ETFs

Laurie wants to start investing, and… (Part 6 of 6)

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…she wants to know what she just bought (in Part 5). What does her investment portfolio look like?

Continuing with the assumption that we bought the June 30, 2019, 30%/70% CPM ETF Portfolio, $300 (30% × $1,000) of the investment portfolio would consist of bonds (the ZAG ETF). Almost 40% of these bonds are AAA rated, consisting largely of Government of Canada and Province of Ontario debt.

The five largest Canadian stock investments (in the VCN ETV), representing about 7.1% of the $1,000 portfolio, would be:

  • $18.87 in Royal Bank of Canada
  • $17.52 in Toronto-Dominion Bank
  • $12.74 in Enbridge Inc
  • $11. 18 in Canadian National Railway Co
  • $10.88 in Bank of Nova Scotia

Similarly, the five largest non-Canadian stock investments (in the XAW ETF), representing about 3.1% of the $1,000 portfolio:

  • $8.94 in Microsoft Corp
  • $7.53 in Apple Inc
  • $6.84 in Amazon.com Inc
  • $4.04 in Facebook Inc A
  • $3.61 in Berkshire Hathaway Inc B

The remaining approximately $600 is invested, in amounts of less than $10 per stock, across hundreds of stocks in Canada and around the world.

What else is important to note? Well, according to the June 30, 2019, 30%/70% CPM ETF Portfolio, the worst 1-year return in the last 20 has been -23.44%. If that’s too much to stomach, then perhaps you should consider a portfolio invested more in bonds and less in stocks.

On the other hand, over the past 20 years (a period which includes the Financial Crisis of 2008-2009), this particular portfolio has returned an average of 5.65% per year. And if the past is an indication of the future, there is about a 2/3 chance than any one year’s return will be between -2.53% and 13.83% (judging by the standard deviation number).

One last thing. The three components of the portfolio will, over time, drift away from their original 30%/23%/47% weightings of ZAG/VCN/XAW. One or two of these ETFs will perform better than another. Therefore, to keep the investment portfolio in shape, it would be wise to:

  • Check to see if your risk profile (see, Part 2) has changed during that period
  • And rebalance the portfolio to your current risk profile (not too frequently, but at a minimum, annually)

Laurie wants to begin investing, but…(Part 5 of 6)

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…she doesn’t know why she should be buying ETFs or which ones to buy.

ETF means exchange-traded fund. An ETF is an investment fund (financed by the pooling of investors’ monies) that is traded on a stock exchange. It is like a mutual fund (another type of investment fund), if you’re familiar with them, but much cheaper to own (mutual funds are not traded on a stock exchange and can only be redeemed at a price calculated at the end of each day).

The main benefit of an index ETF is that it provides you with a way to inexpensively diversify your investment portfolio. By diversifying, you are following the age old adage, “Don’t put all of your eggs in one basket” (lest you trip and fall and all the eggs break). So some of the investments in an ETF will do well and some will “break”, but overall enough of your nest eggs will thrive to make up for the “breakage”.

Part 4 of this series indicated that only 3 ETFs could suffice. Well, what are they? Assuming that a risk assessment was performed as stipulated in Part 2, so that a range of debt (bonds) and equities (stocks) have been determined, and that the account will be a self-directed RRSP brokerage account like those described in Part 3, then the combination of those 3 ETFs may be taken from a chart prepared by CanadianPortfolioManagerBlog.com. Select the “CPM Model ETF Portfolios”, although the other model ETF portfolios (Vanguard, BMO, iShares) do not differ much in cost or content. Here is the list of June 30, 2019 CPM Model ETF Portfolios. The first page is for RRSPs and RRIFs (tax-deferred portfolios).

Continuing with the assumption that we want an RRSP portfolio of investments, we would move along the top of the page until we come to the proportions of debt (bonds) and equities (stocks) suggested from doing our risk assessment in Part 2. Let’s say that as a result of our risk assessment, we decide to invest 30% in bonds and 70% in stocks (the fourth portfolio from the right). Accordingly, with $1,000 to start our portfolio we would buy $300 (30% of $1,000) of the ETF with the symbol ZAG, $230 (23% of $1,000) of VCN, and $470 (47% of $1,000) of XAW.

The reason we buy XAW is because it contains stocks from around the world, excluding Canada. With Canada representing only about 2 to 2.5% of the world’s economy, it makes sense to take advantage of productivity of some of the other 98% of the world. VCN represents our investment in Canadian stocks, and ZAG represents our investment in Canadian bonds or debt securities.

There, we’ve started. In Part 6, we’ll describe our investment portfolio with a bit more detail.

Laurie wants to begin investing, but… (Part 4 of 6)

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…she needs to know in which securities (ETFs, in this case) she needs to invest.

Whenever the shares of a company trade on a stock exchange, there is always one winner and one loser. The winner is the seller if the share price drops after the sale, or the buyer if the share price climbs after the purchase. The loser, you guessed it, is the buyer if the share price drops after the purchase, or the seller if the share price climbs after the sale. In the short-term at least, its a zero-sum, win-lose, lose-win, game. There are no win-win scenarios.

So, how is a person, with no better information than the next person, to decide whether a given price for a security is too high or too low? One answer could be, assume that the market is efficient, and accept the current price of the security as the best estimate of the value of that security. This is not unreasonable, because the current price is based on the buying and selling decisions of hundreds, thousands, or even millions of investors. And one must indeed have some superior information to go against such a large crowd.

In the very long run, it generally pays to be a buyer. See, for example, the U.S. stock market returns over the past 130+ years, for various holding periods. The average return over 20 years is 6.7% (the average his higher for shorter periods of time, but the range of possible returns is also broader, and include losses).

Okay, so what to buy for the investment portfolio. Given the scenario created in the previous posts, one suggestion would be to invest in a simple portfolio of 3 ETFs. Yes, just 3 investments. Details in Part 5.

Laurie want to begin investing, but…(Part 3 of 6)

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…she doesn’t know where to invest in equities (stocks) or debt securities (bonds) for her self-directed investment portfolio.

If you’re like Laurie, you’ve selected what proportions you want to invest in equities and in debt in Part 2. You could now go to any one of your favourite financial institutions and open a self-directed investment account. All major financial institutions (banks and credit unions) in Canada offer them. Note however, that:

  • They all generally charge fees
  • The amount of fees differ between them
  • And, those fees can eat up a significant chunk of your investment returns if you are starting with a small account

Or you could find out which financial institutions do not charge you fees. For example, Questrade doesn’t charge for the purchase of ETFs and comes highly recommended by a number of Canadian financial web sites.

National Bank Direct Brokerage charges $0 commission when buying or selling exchange trade funds (ETFs – more on that in Part 4). Mind you, there are some restrictions, such as the minimum order size must be for 100 units of an ETF.

WealthSimple Trade, a financial technology (fintech) firm based in Toronto charges no commission to trade securities and has a convenient app with which to do so. Do not confuse WealthSimple Trade with WealthSimple Invest, which charges you to manage a portfolio on your behalf – something you can quite easily do yourself to boost your returns. At the time of writing, WealthSimple Trade did not yet offer TFSA or RRSP accounts, but was planning to do so soon.

To compare other self-directed investing options you may view SavvyNewCanadians‘ list of bank and credit union brokerages along with the commissions that they charge for buying and selling ETFs, plus fees for administration. Saving on commissions and administration costs means your investment account will grow faster than if you share your gains with the brokerage.

Once the self-directed brokerage account has been opened and funded with some cash, investments may be purchased. On to Part 4…

Simple Six Update

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It’s been over 6 months since the Simple Six was first offered as a portfolio for consideration. So how has it done?

Well, here are some results. First, and most importantly, the portfolio’s return since March 10th was 6.16% as of this morning. With a ‘balanced’ portfolio like the Simple Six, we can expect that not all components will provide the same return. In fact, one would hope that the returns of the various components are uncorrelated, meaning that there should be relatively high probability that when one component decreases in value, there are other components that increase in value (hopefully, by more than the decrease).

So, the one component that experienced a decrease in value over the last 7 months was the Vanguard Canadian Short-Term Bond Index (VSB). It decreased by just under 0.5%. The best performing component for the period was Vanguard FTSE Canada All Cap Index ETF (VCN) with a return of 9.7%. Another good performing component was the Vanguard Total World Stock ETF (VT), coming in at 7.7%. The remaining 3 components generated between 1.3 and 4.9%.

The Rationale behind the Simple Six

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Here’s some of the rationale behind the Simple Six portfolio.

As the investor’s expenses are expected to be denominated in Canadian dollars when the portfolio is liquidated, a large part of it is invested in Canadian dollar denominated securities. Recognizing that the Canadian economy is less than 3% of the world’s economy, I think its also important to diversify beyond Canada. Accordingly, a significant proportion of the portfolio is invested around the world, but particularly in the U.S.

The 1,100 bond (fixed income) units represent about 25% of the portfolio. I thought this proportion was about right given the risk-reward profile of the investor. These units are expected to have a relatively low rate of return, but they also carry a relatively low measure of risk. The fixed income portion of the portfolio is also diversified among corporate bonds and governement bonds. The largest fixed income component consists of short-term bonds, as I believe the probability of an interest rate increase is greater than the probability of an interest rate decrease in the next 12-24 months, and short-term bonds decrease less than long-term bonds in such an environment.

The largest equity investment is in 500 units of  Vanguard Total World Stock ETF (VT). Over one-third of the portfolio is invested in this ETF. This is because the ETF covers about 8,000 stocks in nearly 50 countries. So, great diversification.

The second largest equity investment is in 1,000 units of Vanguard FTSE Canada All Cap Index ETF (VCN). This ETF is a market-capitalization weighted index representing the performance of Canadian large, mid and small cap stocks. The coverage of a mixture of variously-sized firms provides better diversification than an ETF made up of only the largest or smallest firms.

The third equity investment is in 100 units of iShares MSCI All Country World Minimum Volatility (ACWV). This also a source of international diversification, but based on stocks whose values are expected to fluctuate less than average.

Keeping only six ETF funds in the portfolio minimizes trading costs and simplifies portfolio monitoring. Yet, the Simple Six provides plenty of risk diversification, while expected to provide a reasonable return over the medium to long term.

 

The Simple Six Portfolio

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I was asked by a friend to put together a simple portfolio. One parameter was that it should not be ‘too risky’, but that did not mean a ‘temporary’ drop of more than 10% below initial cost would be unacceptable. Also, the expected return had to be more than what was currently offered in a savings account at a bank, or what could be obtained by purchasing a GIC – not a difficult target to achieve.

The portfolio was not expected to be liquidated within 10 years, and of course, diversification of risk needed to be achieved. So I came up with the following suggestion, based on an assumed CAD 100,000 available to invest. I called it the Simple Six, because it consists of only six ETFs.

The Simple Six portfolio consists of:

300 units of  Vanguard Canadian Aggregate Bond Index (VAB)

400 units of  iShares Core High Quality Canadian Bond Index (XQB)

400 units of  Vanguard Canadian Short-Term Bond Index (VSB)

1,000 units of  Vanguard FTSE Canada All Cap Index ETF (VCN)

100 units of  iShares MSCI All Country World Minimum Volatility (ACWV)

500 units of  Vanguard Total World Stock ETF (VT)

I’ll explain my rationale in my next post.

 

Has the Price of Oil Bottomed Out?

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It appears that the portfolios I manage have begun a slow climb up from their recent lows. At least for the short term, the bottom for the portfolios occurred on January 20, 2016. Given the recent high correlation of the stock markets to the price of oil, relative to the longer term lower correlation, it seems that the market turnaround occurred when the price of oil retreated from its low of less than USD 28. Assuming the price of oil will slowly increase, I purchased some XLE ETFs yesterday for between USD 55 and USD 56. It’s only one day out, but so far I’m not disappointed with my decision. Let’s see what happens.