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.