A Simple Low Cost Diversified ETF Portfolio

1. 1. Canadian Capitalist

   Thanks for the link. As you know, XIC is better in my opinion because it is more diversified and avoids concentration (which might be a real problem with our stock market). Having said that buying a few stocks to represent the Canadian portion is a viable alternative.

   Jul 17th, 2008 @ 8:42 am

2. 2. Telly

   I’d love to see what allocation you’d choose. We had a bit of a discussion at CC’s blog about this not long ago.

   Jul 17th, 2008 @ 11:04 am

3. 3. FrugalTrader

   Interesting question Telly, for me, I would keep it simple and would resemble my RESP strategy.

   Basically mostly, if not all, equities initially then gradually adding to my bond portion as I get closer to retirement. In terms of equity allocation, I would probably choose an equal weight for each ETF rebalancing as I add cash to the portfolio.

   What do you do with your index portfolio?

   Jul 17th, 2008 @ 11:21 am

4. 4. Paul S

   FT

   Great idea.

   What are the historical performance numbers on these funds vs their equivalent indexes? Was this part of your selection process?

   Jul 17th, 2008 @ 12:04 pm

5. 5. FrugalTrader

   I’m not sure about the exact numbers, but there is going to be a small tracking error with all index based funds/etf’s. For my selection process, I assumed that all index etf’s had the same tracking error, and based my selection based on MER and asset allocation.

   Jul 17th, 2008 @ 1:13 pm

6. 6. Ryan

   I use the following allocation:

   Canada - total 20%
   20% - XIC

   US - total 30%
   20% - VTI - total market
   5% - VBB - small cap
   5% - VRB - small cap value

   International - total - 30%
   20% - VEA
   10% - VWO

   Fixed - 20%
   5% - XRB - Real Return Bonds
   5% - XSB - Short Bonds
   10% - XRE - REITs

   The biggest downside is the currency risk as 60% of the portfolio is in US dollars. Also - I would like to find a replacement for XRE as the MER is 0.55%.

   Jul 17th, 2008 @ 2:38 pm

7. 7. Dividend Growth Investor

   There’s not a right or wrong allocation, only one that is suited for each individual.

   As for bonds, I noticed you are looking at short-term bonds. What about long-term bonds? In US you could check out BLV or TLT. What about foreign bonds exposure? Check out BWX.

   Also have you thought about real-estate? Some people say that real estate investment trusts are a separate asset class, just like stocks, bonds, commodities. IYR for US and RWX for international could be a good starting point.

   You might also add some small-caps and mid-caps as well. IWM is the russell 2000 index etf, so it should be ok.

   A very good starting ETF list for US investors could be found form Yahoo! finance:

   http://finance.yahoo.com/etf/browser/mkt?k=3&c=0&f=0&cs=1&ce=794

   There’s 794 ETF’s in the US. I just got a headache simply by opening the list..

   Jul 17th, 2008 @ 4:46 pm

8. 8. FrugalTrader

   Hey DGI, long term bonds have a higher correlation to equities than short term bonds. If I were to hold bonds, the purpose would be to reduce volatility as I get closer to retirement.

   Jul 17th, 2008 @ 5:39 pm

9. 9. Ryan

   Debating allocation decisions is always fun. I use the following:

   Canada - 20% total
   XIC - 20%

   US - 30% total
   VTI - 20% - total market index
   VBB - 5% - small cap
   VBR - 5% - small cap value

   International - 30% total
   VEA - 20% - Europe and Pacific
   VOW - 10% - Emergying Markets

   Fixed Income - 20% total
   XSB - 5% - short bonds
   XRB - 5% - real return bonds
   XRE - 10% - REITs

   The main disadvantage of my allocation is that so much of it is in US$ and therefore there is alot of currency risk. I would also like to find a replacement for XRE as its MER is much to high.

   I am not a believer in market timing but if you are I would suggest sticking with short bonds at this point. That way you wont be hurt when interest rates start to rise.

   Jul 17th, 2008 @ 5:43 pm

10. 10. sid

    Since these are all ETF’s, brokerages treat these as buying stocks. How would you buy into these each month to minimize your trading fees? With 5 ETF’s at $9.99 per trade that’s $50 a month or $600 a year. If you invested in mutual funds with no loads with 1% MER’s, you’d break even at $60,000. I know I don’t have that much to invest every year and I can find mutual funds with no loads and MER’s less than 1%. So is there any advantage with these?

    Jul 17th, 2008 @ 7:20 pm

11. 11. Antony Pranata

    What’s your opinion on Horizon’s Beta ETF? Their MER is higher, but the potential return might be better.

    Jul 17th, 2008 @ 8:27 pm

12. 12. FrugalTrader

    Ryan: Thanks for sharing. Seems that you have a well diversified ETF portfolio.

    Sid: ETF portfolios only make sense for larger accounts like you mentioned. If your account is smaller, it would make sense to stick with mutual funds like the td e-series.
    http://www.milliondollarjourney.com/reader-question-when-to-switch-to-etfs.htm

    antony: I’ve written about the horizon betapro ETF’s before and they seem like a decent choice for “trading”. It’s hard to say what it will do in the long run, there’s not enough data thus far.
    http://www.milliondollarjourney.com/double-your-market-exposure-with-horizons-betapro-etfs.htm

    Jul 17th, 2008 @ 9:26 pm

13. 13. Cannon_fodder

    I took a look at the Beta Pro’s perfomance vs. the underlying indices and it shows within a year that they don’t come close to 2x the performance. It was enough to convince me to pass on them.

    Jul 17th, 2008 @ 9:30 pm

14. 14. Charles in Vancouver

    (please delete if this posts twice)

    Ryan, your VEA and VWO holdings may be priced in US dollars, but they do not represent US dollar exposure because those funds are not hedged to any currency. Rather, they represent exposure to global currencies, namely whichever ones the underlying companies do business in. So that 30% of your portfolio has some US exposure (foreign companies who do a lot of US business), some Euros, some Pounds, some Yen, and a smattering of others.

    So really, only 30% is exposed absolutely to the US dollar; another 30% is exposed to a total coin-toss of currency fluctuations; and 40% is in your home currency. That’s not too bad at all. When you calculate rebalancing, remember to convert everything to CDN$ at the prevailing rate and you may even profit from currency swings over the years.

    Jul 18th, 2008 @ 2:52 am

15. 15. Charles in Vancouver

    Sid: A hybrid approach is also possible. One need not make 5 trades per month. One could:
    a) Add to the ETFs monthly, but only one trade at a time. Each month you add your entire contribution to whichever ETF is most underweighted. Over the course of the year you will stay approximately within your target allocation.
    b) Collect your monthly contributions in a high-interest savings account, money market fund or in no-load funds matching the underweighted category (e.g. if VEA is underweight, buy into a no-load EAFE index fund). Then you can make a small number of annual or quarterly trades with that money when it makes sense.
    c) Same as b, but set a threshold amount - e.g. tell yourself that if any ETF is underweight by more than $1500 and you have that much in cash or a no-load fund of the same category, you will make one trade.

    With an annual-hybrid approach you could make as few as 3-5 ETF trades (this is my preferred strategy). Now the break-even point slides lower.

    Jul 18th, 2008 @ 3:22 am

16. 16. Almost there

    Does anyone know a good low cost dividend paying etf? Ive seen CDZ with a mer .60%.
    Thx

    Jul 18th, 2008 @ 10:08 am

17. 17. Ryan

    Hi Sid - The way I reduce brokerage fees is to only make one ETF purchase every year. My strategy is to automatically purchase TDeFunds (using dollar cost averaging) every two weeks. Once a year I sell my TDeFunds to purchase ETFs from TD Waterhouse. I do use 9 ETFs but because I only make one transaction a year this costs me less than $100 in brokerage fees.

    Charles - thanks for the info on VWO and VEA.

    Jul 18th, 2008 @ 12:27 pm

18. 18. Dividend Growth Investor

    Almost There,

    There are several dividend ETF’s out there. The ones worthwhile in my opinion are SDY and DVY. I do have some problem with the weightings in SDY according to yield though..

    Jul 18th, 2008 @ 2:22 pm

19. 19. Dividend Growth Investor

    FT,

    Short-term bonds will let you maintain some flexibility if interest rates rise. With longer term bonds however you earn higher current interest. If interest rates do not increase a lot or decrease you will be better off with longer-term bonds; If interest rates increase however, like they did in the 1970’s then sticking to short term maturities will be the way to go..

    Jul 18th, 2008 @ 2:25 pm

20. 20. FrugalTrader

    Thanks for the tips DGI !

    Jul 18th, 2008 @ 4:46 pm

21. 21. Ryan

    William Berstein looking at the trade-off between short-term and long-term bonds in his book the Four Pillars of Investing. He found that short-term bonds offer very similar returns as long-term bonds. If thats true than there is little reason to purchase long duration bonds because long bonds are more risky then short bonds.

    Alos - with interests rates this low I would suggest buying short bonds because there value will be less effected when interest rate rise.

    Jul 18th, 2008 @ 5:18 pm

22. 22. Robert Penner

    FT, is this all hypothetical or are you planning to start investing in these? And would you borrow to invest, to get the tax write-off?

    Jul 19th, 2008 @ 11:26 pm

23. 23. FrugalTrader

    Hey Robert, as I mentioned in the article, i’m slowly being converted to an indexer. I’m already indexing a portion of my RRSP but plan to increase the amount when the time is right.

    If you check out my Smith Manoeuvre portfolio updates, you’ll see my leveraged portfolio contents. There is a small index portion of that portfolio, but it’s mostly income producing securities.

    Jul 20th, 2008 @ 6:22 am

24. 24. sid

    FT, Ryan and Charles, thanks for the replies. I’ll stick with mutual funds for another year or two when my portfolio’s a little bigger and then reconsider the ETFs.

    I just noticed that three out five of the funds you listed were in USD. Do you do anything to “hedge” against the change in currencies?

    Jul 20th, 2008 @ 3:21 pm

25. 25. FrugalTrader

    sid, ETF’s that hedge against currency risk have higher MER’s and it’s been shown that currencies risk is reduced significantly if investing for the long term.

    Jul 20th, 2008 @ 3:53 pm

26. 26. Almost there

    Dividend Growth Investor,
    Those 2 look good but they are both american which would have a non-resident withholding tax for Canadians.
    Do you know of any good canadian efts??
    I saw this on TMF.

    Weighing yield
    To distinguish themselves from their competition, dividend ETFs put together their portfolios in different ways. Let’s look at some of them:

    The WisdomTree LargeCap Dividend Index Fund (DLN) uses a simple approach, choosing the 300 largest stocks from its dividend index and weighting them by the total amount of dividends each company pays.

    The iShares Dow Jones Select Dividend Index Fund (DVY) includes dividend-paying stocks that have maintained or increased dividends in each of the past five years, have a payout ratio of 60% or less, and trade an average of at least 200,000 shares daily.

    The PowerShares Dividend Achievers ETF (PFM) screens for companies that have increased dividend payouts for at least 10 straight years and then chooses the highest-yielding stocks among them.

    The SPDR S&P Dividend ETF (SDY) picks 50 high-yielding companies that have raised dividends consistently over at least a 25-year timeframe.

    The First Trust Value Line Dividend Index Fund (FVD) uses Value Line’s safety rankings to screen for stocks it deems safer than average and then takes above-average dividend yields with market caps of more than $1 billion. Unlike most other dividend ETFs, this fund gives each stock equal weight in its portfolio.

    Again all american, but there is some good info as to the differences in the various etfs.

    Jul 23rd, 2008 @ 3:38 pm

27. 27. cnidog

    For what it is worth, here is what CIBC Wood Gundy recommended in their July 2008 Monthly World Markets Report:
    Growth Aggressive Growth
    Cash 0% 0%
    Fixed Income ETFS
    XBB 20% 0%
    Equity ETFs
    XIC 22% 27%
    XTR 8% 8%
    IVV 16% 17%
    EFA 19% 25%
    EEM 9% 17%
    VNQ 6% 6%

    Meanwhile, RBC recommends the following asset allocation in its Summer 2008 edition of Direct Investor. Unfortunately, they do not make Index fund recommendations, only asset classes.

    Growth Aggressive Growth
    Cash 4.1% 3.3%
    Fixed Income 19.5% 0.0%
    Canadian Equities 23.8% 34.3%
    US Equities 31.8% 33.2%
    Int’l Equities 20.8% 29.2%

    The big difference between the two seems to be the CIBC thinks that oil is going to rise to $200/bbl and therefore has placed heavy emphasis on big energy producing countries like Canada, Russia and Arabia. It also likes the trends in the economies of Brazil, China and India.

    RBC, on the other hand, thinks that US stocks are really undervalued now, and has placed heavy emphasis on US equities.

    Aug 8th, 2008 @ 11:19 pm

28. 28. Rob Viglione

    Great foundations for a solid portfolio, but I’d also recommend adding a diversified commodities element, as well as a handful of currencies. For commodities, I highly recommend a broadly diversified ETF such as GSG. It tracks the performance of the GSCI Excess Return Index, which tracks 24 different commodities. It is weighted with approximately 67% invested in energy, 16% in agriculture, 7% in industrial metals, 7% in livestock and 3% in precious metals. The index is production weighted to reflect the relative significance of those commodities to the world economy.

    It’s possible to get into specific commodities, such as oil (USO), natural gas (UNG), agricultural commodities (DBA), and precious metals (XME), to name a few. Still, unless you have reason to be particularly bullish on any of these I’d recommend the far more diversified GSG.

    As far as currencies are concerned, I recommend adding a selective group to your portfolio using ETF’s: FXE, FXF, FXC, FXA, FXM, FXS, FXY, and FXB. I’ve written a more detailed article on how to choose the right currencies: http://www.thefreedomfactory.us/portfolio-considerations-for-currency-investing/

    Two things to consider are how currencies correlate to other assets in your portfolio, namely stocks and bonds (and hopefully commodities), as well as relative income yields. Currency ETF’s pay dividends that are representative of interest rates in their respective countries. It would be prudent to add currencies that have both high yields as well as negative correlation to major assets currently in your portfolio.

    Aug 11th, 2008 @ 2:41 am

29. 29. Patch

    so much for simple…

    Aug 11th, 2008 @ 2:29 pm

30. 30. FrugalTrader

    Patch, if you have questions, the readers and I would be happy to address them.

    Aug 11th, 2008 @ 2:53 pm

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