Here’s Part 2 of the highlights from my recent AMA on Reddit. This is a lightly edited transcript of the exchange, along with some additional comments and links I didn’t have time to provide during the live discussion.
CrushyMcCrush: Two questions: 1) if you have existing stocks that are fairly diversified, would you consider them part of your allocation for that region (e.g. Google, FedEx etc. in place of a US ETF) or would you recommend selling these stocks and buying an ETF?
2) For index investing, what is the minimum amount of time in the market you would recommend for someone with an above-average risk tolerance? For example, if I am saving for a down payment in five years, is that long enough, or would you recommend a high-interest savings account?
CCP: 1) As you can imagine, I don’t recommend holding any individual stocks. They are a huge distraction: believe me, you’ll find yourself focused much more on those individual companies than on the rest of your portfolio. Unless you have very large capital gains that you want to defer, I generally recommend that index investors purge their portfolios of individual stocks and simply use ETFs.
If you can’t sell the stocks for whatever reason, then yes, I would tend to consider them as part of your overall allocation to that country (e.g. Google is part of your US equities, Royal Bank is part of your Canadian equities, etc.).
2) If you’re saving for a down payment, I would recommend GICs: this is about savings, not investing. GICs have zero risk of loss and decent rates now (2.5% to 3.25%), at least compared with years past. Just make sure you understand that GICs are not liquid, so if you think you might need the cash in two or three years rather than five, adjust the maturities accordingly.
jjj7890: I’m investing with monthly purchases of ETFs with a mix of 50% XIC and 25% XAW, with 25% allocated to fixed income—except instead of buying a bond ETF, I’m pre-paying my mortgage. I figure that “earning” a guaranteed 3% return on the mortgage prepayment is preferable to a 2% to 5% (?) fluctuating return on a bond fund. What might I not be thinking of, and what do you think of this approach in general?
CCP: There’s nothing at all wrong with what you’re doing: investing and paying down your mortgage are both ways of increasing your net worth.
I would just frame it differently. You are not allocating 25% of your investments to fixed income. You have a portfolio of 100% equities, and you are also paying down debt. The mortgage prepayments are a sound decision, but they’re not just a different way of buying fixed income. So just make sure you are comfortable with the risk of a 100% equity portfolio.
juggabags: I’ve followed the Couch Potato plan for years, shifting only very occasionally between the recommended ETFs in my RRSP and TFSA. But, now I’m thinking of getting into one of Vanguard’s new Asset Allocation ETFs (probably VBAL) and was questioning whether I should move all my current investments over, or just add any new funds to VBAL.
CCP: I’m getting this question a lot since the launch of the Vanguard asset allocation ETFs. I like simplicity, and I think hybrid solutions (holding the existing ETFs and adding new money to VBAL) undermine that simplicity and can make rebalancing even more complicated. So if there are no tax consequences (i.e. all of your funds are in TFSAs and RRSPs), I tend to recommend selling the current holdings and using only the one-fund solution.
[Note: I recently answered a similar question in more detail at MoneySense.]
domlee87: As someone who has read Millionaire Teacher and The Value of Simple, I feel like I know all that I need to know about investing in index funds. Is there a need to know any more after this point and if there is, do you have any specific books that you would recommend? I am considering reading up on Canadian taxes but don’t know what else to really seek out after that.
CCP: A very insightful question. At some point there are diminishing returns on education about index investing. If you save regularly and have a well-diversified, low-cost portfolio, and you rebalance with discipline, you are already 90% of the way there. A basic understanding of tax-efficiency will get you even closer.
So it’s not unreasonable to decide that you don’t want to spend hours reading about the minutiae that might, at best, save you a couple of basis points a year. Indeed, it’s just as likely you could start to second-guess yourself and unwind the solid plan you’ve already built.
Ulkurz: I’m a 30-year-old who recently started looking to grow my savings mostly by investing in stocks, bonds and other options. However, the learning curve about investing rationally is pretty steep. It can take a while before I’m absolutely confident about putting my money in something I believe in. I’ve around $40K in savings that I do not need at all. Where do you suggest I should start?
CCP: If we start by assuming that you believe in investing in the stock and bond markets, then a simple balanced index fund could be a place to start. If you’re also considering totally unrelated ideas (such as buying a rental property), then you may have little option other than keeping your savings in cash until you are comfortable.
One word of advice: doing your research is important, and you need to be comfortable with your choice. But be aware of analysis paralysis or you may find yourself sitting on cash for years.
schpeucher: I became familiar with your work last year but have yet to ever invest: I have only used savings accounts. So, on top of “Am I an idiot?” my question is, what are your thoughts on opportunity cost in investing? I have almost $100K saved, but I also need some funds available to run a business venture I’m starting. Is it best to invest as much as possible and use a line of credit to fund daily spending? Or better to always be in the black and invest less?
CCP: I can’t comment on your specific situation, but no one is an “idiot” if they don’t invest. If someone plans to start a business, then it’s entirely reasonable to hold cash for that reason (and probably an emergency fund, too, in case the business fails). Investing that cash and using credit to fund the business is adding a double layer of risk.
msvolkl: What would your suggested asset allocation be for two people with defined benefit pensions, both age 30? Would you suggest being more conservative (don’t need to chase higher earnings due to pensions), or taking more risk due to the safety net of the pensions?
CCP: This is a great question, because you can make an argument for both. You have less need to take risk than those without a pension, but also more ability to take risk if you desire. So in the end it comes down to your comfort level.
TradersJoes: Been following your blog and using the CCP balanced portfolio for registered and cash accounts through my discount brokerage. I hold the same three ETFs in each account and rebalance every six months. With a portfolio over $500K, what are the advantages of switching to a full-service advisor vs. continuing to manage on my own?
CCP: Advisors can generally add value in the following situations: the investor has no interest in devoting time and energy to managing the portfolio (not the case here, I’d say); the investor needs financial planning as well as investment management; the portfolio is large and complicated (multiple accounts, some of which are taxable) and requires more expertise; the advisor can impose a discipline the investor lacks; and the advisor can do all of this for a reasonable fee.
pfcguy: I have an actively managed portfolio of >$250,000 managed by professionals. It consists of ~25 stocks, bond ETFs, and an international ETF, and a fee of 1.5% per year. They also provide financial planning, life insurance advice, etc.
I can think of a number of reasons to switch to a passive/index strategy like a CCP model portfolio of ETFs. Can you think of any advantages to stay with active? Are there things a portfolio manager does that I would not get from a passive/index portfolio?
CCP: I think your question is less about active vs. passive and more about advisor vs. DIY. You can reduce your costs by building your own Couch Potato portfolio, but if you get value from your advisor in terms of planning, discipline, etc., then switching to DIY may not really improve your situation overall.
CrasyMike: Here and there someone will post asking if a market-linked GIC is appropriate. This person will typically have a short-term goal that requires limited to zero risk, but wants to figure out how to get the “best possible return.”
I’m sure a high-interest savings account is an appropriate option for this person, but if they are willing to accept the possibility of zero return on investment then why not a market linked GIC? What is so inherently wrong with them?
In this post you point out that some of them are a total rip-off. But are there any market-linked GICs that are not a total rip-off—a limited upside, but still better expected return than a regular GIC?
CCP: I’m not aware of any product that promises a meaningful upside and also no risk of loss. Market-linked GICs are often built in a similar way to the homemade one I described in the post linked above, but they layer on hefty fees and may even cap the upside.
RE: “If they are willing to accept the possibility of zero return on investment then why not a market linked GIC”? I guess I don’t think one should ever accept the possibility of zero return with such a limited upside. I would rather just buy a plain vanilla GIC and accept the guaranteed return.
Jabb: My RRSP is all ETFs, but years ago I became enamoured with the SPDR ETFs where I could allocate my money into ETFs holding specific sectors. Is this majorly hampering my compounding returns?
CCP: I can’t know if it’s hampering your returns in the short-term, but tinkering with narrow, sector-specific ETFs is likely to be a major distraction over the long term. I recommend simply using total-market ETFs and avoiding trying to guess the next hot sector.