I recently received an email from a reader named Thomas who was concerned that his investments were getting unwieldy: “I am concerned I have ETFs with too much duplication and am not keeping it simple.” He agreed to let me use his situation as an example of how investors can make their portfolios more efficient and easy to manage.
Thomas has a pension and adequate RRSP savings, so he’s not worried about covering his retirement expenses. However, he also has about $115,000 in a taxable account and another $15,000 or so in a TFSA. “I have been looking at the taxable account and the TFSA as one overall portfolio,” he says. “I plan to use this money in one of two ways. The first option is to dip into it to renovate our home, perhaps to add a pool. Or I can just let the investments grow until I retire and fund the renovations with a line of credit, paid off in a reasonable time.”
Based on his risk tolerance and goals, Thomas is aiming for an asset allocation of 60% stocks and 40% bonds, with the equity holdings more or less evenly split among Canadian, U.S. and international. Here are his current holdings:
|iShares S&P/TSX Capped Composite (XIC)||16%|
|Vanguard Total Stock Market (VTI)||12%|
|Vanguard MSCI EAFE (VEA)||6%|
|Vanguard Emerging Markets (VWO)||6%|
|iShares DEX Corporate Bond (XCB)||17%|
|iShares DEX Short-Term Bond (XSB)||16%|
|Claymore Balanced Income CorePortfolio (CBD)||2%|
|iShares S&P/TSX Capped REIT (XRE)||5%|
|Claymore Global Real Estate (CGR)||3%|
|Claymore Natural Gas (GAS)||1%|
|Miscellaneous preferred shares||4%|
|Tax-Free Savings Account|
|BMO Dow Jones Canada Titans 60 (ZCN)||4%|
|BMO Dow Jones Industrial Average (ZDJ)||4%|
|Vanguard FTSE All-World ex-US (VEU)||4%|
Thomas’s portfolio is certainly diversified, but it needs some serious decluttering:
Too many ETFs. With 14 different ETFs, Thomas’s portfolio is far more complicated than it needs to be. For starters, since he is planning to use both accounts for the same purpose, he doesn’t need to hold multiple funds for each asset class. The three equity funds in his TFSA, for example, overlap with others in his taxable account. He can dramatically reduce the number of ETFs without significantly changing his overall allocation. (Unfortunately, if he sells ETFs that have gone up in price in his non-registered account, he’ll trigger capital gains taxes.)
Too many small holdings. Several of the portfolio’s holdings are random items that don’t fit into any thoughtful plan. The Claymore Balanced Income CorePortfolio (CBD), for example, holds 14 ETFs in many asset classes. It’s meant to stand on its own, not make up a tiny sliver of a larger portfolio. The 1% allocation to a natural gas ETF and the preferred shares are also misfits. “I have been inclined to add bits and pieces from time to time,” Thomas admits.
Too much tax-inefficiency. By holding equities in his TFSA, Thomas is not taking maximum advantage of the tax shelter. Canadian stocks are best held in a non-registered account, where they benefit from the dividend tax credit. Dividends from the US and international equity ETFs are fully taxable, but the yields on these funds are relatively low, and any capital gains would be taxed favourably. Thomas would save more in taxes by using the TFSA to hold the corporate bonds, which have a higher yield and limited potential for price gains.
Before rebuilding his portfolio, Thomas will need to decide how he wants to fund his reno projects. If he chooses to use his investments to pay for the pool, he should set aside this portion in cash—the remainder can then be used for long-term growth (Option 1). If he decides to use his line of credit for the home improvements, then the whole portfolio can be considered part of his long-term strategy (Option 2).
Here’s how Thomas might rejig his holdings. Without giving up any diversification benefit, he can reduce his portfolio from 14 ETFs to just six:
|Taxable Account||Option 1||Option 2|
|iShares S&P/TSX Capped Composite (XIC)||15%||20%|
|Vanguard Total Stock Market (VTI)||10%||15%|
|Vanguard Total International Stock (VXUS)||10%||15%|
|iShares S&P/TSX Capped REIT (XRE)||10%||10%|
|iShares DEX Short-Term Bond (XSB)||18%||28%|
|Tax-Free Savings Account|
|iShares DEX Corporate Bond (XCB)||12%||12%|
I imagine that many investors, like Thomas, have portfolios filled with too many ingredients, many of which play no meaningful role in their overall plan. By streamlining your holdings you can reduce costs, complexity and taxes, and stay focused on your larger investing goals.
The suggestions in this post are presented as general information and should not be considered investment or tax advice aimed at any individual.