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Trade by Numbers: ETFs

The magic numbers is 3 Add to ...

Here's a mind-blowingly simple answer to the basic but crucial question of how many securities are required for a properly diversified portfolio.

Three.

You read that right. If you're portfolio building with exchange-traded funds (ETFs), three is all you need for a lifetime of diversified investing.

ETFs stand out as an ideal portfolio building block. Whatever kinds of investments you want to put in your portfolio, there's almost certainly going to be an ETF that gives you cheap, transparent exposure. This applies if you want to build a complex portfolio of many parts, or if you want to keep things nice and basic.

We'll cover the basic portfolio here. You want bonds in your portfolio, right? There's an ETF that gives you the entire Canadian bond market in a single purchase. It's called the iShares CDN Bond Index Fund (XBB-T), and it tracks an index comprising federal, provincial and municipal bonds, as well as corporate bonds with an investment grade. That means it's solid enough for pension funds to hold them. The management expense ratio for XBB is 0.3 per cent, which compares to an astronomically high average of 1.67 per cent for mutual funds in the Canadian fixed-income category.

Naturally, you want Canadian stocks in your portfolio, too. Again, you can wrap up the market in a single package. It's called the iShares CDN Composite Index Fund (XIC-T) and it targets the S&P/TSX composite index, Canada's benchmark stock index. Big and medium-size companies are included in the index, as well as some income trusts. The MER is 0.25 per cent, which is far less than the 2.4-per-cent average for Canadian equity mutual funds.

Global stock markets have not been kind to Canadian investors in recent years, but you'll want exposure to them anyway. Think of them as your protection against the day when the Canada's stock market falls behind other countries. Exposure to the global stock market is easily obtained through an investment in a new ETF called the iShares CDN MSCI World Index Fund (XWD-T). The MSCI World Index covers 23 countries and is 50-per-cent weighted to the U.S. market. Japan, the United Kingdom and France account for another 25 per cent, while Canada is the fourth largest holding at 4.3 per cent.

We now have three portfolio building blocks. The question now is how to assemble them. Here are three models, each for a different stage of life. Consider them as illustrations to get you thinking about your personal situation.

The twenty-something investor

Profile: With many decades ahead until retirement, this person can afford to put most of his or her assets in the stock market for long-term growth

Asset Mix:

20% Bonds (iShares CDN Bond Index Fund)

60% Canadian stocks (iShares CDN Composite Index Fund)

20% Global stocks (iShares CDN MSCI World Index Fund)

The fifty-something investor

Profile: With retirement coming up in 10 to 15 years, this person would want to start replacing stocks with bonds to preserve capital

Asset Mix:

50% Bonds (iShares CDN Bond Index Fund)

35% Canadian stocks (iShares CDN Composite Index Fund)

15% Global stocks (iShares CDN MSCI World Index Fund)

The retired investor

Profile: Now living off of his or her savings, this investor must put a make preservation of capital the priority

Asset Mix:

80% Bonds (iShares CDN Bond Index Fund)

15% Canadian stocks (iShares CDN Composite Index Fund)

5% Global stocks (iShares CDN MSCI World Index Fund)

If these mixes are too simple, there are hundreds of other cheap ETF options listed on Canadian and U.S. exchanges. You could add some corporate bonds to juice your returns from the bond portion of your portfolio, you could climb the stock market risk ladder and add some small-size companies or you could branch out globally to include emerging markets.

Just remember the answer to the question of how many securities you need for a balanced portfolio. It's three.

 

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