Exchange Traded Funds (ETFs) – Part II

Building a balanced portfolio with ETFs is pretty straightforward. Similar to mutual funds, as their popularity started rising, companies started providing pretty nifty sector-based or currency-based ETFs. If there is a certain type of market or sector you want to target, there is probably an ETF for it. That being said, the MERs for these products are a lot higher, and your diversification is reduced. So remember, KISS is the way to go. Only reference to Valentine’s Day; I promise! 🙂

Once your accounts are set up and funded, then what? How do you choose what to invest in? Determine your asset allocation and choose the corresponding funds. Since I am 30, I will have 30% in bonds.

30% Canadian bonds – XBB (MER of 0.30% for 2011)

24% Canadian equities – XIC (MER of 0.25% for 2011)

23% US equities – VTI* (MER of 0.07% as of April 29, 2011)

23% International equities – VEU* (MER of 0.22% as of February 25, 2011)

* VTI and VEU are Vanguard products. As they are traded on the US stock exchange, you will be subject to additional costs based on how our Canadian dollar is doing compared to the US dollar. It is currently around par, but you have to remember that the brokerage will take some fees to transfer between the currencies. The lower MERs should make up the difference, but it is something you should be aware about. Another option is to replace VTI and VEU with XSP and XIN which are the i-Shares equivalent. The corresponding MERs are 0.24% and 0.50% respectively.

Assuming your portfolio allocation is IDENTICAL to your ideal asset allocation, your portfolios’ MER is approximately 0.2167% a year. The MER for the TD e-series portfolio is 0.435% a year. Compare these to the average mutual fund in Canada which boasts an average MER of 2.50%. You are saving yourself over 2% every year! Add in the magic of compounding

Sound familiar? It should! I wanted to keep the message consistent; it will seem very intimidating to start, but once you set your allocation and know what your investment plan is, it will become more manageable. You’ll wonder why you didn’t do this earlier! (I know I did!)

Now that you are armed with all this additional information, take a look at the update I did for my own portfolio. (Yup, definitely due for a new update!) You can see that it is pretty messy! I have a lot of ETFs that are overlapping (VTI and XSP for example). This was a result of setting up my target allocation, but also learning new things along the way. My portfolio is the guinea pig! I could just sell all the extra ETFs, but I have to be mindful of the transaction costs, so I made the decision to only re-balance when I put in new money. It is slowly becoming cleaner!

As I mentioned before, I want a well-balanced and diversified portfolio, but I also want to achieve it the easiest way possible. You can always add a couple other ETFs to tweak the annual return and risk factor (i.e. I am looking into adding a REIT ETF into my portfolio, and I’m definitely a fan of the Complete Couch Potato portfolio) but I do strongly believe that the simple portfolio above is sufficient enough to beat your current bank or investment company portfolio in the long run. Once you become more comfortable with investing, you can always learn more and add ETFs to tweak the return, but if investing is intimidating enough for you, the above portfolio is great!

What do you think? Ready to dip your toe in and start building your own portfolio of ETFs?

I need your help! As this is a new blog, please spread the word on Facebook, Twitter, or email the link to a friend or family member. Thanks for the support!

https://vixymoney.wordpress.com/

Exchange Traded Funds (ETFs) – Part I

Now that you’ve had time to read (and absorb hopefully!) all the wonderful information about mutual funds, you must be wondering what ETFs are, and why I prefer them over a portfolio of cheap index mutual funds.

What are they?

ETFs are very similar to mutual funds as they are essentially a portfolio of stocks and/or bonds. The main difference is, as the name implies, that these funds are traded on a stock exchange. So instead of going to your friendly neighbourhood bank or investment company and having them purchase mutual funds on your behalf, you will need to set up a brokerage account and actually purchase the ETFs yourself. You can set up a brokerage account at companies affiliated with the large banks (i.e. RBC Direct Investing or TD Waterhouse), or you can set up an account at a discount brokerage (i.e. ETrade or Questrade). Once your brokerage account is set up, you can then proceed to purchase and sell ETFs on the stock market.

Advantages

ETFs have similar advantages as index mutual funds do: they provide diversification, the MERs are cheaper than both normal mutual funds as well as index mutual funds, you have a fund manager to purchase all the underlying securities for you, and you can easily sell your ETFs on the stock market if needed. Another big advantage is that you can control the tax implications on your portfolio (i.e. you can only trigger capital gain or losses when you sell your ETF, therefore, effectively timing the tax implications to your advantage).

Disadvantages

Transaction costs – as every ETF is traded like a stock on the stock exchange, there is a transaction cost every time you buy or sell. Depending on the size of your portfolio, this may end up being an advantage, but you will have to remember to take into account both transaction costs as well as MERs when determining the cost of your portfolio.

Stock-like feature – the ability to buy and sell an ETF on the stock market is a great advantage, but it can also be a great disadvantage as well. It may become tempting to watch the movement of the price of the ETF and one may try to time the market to lock in gains. This will result in increased transaction costs as well as adding complexity into the equation. Remember, we want the easiest, most cost effective way to save and grow our money. We do not want to add in temptation to sabotage ourselves!

As long as you stick to broad-based market index ETFs, you should be able to replicate index mutual funds at a fraction of the cost. If you are just starting to invest and do not have a large sum of money, or if you are intimidated by the thought of having to purchase ETFs on the stock market, you may want to stick to the e-series index mutual funds for the time being. Once your investment portfolio grows to around $50K, it may be worth looking into replacing the index mutual funds with ETFs as the MERs are much lower and you will have a lot more control over your portfolio.

In Part II, I will go over how you can set up diversified and well-balanced portfolio using ETFs.

What do you think? Are ETFs something you are considering adding to your portfolio?

I need your help! As this is a new blog, please spread the word on Facebook, Twitter, or email the link to a friend or family member. Thanks for the support!

https://vixymoney.wordpress.com/