Financial Basics 8 - Investment Portfolio Alternatives

This post is about alternatives to the portfolio I recommended in the previous post

This post was originally created in April 2015 and updated in April 2017. The Portfolio Alternatives table has been updated along with some wording. 

If you consider alternatives to my recommendation, please remember that each of these ETFs already have a great degree of diversification.  If you stick to index tracking ETFs, have an appropriate percentage of Bond ETF and cover the worlds stock markets, you should not need more than 4 ETFs.  In some cases you may be able to reduce this to 3 by picking one world (non-Canadian) ETF instead of having one each for the US and International.


Differing Percentage of Bond ETFs

The first way you can consider how you may modify my recommended portfolio is the percentage of Bond ETFs.  In general a Bond ETF, over the long run, will give a lower return on investment than a portfolio of stock ETFs.  However it gives that return with much less volatility than stock ETFs.  Stock ETFs may average 7% in the long run, but in a specific year it could be as low as -30%.  If you are a more conservative investor or your time window for investment is shorter then you may consider a higher percentage of Bond ETFs which will give a greater guarantee of return in a given year, but it will come at cost of a lower return overall in the long term. 

I would suggest Bond ETF percentage = Age - 20, and capped at 40%.  So when you start working, saving and investing you have no Bonds and by the time you are 60, you reach a peak of 40%. However the decision is up to you as you should take into account your level of risk tolerance. 

There is the "Age rule of thumb" that says your percentage of fixed income investments, or Bond ETFs should be equal to your age.  Here's an article from the Globe and Mail on an alternative view of this subject Why the age rule of thumb shouldn't be carved in stone. It basically says that since investors are living longer, the rule is too conservative and they will run out of money as the portfolio will not provide enough return. The financial planner interviewed suggests an alternative, that is essentially the square of the age divided by 100 and capped at 50%.  I think that's acceptable, but I'd rather have something simpler as I recommended above.

In Jim Collins' part VI of his stock series, he discusses his recommendation for portfolio and percentage of Bonds. He recommends a lower percentage of Bonds than what I have recommended here.

If you change the percentage of Bond ETFs, you keep the relative percentages of the other classes the same. 

So, if you are about 20 then,

• 0% Bond,
• 40% Canadian Equity, 
• 40% US Equity and 
• 20% International Equity.  

If you are 60 or above then,

• 40% Bonds,
• 24% Canadian Equity, 
• 24% US Equity and 
• 12% International Equity.  

Alternative Funds

In the table above I recommended some portfolios of ETFs based on iShares and BMO funds.  Below is a more complete list of funds from these companies plus Vanguard. I show MER % (Management Expense Ratio) and Yield % (these are the last ones I could find on each funds webpage and are mostly trailing 12 months as of March 2015).  We will use the yield % in the next post when discussing further the tax implications of the funds and how to decide which accounts each fund should be in. I have also included a list of higher dividend yield funds which I will also discuss later. 

	Class	Symbol	Description	MER	Yield
				(%)	(%)
	Canadian	XIU	iShares S&P/TSX 60 Index	0.18	2.62
		XIC	iShares Core S&P/TSX Capped Composite Index	0.06	2.68
		ZCN	BMO S&P/TSX Capped Composite Index ETF	0.06	2.83
		VCN	FTSE Canada All Cap Index ETF	0.06	2.33
		VCE	FTSE Canada Index ETF	0.05	2.68
	US S&P 500	XUS	iShares Core S&P 500 Index ETF	0.10	1.58
		XSP	iShares Core S&P 500 Index ETF (CAD-Hedged)	0.11	1.66
		ZSP	BMO S&P 500 Index ETF	0.10	1.68
		ZUE	BMO S&P 500 Hedged to CAD Index ETF	0.11	1.64
		VFV	S&P 500 Index ETF	0.08	1.59
		VSP	S&P 500 Index ETF (CAD-hedged)	0.08	1.60
	US Total Mkt	XUU	iShares Core S&P U.S. Total Market Index ETF	0.10	1.69
		XUH	iShares Core S&P U.S. Total Market Index ETF (CAD-Hedged)	0.10	1.72
		VUN	U.S. Total Market Index ETF	0.16	1.43
		VUS	U.S. Total Market Index ETF (CAD-hedged)	0.16	1.43
	International	XIN	iShares MSCI EAFE Index ETF (CAD-Hedged)	0.50	2.29
		XEF	iShares Core MSCI EAFE IMI Index ETF	0.22	2.26
		XFH	iShares Core MSCI EAFE IMI Index ETF (CAD-Hedged)	0.22	2.07
		ZEA	BMO MSCI EAFE Index ETF	0.22	2.30
		ZDM	BMO MSCI EAFE Hedged to CAD Index ETF	0.23	2.49
		VDU	FTSE Developed ex North America Index ETF	0.21	2.33
		VEF	FTSE Developed ex North America Index ETF (CAD-hedged)	0.22	2.28
	US+Intl	XAW	iShares Core MSCI All Country World ex Canada Index ETF	0.22	1.69
		VXC	FTSE All-World ex Canada Index ETF	0.27	1.78
	Dividend	CDZ	iShares S&P/TSX Canadian Dividend Aristocrats Index ETF	0.67	3.81
		XDV	iShares Canadian Select Dividend Index ETF	0.56	3.73
		XEI	iShares Core S&P/TSX Composite High Dividend Index ETF	0.22	4.26
		ZDV	BMO Canadian Dividend ETF	0.39	4.32
		VDY	FTSE Canadian High Dividend Yield Index ETF	0.22	3.81
	Bond	XBB	iShares Canadian Universe Bond Index ETF	0.34	2.74
		XQB	iShares Core High Quality Canadian Bond Index ETF	0.13	2.60
		ZAG	BMO Aggregate Bond Index ETF	0.14	2.90
		VAB	Canadian Aggregate Bond Index ETF	0.13	2.74

(updated April 10th, 2017)

Whether to Hedge Currency

As I mentioned in post #7, in my current portfolio the US and International funds are hedged, so that there is no currency risk. If I was starting over again I would re-consider this decision. Here is a good article from the Canadian Couch Potato on Why Currency Hedging Doesn’t Work in Canada. Conversely, here's an article from The Motley Fool on How To Build an ETF Portfolio that recommends currency hedging. 

Will I sell my hedged ETFs and buy non-hedged? No, because I have significant gains in these funds and I do not want to incur any more taxes than I need to. Currently the Canadian dollar is low relative to the US dollar driven by the recent drop in crude oil prices. In the long term I believe oil prices will climb and the Canadian dollar will rise, so if I switch to non-hedged funds that will erode future gains. I'm going to stick with the funds I have, however I may make new investments in non-hedged funds. 

What do I do for more dividend income

If you have significant holdings in your Taxable account you may want to increase the amount of income you receive from Dividends. Certainly in retirement this will be a good strategy as you can earn up to $50,000 of income from dividends and pay no tax (depending on province). 

In the fund table above I listed some Dividend focused ETFs that pay up to 4% dividends. I currently hold some CDZ. I am paying about a 20% tax rate on this income while working, but this tax rate will drop considerably when I retire. 

I feel a future post on whether or not this is a good strategy may be in order.

More reading

Canadian Couch Potato's recommended portfolios. I would only suggest option 3, which is the ETF option and it consists of ZAG (Bond), VCN (Canadian Equity) and XAW (US and International Equity). He provides historical performance for this portfolio at differing percentages of Bond. 
http://canadiancouchpotato.com/wp-content/uploads/2015/01/CCP-Model-Portfolios-ETFs-2016.pdf

Jim Collins portfolio. Note that when he originally wrote this he did recommend REITs, but then recommended against this for some very good reasons.

http://jlcollinsnh.com/2012/05/12/stocks-part-vi-portfolio-ideas-to-build-and-keep-your-wealth/

Article on recent expansion of iShares ETF offerings.

http://canadiancouchpotato.com/2015/02/18/ishares-expands-its-core-etf-lineup/

More Complicated Stuff

What to do if your company Defined Contribution (DC) plan doesn't have the funds you want?

Here's some advice for picking funds from your company DC pension plan (which are notorious for having a poor selection of funds).
http://www.milliondollarjourney.com/choosing-mutual-funds-in-your-employer-pension.htm

Additional details on Foreign Withholding taxes and impact on returns.  

Foreign withholding taxes do not make a big impact on your decision to invest. Read these articles if you have time and interest in the subject. 

Foreign withholding taxes (see referenced paper for tax impact of many funds)
http://canadiancouchpotato.com/2014/02/20/the-true-cost-of-foreign-withholding-taxes/

And an updated version from the Canadian Portfolio Manager:
http://www.canadianportfoliomanagerblog.com/wp-content/uploads/2014/09/2016-06-17_-Bender-Bortolotti_Foreign_Withholding_Taxes_Hyperlinked.pdf?850eac

Disclaimer:  These posts are not fully comprehensive financial advice.  You should seek your own qualified investment, tax and legal advice.