I get a lot of questions from family and friends about investing.  In most cases, these people see the investment world as dark and scary; no matter what advice they get, they’re likely to ask “Is it safe?”  They are looking for an easy and safe way to invest their money.  These people are often easy targets for high-cost, zero-advice financial companies with their own sales force (called advisors), such as the big banks and certain large companies with offices in many strip malls.  An advisor just has to tell these potential clients that everything will be alright and they’ll be relieved to hand their money over. A subset of inexperienced investors could properly handle investing in an all-in-one Exchange-Traded Fund (ETF) if they learned a few basic things.  This article is my attempt to put these things together in one place. Index Investing Most people have heard of one or more of the Dow, S&P 500, or the TSX.  These are called indexes.  They a...

When it comes to investing, we should keep things as simple as possible. But we should also keep costs as low as possible. These two goals are at odds when it comes to choosing between Canadian and U.S. exchange-traded funds (ETFs). However, there is a good compromise solution. First of all, when we say an ETF is Canadian, we’re not referring to the investments it holds. For example, a Canadian ETF might hold U.S. or foreign stocks. Canadian ETFs trade in Canadian dollars and are sold in Canada. Similarly, U.S. ETFs trade in U.S. dollars and are sold in the U.S. Canadians can buy U.S. ETFs through Canadian discount brokers but must trade them in U.S. dollars. Vanguard Canada offers “asset allocation ETFs” that simplify investing greatly. One such ETF has the ticker VEQT. This ETF holds a mix of Canadian, U.S., and foreign stocks in fixed percentages, and Vanguard handles the rebalancing within VEQT to maintain these fixed percentages. An investor who likes this mix of glo...

Reader ML asks the following good question (edited for length): I am relatively new to investing for dividends. Currently my strategy is to invest in high quality stocks and hold them for a long time. You are one of the bloggers who switched from buying individual stocks to buying ETFs. I get the strategy of ETFs in that it’s hard to beat the market with individual stocks. My question: Over years the dividend you receive from an individual stock continues to grow. If ETFs switch over their portfolio would they not miss out on this increase in dividends, year over year? It seems to me that the dividends stay pretty steady in the ETFs. Is that not a big chunk of money to miss out on? The short answer is that ETF dividends do grow. The dividends that low-cost index ETFs pay are mainly the dividends collected from all the individual stocks held within the ETF. There is a small deduction for the costs of operating the ETF and possibly a small increase from securities lending,...

Index investors in Canada who own Exchange-Traded Funds (ETFs) have a choice to make with their U.S. and international stock holdings. They can either buy an ETF that holds U.S. and international stocks but trades in Canadian dollars (such as Vanguard Canada’s VXC), or they can buy U.S.-listed ETFs that trade in U.S. dollars. This choice is a trade-off between cost and complexity. It’s certainly a lot simpler to own VXC. With U.S.-listed ETFs, you need to find an inexpensive way to exchange Canadian for U.S. dollars, such as Norbert’s Gambit . But, as Justin Bender explained, the cost of VXC is higher than the cost of owning U.S.-listed ETFs . This higher cost comes from a higher Management Expense Ratio (MER) and U.S. dividend withholding taxes. For the mix of U.S.-listed ETFs that I own (VTI, VBR, and VXUS), the blended MER is 0.09%, which is 0.18% lower than VXC’s MER. Less obvious, as Justin calculated, is the fact that U.S. withholding taxes of 0.35% cannot be recovered ...

It’s common to hear that certain types of risky investments are not for novices. Some will take this to mean that such investments are good for experienced investors. This isn’t necessarily the case. A recent example of this type of advice is an article warning investors about quadruple-leveraged ETFs : “Investing in even modestly levered funds is a potentially dangerous proposition for inexperienced investors.” This quote is true, but some readers may conclude that these leveraged ETFs are safe if you’re an experienced investor. It’s worth reminding ourselves of a simple truth: if two investors buy the same investment for the same price on the same day, and they sell it for the same price on the same later day, they will get the same return. The more experienced investor won’t somehow get a better result. To perform better than novices, experienced investors must do something different from novices. Quadruple-leveraged ETFs are usually a bad idea for investors no matter th...

I came across an article promising 101 ETF investment tips from 57 ETF experts (but it appears to not be online any more). While debating whether I thought I could slog through such a long article, I decided to focus on just those tips that I don’t follow. If I have a good reason not to follow them, I should be able to explain it. And maybe I’ll find a gem among the tips that changes my mind about the way I invest. Talking about the tips I do follow is like having a meal with like-minded friends. It’s an enjoyable way to spend time, but that’s not my purpose here. So here are just those tips I don’t follow. 4. Allocate your age as your percentage in fixed income. I don’t have any bonds at all in my long-term savings. I only use safe fixed income investments for money I’ll need in less than 5 years. I plan to carry this approach into retirement by holding 5 years of my spending in guaranteed investments and holding the rest in stocks. I expect my allocation to fixed income...

There have been a number of prominent articles about the dangers of trading Exchange-Traded Funds (ETFs) over the past year. The latest ETF story is from the Wall Street Journal . I read each of these articles looking for some new concern, but they tend to be the same recycled fears along with a scary title. Here I’ll list the categories of concerns and what I do to try to avoid trouble. 1. Some ETFs stink. Yup, that’s right, not all ETFs are great. Some have high built-in fees and others are too narrowly-focused to be safely owned by the unwary. I stick to very low cost index ETFs. 2. Investors can lose money trying to actively trade ETFs. True. That’s why I don’t trade them actively. Apart from a rare need to rebalance my portfolio to my target asset allocation, I don’t plan to sell any ETFs until I need the money in retirement. I buy more ETFs when I have more savings to invest. 3. Sometimes ETFs trade for prices far from their Net Asset Values (NAVs). The NAV of...

A reader, J.H. asks the following thoughtful question about leveraged ETFs (edited for length): I am familiar with the decay factor of leveraged ETFs over the long term. However, it seems that using 50% cash, 50% 2X ETF, rebalanced say annually, mirrors the underlying 1X ETF very closely. In fact it is a bit better on a risk adjusted basis. Blue portfolio: 100% SPY (an S&P 500 index ETF) Red portfolio: 50% SHV (short-term U.S. bonds), 50% SSO (a 2X leveraged S&P 500 ETF) These two portfolios gave nearly identical returns from 2008 to the present. I found this to be contradictory to everything I read about leveraged ETFs. A six year back-test should be enough to unveil the presumed decay, but I don't see it. I am particularly interested in this way of investing as it provides a way to beat SPY without taking all the risk of being all-in. If on the cash component one can earn more than what SSO pays to borrow to buy stock (these days, one can make 2.3% or so using a...

In my never-ending quest to clearly explain the devastating effect of investment fees on your savings, I’ve found another way to look at it. Instead of looking at how much of your money gets consumed by mutual fund fees, let’s look at how they affect your retirement age. Suppose that Katie is 30 years old and is just starting out saving in her RRSP. She has set up automatic contributions of $1000 per month. She plans to increase this amount each year to keep pace with inflation. Katie wants to know, “if I plan to draw $3000 per month (in today’s dollars) in retirement until I’m 95, when can I retire?” The answer depends on how her RRSP investments perform. For illustration purposes, let’s assume that her investments beat inflation by 4% per year, before investing fees . Of course, she can’t count on this, and returns vary considerably from one year to the next. But the goal here is to see how fees affect retirement, so we’ll do calculations based on a steady 4% real return. ...

The explosion in exchange-traded funds (ETFs) in Canada continues with the launch of five new funds in September by Purpose Investments . I had the pleasure of talking to Som Seif (CEO) and Ross Neilson (Vice President, Sales) over dinner recently to get their take on where Purpose fits in the investing landscape. ( Disclosure: Som paid for my dinner, but if you think that affects what I write, you should see how many times per week I turn down offers of far more than the cost of a dinner to place “guest” posts on my blog that masquerade as real content.) Som Seif is a very smart, high-energy guy who started Claymore back in 2005 and now runs Purpose Investments. Ross Neilson is no slouch himself, but even he tends to sit back and watch Seif go. Som shows passion and communicates clearly in a way that I think is likely to resonate with a significant fraction of investors who hear him speak. I don’t know how his funds will perform, but I wouldn’t bet against Purpose Investments ...

With the ETF industry producing new products at a furious pace, investors can implement a wide range of investing and trading strategies using ETFs. Unfortunately, most of these strategies are a bad idea. It used to be that investing in ETFs was synonymous with widely-diversified passive investing. Investors could buy XIU for Canadian stocks, VTI for U.S. stocks, and maybe a couple of others for bonds and foreign stocks, and then go to sleep for a decade. However, new ETFs are nothing like these older products. Investors who have been unhappy with their mutual fund returns can now bring their faulty investing strategies into ETFs. Many mutual fund investors used to chase the previous year’s hot fund with disastrous results. Now they can bring new hope to the ETF domain and chase the latest hot ETFs. Investors who used to try to guess the next hot sector using mutual funds can now do the same with ETFs. Unfortunately, most of them will just buy the sector hottest in the rece...

A common problem for young investors who get excited about index investing is that they try to over-think their portfolios in their early saving years. Your asset mix is much more important when your portfolio is much larger than your new contributions than it is when you're just starting out. I'll go through a fictitious example to illustrate a pattern I've seen with novice index investors. Amy is a responsible woman in her mid-twenties with a good job who wants to start building savings for her future. She has read about index investing and is excited to learn that she doesn't have to be an expert on stock picking to be a successful investor. After some study she has settled on the following asset mix: 35% Canadian stocks 30% U.S. stocks 20% International stocks 15% Canadian bonds She has picked the 4 ETFs she plans to use for these asset classes, and she has RRSP and TFSA accounts opened with a discount brokerage. Right now she has $2000 in her RRSP and...

Vanguard's entry into the Canadian ETF market with very low management fees has many ETF investors considering making a switch. However, it costs commissions and spreads to switch over to Vanguard ETFs. This leaves investors weighing the costs to decide whether to change or not. However, there is a middle ground. The most interesting of Vanguard's new ETFs to me is VCE which tracks the MSCI Canada stock index. This is a potential replacement for iShare's XIU which tracks the S&P/TSX 60. The management fees are 0.09% for VCE and 0.15% for XIU. These figures are not the complete MER, but we can assume that the difference in MERs will be close to 0.06%. So, an investor with $20,000 in XIU could save $12 per year by switching to VCE. This isn't exactly a huge savings. It's hard to justify the trading commissions and spreads to make the change. But, there is a simple compromise: just buy VCE whenever you're adding new money or rebalancing toward stoc...

Canadian Couch Potato took a detailed look at whether leveraged ETFs can cause market instability including links to other opinions on the subject. Missing in the various articles I read was a clear and simple explanation of the forces that can cause leveraged ETFs to add to market volatility. 2X Bull ETF Consider first an ETF that seeks to give double the daily return of a given stock index. Suppose that investors have invested a total of $100 million. There are many ways for an ETF to gain double exposure, but we'll look at a simple method: the ETF borrows another $100 million and buys $200 million worth of index stocks. At the start of the day the ETF holdings are Stock: $200M Cash: -$100M The ETF's goal is to maintain a 2:1 ratio between stocks and borrowed cash. Let's now look at what happens on a volatile day. If stocks go up 5%, the holdings are now Stock: $210M Cash: -$100M At the end of the day, the ETF has to borrow another $10 million to b...

Leveraged ETFs are designed to return double or triple the return of an index each day, but they come with disclaimers warning that they won’t double or triple returns over longer periods of time due to a mysterious compounding effect. I’ve come up with a more concrete explanation that is hopefully more understandable. An example of a leveraged ETF is the Horizons BetaPro S&P/TSX 60 Bull ETF (ticker: HXU). If the TSX 60 goes up 1% on a given day, HXU goes up 2%. The confusing part is that if the TSX 60 goes up 10% in a year, HXU doesn’t go up 20% that year. A partial reason is the management fees charged to run HXD, but this doesn’t fully explain the seemingly missing returns. To understand what is going on, imagine a volatile 2 days where the TSX 60 goes up 10% then goes down 10%. Let’s track a $100 investment in the TSX 60 for the 2 days: TSX 60: Start: $100, after up day: $110, after down day: $99 So, by the magic of compounding we lost a dollar. Here is the unsat...

The consensus among index investing experts is that index investors with small portfolios should invest in mutual funds such as TD’s e-series and those with larger portfolios should invest in index ETFs. The idea is to minimize portfolio costs. However, the best choice depends greatly on how you trade in your portfolio. Mutual funds tend to have higher MERs than ETFs do, but buying and selling ETFs has the costs of commissions and spreads. Once the investor’s portfolio becomes large enough, the MER savings with ETFs overcome the trading costs. But we can’t determine the portfolio size where ETFs become superior without knowing the investor’s trading habits. To illustrate what I mean we’ll consider two hypothetical beginner investors: Jack and Jill. Each investor has chosen a portfolio mix of domestic stocks, foreign stocks, and bonds with target percentages for each. Jack chose to invest in mutual funds and Jill chose ETFs. Jack likes to stay very close to his target percen...

The abbreviation ETF stands for exchange-traded fund. It used to mean a basket of equities making up some broad index where the annual fees charged were very low. As investors came to understand that ETFs were good, the name “ETF” began to be used for just about any type of investment. At first it was very narrowly-focused exchange-traded funds that got in on the ETF name. It’s hard to argue that this was really an abuse of the name, though, because these funds were, in fact, exchange-traded. But they were different from the original ETFs in important ways. Firstly, they had higher fees, and secondly, they did not represent a broad index (as Preet observed recently ). For a while I tried to use the cumbersome term “low-cost broad-index ETF” to get at the original meaning of ETF, but that’s not a very catchy name. Lately, the name ETF has been attached to index mutual funds as well. Because mutual funds aren’t exchange-traded, this is hard to justify other than with the we-w...

Many people asking me about do-it-yourself (DIY) investing. Despite their initial interest, the usual result is for these investors to take no action and continue investing in expensive mutual funds. This has caused me to rethink how best to approach the subject. I now think that investors might be best to try easing into DIY investing rather than deciding whether to make one big jump. To illustrate how these interactions between me and a curious investor tend to go, I'll describe the case of a particular investor and acquaintance of mine who I'll call Sam. Sam said he heard that I write a Money blog and wondered if I might advise him on whether he needs to change anything about his investments. Sam had a financial advisor who he seemed to like on a personal level but didn’t make him feel comfortable about his investments. Sam couldn't understand much of what was on his multi-page account summary other than the dollar amounts that weren't going up as fast as he...

The market volatility on May 6th illustrated that wild gyrations in the stock market can affect exchange-traded funds (ETFs) as well as individual stocks. In particular, ETFs can trade at prices that differ from the value of their underlying holdings when markets get crazy enough. Canadian Capitalist's latest roundup of interesting investing articles pointed to a Wall Street Journal piece that explained clearly what happened on May 6th. It went on to give 5 rules for trading ETFs and suggested that investors stick to mutual funds if they don't understand the technical details. I think there is some middle ground. Long term investors in broad index ETFs can protect themselves without gluing their noses to computer screens monitoring ETF data. If you're an ETF day trader who jumps in and out of ETFs multiple times per day, or you like to place stop-loss orders on your ETFs, then I can't help you other than to suggest reconsidering your investing approach. The f...

The MER on many of the popular iShares exchange-traded funds (ETFs) will be going up due to a 5% increase in management fees. This change will affect 29 ETFs. A notable ETF not affected by this change is the S&P/TSX 60 Index Fund (XIU). The Notice to unitholders goes to a lot of trouble to explain that this is just a change in the way that the GST is handled. BlackRock used to pay the GST out of the management fees collected, but now they won’t. The claim is that “There will be no change to the amount of management fees paid by any iShares Fund.” Notwithstanding language games, the amount of management fee kept by BlackRock for the affected funds will be going up by 5%. The amount that investors will pay for the combination of management fees and GST will be going up by 5%. There is no getting around the fact that this is a 5% fee increase.