- Comments (24)
- Text Size: Down Up
moneysense.ca, 13/07/09
Portfolio Case Study 1, Part 2
[In yesterday's post, Phil gave us some background on his situation and his portfolio. Today, he talks about how current holdings are split between his and his wife's registered and taxable accounts.]
Our Portfolio
Our portfolio is comprised of six different accounts. I’ve listed our target weight and the actual market weight of each security as of June 15/09.
Phil’s RSP
Below are the holdings of my RSP, with target weights and actual weights (both expressed in terms of the overall value of the account, not the portfolio as a whole). The securities marked with a * are the ones I plan to sell as soon as I can cover my average cost. I have made several mistakes in assembling this portfolio. For example, I bought XSP and XIN before I learned about the cheaper USD denominated alternatives. The clear message I get from looking at my RSP portfolio is that I need to dramatically bump up my fixed income.
| Security | Target Weight | Actual Weight |
|---|---|---|
| Candian Equity | 8% | 26% |
| XIC* – 0% XIU – 3% XEG – 5% |
XIC – 15% XIU – 5% XEG – 6% |
|
| US Equity | 19% | 17% |
| VTI – 7% XSP* – 0% CLU – 8% VBR – 4% |
VTI – 5% XSP – 2% CLU – 5% VBR – 5% |
|
| International | 14% | 6% |
| VEA – 7% XIN* – 0% CIE – 7% LifePoints Fund* – 0% |
VEA – 0% XIN – 6% CIE – 0% LifePoints Fund – 34% |
|
| Emerging Markets | 9% | 4% |
| VWO – 5% CBQ – 4% |
VWO – 4% CBQ – 0% |
|
| Fixed Income | 32% | 5% |
| Govt. Bonds – 5% RRBs – 5% Corporate bonds – 5% Preferreds – 3% XCB – 2% Short-term GIC – 4% Mid-term GIC – 3% Long-term GIC – 3% |
XCB – 5% | |
| Cash | 2% | 5% |
| Alternative Investments | 16% | 5% |
| XRE – 5% GLD – 5% CIF – 2% CWW – 2% COW – 2% |
XRE – 3% CWW – 2% |
Bonnie’s RSP
Like my RSP, Bonnie’s RSP is almost 40% tied up in the Life Points fund. Bonnie has more protection on the fixed income side with a 3 year GIC from TD Mortgage Corp and a corporate bond from Scotia Capital (maturing in 2011), but apart from that our RSPs are very similar. Like my RSP, the investment horizon for this account is definitely long term (+30 years). [Ed. Note: For the sake of brevity, I've dropped the actual allocation but it is similar to Phil's table above]
| Security | Target Weight | Actual Weight |
|---|---|---|
| Candian Equity | 8% | 16% |
| US Equity | 19% | 11% |
| International | 14% | 52% |
| Emerging Markets | 9% | 7% |
| Fixed Income | 32% | 12% |
| Cash | 2% | 0% |
| Alternative Investments | 16% | 3% |
Joint Non-registered brokerage account
This account is in shambles. In addition to putting us in the Life Points fund, our advisor also suggested we dump a sizeable sum on a basket of six Canadian securities (CIBC, Royal Bank, TD Bank, Potash Corp., Shoppers Drug Mart plus Enbridge, which I recently sold for a small profit). The US ETFs are pet projects of mine and have taken a big beating in recent months. I do not think 5 stocks (or 7 if we include the ETFs) are enough to eliminate market risk (especially since 3 of them are in the same industry – Canadian banks). I don’t even feel 100% comfortable holding individual stocks, but if one wants to go down this path a much broader basket is needed. [Ed. Note: The Canadian Equity portion targets consists of 2% each in Royal Bank, TD Bank, Potash Corp., Barrick, Encana, Shopper's Drug Mart, Canadian Hydro Developers, Rugged.com plus XIC, XEG, CDZ and CPD. The US ETFs include VTI, PZD and PBW].
| Security | Target Weight | Actual Weight |
|---|---|---|
| Candian Equity | 46% | 96% |
| US Equity | 9% | 4% |
| International | 4% | 0% |
| Emerging Markets | 4% | 0% |
| Fixed Income | 20% | 0% |
| Cash | 12% | 0% |
| XRE | 5% | 0% |
Phil’s TFSA
My TFSA is currently empty. In a very foolish attempt to time the market, I liquidated my TFSA account in early January and put all of it into HOU, a leveraged ETF offered by Horizons Beta Pro that is long on oil (NYMEX crude futures). I made the trade through an account with Questrade (See Questrade Review). I have not included the Questrade account in my portfolio because I intend on shutting it down once (and if) HOU returns to my average cost. It was very foolish to get involved with a product I didn’t fully understand (e.g. I’m not convinced HOU actually does what it says it does). So it’s a waiting game for now.
Bonnie’s TFSA
We made the full contribution to this account (ING High interest savings) in January but subsequently withdrew the full amount to put against our mortgage. We are waiting until 2010 to re-contribute. Our intention for both TFSA accounts is to concentrate on building a bond ladder through direct bond purchases.
moneysense.ca, 13/07/09
A couple of comments:
(1) I think of all our accounts (other than the kids RESP) as one big pot because almost all of it is a retirement account. I think of the total allocation of the account and then I put foreign stocks, bonds, REITs in a RRSP and only when contribution room is not available Canadian stocks in a taxable account.
The biggest problem I see is that taxable accounts holds foreign stocks and bonds whereas these are best held in a RRSP.
(2) Maybe you have a good reason but I don’t know why Canadian equity is split between XIU and XEG. Seems like a bet on energy to me. In the same vein, a 20% allocation (of equity holdings) to emerging markets seems a tad excessive.
(3) I’m a bit confused about fixed income. Presumably Phil is holding bonds to reduce volatility. If that’s the aim, do corporates and preferred shares have a place considering their high correlation with stocks? Also, I’m not sure what short-, mid- and long-term GICs mean. GICs can have a term of up to 5 years which would be equivalent to a short-term bond.
The sum of the MERs is definitely going to be lower than your current mutual funds, so that’s a plus. But based on some of the choices of highly specific funds (ie CBQ=BRIC and XEG=Canadian NRG), I think your diversification might be on the weak side. Even the CIE fund which you have under international is 5% Canadian, and much of that is energy. If the next 10 years of global growth look much like the last 10, this portfolio will do well. Consider however that something may actually be done about climate change, Canadian oil sand companies and many of your funds are going to get hammered.
Your alternative funds are in a similar position, they’ll do very well if future growth looks like past growth. That may be a very smart move but it could cost you from a lack of diversification.
Sorry to hear about your HOU trade, I can promise you’re not the only one to have been bitten with that.
“What we are hoping to get is candid feedback on the target weights of the securities in our portfolio, our choice of securities and our strategy with respect to spreading our investments out across the six accounts that comprise our portfolio.”
Have an open mind and perhaps you will find solutions that work far better than having the right asset allocation mix.
I’m telling you that collars will give you exactly what you seek. Safety and opportunity for growth. Don’t dismiss the idea before learning more.
I agree with Mark that options must be understood.
About “I do not think 5 stocks (or 7 if we include the ETFs) are enough to eliminate market risk (especially since 3 of them are in the same industry – Canadian banks).”, market risk cannot be eliminated unless you hedge you position. I think what you are trying to do is to eliminate non-market risk or unsystematic risk. Depending on what you want to do, you might want to take unsystematic risk. For example, buying RIMM or Apple due to superior growth prospects. I am not recommending RIMM or Apple, but I am saying there might be reasons to take unsystematic risk.
I think it’s brave of you to undertake this re-organization of your financial house. Admittedly, my own asset allocation could use some (a lot) of looking at.
I must agree with Mark’s comments from yesterday’s post. You shouldn’t let the average purchase price influence your decision on when to sell. The longer you hang onto a “bad” investment, the more time that money isn’t doing work in a “good” investment. Don’t wait!! Sell it now!
Aside from that, well done.
I am curious how much of the target asset allocation has been created due to your past hard knocks and how much has been carefully crafted due to investment horizon.
I am aware that you have taken some hard hits in the past 6+ months, but so has 90% of investors. Alot of people are over reacting in the reverse and committing themselves to a “safe” route. The problem with safey is that you limit your growth. If you limit your growth too much you won’t have enough money come retirement.
Consider that inflation will likely rise at between 1 and 6% between now and your retirement. This will mean that you need somewhere (rough calculations, likely higher) between 30% and 180% more money per year than now. It can be rather hard to ensure that requirement will be met if you eliminate risk too early and for emotional reasons.
Everything is fraught with risk, just make sure you are not eliminating risk now for emotional reasons and adding the risk later of not having enough money for retirement. Ensuring your life is short enough for the money is far less enjoyable than ensuring you have enough money for a long life.
When I designed my asset allocation, one big problem I faced was an instinctive desire to make things more complicated than they needed to be. It looks like you’re going through exactly the same thing I went through! Are you sure you need more than 20 individual securities in your RSP? The great thing about investing with ETFs is that with just a few holdings you can have a broad portfolio covering all of the needed assets.
Here are some specific comments on each type of account:
RSP
Consider reducing the total number of securities you hold. It would be possible to build a broad balanced portfolio with just 5 of the securities you have listed.
Can equity – XIC
US equity – VTI
Int equity – VEA
Fixed Income – XCB and some GICs
These 5 holdings already have everything you need. You may want to add some alternative investements to this, but make sure you decide WHY EACH ALTERNATVE INVESTMENT IS ADDED.
Remember that most of the alternative investments can be used to increase returns, by increasing risk (such as VWO, XRE)
Some can be used to increase returns through rebalancing (such as holding gold stocks)
And some can be used to place a wild bet on the market (such as sector specific ETFs), but keep in mind that if you’re placing bets in too many directions (ie. holding too many sector specific ETFs) then you’re really just betting on the whole market, but paying higher fees.
TFSA
Consider using the TFSA to build a GIC ladder. The $5000 yearly limit will make it too difficult to build a diversified bond ladder, considering many bonds are purcahsed in $5000 increments, this would essentially mean buying one bond in each account per year. Far too risky! A simple alternative to the GIC ladder would be to hold XBB. The relatively low MER of 0.3% gives you low risk, broad exposure to the Canadian bond market, and you only need to hold one security.
Non-registered accounts
Unless your registered accounts have been maxed-out. The only things you should really consider holding here are Canadian equities (because of the tax advantages), and cash (or something highly liquid, assuming that the cash you hold here could be needed on short notice). If you decide to use ETFs for your Can equities, rememer that you want low turnover, which is likely best accomplished with a broad-cap weighted ETF like XIC. If you decide to also hold a more specialized fund, I would recommend choosing not more than one or two, and to make sure that they are cap weighted, not likely to change their holdings or go out of buisness, otherwise you’ll get dinged with capital gains taxes.
When you have so much money that your registered accounts can no longer hold enough fixed income, then it will be time to start holding other securities in your non-registered account, like prefered shares.
With respect to savings, I have opened a saving account and hold a large GIC with Achieva Financial (A division of Cambrian Credit Union in Manitoba). Their rates are always at least 0.5% higher than ING Direct and as an added bonus (unlike CDIC) the entire balance is insured, not just $100k. Its been over four years now and I am currently approaching seven figures with them. Have never had any issues or problems.
Question for CC in ref. to your comment (1):
Not sure why your reasons for putting the REIT in the RRSP account (unless it’s a foreign equity)?
Phil:
Wow ! 26 different asset allocations , you might want to add canned tuna , toilet paper ,hand soap and a box of rifle shells.
Anh, the REIT should go into the RSP because of how the distributions are taxed. REIT distributions are taxed at a similar rate to interest income or dividends frrom non-Canadian companies (for the most part, there is generally a small portion of a REIT’s distribution that is a return of capital and is taxed at a lower rate). Also REITs won’t be impacted by the 2011 income trust rule changes.
What about a simpler approach:
1. Most of us have mortgages (you did not specify it, so I assume you do too), so consider paying off mortgage faster and this will be the bond component of your portfolio. What bond now can pay you the after tax return, which equals your mortgage interest? Let’s assume the value of the house is not important, but the outstanding mortgage balance is: and that is the bond you are buying. No MER, transaction cost, or taxes.
2. The rest goes to XDV or CDZ (I prefer CDZ, because it pays monthly and has DRIP) and reinvest distributions. Or invest in companies, but that is much more effort… Once registered accounts are full, buy in a non-registered. Then make RSP contributions in kind.
Now, here is how I make it work:
1. Once a year prepay your mortgage (figure how much you can allocate for this).
2. Once the payment is processed, call your mortgage company and have them lower your mortgage payment to bring the amortization back to 25 years, or whatever it is. This gives you immediate payback: instead of getting income from a bond, you save by having smaller mortgage payment for the remainder of your mortgage year.
3. Invest the rest into CDZ/XDV/anything dividend paying and reinvest distributions.
4. Repeat next year and the year after.
5. Calculate you balance as a sum of the repaid mortgage balance & you dividend paying stocks: the bond/mortgage poprtion will lower volatility greatly.
Has anyone compared the price charts of XDV/CDZ against the charts of their distributions? Price wise they fell 50% or more, but the distributions fell by 10..15% tops. Now the distributions are even higher then a year or two ago (in absolute amounts)…
What to do in the case of a job loss?
1) Regularly prepaying your mortgage and lowering the regular payments will make sure that your EI covers your mortgage payments and property taxes for a year.
2) Stop reinvesting distributions and start spending it
3) you spouse works: so considering #1) and #2) you do not really need a huge emergency fund. A line a credit would work great in your case.
Once the mortgage is paid off one would start thinking about buying bonds…
A few points.
I also question the need to hold so many ETF’s. I think you should use the KISS pricinple here with respect to your fixed income and alternative investment categories.
For example, I don’t think you need to hold actual corporate bonds if you also plan to get the XCB. I’d trim that to one broad bond fund (XSB) and something with higher risk/reward, XCB. Re: alternative investments, GLD, COW etc, seem a little superfluous. They don’t hold enough weighting to make a significant impact on your portfolio AND most of those companies are already held in your CAD ETFs.
Re: selling when assets return to average cost – I have to strongly concur with the sentiment to cut your losses immediately. I’ve got a very simple example of why.
You are obviously firm believer of passive index investing (i.e. money managers cannot beat the index).
Say your cost for the Lifepoints was $20000 and now its $10000. If you had $10000 in the Lifepoints or $10000 in an index tracking ETF, which will do better one year from now? The LifePoints may return to average cost, but that ETF will have produced a greater gain in that same time (maybe 2-3%). There’s some opportunity cost associated with waiting for your investments to return to purchase value.
Like others, I want to make a point about “get-even-itis”, an affliction many investors suffer from. The price we paid for an investment is meaningless to the market, what matters is the price it is currently trading at. Someone who paid $50 for Nortel is never going to get her cost back. Sometimes, it just makes sense to sell and move on.
I personally wouldn’t go with so many ETFs either (as a matter of fact, I don’t recognize many of the names in the list). Ditto about alternative investments. Other than REITs, I’m not convinced many are all that “alternative”. XIU, for instance, has a healthy chunk of gold stocks already. To me, most of the alternative ETFs are simply vendors taking advantage of the craze for exotic asset classes that make a nice story such as BRICs are growing like crazy and there is going to big demand for grains and foodstuff. Holy COW!
@CashCanuck: Perhaps, you’d be interested in a portfolio case study?
If you are, feel free to contact me.
@anh: Like oxcc says, the portion of REIT distributions that is not ROC is taxed at your marginal rate. Let’s say the yield ex-ROC comes to 5%. A tax payer in the 40% bracket would lose 2% to taxes. So, its best to keep REITs in tax-sheltered accounts.
@simple approach: I’m not sure if Phil has a mortgage either. If he does, I’d opt for pre-payment over building a taxable portfolio. I don’t know if I’ll go the extent of resetting the amortization. A taxable portfolio can be assembled once the mortgage is killed off.
@Canadian Capitalist
I did not mean to suggest resetting the amortization; not sure if it is even possible without breaking the mortgage. Let’s say one is 4 years into a 25 year amortization. Let’s assume, a $30,000 prepayment shortens the amortization to 18 years (18 – 4 = 14 years left if the payment stays unchanged). Then my mortgage company would be only too glad to lower my payments so that my amortization is back to 25 years starting four years ago (meaning 18 more years from today). The amortization always stays 25 years, but the payments get lower and lower to the point that you either just ignore it or you just payoff the remaining balance when it is very low.
The prepayment amount is 15% of the original mortgage, so instead of increasing your payments just increase the one-time pre-payment amount. It will work the same way…
Correction to the above: “meaning 18 more years from today” should have been “meaning 21 more years from today”
@Simple approach: Thanks for your explanation but I did understand your original comment correctly. What I meant is that I won’t go to the extent of calling the bank to reduce the monthly payment to keep the amortization same as it was before the pre-payment. Instead, I’d go for killing off the mortgage sooner and then start assembling a taxable portfolio. The reason is that I don’t think most investors can do better than a guaranteed, after-tax return equal to their mortgage rate (unless they have one of those crazy Prime minus 1% mortgages).
I’d echo other commenters in saying that you probably have way too many ETFs in your target allocation. Although I’m assuming you can buy and sell for $9.99 or less, with regular contributions and rebalancing, your transaction costs could easily amount to hundreds or even thousands of dollars per year.
For equities, I would pick one ETF only for each region. E.g. for US exposure, I’d go with the S&P 500 as that provides excellent diversification that can be had at a very low MER. Anything more than that is of dubious value, IMO. Picking sector ETFs starts to sound more like active investing than passive investing to me.
For fixed income, do consider what I and others have already posted re: the benefits of paying down your mortgage in lieu of making fresh contributions to fixed income. I don’t like the fixed income space at all right now. The returns are generally quite meagre, and the risks of loss are great if inflation returns in force. You would be hard pressed to make more in fixed income right now then you would by paying down your mortgage principal, at least in my opinion.
If you’re especially concerned about inflation, you could ramp up your exposure to RRBs in your existing fixed income portfolio, and/or purchase a REIT ETF in your equity portfolio. Gold is another option I suppose, but not one I’m fond of for many reasons.
@All, many thanks again for all of your comments.
@CC, XEG was indeed a bet on energy. I work in the energy field and am very bullish on oil. As for fixed income, I am indeed trying to reduce volatility but also trying to generate some income. Corporate bonds seem attractive right now given very low gov’t bond yields. As for GICs, I consider short to mean cashable to 1 year, medium to mean 2-3 years and long 4-5, so as you point out this is a different time scale than bonds.
@Steve, I’ve decided to switch out of CBQ. Happily, I got into it at a low price so can sell for profit. The general takeway from all contributors is to apply the KISS principle and forego some of the more esoteric ETFs.
@Cam Birch, I can’t say my target asset allocation has been carefully crafted in the sense that it wasn’t quantitatively determined. I’ve simply applied some rules of thumb (e.g. % fixed income exposure should be your age, etc) coupled with some personal observations about the market. I’m comfortable with a 50-60% equity allocation going forward.
@Chris, thank you very much for your suggestion. As for your suggestions, I appreciate the simplicity of your figurative portfolio. Can I ask, would you be concerned about currency exposure over the long run (e.g. risk of a collapse in the US dollar, which would drag on VTI and VEA). I agree predicting currency movements over 30+ yeas is impossible, which is why I’ve tried to structure the portfolio so as to get both CAD and USD exposure under US equity/Int’l Equity/EM equity. Perhaps this additional layer of diversification to protect against currency risk is unnecessary but I just don’t feel comfortable having all US and Int’l equity in USD. Thoughts?
@Simple Approach, yes I do have a mortgage and since I’m debt-adverse I typically avail myself of about 75% of the annual pre-payment room. Thanks for your idea of using this as the bond component of my portfolio, that had not occurred to me.
@Sampson, would you be concerned about holding XCB or XSB over long run given that these ETFs do not offer principal protection? There’s an enormous literature on direct bonds vs. bond funds and I find myself sitting in the middle – I see benefits on both sides.
@CC, I’ve decided to scrap the esoteric Claymore plays on agriculture, water, etc.
Re: inflation risk eating into bond returns. I mitigate as much risk as possible by holding only short-term bonds. Even if you are locked into some low % coupons, 2-5 year turnover means you’ll get out of those soon enough.
I absolutely agree with holding bonds directly vs. funds, and for me the trade-off is that my bond allocation is so low, I wouldn’t be able to get adequate diversification if I held them directly.
I’m not too concerned with inflation overall. Since you’ve got ~70% equity allocation, these should at least keep up or slightly outpace inflation – but going forward who knows. Lots of people are starting to say returns will not be what we once thought they were.
Regarding alternative investments, hot sectors and emerging markets. When the house is in order, maybe you can be a little more risky with your stocks. The 5 CAD companies you listed are all well represented in your ETF’s, so maybe you can start an account where you make 0.5-1% (total portfolio bets). You don’t want to get so bored with ETF’s that you lose interest/focus in your portfolio.
Sounds like you’re doing great! Congrats.
Just one suggestion that I haven’t seen made yet. Have you considered Claymore’s two bond ETFs, CBO and CLF? The usual knock against Claymore is that the fees are higher than the iShares couterparts, but in this case, Claymore is cheaper. Their government bond ETF (CLF) charges just 0.15% and the corporate bond ETF (CBO) is 0.25%.
What I also like about these products is that they are nicely laddered (25 securities, with five maturing each year for the next five), and that you can set them up with a DRIP.
Just a thought for the fixed income portion of your portfolio.
@Phil, I worry more about the high cost of hedging, and tracking error observed in hedged Funds. I believe that the drag on performance over 20-30 years is a far greater risk than currency fluctuation.
In fact, I think that exposure to several currencies is a form of diversification. Yes, I will retire on Canadian dollars, but who knows what Canadian dollars will buy in 2035? As it stands ~ 45% on my portfolio is held in Can$ (equities and GICs) which seems like a lot of exposure to one currency already.
One more thing to point out: VEA (and similar international equity products) does not expose you to the US dollar, even though it is denominated in US dollars. The actual stocks held in these funds are held in the currency of the local stock market. So VEA primarily exposes you to fluctuations in the Euro and the Yen. Again diversifying your currency exposure.
I want to also reiterate that you should not “hold out” to break even on old investments. Generally speaking, the right behaviour is to totally ignore your historical transactions, losses or gains. Your decisions should be based on what allocation you want now, and completely ignore what your current allocation is or previous allocation was. Then simply calculate the most efficient way to get from what your portfolio is to what you want it to be.
[...] Portfolio Case Study 1 [...]