The answer to that question is trickier than it appears. And it’s a question that was often posed to me when I was an advisor on the index based portfolios at Tangerine Investments. In fact, and often, I was not asked but challenged. Once the clients understood that the portfolios tracked the S&P 500 for US stocks, the TSX 60 for Canadian stocks, the EAFE Index for International stocks and the broad based Canadian Bond Universe index for Canadian bonds, I would at times hear …
I can just do that myself in an ETF portfolio can’t I?
“Absolutely” I would reply. An investor can create or copy that asset mix and keep the management expense ratios much more cost-effective. Here’s the fee breakdown using the popular iShares ETF versions for those indices.
TSX 60 – ticker (XIU) – .18% MER
S&P 500 – ticker (XUS) – .10% MER
EAFE – ticker (XEF) – .22% MER
Canadian Universe Bonds – ticker (XBB) – .19% MER
A Canadian investor can create an ETF portfolio with fees below .20% compared to 1.07% for those Tangerine Portfolios. Of course that’s in the area of 5x cheaper. That said an investor will have a transaction cost for every time they buy or sell those ETFs. Those fees are generally in the area of $5-10 per transaction. Certainly the discount brokerage houses will at times have special offers, packaging a bunch of trades for a bulk cost. They might even offer a series of free trades for new clients, so keep those deals in mind. That said, if an investor has trading costs they can quickly erode the MER advantage. Discount brokerage firms can also include annual administrative fees. My discount broker charged me $100 per account until I brought one of the accounts above $100,000.
For an investor who is adding monies on a regular schedule (a great idea of course) the MER advantage might quickly disappear for the ETF portfolio option. And of course many of the Canadian robo advisor offerings can bring those fees much lower than 1.07%, typically in the area of .50%-70%. While those other robo’s use ETFs to create portfolios for their clients, some of the robo’s will cover the transaction costs. At some robo houses you will have to pay the ETF transaction costs. That’s why it’s important to ‘know your robo advisors’. Stay tuned to cutthecrapinvesting for my more intimate look at each of the Canadian robo advisors, including Tangerine Investments.
But there is a factor or consideration that is much more important than fees.
Do you know what you’re doing?
Are you a competent investor? Now I’m not suggesting for a second that effective investing has to be complicated, it’s not. On Seeking Alpha, I often like to mangle a few expressions to suggest that “It ain’t rocket surgery”. But you do have to understand the basics, and you have to understand well – you. You have to understand and know Investor You.
You have to know your risk tolerance level. Meaning, you have to know how ‘comfortable’ you might be watching your portfolio get cut in half. Sound too scary? How about having 30% less money than you had a few months ago? Still not comfortable? How about 20% less? In the investment advisory world it is a compliance/regulatory staple to Know Your Client, short formed to KYC. If you’re running your own investment show, then you have to Know Thyself. It becomes KT. And risk tolerance is just one component of the KYC, er make that KT.
And once you’ve figured out your risk tolerance level, do you know how to create a portfolio that might only drop by that 30% in a major market correction? By 20%, or by 10%? Once again creating the portfolio to match the risk tolerance level is not that difficult, we’re just mixing in more of less of those bonds (shock absorbers). But investors that do not know how ‘to do this’ could set themselves for investment losses, the worst financial outcome for an investor. Most investors take on too much risk unknowingly, or they simply overstate or over-estimate their risk tolerance level.
You’ll find this as a shocker, but when the markets offer 9-10% annual investment gains over longer periods, the average investor has grabbed much less at 3-4%. Sorry to break the news to you but humans are typically terrible investors, especially men. Here’s a head scratcher of a chart from Dalbar figures measuring actual returns of mutual fund investors. That Orange bar is the market returns, that Blue bar (only coming up to the knees of the Orange bar) is the average investor. For the 30 year period we see 10% annual gains for the market and 4% for the investor.
The source of the underperformance is often an attempt to time the market, but mostly the culprit is investors running away in fear (selling) when the markets collapse. It’s the buy and hold and add investor who will grab the gains of the markets (minus any fees of course). And yes, it’s important to keep those fees low.
That’s why it’s so important to understand your comfort level for stock market volatility.
There are many other considerations of course. Your investment time horizon is important. How aggressive do you need to be to reach your goals? There are taxation issues to consider in the accumulation stage (building wealth) and the retirement funding stage. There may be a transition stage required from accumulation to retirement funding as well.
Now I’m not trying to scare you off the low fee indexing ETF route. It’s arguably the best way to build a portfolio for the investor that has done his or her research. That investor understands the stock and bond markets and portfolio construction techniques. That investor understands their ‘investorself’. And perhaps it’s not all that difficult to build a solid understanding of all of the above. I have many blogs on the investment basics from What is Index Investing to What is an Exchange Traded Fund? to how simple it can be to build that Easy Street Portfolio.
But as I write in my disclosure – if you don’t know what you’re doing, don’t do it. What I would suggest is that if you’re not quite ready you might start with one of the Canadian robo advisors and you can learn on the fly. You can continue and perhaps complete that portfolio education process with your monies in play. As Yogi Berra quipped “You can observe a lot, by watching”. At some point you might be able to say thanks and say goodbye and then move on to manage your own investment portfolio.
Another option is to find a fee for service advisor that will typically charge you a flat fee and then help you set up your own ETF portfolio. You get professional advice, and a low fee investment portfolio. You might check in with your advisor once a year and at that point, rebalance your portfolio. Once again, eventually, you might be comfortable moving on and managing that ETF portfolio.
Now if you feel you are fully prepared to build your ETF portfolio, congrats. And of course there’s always help and a sounding board at Canadian Couch Potato, moneysense and right here on this site. And as always it might be a good idea to pay up for some tax advice. It’s not what we make, but what we keep.
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