active management | Trevor Abes: Writer

August 25, 2021

Young Canadian Investor #33 – How I’m Invested

After 32 posts covering investing basics for the young Canadian investor, I figured I should show how I apply the principles I’ve written about thus far. Here’s what my personal investment portfolio looks like.

I currently have two TFSAs, one RRSP, and one taxable brokerage account.

One TFSA holds indexed mutual funds and ETFs and individual stocks. Its allocation breaks down into:

Canada: 30% (including 10 per cent to individual small cap and micro cap stocks)
USA: 25% (including 10 per cent to small cap stocks)
Developed International: 20%
Emerging Markets: 20%
Canadian bonds: 5%

The rationale here is to hold even slices of every public stock market in the world, which index funds offer, with tilts toward small cheap companies, which have historically offered higher average returns compared to their large counterparts.

The index mutual funds are no load, meaning I can stuff small amount of money in them without paying a commission, compared to ETFs, which, at this bank, cost me a commission of $10 every time I buy or sell them. The mutual funds have higher annual fees than indexed ETFs, but not that much for the size of my investments, making me comfortable about using them as accumulation vehicles I’ll eventually transfer over to ETFs when I’ve saved enough for the annual fees to matter.

I do pick individual stocks in this account, and I’m fully aware that the odds are against me. That said, I’m happy to take the extra risk, tempered by thorough research, for the promise of higher returns compared to just owning index funds.

The incredible cover of my book on getting started with index funds, which is linked at the end of the article.

The other TFSA is at an institution that allows me to buy ETFs commission free. Indexed ETFs charge much cheaper annual fees than mutual funds, and I was interested in not having all of my accounts at the same institution, so it made sense for me to open the second account. It holds only index ETFs as follows:

Canada: 20% (including 5% to real estate)
USA: 20% (including 10% to small companies)
Global value stocks: 10%
Developed International: 20%
Emerging Markets: 20%
Global bonds: 5%
Canadian bonds: 5%

Besides institutional diversification, the rationale here is to lower my overall investment costs by investing in ETFs, which are the cheapest way for everyday investors like you and me to benefit from stocks. Again, everything is more or less evenly split across the world with value and small company tilts.

I own bonds in both accounts so I have cash around in case markets drop, offering me a discount. I also own them as a second layer to my emergency fund, just in case I find myself in a royal jam. Additionally, the bonds and the real estate pay me monthly income, and I like a slug of my portfolio doing that, again for diversification’s sake.

The RRSP, and this will start to sound like a broken record, is invested in indexed ETFs, even slices, you get the deal. It looks like this:

Canada: 25%
USA: 25%
Developed International: 25%
Emerging Markets: 25%

Not bothering with the small caps here, just broad index funds that represent what their names say. I may change my mind about that later, but for now, the extra simplicity is welcomed, and the four funds are likely to do their fair share to get me to my financial goals anyway. I get granular in the TFSAs because there’s academic evidence supporting it, but also because investing is a passion. Mindlessly socking away money in a diversified portfolio of index funds will serve you well over the long term.

There isn’t much money in the RRSP or taxable brokerage account because a TFSA offers me tax-free investment growth and I can take the money out no penalty as I please. You can’t get your money from RRSPs without paying a 5-15% withholding tax per withdrawal, plus adding it to your income for the year. Alternatively, you could ask your bank to turn the account into a Registered Retirement Income Fund and start paying you out the money, which nixes the withholding tax, but you’re not retired, so that makes no sense.

I opened the taxable brokerage account just to do it, because eventually, when I run out of RRSP and TFSA room, that’ll be the only place left to sensibly invest for the long term. Unlike a TFSA, which offers tax-free investment growth, and RRSPs, which offer tax-deferred investment growth, investments in taxable brokerage accounts will ding you for every gain.

Here’s what it looks like:

Canada: 50%
Berkshire Hathaway: 50%

The Canadian allocation is to an ETF that doesn’t pay any dividends as part of its mandate. That means I can just hold the ETF and let it rise over time without having to worry about taxes until I sell, which I plan on doing in a few decades. The investment company offers international ETFs with the same no dividend mandate, but I find their fees too expensive, so I’m eschewing proper diversification for now.

The Berkshire allocation is strategic in that no dividends is also part of its mandate, and it owns a broad selection of companies in different industries, but I’m also just fanboying out on owning Warren Buffet’s company, exercising my belief in what he and Charlie Munger have built and the structures they’ve left in place to steer the ship when they’re gone. I don’t even care that the institution where I have the account robs its investors by charging 1.5% per C/USD conversion. It’s such a small percentage of my overall portfolio, and I believe in management enough to feel good about them earning me a return I’m satisfied with over time.

I’d like to eventually make some investments in private companies when that gets easier here in Canada, but that’s just me nerding out again. As you can see, the core of my holdings is made up of index funds, which is basically equivalent to owning the entire global stock market, a strategy that has beaten active managers or stock pickers 90% of the time or so over periods longer than 10 years. Not really a popular stance in Canada, where pretty much everyone relies on active management, but the evidence is on my side.

Oh yeah, I own a little Bitcoin and Ethereum as well. They’re 1% each of my overall holdings, small as venture investments ought to be. I feel I’ve gone down the rabbit hole and learned enough to be happy to be there in that capacity.

Another oh yeah, the ETFs I own come from Ishares and Vanguard.

If you read this far, I bet you have questions. Feel free to drop them below.

I also have a book on index investing you can learn more about here.

Disclaimer: This article is meant for general education purposes only. It does not constitute financial advice as I am unaware of your personal financial situation. Consult with a professional who abides by a fiduciary standard before making any investment decisions.

January 16, 2021

Young Canadian Investor #21 — What It Costs To Invest

While investing is an essential part of being financially responsible, it’s important to know that it isn’t something you can do for free. There are costs associated with acquiring and owning stocks and bonds to save for your future, so you might as well learn about them now instead of being startled by them on a monthly statement years down the line. Let’s get going.

First off, anyone who buys or sells shares of stock has to pay a commission to the brokerage house facilitating the transaction. Usually that’s between $5-$10—if you do business with Questrade or one of the big banks—but Wealthsimple recently became the first financial institution in Canada to let you trade stocks for free.

If you own shares of a mutual fund or ETF that owns numerous stocks, bonds, or both, you’re going to pay something called a Management Expense Ratio (MER). The MER includes the salaries of investment professionals in charge of overseeing the fund, as well as any associated legal and administrative costs. What you’re charged is a percentage of the money you have invested on a yearly basis. Ex: suppose your fund’s MER is 0.5% per year. That means 0.5% of your investment will be taken by the fund to keep the lights on, usually calculated daily and withdrawn monthly from your balance.

Funds will also charge you a Trading Expense Ratio (TER), which is simply the amount of brokerage commissions the fund incurs to implement its investment strategy. The more stocks and bonds the strategy dictates that they buy and sell, the higher the TER will be.

If your fund engages in active management, that means its portfolio managers try to pick what they consider to be the stocks and bonds with the highest potential return. This tends to entail a hefty research budget to figure out what investment to pick, as well as a higher TER that reflects the buying and selling of these investments as they fall in and out of the research results. In Canada, an active fund will generally cost you 1%-2% of your investment per year all things considered.

If your fund engages in passive management, that means its portfolio managers don’t go to the trouble of trying to make predictions about the best investments to own. They opt instead for owning every stock, bond, or both in the markets they cover, or at the very least a sample or index of them that’s representative of the whole. The managers take this route because they believe that human progress will continue indefinitely, which will be reflected in the long-term rise in value of their stocks and bonds. A passive or index fund in Canada will cost you 0.1%-0.3% per year depending on what parts of the world it covers.

Which style has made investors the most money dependably over time? The evidence is squarely in passive investing’s corner.

Then there’s always the option of hiring a financial advisor to make all of your investment decisions for you. If you truly feel that you don’t have the time or patience to learn by yourself, this is the way to go. An advisor will probably cost you about 1%-1.5% of the value of your investments per year—and that’s on top of any fund MERs and TERs—but the fee is worth it if it frees up your time to do more of the things you love.

Now you have a good working sense of what it costs to invest, making you better prepared to make informed financial decisions.

Feel free to ask any questions in the comments!

If you are ready to learn how to invest on your own, have a look at my new investing guide for young Canadians. It’ll give you the tools you need to put your money to work in index funds in no more than an afternoon.

I’m also available to teach you 1-on-1 over Zoom if you prefer.

Disclaimer: This article is meant for general education purposes only. It does not constitute financial advice as I am unaware of your personal situation. Consult with a professional who abides by a fiduciary standard before making any investment decisions.

December 5, 2020

Young Canadian Investor #14 – The Downsides of Stock Picking or Active Management

If you’ve ever thought it’d be a good idea to pick your own stocks, as opposed to investing in broad index funds, I’m here to dissuade you.

1200px-Wall_Street_bubbles_-_Always_the_same_-_Keppler_1901

Illustration by Udo Keppler.

For one, if you invest in a fund that tracks the global stock market, it’ll never go to 0 unless the world ends. If you buy $1000 worth of shares in a single company you believe in, on the other hand, it could fall on hard times, causing the share price to plummet, and with it your ownership stake.
The only way stock picking can work out is if you treat the endeavor like index investing, by which I mean owning stakes in a diversified group of businesses and holding them for decades. To follow through here, your research needs to support the long-term success of these businesses in spite of temporary drops in prices per share. It’s common for great investments to drop by 50% or more on their way to paying off for you. Will you be able to keep your convictions and hold on, or will you cave at the first whiff of trouble, make up an excuse, and panic sell at a low price like most self-directed investors? What makes you so sure that the investments that have caught your eye aren’t just the latest overpriced fads everyone and their grandmothers are joining the herd to own?
To produce high-quality research, you need to take the time to learn how to evaluate a business as it stands to make a judgement about its future prospects. If you’re interested in building up savings over the long term so you can live with dignity through your golden years, this is not something you can do casually when the fancy arises. You’ll have to immerse yourself in the intricacies of balance sheets, income statements, cash flow statements, and quarterly and annual reports at a minimum to give yourself a chance.
As an active investor trying to earn returns above the global stock market as a whole, or at the very least your national stock market, history is decidedly against you. Over 10 years, you’re looking at about a 20% success rate among professionals, with the percentage dwindling the farther out in time you go. Compare this to participating in your national stock market by owning an index fund that tracks it, which will provide you with that market’s return year in and year out minus a very small fee.
Speaking of fees, one of the hardest parts about making active investing profitable is keeping commissions under control. You usually pay $5-$10 per transaction when buying or selling stocks, while index funds can be bought on Questrade for free.
It’s also important to realize that, if you buy individual stocks in your RRSP or TFSA and they permanently tank, you can’t get that contribution room back. It might be hard to feel strongly about the benefits of accounts where investments can grow tax-free, especially if you’re young and justifiably all about the now, but it’s basically free money. You’d be doing your future self a huge disservice by letting it go to waste.

Still feel like building wealth by buying shares in individual companies? It’s not that it’s impossible to do well for yourself in this way. There are plenty of examples out there of people who dedicate their lives to investing through in-depth research and make a decent living off gains, as opposed to investment management fees they’re paid whether or not they produce satisfactory returns for their clients. If you’re consumed by your passion for picking stocks, by all means, have at it. But if you’re not, I wish you more than luck.

If you’re interested in learning how to invest through index funds and you’re looking for a concise guide to see you through the process—from establishing financial goals, to opening an RRSP or TFSA, to purchasing your investments and caring for them year to year—you’ll likely find my new book to be of service. It’s called Nine Steps to Successful Investing: A Guide for Young Canadians. It uses plain language, and draws from some of Canada’s leading voices in personal finance, to set you up with the fundamentals you need to grow your money as a self-directed investor.

I’m also available to teach you 1-on-1 over Zoom if you prefer.

Feel free to drop your questions in the comments.