Canadian Couch Potato Podcast

Dan Bortolotti, the writer of the popular Canadian Couch Potato blog, has recently started a podcast series discussing topics around do-it-yourself investing. There are currently two episodes, which last between 30-40 minutes:

Episode 1: Are You Ready for DIY (28th November, 2016)

Episode 2: Planning vs Investing with Sandi Martin (14th December, 2016)

I highly recommend having a listen to these, they are a fantastic source of DIY investment wisdom. The podcast is available on iTunes and other major podcasting apps. You can find the podcast by searching "Canadian Couch Potato Podcast" in the iTunes store (it is completely free).

I also want to take the chance to wish all the readers a merry Christmas and a happy new year!

Remember that with the new year comes new contribution room to your TFSA!

-Yinvestors.

Bond Indexes and Currencies

When it comes to establishing your index portfolio, some form of bond index will likely be a key component of it. It may be a small or substantial part of your portfolio, depending on personal factors such as risk tolerance and age. One key consideration that is generally recommended is to purchase a bond index in your local currency (i.e. a Canadian would purchase a bond index in CAD, while alternatively an American would purchase a bond index in USD). The reason this is generally a good idea is due to the fact that currencies tend to experience greater fluctuations than bond indexes. As your objective is to invest in a bond index, not a currency, and assuming that fluctuations are equally probable to swing in + or – direction, the logical move is to purchase a bond index in your local currency.

If we look at the currency fluctuation between the USD/CAD since the year 2000:

(click image for increased resolution)

As compared to the calendar performance since 2008 of TD e-series Canadian Bond Index - TDB909:

As you can see from the graph, even currencies of large and geographically nearby economies can still fluctuate rather heavily over time. In comparison to a relatively steady return from the Canadian Bond Index. Bond indexes are generally considered one of the most stable types of investments you could possibly own. By purchasing one in a foreign currency, you add a multiplier of variance which is random by nature thereby defeating much of the purpose of buying a stable investment in the first place.

Hope you guys enjoyed the article and managed to take something away! As always feels free to share the article and interact in the comment section below!

-Yinvestors. 

The Great Move Away From Active Funds

While reading Bloomberg Businessweek magazine (June 27th-July 3rd 2016), there was a fascinating article on the shrinking business of actively managed funds, which definitely warranted a blog update. The article is titled “Active Managers Start To Feel the Pain” by Charles Stein.

The article underlines how many active funds are cutting down on staff as a response to recent reduction in portfolio sizes. These actively managed funds aim at picking investments (bonds and stocks) to beat the market index benchmarks. The Bloomberg article states that in the past 5 years, using December as the reference point, only 39% of active funds beat their benchmark. What’s important to note here is that these funds are substantially more expensive to own they index funds, especially if you are located in the U.S. - where you have direct access to certain index funds that can cost you around 0.05% in MER, while an active fund can charge you north of 1% (weighed average of 0.82%, according to the article). People are catching on - why pay more for what will probably perform worst?

The article states that since 2011, passive funds have experienced an inflow of $1.7 trillion while, while active funds experienced an outflow of $5.6 billion.  This is bad news for the active managements.  Money is flooding into index funds and slow sifting out of active funds, and the trend is likely to continue. The U.S. department of labor has placed new rules that require financial advisors to recommend retirement investment that puts their clients' needs as the primary focus; which will more often than not result in some type of passive fund.  Historically, financial advisors may have been biased or incentivized to recommend other products, such as actively managed funds.

Here are two quotes from the article:

“It’s pretty clear that active managers have not performed above their benchmarks to any great degree” – Peter Kraus, CEO of AllianceBernstein Holding (Asset management company).

“The reality is indexing is taking over” – Gregory Johnson CEO of Franklin Resources (Global investment firm).

Such trends are beneficial for the individual investor, as more money will be retained, on average, by the investor as opposed to making active fund managers extremely wealthy. Furthermore, the more individual investors that are getting into index funds, the more competitive products will likely become available. This may be especially significant in Canada where index funds that are directly available (such as TD e-series) are still substantially more expensive compared so those in the U.S. (such as Vanguard)*.

Hope you are all doing great and apologies for the long delay in not producing an article. Please interact by commenting below and help share the blog if you enjoy the content!

-Yinvestors.

Check out some of our other popular articles:
Best Index Funds and ETFs (Canada)
TFSA: Index Funds vs. ETFs
Choosing an Index Portfolio Model

*Vanguard funds can be obtained in Canada, but they must be purchased as ETFs through a broker, which comes with added fees. 

The Efficient Market Hypothesis and Indexing

We will get slightly more theoretical in this article, but we`ll keep it simple and brief!

The Efficient Market Hypothesis (EMH) states that stock prices perfectly reflects information currently available. The market is therefore perfectly efficient at pricing an asset. As the output of new information is, by nature, random (could be positive or negative, and to varying degrees) it would be impossible to predict the future trends of a stock by either technical or fundamental analysis. While this is simply a hypothesis (and one that does not come without controversy) it is interesting to discuss and see how it relates to index investing.

Following the hypothesis that the market is perfect at pricing a stock under the current conditions, trying to pick a winning stock (one that is undervalued) is a loser’s game. Beating the market would therefore be impossible. An investor would be best off investing in an index fund and enjoying normal market returns while minimizing fees.

The controversy comes from certain fundamental conditions or examples in the real world that challenge statements and assumptions of EMH, for example:

• The response time to new information varies, and therefore perhaps some edge can be gained by responding to new information faster than others.
• Information (and stock valuation) is not viewed the same by all investors, thus there is not a linear translation from information interpretation to stock pricing.
• Potential in human errors or emotions in influencing stock prices provide an additional element that the EMH does not account for. 
• Some proven investors do exist, such as Warren Buffet, that have consistently beaten the market over a long period of time.

While these concerns definitely hold weight, the market is becoming progressively more efficient in terms of response time to new information given how easy it is to trade stocks. This reduces the window of possibility for timing edges. There are also such a large number of investors participating in the market that if we assume information perspective (and stock valuation by individuals) is random, then the distribution of these random perspectives would average out to agreeing with EMH. This leaves emotional aspects, which contributes to variance in the market. Having said that, human emotions can also be viewed as random and thus making stock picks based on predicting human emotions would also be a loser’s game! Now there are definitely some stock pickers such as Warren Buffet that have disproven the EMH by being long-term winners in the market. As a Warren Buffet could simply not exists under the EMH.

Likely the EMH as a framework holds weight but it is influenced by some factors such as those mentioned above, which can challenge the legitimacy of the hypothesis during their extremes. Either way, it does reflect the high degree of randomness involved in trying to beat the market. Even if an exceptional investor continues to hold a winning strategy in beating the market, there would be high variance in the performance outcome due to vast uncertainties from randomness. As human beings are generally not good at dealing with uncertainties, investing in index funds may very well be the best strategy for the vast majority of investors.

Thank you for reading, if you have an topic recommendations please comment below!

Source: Dilbert

-Yinvestors.

Index Portfolio Planning (with Excel)

In our previous articles we’ve discussed how you can balance your index account using some example portfolio models, and we’ve also discussed the general importance of yearly rebalancing. In order to do this effectively, you will need to keep track of your progress. One easy and efficient way of doing this is to use excel. Excel is an extremely powerful tool and can do a lot of the work for you (which is perfect for couch potato investors).

Here is an example of an excel spreadsheet that I use:

In this example, our new investor has $5,000 to invest in a brand new TD e-series portfolio. 

Add in some equations and your portfolio distributions can be calculated for you. All you need to input (for numerical values) would be your initial investment amount and the % allocations you decide on. I like to include summation operators just to ensure no mistakes have been made before I place any orders. I also use the spreadsheet to keep track of which date I added to my investment as well as the reference number of each transaction.

It becomes very slightly more complicated when it comes to rebalancing, but follows the same logic. Here is an example of a spreadsheet for rebalancing:

To build on the previous example, our investor friend is adding $2,000 to his portfolio (one month later). For simplicity sake, we are assuming his investments have individually broken even over the past month (amounts are unchanged). 

This time you will need to enter your beginning account value. If you are not 100% confident with you excel skills, you can include more steps to reduce the use of longer formulas. Using the spreadsheets above I can easily add to my investments and have one master file that holds all this information for me. That way I know exactly when money was added, how my percentage allocations have changed over time, how much money was contributed, etc. It's simply good practice and not very complicated to do. I also recommend you save your file in a Dropbox or some other location that allows you to have a constant backup incase your computer fails.

Hopefully this article gives you some ideas on how you can better keep track of your investments as well as simplifying rebalancing. If you have any questions, comment below!

Thank you for reading and give the blog a follow/share if you enjoy the content!

Here are some of our other articles on similar topics:

Best Index Funds and ETFs (Canada)

Setting Investment Goals with Index Funds

What is Couch Potato Investing

-Yinvestors. 

Reasons for Index Tracking Errors

Index funds and ETFs have the purpose of tracking a given exchange, or market benchmark. To do this, the fund will typically have a portfolio ownership that is closely in-line with the characteristics of its benchmark (generally based on market capitalization for stock indexes). However, there are some key reasons why passively managed funds can (and do) slightly deviate in actual performance from their benchmarks. Deviations are known as tracking errors, and can be thought of as general inaccuracies in terms of fund performance. These are interesting concepts to dig deeper into, which also depict some fundamental workings of index funds.

A quick note on comparing fund accuracy to a benchmark, recall Beta and R-squared, which are both useful measures to asses the extent of tracking errors. Beta (or Beta coefficient) depicts how much more volatile an index fund is from its benchmark, with 1.0 representing perfect tracking; an index with beta of 1.10 is considered 10% more volatile than its benchmark. R-squared depicts how strongly correlated the benchmark and index are, from 0-100 with 100 representing a perfect correlation. Note that while tracking errors are part of an indexing portfolio, by the nature of being passively managed, these deviations should be relatively minimal (beta close to 1.0 and high R-squared values are expected). Note that another clear indicator of fund accuracy is past performance as compared to benchmark past performance. For the purpose of this article, we will consider index funds and ETFs as one unity and simply refer to them as index funds.

Possible Reasons For Tracking Errors:
- Trading Costs: Any trading costs will result in some reduction in performance and therefore a slightly lower return in the index fund as compared to its benchmark. Having said that, index funds are passively managed, so transactions (and associated commissions) should be very minimal. Regarding trading implications there are other factors such as taxes and exchange rates that can impact fund performance.
- Structure of the Fund: While an index fund will typically be weighed by market capitalization (to mirror its benchmark), there are other indexing strategies such as smart-beta which weighs differently to give investors greater potential return. Such strategies will by default fundamentally deviate the tracking ability of a fund from the base benchmark (you can think of the base benchmark as being shifted for some strategy, for example towards ‘Aggressive Growth’).
- Number of Investments: Along the same lines as the previous point, it is possible for an index fund to include some minor investments outside of its benchmark index. For example, TD903 (Dow Jones Industrial Average e-series index fund) consists of 32 total investments, while there are only 30 companies in the DJIA.
- Cash Drag: Any amount of cash that is held in an index portfolio un-invested will create a fluctuation buffer that will reduce tracking accuracy. Given the nature of index funds, it is rare that any substantial percentage of the portfolio will be cash. One situation where cash drag would be present is due to dividends. These would then typically be shared with investors and/or be reinvested into the fund.

These are some of the key reasons why you can expect an index fund to have slight performance deviations from its benchmark. As an index fund aims to track an index, not beat it, the ability to track a benchmark is thus a fundamental characteristic of fund quality. Being aware of tracking error dynamics can allow individual investors to compare multiple index funds and assess which funds may suit their investment goals and strategies best.

Thank you for reading, if you have any comments of questions please post below! If you have any recommendations for topics also post below or contact me in the form located on this page. Please give the blog a share and follow if you enjoy the content (especially the fantastic handmade graphical example)!

Here are some of our other articles on similar topics:

- Best Index Funds and ETFs (Canada)

- What Exactly is an Index

- E-series Top Holdings Breakdown

-Yinvestors. 

Best Index Funds and ETFs (Canada)

If we assume that any two funds are identical in effectiveness of tracking an index, it would be most beneficial to own the cheapest one. After all, why pay more for more-or-less the same product? While this may be the case, there could be some situations where you might chose a more expensive product, for example, due to practicality. In this article we will discuss the major ETFs and index funds available to Canadian investors. While we've discussed Vanguard ETFs and TD e-series index funds multiple times before, there are other competitive options available.

To give a quick recap, index funds are passively managed portfolios that track major indexes by owning many investments within that index. Exchange-Traded Funds (ETFs) are index funds that are traded on major markets, which come with a commission for trading, but tend to have lower Management Expense Ratios (MERs). You obtain an index fund from the company managing it (usually at no commission), while you buy an ETF off the market.

In the following comparisons we will only focus on: Canadian stock index, U.S. stock index, Canadian bond index and international stock index. Note that there are other index options with most of the funds listened below, although we will only focus on the most common indexes.

Exchange-Traded Funds For Canadians - abbreviated fund name (ticker), MER
Vanguard ETFs

Canada All Cap Index (VCN), 0.06%
S&P 500 Index (VFV), 0.07%
Canadian Aggregate Bond Index (VAB), 0.14%
Developed Europe All Cap Index (VE), 0.20%
Emerging Markets All Cap Index (VEE), 0.19%
Developed Asia Pacific All Cap Index (VA), 0.20%

BMO ETFs
S&P/TSX Capped Composite Index (ZNC), 0.09%
S&P 500 Index (ZSP), 0.13%
Aggregate Bond Index ETF (ZAG), 0.23%
MSCI EAFE Index (ZEA), 0.25%

iShares (BlackRock) ETFs 

S&P/TSX Capped Composite Index (XIC), 0.06%
S&P U.S. Total Market Index (XUH), 0.11%
High Quality Canadian Bond Index (XQB), 0.13%
MSCI All Country World (ex. Canada) Index (XAW), 0.22%
MSCI Emerging Markets IMI Index (XEC), 0.28%

If you’re going to purchase ETFs, Vanguard funds remain the cheapest option available, although both BMO and BlackRock offer competitive products. Given the nature of ETFs (traded on exchanges) you should really be getting the cheapest ones possible, unless you wish to purchase a specific fund not offered elsewhere. Another option not mentioned are Horizon ETFs, Horizon provides a way range of ETFs (including commodity ETFs), although they are more expensive than those mentioned above. Currently Questrade discount broker offers free purchases of ETFs, while you will still have to pay transaction fees on sales, removing all purchasing costs is already fantastic.

Index Funds For Canadians - abbreviated fund name (ticker), MER
TD Canada e-Series Index Funds
Canadian Stock Index – e (TDB900), 0.33%
U.S. Stock Index – e (TDB902), 0.35%
Canadian Bond Index – e (TDB909), 0.50%
International Stock Index – e (TDB911), 0.54%

Even though TD increased the MERs of e-series slightly over the summer of 2015, they continue to be the cheapest index funds directly available to Canadians. You can purchase these investments online through a TD e-series Funds account (accessible online through TD Canada Trust EasyWeb, or through TD Direct Investing). It is also possible to purchase e-series through a TD TFSA. If you have a medium to small sum to invest, e-series index funds will very likely be your best option for simplicity and pure value.

RBC Global Asset Management Index Funds
Canadian Index Fund (RBF556), 0.72%
U.S. Index Fund (RBF557), 0.72%
Canadian Government Bond Index (RBF563), 0.67%
International Index (RBF559), 0.71%

National Bank Index Funds
Canadian Index Fund (NBC814), 0.66%
U.S. Index Fund (NBC846), 0.67%
International Index Fund (NBC839), 0.66%

While RBC and National Bank also offer index funds, they are substantially more expensive to own than e-series. If you have all your banking accounts with one of these banks and have a relatively small sum to invest, it may not be worth the trouble of opening an investment account with TD. Also take note that you have more indexing options with TD e-series than with either RBC or National Bank. An advantage to RBC and National Bank indexes is that they are also available through discount brokerages (although at that point, you really should be buying ETFs).

Tangerine Investment Funds
Balanced Income Portfolio (INI210), 1.07%
Balanced Portfolio (INI220), 1.07%
Balanced Growth Portfolio (INI230), 1.07%
Equity Growth Portfolio (INI240), 1.07%

I came close to leaving Tangerine funds off the list since having an MER of 1.07% is very high for an index fund, but there are benefits to owning these funds. For one thing, it does all the work for you. Each Tangerine fund listed above is actually already a balanced index portfolio, so you only need to buy one to be very diversified and don`t need to worry about rebalancing. For example, the ‘Tangerine Balanced Income Portfolio’ consists of: 70% Canadian bonds, 10% Canadian stocks, 10% US stocks and 10% International stocks. The other three portfolio options are simply more aggressive on stock index ownership. You have to open an account directly with Tangerine to obtain these funds (TFSA option available), and there is no account minimum. If you have just a small sum to invest, this may well be a great option; although if you have even just a couple thousand to invest, you would very likely be better off investing in e-series.

The index or ETF that is ideal for you will depend on a few factors such as: investment amount, frequency of transactions, simplicity, brokerage fees, products to purchase and personal preferences. Please have a look at the complete list of funds available before making a selection, as there are other funds I have not listed for simplicity sake. Also note that not all funds listed can be directly compared in terms of MER, as they do not all track exactly the same indexes (especially the case for international stock indexes). Its is also important to note that while index funds that track the same index are not identical in nature, they tend to be very similar.

Here are some of our other articles on similar topics:
Choosing an Index Portfolio Model
What Exactly is An Index?
TFSA: Index Funds vs. ETFs

Please help pass on this article and give the blog a follow if you enjoy the content!


-Yinvestors


Note that MERs consist of management fees and all associated operating fees. It is typically based on the previous costs experienced over the last 12-month period (or as reported). It is worth nothing that it is based on 'historical data' and does not perfectly depict future costs. Having said that, the most recent numbers provided by each company are used and MER does provide the most accurate basis for cost comparison available. MERs are also fairly consistent given an index fund will typically have relatively stable and predictable costs due to its passive nature. 

Setting Investment Goals with Index Funds

Establishing investment goals can be difficult given the number of uncertainties and complexity with time scales. Never-the-less, investment goals are useful in establishing how reasonable certain expectations can be. In this post, we depict a simple way to establish and assess long-term investment goals with index funds. This is good practice when you start out investing (or start to have a stable source of income) to give you a very realistic chance of achieving your goals.

Framework for index investment goals
Objective: How much do you want to have saved and for when.
Limitations: What is your time frame, starting investment sum, risk tolerance, etc.
Savings target: How much per year (or per month) can you add in contributions.
Portfolio model: Which portfolio model will you be following (article on portfolio models).
Rebalancing strategy: How often will you be rebalancing.
Monitoring strategy: How often will you monitor your investment and for what reason.

Let's look at an example:
Objective: Save $1,000,000 post-inflation (assuming 3%/year) in a TFSA for retirement.
Limitations: Invest for 40 years, with starting portfolio value of $30,000 at relatively low-risk (decent bond exposure).
Savings target: $5,500/year for first 10 years, then $6,000/year for remaining 30 years.
Portfolio model: Following the bond-by-age model (to lower risk exposure with age).
Rebalancing strategy: Once a year.
Monitoring strategy: Monitor investments biyearly, if an index ever shifts 10%+ in this time period, rebalance portfolio.

We also need to make an assumption on the annualized return of the modeled index portfolio. If we assume it generates 7.5%/year, this would represent a post-inflation corrected return of 4.5%/year. Will we achieve our goal?

While the graph looks great, under the given conditions, this portfolio will only be valued at $829,376 after the 40 year period (with a 3% annualized inflation correction). By knowing this, we can play with certain conditions to place ourselves in the best situation possible to achieve our investment goals. For simulation purposes, conditions we can change include: starting investment sum, investment time period, contribution amount/frequency and expected annualized rate of return. For example, if we were somehow able to begin investing with $58,200 instead of $30,000 with all other conditions unchanged, we would end up with $1,000,778. If markets performed better than expected and we averaged 8.5% annualized (5.5% post-inflation), without changing any other conditions, our portfolio would be worth over $1.1 million. I recommend you set your investment goals and apply some conservative conditions and then some slightly optimistic conditions, so that you can have an idea of the realistic range of expected return.

Post below if you have any questions and thank you for reading!


-Yinvestors.



keywords: index fund investment strategy, investing framework, index funds, index portfolio, inflation, rate of return, investing goals.

What is Couch Potato Investing

The term 'Couch Potato' is perfectly defined by the Urban Dictionary as:

“A lazy person who does nothing but sit on the couch and watch television.”

It comes with fantastic synonyms like: slacker, lazy, bum and slug.

That doesn’t sound too much like a life goal, but it actually does present a viable strategy for investing. A couch potato investor would be a passive investor who deals with his investments once a year. The rest of the year, this investor may or may not contribute to their investments and they may or may not even care to see how their investments are performing. How could this possibly be a good strategy?

1) You are not being emotionally influenced by short-term market fluctuations. How can you be when you’re not even looking at your investments! If you hold a balanced index portfolio, you are so heavily diversified that any short to medium-term swings will likely be insignificant. Not tracking your performance daily or even monthly allows you to keep an eye on the bigger picture, which is long-term growth.

2) You are avoiding heaps of fees. While you may have free transactions if you are buying e-series or other index funds, ETFs tend to come with commissions. The more you trade, the more fees you accumulate. By trading only once a year (adding to investments and rebalancing) you are limiting fees while maintaining some level proactivity.

3) It’s an easy approach. Yep, being lazy is easy. A couch potato investor might deal with their investments for an hour or two a year and achieve better returns than their neighbour who spends nights trying to find the next hot stock. You could know next to nothing about the stock market and still carry out a couch potato investment strategy (and obtain solid results), making it an attractive option.

The key concept here is that a couch potato investor keeps things simple, there is incredible power to simplicity when it comes to investing.  

To expand on index investing, taking the couch potato approach can be very beneficial to youth investors. One of the key objectives is to begin investing at a young age and use time to your advantage (as depicted in our previous article: The Power of Time). Most young people tend to know little about the stock market and investing, creating a barrier to entry as investing is viewed as being immensely complicated. In most North American education systems, business literacy is given little importance. It is also viewed as a personal topic and rare that people will openly discuss their finances. Most youth likely have little idea what their parents’ true financial situation is (and nor do their parents tend to want to talk about it). This results in young people making bad financial decisions as no one has taught them how to deal with money. Getting involved in index investing is perfect for young people as it is a passive approach that doesn’t require deep market knowledge to be effective. So, for once it may actually be a good idea to be a couch potato.

If you enjoy the article, please help share and give the blog a Google+ follow! Learn how you can begin investing in index funds.

-Yinvestors.

keywords: couch potato investing, index investing, what is couch potato investing, index funds Canada, e-series, index investing strategy. 

Choosing an Index Portfolio Model

We discussed briefly in the 'Combining a Tax-Free Savings Account and Indexing' article about how to balance your index fund portfolio, but it is a fundamental step in getting started and worth discussing more in-depth. How you first set up your index portfolio will likely impact how you invest for years to come.

The purpose of having a balanced index portfolio is to increase exposure to various markets and investment types. A common strategy for North American investors is to include the following four index types:
- Canadian Stock Index
- U.S. Stock Index
- International Stock Index

- Bond Index

For the U.S. stock index, you can either choose an S&P 500 index or a Nasdaq Index. I tend to prefer an S&P 500 index as it consists of more companies. For example, the e-series Nasdaq index actually consists of 110 investments, while the S&P 500 index consists of 504 investments. Regarding the bond index, you should obtain one that is in your local currency. The reason for this is that currency fluctuations can often be greater than bond returns. Since you are looking to get bond exposure, not currency exposure, sticking to a bond index in your local currency is most logical. An international stock index will typically consist of the some of largest international markets combined as one unit. If, for example, you only wanted to invest in European stocks, you could purchase an all-European stock index instead.

Great, so now we have an idea of what to buy, but how much to buy of each? There are four general strategies you can follow as a balanced index investor:

Strategy 1: bond allocation = age
(example for a 22-year-old investor)
Bond Index (22%)
Canadian Stock Index (26%)
U.S. Stock Index (26%)
International Stock Index (26%)

One effective and common solution is to set your bond percentage allocation as your age and to then split the remaining allocation across all stock indexes. As in the example above, a 22-year-old investor would place 22% in a bond index and split the remaining 78% across the three stock indexes. One advantage of having this strategy is that your bond allocation naturally increases over time. Meaning you are gradually decreasing risk exposure with age while having substantial stock exposure at a younger age, giving you a chance at greater returns.

Strategy 2: even distribution across all indexes
Bond Index (25%)
Canadian Stock Index (25%)
U.S. Stock Index (25%)
International Stock Index (25%)

This option is great for simplicity and offers strong stock exposure, but you are not reducing risk over time.

Strategy 3: bond index heavy
Bond Index (70%)
Canadian Stock Index (10%)
U.S. Stock Index (10%)
International Stock Index (10%)

An option for a low-risk portfolio still with some stock exposure. This option will be the least volatile, but will generally have the lowest average expected long-term return.

Strategy 4: stock index heavy
Bond Index (10%)
Canadian Stock Index (30%)
U.S. Stock Index (30%)
International Stock Index (30%)

An option for a higher-risk portfolio still with some bond exposure. This option will be the most volatile, but will generally have the highest average expected long-term return.

Pie Chart Overview of the Four Index Portfolio Models

These are only some general models you can follow. You can select indexes and set percentage allocations are you see fit for your own situation. Keep in mind that greater stock exposure tends to represent greater risk but greater potential rewards.

Steps Overview:
Step 1: decide which types of index funds you want to invest in. I recommend choosing between 3-5 indexes, including a bond index in your local currency.
Step 2: decide which portfolio model strategy you want to follow. If you are unsure, I would recommend going with the first option (bond allocation=age).
Step 3: if you already have an investment account, you can now place orders! Continue to rebalance to your original allocations through contributions (at least once a year).

If you have any questions about portfolio models, comment below!

Here are some of our other articles on similar topics:
Best Index Funds and ETFs (Canada)
The Case For and Against Rebalancing Your Index Portfolio
Adjusting Your Index Portfolio During Market Downswings

-Yinvestors.

keywords: index portfolio models, index investing, e-series, bond index, stock index, how to balance my index portfolio, S&P 500 index, index funds. 

Adjusting Your Index Portfolio During Market Downswings

Theres no doubt markets are off to a horrible start to begin the year. Here is the current overview of North American markets to start 2016:

Dow Jones (8.67%)

S&P 500 (9.40%)

Toronto Stock Exchange (6.34%)

And many of the international markets are doing even worse. It's not exactly all sunshine and rainbows at this point. So, how can you respond effectively to this?

Stick to the same strategy we've been talking about since the beginning.

Continue with your monthly contributions but now you will likely be splitting them between the stock indexes only to increase you percentages back to your original allocations. If you are unable to contribute enough to your investments to reset percentage allocations, consider selling off some bond indexes (which have remained relatively stable this year) and buying more stock indexes instead. If you have not read our blog post on discussing % allocation click here.

All you can do is make the best of the situation and put your money to use so that it can build on itself in the future. If you were comfortable with buying S&P 500 stock indexes at the end of 2015, they are now at a 9.4% discount! It would be illogical to put off on buying more given we do not know the future of the market. Continue with the strategy and variance will ride itself out.

Stock may continue to drop, they may rebound, they may do a mix of both, no one knows. By continuing to buy during lows, you stand to benefit from downswings by having bought cheaper units. When upswings do occur, you will be there to reap the benefits.

In 2008 when the market crash occurred, the Dow Jones ended down 33.84% on the year (S&P 500 was down 38.49%) only to then rise for the next 6 years. The losses were more than made up for. The cheapest index units you could've possibly bought over the past 10 years were during this recession. Savvy index investors should think of the word opportunity when markets crash.


-Yinvestors.


keywords: index, index investing, stock market, index balancing, rebalancing index, index funds, e-series, S&P 500 index, S&P 500, TSX index, DJIA index, U.S. stock index, Canadian stock index, Canada index.
Graphs source: Yahoo Finance 

The Power of Time (and why you should start investing now)

I often see over the internet people asking questions such as:

- "I am 17 and want to learn about investing, where do I get started?"

- "I am a college student with $5,000 to invest, what are my options?"

- "Can I start investing with $1,000, and how?"

These are all questions that cross the minds of many young people and, to some extend, depict how our education system has failed. It is fascinating that so often business/investment education is not a critical aspect of education systems, while managing and investing money will be of fundamental importance for the rest of our lives. This blog is motivated to help people find answers to such questions in a simple manner so that they have a starting point to develop their investment strategies.

Regarding the last two questions that depict some fix amount ready to invest, some answers I have seen were that it's a small amount and probably not worth investing. While having $1,000 to invest will not give you much flexibility to trade individual stocks (commissions will eat your money away), you definitely have some options! Two clear-cut options are to buy bonds or index funds, where you will face a percentage fee that will be low due to your investment amount.

So is starting to invest $5,000 today worth it? Let's have a look.

We will assume our passionate youth investor has $5,000 and will be building himself a well-balanced index portfolio that yields him 7% annualized average. We will assume that over the years, he will contribute $1,000/year to his investments. Let's watch how his money grows over 50 years:

After 50 years, our investor is now a bit older and has contributed a total of $55,000 to his investment portfolio ($5,000 to start and $1,000/year afterwards). His portfolio value is now a staggering $553,814! How is that possible? Well, your best friend when it comes to investing is time. The younger you are, the more time you have to make your money work for you. Even if it is a small sum, it really does add up. That initial $5,000 alone would be worth $10,000 after about 10.5 years and by the end of the 50-year period, it would be worth $147,285.

Let's look at some of the assumptions here. First off, you never paid any taxes on your earnings, which could be the case if you made use of a TFSA. Second, a 7% return annualized is achievable with a balanced index portfolio, although if you were to hit a downswing right out of the gates, this would significantly impact you down the line (given your initial capital is 5x your yearly contribution). In this example, we simply assessed 7% as a linear return, which would not be the case, some years your might lose 5%, some years you might gain 12%. Regardless, the example does depict the power of time.

Let's now look at a different case, let's compare the same investor who decided to spend his $5,000 and held off investing for another 10 years. Can't be that bad can it? Well let's have a look over that same 50-year period:

So actually, it's pretty significant. In the second case, a total contribution of $45,000 has been made, as compared to $55,000 in the original case (an extra 10 years at $1,000/year contribution). Let's look at the end result though: our delayed investor has a portfolio value of $274,507 versus the more diligent investor with $553,814 - over twice the amount! How is that possible? Again, think back to compounding. The 7% you made your first year off the $5,000 has made 7% from itself every year, this progression reiterates itself every interval and for your contributions. This is how you can establish wealth off not much starting capital!

The sooner you begin investing, the better off you will be. Even a small sum can grow into a fortune under the correct conditions. Don't listen to those telling you a small sum isn't worth investing! You have to start somewhere and if the small sum even just motivates you to save up money, it is immensely valuable.

Here is a link to the table breaking down the number for the graphs depicted above (graphs may not load, but table works). Comment below if you have any questions and please give the blog a G+ follow! More posts on similar topics coming soon!


-Yinvestors.


keywords: youth investing, compounding interest, compounding growth, growing money, how to make money grow, investing, money growth, index funds, index investing, money. 

Index Funds and Mental Strength

One of the key characteristics of good long-term investors is drawing the line between making sound investments and emotions. When the stock market crashes, it is common for people to panic and sell off their investments without really understanding why this is happening and being critical as to whether the quality of their investments is still present. Logically speaking, if the quality of the stock has been maintained but the overall market is tumbling, the stock is becoming progressively cheaper. This is an easy concept to understand, but much harder to practice when your life savings are on the line. The emotional element of investing outlines why smart-analytical people can become losing investors. In this article we will discuss why index funds provide emotional comfort when investing in the market, which may be especially important to youth encountering monetary swings for the first time. 

With the correct mindset and investment strategy, managing
your investments can be an enjoyable experience! (source)

Not Trying to Predict the Market

When investing in indexes you are not trying to predict the market. For the most part, you are adding to your investments along the way - at least once a year. By continuously adding to your investment you are reducing variance over the long term. For example, if a given index is down 5% a certain month, through monthly contributions you are lowering your average cost per unit. Not trying to predict the market also means you do not hold off on adding to your investments because the market seems expensive. Even if the market is at a 5-year high, if you choose to hold off on contributing to your portfolio waiting for it to drop, you are somewhat trying to predict the market! What if the market remains relatively stable for the next five years? What if it rises another 20%, or what if it drops 20%? How will you know if it will not drop another 30%? Money is better invested and contributing to dividends since market dynamics are excessively complicated and impossible to predict over any extended period of time. Following the same principle, if you are about to contribute to your investments but markets are tumbling, is it worth waiting? The concept of trying to predict the lowest an individual stock will fall is referred to as 'catching a falling knife'. No one knows how low it will reach and if you misevaluate, you might get cut. This principle somewhat applies to index investing. If you are worried about the state of the market, you could choose to contribute your money in smaller amounts and more often instead.

If you are limited in your ability to add to your investments, another potential strategy would be to keep a certain (but small) percentage of your portfolio in cash, say 5%. This may be a more legitimate strategy to investors buying individual stocks as by the nature of their investments, their portfolios will be less diverse. Meaning it is more likely for a market crash to impact all your investments, versus an index investor than has money in foreign markets and bonds. Having a fix cash allocation gives you the flexibility to buy cheaper units of stocks or index if markets slump. For Index investors, owning bond indexes in your account that provide more stable returns and still give you buffer to rebalance may well be a better strategy. 

You Cannot Blame Yourself for Swings

One of the benefits of owning a well-balanced index fund portfolio is that the swings will be much smaller as compared to owning individual stocks. When substantial swings do happen, it will be because of global market dynamics that no one could've predicted accurately. This means that as an investor, you should be rather emotionless towards swings. You cannot be down at yourself for your recent stock purchase, since you've bought the whole market! By having your money invested in indexes, you are giving yourself a chance at experiencing greater returns than fix investments and keeping ahead of the inflation curve. On average you are making a winning investment. The greatest swing the DJIA experienced in the last 10 years was 7.87% in one day (which is a massive swing for an entire market). If you had 30% of your portfolio allocated in the DJIA, you would've experienced a decrease in value of (0.3*0.00787)*100=2.36% in portfolio value (or $236 on a $10,000 portfolio).

Another key characteristic that distinct index investing versus common stock investing is the risk assessment of losing your entire capital. Assuming that the company managing the index is reputable (such as Vangaurd, BlackRock, banks etc.), it becomes effectively impossible for an index portfolio to go bust. You would need major governments (provincial and federal) to fail to meet bond payments and all major companies to go broke, both domestic and international. Taking the concept of 'too big to fail' to a whole new level.

Remain Realistic About Your Investments
Regarding the mental game, it's also important to be realistic about market returns and understanding that investing in index funds requires a long-term outlook. It's very possible that you could lose money on your investments over some period of time, this does not mean you are making bad investments! Markets fluctuate year-to-year, but do go up on average. Keep a long-term outlook and continue to lower your average cost per index unit during index slumps.

Post any questions below and give a Google+ follow!


-Yinvestors.


keywords: index investing, index funds, mental strength, market dynamics, e-series, index funds. 

What Exactly is an Index?

- Sure all this index talk sounds great, but what really is an index and how does it represent companies in the market?

The most simple way to explain an index is that it is a list of stocks.

You have common indexes such as the Dow Jones Industrial Average (DJIA), Standard & Poor's 500 (S&P 500) and Nasdaq that consist of the largest public companies in the U.S. In theory, you could create you own index and track some segment of the market. For example, you could create a Canadian banks index, decide on a weighing system and track it over time to depict how banks as an index unit are doing. Indexes provide a simple way of tracking a group of stocks without having to process too much information. It's all about reducing sample size to gain a general image of market dynamics.

- So where did this all start? And how does it actually work?

The first Index was created in 1896 by Mr. Dow and appropriately named the Dow Jones Industrial Average. At the time, it consisted of 12 of the biggest companies in America (today it consists of 30). The value of the DJIA was established by adding the the prices of the 12 companies together and dividing by 12, providing a simple average. While there are flaws in doing this, it was a simple and efficient enough method at the time. 

It is now more common to use a market capitalization (market cap = share price * number of shares outstanding) method of weighing companies within an index. For example, if a company has a market cap of $5,000,000 and the complete value of all stocks in the index is $500,000,000, this company would represent 1% of the index. Let's say the stock dropped by half in value, while all other stocks remained unchanged, the index would drop by 0.5% in representative value. To calculate the actually price of an index, an index-specific divisor is used. The divisor accounts for structural changes within companies, such as share repurchases and mergers. In the example of the S&P 500, the sum of all 500 market caps are divided by the divisor, giving the index level (or value of the index). To give an idea, the current index level of the S&P 500 is $1880 and has a 52-week range of $1812-$2134.

- So why does knowing this matter?

As an investors, its always beneficial to be knowledgeable on what you're buying. Understanding how an index price fluctuation actually relates to individual stocks can be beneficial (and vice versa). You may also be interested in assessing how heavily weighted some of your favourite companies are within their respective index. Understanding how an index is designed can also help you asses the effectiveness of your index fund. For example, the three biggest companies in the S&P 500 are: Apple, Google (Alphabet) and Microsoft. An effective index fund should probably hold these companies as their top holdings, as they will have the most influence of any company on price fluctuations of the index (remember they are weighed by market cap!).

Knowing how an index is computed also depicts how an index could be down over a given time period while most of the stocks within the index could actually be up. This could be the case if a few stocks (or specific industries) in the index were down significantly, bringing down the complete index.

- How does this relate to index funds?

Index funds track these major indexes by purchasing stocks of many (sometimes all) of the companies within the index. You can expect that your index fund will have top holdings of the largest market caps within an index. Looking back to our article on the top holdings of e-series, for TDB 902 (S&P 500 index fund), the top 3 holdings were in fact:

Apple Inc. (3.3%)
Alphabet Inc. (2.5%)
Microsoft Corp (2.5%)

The metric used to asses how well an index fund tracks its target index is R-squared. R-squared is a common statistics metric that asses the strength of correlations between two sets of data. The values range from 0-100%, where 100% would present a perfect fit. When assessing the effectiveness of an index fund, you'd expect this value to be in the high nineties. For example, the 1-year R-squared value of TDB 902 is 99.00%, its 3 year value is 98.70% (Yahoo link). This signifies the index fund has been very accurate at tracking the S&P 500.

If you have any questions regarding indexes, comment below! Happy investing!


-Yinvestors.



keywords: index investing, index funds, what is an index fund, e-series, index, what is an index, index funds Canada, stock indexes, how does an index work

The Case For and Against Rebalancing Your Index Portfolio

Case For Rebalancing

Owning a well balanced index portfolio is a strategy to reduce volatility within your investments. Over time, some indexes will over-perform while some will underperform. In order to maintain a high level of protection against market volatility, it is good practice to rebalance your portfolio at least once a year. When rebalancing, you are looking to lower risk exposure, but not maximize long-term returns. Meaning the volatility of your investments will be lowered but so will your average expected long-term returns. Vangaurd has compared how two hypothetical portfolios (50% global bonds, 50% global stocks) would have differentiated from 1929 to 2014 with or without rebalancing. Regarding the benefit of balancing, the annualized volatility was dropped from 13.2% to 9.9%. This is because stocks have historically had higher returns than bonds, thus over a larger sample size the portfolio becomes progressively more stock-heavy and therefore more volatile.

One benefit of rebalancing is being honest about the time horizon of your investments. Any given year when the stock market experiences a loss, the investor with a greater bond exposure will do better. Bond indexes tend to provide an almost linear return. Here is how the Canadian Bond index has grown (with reinvested interest) since inception in 2000. 

TDB909  Canadian Bond Index Performance Since Inception

Source: TD Canada Trust

Clearly having a greater exposure to this index in your portfolio will offer risk protection versus more more volatile stock index. You expected returns on the flip side will be capped lower. This index has actually increased in value in 9 of the past 10 years, with returns ranging from -1.6% (2013) to +9.1% (2011). (fund fact page)

If we compare it to how the Canadian stock Index has done since inception in 1999 (with the use of DRIP).

TDB900  Canadian Stock Index Performance Since Inception

Source: TD Canada Trust

While still exhibiting an upward trend, the road is more bumpy here. In the past 10 years this index has increased in value 8 of 10 years, with returns ranging from -32.9% (2008) to +34.6% (2009). (fund fact page) 

Note that when assessing historical prices, these represent indications of volatility, risks and historical trends, but do not present future predictions on returns. 

Another benefit of indexing is that it forces you to stay up to date with your investments. If at least once a year, you analyze your portfolio and add money to it, you are being a proactive investor! This in itself is very valuable. Another benefit of rebalancing is that it forces you to add money to investments that have had mediocre results, not to the winning funds. This way you are not engaging in any sort of performance chasing (i.e. putting your all your contributions in the index that has had the best returns last year).

Case For Not Rebalancing

You could also make a strong case for not balancing. Since balancing is a strategy to reduce variance, not maximize returns, you may decide it's not worth it. You just have to be ready to accept that your portfolio will be more exposed to market fluctuations. Going back to the Vangaurd comparison, the annualized return of the balanced portfolio was 8.1%, while that of the unbalanced one was 8.9% (over the 85-year assessment). While this is a hypothetical scenario, it does indicate a notable difference in returns. If you do not value rebalancing, then you could also simply omit investing in bond indexes altogether, as this will further increase your chance of obtaining maximum returns. This comes down to a personal question of how comfortable you feel with handling risks within your investment portfolio. Personally, I find that having some small bond allocation is a good idea. If global markets drop and you have no additional money available to invest but hold 15-20% of your portfolio in bonds, you can sell some to purchase cheaper stock indexes. This enables you to remain more versatile with your investments and gives you more flexibility to react to external market dynamics.  

Another potential argument for not investing in bond index is that they represent a higher MER than both North American stock index options. Therefore by investing in stock indexes, you are paying less to own an investment with greater potential returns (not the case for the international stock index). 

Whether or not to use rebalancing will be a personal decision, although it is considered to be good practice. If you have any questions about rebalancing, comment below!

-Yinvestors.

keywords: index balancing, index funds, e-series, etfs, exchange traded funds, MER, management expense ratio index funds, td e-series, index investing, index investing Canada, best Canadian index funds

The Importance of Dividends and Why You Should Use DRIP

Following up on our previous post explaining e-series and how they offer a DRIP program (Dividend Reinvestment Plan). In this blog post, we will analyze the importance of reinvesting dividends for long term growth. Dividends are an important portion of your earnings, they represent your only earnings that are ensured within the market a given year. Dividends fluctuate over time, for example, during the market crash of 2008, many companies that were historical dividend payers cut their dividends in order to retain funds for recovery. Here are the current dividend payout of four common e-series index funds:

TDB900 - Canadian Stock Index

(.531/20.67)*100 = 2.57% (variable, annually)

TDB909 - Canadian Bond Index

(0.034/11.71)*100 = 0.290% (variable, monthly), or 3.48% (annually, assuming no compounding).

TDB905 - International Stock Index

(0.213/8.78)*100 = 2.43% (variable, annually)

TDB902 - U.S. Stock Index 

(0.745/46.99)*100 = 1.59% (variable, annually)

Sample Equation:

(last distribution/current price)*100= dividend % (or interest, in the case of bonds)

Note that these are variable and the percentages are a function of the current price and the most recent payouts (which was throughout December 2015 for the three stock index and on January 29, 2016 for the bond index). The payout itself is dynamic as it can change depending on the characteristic of the index portfolio, but also if companies within the portfolio change their dividend payouts (for better or for worst). The bond index is the only one to payout monthly, currently at a rate of 0.29%/month or 3.48%/year (if not reinvested); if DRIP is used, effective annual interest rate would actually be around 3.54% due to compounding. Note that for the bond index it is interest, not dividends, that you are receiving. 

Now let's assume you have the following portfolio allocation:

30% Canadian Stock Index @ 2.57% dividend yield

15% Canadian Bond Index @3.54% dividend yield (compounded monthly)

25% International Index @ 2.43% dividend yield 

30% U.S. Stock Index @ 1.59% dividend yield

You would obtain an average dividend yield of around 2.39% per year. On a $10,000 investment, this amounts to $239. Not so bad for earnings from dividends alone! Assuming you made no additional contributions to your portfolio, the following year you would stand to earn even more due to compounding.

Now lets assume your $10,000 investment somehow remains completely stagnate in market value over the next 50 years (and assuming yearly re-balancing), here is how your 2.39% dividends would compound:

Compounding Dividends Impact

$ amount (year)

239.0 (1)

244.7 (2)

250.6 (3)

256.6 (4)

262.7 (5)

302.7 (10)

383.3 (20)

485.4 (30)

778.5 (50)

Your initial $10,000 would now be a portfolio valued at $33,353 due to DRIP alone! Had you not used DRIP over the complete 50 years, you would've earned 50*$239= $11,950 - but by reinvesting dividends, you have now accumulated $23,353 in dividends, or 95.4% more money! While using a 50 year time scale is a bit extreme, it depicts the power of compounding interest by using a dividend reinvestment program. Click here to view the complete breakdown.

Let's look at a more concrete example relating to e-series. Below are two graphs that show how $10,000 would've grown in the U.S. stock index (TDB902) over the last 10 years with or without DRIP.

Case A: TDB902 last 10-year return with DRIP

Source: TD Canada Trust

Case B: TDB902 last 10-year return without DRIP

Source: TD Canada Trust

This indicated a difference in portfolio value of $21,742 - $18,284 = $3458, or a portfolio worth 18.91% more. In the second graph, the investor still received dividends but decided not to reinvest them. If we focus on the last term on the graph, and taking the current 1.59% dividend yield, investor in case A would make $345.70 in dividends, while investor in case B would only make $290.72. This difference again would continue to magnify over the years as investor A would enjoy compounding growth while investor B would not, as depicted in the prior example.

Reason to use DRIP:

• Allows your dividends to compound year after year
• Free program (e-series)
• Easy to set up
• A great way to contribute annually to your investments

For long term investors, there's really is no good reason to not be using the DRIP program if it is available and free, so I suggest you do so! If you have any questions regarding dividends or DRIP programs, please ask below!

-Yinvestors.

Note that dividend section was written in relation to the price and payouts at the time this article was written, please view this TD page for up-to-date prices and payouts for index and mutual funds. 

keywords: e-series, index funds, index investing, dividends, DRIP, dividends, dividend reinvestment plan, high dividend index, dividend yield, compounding dividend, index funds, Canadian stock index dividend, Canadian bond index interest, dividend reinvest.