Our intermediate investor, Rob, is now in the third week of our unique investment mentoring program. He's learned all about asset allocation. Now, his mentor, Warren MacKenzie, helps him define a core investing strategy using ETFs.
ETFs are an inexpensive way to diversify your portfolio and earn the market return. Below is an online discussion from Tuesday about how to build a strong portfolio using exchange-traded funds.
Weeks ago, we ran an investing contest. The winners were classified in to three categories: advanced, intermediate and beginner.
The winner of our intermediate category, who can be identified only as Rob from St. John's, and Warren MacKenzie have had two online discussions on sharpening Rob's investment strategy. You can review them here:
Warren MacKenzie is the founder of He is a CA, CFP and CIMA (Certified Investment Management Analyst), the author of The Unbiased Advisor and co-author of New Rules for Retirement.
The third week's discussion is below. The next discussion will be on Thursday at noon, ET. You can get a jump on the queue by submitting your question here.
Editor's Note : globeandmail.com editors will read and allow or reject each question/comment. Comments/questions may be edited for length or clarity. HTML is not allowed. We will not publish questions/comments that include personal attacks on participants in these discussions, that make false or unsubstantiated allegations, that purport to quote people or reports where the purported quote or fact cannot be easily verified, or questions/comments that include vulgar language or libellous statements. Preference will be given to readers who submit questions/comments using their full name and home town, rather than a pseudonym.
Sonali Verma, Globe Investor: Hello, everyone, thanks for joining us. We've got lots to talk about today, so let's get right to it. Let's start with some reader questions this time.
Robert Hurdman writes: Over the last six months, ETFs have not performed any better than mutual funds. Further, asset allocation hasn't helped even the Ivy League endowment funds, since everything went down.
How does that affect your investment approach? Should a person invest the same way today (eg. 40% Cdn stock, 20% US stock, 20% Cdn gvm't bonds) as they were six months ago? Twelve months ago? Five years ago?
Why do you recommend ignoring the companies that you own and using an ETF to own them all? Aren't there well-run companies that you would prefer to own, and poorly managed companies you would prefer to avoid?
Warren MacKenzie: There is a long term view and a short term tactical view. Unless things change for the individual, there is no reason to change the long-term asset allocation. If you believe that equities are going to outperform other asset classes over the next year, you would overweight them relative to your long-term asset allocation. If you believe the opposite you would underweight equities.
On Q 2.: Are there not some well run companies that you would like to own - instead of an ETF?
A. The quality of a company often has very little to do with its price performance in the future. It is easy to differentiate between good quality companies and poor quality companies but it is more difficult to use this information to predict the future price. Microsoft, General Electric and Cisco were all excellent companies in 2000, they are still excellent companies today - but their stocks prices are considerably lower today.
Daniel de Young writes from St. Marys, Ontario: I would like to have a substantial international (outside of US/Canada) allocation with my ETF's to be better diversified. However, due to the different withholding tax treatment of international dividends, I have made the allocation smaller than I would like at 20% of my all-equity portfolio.
Do you think the effect of withholding taxes is significant enough that it should affect my portfolio allocation, and what do you think a good allocation for international stocks is for a Canadian investor?
Warren: Withholding tax is a small consideration compared to the real risk of currency fluctuations. We would suggest that you should have approximately 50% Canadian and 50% not Canadian equities.
Tony Lee writes: What are the differences between ETF providers (are some "better" than others)? If there are comparable ETFs from say, iShares and Claymore, what should my considerations be?
Warren: In most cases the main difference between ETF providers is that different providers have licenses for different indexes. For example Claymore has a completely different line up of indexes than does iShares.
You should find the ETF which is most appropriate for your needs, and don't be concerned about the provider.
Paul Lear writes: Can you explain how US taxes/withholding work for US$ funds? Can it be avoided with certain brokers?
Warren: The important thing is that US withholding tax does not change the amount of tax you pay. It is simply that you pay the tax earlier and then get a credit for it when you file your Canadian return. It cannot be avoided because it is the US Government that deducts it.
Sonali: Our intermediate investor, Rob from St. John's, has been reading up on ETFs and has a few questions as well.
Rob: What are the tax benefits of E.T.F.s as opposed to mutual funds?
Warren: The main tax benefit is that an ETF does not trigger as many capital gains within the fund because the ETF does not trade as much.
Rob: On a passively traded E.T.F. what is the median MER (management expense ratio)?
Warren: On an ETF, the MER could be as low as .09% on the SPDR S&P 500 E.T.F. , or the iShares S&P 500 E.T.F. and as high as .75 to .90 on more specialized ETFs.
Rob: Are ETFs front loaded or back loaded?
Warren: ETFs trade like a stock and you pay a commission like you would on a stock - so there is neither a 'front load' or a 'back load'.
Rob: What are the benefits of an ETF over a straight index fund?
Warren: There are four main benefits:
(1) lower MERs
(2) you can buy at any time during the day as opposed to only at the end of the day
(3) there is a greater selection of ETFs versus index funds
(4) you can only trade Index funds that are registered in Canada where you can buy ETFs from all around the world.
Rob: Why do investment advisors tend to try to steer investors away from ETFs?
Warren: We suspect that commission-based advisers tend to steer away from ETFs because investors generally do not trade them frequently. There is normally no trailer fee, so advisors who rely on trailer fees are not interested in them. However, many advisors who operate fee-based accounts will hold ETFs in the fee-based account.
Sonali: And, Rob, what are the key things you've learnt over the past week of frantic reading? Any advice you might want to share with our readers?
Rob: A couple of things this week:
1. Investment advisors are sometimes not your friend. In some cases, they are more interested in steering you towards their block of investments rather than things that fit more into your interests, and don't generate a commission for them.
2. The hidden costs of investing - MERs, front ended and back ended costs. Will these even out with the expected return on your investment?
Sonali: Those are good points.
And before we wrap up, some more questions from our readers:
Andrew Leung writes: I'm interesting in purchasing an agriculture ETF PowerSh DB Agriculture E.T.F. to gain exposure to agriculture commodities but I do not want to be exposed to the risk of the US dollar depreciating against the Canadian dollar. Is there any way to avoid this, or is it effectively a "wash" because commodity prices are inversely correlated to commodities anyway? Thank you for fielding my question.
Warren: In our view, the volatility on the commodity is going to be much higher than the volatility on the currency - so if you're right on your commodity call, the currency will not matter.
Alternatively you could hedge your currency risk on the futures or options market.
Anil Mohamed writes: I am seriously thinking of moving my funds from mutual funds into ETFs for the following reasons:
- Transparency
- Low cost
- Flexibility
I am 50, with 40% of my portfolio in fixed income comprised of bonds and preferred shares and the remaining in mostly Canadian equities.
Can you please tell me any reason why I should pay an average of 2.7% fee and lock my funds for seven years to get almost the same results as a simple ETF index like I60 or various sub indexes.
Warren: We have come across advisors who simply refuse to buy ETFs. But, assuming your advisor is not one of these types, we see no reason why you should not switch to ETFs.
Sonali: Thank you very much for all your time. We really appreciate it and are looking forward to our next discussion next week.
Warren: Thanks - it was fun. Talk to you next week.
Rob: Thank you, Sonali, and thanks to Warren who helped me this week in figuring out what a Sharpe's Ratio is and the Modern Portfolio Theory. Now that I understand more of the theory and pitfalls to investing, I'll be even more informed next week. I'm looking forward to it.