I recently hosted an AMA (“Ask Me Anything”) on Reddit, the online discussion forum, and over 90 hectic minutes I answered as many questions as I could from investors. Here is a lightly edited transcript of the discussion, along with some additional comments and links I didn’t have time to provide during the live AMA.
vbally101: I’m newly financially stable, 31, single female, own my home and car. Finally in a full-time job with a salary and benefits and have paid off my debts (with the exception of my car and mortgage). Current annual salary is $90K before taxes. I have about $13K in savings.
My new company has a defined contribution pension plan (7% individual contribution; 6% company matching). I have no other investments and am not sure where to begin. I’m trying to look to the future, but there is so much information I don’t know how to sort through it all.
Canadian Couch Potato: Sounds like you’re off to a great start! Taking full advantage of your workplace plan is the place to start, especially if the plan offers low-cost index fund options (most do). You could consider making additional contributions to that plan: your RRSP room will be 18% of your previous year’s salary and it sounds like you’re doing 13% now.
If you still have surplus cash after maxing your RRSP and keeping some aside for emergencies, consider making additional mortgage prepayments: that’s a risk-free, tax-free way to increase your net worth that requires no investment knowledge.
princessdianasauce: I haven’t been investing long enough to have endured the 2008 financial crisis or any extended bear market. However, I have been very disciplined during the market volatility in the last 3 months, and for the entirety of my DIY experience. Do you think that is sufficient evidence to increase my risk tolerance? I am 28 years old, currently using 75% equity, 25% fixed income, but I am considering 85% to 90% equities.
CCP: The market volatility we’ve experienced in the last several months is not a gauge of an investor’s tolerance for loss. Not even close. The true test is when you have lost at least 30% to 40% of your portfolio. In 2008–09, it was closer to 50% in six months. Few people can endure that without panic. You might well be able to stomach a portfolio of 90% equities, but I would make that decision after the next ugly bear market rather than before.
derekcanmexit: What is your opinion of Horizons total return ETFs, which use swaps to deliver index returns in a low cost and tax-efficient manner. Are you recommending these ETFs to clients? They seem too good to be true, and I am afraid I am missing something in the details.
CCP: We’re not currently using these swap-based ETFs with our clients, but I don’t have any objection to them as long as investors understand the additional risks, which I’ve written about a fair bit. Certainly they have done an outstanding job of delivering on their promise of matching their index returns minus fees.
One concern we have is that the government may eventually stop allowing this structure (as they have done with other tax-advantaged products), which could cause investors to sell the funds and realize all of the accrued gains in a single year.
p0u1337: For someone with a defined benefit pension plan that uses up most of my RRSP room, as well as a maxed TFSA, what are some options for the CCP model in unregistered accounts? Currently with HXT and HXS for the simplicity until I figure it out!
CCP: Investing tax-efficiently across multiple accounts can tie people in knots, so I’d urge you not to look for an “optimal” solution, because there probably isn’t one.
In general, I agree with your decision to hold Canadian and U.S. equities in the non-registered account: Canadian dividends can be very tax-efficient, and yields on U.S. equities are generally low these days, so there’s little taxable income. Whether you use HXT/HXS or plain-vanilla ETFs is a different topic, but either is likely to be fine.
If you hold cash or GICs, a non-registered account can also be appropriate, as the interest income is relatively low and therefore little tax would be payable. I would not, for example, hold low-growth, low-income assets like this in a TFSA while holding higher-growth, higher-income assets in a taxable account.
[Note: While my model portfolios are generally more appropriate for tax-sheltered accounts, my colleague Justin Bender offers a model ETF portfolio for non-registered accounts that includes the BMO Discount Bond ETF for fixed income.]
falco_iii: If I can max my TFSA and RRSP and have some left over for a taxable account, where should I put the ETF assets? Can you include that in the next model portfolio? There is an older blog entry but it does not have the current ETFs or TD e-Series funds.
CCP: As mentioned in the reply to p0u1337, above, asset location across multiple accounts is probably the most difficult part of DIY investing. There are very few hard and fast rules, so a full understanding of the situation is essential.
How big are the accounts relative to one another? Where is most of the new money being added? Do you need liquidity? What tax bracket are you in? Are you using index mutual funds or ETFs? Are you willing to use U.S.-listed ETFs or only Canadian?
If you’re simply asking which assets should be the first to go in the non-registered account, it’s hard to go too far wrong with Canadian equities.
Titanmowgli: In terms of rebalancing one’s portfolio consisting of an RRSP, TFSA, and taxable account, do you recommend factoring in that the government owns a certain portion of your RRSP upon withdrawal? Will doing it one way or another affect the level of risk that one is taking on?
CCP: Another common question that doesn’t have an easy answer. The short reply is, no, we don’t manage portfolios that way because it is hopelessly impractical. There are also behavioural issues to consider. If you lost half of the value of your RRSP, would it make you feel better to know that 30% would have gone to taxes in retirement anyway? I doubt it. So I don’t disagree with this idea in theory, only in practice.
[Note: To clarify the background here, some people argue that, for example, if you hold $75,000 in equities in a TFSA and $75,000 in bonds in an RRSP you don’t really have a 50/50 asset mix. Because some percentage of those RRSP dollars will be taxed upon withdrawal, you own less in bonds than you think. Therefore, you should consider after-tax dollars when setting your asset allocation.
The most vocal advocate of this strategy is the author of the Retail Investor website. If you feel you can apply these insights to managing your own portfolio, I welcome you to do so, but I suspect it will defeat most DIY investors. For professionals managing portfolios for multiple clients it is close to impossible, and I am not aware of any firm that does so.
I also encourage you to read a this new article at Holy Potato, authored by John Robertson, who recently appeared on my podcast. John is a very smart guy who understands the math of after-tax asset allocation as well as anyone. But at the end of his blog he concludes that “all these optimization games can bring is a few basis points of extra return,” and the added complexity is not worth it. “My default suggestion is that it’s best to just replicate the same allocation in all your accounts.”]
throw0510a: Someone recommended that instead of putting bonds into non-taxable account, that they should be put into a taxable instead. The reasoning is that since returns are so low with bonds lately that it’s not worth try to save on them with regards to tax-efficiency. The claim is that it is better to put equities in the non-taxable accounts so that one can keep as much of the returns as possible for oneself. How crazy is this idea?
CCP: This idea is not crazy at all. Fixed income can be perfectly appropriate in a taxable account. However, some bond ETFs are particularly tax-inefficient, so if you hold fixed income in a taxable account it’s important to use the right products (i.e. GICs or tax-efficient ETFs).
derekcanmexit: I’d like to know your thoughts on factor-based ETFs? Would you recommend them as a complement to any CCP strategy?
CCP: This is another theory vs. practice issue. I think many of the premiums (value, size, momentum) are real. I just think that in practice they are very hard to capture with an index fund, and the additional costs can easily overwhelm any premium that does exist.
I also worry that once you go down the road of looking for the best way to capture factor premiums you create new behavioural problems. You may find yourself perpetually looking for something better instead of settling into a long-term strategy.
[Note: I wrote a long series of blog posts about factor-based, or “smart beta,” ETFs in 2016. I concluded by arguing that most investors are better off sticking to plain-vanilla index funds.]
CrushyMcCrush: Two questions: 1) if you have existing stocks that are fairly diversified, would you consider them part of your allocation for that region (e.g. Google, FedEx etc. in place of a U.S. ETF) or would you recommend selling these stocks and buying an ETF? 2) For index investing, what is the minimum amount of time in the market you would recommend for someone with an above-average risk tolerance? For example, if I am saving for a down payment in five years, is that long enough, or would you recommend a high-interest savings account?
CCP: 1) As you can imagine, I don’t recommend holding any individual stocks. They are a huge distraction: believe me, you’ll find yourself focused much more on those individual companies than on the rest of your portfolio. Unless you have very large capital gains that you want to defer, I generally recommend that index investors purge their portfolios of individual stocks and simply use ETFs.
If you can’t sell the stocks for whatever reason, then yes, I would tend to consider them as part of your overall allocation to that country (e.g. Google is part of your U.S. equities, Royal Bank is part of your Canadian equities, etc.).
2) If you’re saving for a down payment, I would recommend GICs: this is about savings, not investing. GICs have zero risk of loss and decent rates now (2.5% to 3.25%), at least compared with years past. Just make sure you understand that GICs are not liquid, so if you think you might need the cash in two or three years rather than five, adjust the maturities accordingly.
jjj7890: I’m investing with monthly purchases of ETFs with a mix of 50% XIC and 25% XAW, with 25% allocated to fixed income—except instead of buying a bond ETF, I’m pre-paying my mortgage. I figure that “earning” a guaranteed 3% return on the mortgage prepayment is preferable to a 2% to 5% (?) fluctuating return on a bond fund. What might I not be thinking of, and what do you think of this approach in general?
CCP: There’s nothing at all wrong with what you’re doing: investing and paying down your mortgage are both ways of increasing your net worth.
I would just frame it differently. You are not allocating 25% of your investments to fixed income. You have a portfolio of 100% equities, and you are also paying down debt. The mortgage prepayments are a sound decision, but they’re not just a different way of buying fixed income. So just make sure you are comfortable with the risk of a 100% equity portfolio.
juggabags: I’ve followed the Couch Potato plan for years, shifting only very occasionally between the recommended ETFs in my RRSP and TFSA. But, now I’m thinking of getting into one of Vanguard’s new Asset Allocation ETFs (probably VBAL) and was questioning whether I should move all my current investments over, or just add any new funds to VBAL.
CCP: I’m getting this question a lot since the launch of the Vanguard asset allocation ETFs. I like simplicity, and I think hybrid solutions (holding the existing ETFs and adding new money to VBAL) undermine that simplicity and can make rebalancing even more complicated. So if there are no tax consequences (i.e. all of your funds are in TFSAs and RRSPs), I tend to recommend selling the current holdings and using only the one-fund solution.
[Note: I recently answered a similar question in more detail at MoneySense.]
domlee87: As someone who has read Millionaire Teacher and The Value of Simple, I feel like I know all that I need to know about investing in index funds. Is there a need to know any more after this point and if there is, do you have any specific books that you would recommend? I am considering reading up on Canadian taxes but don’t know what else to really seek out after that.
CCP: A very insightful question. At some point there are diminishing returns on education about index investing. If you save regularly and have a well-diversified, low-cost portfolio, and you rebalance with discipline, you are already 90% of the way there. A basic understanding of tax-efficiency will get you even closer.
So it’s not unreasonable to decide that you don’t want to spend hours reading about the minutiae that might, at best, save you a couple of basis points a year. Indeed, it’s just as likely you could start to second-guess yourself and unwind the solid plan you’ve already built.
Ulkurz: I’m a 30-year-old who recently started looking to grow my savings mostly by investing in stocks, bonds and other options. However, the learning curve about investing rationally is pretty steep. It can take a while before I’m absolutely confident about putting my money in something I believe in. I’ve around $40K in savings that I do not need at all. Where do you suggest I should start?
CCP: If we start by assuming that you believe in investing in the stock and bond markets, then a simple balanced index fund could be a place to start. If you’re also considering totally unrelated ideas (such as buying a rental property), then you may have little option other than keeping your savings in cash until you are comfortable.
One word of advice: doing your research is important, and you need to be comfortable with your choice. But be aware of analysis paralysis or you may find yourself sitting on cash for years.
schpeucher: I became familiar with your work last year but have yet to ever invest: I have only used savings accounts. So, on top of “Am I an idiot?” my question is, what are your thoughts on opportunity cost in investing? I have almost $100K saved, but I also need some funds available to run a business venture I’m starting. Is it best to invest as much as possible and use a line of credit to fund daily spending? Or better to always be in the black and invest less?
CCP: I can’t comment on your specific situation, but no one is an “idiot” if they don’t invest. If someone plans to start a business, then it’s entirely reasonable to hold cash for that reason (and probably an emergency fund, too, in case the business fails). Investing that cash and using credit to fund the business is adding a double layer of risk.
msvolkl: What would your suggested asset allocation be for two people with defined benefit pensions, both age 30? Would you suggest being more conservative (don’t need to chase higher earnings due to pensions), or taking more risk due to the safety net of the pensions?
CCP: This is a great question, because you can make an argument for both. You have less need to take risk than those without a pension, but also more ability to take risk if you desire. So in the end it comes down to your comfort level.
TradersJoes: Been following your blog and using the CCP balanced portfolio for registered and cash accounts through my discount brokerage. I hold the same three ETFs in each account and rebalance every six months. With a portfolio over $500K, what are the advantages of switching to a full-service advisor vs. continuing to manage on my own?
CCP: Advisors can generally add value in the following situations: the investor has no interest in devoting time and energy to managing the portfolio (not the case here, I’d say); the investor needs financial planning as well as investment management; the portfolio is large and complicated (multiple accounts, some of which are taxable) and requires more expertise; the advisor can impose a discipline the investor lacks; and the advisor can do all of this for a reasonable fee.
pfcguy: I have an actively managed portfolio of >$250,000 managed by professionals. It consists of ~25 stocks, bond ETFs, and an international ETF, and a fee of 1.5% per year. They also provide financial planning, life insurance advice, etc.
I can think of a number of reasons to switch to a passive/index strategy like a CCP model portfolio of ETFs. Can you think of any advantages to stay with active? Are there things a portfolio manager does that I would not get from a passive/index portfolio?
CCP: I think your question is less about active vs. passive and more about advisor vs. DIY. You can reduce your costs by building your own Couch Potato portfolio, but if you get value from your advisor in terms of planning, discipline, etc., then switching to DIY may not really improve your situation overall.
CrasyMike: Here and there someone will post asking if a market-linked GIC is appropriate. This person will typically have a short-term goal that requires limited to zero risk, but wants to figure out how to get the “best possible return.”
I’m sure a high-interest savings account is an appropriate option for this person, but if they are willing to accept the possibility of zero return on investment then why not a market linked GIC? What is so inherently wrong with them?
In this post you point out that some of them are a total rip-off. But are there any market-linked GICs that are not a total rip-off—a limited upside, but still better expected return than a regular GIC?
CCP: I’m not aware of any product that promises a meaningful upside and also no risk of loss. Market-linked GICs are often built in a similar way to the homemade one I described in the post linked above, but they layer on hefty fees and may even cap the upside.
“If they are willing to accept the possibility of zero return on investment then why not a market linked GIC”? I guess I don’t think one should ever accept the possibility of zero return with such a limited upside. I would rather just buy a plain vanilla GIC and accept the guaranteed return.
Jabb: My RRSP is all ETFs, but years ago I became enamoured with the SPDR ETFs where I could allocate my money into ETFs holding specific sectors. Is this majorly hampering my compounding returns?
CCP: I can’t know if it’s hampering your returns in the short-term, but tinkering with narrow, sector-specific ETFs is likely to be a major distraction over the long term. I recommend simply using total-market ETFs and avoiding trying to guess the next hot sector.
This post ran originally as two posts on Dan Bortolotti’s Canadian Couch Potato website. Dan is a contributing editor to MoneySense and an investment advisor with PWL Capital in Toronto.
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