Personal Finance

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…

Laurie wants to begin investing, but…(Part 2 of 6)

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…she needs to figure out whether she should be investing in:

  • A tax-deferred portfolio (for example, a Registered Retirement Savings Plan – RRSP)
  • Or, in a Tax-Free Savings Account (TFSA)
  • Or, in a taxable portfolio (I’m going to assume that paying taxes every year on your portfolio’s return is not Laurie’s preferred option, so we’ll ignore the taxable portfolio for now)

According to the Ontario Securities Commission’s GetSmarterAboutMoney, “The main difference between an RRSP and TFSA is the timing of taxes: An RRSP lets you defer taxes – an advantage if your marginal tax rate is lower in retirement. With a TFSA, you’ve already paid tax on the money you contribute – an advantage if your marginal tax rate is higher when you withdraw the money.”

SunLife has a chart that suggests that a family with a mortgage use:

  • A TSFA as an emergency fund and to save for vacations
  • A Registered Educational Savings Plan (RESP) to save for children’s education and to collect the Canada Education Savings Grant
  • And an RRSP to save for retirement. I would suggest Laurie start with an RRSP, especially if she doesn’t have a company sponsored pension plan.

So where does Laurie open one of these investment accounts? Find out in Part 3.

Laurie wants to begin investing, but…(Part 1 of 6)

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… doesn’t feel confident enough to start. Well, then the following might be steps for her to consider.

Suppose you are Laurie. First, you should figure out the maximum risk you are willing to take, or able to take. There is a difference. For example, your financial situation may enable you to take considerable risk, but your personality makes you unwilling to do so. On the other hand, your family responsibilities could make you less able to take risk, despite your willingness to take more risk. For a more complete description of the distinction between ability and willingness to take risk, you may refer to Risk tolerance (by the Ontario Securities Commission).

It is generally understood that, of the two major asset classes of securities, equity investments (think stocks) are generally more risky than debt investments (think bonds). There are a number of online risk tolerance questionnaires you can experiment with, to determine what proportion of your investment portfolio should be in equity and what proportion in debt. None of these questionnaires are perfect. (Some of the issues with risk tolerance questionnaires may be found in this article). However, one of the better questionnaires, in my opinion, is Your investor profile, by the Autorité des Marchés Financier (the Quebec securities regulator, in English). Upon completion of the questionnaire, you are provided with a range of the proportion for your investment portfolio you should consider investing in debt or equities, with the remainder for investing in the other asset class. The range suggested may be rather wide, so pick any point along the range, remembering that such an assessment is not based on an exact science. Keep your risk tolerance numbers handy for Part 3 (Yes, Part 3, not Part 2).

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%.

Basics of running your finances

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I came across an article on Bloomberg describing the “basics of running your financial life” and thought I would share it with you. It uses some US-specific terms. Just replace “401(k)” with RRSP and “Roth 401(k)” with Tax-Free Savings Account (TFSA), and you will have a Canadian version.

If you’re carrying credit card balances or have outstanding lines of credit on which you are paying non-tax-deductible interest, then paying off these debts (in order of decreasing interest cost) would be a substitute for #1 until those debts are eliminated. I would slightly reorder the priorities, so that #6 was actually at the top of the list.