The people at the Canada Pension Plan seem to have a good grasp of how to safely make money grow, so let's get them to work on your registered retirement savings plan.
The CPP's pool of invested funds has averaged a 9.9-per-cent annualized rate of return over the past five years and is certified by the Chief Actuary of Canada as being solid for at least the next 75 years. There are people in the investment industry who disingenuously troll for RRSP business by questioning the solidity of the CPP, but the truth is that this public pension plan is a model for effective, conservative investing.
Emulating the CPP is realistic, even if you're not an experienced investing professional. All you have to do is use the same mix of investments, or asset allocation, that the CPP discloses in its financial statements. The CPP has a bit more than 60 per cent of its assets in publicly traded stocks — so will you. The CPP is 26 per cent invested in bonds — same goes for you.
Instead of picking individual securities to buy, you'll keep things simple by using exchange-traded funds (ETFs) that track major stock and bond indexes. A quick summary of the benefits of ETFs for retirement savings plans: They're much cheaper to own than mutual funds, and they're the simplest portfolio building blocks ever. ETFs trade like stocks, which means you'll need a discount or full-service brokerage account to buy them. With a discount broker, your commission costs will range from as low as $5 per order to as much as $29.
Now, let's get down to building a hypothetical $100,000 RRSP portfolio using the CPP as our guide.
Step 1: Canadian stocks
CPP weighting: 25.1 per cent
Amount to invest: $25,100
ETF to use: iShares Cdn Composite Index Fund
Notes: Sharp-eyed investors will immediately notice the low overall weighting of Canadian stocks here. This may seem unconventional to investors who have made a lot of money in our home market over the past four years, but there's some logic here in that Canada represents only about 3 per cent of the global stock market. Also, the Canadian market's strong performance of late suggests there could be more upside abroad.
There are roughly half-a-dozen ETFs you could use, but the composite index fund stands out for two reasons. One, it offers broad exposure to the Canadian market thanks to its 273 constituent stocks and, two, it has a reasonable management expense ratio of 0.25 per cent. There's also a modest dividend yield of roughly 2.2 per cent.
The cheapest Canadian-market ETF to own is the iShares Cdn Largecap 60 Index Fund, with its MER of 0.17 per cent. But this fund focuses strictly on big blue-chip stocks and doesn't reflect the breadth of the Canadian stock market. A relatively new alternative is the Claymore CDN Fundamental Index ETF, which emphasizes stocks that are comparatively undervalued and puts less of a weighting on stocks that have run up in price (for example, this ETF is underweight on energy right now). The MER for this fund is a hefty 0.65 per cent.
Step 2: Global stocks
CPP weighting: 35.3 per cent
Amount to invest: $35,300
ETFs to use: Claymore U.S. Fundamental ETF C$, iShares MSCI EAFE Index Fund.
Notes: The CPP doesn't disclose how much of its non-Canadian equity holdings are in U.S. and international stocks, so let's just go with a 50-50 split. This can be easily done using ETFs that focus on the U.S. market and on international stocks.
The Claymore U.S. ETF has an MER of 0.65 per cent, but we'll try it here because it offers two levels of diversification. First, it offers exposure to 1,000 of the largest U.S. companies. Second, it uses a unique process that seeks out the most attractively valued stocks by such criteria as dividends and cash flow. The typical ETF is "dumber" in that it follows an index that weights stocks strictly according to their size, or market capitalization. This ETF also offers currency hedging that limits the impact of moves in the Canadian dollar versus the U.S. currency.
Claymore has an ETF that takes a similar approach to international stocks, but it includes a bit of Canadian exposure that would be redundant here. So let's go with the NYSE-listed iShares MSCI EAFE Index Fund, which has a reasonable MER of 0.35 per cent . There's no currency hedging here, but you don't really need it because exposure to a variety of global currencies is a form of hedging unto itself.
