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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.
Step 3: Conventional bonds
CPP weighting: 22.6 per cent
Amount to invest: $22,600
ETF to use: iShares Cdn Bond Index Fund
Notes: The iShares family of ETFs from Barclays Global Investors offers six different fixed-income choices, but this one is ideal for RRSPs because it's designed to be a proxy for the entire Canadian bond market, including government and higher-yielding corporate bonds. The MER is 0.30 per cent, which is much lower than bond mutual funds.
Conservative investors who are worried how their bond holdings would perform if interest rates were to rise might want to mix in the iShares Cdn Short Bond Index Fund, which should hold up somewhat better in a rising-rate environment. Something to remember with this ETF is that it never matures like an actual bond.
Step 4: Inflation-linked bonds
CPP weighting: 3.5 per cent
Amount to invest: $3,500
ETF to use: iShares Cdn Real Return Bond Index Fund
Notes: Real-return bonds offer yields that provide a premium over and above the rate of inflation, and the principal you get back on maturity is adjusted upward for inflation as well. As such, these bonds make a good hedge against the rising cost of living.
The iShares real return bond ETF has a fairly pricey MER of 0.35 per cent, but it's the only option for investing in real-return bonds aside from a handful of retail mutual funds.
Step 5: Private equity
CPP weighting: 6.4 per cent
Amount to invest: $6,400
ETF to use: PowerShares Listed Private Equity Portfolio
Notes: Private equity refers to companies that are not publicly traded on stock exchanges and can include both startups and mature businesses. Pension and hedge funds have been big players in private equity over the past few years, while individual investors have mainly been able to participate through chronically underachieving labour-sponsored venture capital funds.
Recently, however, a new private equity option for small investors has emerged in the form of the PowerShares private equity portfolio. Instead of investing in individual private companies, this ETF holds shares in publicly traded venture capital companies. The MER for this fund is high at 0.7 per cent, and there's some risk in that the private equity trend has been very hot lately and could take a hit at some point.
Step 6: Real Estate
CPP weighting: 4.5 per cent
Amount to invest: $4,500
ETFs to use: SPDR DJ Wilshire International Real Estate ETF and DJ Wilshire REIT ETF
Notes: The SPDR Wilshire ETF offers exposure to real estate stocks and real estate investment trusts in markets around the world, but not the United States (Canada accounts for 7.3 per cent of its assets). The American market is too big to ignore, so put about $2,000 into the DJ Wilshire REIT, which holds U.S.-based REITs, and the rest into the global ETF. The DJ Wilshire fund is a bargain thanks to an MER of 0.25 per cent, while the SPRDR fund's MER is 0.6 per cent.
There's a TSX-listed ETF that focuses on REITS in the Canadian market, but it's not an ideal choice here because it lacks global diversification. This is a major consideration right now because Canadian REITs have had a sharp runup in price lately and may offer less upside than global peers.
Step 7: Infrastructure
CPP weighting: 1.9 per cent
Amount to invest: $1,900
ETF to use: SPDR FTSE/Macquarie Global Infrastructure 100 ETF
Notes: Pension funds buy stakes in hard assets like power plants and bridges because they offer stable returns. For individual investors, this ETF makes a decent substitute because it invests in infrastructure companies around the world, including Canada.
This ETF is brand new and it hasn't attracted much of a following yet, even though infrastructure investing is big with pension funds. The MER is 0.6 per cent.
Step 8: Cash
CPP weighting: 0.7 per cent
Dollar amount to invest: $700
ETF to use: None
Notes: Find a money market fund with a low MER and leave it at that.
