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moneysense.ca, 14/12/08
The Amateur Investor Manifesto, Part 3
100% / 4.25% — Vanguard Emerging Markets (VWO)
REITs
I’ve split Real Estate into 75% Canadian, 25% International. The question here comes from iShares REIT Sector Index XRE. It has a high MER of 0.55% but only a few equities. With my estimated starting allocation of around $30,000 it might be best to unbundle and save a bit on fees. This is appealing because I’ve never bought and sold stock myself, this could serve as an interesting lesson. The next idea is what about owning REITs in a DRIP plan which has no fees, plus lots of real estate trusts give drips a 3% or more bonus/discount. It would be more work and harder to rebalance, is it worth it? Would a REIT portfolio try to mirror the cap weighted index or evenly spread out between different types of trusts (malls, offices, senior’s homes, residential, etc). Is it worth it?
75% / 6% — iShares REIT Sector Index (XRE)
25% / 2% — Wisdom Tree International Real Estate Index (DRW)
Cash & Bonds
For the cash component of the portfolio I feel safer having 6 months of core living expenses in a cash emergency fund in high interest savings accounts, current this is about $16,000 or 4% of the total portfolio.
The remaining 16% is going to be invested in short term bonds with the goal of lowering equity risk. The Sleepy Portfolio uses the iShares Bond Index (XSB) but I am planning to use the lower cost Claymore 1-5 Year Laddered Government Bond ETF (CLF). Since it lacks higher yielding corporate bonds present in XSB, so would it make sense to split the bond allocation further with 80% CLF and adding 20% of iShares Corp Bond Index (XCB)? Combined the weighted MER would be 0.2%, instead of 0.25% for XSB. Is it worth it?
How and at what point should you buy real bonds directly?
40% / 8% — Claymore 1-5 Year Laddered Government Bond (CLF)
10% / 2% — iShares Corp Bond Index (XCB)
50% / 8% — High Interest Bank Accounts
moneysense.ca, 14/12/08
Regarding to Asset Allocation, it is good that you are comfortable with you have designed.
Regarding to Canadian Allocation, I don’t think you need to overweight in Canadian small cap. 65% Composite index / 35% Fundamental Index sounds good to me. I think there are a lot of microcap companies on the TSX stock exchange and microcap companies tend to have weak balance sheets.
Regarding to US Allocation, you can consider Vanguard Small-Cap Value ETF (VBR) instead of Vanguard Small-Cap (VB). VBR’s MER is only .11%. William Bernstein in Four Pillars of Investing showed that US Small-Cap growth stocks has the weakest historic performance, while US Small-Cap value stocks has the strongest historic performance.
Regarding to REITs, I don’t think you need international real estate exposure. Make your own fundamentally weighted Canadian REIT index and that will be 8% of your total portfolio.
Regarding to Bonds and Cash, I would remove the corporate bond section if you are worried about MER. Since you already have 80% exposure to equities, chasing the yield of corporate bonds for a very small part of your portfolio seems unnecessary. Also Canadian corporate bonds may depreciate further in value.High Interest Bank Account instead of a money market fund seems like a pretty good idea if the yields are higher.
In a similar vein to EconStudent, I’m totally against bond funds altogether. A bond fund doesn’t have a maturity date, so the bonds contained within them get marked to market on a daily basis. As a result, you CAN lose money on a bond fund in a rising interest rate environment. I strongly recommend purchasing individual GICs, bonds or T-Bills instead of buying any bond fund.
I think a GIC or bond ladder once you’ve accumulated enough in your portfolio for those to be effective is a much better alternative than going with a bond fund over the long-term. Now might not be the best environment to do so, but its something to keep in mind.
Good job on organizing your portfolio!
On the US selection, how do you account for the currency conversion costs when you buy and sell VTI? No matter what you will have to do it twice. With RBC Direct Investing that will be 1.5%, or so, for each transaction. Would it not take a ridiculously long time to make up the MER difference between VTI (0.07%) and XSP (0.24%)? I calculated 17+ years…
Am I missing something?
Yes I also wonder about the wisdom of using VTI. First, you are exposing yourself to additional conversion fees with most brokers. Second, any devaluation in the US dollar relative to the Canadian dollar will eat into your gains. If you are bullish about the Canadian dollar against the US dollar over the longer term, I think it makes more sense to buy XSP. But I also agree it’s important to have some small-cap US exposure. I suspect IShares Canada will create a currency hedged US small-cap ETF sometime soon.
Thanks very much to everyone for their detailed comments and suggestions. It is obvious fixed income is the topic I know the least and so this feedback really helps the most.
@EconStudent
What is the reason to avoid Canadian SmallCap? Do you think the market is just too small for the smallcap risk/reward premium to exist? It’s interesting that DFA also doesn’t have a separate smallcap index for our market.
Thank you for reminding me of Berstein’s advice on SmallCap Growth. I started with the idea that the fundamental index would have the “value” portion and then I was originally just looking to add the “small” component. For this I was only comparing the various straight smallcap indexes like iShares S&P SmallCap 600 and the Russel 2000. I didn’t really expand my search to find the SmallCap Value index, but it makes sense to me, so I’m going to switch that.
I wanted to treat REITs as a separate asset class, so I thought it should have both local and international exposure. However I don’t claim to have a lot of knowledge of REITs, is there information that shows that they are very highly correlated across geography so there would be little benefit to doing this?
You have a good point about that the Corp bond exposure might offset the negative correlation it offers with the equity portion of my portfolio. I was actually only thinking of adding this asset class because of CC’s comment that XSB would outperformer CLF even thought it has a higher MER because of the Corp bonds. But my interest in bonds is really just to offset the equity’s risk, so maybe as a component of my portfolio straight bonds would be best.
What is your opinion of splitting bonds between short term and real return considering this is lightly to be a very inflationary period?
@Phil S
That is a very interesting comment. I didn’t realize that was a problem for a bond fund. Why do so many DIY investors and asset allocations use a bond index fund instead of a DIY ladder?
@Phil S & Nurse911
The thing that strikes me about building my own GIC ladder is it doesn’t seem easy to find the best rates because they are different at every place. So do you just have to stay at one place or have 10 different accounts to get the best rate each time you purchase? Is it possible that even after fees and marked to market that a fund could outperform a ladder because they get a price discount for the size of their purchases and are able to be more diversified by constantly buying and selling throughout the year?
@chum
This is the primary reason why I chose to use Questrade as my discount brokerage. They allow you to maintain a separate US balance in registered and non-registered accounts, so there are no currency conversion fees. You can also do preauthorized deposits in US funds. For me this avoids all currency conversion fees because I’m actually paid in US dollars. Normally I would swap all of my income to CAD each month via the TDFX currency exchange, but now for US dollar investments I don’t have to do that either.
@DM
I’m not really bearish or bullish on the US dollar or ours. I have some fear of the US economy after watching all those Peter Schiff interviews and reading Crash Proof. But I don’t really know if I would bet on it either way because even if his predictions come true we might follow their lead into inflation. That is part of the reason why I split the US between a VTI and CLU which is hedged.
In the past with my US income I’ve tried to “time” the currency market and swap when I thought the dollar was good, or thought I had an idea where it was going. I did this at an amateur level and as is always the case it didn’t work out at all. I manage to build up a huge USD savings while CAD was rising, then lost faith and started converted it during the highs just before it came crashing down.
Hi Jordan, I take your point about trying to time currency conversion. I like how you’ve hedged your bet by having both USD and CAD exposure in US equities. One question I had is whether this portfolio is for your RSP. I’m in the process of putting my RSP portfolio together. I’m in a position to max it out every year, so I’m also working on a non-registered one. Beyond concentrating on Canadian dividend paying companies to take advantage of the tax credit, I’m not sure if I should be structuring my non-registered account any differently.
Jordan – for you it makes sense to buy and hold VTI if you get paid in US dollars. For traders (which I am not) it would make a huge difference as well.
But if you get paid in Canadian dollars and you are a buy and hold investor, then the Questrade bonus of being able to hold US cash doesn’t help with the conversion fee issue anyway. You will need to convert it at least once (assuming they let you withdraw US cash?).
@DM
For account allocation this portfolio is actually being spread across 8 different accounts. 2x RRSP, Spousal RRSP, 2x TFSA, Corporation, Children’s Trust, and a taxable account.
So that is another complication to pick which assets are least efficient by throwing off interest, dividends or capital gains and putting those into the tax free & tax deferred accounts first.
I’m still trying to learn and build a spreadsheet to help pick the best way to split the assets the most efficiently. It’s an important topic and I’m sure there are a lot of great ideas of how to do it.
@chum
Yeah I don’t like currency exchange fees either. But long term I think a one time fee to buy and hold isn’t too bad.
There are also cheaper ways to transfer funds then through the broker. I use TD’s TDFX currency trading platform which gives you a very close spread on the currency without any fees and it transfers right in and out of your CAD & USD TD bank accounts in the same day.
I think xetrade.com and customhouse.com also have low spread currency trading which isn’t tied to your bank account.
Hi Jordan,
I don’t have any clue why anybody buys a bond fund, actually. It’s not guaranteed to rise and there’s always some sort of MER eating away at your normally miniscule returns these days. I suspect that a lot of investors who pick funds for their RRSPs just don’t know any better – similar to me when I first got out into the world of investing. As for knowledgeable DIY investors, I suspect it may be laziness.
For me, I use BMO Investorline and they do offer a few other GICs other than their own brand. Assuming that you are pursuing a sort of asset allocation strategy, you will always have some amount of fixed income. So, if you lock into one institution like ING, for example, for your fixed income portfolio then it’s not necessarily a bad thing in my humble opinion. Keep in mind, you will be buying for maturities up to 5 yrs, so it is definitely a longer term outlook.
Keep in mind that the G stands for Guaranteed and that CDIC has a limit of $100K per account per institution total, whichever you reach first. So, if the total of all your accounts at one institution gets close to $100K – let’s say you have $80K at one institution… Then you may want to consider putting money into another institution if at maturity, your combined assets will get close to that $100K limit.
Taxation wise, I think the new TFSA is the ideal vehicle to hold fixed income like GICs. It grows completely tax free as opposed to tax-deferred if it were in an RRSP. So, it is even more tax efficient than an RRSP. The problem with holding equities in a TFSA, I don’t think you can write off capital losses if you incur them in a TFSA. I know for sure that you can’t write off capital losses incurred inside an RRSP.
Sincerely, Phil
Jordon- I have been personally burnt in small cap companies, where things are a lot less transparent and poor management is the norm than the exception. I think exposure to small cap is a good idea, but I would not overweight them especially small cap growth.
About correlation, I think more assets are moving together at the same time. This is partially due to indexing. When SPY (S&P 500 etf) is in the process of share destruction, all S&P 500 stocks get hammered. Things seem to be more correlated than ever.
I have not read much about REITs, but I never came across anyone recommending for global diversification of REITs.
Unlike other posters, I think bond fund is the way to go. There is diversification and the smaller bid spread justify the low MERs. Never buy individual corporate bonds.
I think 50% short term bonds/ 50% real return bonds is a decent ratio. However, deflation is often mentioned nowadays. Short term deflation will depreciate real term bonds. That needs to be put that into consideration, before buying real return bonds.
I only agree with EconStudent when it comes to CORPORATE bonds, that it is best to diversify. That said, I also don’t own any corporate bonds or corporate bond funds…
But why pay anybody any MER at all to hold a government T-Bill or Bond when you can buy it yourself and be nearly guaranteed a positive return at maturity? Interest rates are near record lows, so in the future, chances are that the interest rates will go up, which will destroy the face value of the bonds. As mentioned earlier, bond funds are marked to market daily, so in that scenario, you will be losing your principal capital in a bond fund.
I hold Real Return Bonds, but I think the government has been monkeying with the numbers to reduce my returns. The real return bonds that I hold have only been yielding a measly 2.5% interest, whereas I KNOW every time I go shopping that the CPI is growing MUCH faster than 2.5%!!!
The problem is that Real Return Bonds are only measured against things we buy daily like Cars, TVs and Real Estate… And the things that we almost never buy, like Food and Gasoline are stripped out of the measurement. * Note the extreme sarcasm there…
CC – any way to ban the adult advertisements sneeking into the comments?
@ Phil S
I have my fixed income exposure 50% bond funds/50% GICs. And within bond funds I have 50% in real return (XCB) and remainder in a mixture of corp/gov.t The general rule of thumb is to select funds with relatively low duration, since short-term bonds are less exposed to interest rate risk than long-term. The nice think about bond ETFs is that they are much more liquid than holding the underlying bonds. You are at some risk of capital loss but I don’t think it’s a hugely significant risk for most funds as the underlying bonds are being constantly recycled. One question – what would you say about a 5 year 5% GIC in this environment? I’m usually loathe to lock my money up for so long but my broker is offering me this GIC “on special” (I haven’t seen 5% yield on any comparable products out there).
@ DM
My response would be to diversify through the use of a ladder. So, if you have $50K to invest in GICs, put $10K in a 1-yr, $10K in a 2-yr, etc. That way you run the entire gambit and only 20% of your GIC portfolio is locked into the 5-yr rate.
Who is the issuer on a 5-yr 5% at this point in time? I think the best I’ve seen after the BoC’s latest move is around 4.05% 5-yr.
@Phil S
Thanks for your response. I think laddering is the way to go. The GIC is being issued by TD. I think I’ll invest the bare minimum that is needed to get the 5%.
Its good that people rethink about their investments. In this environment of economic crisis, we need to spend and use our money wisely.
Wow, you’re 26 and already have a 400,000$ portfolio?
@ crackrock
No, I’m not sure how you worked that out but CC asked me not to include the actual $’s so let’s leave it at that.
“For the cash component of the portfolio I feel safer having 6 months of core living expenses in a cash emergency fund in high interest savings accounts, current this is about $16,000 or 4% of the total portfolio.”
Hi, I am a bit late to the party, but I would like to ask why bother with bonds at all? Given your long time horizon, and your ambitious goals, bonds are just going to be a drag on your long term returns. I say go with 100% stocks. All things considered, getting a margin account to get even more exposure to equities might be a good idea- and is something I am considering for myself as well.
Just my $0.02!
TEMPLE
TEMPLE: Instead of buying on margin, I think it might be beneficial for your to explore options.
This bear market may last very long and it is not advisable to buy all your equities at once. A significant amount of bonds allows you to invest in more equities if prices become cheaper.
I don’t know about you but I feel very optimistic about the stock market.
There is so much fear in the market. Great companies are going for half the price. I hope I’m not wrong but I feel some of those companies are really undervalued right now.
I had about 80% cash and 20% equities when the market crashed and now moving this cash in companies and ETFs I like. Bought some HMC, INTC and, AMAT in the last two weeks.
I still have about 25% in cash and will use it to buy more ETFs, but I will wait a month or two to see how it goes. Looking into PIQ and emerging markets.
cark: Good job with getting out of the market before everything went wrong. I think it is a good time to get back into the market if you do some sort of market timing. I think there will be a 50% rally during the first half of 2009. After the 50% rally, there might be another 50% drop due to much weaker economic recovery than expected.
In Jordan’s case, I think he is more of a passive investor. As a result, the only market timing he will be making is the time that he is entering the market. Buying everything at once will be very dangerous.
@TEMPLE
I was just re-reading parts of the Four Pillars book and came across the advise of lowering the bond allocation by 5% after a major market decline of 25% or more. So I’m giving serious thought to dropping the bond exposure to 15%.
One of my principals in life is to avoid all debt (with the exception of a mortgage) so investing on margin isn’t for me.
@ cark
I also feel optimistic about invested in this down market, but generally don’t feel the economy is set to spring right back. Just watch some of the video clips of Peter Schiff on YouTube to make you worry a bit about the fundamental problems in the economy.
@ EconStudent
How long would you suggest I take to become fully invested? Over the last month I’m about 1/3rd of the way there. I’ve had pretty good luck buying in on the low end on these dramatic market swings with limit orders.
EconStudent: My money was stored waiting for a good opportunity, and here it comes.
Jordan: With everybody being so pessimistic and the market dropping so fast, I think that the doomsday scenarios everybody are expecting are already factored into the price. However, I am quite a novice, don’t have a good track record and am drunk so take everything I write with a huge grain of salt.
Then, in the next five to ten years, I plan on selling the stock and buying real estate at bargain basement prices. I think the real estate market takes longer to react than the equities market and that the real estate market will go down for the next five years.
So for the next few years, I am investing in equities. In strong companies that do business all over the world.
If I need cash, I will just sell portions of whatever in my porfolio got the best return (or the smallest loss).
This is really an adhoc strategy and would probably benefit from more diversification. I just hope for the best.
I am very concerned about the US debt. They print and borrow money crazy. This is unsustainable. The dollar is artificially supported because it is the defacto currency for trading oil. One day, the world will wake up and select another currency and it will be a shock. The dollar and the US treasury bonds will drop and this will mark the end of the american empire. This is a primary reason why I am buying companies that do business everywhere.
I am thinking about shorting US treasury bonds, but I will wait and see. I don’t know how to proceed yet and still have time to figure it out. Maybe buying put options (long term) on some bond ETF to limit my risks.
I’m really interested in hearing what you think about this.
Jordan: I never watch shows like the Peter Schiff videos on YouTube. I don’t know but I feel there is something very wrong about this. I just have a negative bias towards TV.
Financialwebring.org I think is worth a look. I stumbled upon smarteconomy.typepad.com today will read some more before forming an opinion but it already gave me some ideas. An all time favorite of mine is globalresearch.ca
@ cark
I’m also planning to jump into the real estate market once Vancouver comes crashing down but I’ll also stay in stocks for the long haul. I’m hoping local real estate will bottom out in 2-3 years.
I read Peter Schiff’s book Crash Proof that explains his view in a lot of detail. The youtube videos are just a quick way to digest his argument. I think you hit pretty similar fundamental points about the US debt and trade deficit problems.
Hi Econstudent, I agree that dumping a lot of money into the stock market at once might not be the best strategy, and in that sense, I think averaging into stocks is probably a good idea. However, I was talking more about bonds regarding long term planning. While bonds might be useful for parking money in the short term, their usefulness is compromised over the longer term by their drag portfolio returns.
I have thought about options, but such an approach seem like too much of a gamble, so to speak. In other words, it smacks of timing and prediction, which is something I don’t think many people can consistently do with accuracy. However, I think being 100% long in equities is a smart allocation over the long term, and if there is enough of a time horizon, margin can even further enhance the power of long term stock performance. The majority of people readily use “margin” for real-estate purchases (although, FWIW, I rent so I can invest more in stocks), so why not do the same for an asset class that has consistently beaten every other asset class over the long term? That said, I haven’t invested on margin myself, but with stock prices being as low as they are, I really wish I had more money to buy stocks at this point.
Happy holidays!
TEMPLE
Jordon: Keep the money that you plan to buy Vancouver real estate in cash equivalents. I am sure that banks would require a 25% down payment.
TEMPLE: Buying on Margin isn’t gambling? I don’t know, but I heard margin calls are very scary. At least with options, you know the amount that you are going to loose.
Hi Econstudent, I wouldn’t consider buying stocks on margin to be gambling at all, any more than buying real estate with a mortgage is gambling. Consider that in both the case of real estate and stocks, the long term returns are invariably positive, albeit somewhat anemic with respect to real estate. In both cases, leverage (i.e. margin) allows you to own more, or better of whatever asset class you are purchasing.
However, when buying or selling options, my understanding is that you are making a short term prediction on stock price. In my mind, that seems like gambling, rather than investing. But, like I said before, I still haven’t increased my stock exposure above 100%. I have never been in debt for anything in my life, but the only two things I would consider having debt to own are stocks or real estate, and even then, I think I would be most comfortable with debt to own stocks.
Regards,
TEMPLE
Stocks have high volatility than real estate. (I personally think that Vancouver real estate might fall 50% easily, but that is the exception than the norm.) Margin for stocks has higher interest rates than mortgages. The factors combined suggests that there is definitely higher risk to buying on margin than mortgages.
I think the next “hot” sector would be global infrastructure. I am using IGF as the etf to play this sector. Maybe buying IGF on margin or using a line of credit is a good mid term idea? You must control your systematic risk when buying on margin.
Interest on money borrowed to invest is also tax deductible, unlike money borrowed for a mortgage (unless you are using the Smith manoeuvre, or so I gather). Plus, while stocks have higher volatility, they also have higher returns than real estate. Hence the risk premium reduces the risk of borrowing to buy stocks over the long term. My point is that borrowing heavily to purchase an asset class that has mediocre returns is viewed as normal (and even safe) by most people, while borrowing to buy an asset class with superior returns is viewed as risky. I think that is wrong. The threat of mediocre returns is, in my opinion, more risky to money management goals than a portfolio with high volatility over the short term.
Interesting idea with IGF. I’ll check that out, thanks.
TEMPLE
It is amazing that so many people manage not to predict the fall in stocks but think they can time the rise in stock markets. The fact remains that equities are risky and the current market is totally unpredictable.
I have been hearing folks tell me to leverage up and jump in since last September. Equities will be a great investment over the next ten years in my opinion , but over the next year I refuse to believe anybody who tells me “now is the time”. To leverage is just to double the consequences, good or bad.
The good would be nice but not necessary; the bad would be a terrible blow to my hard earned nest egg. If I want to maximize leverage and profits I will just spend my dollar on a lottery ticket. I firmly believe its time in the market not market timing, leveraging, or jumping from one asset to another. Simple and low cost diversification is my unbreakable rule.
Hi 2op mike, just to be clear, in case you are referring to my posts regarding margin, when I am suggesting leverage, I am in no way saying that the market is about to go up and that a person should buy on margin right now. Leverage has nothing to do with market timing. In fact, it goes hand in hand with time in the market by making that time more productive. As such, I am talking more about using leverage long term, as part of asset allocation. Check out “Stocks for the Long Run” for one example of the use of margin over the long term – there is a chart in there with recommended equity exposures – it is interesting to note that for younger investors, the suggest allocation to stocks is greater than 100%. This is the type of situation I am referring to when it comes to the use of long term leverage.
Of course, like I have been saying, I haven’t done it yet, but I am thinking about it.
Just my $0.02,
TEMPLE
To Temple: My comments are very generic. I think too many people look at equities as a guaranteed long term winner. There have been decades where that has not been the case. Check out “Juggling Dynamite” for a view that says the markets will go sideways for up to 17 years a cycle. The fact is, we can all support our positions or anybodies position with the variety of books out there by some what reputable sources.
Being old fashioned, I gravitate to basics such as:
- pay down all debt as quickly as is reasonably possible
- broadly diversify across at least 5 asset classes
- keep expenses low
- its OK to have an advisor for their expertise in security selection but never give an advisor control over how your money is invested i.e. style, strategy, asset allocation
- if you want to take a flyer on a hunch (and we all do at some point) take the funds out of your core investment account and create a “satelite” account
Having said that, I also think others have just as strong a belief in their system, and while I might disagree I still wish everybody success with whatever they try. A last comment might be, did the leveraging to over 100% equities make sense 24 months ago and are there folks out there who did it and would share thier thoughts?
20p Mike: I entered 2008 with a 50% equities/50% money market and I have to tell you that 2008 has been very, very painful. I am going to believe that leverage would be very painful. However, if the person used margin to short stocks, it must of been a sweet year. One needs a more aggressive market timing methodologies if one wants to leverage. Double the consequences whether good or bad.
In Canada, keep expenses low tend to be a major problem with all the trailing fees, advisor fees, etc. The number of low cost of mutual fund families can be counted with one hand. I know that people think this is impossible, but I am trying to propose for Vanguard to come to Canada.
@EconStudent
I had the same thought, I think if Vanguard came to Canada it would really shake up the industry and give us some much need low cost competition.
Does anyone know why they haven’t entered our market? Is it possibly too small?
As a follow up to my last comment, here is some information I sluethed up on the Vanguard Group in Canada.
The website bylo has been pushing an email letter writing campaign to suggest Vanguard come to Canada. Check it out and if your inclined email them too, I will be.
http://www.bylo.org/emailvan.html
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