Your Complete Guide to Index Investing with Dan Bortolotti

Podcast 11: Fighting Evil With Index Funds

2018-05-28T22:25:26+00:00October 5th, 2017|Categories: Podcast|Tags: , |33 Comments

The waiting is over: we’re back with another episode of the Canadian Couch Potato podcast:

Our featured interview this time around is with Mike Foy, senior director of the Wealth Management Practice at J.D. Power, the well-known research firm. Mike was the lead author on the Canadian Self-Directed Investor Satisfaction Study, released in September. The survey included some 2,500 clients of the major online brokerages in Canada.

The full J.D. Power survey is not available to the public. But if you’re interested in comparing online brokerages in Canada, MoneySense has been doing an annual survey since 2013, and I was closely involved in establishing the criteria and writing the articles during the first couple of years. The 2017 edition includes a handy comparison tool that lets you scan for the features that are most important to you.

If you want to dig more deeply, you can visit the website for Surviscor, the research firm that provides the raw data for the MoneySense rankings.

Rob Carrick and the Globe and Mail also do an annual review of online brokerages and robo-advisors.

Indexing is the new Satan

I’m having little trouble finding new media items to feature in the popular Bad Investment Advice segment of the podcast. In this episode, I feature an article that appeared in the September issue of The Atlantic with a title that is pure clickbait: Are Index Funds Evil?

Here’s the main argument in a nutshell: index funds may be a triumph for ordinary investors, but their success has led to some collateral damage: namely, consumers may be paying more for certain goods and services.

The reason, say some economists, is that a small number of mutual fund firms—Vanguard, BlackRock (the parent company of iShares), State Street and Fidelity—hold trillions of dollars’ worth of shares in U.S. companies. And because index funds, by their nature, include the stocks of almost all the companies in their universe, they will frequently be major shareholders of firms in the same industry. This kind of common ownership can reduce competition and lead to higher prices for consumers.

The academic paper cited in the article, for example, says that Vanguard, BlackRock, and State Street together own about 15% of the shares of major U.S. airlines. They suggest this common ownership is correlated with higher ticket prices.

This is just the latest in a parade of popular articles targeting ETFs and index investing as a threat to capitalism and a blight on society in general. On the podcast, I offer a rebuttal.

Coping with a 2% loss

In the Ask the Spud segment, I address a comment posted recently on an online forum. The investor recently started using my ETF Model Portfolio and chose the aggressive version with 90% equities. Over the previous six months, his portfolio was down 1.94%, and he seemed shocked by this result.

Of course, it’s not unusual for equity markets to fall 2% in a few hours, let alone six months. These kinds of comments make me worry that many new investors have overestimated their risk tolerance because they have never experienced a bear market. A portfolio of 90% equities can easily see a drawdown of 30% to 40%, and it can take years to recover from a loss like that.

Here’s some context from a research brief prepared by Vanguard Canada. It looked at the 36-year period from 1980 through the end of 2015 and found the following:

  • During this period, there were 12 corrections (generally considered to be a 10% decline from peak to trough), or about one every three years. The average correction was –13.7%. It took an average of about three months for the market to bottom out, and about four months to recover.
  • Since 1980, there have been seven bear markets (defined as a peak-to-trough decline of at least 20%), or about one every five years. The average loss during these bear markets was –33.4%. On average, it took just over a year for prices to touch bottom, and about 26 months for them to recover.

If those numbers surprise you, then you may want to reconsider your asset allocation before the next bear market is upon us. Consider your ability, willingness and need to take risk in your portfolio, and don’t make the mistake of thinking that the long-term average for equity returns looks anything like the year-by-year returns you’ll actually experience.



  1. Greg October 6, 2017 at 11:09 am

    Dan, I think you’re spot on when it comes to many people who are over-estimating their risk tolerance, especially those who have never gone through a bear market. Myself, I lost pretty much everything in the crash. In the financial crisis, I did better and learned to hold through. The worst thing you can do is panic and sell. Of course, that wouldn’t have helped you in the crash if you held stocks like Nortel which never came back. That’s a different lesson in diversification. Score one for the ETFs!

    I think it really takes actual experience to know the feeling of losing most of your money. It’s not something you can just assume you can do. When, not if, the next correction comes, I will TRY to focus on the long-term and TRY to do the smart thing and buy on the cheap and/or rebalance, but I also know that it’s easy to say in theory, but harder to do in practice.

  2. George October 6, 2017 at 1:40 pm

    I personally think “risk tokeance” is the wrong term to be used by advisors. I do not take “risks”. However, ”portfolio fluctuation” is a good term. I am overly tolerant to this. If told an investment is high risk, I would avoid it. If told the maximum fluctuations (the recovery time Is very useful), I would purchase it. This was a problem for me as a young investor – avoiding risk. Explained differently by my advisors then, I would be much further ahead, as I have been through 3+ crashes, of which non bothered me. I would have been much higher equity in my 20’s and 30’s. On another note, a former advisor told me he agreed with indexing but didn’t do it because of the volatility. This I find under stated by most authors and blogs, especially for a new DIYer, when you can see the daily fluctuations. I then indexed and looked 1/ year. Not ideal for rebalancing, but Warren Buffet recommends looking at investment statements every 5 years. Thanks for all the advice in your columns and podcasts over the years. I’m still old school with vxus and vti though.

  3. Oldie October 6, 2017 at 6:00 pm

    @Dan: Did the Atlantic really go too far in its article? Taking the cynical view that any publication’s only duty is to attract maximal readers’ attention to maximize readership and revenue, and that its responsibility to truth is only to avoid getting publicly caught in a blatant lie, and only then because it would be bad for business, then the Atlantic did not. After all, look at the attention we are now giving it!

    Your point about the conflicting motivations of the journalist and his editors is well taken — and maybe we can forgive the writer for some of the journalistic dishonesty, or at least the integrity legerdemain, that seems to be manifesting here. When you’ve gone through the article, you’ll note that he has highlighted the provocative question raised by academics but has not actually agreed with them or supported them, so his answer may well be, “maybe not”, but by then the headline has done its damage. But that’s how the game is played.

    My first thoughts jumped to the argument that if the airline industry has a legitimate point, then the Big Five Canadian banks should have the same objection, too, and sure enough you raised that point and a whole myriad other ones to thoroughly demolish the argument.

    It would seem to me that if the Passive Index Fund industry (in the US anyway) only holds 15% to 20% of all capitalization, it can’t have much of a damping effect of competitiveness on all of the businesses in the stock market. That percentage rose rapidly initially early in the history of introduction of passive index funds, but the curve seems to be flattening out. Maybe it’s due to successful scaremongering by those with the most to lose, i.e. the active fund managers, or maybe because, despite the compelling statistical support, the sheer non-intuitive feeling associated with investing in the “average” is too much for most investors. But maybe the percentage of passive index investors is destined to rise slowly from now on then flatten out at the immutable “believer’s plateau” that some future Nobel Prize winner will one day document as an intrinsic mean attribute of human behaviour.

    And even if the phenomenon of index investing is bad for the industry as a whole, as long as we can demonstrate that it is good for the index investor, should the latter be morally obligated to refrain from this practice? After all, in the investment industry as a whole, the winners profit at the expense of the losers, and no one seems to consider this fundamentally wrong. No, I think this whole idea is overwhelmingly a red herring, promoted by those with the most to lose.

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  5. Tom Bradley October 9, 2017 at 11:17 am

    Dan, one thing that was not mentioned in your discussion about the discount brokers was how they handle low-cost, no load mutual funds. I know most of your readers and listeners are index investors (except me), but there may be a time when they want to buy a particular mutual fund. In this regard, the brokers vary widely. Some transact in funds at no cost (iTrade, InvestorLine and Qtrade to name three that I’m aware of), while some won’t even facilitate a trade in non-trailer fee funds (RBC). As for commissions, they’re all over the map. For a group of brokers who are so tightly bunched on their rating, this is one area that hopefully JD Power’s assessment found some differentiation. TB

  6. Canadian Couch Potato October 9, 2017 at 11:50 am

    @Tom: Thanks for the comment. I don’t have any data from the JD Power study regarding how the brokerages differ around mutual fund availability and costs. But this is a god point: Questrade, for example, is an excellent choice for ETF investors (no commissions) but is one of the few brokerages that charges a commission to buy mutual funds. It’s another example of how your choice of brokerage should really depend on your specific needs, and this is hard to address in rankings.

  7. Jeff October 10, 2017 at 12:46 am

    Why don’t brokerage comparisons for DIY investors ever mention the treatment of Norbert Gambit transactions? As discussed in the podcast, there isn’t that much to differentiate the brokerages either in terms of features or customer experience, but the handling of Norbert Gambit transactions does vary widely. The ability to exchange currencies can be important for the DIY investor so why is this not often discussed? Personally I value this aspect much more highly than any research tools the brokerage might offer.

  8. Canadian Couch Potato October 10, 2017 at 10:28 am

    @jeff: I agree with you, but while Norbert’s gambit is very familiar to hardcore DIY investors, the vast majority of brokerage clients are not likely to even know what it is. Moreover, brokerages don’t like to talk about it because they would prefer people not know how to get around their high forex costs.

  9. Oldie October 10, 2017 at 6:11 pm

    Now that I’ve accumulated some practical investing experience, including using Norbert’s Gambit, I can sit back and realize that if a brokerage treats Norbert’s Gambit favourably, that’s nice, but should not be your bottom line reason for staying with that brokerage. Firstly you should not be trading frequently enough to make a difference on Norbert’s Gambit the reason for long term staying with that brokerage. And if you really have to make one massive US dollar exchange in your lifetime for a transaction of a US$ ETF, open an account with a Norbert-friendly brokerage, buy (or sell) your US$ ETF then transfer the ETF to the brokerage you intend to stay with long term. If the brokerage treatment on Norbert’s is really that different you’ll still be further ahead at this point.

    I have about 5% of my non RRSP investments in US$ priced ETF (as VBR, actually); they generate $US dividends that I just spend in US$ as they accumulate, and not re-investing this amount simplifies my accounting and my life.

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  11. Dan October 15, 2017 at 11:25 am

    Thanks Dan for another great podcast. The reminder about risk tolerance is great. I do a 75:25 equity:fixed income split (XAW, XBB, XIC) and I keep having the feeling i should be taking on more risk. Although i have only been investing for 4 years i am pretty sure i can stick with this. i managed to re balance right back to my target allocation in Jan 2016 which was an aggressive correction. I am quite comfortable with this in RRSP and TFSA accounts.

    What are your thoughts on a more aggressive allocation for someone’s taxable accounts. The after tax, after inflation return of a GIC is negative. At least in my tax advantaged accounts i am getting a tiny real return on my fixed income. In a taxable account there is the other benefit of having the ability to tax loss harvest as well. I was thinking that a taxable allocation of 80% equities:10% preferred shares: 10% 1yr GIC would be riskier than what i have but not as risky as 100% equities and still give me some dry powder to re-balance once a year.

    Do investors you work with have different asset allocation and risk profiles from taxable to tax advantaged because of some of these factors?

  12. Oldie October 15, 2017 at 3:56 pm

    @Dan the reader: you are really asking an unanswerable question of the other Dan. I think CPP has said all that can be expressed when he pointed out that most of us have no idea of our real tolerance for loss, and generally in this respect are way too cavalier in our Asset allocation. He’s right, of course, but no one can really know in advance of the loss how it will feel. This is a difficult question to answer, but we must all try or best to answer it for ourselves, as our emotional well-being in the future depends on it. To your point of the opportunity for tax loss harvesting; it is true that is an opportunity, but it is still a loss, even if temporary. In general I would say increasing your equities to 80% is pushing it, but then I don’t know you. It’s such an individual issue — exactly how do you quantify how bad do you feel when caught with your pants down?

    I too dabbled in preferred shares for my unregistered account, but on recognizing the bad fit, I managed to get out unscathed. That was pure luck and inexperience on my part. (CPP suggests there is little merit in the yield side or the negative correlated buffering side for preferred shares, and generally the tax aspect isn’t helpful. Have you considered HBB?)

  13. Dan October 15, 2017 at 4:29 pm


    Thanks for the comments. Yeah i have looked at HBB, it looks like it would be fairly tax inefficient with a average coupon of 3.4% and a weighted average yield to maturity of 2.4%. That’s a decent premium but still more efficient than XBB.

    I wonder how common it is for people to have a different fixed income exposure in taxable accounts.

  14. Canadian Couch Potato October 15, 2017 at 5:13 pm

    @Dan: I think the issue here is that you are thinking about the parts rather than the whole. It is indeed very common to have different asset allocations in different accounts, but the overall allocation has to be on target with your long-term goals and your risk tolerance.

    It doesn’t make sense to set targets like “I want to be 75% equities in my TFSA and RRSP and 80% equities in my non-registered account.” It’s better to set an overall asset target and only then decide on the best account for each of the asset classes. And that decision is based on tax-efficiency, not risk tolerance. This situation is different for every investor. For example, how large is the taxable account relative to the RRSP and TFSA? Do you need liquidity in the non-registered account? What tax bracket are you in?

    Some rules of thumb: fixed income is usually better held in an RRSP than a TFSA. To take full advantage of the TFSA’s permanent tax-free status it makes sense to keep the highest-growth assets there rather than filling up with this precious tax shelter with low-yielding bonds and GICs. Conservative investors who have large taxable accounts relative to their RRSP may have no choice buy to hold some fixed income in taxable accounts. In that case, they should avoid traditional bond ETFs and use a more tax-efficient alternative (such as GICs).

  15. Dan October 15, 2017 at 11:08 pm

    @ Dan B. Thank you! That actually clarifies things a lot! I have clearly been overthinking this, I feel kinda dumb now that i see how obvious it is. I currently have the same static 75:25 allocation within all three of my accounts (DC pension, RRSP and TFSA). I haven’t started taxable investing yet but all my tax advantaged accounts will be full by the end of January and i will be putting about $1000/month into taxable investments.

    I need to have 1 asset allocation across all accounts – very simple.Then build with the pieces based on tax efficiency and cost. For example, I have access to US, International and bond index mutual funds with an MER of .2 but only expensive (0.8%) active Canadian funds in my DC pension. It would make sense to not hold Canada in that account and hold more Canada in my RRSP with XIC and fill up my TFSA with mostly or exclusively equities.

    I will have to make a spreadsheet to track it all for re-balancing but that really should be pretty easy.

    Thank you for the great examples and for this blog; it has been a great help to me over the last few years.

  16. Daniel October 16, 2017 at 9:06 pm

    Dan, first of all thanks for the blog! On the subject of robo-advisors, I was wondering what your opinion was of the firms such as wealth simple that offer passive investment portfolios that are automatically rebalanced. In my view these just seem like the Tangerine funds but with a lower MER. Am I missing something?

  17. Canadian Couch Potato October 17, 2017 at 8:09 am

    @Daniel: Thanks for the comment. Robo-advisors can indeed be a good alternative to my model portfolio options. One of my concerns is that most of them stray from traditional index portfolios and some even use actively managed funds. I don’t feel these will add value in the long run. But for small portfolios, especially, they are preferable to most of the other investment options out there, and the focus on regular contributions and rebalancing is certainly a healthy one.

  18. Paul October 18, 2017 at 5:22 pm

    About asset allocation across accounts, even though I calculate asset allocation on the basis of the sum of all accound, I try to have some cash or bonds in every account so that if ever there’s a correction, I don’t have to deal with the additional problem of having to re-set which assets I have in various accounts, I can do a lot of rebalancing by selling off fixed income/cash from within the RRSP, TFSA, etc.

    If a crisis comes around, I want to have the simplest possible scenario to figure out, since I suspect it would be stressful enough without added complexity.

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  20. John October 20, 2017 at 2:19 am

    Dan, I am interested in knowing more about Wealth Management from big 5 banks and private ones like PWL Capital. Would you be able to write an article or do a podcast on such topic in the future? It would be interesting to know what products you/they offer and how they compared to DIY index investment.

  21. Canadian Couch Potato October 20, 2017 at 7:26 am

    @John: I am happy to introduce you to our approach if you email me directly. I can’t speak for the big banks. Obviously any comparison I make would be rife with conflict of interest anyway.

  22. Owen October 31, 2017 at 8:00 am

    It would be interesting to see how much new investors over-estimate their risk tolerance.

    I started investing just before the 2008/2009 financial meltdown and I definitely over-estimated my risk tolerance as a new investor. I had some pretty nauseous moments in late 2008 early 2009. Its easy to say you’ll be ok with losing a 30-50% of your investments until it actually happens.

  23. Oldie October 31, 2017 at 4:02 pm

    @Owen: I’d be interested to know what you, as an “older but wiser” investor who got burned (or so you imply) in 2008-2009, now see as your range of comfortable risk tolerance today. If this present-day comfort range is in the wake of actual past loss experience, do you think your attitude would be more brave (risk tolerant) nowadays if you had not over-estimated your risk tolerance prior to 2008-2009? In other words, I suppose I am asking, would merely witnessing or living through the crash without having your investments unwisely over-extended into equities at the time been as instructive as actually personally taking a heavy loss due to the equities decline?

    I ask this because just before this period, before I became knowledgeable about passive index investing, or indeed investing in general, my RRSP was invested fully into an actively managed equity mutual fund. Fortunately, shortly before the crash during a financial consultation I was advised to spread my risk into a more conservative portfolio that included a healthy buffer of fixed income (although generally, the portfolio was still actively managed). I followed this advice a few months before the crash happened. Therefore by sheer luck I avoided disaster. I think I have become reasonably prudent due to my my increased financial reading and education since then, but I often wonder if I would be even more conservative today if I had not been so lucky in being advised in the nick of time, and had taken the financial hit like so many ill-advised investors did at that time.

  24. Owen November 2, 2017 at 8:54 am

    @Oldie: To this day I can still vividly recall the physical feeling of wanting to vomit as I saw my portfolio drop day after day. It’s something I’ll never forget. It lasted for weeks.

    I lost a sum of money that was significant for me at the time (not nearly as significant now) but I also made more than one mistake. I was invested past my risk tolerance. I wasn’t diversified. I had some money invested that I needed in the next 5 years.

    The good news is that this experience was the impetus for me to learn about investing and personal finance. That self-education has already “paid” me multiples of what I originally lost. So I actually look back on it as a positive experience overall.

    That being said my asset allocation would probably be considered conservative for my age. My wife and I target an allocation in-between balanced and assertive.

    We consider ourselves the tortoise. We might not have the fastest/highest growth portfolio, we prefer to make up for that with discipline and steady savings, but we sleep very well at night.

    In the end personal finance is only partially about the $$$.

  25. Oldie November 2, 2017 at 7:51 pm

    @Owen: Thanks so much for your graphic, no, visceraldescription. As someone who had foolishly lost smaller amounts of money on youthful ventures before, but never serious money in what could actually be called “investing” (even if poorly advised investing), I was missing a valuable subjective life experience that your detailed spelling out filled in for me. I hope other thoughtful investors who have been lucky so far have been carefully reading this, and have got as much value out of it as I have (without needing to actually personally suffer the same pain).

  26. Nic November 4, 2017 at 9:23 pm

    Hello Dan I’d like to know your opinion concerning investing my RRSP in an index funds vs an FTQ fund? If you’re not familiar with it, it’s a fund in Quebec in which they give you a +30% tax credit for investing in it. (I would invest the tax credit in an index fund afterwards)

  27. Canadian Couch Potato November 5, 2017 at 11:17 am

    @Nic: I don’t know much about the FTQ program specifically. But other provinces have similar tax incentives for what are called labour-sponsored venture capital funds. They are risky, highly illiquid, and carry the very real possibility of going to zero. I would never buy such an investment myself and would not recommend them to others.

  28. Paul November 7, 2017 at 10:08 am

    Nic: I looked into FTQ funds. There are a lot of nasty little rules such that you can’t sell it off at will, or within a certain timeframe, or even if you have other RRSPs, and the returns are low, historically. The only case for investing in them is to take advantage of the tax credit when within a few years of retirement. If investing for more than 5 years, index funds will have the edge.

  29. Donna November 8, 2017 at 12:14 am

    Totally unrelated, but would you be able to tell me if it’s ok to sell vcn / vxc to trigger a gain to offset some losses incurred earlier in the year from individual stocks and then repurchase them the same day ? Somehow it seems like that would be frowned apon.

  30. Canadian Couch Potato November 8, 2017 at 7:31 am

    @Donna: Harvesting capital gains like this is perfectly fine, and can be a good strategy if you have carried-forward losses.

  31. Donna November 8, 2017 at 9:30 pm

    Thank you so much Dan. You are a national treasure sir ! I couldn’t love your blog anymore than I already do ?

  32. Canadian Couch Potato November 9, 2017 at 1:04 pm

    Donna, you’re making me blush. :)

  33. DAR November 19, 2017 at 6:01 pm

    Hmmm. Norbert’s Gambit. Heard of it, never used it. If I can “journal” shares w/o an FX penalty of shares purchased on a CDN exchange to their equivalent on the US side, am I at a disadvantage doing so? Am I missing something here?

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