The latest episode of the Canadian Couch Potato podcast features an interview with Dr. Stephen Wendel, Head of Behavioural Science at Morningstar. Wendel heads up a research initiative called the Investor Success Project, which focuses on the human factors that dominate personal finance.

So much discussion around financial well-being focuses on investing, but as Wendel points out in our interview, “In the finance industry, we often focus alpha, asset allocation and fees, but these are only important for people who have saved.” And according to his research, nearly half of all Americans have saved nothing for retirement. I don’t imagine the numbers are any more encouraging in Canada.

Wendel and his team are devoted to helping investors overcome the many challenges they face in the effort to save more and enjoy a comfortable retirement. His specialty is understanding how people can close the gap between what they say they want to achieve and what they actually do. It’s fascinating work, and you can download the Investor Success Project white papers for free.

One-fund vs. multi-ETF portfolios

In the Ask the Spud segment of this episode, I answer a common question about the relative benefits between the popular new one-fund solutions and portfolios of individual ETFs.

With the goal of keeping them simple, my model ETF portfolio includes just three funds, and I have not created tax-optimized versions for different account types. However, my colleague Justin Bender offers model ETF portfolios of five funds (one each for Canadian, US, international and emerging market equities, plus another for bonds), with some variations. For RRSPs, for example, he includes US-listed ETFs to reduce foreign withholding taxes, and for non-registered accounts he subs in the tax-efficient BMO Discount Bond Index ETF (ZDB).

There’s no question that the multi-ETF portfolio has lower fees and less drag from foreign withholding taxes (at least in RRSPs). They also allow more flexibility if you want to hold asset classes in different account types: for example, favouring equities in your TFSA, or bonds in your RRSP. But the trade-off is that you have five funds to manage instead of one, which means significantly more complexity and additional trading costs.

I set out to try to quantify these differences, with the help of Justin’s excellent Foreign Withholding Tax Calculator, which you can download from his Canadian Portfolio Manager site. The spreadsheet estimates the total cost of a portfolio built from several popular index ETFs in TFSAs, RRSPs and taxable accounts.

In my example, I’ve assumed a balanced portfolio of 40% bonds and 60% stocks, which is the asset mix used in the iShares Core Balanced ETF Portfolio (XBAL). I compared this one-ETF solution of the five-ETF alternative that has a similar asset allocation (minus the US bonds). The cost differences—including both MER and foreign withholding taxes—are summarized in the table below. For non-registered accounts, I added an additional 0.05% to estimate the additional tax drag from the premium bonds in XBAL rather than the more tax-efficient ZDB. Here’s how it shakes out:

Account TypeCost of Five-ETF PortfolioCost of XBALDifference
TFSA0.25%0.36%0.11%
RRSP0.12%0.36%0.24%
Non-registered0.11%0.27%0.16%

Remember that every 0.01% represents a cost of $1 annually on every $10,000 invested. That means for TFSAs, the additional cost of using the one-ETF option in a TFSA works out to less than a dollar a month for every $10,000 in the account. In an RRSP, the difference is $2 per month, while for non-registered accounts, it’s an additional $1.33 a month or so.

These dollar amounts certainly add up once your portfolio is into six figures. But the part many people gloss over when making these comparisons is that MER and foreign withholding taxes are not the only costs to consider here. You also need to factor in the commissions to buy and sell the ETFs (even Questrade charges commissions to sell, which you may need to do when rebalancing). If you’re paying $10 per trade, that will quickly close the cost gap between the two options on smaller portfolios.

Moreover, holding US-listed ETFs in an RRSP means you will need to eat your brokerage’s (terrible) currency conversion rate, or do Norbert’s gambit to convert your loonies to US dollars. This technique can dramatically lower the cost of currency exchange, but it’s not free, and it can be tricky and time-consuming. Your rebalancing will also be more complicated, because you’ll need to set up your spreadsheet to convert US-dollar values to Canadian dollars.

And to be sure, in a non-registered account, tracking your adjusted cost base and other recordkeeping will certainly be easier if you’re using only one ETF.

In the end, it’s up to every investor to determine how much they’re willing to pay for convenience and peace of mind, and how much additional complexity they’re willing to accept in order to enjoy some savings. Just make sure you think through all of the costs—financial and behavioural—before making your decision.