have your thoughts on this changed at all in the interim?
Hi Dan, appreciate all the hard work and advice you give. I have been able to put to work your model etf portfolios for my wife and I with our discount online brokerage the last few years and are happy with the ease and results. Our 3 young adult children have accounts opened as well with a few small investments started by the grandparents. As mentioned by someone else in these posts (Francis) any options outside of the TD e series as the accounts are not with TD so the e series are not an option and neither is the tangerine fund. Starting with a new online brokerage is not an option as they would like to stick with BMO investorline and have about 3000 – 7000 to invest.
Dan, thanks for educating investment dummies like me :) Couch potato philosophy is the best for me. I had e-funds in TD and RBC for a while and now finally combined everything uder one roof at Questrade to go ETF route.
Just one quick question: do you think it’s worth some extra hassle to convert part of CAD into USD (Norbert’s Gambit) and by US ETF directly? I’m talking about $30.000-$40.000 worth of US part of portofolio? And which ETF would you suggest?
Thanks again!
Aleks
@Joseph T: Unfortunately the index mutual fund options in Canada are pretty bad, with the exception of the e-Series funds and Tangerine. Your best bet in this situation is likely to be the RBC index funds.
@Aleks: In terms of long-term cost savings, if the $30,000 to $40,000 is an RRSP, then it is probably worth doing a Norbert’s gambit so you can use US-listed ETFs. But as always, whether the “extra hassle” is worth it is a personal question. It depends on how comfortable you are with the process and whether you’re willing to do it again from time to time as you ad more money to the portfolio.