Reader LR wants to know whether he should be buying index mutual funds or ETFs for his portfolio:
I am in my late twenties and after years of studies (engineering and masters), I try to follow most financial advice and good sense. My problem is investing. I tried unsuccessfully to find a good financial adviser and after being totally disappointed by advisers from banks who keep pushing their product without so much as acknowledging my own situation and independent advisers that simply do not seem to be competent, I am a bit pessimistic on what could be my next step. I would consider a lazy portfolio for the time being but with $30 commission it seems a bit pricey. In a recent post, you mention e-series funds. Would that be a less costly alternative for an overall portfolio of $25K? With not a huge amount of time to spend on following my investments, I am trying to figure out the best approach. What do you think?
You raise some interesting points: young people are told that they should start investing early but there is precious little guidance because independent financial advisors require a huge minimum portfolio and advisors who accept small accounts are simply salespeople interested in pushing product. Younger investors with small portfolios are essentially on their own.
As you do not want to spend a lot of time tending to your portfolio, an entirely passive portfolio would best suit your needs. First, you have to arrive at an asset allocation that is suitable for your circumstances and risk tolerance. Then, you simply have to buy index funds that provide you with exposure to different asset classes and rebalance occasionally. By keeping your costs down and letting your asset allocation (not emotions) drive your investing, you are well on the way to investment success.
There are two ways to invest in index funds: mutual funds and exchange-traded funds (ETFs). ETFs typically charge a lower fee but you have to pay a commission to buy or sell, which makes them more expensive to own for small portfolios or investing small amounts of money regularly. TD Bank’s e-Series index mutual funds are an excellent option for smaller portfolios like yours. The most expensive fund in the e-Series lineup will cost you 0.48% per year, which means that for a $25K portfolio, the maximum you will spend in expenses is $120 per year. You can also consider a broker who charges ultra-low commissions like Questrade and implement an all-ETF portfolio. If you implement a portfolio like the Sleepy Portfolio, you’ll only spend $35 in commissions every year and are likely to save money compared to TD e-Series funds.
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16 responses so far ↓
1 The Divided Guy // Aug 21, 2007 at 10:56 pm
Good breakdown CC. I think this makes good sense for this investor.
2 abe // Aug 22, 2007 at 7:42 am
Buy IA clarington Canadian Dividend Fund. It pays 8c/Unit every month.
3 Phil S // Aug 22, 2007 at 8:29 am
For a time, I thought that I wanted to join the financial services “industry” and started to get in with a broker of insurance and mutual funds. At first I thought this place was different but as I got further into it, all they’re doing is just pushing product like the rest and not considering the situation of the customer whatsoever. I ended up breaking off that entire goal.
Recently, I’ve been taking a closer look at the Claymore ETFs. Some of them look rather interesting, but it takes a fair amount of time to read through their fund facts and probably wouldn’t be appropriate to a novice investor.
Normally, I don’t add ETFs to my investment portfolio, but sometimes you get what the industry calls “tracking error”, meaning that the ETF trades at a value that is more or less than all of its net assets. The only time I like to buy these ETFs is obviously when it appears as though it is trading for LESS than its total net assets. It’s like paying $0.90 for $1.00 worth of investments.
4 Canadian Capitalist // Aug 22, 2007 at 10:58 am
Phil: You would almost never get a 10% discount over underlying assets with ETFs that track the broad indices. The reason is that you can exchange a large block of ETF shares for the underlying shares and arbitrageurs would exploit any profitable deviation from NAV.
Having said that, huge discounts (or premiums) to fund NAVs are common in Closed-end funds that trade on stock exchanges because you cannot redeem these CEFs for underlying assets but only trade with other investors.
5 TonyR // Aug 22, 2007 at 12:02 pm
LR highlights a point I believe: “My portfolio is too small to interest the really good advisors and I’m smarter than the rest of them.” I think everyone else here is similar and with a M.Eng., LR probably is too.
6 Phil S // Aug 22, 2007 at 12:26 pm
CC. Yes, I was referring to a closed end exchange traded fund, not an index fund. To me the biggest indicator is if the distribution yield on a closed end fund is higher than the yield of the investments inside of it, that’s an indication that I should take a closer look - it might be trading at less than the total value of the investments inside of it.
7 WhereDoesAllMyMoneyGo.com // Aug 22, 2007 at 4:52 pm
You could hire an advisor to write a plan for a flat amount (one time) or use someone who charges by the hour.
I teach a workshop at U of T on personal finance - I share your concerns about younger investors getting the shaft. I don’t get paid for it, and none of those students will be clients… anytime soon. But 5 to 10 years down the road they might.
I do write plans free of charge for young investors with the caveat that when they get to $100,000 I’m the first phone call they make! I generally send them to the bank branches to implement it if they don’t know what they are doing, but in your case if you are comfy with online trading, you could setup the portfolio and recommendations yourself.
You could try to find a planner who does the same - I’m sure I’m not the only one. I HOPE I’m not the only one!
As a breakdown of my income, it is as follows:
1. Fee based advising (set percentage per year) 75%
2. Transactional 20%
3. Hourly or flat fee one time 5%
Those are “shoot from the hip” guestimates.
If you can get a masters in engineering, you should breeze through the CSC and then read through the books for a CFP yourself - then you could figure it out on your own…
The portfolio suggestions from other comments are fine, but you need to look at everything else too (estate planning, tax, insurance, mortgage, cashflow, etc.) Having a well constructed portfolio is great, but useless if you have a young family and no insurance and you get smoked on the way to work.
There’s a good sample of a financial plan (I like to think, anyways!) on my website - I don’t know if URL’s work here, so just visit the site and do a search on financial plan.
CC - you have a great blog.
8 Canadian Capitalist // Aug 22, 2007 at 10:03 pm
WDAMG: Good point about considering aspects of financial planning other than investing. Investing is the easiest to get right but unfortunately, most people do poorly in their investments.
9 Jennie // Aug 23, 2007 at 12:18 am
Agree with C.C on saving cost.
But, one feature I like about Td e-fund is you can contribute small $$ each time and do Dollar-Cost Averaging investing. Given current volatile equity market, it’s hard not to time the market if you trade ETFs in trading accounts. Who knows if you will get the timing right or not?
10 WhereDoesAllMyMoneyGo.com // Aug 23, 2007 at 9:50 am
Peter Lynch commissioned Fidelity’s research department to do a great study - I don’t remember the exact dates and figure, but do remember the “punchline” as it were.
He asked them to compare the long term rate of return between someone who put their money in January 1st of every year VS someone who put their money in at the very peak of the market for the year VS someone who put their money in at the very bottom of the market every year.
After 30(?) years there was only 1(?)% difference between “the best timer” and “the worst timer”. Moral of the story is that you can pull your hair out trying to get the timing right, but really it is all about time and getting the money in.
But theory and practice are two different things. In practice it is easy to deal with seeing the contributions “mask” the volatility.
In theory you should figure out how long you will save and how much, and get a loan and put it all now. Ultimate volatility, but if the markets do what they have done for the last 200 years you have the best outcome.
Jeremy Siegel’s book “stocks for the long run” have a chart that shows stock, bond, and commodity performance over 200 years - very cool.
11 Canadian Capitalist // Aug 23, 2007 at 11:10 am
Jennie: One option is to invest regularly in TD e-Series funds and every year or so sell the mutual fund and buy the equivalent ETF. That way, you can get the benefit of regularly committing money and the lower costs of ETFs. This would work well in registered accounts but could take a small tax hit in taxable accounts.
12 WhereDoesAllMyMoneyGo.com // Aug 23, 2007 at 1:00 pm
I don’t use mutual funds for my clients per se, but I do use investment pools on occasion which really are the same thing - when it comes to management one should look for a manager than can beat the index, but they also look for the “upcapture/downcapture” ratio. i.e. if the long term rate of return is less by 1% for an actively managed fund you would think that this is bad. And it is, unless the downside capture is less than the upside capture - then you don’t have to worry as much about when you put in the funds. Alot of performance reporting suffers from what is known as end date bias - you may find that alot of mangers beat the index depending on what type of market we’ve just been through (bull vs bear).
End date bias can be extreme. There is also something called universe inclusion bias - sometimes group averages are lower than normal because they included all the funds that became delisted. On the other hand sometimes group averages only include the funds that currently exist and have dropped the performance data of the crappy funds.
So my point is that looking at performance numbers and comparing indices and benchmarks is not so cut and dry. I’m not trying to say everyone should be in managed product either, it’s almost like your yard: you KNOW how to do it, but sometime you’d rather someone else do it. A simplistic analogy I realize, but nonetheless some people just do not want to be bothered with their investments or financial plans. Others are much more empowered.
There IS a group of super smart dudes out there on Bay street that charge $800/month for their portfolio guidance and that’s it. They have averaged 20%/year for the last 25 years although with a higher beta than the TSX if I’m not mistaken using an earnings momentum valuation model.
Warren Buffet is a prime example of an active manager - he’s averaged 28%/year for 5 decades. But these are extreme cases and these are people much smarter than myself - they do not follow modern portfolio theory, and are engaged in their investments to a larger degree than non-financial professionals.
13 Talkinggoat // Aug 23, 2007 at 1:18 pm
I am also planning on purchasing the efunds from TD but if I am not planning on purchasing any etfs in the near future am I better to just purchase them through my local branch or open a TD Waterhouse account. I have currently have a little less than $20,000 to invest so if I open a Waterhouse account I would have to pay $125 yearly fee until I reach $25,000. Any thoughts?
14 Canadian Capitalist // Aug 23, 2007 at 2:03 pm
TG: Our boys RESP is entirely in TD e-Series funds. I didn’t want to pay the annual fee, so I opened an account at my local branch. You can move an account from TD Bank to TD Waterhouse (for free, I think) in the future, when you have the minimum portfolio.
15 willfly // Aug 26, 2007 at 12:07 pm
Biggest hurdle in implementing DCA for fund haters are the frictional costs. Someone recomended Interactive Brokers - charging 1cent per share; minimum 10$/mo - seems an excellent place to start dollar cost averaging. I have applied for an account and monthly contributions will be applied towards a basket of ETF’s.
On the side note - IB allows FX trades as well, good for someone like me to convert foreign currency without paying high spreads to banks.
16 WhereDoesAllMyMoneyGo.com // Aug 27, 2007 at 9:49 pm
willfly - another option is to sign up for a direct stock purchase plan through the company itself. It basically adds you to the companies ESOP (without the E)
(or the matching :).
No frictional costs whatsoever - no brokerage costs, no commissions. However, if you are contributing say $200/month to your savings then perhaps you can only enroll in 4 DSPPs - not an ideally diversified portfolio - but to each his own…
Usually these are only available through blue chip companies (which is a good thing!) I remember seeing a list of all companies with DSPPs in North America somewhere - I’m sure it’s on the web too.
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