The earlier you start saving for retirement, the more painless it is.
Manageable amounts invested automatically every payday over 35 to 40 years will produce a solid retirement fund if you keep ramping up the amount you put away as your salary rises. The hard part is getting started. There are thousands of mutual funds and exchange-traded funds (ETFs) to choose from, and almost as many investment firms to consider.
In The Globe and Mail Gen Y Getting Started Saving For Retirement Guide, we'll simplify things by focusing on four different ways to begin saving for retirement. The guiding principles in building this list are:
Cheap fees: Particularly when you're starting out and have only a small amount to invest, fees can really undermine your returns.
Simplicity: The easier it is to get started and manage your money, the more likely you are to follow through.
DIY, or close to it: Advice may well come in handy later as your financial life evolves, but for now we'll work on the basis that you want to get started as an investor and are willing to do it yourself to get the lowest possible fees; an exception to this DIY rule is made for robo-advisers, which run your portfolio for you at a low cost.
Long-term: Ignore all of this if you're planning to buy a house in a few years or you otherwise see a chance you'll need this money in the near to medium term; this plan is based on time horizon measured in decades, not years.
Annual rebalancing: Once a year, sell some of your strongest performers and buy more of the weaklings to bring everything back into your target mix of stocks and bonds (see below for more details).
No currency hedging: Hedged mutual funds and ETFs protect your returns from the effects of changes in the value of the Canadian dollar against the U.S. buck and other currencies. A rising loonie reduces returns in other currencies, while a falling dollar pumps up your returns. If you're investing over several decades, the ups and downs in the dollar will more or less offset each other.
Before we look at investment products, let's first consider the right mix of stocks and bonds.
The Portfolio Blueprint
Bonds: 25 per cent
Canadian stocks: 25 per cent
U.S. stocks: 25 per cent
International stocks: 25 per cent
Estimated annual return on average before fees: 5.5 per cent
Notes: This is a somewhat conservative mix of stocks and bonds for a young adult whose retirement long into the future will not be affected by near- and medium-term stock market crashes. In fact, a millennial investor could easily go with 90 or 100 per cent stocks. The reason for adding 25-per-cent bonds is to address the nervousness some young people feel about investing in stocks after the 2008-09 market crash and subsequent ups and downs.
If you use too aggressive a mix, you're vulnerable to a crisis of confidence after a stock market correction that can set you off course. You might, for example, pull your money out of your investments and leave it in a savings account earning close to nothing. It will be tough to meet your retirement savings needs if you don't stay invested.
Our blueprint is also easy to follow – equal amounts in bonds and Canadian, U.S. and international stocks (outside North America). Diversification is crucial in portfolio building, but it's not an exact science. The idea is to expose yourself to a variety of investment categories, not micro-manage the percentage in each. The estimated portfolio return here is 5.5 per cent before fees. That may seem a reasonably subdued projection, but it's in synch with expectations for modest economic growth in the years ahead thanks to an aging population.
Four Low-Cost Retirement Investing Options
Average portfolio MER: 0.13 per cent
Commission costs as a percentage of your account size: 0.8 per cent*
Estimated forward-looking portfolio return if you pay commissions to trade ETFs: 4.57 per cent
Estimated forward-looking portfolio return if you do not pay commissions to trade ETFs: 5.37 per cent
Where to buy: Any online brokerage
Minimum investment: None
Fees to watch out for: Online brokers typically charge up to $10 to buy and sell ETFs, but Questrade and Virtual Brokers offer zero-commissions on ETF purchases (commissions apply when you sell). Qtrade and Scotia iTrade offer zero-commission trading on a limited number of ETFs, while National Bank Direct Brokerage has no commissions on trades of 100-plus ETF shares. As well, some online brokers charge quarterly maintenance fees of $25 for small accounts.
*Based on a $25,000 portfolio and 20 trades per year (buying four ETFs quarterly plus rebalancing) at $10 apiece.
Notes: ETFs are the cheapest way to build a diversified retirement portfolio, and they also have the advantage of being a transparent and user-friendly investment. With one ETF, you can get exposure to all the stocks in big stock and bond indexes like the S&P/TSX composite and the S&P 500, minus a tiny fee measured through what's known as the management expense ratio (MER).
Mutual fund managers and investors who buy individual stocks often have trouble matching the returns of major indexes after fees. The challenge with ETFs is to find the four to six needed to build a sound portfolio from the hundreds listed on the TSX. The ETFs shown here were chosen for being representative of products that combine very cheap fees and coverage of core stock and bond indexes. The weighted average management expense ratio for this portfolio is 0.13 per cent, which is very low. Balanced mutual funds, which combine stocks and bonds, are in the 1 to 2 per cent range or even a bit more.
One thing to remember in this comparison is that mutual fund fees typically include a component to cover the cost of investment advice. ETFs do not. Later in life, you may decide to find an adviser to see if you're on track for retirement, to minimize taxes and more. As a rough estimate, expect to pay an additional 1.5 per cent for advice.
Average portfolio MER: 0.42 per cent
Estimated forward-looking portfolio return: 5.08 per cent
Where to buy: Easiest through TD Direct Investing, an online brokerage
Minimum investment: $100
Fees to watch out for: None for the funds, but TD Direct Investing has a $25 quarterly maintenance fee for accounts of less than $15,000. You can avoid this by setting up a plan to have at least $100 invested in e-funds monthly.
Notes: Index mutual funds are like many ETFs in offering a low-cost way to get the instant diversification of investing in major stock and bond indexes. But while most index funds are cheaper than traditional mutual funds, they are still pricey when compared to ETFs. One exception is the TD e-series. If you build our portfolio blueprint with these index funds, you will end up with a reasonable MER of 0.42 per cent.
An advantage over ETFs is that there is no cost to buy or sell e-series funds. There isn't a huge selection of e-series funds, at least in comparison to ETFs. But that's actually a plus. All you need is available, and there's not much clutter to deal with in finding core funds.
3. A Robo-Adviser
Robo-advisers will build a portfolio of ETFs designed for your needs and personal profile, then manage it for you by rebalancing as required.
Fee for managing your portfolio: 0.5 per cent
Portfolio MER: 0.25 per cent
Estimated forward-looking portfolio return: 4.75 per cent
Where to buy: Directly from robo-advisers
Minimum investment: Some have none, others are at $2,000 to $5,000
Fees to watch out for: Most robos include ETF trading commissions in their fee, but a few may charge extra
Notes: Running a simple ETF portfolio yourself is not hard, but some people are going to be more successful if they have someone look after their investments for them. All robo-advisers have their own methods for deciding on the right mix of ETFs, and whether or not to use currency hedging.
A robo portfolio of ETFs might look a fair bit different from the one in low-cost retirement investing option No. 1. The 0.5-per-cent fee shown here for robo-advisers is typical – some may be cheaper or more expensive. The fee covers the cost of running your portfolio. You will pay additional costs for the ETFs in your portfolio, probably something in the range of 0.25 per cent or somewhat more. You'll find comparative information on 11 firms in the latest
Globe and Mail Robo-adviser guide.
4. Tangerine Balanced Growth Portfolio
This is a balanced fund with about 25 per cent of its holdings in bonds and cash and the rest in Canadian, U.S. and international stocks.
Fund MER: 1.07 per cent
Estimated forward-looking fund return: 4.43 per cent
Where to buy: Directly from Tangerine
Minimum investment: None
Fees to watch out for: None besides the comparatively high MER
Notes: The Tangerine Balanced Growth Portfolio is offered by Tangerine, an online bank owned by Bank of Nova Scotia. It has the most expensive fees of any of the three options used here, but it does offer pure convenience. Contribute any amount of money to your account – there's no minimum – and it is automatically invested in roughly even amounts in bonds and Canadian, U.S. and international stocks. You never have to rebalance the portfolio. Setting up regular electronic transfers to this fund would basically be it – set-and-forget investing.