User:LadyGeek/Simple portfolios

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The simplest portfolios, also known as lazy portfolios, use Guaranteed Investment Certificates (GICs) or single mutual funds. Other simple portfolios are based on using index funds or the corresponding exchange-traded funds (ETFs) to build a low-cost structure with a small number of funds (generally five or less) that are easy to rebalance.

Sector diversification and index concentration

The Canadian stock market is far less diversified than the US market, and is highly dependent on just three sectors:[1][2] financials; energy (oil and gas); and materials (gold and mining). Therefore, an investor who purchases only Canadian securities may have insufficient sector diversification.

There are several ways to deal with this problem. All have drawbacks or associated costs. Several of these may be used in combination.

  1. Accept the lack of diversification. This means having little exposure to other sectors like consumer staples.
  2. Use additional broad equity funds or ETFs from other countries, particularly the US. Depending upon the amounts involved, this may expose the investor to wishes to live and retire in Canada to currency risk, since most of their expenses will be in Canadian dollars.
  3. Use currency-hedged ETFs or mutual funds. This adds additional costs.
  4. Use an actively-managed Canadian equity fund rather than an index fund or ETF. This adds additional costs and the fund or ETF may or may not outperform the index.
  5. Select individual stocks to maintain sector balance. This adds the risk of underperformance, as well as additional costs.

It is also possible for a single stock or small number of stocks to dominate the Toronto stock exchange. Nortel was 36.5% of the TSX on July 26, 2000, before eventually becoming bankrupt in 2009.[3] Although the index methodology has since been changed to limit the holdings to 15%,[4] the relatively small size of the Toronto market still leads to a heavy concentration of the index in a relatively small number of stocks, as is shown in Canadian-US investing differences.

The GIC or bond ladder

Main article: Fixed income ladder

One of the simplest portfolios can be obtained by dividing the portfolio sum into several equal parts and investing each part in a GIC which matures in each of the subsequent years. A five-year ladder would have five GICs maturing one, two, three, four, and five years hence. Since certificates maturing more than five years in the future are not covered by the Canada Deposit Insurance Corporation (CDIC),[5] a federally-guaranteed GIC ladder is restricted to a maximum of five years. A similar bond ladder, using Government of Canada bonds, can be extended up to 30 years.

Low cost balanced funds

One of the simplest ways to obtain a diversified portfolio is to purchase a single balanced or income mutual fund. However, simplicity comes at a price, as the management expense ratio (MER) of the fund will seriously affect future returns, as can be shown on the Mutual fund fee calculator | Investor Education Fund.

Rob Carrick has reviewed[6] several of the balanced funds available to Canadians.

The two fund portfolio

A low-cost way to achieve diversification between fixed income and equities is simply to divide funds between a Canadian bond index and a Canadian or global equity fund.

Index funds can be purchased as ETFs or as mutual funds. The ETF approach may be worthwhile for individuals who use a discount brokerage (and thus have low trading commissions).

Investors who chose a Canadian equity fund or ETF may not have direct exposure to foreign equities, but some foreign diversification is provided by the pricing of commodities such as oil and gold in US dollars and the non-Canadian earnings of Canadian-based international corporations. ETFs that might be considered for such a simple portfolio include the Ishares bond ETFs XBB or XSB and the Ishares large-cap ETFs XIU or XIC.

However, as pointed out above, investors choosing this approach should be aware that the Canadian market is relatively undiversified. Investors who wish a more globally diversified two-fund portfolio can substitute a global fund or one of the all-world ETFs discussed in the following section for the Canadian equity fund.

Two-Fund Portfolio
Asset Class ETF Amount
Domestic stocks iShares Core S&P/TSX Capped Composite Index ETF (XIC) 50%
Domestic bonds iShares Canadian Universe Bond Index ETF (XBB) 50%
Note: Enable browser cookies to view iShares website.
Canadian 2-Fund Portfolio.png

The two-fund portfolio can (and probably should) be expanded to add additional index funds or ETFs, making a three- or four-fund portfolio, when additional funds are available.

Three fund and four fund portfolios

Three-fund portfolios are formed by utilizing Canadian bonds, Canadian equities, and global stocks. A four fund portfolio further decomposes the global stocks into two funds: (1) US stocks and (2) international stocks. The developed markets portion of "international stocks" is also known as "Europe-Asia-Far East" (EAFE).[note 1]

Vanguard Investments Canada started ETF trading on the Toronto Stock Exchange in December 2011.[7] A simple three-fund portfolio can be constructed by first selecting an appropriate asset allocation between stocks and bonds, and then dividing the stock allocation between domestic and global.[8][note 2]

An example portfolio is shown in the following table.[9]

Vanguard Canadian Three-Fund Portfolio
Asset Class ETF Amount
Domestic stocks Vanguard FTSE Canada All Cap Index ETF (VCN) 25%
Global stocks Vanguard FTSE All World ex Canada Index ETF (VXC) 25%
Domestic bonds Vanguard Canadian Aggregate Bond Index ETF (VAB) 50%
Vanguard Canadian 3-Fund Portfolio.png


The four funds of a "four-fund portfolio" are: Canadian equities; US equities; Europe-Asia-Far East (EAFE Equities); and Canadian bonds. In different combinations, these index fund funds can provide a simple means of approximating the composition of the FPX Indexes (below).

For example, the FPX Balanced can be approximated by the following four ETFs:

FPX Balanced Four-ETF Portfolio
Asset Class ETF Amount
Domestic stocks XIU (iShares™ CDN LargeCap 60 Index Fund) 25%
International stocks VEA (Vanguard Europe-Pacific ETF) 15%
US stocks SPY (SPDR S&P 500 ETF) 10%
Domestic bonds XBB (iShares™ CDN Bond Index Fund) 50%
FPX Balanced Four-ETF Portfolio.png

The Couch Potato Portfolios

The original "Couch Potato Portfolio" was conceived by columnist Scott Burns of The Dallas Morning News.[10] Canadian versions of the portfolio were designed by MoneySense magazine.[11]

The following spreadsheet contains charts and tables of Canadian versions of Couch Potato portfolios. These portfolios are suggested by the Canadian Couch Potato web site.[12] The portfolios include:

  1. The Global Couch Potato: This simple portfolio—popularized by MoneySense magazine—gives exposure to stock markets in all developed countries, as well as a firm foundation of Canadian bonds.
  2. The Complete Couch Potato: This portfolio goes beyond the basics to add three additional asset classes (emerging markets, real estate and real-return bonds) while remaining extremely easy to manage.
  3. The Yield-Hungry Couch Potato:This portfolio was designed for investors who are seeking current income rather than long-term growth from their investments, and who are using a non-registered account. In January 2013, this portfolio was removed from the list of model portfolios.[13]
  4. The Über–Tuber: This portfolio is based on the academic work of Eugene Fama and Kenneth French. Because it includes so many funds, it may be difficult to manage and is not recommended for inexperienced investors. It is not likely to be efficient for accounts less than $200,000.

The fifth tab in the spreadsheet contains a table containing suggested ETFs for funding the portfolio allocations. Additional details regarding the portfolios are available from Canadian Couch Potato.


(view Google Spreadsheet in browser or download as xls, ods, or pdf)

Further discussion can be found at Canadian Couch Potato.

Prebuilt portfolios

Prebuilt portfolios in the form of mutual funds or ETFs, with different asset allocations or maturity dates, are offered by several vendors including Tangerine (formerly ING Direct),TD Investment Services, and BlackRock Canada .[14]

The FPX Indexes

The three Financial Post Indexes ("FPX Indexes") constructed by Richard Croft and Eric Kirzner[15] were designed to provide investable benchmarks for measuring portfolio performance. The three indexes are the FPX Growth, FPX Balanced, and FPX Income, and are designed to for Growth, Balanced and Income (Conservative) investors, respectively. Being investable indexes, any investor can buy the investments that make up the index. Daily values can be obtained from the Financial Post. Historical returns are available on this calculator from Croftgroup.

The 52-week highs and lows on November 1, 2013,[16] as well as the percentage drops of the three indexes, are shown below:

FPX Indices at 2013.11.1
Index 52-week High 52-week Low % Difference
FPX Growth 3129.195 2642.745 -15.5%
FPX Balanced 3192.224 2858.595 -10.5%
FPX Income 3224.180 3078.811 -12.5%

Notes

  1. ^ From a Canadian perspective, a global fund includes everywhere except Canada; an international fund includes everything except Canada and the US.
  2. ^ Rob Carrick has recommended the single all-world ETF XWD, offered by Barclays Canada. (Ref: Rob Carrick, The three-dimensional portfolio, Globe and Mail, July 31, 2009.)
    Comparable ETFs are provided by Vanguard: All World ex Canada (VXC) and World (Total World VT). Since Canada represents only 4% of Total World (VT), it and All World ex Canada (VXC) are very similar.

See also

References

  1. ^ MSCI Indices, Global Industry Classification Standard (GICS®) Structure - GICS - MSCI, retrieved November 28, 2012.
  2. ^ iShares Canada, XIC Overview: Sector Breakdown, viewed May 22, 2012. Sector breakdowns as of that date were: Financials, 31.59%; Energy, 25.76%; and Materials, 18.52%.
  3. ^ CBC News, Nortel's Icarus-like stock, January 15, 2009.
  4. ^ Wikipedia, S&P/TSX Composite Index, viewed May 30, 2012.
  5. ^ CDIC, What is insured?, viewed Dec 26, 2010.
  6. ^ Rob Carrick, The right balance: Low fees, high returns, Globefund, September 22, 2009.
  7. ^ Vanguard Exchange-Traded Funds Begin Trading on Toronto Stock Exchange | Business Wire, viewed September 11, 2014.
  8. ^ The role of home bias in global asset allocation decisions, - A decision framework to divide the stock allocation between domestic and international.
  9. ^ Re: Simple Portfolios 2014, Financial Wisdom Forum discussion.
  10. ^ Wikipedia, Scott Burns (newspaper columnist), viewed Feb. 18, 2009.
  11. ^ Hood, Duncan and McGugan, Ian, Couch Potato Portfolio: Introduction, April 5th, 2006. Viewed September 9, 2014.
  12. ^ Canadian Couch Potato, viewed May 23, 2011.
  13. ^ Revisiting the Couch Potato Model Portfolios | Canadian Couch Potato, viewed September 9, 2014.
  14. ^ BlackRock Canada, Portfolio Builder iShares Funds, viewed Dec. 26, 2014.
  15. ^ Richard Croft and Eric Kirzner. Financial Post Indexes, viewed Feb. 18, 2009.
  16. ^ Financial Post, FPX Daily Indices, viewed November 3, 2013.

External links

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