Archive for the 'RRSP' Category

Ask Dave: All Foreign ETFs RRSP-eligible?

Charles asks:

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.

Popularity: 14% [?]

RRSPs versus TFSAs

Here is a great little summary of how the RRSP and the TFSA differ: “RRSPs versus TFSAs: The Math

In summary:

So, while it appears that the two plans produce the same results, that only holds true if your upfront tax rate is the same as your tax rate later on.

RRSPs will make more sense when the tax rate upon withdrawal is expected to be lower than the tax rate upon original contribution. Conversely, TFSAs will work out better if your tax rate (including the effect of RRSP withdrawals on benefits such as the Guaranteed Income Supplement or the Old Age Security, which are clawed back based on income) will be higher upon withdrawal than it was when you contributed.

Popularity: 6% [?]

Differing Opinions on US Currency Investments for Canadians

A fellow blogger (Y HAT) has a somewhat different view on investmenting USD currency investments:

As I write this the Canadian dollar is trading at $1.07 to the US greenback and most Canadian finance articles I’m reading are suggesting you should jump into US equities – these are cheap by historical standards and the Canadian dollar is bound to retreat. This blog’s opinion is that no one knows were the loonie is headed next. Consequently, you should save yourself a lot of stress by insuring your portfolio against currency movements.

First of all, there is no right answer. Just like there is no formula for how much fixed-income you should hold versus how much equities, or how much emerging markets/small caps you should hold versus everything else. It’s all about how much risk you can handle. Certainly the advice that you should “save yourself a lot of stress by insuring your portfolio against currency movements” does not apply to everyone.

I agree that “no one knows were the loonie is headed next,” just as no one knows where the Canadian equities market is headed next or where the bond market is headed next, which is why I hold a bit of each to reduce my overall risk and/or increase my overall returns through diversification. In the long run though, by the time I retire, I don’t think swings in the USD/CAD exchange rate will amount to any significant gain/loss in my portfolio, but I may have gained more significantly through rebalancing (better with less correlated assets) and lower costs. Maybe in the future I will look back and with perfect hindsight I will wish I had bought XIN instead of VEA, but my present opinion is that I do not think anyone needs to get their knickers in a knot over purchasing US dollar-based investments.

Popularity: 13% [?]

Ask Dave: US Dollar Investments Inside Your RRSP

With no more foreign holding limits inside RRSPs, a lot of people are looking into holding foreign currency investments inside the RRSP. In fact my first ever “Ask Dave” post was about this very topic (see “Ask Dave: USD Holdings In an RRSP“).

Another reader recently wrote me with similar questions. Rob writes:

I’m confused. I want to own US $ investments in my RRSP. RBC Direct advises that all RRSP investments must be in CDN $. They didn’t know what a “wash trade” was. With the Cdn $ at $1.08+ is this a good time to own US $ denominated equities or a USD ETF? If so, can I do this in an RRSP or does it have to be held outside?

Rob, you can certainly own US $ investments inside an RRSP (ie. any US stock (this includes ETFs)). As for US$ mutual funds I’m not really sure (as I’ve never done it) although you probably could. If RBC Direct truly does not allow you do hold USD investments in your RRSP (I would be REALLY surprised if they didn’t), find another broker. The one restriction that the Canadian banks and brokers place on customers (although there is nothing in Canadian laws/regulations that forces them to do so, see “Foreign Currency Investments and Exchange Spreads Inside Your RRSP” and this class action lawsuit against BMO for more information) is that you may not hold any foreign currency inside an RRSP. All cash inside an RRSP must be in Canadian dollars. As a consequence of this ridiculous restriction, if a USD investment is sold, the proceeds must be converted into CAD, then to buy another USD investment, the CAD cash is converted into USD again. Hence huge foreign exchange rate spread-related costs, and hence, wash trades’ raison d’être…

I am not surprised that RBC Direct did not know what a “wash trade” was as I think TD Waterhouse is the only one that offers it (and even then, they will only do it for a phone trade, not an online trade). Refer to the Canadian Capitalist’s site on how to make a wash trade. At the time (August 2006) the Canadian Capitalist said that “as far as I know, RBC Action Direct, which is our primary brokerage account does not offer this feature.”

It is impossible to predict what the US or Canadian dollar will do at this point. Much like with the Vancouver housing market 2 years ago in Vancouver, would it defy all odds and go up even further? Or would it come crashing down as it seemed destined to? The pundits and economists will say whatever they want but they have no clue what will actually happen (although there have been some rumblings about possible Bank of Canada currency intervention measures). I say don’t worry about timing your purchases of USD investments and don’t ask the question “is this a good time to own US $ denominated equities.” Instead you should think long term and ask “should I have US $ denominated equities in my portfolio (for the next 10+ years).” You especially should not be trying to “time” investments in USD investments (or any other currency) because the costs of buying and selling USD investments inside an RRSP are huge unless you use wash trades. Your best bet to minimize costs is to buy them once and hold. For more on the costs associated with USD investments inside an RRSP, see “Foreign Exchange Costs Associated With USD Investments in an RRSP.” If you really want to speculate, use a non-RRSP US$ trading account.

It’s good to be diversified and not have all your investments in Canadian dollars, although if you plan to retire in Canada you definitely want to have most of your retirement assets in Canadian investments as you approach retirement and not expose yourself to unnecessary currency risk (see “US vs. Canadian dollar investments made inside an RRSP” for more detail, especially bullet point 2). You will also incur lower costs (assuming you don’t incur too many foreign exchange-related costs). Observe the difference in MERs between the Canadian iShare XSP (0.24%) vs. the American iShares’ IVV (0.09%) or the Vanguard’s VTI (0.07%), for example. Adding foreign currency investments also decreases the correlation between the different components of your portfolio even further, thus providing more diversification, and in the end, a higher risk-adjusted return.

Send your questions for my “Ask Dave” posts using my contact form. I look forward to hearing from you. My queue of questions is not long, but it’s not short either, so I may take anywhere from a few days or a few weeks to respond. Thanks for your patience.

Popularity: 33% [?]

Ask Dave: Switching to an Index-Based Portfolio

Dear Dave,

Firstly, I wish to compliment you on your excellent blog. Your posts are simple and they have certainly helped me navigate towards a passive portfolio. Please keep up the excellent work.

Why thank you! Keep reading, tell your friends. And sorry for taking so long to respond to this, I’ve been quite busy.

I know that you are not in the business of giving financial advise, but I was wondering whether you could provide some guidance, or post on subjects related to my current situation. I am a relatively young investor, like you, (25) who now has a steady job and am looking to invest for the long term. I have been investing for a while now and have built up savings of, let us say a fictional $100,000, primarily of mutual funds, including some index funds. I currently use TD Waterhouse’s self-directed brokerage.

My portfolio is as follows:

TD Canadian Index-e
TD Monthly Income
TD Balanced Growth
TD Dividend Growth
Canadian – 12%

TD International Index currency neutral
Cundill International Value
Trimark Fund SC
International – 26%

Vanguard Total Market E.T.F. – VTI
RBC O’Shaughnessy US Value
US – 13%

TD Latin American Growth
Emerging Markets – 2%

GIC (one year, 3.75% matures in Dec. definitely can cash this earlier)
Corporate Bond ($160 a month)
Fixed Income, Bonds – 43%

Cash – 4%

Reminds me of my old portfolio at TD Mutual Funds (not Waterhouse, I had a mutual fund-only account at TD, used to be called TD Greenline Mutual Funds). Lots of funds with a lot of the same holdings; I had TD Canadian Index-e, TD Balanced Growth, TD Dividend Growth on the Canadian side. 3 International funds, 2 US Funds, etc… As my former advisor said to me “with so many mutual funds, what you’ve got is basically an index but with a high MER.”

Most of my portfolio is outside of an RRSP (20% is in RRSPs – I cannot really contribute much more to my RRSP). So if I wanted to switch my actively managed funds into ETFs, how should I do it? I am aware of the early redemption fees, but aside from that, do I just sell them and take that big chunk of cash and buy my proper allocations of ETFs? Are there tax consequences that need to be thought about? I know your thoughts on timing the market, so should I just buy everything I need on one day (the VTI I bought at $150 a couple weeks ago, and I know I shouldn’t even think about it)?

First of all you can do the switch to ETFs outside or inside, and you won’t incur any more costs either way. If you do it outside, you can transfer them into your RRSP later “in-kind” without having to sell them. As far as the tax consequences go, outside an RRSP you will have capital gains (losses) to pay taxes on if you sell anything, or when you transfer them into an RRSP. I think when I did it a long time ago, I sold them outside the RRSP and incurred a capital gain, and when they were sold they went into my linked bank account. I then moved that money into an RRSP cash account and then bought investments from there. I was selling and buying no-fee mutual funds outside and inside respectively so I didn’t incur any costs. I think the only tax consequence you should really worry about is to maximize your RRSP contributions every year and that’s about all you can control. Of course, since you are probably planning to keep VTI inside your RRSP, just transfer the VTI in-kind and you will incur a capital gain (loss) on any gains (losses) since you bought it.

Next, don’t switch all those things into ETFs if your commissions are going to be huge relative to the size of your portfolio. If you are going into 4-5 ETFs and the total commission is going to be about $100, I would say that if your portfolio is $10,000 or more, go ahead.

As for your timing try not to even worry about what the market is doing. Pick an asset allocation that you are comfortable with and then go with it. Switch all at once to a new allocation if you want.

With RRSP space that I do gain each year, which investments should be prioritized to be bought within an RRSP?

I guess if you don’t have the RRSP space for everything yet, it would make sense to put non-Canadian stuff into the RRSP first. The Canadian stuff doesn’t suffer from as much double-taxation as the non-Canadian stuff. I cannot remember what the difference in taxation is between dividends and capital gains (I don’t have any non-RRSP investments at the moment, just some debt :-) ) but it’s probably not enough to worry about.

(Aside: when I say double-taxation, I mean that money outside an RRSP is taxed once (as income on your paycheque) and then again when it earns interest or realized capital gains, whereas inside an RRSP it is only ever taxed once (as income).)

It seems that my allocation for bonds/fixed income is too great, but that is only because I did not know exactly how to allocate it, in the end, I only want about 20% bonds.

How did you feel about the recent market downturn? Were you glad to have so much in bonds/cash? If so, keep your current allocation. If you didn’t care too much and think that you could have suffered more and not cared, go with less. Just don’t worry about timing. If you switched to more stocks now, the equities market could continue its fall over the coming year. If you keep your current allocation, the equities market could just as easily bounce back over the coming year as well and you might miss it. You cannot even hope to predict the future.

I recently thought about my emotions during the recent slide, and in retrospect I kind of wished I had a little bit more bonds/cash than the 20% I have (maybe 30%?). I am going to add 5% REITs to my portfolio eventually, so I will eventually have 25%.

I was doing a systematic investment plan where money was taken out and a number of the mutual funds were purchased on a biweekly basis. Now I have stopped the plan and will accumulate money until there is enough to purchase the right ETF (VTI, VEA, VWO, XIC).

I used to do what you did with mutual funds as well. Biweekly, and I would purchase several different funds. Now I also save up cash in my RRSP until I have enough to buy an ETF. I usually wait until. I have $2000. Since I pay commissions of about $20 that means the commission will be 1% of the purchase amount.

I know this is a long rambling post, but any guidance you might be able to share, even if not directly but through future postings, would be much appreciated.

Popularity: 10% [?]

Vanguard Europe Pacific ETF

The Canadian Capitalist mentioned today how he substituted EFA for VEA, a new ETF from Vanguard. The Vanguard Europe Pacific ETF (VEA) is almost identical to iShares’ EFA, which follows the MSCI EAFE index. This is so cool, and its MER is 0.20% less. Not a huge deal, but hey, why not go for VEA over EFA. Looks like Vanguard has the complete offering of ETFs now.

I’m currently in XIN, the Canadian-dollar traded version of EFA. I was thinking of switching to EFA the next time I plan on making a purchase of XIN/EFA (which will probably in 3-6 months time), so I’ll probably go with VEA instead. The bulk of my portfolio will be made up of VEA and VTI, along with XIC, VWO, XRB, and XSB. (Probably phasing in some XRE later too).

Popularity: 8% [?]

Ask Dave: USD Holdings in an RRSP

A reader recently e-mailed me with a question. Here it is:

Hi Dave,

Just a quick question, please.

I saw that you included Vanguard funds in your RRSP holdings but I am confused about that. I thought Vanguard only sells their funds to Americans (not to Canadians) so how are you doing that within the RRSP?

My answer:

Nope, anyone can by Vanguard ETFs. Not sure what you mean by “funds”. If Vanguard also has mutual “funds” those might be different. But their ETFs are just like stocks so you can buy them in the same way that you can by stock in other US companies.

He continues:

I am ready to open a self-directed RRSP for the first time. My wife is an American and has Vanguard funds and we just can say enough about them. I would love to include Vanguard funds (read index/ETFs) in my RRSP as well but how do I do it? Can I acquire them within any self-directed RRSP account company?

My answer:

I see, you DO mean index/ETFs. Yes all companies should allow you to buy them. The only annoying part is that no broker allows you to keep US cash in your RRSP (even though by Canadian law that is allowed). The consequence of that is that if you own VTI in US dollars and want to change it to VWO in US dollars you have to sell it, at which point it gets converted to Canadian dollars and then buy VWO at which point it gets converted to US dollars. So you get dinged on the exchange. If you only did this every 10 years or something like that, it would not be a huge deal (compared to the gains/losses you made on the underlying investments). See an article of mine, “Foreign Exchange Costs Associated With USD Investments in an RRSP” for related calculations. There is currently a lawsuit going on against BMO to stop the practice of not allowing Canadians from holding US cash in their RRSPs (even though it is allowed).

Popularity: 9% [?]

Some Minor Rebalancing: Bought XRB

There was some cash piling up in one our RRSPs again so it was time to buy something with it. I entered in my current portfolio into a spreadsheet that I have been using for probably over five years now. Once I enter in the current values of every part of the portfolio it tells me how much of each investment I would need to buy (or sell) in order to make things balance out. This assumes I sell my investments and buy others (which I don’t, I just buy more of the investments I have with available cash). So the spreadsheets numbers don’t exactly mean much. Basically it gives me some idea of how far off my portfolio’s asset allocations are from my desired asset allocations. I was wrestling last night with the decision of which investment to buy. I had about $2400 in spare cash. My holding in iShares MCSI EAFE International Index ETF (XIN) where a bit lower than the desired. $1000 or more into it and it would be balanced (bare in my mind that I won’t be splitting up this $2400 at all; I just want one transaction here). So if I put $2400 into XIN it would be more than balanced. Which is fine. Some of the other investments that I had small holdings in, such as Vanguard’s Emerging Markets Index ETF (VWO) and iShares Real Return Bond Index ETF (XRB) had much larger deviations from their desired/original allocation relative to their original allocation. So maybe I should be buying some more of those? So I modified my spreadsheet by adding a column that showed the percent change between the desired/original and actual allocations. I decided that since XRB had declined the most recently, and it’s actual allocation was the most below the desired, in relative terms, that I should buy some of it. I only needed to put in about $500 more into XRB to rebalance it. Buying $2400 more of XRB would put the actual allocation well above the desired. Like driving a boat, I’ve overcompensated a bit but that’s ok.

The most important thing I am trying to do is to minimize cost by only incurring one buy transaction every time I have enough money to reduce my commission to 1% of the trade’s value. E*Trade trades are $20, so I make a purchase every time I have over $2000 in cash. I never plan on selling in the near term, and finally, I try to add to an existing holding whose actual allocation is less than the desired/original allocation.

Popularity: 8% [?]

High Cost Group RRSPs

So my new company offers a group RRSP. It’s free cash so I can’t turn that down. But I am not too impressed with the investment selections available. Basically they are just a bunch of mutual funds and a few “managed portfolios” classified by risk profile. Nothing here that isn’t giving at least 2% in MERs to some company. I might just go for the managed portfolio option, somewhere between balanced and aggressive, so that I don’t have to worry about anything. I will definitely be calling HR and talking about what alternatives they could be doing instead. Like offering some low-fee index mutual funds instead. I definitely will not be putting any of my own money into the group RRSP. Instead I will put the rest of my allotment into my E*Trade account where I will continue to purchase low-cost passive index ETFs.

Update (June 28, 2007): I might have jumped the gun on that post a bit. Assuming that the mutual funds are all high MER funds. It turns out if I don’t choose anything on the initial form, they will just put it in a high interest savings account. Then, when I get online access you can supposedly play around from there all you want. Since I don’t have time to call HR and find out more about the investments options I might just do that for now.

Update (July 10, 2007) : Looks like there are some somewhat low-cost options available. Nothing as low-cost as index ETFs though.

Popularity: 9% [?]

My New Passive Index ETF Portfolio

Unfortunately this is the second time my portfolio has changed in the past two years. The first change was when I moved from a TD Mutual Funds account to Clearsight last year. My advisor had great plans for my portfolio. He wanted to eventually have me primarily invested in low-cost ETFs and we were going to have a 25-25-25-25 split between Canadian bonds, Canadian equities, international equities, and US equities. Due to the high commissions ($75) charged by Clearsight we bought one ETF and the rest was in mutual funds. Anyways, before we got very far Clearsight was acquired by Wellington West and my advisor was let go, so I began the transition to E*Trade where I could manage my portfolio on my own. I learned a lot from my advisor at Clearsight, like what an ETF is, and importance of lowering cost. I have come a long way since just owning just TD mutual funds and eFunds through a TD Mutual Funds account back in 2005. So before I introduce you to my new portfolio at E*Trade, here’s what my portfolio looked like when I was with Clearsight:

RRSP holding Symbol Type %
CI Value Trust US Equity 11%
Templeton International Stock Fund Global Equity 26%
Canadian TSX60 index ETF XIU Canadian Large Cap 34%
E&P Growth Opportunities Canadian Small Cap 4%
TD Canadian Bond Fund Canadian Bond 25%

Some of the things I did not like about my old portfolio are:

  • High cost – Too many mutual funds with high MERs. I checked all of these funds’ performance again and for the most part they didn’t seem to be capable of beating their benchmarks in the past. The Growth Opportunities has not beaten the S&P/TSX Venture Composite Index in the range I looked at. CI Value Trust (clone of Legg Mason Value Trust) has not been impressive of late, but even worse, it has assumed far more risk than an index, with its investments in Google and other high-tech stocks. The Templeton International Index fund (last time I checked) had not beaten the MSCI EAFE index over the long term. Also, the TD Canadian Bond fund is not all that spectacular compared to ETFs like XSB.
  • No emerging markets – I wanted some emerging markets to provide increased diversification and greater risk-adjusted return due to their low correlation with other markets. The fact that emerging markets have done very well of late is of no concern to me, I realize if I buy emerging markets equities now I might suffer a bit in the near future.
  • No real return bonds, or inflation-sensitive assets – I looked at the Ontario Teacher’s Pension Plan and the CPP Investment Board and both have significant real return bond holdings. The former has 11.1% and the latter has 3.5% in real return bonds.
  • Huge domestic bias – Although I had originally wanted 25% in Canadian equities my advisor had me at 40% because he had concerns about the US dollar, so we weighted Canadian equities more. This is way too much allocated to a handful of Canadian companies that make up a large part of the TSX/S&P 60 Index.
  • No foreign currency exposure – Foreign currency exposure can be a good thing. If inflation is high in Canada, our dollar will decrease in value relative to other currencies. More importantly, some of my investments, such as the CI Value Trust were hedged versions of USD mutual funds so I was paying extra management expense when I could have just owned the USD version and possibly reduced my total risk at lower cost.
  • Lack of US exposure – I only had something like 11% of my assets in US equities. This is extremely underweight for such a large market like the US. My advisor was planning to “ease in” to US equities (he had some issue with the falling US dollar) but I would prefer to just go with some desired allocation and re-balance when necessary rather than thinking one can be smarter than the market.
  • Lack of broad US exposure – Bill Miller’s Value Trust is invested in relatively few investments compared to the size of the US market. He also invested a lot in high tech companies like Google, Yahoo, Amazon, eBay, etc… I wanted to own more blue chips/boring companies, mid-caps, small-caps, etc…

So based on some of the things I did not like about my old portfolio, and some information that I gleaned from various blogs and internet sources, here is my new portfolio that I have putting together for the past couple months:

RRSP holding Symbol Type %
iShares CDN MSCI EAFE Index Fund ETF XIN-T International Equity 35%
Vanguard Emerging Markets ETF VWO Emerging Markets 5%
Vanguard Total Stock Market ETF VTI US Equity 32%
iShares Canadian Short Bond Index Fund ETF XSB-T Canadian Short-Term Bond 15%
iShares Canadian Real Return Bond Index Fund ETF XRB-T Canadian Real Return Bond 5%
iShares Canadian Composite Index Fund ETF XIC-T Canadian Equity 8%

Now I’ll expand on some of the reasons why I chose the above asset allocation as well as the reasons why I chose each investment in my new portfolio. This portfolio is inspired primarily by Martin Gale, Canadian Capitalist, Dan Solin (author of The Smartest Investment Book You’ll Ever Read), and Burton Malkiel (only part way through his book right now).

NOTE: I am under 30, I am looking for long term growth only, I am not planning to take out any of this money until I retire at age 55-65, and I can handle some short-term swings in the market.

ETFs vs. mutual funds
Using ETFs instead of mutual funds was a no-brainer for me. I have come to the realization that beating the market is virtually impossible for all but a few very talented people, and that passive investing can yield greater returns with less risk due to its lower costs. For more information, read my recent blog post “Malkiel, Bogle Argue Against Non-Market Capitalization Weighted ETFs” or read “A Random Walk Down Wall Street.” I can also give credit to the Canadian Capitalist and his blog for convincing me of this fact. He has been tracking a “sleepy portfolio” for a while now, consisting of a few ETFs and it seems to do pretty well.

Bonds
It was clear to me that I was not going to have a 100% bonds portfolio, nor was I going to have a 100% equities (as my advisor wanted me to have last year). Benjamin Graham is very clear in The Intelligently Investor page 56-57 about his opinion on this issue when he says “just because of the uncertainties of the future the investor cannot afford to put all his funds into one basket–neither in the bond basket, despite the unprecedentedly high returns that bonds have recently offered; nor in the stock basket, despite the prospect of continuing inflation . . .” There is much more discussion about this in the book. Martin Gale also has an excellent article about stocks vs. bonds. He says,

Many investors make the mistake of thinking that the least risky portfolio is one containing just cash and short-term bonds; or that the most aggressive portfolio is one containing only equities. Somewhat surprisingly, that is false. The safest portfolio contains a mix of stocks and bonds, as does the most aggressive. For any portfolio containing all bonds there is a less risky portfolio with a better return that contains some stocks. This is counter-intuitive because in and of themselves bonds are safer than stocks.

I saw some similar arguments in a Powerpoint presentation from an investment advisor recently, that basically said, no matter how risky you want to be, at least hold some bonds (like at least 10%). It is pretty widely accepted that you should have some bonds and some equities. How much of each is up to you. I followed Martin Gale’s advice on short vs long term bonds, and decided to stick to buying short-term bonds, because “whatever risk/return ratio you achieved by buying longer duration bonds, you could achieve by holding fewer bonds and more equities. In general I think the equities have the better risk/return ratio. That could always change–but at least historically, it’s been the case that equities have been a better investment than long-term bonds.” This backs up what I was told by my ex-advisor at Clearsight; stick with short duration bonds and avoid long duration bonds.

So, to minimize cost I see only two options. Buying iShares Short-term Bond Index Fund (XSB), or buying individual bonds and making my own bond ladder. I decided to buy XSB since the commission costs of making my own bond ladder would be prohibitive at this point, although when my nest egg is larger this might be more cost-effective because it would eliminate the MER.

Real-Return Bonds
As I said above, one of the disadvantages of my old portfolio was that I had no real-return bond component. Real return bonds are resistant to inflation because the interest is set to be x number of points above the inflation rate. I looked at the Ontario Teacher’s Pension Plan and the CPP Investment Board and both have significant real return bond holdings. The former has 11.1% and the latter has 3.5% in real return bonds. I decided to have 1/4 of my bond portfolio invested in real-return bonds which amounts to 5%. I might re-evalute this allocation later (in about 5 years).

Canadian Equity Component
Now that the foreign content limits are removed we are starting to see more and more people suggesting that Canadians hold somewhere around 3-10% Canadian equities in their equity portfolio, rather than the insane 25-70% allocations we used to see. At the Canadian Capitalist, Dan Solin comments on why investors should have no more than 10% Canadian equities in the equity portion of their portfolio. There is also a good article by Martin Gale here about domestic bias and foreign asset allocation. Finally, according to Carl Spiess at Scotia Macleod, “over the last 20 years, international markets have outperformed Canadian markets by almost 2% a year.” We have had some excellent years in the Canadian equities markets recently as well as in the late 1990s thanks to Nortel so people often forget that Canadian equities have historically underperformed against international markets. If you looked at the risk-adjusted return, the picture would probably be even worse. He continues, “it makes sense to invest globally not only based on historical returns, but also because many economic sectors (eg. Healthcare) are not significantly represented in Canadian markets. In addition, despite several good years recently, Canada only represents 3% of world stock markets.” He’s right; The Vanguard Total Stock Market Index has 12% in healthcare, for example, while the TSX Composite contains less than 1% in healthcare as it is dominated by financials and energy.

Another article here gives “10 key reasons for going global in your RRSP.”

US Equity Component
I relied heavily on Martin Gale’s advice on his Efficient Market Canada website. Specifically, his “Building A Globally Efficient Index ETF Portfolio (updated)” article (and it’s predecessor) and also “Foreign Asset Allocation in your RRSP.” I ended up making US Equities 40% of the equity portion of my portfolio, which corresponds to 32% of my total portfolio. The obvious choice here was some sort of S&P 500 Index, like XSP or SPY, but instead I went with the lowest-cost option out there, which is probably the Vanguard Total Stock Market Fund (VTI). It is even more diverse than the S&P 500 in that it currently holds 3692 different stocks. The US market is huge and this is a great way to own it all without having to purchase both the S&P 500 Index ETF (SPY) and the S&P Mid-Cap Index ETF (MDY) for example.

International Component
Again, as above, I looked at the global market capitalization and decided to put 50% of the equity portion of my portfolio into international stocks. This corresponds to 40% of my overall portfolio. Since Vanguard does not really have much for international index ETFs, and the iShares $USD MSCI EAFE Index ETF (EFA) has the same cost as the iShares $CAD MSCI EAFE Index ETF (XIN), the best option was to go with XIN (see “Exchange Traded Funds: Recommendations“).

CAD vs. USD
I was worried that with my much lower Canadian equity component that I would end up having a lot of US dollar investments in my RRSP. As I mentioned above, since Vanguard does not really have much for international index ETFs, and the iShares $USD MSCI EAFE Index ETF (EFA) has the same cost as the iShares $CAD MSCI EAFE Index ETF (XIN), the best option was to go with XIN, which is traded in Canadian dollars. So now my only USD holdings are the Vanguard Emerging Markets Fund (VWO) and the Vanguard Total Stock Market (VTI) which take up about 37% of my total portfolio. Having less than 50% of my RRSP assets in USD seems alright to me. When I get older and closer to retirement I could move more of my money into CAD investments if I feel the need.

Emerging Markets
There are two emerging markets funds to choose from, the iShares one (EEM) and the Vanguard one (VWO). After much searching on Google for “EEM vs. VMO” and reading many articles I could not discern much difference between the two. The Vanguard one uses a slightly difference underlying index as I discussed in my previous blog post entitled “Foreign Exchange Costs Associated With USD Investments in an RRSP” and, like most Vanguard funds, has a much lower cost than its competitors. So I went with the Vanguard fund. Because of the high risk associated with emerging markets and because of their recent stellar performance, I put only 5% of my total portfolio in emerging markets, even though emerging markets make up about 9% of the world market capitalization. I may increase my desired allocation of emerging markets later, relative to my other international holdings.

REITs
REITs are a good addition to the fixed-income portion of a portfolio and they provide good negative correlation with other asset classes. Most of the large pensions funds hold a significant amount of REITs. XRE is the iShares offering and I will probably be adding this in eventually. I don’t want to do too many things at once. I need to decide if I should reduce my bond allocation from 20% and add in the REITs or if I should reduce my equities from 80% and add in REITs. Or lower both? My original thought had been to have 20% bonds, 5% REITs, which is why I went with 20% bonds rather than 25% bonds as I had before.

Please let me know if you have any comments and I will add any details to this article that I may have left out.

Canadian Tour of Personal Finance Blogs

Popularity: 46% [?]