On the Cut The Crap Investing ETF Model Portfolio page you’ll find 3 Balanced Portfolios. Next in line is the All Stock Portfolio. This is the ‘plain vanilla’ couch potato approach of using broad market indices. In this portfolio the stocks are flying solo without the support of those bonds that can work as shock absorbers. As I will often suggest, Stocks are the unruly kids, bonds are the adult in the room.
You might call this one, the unruly kid portfolio. But with that risk return proposition at play this model has the potential to reward you for taking on that greater risk – with greater returns.
Once again we see the core building blocks of Canadian, US and International companies. Here’s the asset allocation and ETFs for consideration.
XUU replicates the Core S&P Total Market Index. At the time of writing the underlying holdings includes over 3400 US companies. That exposure to more mid and smaller cap companies has the potential to provide some slight outperformance compared to the most, or more popular S&P 500 index. This is known as the size premium as mid cap and small cap companies have a tendency to outperform large cap, and especially mega cap companies. The lesser cap companies have more ‘growth runway’ in front of them compared to the more mature (but already greatly successful) large and mega caps.
XUU is priced in Canadian dollars and is essentially a fund of funds. It is an ETF comprised of other US Dollar iShares ETFs. The MER is .07%.
The weighting to those lesser caps is quite modest but you might see a slight boost over the S&P 500 thanks to IJH and IJR. At time of writing that midcap and small cap fund has outperformed the IVV and ITOT over a 10 year period and beyond.
Here’s a comparison of the mid cap ETF IJH as Portfolio 1, the small cap IJR as Portfolio 2, and the S&P 500 fund IVV as Portfolio 3.
The chart is courtesy of portfoliovisualizer.com. This is a wonderful site and tool for the self-directed investor. You can test mutual funds, ETFs and asset allocation models in the accumulation and decumulation periods. There are Monte Carlo simulators, model portfolios and more.
The outperformance is significant, and again that is the long term history and potential for the lesser caps. For more on factors that beat the market, I’d suggest you read Ploutos on Seeking Alpha. The size premium is just one of the 5 Ways To Beat The Market.
Now keep in mind that with the fund of fund XUU the lesser caps make up a slight percentage of the total fund. For those that want greater exposure to the mid and small cap funds see the Greater Growth Portfolio on the ETF Model Portfolio page. As a self-directed investor you have the freedom to dial up or down that lesser cap exposure.
Moving North of The Border
For the Canadian stock component you’ll see iShares XIU as an option. While many Robo Advisors will go with a total market for their choice for a Canadian market ETF, seeking greater diversification and exposure to the lesser caps, I prefer to load up on the bigger caps that includes a greater allocation to the big Canadians banks and other long time and generous dividend payers. Many (including the world’s greatest investor Warren Buffett) will suggest that nothing beats a wide moat around a company. Those big Canadian banks and insurance companies and the big Canadian telcos operate in an oligopoly situation – largely protected from competition.
That wide moat.
There’s nothing like a free hand to produce generous long term profits and big and growing dividends. To each his or her own, but I am hopeful that the TSX 60 index will continue to (marginally) outperform the broader market indices thanks to the wide moat of the large caps. As you may or may not know, the big Canadian banks are the only large cap sub sector to beat the pants off of Warren Buffett (BRK) – essentially beating him at his own wide moat game. Even Mr. Buffett’s ability to find value it not enough to overcome that Canadian big bank oligopoly at work.
The MER for XIU is .18%.
And Moving Overseas
For International exposure you’ll see iShares XEF. This fund replicates the MSCI EAFE IMI index and will invest in ‘the stock markets’ of developed nations and holds over 2500 companies. EAFE stands for Europe, Australasia and the Far East.
Here are the top 10 International holdings. With this fund we will add some geographic and sector diversification. Once again the fund is in Canadian dollars and all currency conversion costs are covered in the management expenses. The MER is .22%.
The Risk Level
As an all stock offering there is the potential that the portfolio could fall by 30%, 40%, 50% in major market corrections. Twice in the last 20 years markets have fallen (crashed) by some 50%; in the correction of 2000-2002 and in 2008-2009. One who invests in an all stock portfolio should be prepared for those events but at the same time realize that volatility is ‘normal’ stock market behaviour. It’s not a straight line up. Historically, think of it as a roller coast that goes up in the sky. It can be a rough ride, but the general direction is up, up and away. Of course we also need a longer time horizon of several years or more to invest in an all stock portfolio.
Here’s a 25 year chart, the portfolio is 50% US market and 50% Developed International markets. Could you hang on? It might be worth the white knuckle ride if you can. In the example below we see that the investor would have enjoyed more than a 550% return on initial funds invested. Figures do not take into account any fees, inflation, or currency effect.
If you are young (and brave) and in the accumulation stage with many, many years and perhaps decades to invest you might embrace that volatility and remember that the stocks and stock funds ‘go on sale’. When the markets collapse those lower prices allow you to accumulate more shares or units. If you’re investing on a regular schedule, you’ll be scooping up those shares at sale prices, and you’ll ‘catch the bottom’.
Self directed investors should be aware of currency conversion charges and withholding taxes on US dividends. It can be best to hold your US funds in a US-listed ETF in an RRSP account due to the reciprocal tax treaty between the US and Canada on registered retirement accounts. There are many other nuances on ‘what goes where’.
If you have any questions, please send a note to email@example.com and I’ll get you the answer or direct you to a financial planner who can offer a more detailed response. Here’s a great primer offered by John Heinzl of The Globe & Mail, Watch Out For Tax Traps With US Index Funds.
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