The following chart gives some basic information about the ETFs in my portfolio:
|ETF||Allocation||Asset Class||# Stocks||MER||Purchase Currency|
|VCN||30%||All Cdn Stocks||248||0.05%||C$|
|VTI||25%||All U.S. Stocks||3772||0.05%||US$|
|VBR||20%||All U.S. Small Cap Value Stocks||812||0.09%||US$|
|VXUS||25%||All World Stocks ex. U.S.||5783||0.14%||US$|
If we focus initially on the “# Stocks” column, we see that each ETF contains within it a large number of individual stocks. For example, VCN holds 248 stocks and is intended to be representative of the entire Canadian stock market. Similarly, VTI holds 3772 stocks and represents the entire U.S. stock market. With even more stocks is the international ETF called VXUS at 5783 stocks. These three together cover the whole world and form the core of my portfolio. This is extremely broad diversification with a total of over 9500 different stocks.
The remaining ETF, called VBR, could be considered somewhat narrow because it contains only U.S. small capitalization value stocks. However, even this ETF holds 812 stocks. The style of stock is somewhat narrow, but the number of stocks is high. Overall, holding only 4 ETFs is misleading when it comes to the optics of diversification. I’m well diversified and hoping that the historical outperformance of small cap value stocks continues into the future.
The blended Management Expense Ratio (MER) of my portfolio is 0.08%. This means that I pay $80 per year on each $100,000 I have invested. For the lucky among us who manage to amass a million-dollar portfolio, this is $800 per year. If I were invested in typical mutual funds in Canada, this would be more like $20,000 per year. More savvy investors who seek out professional portfolio management for a million-dollar portfolio still pay about $10,000 per year.
Another cost I have is international withholding taxes on dividends from VXUS. When spread across my entire portfolio, this adds about another 0.09% per year in costs. The U.S. has dividend withholding taxes as well, but fortunately, a tax treaty with Canada eliminates U.S. withholding taxes in RRSP accounts. This doesn’t apply to TFSAs or non-registered accounts, though. I’d have to pay taxes in non-registered accounts anyway. So, my main rule for “asset location” is to never hold VTI, VBR, or VXUS in a TFSA.
Other costs are very small for me. ETFs and mutual funds have internal trading costs that are not part of the MER, but these are very small for my 4 ETFs. However, I’ve seen trading costs in the 0.25% range for some actively-managed mutual funds, so investors can’t just ignore this cost. I also have to pay trading commissions ($10 each), and I lose half of the bid-ask spread on each trade. Fortunately, these costs are very low for me because I rarely trade.
Another category of costs is currency exchanges. Notice that 3 of my ETFs trade in U.S. dollars. This means that I can’t buy them directly with Canadian dollars; I need to exchange Canadian dollars for U.S. dollars first. All currency exchanges cost money. Unfortunately, this cost is usually hidden in the quoted exchange rate.
A good way to tell what currency exchange costs you is to look at a round trip: Canadian dollars to U.S. dollars and back to Canadian dollars again. If you lose 2% on a round trip, then each exchange costs you about 1%. That’s a $100 cost on a $10,000 exchange. This isn’t too far off what most of the big banks charge. When you make a trade and click the “settle in Canadian dollars” button, it’s easy to forget about this hidden cost.
There is a great way to save money on large currency exchanges called the Norbert Gambit (see Canadian Couch Potato’s detailed explanation). I use a variant of this method using Royal Bank’s interlisted stock instead of using the ETF called DLR. My way is a little cheaper but a little riskier because it involves holding Royal Bank stock for a few minutes.
After initial setup, this portfolio has taken very little time to maintain. The main activity comes when I have new money to add. I use a spreadsheet to tell me which ETFs are below my target allocation and I buy them to get back in balance. On the rare occasion that this isn’t enough to keep the balance, I have some rebalancing rules coded into the spreadsheet to make a cell glow red if I have to do something.
Before choosing your own portfolio allocation, make sure your costs are sensible for your portfolio size and that you can truly handle the volatility of the allocation to stocks you choose.