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 on 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 Type | Cost of Five-ETF Portfolio | Cost of XBAL | Difference |
|---|---|---|---|
| TFSA | 0.25% | 0.36% | 0.11% |
| RRSP | 0.12% | 0.36% | 0.24% |
| Non-registered | 0.11% | 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.
Hi Dan:
Great podcast as usual, thank you so much for doing these! The answer about all-in-one-funds versus multiple ETFs was super informative, but I had a couple questions about the all-in-one-funds I’m hoping you can clear up:
1.) Here you used XBAL, which Justin’s spreadsheet shows has a 0.21% MER, but on both Morningstar and Blackrock’s site I see an MER of 0.76%?
2.) As an alternative I was looking at Vanguard’s VBAL. But on Morningstar I noticed that the 1-Year Trailing Returns are significantly underperforming XBAL (4.35% vs 5.71% at time of posting), as well as its index (-1.73 according to Morningstar). I realize two funds with similar strategies and fees won’t perform the exact same, but this seems like a large difference. Any idea what’s going on with VBAL?
Thanks,
Graeme
@Graeme: Many thanks for the comment, and for the great questions. Both actually have the same answer.
XBAL and XGRO (unlike their counterparts from Vanguard and BMO) were not brand new funds: they evolved from two older ETFs (tickers CBD and CBN) that had much higher fees. Published MERs are backward-looking: they tell you the expenses of the fund over the previous 12 months. So investors holding CBD or CBN did pay an MER of 0.75%, but when iShares changed the mandate of these ETFs they lowered the management fee to 0.18%. I would estimate another 0.02% or so for taxes, so the MER will be right around 0.20% or 0.21%. But only after these funds have been live for a full year will the published MER reflect that current investors are paying this much lower cost.
This also explains the difference in 12-month trailing returns. XBAL and XGRO have not had a full 12 months under their current mandate, so it will take some time before you can compare them with VBAL and VGRO over any meaningful period. (Even then, the reported returns will be very misleading for a long time.) But you should expect them to be very similar to their Vanguard and BMO counterparts. Any short-term differences will be random and not meaningful.
Thanks for the explanation! That also explains the bizarre XBAL performance numbers under 3, 5, and 10 years :).
I’m still a bit confused about VBAL though since it also underperformed the Tangerine Balanced Portfolio (4.35% vs 4.74% according to Morningstar) despite significantly lower fees. Before fees, it seems like the Tangerine fund outperformed VBAL by well over 1%. Is that to be expected over the relatively short-term (1 year) just due to minor differences in fund makeup and balancing?
@Graeme: There are a few differences between the Tangerine and VBAL portfolios: Tangerine is large-cap only, while VBAL includes mid and small-cap stocks. VBAL also includes global bonds and emerging markets, while Tangerine includes neither. These differences will result in short-term differences in performance.
Thanks for the information. Very helpful. I am using VGRO in my CCPC. I am letting taxes fall where they may.
Even my accountant can barely tell me if this makes sense.
I will gladly pay for the convenience of these all in one ETFs.
Dan, after listening to your podcast discussion on portfolio models, I can see the benefits of a one-fund ETF portfolio during the accumulation phase. I was wondering if there is a downside in the decumulation phase during a stock market crash. With my multi-ETF portfolio, I can forgo cashing in the equity ETFs and just sell units of the bond ETF, for years if needed. With a one-fund model in such a market crash, would I be cashing in both equity and bonds, when I don’t really want to be touching the equity? I was wondering if a diversified equity only ETF (VEQT) plus a bond ETF (e.g. ZAG) would be a better option.
One other question: with a multi-ETF portfolio, if one asset has significantly out performed the other assets, I can sell that one particular asset, bringing the portfolio back into balance. Is this done automatically in the one-fund ETF, and I really don’t need to have any concerns about what assets are being sold?
Your thoughts would be most welcome.
@Bob: This is a great question and one I might explore in a future podcast or blog. Holding one bond and one equity fund (such as ZAG + VEQT) certainly offers more flexibility. But remember that during a downturn in equities, a one-fund ETF will be continually rebalancing by investing new cash flows into stocks and (if the downturn is large) probably selling bonds as well. Same with the individual equity asset classes: these are continuously rebalanced in the fund. All of this is going on even if you’re not seeing it.
So I think a one-fund portfolio can be appropriate even in the drawdown stage. That said, most retirees might want to set aside some funds in cash and/or GICs to provide a few years’ worth of cash flow. They can then periodically sell some shares of the ETF to replace the GICs as they mature.
@Emily: A fund like VGRO can be very good choice in a corporation for DIY investors. RE: “letting taxes fall where they may,” this implies that you’re not concerned if you pay more tax than you need to, but I don’t want others to get that impression. VGRO is generally a very tax-efficient fund in a non-registered account and you’re not giving up much at all.
Thank you for this comparison of one-fund vs. five-fund solutions for RRSP, TFSAs and non-registered accounts. Very helpful!
hey could you make a podcast on bonds, like in 2019, is it even worth getting bonds, if gic’s or competitive saving accounts are close enough with very limited risk? like my savings account has a promotion at 2.75%
@michael: These may help:
https://canadiancouchpotato.com/2015/05/07/should-you-replace-bonds-with-cash/
https://canadiancouchpotato.com/2015/03/27/ask-the-spud-gics-vs-bond-funds/
You can certainly make a good argument for holding cash instead of bonds if you can get 2.75% and bond yields are lower than that (like they are now). You just need to be prepared that there will be periods when rates fall and bonds get a boost. Over the 12 months ending June 30, for example, broad-market bond ETFs returned over 7%. During periods where rates rise, the cash and GICs would generally outperform. So it’s always a trade-off and usually the best strategy is to include a little of all three in the mix.
Hi Dan,
I don’t think there is any question that ETFs are great when the funds are growing and there is more money flowing in than out. As you pointed out, rebalancing can be done with new funds and capital gains are low.
The question is, how might these asset allocation ETFs (and other index ETFs such as VCN, XAW and ZAG) be expected to perform during a prolonged multi-year period where more funds are flowing out than in? I don’t just mean tax efficiency, I am wondering if there is anything else to watch out for that no one has really thought about because it hasn’t really happened yet? Any big surprises?
Would love to hear this covered in a future blog post or podcast. Thanks!
@Mark: I can’t imagine that multi-asset class ETFs would be any more vulnerable than single-asset class ETFs. And the idea that traditional ETFs are somehow going to fail investors during a market meltdown has been broached many times with no supporting evidence. Remember that ETFs were already quite mature in 2008-09 and they held up just fine.
Let’s also remember that ETFs are just a type of mutual fund, which is simply a wrapper for stocks and bonds. Panic-selling during a market crash is always gong to happen, and this will tend to drive equity prices down further, but whether those stocks are held individually or inside mutual funds or ETFs should not have any meaningful impact.
I deal with a related idea in the “Bad Investment Advice” segment of this podcast:
https://canadiancouchpotato.com/2017/02/08/podcast-5-master-class-with-the-millionaire-teacher/
Thanks for another very interesting podcast, Dan. A very interesting guest, and I particularly liked your analysis of one fund vs multi fund portfolios. I think the one fund ETFs really are a game changer. It’s very difficult to sell those nice bond funds that are rising in price and buy those lousy stock funds that continue to go down nearly every day in a serious bear market. So, my guess is that failing to rebalance in a crash is one of the more costly behavioural errors that many investors can make and having that done for you will likely more than make up for the slightly increased cost and tax inefficiency in any account for many investors. The one funds also fits perfectly with Jack Bogle’s advice “Simplicity is the master key to financial success”.
Hi Dan,
Thanks for continuing to put together this great info.
I know it wasn’t the intention of the discussion, but I wondered if there would be an indication to use mutliple ETFs that track the same or similar indices if an account size starts getting big. Perhaps this could mitigate the (low) risk that one ETF provider could be a victim of fraud/cyberattack/etc. and that one holding would get affected negatively in a significant way, while it’s alternatives would be unimpacted.
Assuming that everything else is in order in regards to a person’s portfolio and planning, and that person will hold $500K or a million of broad market ETF from one region as part of their investments, would you consider it okay for that to all be in one fund (like VCN only) rather than spreading it out between VCN, XIC and ZCN?
I realize that spreading out to multiple ETFs providers may impact tax loss harvesting opportunities and there is value in simplicity of fewer holdings plus simplicity related to tracking ACBs, plus there could be a slight drag on returns if more change is left uninvested after DRIPs. My question is really about risk for ETF provider default/problems only, like the example of one insurance company going belly up. Is there some arbitrary (or specific) dollar amount that you try not to let your clients exceed before you start funneling money into a similar fund provided by another company?
Thanks in advance Dan.
@Diego: In our practice it’s not that unusual for us to hold $500K to $1M in a single ETF for one client. The risks here are not the same as they would be for an insurance company or GIC issuer. Even if an ETF provider were to go bankrupt, the stocks and bonds held in their funds do not disappear, and their creditors have no claim on those assets, which are held by a third-party custodian.
That said, if your portfolio is large and spread across multiple accounts, there’s nothing specifically wrong with using different ETFs if it makes you more comfortable. For example, one spouse could hold a Vanguard ETF and the other could use an iShares or BMO equivalent.
Hi Dan,
Great podcast and very useful info. I do have a question in regards to one-fund solution.
–I was wondering what is happening with these ETF’s when the allocation of a country decreases drastically. (Ex: assuming US is going through the same scenario as Japan)?
–Are these one-fund ETF’s solutions adjust automatically or there might be new ETF’s created with the new allocations?
Thanks.
@Alex: This is a good question, and I don’t think anyone can answer it in advance. The multi-country international indexes tracked by these funds already adjust automatically to the changing sizes of each country’s market cap. But the US and Canadian allocations in these funds are currently fixed. So if the US’s share of the global market cap changes significantly, I think it’s possible that the funds would change their asset allocation slightly. But the move would need to be quite big, I think, and I don’t imagine this would happen in the next several years.
I am a new listener and find these podcasts very useful. In the podcast, the advice I took away is not to shy away from single ETF portfolios, and all things the same, the lowest fee ETF should be used. However, in a rather sizable non-registered portfolio (say $3 million), would it make sense to split the allocations up evenly into three equivalent ETFs (say VGRO, ZGRO, and XGRO) in order to mitigate the risk of a large capital gain should one of the funds close down? How long on average do successful ETFs stick around for? Thank you and good day.
@Steve: Thanks for the comment. I think it’s probably unnecessary to use ETFs from more than one provider, but it’s reasonable if it makes you more comfortable. If you have multiple accounts, you could just use different ETFs in each of these. If you plan to add more money over time you could also consider using a different ETF for future purchases. Over a long enough time period that may also allow you more flexibility when it comes to realizing capital gains.
ETFs are shut down all the time, but they are almost always very narrowly focused products. Huge providers like Vanguard, iShares and BMO are unlikely to shut down products like these, especially because they are built from other ETFs that already have a huge amount of assets, making them very cheap to manage.
Hi Dan,
Do you have any suggestions for those of us who regret jumping into a multi ETF approach with some US-listed funds, and now long for the ease of an all in one asset allocation solution?
I may put my greenbacks into something like VT that self balances, then put all future contributions into a VEQT or XGRO.
How do we know when we can sell the US funds and Norbert it back home with taking a big hit?
Thank you,
Brendan