Your Complete Guide to Index Investing with Dan Bortolotti

Vanguard’s One-Fund Solution

2018-12-19T20:20:09+00:00February 5th, 2018|Categories: ETFs, New products|Tags: |266 Comments

It was one of the great mysteries in the Canadian fund market: why had no one created an ETF version of the balanced index mutual fund?

These days you can find ETFs focusing on just about every sub-sector of the market, and a pile of others with active strategies that make particle physics look easy by comparison. Yet until last week, no one offered an index ETF that included a simple mix of global equities and bonds. That’s shocking when you consider the balanced mutual fund is a staple in the industry, with over $766 billion in assets as of December. That’s more than five times the assets held by all Canadian ETFs combined.

That yawning gap has now been filled with the launch of three new ETFs from Vanguard. The new family of asset allocation ETFs are built using seven other ETFs. The Vanguard Conservative ETF Portfolio (VCNS) holds 40% stocks and 60% bonds, while the Vanguard Balanced ETF Portfolio (VBAL) uses the opposite proportion. The most aggressive version, the Vanguard Growth ETF Portfolio (VGRO), is 80% equities. All three ETFs carry a very competitive management fee of just 0.22% (expect the MER, which includes taxes, to come in at about 0.24%).

The reaction to the launch of these new funds was swift and overwhelmingly positive. Indeed, they’re probably the most important new ETFs to be launched in Canada in the last couple of years. So let’s spend some time considering whether they’re right for your portfolio.

What’s under the hood

Each of the new funds is built from four equity and three bond ETFs: the only difference is the proportion allocated to each. You can find the specific breakdown in the ETFs’ marketing brochure.

Let’s look at the equity component first. The underlying holdings include the Vanguard FTSE Canada All Cap (VCN) and Vanguard U.S. Total Market (VUN) for North America. For overseas stocks, the funds hold the Vanguard FTSE Developed All Cap ex North America (VIU) for western Europe, Japan and Australia, and the Vanguard FTSE Emerging Markets All Cap (VEE) for China, Taiwan, India, Brazil and other developing economies. All of these underlying ETFs use plain-vanilla, cap weighted indexes of large, mid and small-cap stocks.

While my model portfolios assign one-third each to Canadian, US, and international equities, the Vanguard ETFs allocate things a bit differently. In all three ETFs, Canadian stocks make up 30% of the equity allocation, while the US gets about 38% and overseas stocks get the other 32%. The international allocation is then subdivided with 77% in developed markets and 23% in emerging.

On the fixed income side, the new ETFs use a mix of Canadian and foreign bonds. About 59% of the fixed income in each fund is allocated to the Vanguard Canadian Aggregate Bond Index ETF (VAB), with another 18% to the Vanguard U.S. Aggregate Bond (VBU), and about 23% to the Vanguard Global ex-U.S. Aggregate Bond (VBG). These latter two funds use currency hedging, which is essential for foreign bonds.

What to make of Vanguard’s decision to include US and global bonds? As I’ve written before, I’m agnostic on this question: since interest rates in foreign countries do not move in lockstep with those in Canada, a global bond allocation might reduce volatility, but the benefit is modest, and if you’re managing your own portfolio it’s not worth juggling three funds. However, if there’s no additional work or cost involved, then it’s probably just fine to include US and global fixed income.

Kudos to Vanguard for sticking to the core asset classes in these funds, for using traditional cap-weighted indexes, and for setting a long-term asset mix that won’t change based on economic forecasts. They could have tossed in their new factor-based ETFs, or dividend-focused funds, or given the manager a wide berth to tweak the allocations, but they didn’t. That was a wise choice, because trying to improve on this simple model is, in my opinion, one of the knocks against many robo-advisors, who can’t resist adding unnecessary asset classes that sound sophisticated but do little more than pile on cost and complexity.

The appeal of one-fund portfolios

A couple of years ago, my model ETF portfolio evolved to includes just three funds instead of five, as the launch of new “ex-Canada” equity ETFs allowed investors to get US, international and emerging markets in a single fund. These new Vanguard asset allocation ETFs makes life even simpler by rolling the whole portfolio into a single fund. That should reduce the number of trades you need to make, and remove the need to rebalance. (The fund literature is not specific about how often this will occur.)

There are other advantages to a one-fund solution as well. When your portfolio includes a different fund for each asset class, it’s easy to dwell on the individual parts rather than the whole. (“My portfolio returned 8% last year, but Canadian stocks didn’t do as well as international. Maybe this year I should put less in Canada.”) With a one-fund portfolio, you’re less likely to fall prey to these distractions and stay focused on the long term.

The new Vanguard ETFs are also much cheaper than other one-stop solutions, such as the Tangerine Investment Funds and robo-advisors. The obvious disadvantage of ETFs is that you usually pay a commission to buy and sell them, whereas index mutual funds and most robo-advisors don’t have trading costs. But if you’re now able to use only one ETF per account, you may still come out ahead even if you’re paying $10 per trade.

Consider the Tangerine funds, which are simple, convenient and well diversified, but carry a relatively high fee of 1.07%. A $50,000 holding in one of the Tangerine funds would carry an annual fee of $535. If we tack on a couple of basis points for taxes, the new Vanguard ETFs should have an MER of about 0.24%, giving that $50,000 holding an annual fee of just $120. Even if you spend another $10 per month on commissions your all-in cost would still be less than half as much as the Tangerine option.

The new balanced ETFs offer a similar cost advantage over robo-advisors, most of whom add an additional 0.50% fee to the cost of the underlying ETFs. One of the primary advantages of robo-advisors over do-it-yourself options is the automatic rebalancing, but now that this feature is built in to the Vanguard ETFs, the value offered by a robo-advisor is somewhat less than it used to be.

Not so fast

Since the ETFs were announced on February 1, my inbox has been bursting with emails from readers who want to know whether these funds have revolutionizing index investing in Canada. Many seem to think virtually every other option—Tangerine, the TD e-Series funds, robo-advisors, and even portfolios of individual ETFs—have become obsolete overnight.

Now there’s no doubt the Vanguard asset allocation ETFs will have broad appeal for investors who want to keep things simple without paying more for convenience. But before you liquidate your portfolio and go all-in with a brand new ETF, make sure you consider the big picture.

One of the key benefits of mutual fund options such as Tangerine and TD’s e-Series is that they allow you to set up pre-authorized contributions, and these get invested automatically. (This is also true for robo-advisors, though they use ETFs rather than mutual funds.) Don’t underestimate the importance of disciplined savings and systematic investing. If you use an asset allocation ETF instead, you’ll need to make a trade every time you add money to your accounts. Even with a one-fund portfolio, you can easily fall into the trap of wondering whether this is the “right time” to buy.

The point here is that if you are successfully using one of these other options and you’re not enthusiastic about buying ETFs, don’t feel pressured to switch.

And while a one-ETF solution is a great choice for investors who hold all of their investments in TFSAs and RRSPs, those with larger portfolios may want more flexibility. Traditional bond funds, for example, may be a poor choice in taxable accounts, and VCNS and VABL include a significant amount of fixed income. If you have a large non-registered account you’ll want to consider using individual ETFs for each asset class for more tax-efficiency.

These new Vanguard asset allocation ETFs are a welcome addition to the marketplace, and if you’re looking for an easy way to get started with ETFs, you just found it. But always remember that investing is about process, not products. Cheap and easy solutions certainly help, but in the end it’s up to you to stay focused on saving, investing with discipline, and tuning out the noise.

 

266 Comments

  1. Canadian Couch Potato November 18, 2018 at 12:29 pm

    @FanDan: Thanks for the comment.

    1) I don’t think VGRO is a problem in taxable accounts. Traditional bond funds tend to be tax-inefficient and are not ideal in a non-registered account. However, as interest rates have risen over the last two years or so, the problem of tax-inefficient premium bonds is not nearly as great as it once was. Moreover, VGRO is only 20% bonds. Things would be different if the ETF you were considering was, say, 50% or 60% fixed income and most of these were premium bonds. Then it would be worth looking at other options.

    2) You cannot buy US-domiciled mutual funds in Canada. And while you can buy US-listed ETFs, be careful about taking portfolio construction advice from US sources, because the situations are different. As discussed in the podcast, it’s usually not a good idea to take currency risk with fixed income, so BNDW is not something I would ever recommend for the typical Canadian investor.

    If you want to hold USD in your account, then you will necessarily be making the portfolio more complicated. You could use the USD to hold your US and international equities using US-listed ETFs (something like VT could do the trick here) and use the CAD to hold Canadian equities and bonds. But this is far from a one-fund simple solution.

    It’s also worth questioning the idea of holding USD at all. You could convert it very cheaply using Norbert’s gambit, and you could get all the USD and foreign curency exposure you want/need using Canadian ETFs that unvest in US and international equities. Remember, too, that managing US-denominated ETFs in a taxable account makes your bookeeping much more difficult. Some background:

    https://canadiancouchpotato.com/2014/01/13/how-a-falling-loonie-affects-us-equity-etfs/
    https://canadiancouchpotato.com/2014/01/16/currency-exposure-in-international-equity-etfs/
    https://canadiancouchpotato.com/2014/04/10/adjusted-cost-base-with-us-listed-etfs/

  2. FanDan December 6, 2018 at 8:14 pm

    Hi Dan,

    Thanks for the quick reply and your wise insight.

    1) The USD to CAD exchange is quite favourable, so I am in the process of dispose of USD assets using the Norbert’s gambit.
    2) It came to me suddenly as a revelation that I can’t help to share with you regarding the One Fund strategy that may benefit other readers.

    Having made decision to transition toward ONE FUND strategy with VGRO, and with relatively larger amount of funds to be invested, I am facing a conundrum. The stock market has had a awesome run in the last few years (with the exception of minor correction in the last few weeks.), so I was hesitant to commit to one large trade. Looking for a solution and after much thought, I decided to divide the assets and purchase termed deposit (GIC, 30d – 1year+), I will spread my purchase of VGRO through a year + period.

    This provides my some comfort, but on a second thought, one could use VGRO/GIC to re-balance one’s account. Once a year or so, investors can re-assess and rebalance between VGRO and GIC holding – this may offer some flexibility for some investors… When market is red and hot, one can sell some VGRO to purchase GIC, vice versa…

    What your thought on this? Thanks again. BTW Moneysense is now sold, I would love to hear something on that as well, since you previous worked for the magazine and had a great interview with its editor.

  3. Canadian Couch Potato December 7, 2018 at 8:42 am

    @FanDan: “When market is red and hot, one can sell some VGRO to purchase GIC, vice versa…” This strategy is essentially market timing. If you’re comfortable with 80% equities (the asset allocation in VGRO) then a more disciplined strategy is to simply maintain this asset mix indefinitely. The fund rebalances itself to maintain a consistent exposure.

  4. Willow on Couch December 10, 2018 at 5:10 pm

    Hi guys, in order to make life easier come tax season – which Vanguard funds would you recommend to invest in, for a Canadian?
    Index funds in Canadian dollars that would have exposure to U.S. markets is what I’m looking for – or I believe that would be wise.

    I have a main investment account, RRSP and TFSA @ my bank.
    These are self-directed accounts and everything I have purchased is on the TSE, so I’m completely new to any foreign investment.
    It’s 100% stock based (reits/banks/telecom/energy/insurance).

    I just think it might be wise to purchase something in foreign markets and I was thinking that would be in the RRSP to keep things simpler come tax season.

    Thoughts?

  5. Jamie December 12, 2018 at 8:25 pm

    Any insights on whether Vanguard will eventually create a 100% equities version? I would love keep all bonds in my non-taxable accounts and have all overflow into the non-registered accounts be equities. Can you pull some strings?!

  6. Canadian Couch Potato December 14, 2018 at 7:43 am

    @Jamie: Alas, I have zero influence on Vanguard’s product development. :)

  7. DRS December 17, 2018 at 2:53 am

    What is your recommendation regarding new etf by ishare xgro and xbal?
    With lower mer of 18% compared to 25% is it a better option than vgro and vbal for tsfa account.

  8. Canadian Couch Potato December 17, 2018 at 8:19 am

    @DRS: Stay tuned, I’ll be writing about these soon.

  9. Charles Potato December 21, 2018 at 1:46 am

    Hi Dan,

    Great post. Question from someone who doesn’t mind dealing with 7 ETFs instead of one.

    -VGRO.TO has 0.22% management fees
    -But if you weight average (based on allocation) the fees for the 7 underlying ETFs, you get 0.14% management fees

    Why buy VGRO.TO then? if you can easily reproduce this asset allocation in your portfolio and save 8 bps on management fees? (0.22% – 0.14% = 0.08%)

  10. Canadian Couch Potato December 21, 2018 at 7:20 am

    @Charles: First, while it is theoretically easy to reproduce the portfolio in a fund like VGRO, managing a portfolio of seven ETFs is not as simple as it may sound. If you are currently doing that successfully, then there’s no reason to change. If you’re not, don’t underestimate the challenges.

    The balanced ETF, for example, rebalances on an ongoing basis so you will drift away from your target asset mix. Most investors are not diligent about rebalancing.

    Unless you are using a discount brokerage with zero commissions, a multi-ETF portfolio will also be expensive in terms of trading costs, especially if you are adding new money from time to time. With funds like VGRO, you’ll make far fewer trades.

    There is also a huge behavioural benefit to using a single balanced fund. During a year when some asset classes are up and others are down, you’ll be less distracted and less likely to tinker with your portfolio. (“Should I buy bonds when they’re doing poorly? Why wouldn’t I buy more U.S. stocks?”).

    All of these are worth at least 8 basis points!

  11. RAB December 30, 2018 at 2:36 am

    Hi Dan!

    I’m a beginner, sorry if this is a dumb question.

    If going with VGRO in my 30s, what would be a good strategy to transition to holding more bonds as I approach 40? Would I sell VGRO and buy VBAL? Would there be a period where I hold both VGRO and VBAL?

  12. Canadian Couch Potato December 30, 2018 at 12:56 pm

    @RAB: Not a dumb question at all: others have made this suggestion as well. In my opinion, however, if you are already resigned to using two ETFs rather than one, then it would be cheaper to combine VGRO with a bond ETF (or with GICs). That would allow you to hold VGRO indefinitely and just make your overall portfolio more conservative as you get older by adding to the fixed income holdings.

    https://canadiancouchpotato.com/2018/12/31/beyond-one-stop-etf-shopping/

  13. Barry January 21, 2019 at 8:51 pm

    What is the difference in us withholding tax on these 3 different ETF approaches:
    1) Vanguard S&P500 [$us] (VFV)
    2) Vanguard S&P [$cdn hedged] (VSP)
    3) Vanguard Growth [global] (VGRO)

  14. Canadian Couch Potato January 21, 2019 at 9:24 pm

    @Barry: VFV and VSP have the same withholding tax implications: the hedging doesn’t make a difference. VGRO is a different animal because it is a balanced portfolio, not just US equities. The withholding tax on the US equity portion of that fund, however, is the same as it is for VFV and VSP. Specifically:

    – In an RRSP and a TFSA, the 15% withholding tax on dividends applies and is not recoverable.
    – In a non-registered account, the tax applies but is recoverable via the foreign tax credit.

  15. Fran February 7, 2019 at 10:31 pm

    Thank you for all the great info. In the interests of simplicity I want to invest in at least one or more of the “all in one” ETF funds within my TFSA and RRSP. – both held in a self directed account with a large bank. I have at least 7 year time horizon before I would need to start drawing on my RRSP (when it convert to a RIF) and also don’t plan to access my TFSA until around the same time. I have $100,000 cash to invest in my RRSP an $50,000 to invest in my TFSA. This money is currently in money market funds and a few equities and not earning much. The idea of investing either of these entire amounts in one or two funds is a bit daunting. And so is a huge market correction that can’t be balanced out in this time period. Would it make sense to do mix of Balanced and conservative ETF funds (VBal and VCns) in each account? Or does this defeat the purpose of these funds? Am also looking at IShares XBAL. I know I can move the funds “in kind” to a RIF if the market was tanking at the time, and am OK with some risk along the way. I am also reading that even the best bonds may be in for a period of low returns as we will be in a rising interest rate environment in the years to come – so funds with a higher weighting in equities (balanced vs conservative) might be a good idea even for a senior. I am 65 and a have good defined needed pension so these funds are being set aside.for possible needs a bit further done road into my 70’s and 80’s. Thank you for any advice.

  16. Canadian Couch Potato February 8, 2019 at 12:15 pm

    @Fran: All good questions, but it sounds like you need a proper financial plan that will address all of them carefully.

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