If you had purchased shares in the S&P 500 index (through the SPY index ETF) in July 1997 (at about $91-92 per share), your investment would be worth the same amount today, but in today’s dollars. So technically you would have lost money if you consider inflation. So it has an annualized return of about 0%, neglecting inflation. All this ignores dividends which were roughly 1.5-3% during that period (very rough guess). So let’s just for sake of argument that the dividends cancel out inflation. So again, the annualized return would have been roughly 0%. If you made any more purchases of the S&P 500 index after 1997, well, you annualized return would have only gotten worse because except for a brief period in early 2003, SPY hasn’t been below $91-92 since 1997.
How do currency exchange fees factor into the decision between VEA and XIN? XIN’s MER is 0.35% higher than VEA’s, but it is purchased using Canadian dollars, so there is no exchange fee. VEA’s MER is nice and low, but don’t you immediately lose a few percentage points of your investment when you buy it due to currency exchange fees?
He’s exactly right. The answer to “which one is better, VEA or XIN, from a cost perspective” is “it depends.” In this case, it depends on how long you hold your investments.
I did some similar calculations to determine the “effective MER” of a foreign currency investment over time but this time I do it a bit more simply, to determine, simply, how long to I have to hold my VEA until it beats XIN.
When you buy VEA, you’ll pay a foreign exchange fee (spread). This varies depending on your broker but they range from 0.5% to 1.5% each way. Let’s assume it’s 1% each way. So when you use Canadian dollars to buy VEA they convert your dollars to USD but they take 1.5% for themselves. So our present value has gone down by 1.5%, or 98.5% of the original. When we sell your USD investment, VEA, in the future, the broker/banks will again take 1.5%. So your final value is also reduced by 1.5%. So originally, we had this:
Our initial PV needs to get reduced to 0.985 of the original, and the result of the right-hand needs to be reduced by 0.985 (when we sell the investment). So what we end up with is this:
If we invest in XIN, there are no foreign exchange, just an MER that is 0.35% higher. This 0.35% will reduce our annual return, so we get this:
We can get rid of PV (it won’t affect the result) and assume a return of 7% (i=0.07). It turns out that:
So if we hold onto our investment in VEA for 10 years or greater, we will end up better off, assuming a rate of return of 7% (note that the rate of return does not have much effect here, eg. 10% rate of return gives the same result) and a foreign exchange fee of 1% each way. The two variables that have the greatest effect here are the foreign exchange fee and the difference in MERs.
I was hoping to buy some VTI today but I couldn’t buy it through E*Trade’s website because there was no quote available. I had noticed in the past few weeks that there was an asterisk next to the market prices of my Vanguard ETF holdings that said: “A quote was not available on this security. It has been priced using the previous day’s closing value.” I called E*Trade and they weren’t much help. The lady kept saying “that is not the correct symbol” to which I kept replying “I don’t understand what you are saying.” Eventually she said that it was on the “Pacific Exchange.” Well the Pacific Exchange doesn’t actually exist anymore:
by 2005, the Pacific Exchange was bought by the owner of the ArcaEx platform, Archipelago Holdings, which in turn was bought by the New York Stock Exchange in 2006. The New York Stock Exchange conducts no business operations under the name Pacific Exchange, essentially ending its separate identity. Pacific Exchange equities and options trading now takes place exclusively through the NYSE Arca (formerly known as ArcaEx) platform
Googling for NYSE Arca and Vanguard finally gave me some hits. Apparently on September 19th, 2008, Vanguard ETFs are now trading on the NYSE Arca Exchange after moving from the American Exchange:
NYSE Euronext (NYX) announced that its fully-owned subsidiary NYSE Arca today began trading 34 Vanguard Exchange Traded Funds (ETFs) after the group transferred over from the American Stock Exchange (AMEX).
I wonder if E*Trade will ever support quotes from the NYSE Arca exchange? Apparently I can buy them over the phone. Going to give it a go tomorrow because the markets were closed by the time I sorted everything out.
Update (2008/10/7): They will not charge you extra commission because it is sold on an exchange that E*Trade’s website doesn’t support. They have apparently always done this with stocks that cannot be purchased through the online system. We just bought some VTI shares. I’ll give it a few days and I’ll let everyone know if I see any extra commissions drawn my account due to this trade.
European and North American markets are WAY down today. To tell you the truth, I haven’t really been following the markets too closely of late, although I have heard a lot of grumblings here and there and a noticed a few blog posts about it; however, because I don’t follow what the markets are doing every day, the fact that the S&P TSX Index Composite fell 500 points doesn’t really mean that much to me. For all I know, it could have been up 500 points last week/month and so all that really does is wipe a weeks/months gains. Ignorance is bliss.
No changes here in my investment strategy. Our RRSP monthly contribution amounts have been the same since last tax season when we adjusted them based on our 2007 incomes and they will continue to remain the same until June or so 2009. Every time my portfolio or my wife’s contains more than $2000 cash, we buy some more of the ETFs that we already own. No surprisingly, since our portfolio is 25% bonds and 75% equities, we haven’t purchased many bonds recently, since equities have performed so poorly, we have been underweight in equities in recent months.
I’m looking forward to the next bull market and remaining fully invested (only in low-cost index ETFs) until then.
Just found this great interview with John Bogle, “the father of index investing.” A must-listen for any investor, especially those who own mutual funds and those who have no idea what index investing is all about. If you already use indexes in your portfolio, they is still a lot of great information here, and it will help give you even more confidence that you are on the right track!
Are all Vanguard’s ETF RRSP eligible? What about U.S. iShares or Wisdom Tree or Powershares?
Thanks for the help!
Well all US stocks are RRSP-eligible and ETFs are just stocks. I suppose the only hitch is that you have to find a broker that offers registered accounts and allows you to put US stocks in them. Fortunately, I don’t think there are any discount brokers in Canada they don’t allow you to purchase US stocks and that don’t offer registered accounts.
Be wary of Wisdom Tree and Powershares. The MER of Wisdom Tree’s ETFs are higher than Vanguard’s. I was not able to find the MER of Powershares funds within 5 minutes so they are most likely high. They sell an insane number of ETFs–also a sign that their ETFs are probably costly.
iShares has some low MER ETFs. For example, iShares S&P 500 Index Fund (IVV) has an MER of 0.08% compared with Vanguard Total Stock Market ETF (VTI) which has an MER of 0.07%. In general, Vanguard sells the lowest cost ETFs.
Rob Carrick recently did some analysis of mutual funds’ and ETFs’ MERs relative to their performance, which he calls FFI (Fund Fee Index) (see “How to get the skinny on your fund’s fat fees“). The FFI is supposed to be used as “a new way to measure the value you get from the fees you pay to your own mutual funds and exchange-traded funds.” It is calculated as follows:
Cute idea, but unfortunately it is a fairly meaningless measure since paying more expenses to a mutual fund company will not get you more gross returns (because returns are random). The big thing you will notice from the chart is that all the iShares ETFs scored far lower. In fact, as Carrick points out:
The best index score for a mutual fund was the 8.7 earned by the Phillips Hager & North Dividend Income. The worst score on the ETF side was the iShares Cdn Short Bond Index Fund at 4.8. Here, we have a vivid example of how the low fees of ETFs work to the advantage of investors. The ETF scoring worst on the Fund Fee Index beat the mutual fund with the best score.
That’s right, each of the 12 ETFs he chose beat the top 50 mutual funds of all types according to his FFI measure. He praises ETFs’ low fees, which is why the ETFs’ FFI scores are consistently lower than those of mutual funds, but stops short of making any grander conclusions. He says “it’s pointless to generalize about the value that investors get for the mutual fund fees they pay – some funds are outstanding, many are middling and some are pretty bad.” Maybe so, but we can definitely generalize and say that investors get much more “value” (I’m using Carrick’s definition of value here… a low FFI) out of ETFs than they do from mutual funds.
In general the FFI is a useless measure. Here’s an example. If a mutual fund or ETF had a 5 yr. annualized return of 1% and an MER of 0.1%, we get an FFI of 11 . Let’s say another fund or ETF had a 5 yr. annualized return of 20% with an MER of 2%. That gives the same FFI of 11 . So what does that tell us? That these two investments are equally “good”? The FFI hides the returns and in the end doesn’t tell us anything.
The only way in which the FFI is moderately useful is for comparing funds in the same sector or market. Then we can truly understand why the ETFs have lower FFIs than the mutual funds and what that actually means. The FFIs for the ETFs range from 0.9 to 4.8. These are ETFs such as iShares CDN Composite (XIC) with an FFI of 1.3 and the iShares CDN Short Bond Index (XSB) with an FFI of 4.8. The gross returns of the mutual funds should, on average, be equal to the gross return of the iShares ETF in the same category (because the gross return of the iShares ETF is the market average’s return). So when comparing ETFs and mutual funds in the same sector, the only variable affecting the FFI score is the MER. The higher the MER, the higher the FFI. So for this specific case, the FFI basically just becomes another measure for the net return, and as Rob Carrick says “The ETF scoring worst on the Fund Fee Index beat the mutual fund with the best score.” But what he is really saying here is that in any given sector, the iShares ETF for that sector had a higher net return than all the mutual funds in that sector that he looked at.
John Chevreau looks at the latest “the SPIVA (Standard & Poor’s Indices Versus Active Funds) scorecard for 2007” and it doesn’t look good. When will the average Canadian realize that investing in mutual funds is a loser’s game? Check out Andrew Teasdale’s interesting comments below the article. Here’s a snippet:
Mutual funds in general are products whose main objective is to earn returns for financial intermediaries and financial institutions and in many respects pander to the short term whims of the general investing public and the financial community at large. Sadly the mutual fund industry (as a whole) could be considered more of a game with the odds stacked against the investor than a serious attempt to deliver value and discipline. . . Canada however is one of the worst offenders when it comes to the value for money mutual funds offer the investor. When will Canadian investors as a whole start to realize that the odds, based on the current status quo, are more often than not stacked against them?
Our question today comes from Charles who asked me what he should do with his dad’s pension assets, which are currently invested in two mutual funds:
My name is Charles, and I am a Finance student at the John Molson School of Business in Montreal. Lately, I decided to take over my dad’s pension fund. His company provides my dad with $15,000/year to be invested with Desjardins Financial Security (I don’t think you have this Quebec bank in BC but it is popular here and in Ontario). His plan is a defined contribution plan and not a benefit plan. When I look at my dad’s assets, he had 2 funds: 1) Jarislowsky Fraser Balanced Fund 2) Jarislowsky Fraser Canadian Equity Fund — These funds are not beating the market (benchmark) often and if they do…well these funds MER are expensive so they perform worse than the market.
Therefore, I wanted to take over his asset allocations but I have no choice but to deal with Desjardins since his company deals with them but of course I or my dad can choose its asset allocations.
I am a strong believer of index funds and ETFs. Desjardins offers great Barclay’s (iShares) ETFs: 1) Active Canadian Equity fund, 2) EAFE Equity Index, 3) Universe Bond Index Fund, and 4) S&P/TSX Composite Index Fund.
My dad is currently 48yrs old and wants to take its retirement when he his 63 – 65 years old. Therefore, a good 15 years of investment.
Here’s my question…what should be my weights in each asset class?
I was thinking 70% equity; 25% bonds and 5% T-Bills. Is having all of the 25% bonds in the Universe Bond Index Fund good? As for the equities, is 60% in S&P/TSX Composite Index Fund and active Canadian Equity fund and 40% for EAFE Equity Index any good? If I have the S&P/TSX index..is Active Canadian Equity relevant?
You can find all the info for each fund on Desjardins‘ website:
Again, thanks for your help and thanks for your great website!
First of all, it’s too bad that Desjardins does not publish the MER of those funds, although it is pretty much a given that they are going to be higher than any Barclays (iShares) ETF.
Although Charles says that “these funds MER are expensive so they perform worse than the market” it seems that over the last 10 years the Jarislowsky Fraser Canadian Equity Fund has outperformed the S&P Composite Index (16.3% to 9.5%). Although that probably says more about your dad’s reasons for choosing this fund over the others and this fund’s longevity, than it does about the fund’s prospects of “beating the index.”
Currently Charles’ dad is invested in 77.5% equities (50% from JF Canadian Equity Fund and 27.5% from JF Canadian Balanced Fund) assuming that he is invested equally in both of these two funds. My first recommendation would be not to deviate too much from what his dad was invested in before. This isn’t Charles’ portfolio, and if things turn ugly (or uglier?) for either stocks or bonds he doesn’t want to be the one to blame for shifting him more or less into either category. So I don’t see anything wrong with going with 70% equities in his new ETF based portfolio. I really don’t have a precise answer on what allocation of bonds/equities is right for your dad. I would try to stick with a balanced approach, and by that I mean that he should be invested 25-75% in equities and 25-75% in bonds (neither all bonds or all stocks). Risk assessments on banks’ websites (like TD Canada Trust’s Retirement Strategy Tool) are somewhat useful, not to come up with a precise answer, but to give you something that is in the ballpark. If anything, psychologically they can give Charles and his dad some comfort.
The Bond Universe fund is a good way to capture the bond market.
I don’t see anything wrong with his allocations within the equity class. I would not bother with the Active Canadian Equity as he will just get poorer performance (on average) than the index itself (after MERs). The only other thing that I noticed is that there is no exposure to the US market here as it looks like Desjardins does not offer Barclays’ (iShares) S&P 500 Index. I assume his dad has other investments besides this pension? If so, then I hope Charles will look at his entire portfolio (pension + RRSP + spouse?) as one, rather than each individually and hold a US index outside of his pension.
Another question (or should I say several questions) from a reader about US dollar ETFs. Paul wrote:
Thanks for the great blog – as a relatively new investor interested in building an ETF portfolio, I have found a great deal of useful information on your site – its much appreciated. I wanted to ask you a few questions regarding the use of the Vanguard ETF’s especially in light of the soaring loonie which is nudging US$1.06 these days.
Do you think that the strong loonie should be an extra incentive for Canadians to buy the Vanguard ETF’s to diversify their portfolios? I feel that the strong loonie offers us an opportunity to buy these US$ based shares at a discount given that historically the CAD has been weaker than the US$. But I have read some blogs that warn that that may all be changing and that with increasing global demand for Canadian resources and with the problems in the US economy, we may see our dollar at least on a par with the US$ for a while to come.
No, I don’t think that the fact that the Loonie is extra strong (relative to the past) should be any extra incentive to buy Vanguard ETFs (read: US dollar ETFs). You are right, with pending problems in the US economy and increasing demand for Canadian resources the Canadian dollar may go even higher, or the Canadian dollar may fall back (or the US dollar may rise) to it’s historical norm relative to the US dollar. It is difficult to predict. It is good to own Canadian dollars if you plan on spending the proceeds of you investments in Canada. On the other hand if inflation ever became very bad in Canada and the Canadian dollar fell against the US dollar it would be nice to have US dollars. Also, if the Canadian dollar fell against all other currencies and you planned to spend your retirement savings travelling, then it would be nice if some of those investments were in something other than Canadian dollars. I think it’s important to have a balance and to not put all your eggs into one basket. He continued,
Also, I read your post about the exchange rate spread issue when buying US based ETFs and how if you do not plan to keep these ETF’s for a long time, the MER is essentially boosted by the costs associated with converting CAD to US$ and then eventually back again. Would this issue not lend more argument to buying ETF’s like XIN or XSP which have higher MER’s but at least you do not have to pay a chunk of change when you convert back to CAD?
Of course you would have to do some calculations yourself to see which is better (or see my post about foreign exchange costs). There are a bunch of variables involved: the foreign exchange rate spread, the MERs of XIN/XSP, the MERs of the Vanguard US$ equivalents, and the length of the time the investments were held. In general you’ll probably see that as the length of time increases, the lower MER investment will become more attractive. As the length of time decreases, the investment without the foreign exchange fees will become more attractive.
Lastly, I have read a lot about the exchange rate risk Canadians face buying ETF’s like VWO, VEA, VPL or VGK. How much of an issue is this? Surely as long as the ETF grows and we are buying these ETF’s now with a strong loonie, the risk must be fairly small and one could do well when the CAD eventually returns to a more realistic level with the US$.
I try not to worry about it too much because if you look at the long term historical trend, the Canadian dollar and the US dollar have not diverged substantially, although they do encounter some pretty big swings, as we have recently witnessed.
Right now I am inclined to overweight my portfolio with VTI, VWO, VPL and VGK to take advantage of the buying power of the loonie and then rebalance it with more XIC later when the CAD weakens a bit. Would this make sense right now or is there serious risk to assuming the CAD will weaken in the next few years?
Personally I wouldn’t assume the CAD will rise of fall in the next few years. Plan for a probability of either situation happening. Stick with an allocation of CAD and an allocation of USD that you are comfortable with, no matter what the current state of the loonie/dollar is, and the stick to that allocation. If you want to speculat, that’s up to you, however, but if you’re talking about a retirement portfolio I would just pick an allocation and go with it. If one currency rises substantially above the other you’ll find yourself buying the cheaper currency just to keep the portfolio balanced.
Anyway, thanks for you help and I look forward to reading your thoughts on these issues.
Thanks for your question Paul, and sorry for the delay in responding to it.