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Portfolio Strategy

If you hate fees, have I got a bargain for you Add to ...

Here's an investment portfolio so cheap you'll weep.

The fees to own this six-pack of exchange-traded funds amount to just 0.15 per cent, which is 15 cents per $100 each year, $1.50 per $1,000, $15 per $10,000 or $150 per $100,000. Too much information? Sorry, that's how carried away it's possible to get with what we're going to call the Mega-Cheap Portfolio.

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Of course, there will be costs to set up the Mega-Cheap portfolio in the form of commissions paid to an online broker. Expect those to come in between $5 and $29 per online trade, depending on which broker you use. If you have an adviser, expect to pay the costs associated with the portfolio plus an additional 1 per cent or so of your account assets.

Still, nothing beats the Mega-Cheap Portfolio for low costs on a year-by-year basis, except a buy and hold portfolio of stocks.

ETFs have long been known as the frugal investor's friend because the fees they charge are much lower than mutual funds. This applies - to classic ETFs, anyway.

Truth be told, the ETF industry has introduced ever more complex and pricey new products in the past few years that are relevant only to traders and sophisticated investors. Classic ETFs - those that track bedrock stock and bond indexes in Canada and globally - are a much better choice for cost-conscious investors.

That's especially true when applied to a small number of ETFs with fees so low they almost demand a second glance to make sure you've read them correctly. These low-fee funds are the result of another trend in the ETF industry - competing to attract investors by seeing who can lower fees the most. Not all ETF companies are playing this game, but the overall level of price competition puts the ever-complacent mutual fund industry to shame.

A shining example of mega-cheapness is the Horizons S&P/TSX 60 Index ETF which gives you the returns of the S&P/TSX 60 index of dominant Canadian blue-chip companies with a management expense ratio of 0.08 per cent.

Some context to help you understand how low this is:

  • The average Canadian equity mutual fund has an MER of 2.43 per cent.
  • The 10 largest Canadian equity mutual funds, where economies of scale are supposed to be at work for investors, have an average MER of 2.1 per cent.
  • The iShares S&P/TSX 60 Index Fund, the most popular ETF in Canada and another way to invest in the 60 index, has an MER of 0.17 per cent.
  • Competing ETFs from the BMO and Claymore families have fees ranging from 0.15 to 0.69 per cent.

The Horizons S&P/TSX 60 index fund is an example not only of rock-bottom costs, but also of how the cheapest ETFs aren't an automatic choice. In fact, some money managers won't use HXT because of a structure that relies not on the actual stocks in the 60 index, but rather a complex financial instrument called a total return swap that replicates the index's returns.

There's slightly higher risk profile to this ETF because of its structure, but there are offsetting benefits that include minimal tracking error (mistakes made in trying to mimic the returns as the index) and a degree of tax efficiency in non-registered accounts. Instead of paying dividends that are taxable each year, this ETF reinvests the value of the dividends and reflects them in the net asset value of the fund. You'll only pay tax on capital gains realized when you sell.

Bonds in the Mega-Cheap Portfolio are covered off by a pair of more conventional ETFs, the Claymore 1-5 Year Government Bond ETF (MER of 0.16 per cent) and 1-5 Year Corporate Bond ETF (0.27 per cent). Both of these funds make strategic sense right now, not just economic sense.

By holding bonds that mature in five years or less, these ETFs will minimize the damage caused by rising interest rates. And both use a laddering strategy of dividing assets equally between bonds maturing in one through five years. As bonds come due every year, the proceeds are automatically reinvested in a new five-year term at what you have to expect will be higher interest rates.

The three ETFs mentioned so far are easy choices because they're low-cost leaders in their respective categories. But in addressing the U.S. and international portion of the Mega-Cheap Portfolio, we're going with the next-to-cheapest ETFs.

Those would be the increasingly popular Vanguard series of ETFs listed on the New York Stock Exchange. ETFs from Charles Schwab, the same company that pioneered the discount brokerage back in the 1970s, are cheaper by one or two hundredths of a percentage point. But that's not enough of a cost saving to offset the fact that Vanguard ETFs are more heavily traded and thus easier to buy and sell at competitive prices.

The Vanguard Total Stock Market ETF at 0.07 per cent, offers one-stop shopping for the entire U.S. market. The underlying MSCI U.S. Broad Market Index includes small and medium size companies as well as the big boys you'll find on the much better known S&P 500 index.

Topping off the Mega-Cheap Portfolio is the Vanguard MSCI EAFE ETF, which tracks the Morgan Stanley Capital International Europe Australasia Far East Index (everywhere but North America) and costs 0.15 per cent. Or, you can take a more aggressive approach by combining this fund with the Vanguard MSCI Emerging Markets ETF. Fees for this fund come in at 0.22 per cent.

If you buy U.S.-listed ETFs, you have to be aware that an upward move in the Canadian dollar against its U.S. counterpart will undermine your returns while a decline in our buck will help you. Long term, our dollar has more room to fall than rise.

Another caveat is that the cheapness of the U.S.-listed ETFs mentioned here is weakened somewhat by foreign exchange fees, which are a profit centre for brokerage firms. If you hold for the long term, however, those fees will be more than offset by the mega-cheap fees.

The Mega Cheap Portfolio

Using the some of the best bargains in the exchange-traded fund world, you can build a sound portfolio with ridiculously low fees. Here's an example:

Profile: A diversified portfolio suitable for a modestly aggressive investor seeking mainly long-term capital gains (Asset Mix: 30% bonds, 70% stocks)

Fund

Ticker

MER (%)

Portfolio

Weighting (%)

Price ($)

Claymore 1-5 Year Government Bond ETF

CLF-T

0.16

20

20.07

Claymore 1-5 Year Corporate Bond ETF

CBO-T

0.27

20

20.36

Horizons S&P/TSX 60 Index ETF

HXT-T

0.08

30

11.53

Vanguard Total Stock Market ETF

VTI-N

0.07

10

67.90

Vanguard MSCI EAFE ETF

VEA-N

0.15

10

37.31

Vanguard MSCI Emerging Markets ETF

VWO-N

0.22

10

47.79

Total Portfolio

0.15

100

Next Steps…

To find low-cost ETFs: Try this screening tool

To learn the basics on investing in ETFs: Try this online slideshow

Find out more about ETFs: Try the ETF page on Globeinvestor.com

To see how much your ETFs or mutual funds are costing you in dollar terms: Try the fund fee calculator offered on GetSmarterAboutMoney.ca

Follow on Twitter: @rcarrick

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