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. If you have a large non-registered account as well, you may 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.
Hi Dan! I am looking for a type of product which, in principle, should be pretty standard, but I just can’t seem to find it. Specifically, I am looking for a balanced, index mutual fund (not an ETF) with minimal fees. In other words, the equivalent of an asset allocation ETF, but packaged in a mutual fund (I want to set up automatic contributions, hence my preference for mutual funds). I would be willing to pay max. 0.5% in MER.
I am assuming this type of product does not exist since you haven’t included something similar in your model portfolio. Do you know whether this type of product might soon be available in Canada? Or would you have any alternative to suggest? Thank you so much for your precious advice :)!
@Sam: I wish such a product existed, but it does not. The closest you can get is the Tangerine portfolios, but these have MERs of 1.07%. Have you considered a robo-advisor? Even then, the all-in fee would be more than 0.50%.
Very Insightful! Thank you Dan!!
I have VGRO in my accounts – TFSA, taxable and corporate. I hold VAB in my RRSP.
I know about the tax inefficiency of the bonds in taxable and Corporate.
Is there a big risk of just keeping my strategy this simple?
I keep my AA around 60/40.
I figure since I DIY, I would still save even though my portfolio is not maximally efficient.
Should I be going to an advisor for them to double check this?
@Emily: The tax-inefficiency of the asset allocation ETFs is often overstated. Are they optimal? No, but they don’t need to be, especially for DIY investors. I think you’re absolutely fine using VGRO in taxable accounts.
Thanks for answering such an old blogpost!! I am actually leaning towards VBAL in all the accounts. I am 10 years away from retirement.
The only reason I was holding VGRO was because then the inefficiencies of the bonds would be half as expensive.
But with the complexities of having many different types of accounts including a corporate account, I think it is high time for me to stop managing so much extra cash.
Would you still approve for a DIY investor to hold VBAL in all accounts? I figure any higher costs of extra premium bonds may be balanced out by me not touching things as much.
And by the way, your blog changed my ENTIRE financial life. I am absolutely serious.
You have my deepest of respect and gratitude Dan.
@Emily: Thank you so much for those kinds words. They really do mean a lot, and I’m very glad to hear that my work has been helpful.
I absolutely think that holding VBAL (or a similar asset allocation ETF) across all accounts is totally fine. Your comment (“I figure any higher costs of extra premium bonds may be balanced out by me not touching things as much”) is exactly the point.
You may find this blog from Justin helpful:
His conclusion: “So, should you avoid these ETFs in taxable accounts entirely? I don’t think so, especially if they help you maintain discipline and stay invested. Managing more than one ETF requires slightly more effort, and trying to keep up to speed on all the tax jargon is exhausting (take my word for it). Potentially giving up 10 basis points of return for less time with family and friends doesn’t seem worth it to me, but I’ll let you decide for yourself.”