Three great ideas for small potatoes

Here’s how to get started, even if you don’t have thousands to invest.

 

by

From the May 2010 issue of the magazine.

 

canadian-couch-potato
From Dan Bortolotti’s new Index Investor column. Visit his MoneySense blog for more Couch Potato tips.

I admit it: I’m an ETF geek. My bedside table usually holds a well-thumbed book on exchange-traded funds, and I routinely bore people with meditations about the merits of cap-weighted indexes. My wife recently asked, in her charming way, if I would love her more if she were an ETF. I answered yes, since she’d be less expensive, more transparent and easy to trade. Then I ducked.

Given my own enthusiasm, I shouldn’t be surprised when I hear from readers who have sold their dreary, high-fee mutual funds and want to know which ETFs to use in their first Couch Potato portfolio. (For the uninitiated, Couch Potato investors don’t try to beat the market, they simply track stock and bond indexes at low cost.) Some are new to do-it-yourself investing and are still fuzzy on what exchange-traded funds are. Others are keen to cover every asset class, but have only a few thousand bucks in sav­ings. It pains me to say it, but for these investors, ETF port­folios usually don’t make sense. Luckily, though, they can still become Couch Potatoes.

ETFs are not the best way to start out, because they trade on an exchange, like individual stocks. That means you need a discount brokerage account to buy and sell them—and if you have no experience managing your own money, this can make you nervous.

As well, if you’re investing less than $30,000 or so—or if you’re making small regular contributions—ETFs may not make sense when you add up the trading fees. As with stocks, every time you buy or sell shares in an ETF you pay a commission: about $29 at the bank-owned brokerages, or $9.95 at independent ones such as Questrade and Qtrade. If you’re periodically rebalancing your portfolio or diligently tucking a couple of hundred dollars a month into an RRSP, RESP or Tax-Free Savings Account, those commissions will eat you alive. (One exception would be a portfolio of ETFs from Claymore Investments, which offers free pre-authorized cash contribution plans—but such plans are not yet available through the big bank discount brokerages.)

For newbie Couch Potatoes, or those saving in small accounts, low-cost index mutual funds are a more sensible choice, as you can set up regular contribution plans and you don’t have to pay each time you add money. Here are three ideas for the simple spud:

Less than $5,000
If you’re starting from scratch, you won’t find anything easier than ING Direct’s Streetwise Funds. Launched in 2008, the Streetwise Funds are one-stop Couch Potato portfolios. They hold a mix of Canadian, U.S. and international stocks, as well as Canadian bonds, all passively managed and tied to well-known indexes. The Streetwise Funds come in three flavors: the Balanced Fund, the Balanced Income Fund, and the Balanced Growth Fund. All work fine in an RRSP, but RESP versions are not yet available.

The Streetwise Funds have a management expense ratio of 1%, which is higher than you’d pay for a portfolio of ETFs (but less than half the MER of most actively managed funds). And that’s the all-in cost. There’s no fee to open or maintain an account, no minimum account size, no trading commissions, and the fund automatically rebalances every quarter. Once you set up an automatic contribution from your chequing account, you can safely lapse into a coma.

Between $5,000 and $30,000
If you’ve accumulated some savings and you’re comfortable managing your own portfolio, consider TD’s e-Series mutual funds. There are 10 funds in the e-Series family, but a Couch Potato needs only four: TD Canadian Index, TD U.S. Index, TD International Index and TD Canadian Bond index. These are the cheapest mutual funds in the country: you can build a diversified portfolio for less than 0.5% a year. It costs nothing to buy and sell new units, and you can set up automatic contributions from your bank account.

The only drawback is that you must buy them online through TD. You can do this with a TD e-Series Funds account, or you may want to consider opening a brokerage account with TD Waterhouse, which will give you access to ETFs further down the road.

More than $30,000
As your portfolio grows, the low management fees of exchange-traded funds become more attractive. Here’s an idea for moving into ETFs in a cost-efficient way: build a Global Couch Potato portfolio with four ETFs in a discount brokerage (see the Canadian Couch Potato blog for instructions). Then set up automatic monthly contributions to a money market fund in the same brokerage account. Once a year, use the cash in the money market fund to rebalance your portfolio. Assuming four trades a year at $29, the commissions would be $116, but that’s offset by the lower annual fees on the ETFs.

Compared with the e-Series funds, this only makes sense for portfolios approaching $100,000. But if you’re currently using pricier index mutual funds, or if your broker charges just $9.95 for trades, this technique will work for accounts as small as $30,000.

Do the math and figure out what works best for you. Just don’t forget that while costs are important, saving regularly and sticking to the strategy are the most important ingredients in the Couch Potato formula.

57 comments on “Three great ideas for small potatoes

  1. Pingback: This and That: Emotional investors, forecasting folly and more… | Canadian Capitalist

  2. One problem with ING's Streetwise funds is that they are not available "a mari usque ad Mare".

  3. Pingback: This and That: Emotional investors, forecasting folly and more… | MoneySense

  4. Pingback: ShareOwner: A Better Way to Buy ETFs? Part 2 | MoneySense

  5. Should you really be encouraging investors to pay a 1% MER on the fixed income portion of a balanced Streetwise fund? Wouln't GICs be better?

    • Remember that we're taking about a very small amount of money here. If the fixed income portion is 40% of a $5,000 investment, that 1% fee is $20 a year. The ING funds are not as cheap as they could be, but for the novice investor I think they're good value. You could also make an argument that the bond portion of the ING fund will have a higher expected return than a GIC.

  6. Not sure what Bortolottii means by the following, which is his advice for those investing with less than $30,000:

    "As with stocks, every time you buy or sell shares in an ETF you pay a commission."

    Who's buying and selling shares within the ETF?

    • Fred: That wasn't worded as well as it should have been. I meant shares of an ETF, not shares within an ETF. Sorry for the confusion.

  7. Can I see some back testing…

  8. To Fred …Bortolottii must have meant "shares of an ETF" which like any other shares attact a commission when buying and selling unless they are in a fee based account.

    Perhaps following the suggestion in John Reese's column in todays G & M Report on Business and/or buying BRK.B would produce better results.

  9. One thing to note about TD's e-series funds are that they also charge a trading fee (TER) on top of the 0.5% MER – it ranges from 0.1-0.4% (there's a discussion of it here: http://www.canadianmoneyforum.com/showthread.php?…

    So the it's fees of 0.6 – 0.9 – and both those fees are subject to HST.

    For ING Direct's Streetwise funds, HST and TER are included in the 1% – I recently got sent a new prospectus from a Streetwise Balanced fund that said the MER was changing to 0.8% to keep the MER under 1% after the new taxes are added.

    The ING Direct fund is straightforward and requires no maintenance. It's where my TFSA and RRSP are right now.

  10. Pingback: Should You Use Index Funds or ETFs? | MoneySense

  11. Pingback: Should You Use Index Funds or ETFs?

  12. I have just opened a TD account so I can purchase the e-series investments online. I want to move my investments and cash from an existing CIBC Wood Gundy RSP account but I cannot locate any information on whether it is better to have my current advisor sell my investments (which will incur costs as some have DSC's) or if I should transfer the account holdings as is and sell on my own (which I think may incur the same costs but not sure if this might be a less expensive option).

  13. Dan, Could you offer some clarification please. Under your heading "Between $5,000 and $30,000," you mentioned TD Canadian Index, TD U.S. Index, TD International Index and TD Canadian Bond index. However, the historical track record of the last two is not very good.
    http://www.theglobeandmail.com/globe-investor/funhttp://www.theglobeandmail.com/globe-investor/fun

    Could you please explain why you are suggesting these funds if their performance is not very good?

    • Darren: It's important to understand what the Couch Potato strategy seeks to do. Its goal is to earn the same returns as the overall markets, minus only very small costs. The TD e-series Funds have done an excellent job in this respect. On the GlobeFund page that you link to, go to the "Compare v. benchmark" menu under the graph and choose "MSCI EAFE (Cdn$)". This is the index that measures the international stock market. You'll see that the TD e-Series International Fund tracks it extremely well: Over almost 10 years, the difference between the index returns and the fund's return is $16 on a $10,000 investment, or 0.16%. That is a marvellous track record for an index fund.

      Yes, overall, the fund lost money during the last decade, but this is because the market delivered negative returns. International and US markets saw huge losses from 2000 through 2002, and again during 2008 and early 2009. Index funds do not offer protection from bear markets: when the markets fall, so do index funds. And when the markets go back up, you get the full benefit of the recovery.

      Active managers will tell you that they can time the markets to reduce losses and improve gains, but the Globe Fund chart demonstrates that they usually fail. Notice that over the last 3-year, 4-year and 5-year periods, the e-Series fund has beaten the group average. In other words, most actively managed funds that tried to beat the market actually trailed it.

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  15. Pingback: ShareOwner: A Better Way to Buy ETFs? Part 2

  16. Pingback: Would You Like Fees With That?

  17. Pingback: Would You Like Fees With That? | MoneySense

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  19. Why continue making TD money? Make money for yourself. You have numerous advantages when trading stock in comparison to the funds and brokers. Take advantage of your small size and take small profits frequently with very high accuracy. 90%plus is achievable.

  20. For someone starting out you suggest INGStreetwise Funds. They are conveniently easy to buy, and their MER is nice.
    But their performance posted http://www.ingdirect.ca/en/save-invest/mutualfund… shows low to negative returns since Inception in Jan 2008
    Balanced Income Fund 2.23%
    Balanced Fund -1.76%
    Balanced Growth Fund -3.55%

    • @M-C: Thanks for your comment. As I point out in my reply to Darren, above, all an index fund can do is deliver wat the market returns. The Streetwise funds launched in 2008, and within months we experienced the worst financial crash in decades. When the markets go down, index funds go down too.

    • I think the point is that since the funds follow the index with a low MER, the loss is not as great as paying the higher fees and relying on someone guessing. The whole point of the couch-potato philosophy is to follow the index, regardless of the recent returns because you are relying on long term activity and low MERs over that long term to beat the average return that you would get with an advisor and mutual funds.

      • oops, did not see the reply here before I posted, sorry.

  21. I realize this is an older post but I would love a clarification of how the bid/ask spread on ETFs factored into consideration…

  22. I found that a self-constructed Global Couch Potato (20/20/20/40) seemed to have performed better than the ING Streetwise Fund this past year and will be transferring my funds from ING to bolster up my own CP fund.

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