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. 

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. 

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. 

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. 

e-Series Top Holdings Breakdown

When you purchase an index fund, you are purchasing a very small portion of a pool of stocks. Some index funds can have hundreds of stocks within the fund. In this short article we will discuss some of the major holdings of common e-series index funds. Note that this article reflects only the major holdings at the time of the writing and that these can and do change overtime! This article stands to give an idea of what major stocks are held within some of key e-series funds. 

TDB 900 : Canadian Stock Index (Tracks TSX)

Top 5 Holdings (%):

Royal Bank of Canada (6.7%)

Toronto-Dominion Bank (6.1%)

Bank of Nova Scotia (4.1%)

Canadian National Railway Co. (3.7%)

Suncor Energy Inc. (3.1%)

Total Investments: 250

Fund Fact page

TDB 902: U.S. Stock Index (Tracks S&P500)

Top 5 holdings (%):

Apple Inc. (3.3%)

Alphabet Inc. (2.5%)

Microsoft Corp (2.5%)

Exxon Mobil Corp (1.8%)

General Electric Co (1.6%)

Total Investments: 504

Fund Fact Page

TDB 905: International Stock Index (Consists: MSCI Europe, Australasia and Far East Index)

Top 5 holdings (%):

Nestle SA (1.8%)

Novartis AG (1.7%)

Roche Holding AG (1.5%)

Toyota Motor Corp. (1.4%)

Royal Dutch Shell PLC (1.4%)

Total Investments: 935

Fund Fact Page

TDB 908: Nasdaq Index Fund (Tracks Nasdaq)

Top 5 holdings (%):

Apple Inc (14.6%)

Microsoft Corporation (7.4%)

Google Inc. (6.5%)

Amazon.com Inc. (3.8%)

Facebook Inc. (3.4%)

Total Investments: 110

Fund Fact Page

The Canadian Bond Index, as expected, consists of a variety (1229 investments in total) of bonds with various coupons and maturity dates. The Top 10 holdings are all Federal/Provincial Government bonds (Fund Fact Page). 

For youth investors interested in putting their money in individual stocks, but who may not have enough money to warrant transaction fees, realizing what the top holdings are of these common e-series funds may be intriguing. Say you only had $500 to invest and wanted to be a shareholder of Apple, purchasing the TDB 908 e-series fund would allow you to indirectly place 500*0.146=73 dollars of that $500 into Apple, while avoiding transaction fees and also exposing yourself to 109 other stocks. The top holdings can also give you some slight idea on the dividend payout of the fund. For example, the top 3 holdings of TDB 900 are all large banks that pay out strong dividends, meaning that you could estimate the overall fund to pay decent dividends (and it does, at slightly over 2.5%). Click here for an article on dividends and the use of DRIP.

-Yinvestors. 

keywords: e-series, Canadian index funds, top e-series holdings, index funds Canada, index investing, dividends, DRIP.

TFSA: Index Funds vs. ETFs

Both index and exchange-traded funds are types of mutual funds that are passively managed. They are designed to track a specific exchange, as oppose to mutual funds that aim to beat an exchange. For example, a TSX index fund would consist of many major Canadian companies. If the fund performs as it should, year after year it should fluctuate very closely to its respective tracking exchange. So what's the difference between Index funds and ETFs and which ones should you buy? Let's get in the lab and crunch some numbers.

Index Funds

Index funds are sold by the company managing the fund, for example you buy TD e-series directly through TD's broker. These index funds would not be available on the market to external investors who do not have an account at TD. Given that Index funds operate on MERs, purchasing and selling them will often be free of charge. We will discuss e-series heavily in throughout this blog as they are currently the cheapest index funds directly available to Canadians.

Exchange Traded Funds

ETFs are also index funds but openly traded on the market. This has two key implications, you now have to pay a commission to purchase/sell the fund and it has access to a greater pool of investors. The brokerage company will not be the entity managing an ETF you purchase. On the positive side, EFTs can be cheaper than standard index funds. A popular company that has the cheapest ETFs out there is Vangaurd. While being an American company, Vangaurd is increasingly providing new products targeted towards Canadians.

So it all comes down to balancing the need to have a discount broker and pay transaction fees to purchase a cheaper product, or simply to get a slightly more expensive product for no other fees.

TD E-series (Cheapest Canadian Index)
Given that e-series are currently the cheapest index funds available, we will use them as a basis for comparison. Here are the fees associated with e-series:

Table 1: MER associated with common TD E-series*

Canadian Stock Index (TDB900) MER: 0.33%

U.S. Stock Index (TDB902) MER: 0.35%

Canadian Bond Market Index (TDB909) MER: 0.50%

International Stock Index (TDB905) MER: 0.54%

Average: MER: 0.43%

The MERs are background fees charged. You do not see them ever passing as fees in your account transactions and they are not included in the performance assessment of an index. The four funds mentioned are some of the main e-series available (17 in total). On the TD Canada Trust e-series page you can find information on all of their available e-series (link here). To put the MER in perspective, it costs $43 per year on a $10,000 investment that is equally balanced between the four funds. That’s right, for $43 you can own a wide scope of the market that consists of hundreds of individual stocks and bonds!

If you are interested in getting started with opening an e-series account with TD, click here to learn (Article Coming!) more about how you can do this. The minimum amount required to open an account is only $100 and there are completely no fees for purchasing or selling e-series (although there is a 30-day minimum holding period).

Vangaurd Index (ETF)

Now let’s compare this to the Vangaurd indexes (ETF). Vangaurd in a non-profit company that is the biggest provider of index funds and currently manages around $3 Trillion in assets. If you are American, you can open an account directly through vanguard and purchase indexes that way. Unfortunately for Canadians, the only way to purchase Vanguard funds is by buying them as ETFs. Never-the-less, here is a look at the MER of some common Vangaurd indexes:

Table 2: MER associated with common Vangaurd ETFs

Vangaurd Canada ETF                           MER: 0.09%
Vangaurd Emerging Markets ETF          MER: 0.29%
Vangaurd S&P 500 ETF                         MER: 0.13%
Vangaurd Canadian Aggregate Bond     MER: 0.19%
Average                                                   MER: 0.175%

On a $10,000 investment equally balanced between all 4 index, the yearly fee would be around $17.5. This represents a near 60% discount from e-series. But! There are transaction fees not accounted for. If we assume each transaction costs $5, a total of 8 transactions per year would cost $40 (assume biyearly contributions). This would now make e-series the cheaper option. One of the fantastic options with e-series is the ease to add to your investments continuously throughout the year without having to worry about transaction fees. This is no longer the case when you have to pay a commission. If you have significantly more money to invest, ETFs can become a better option as depicted below:

Table 3: Comparing TD e-series and Vangaurd ETFs

As the table above shows, unless you have a substantial sum e-series would be a cheaper option. By linear interpolation, the break-even point would be around $15,700 under the estimated fee structure. The take away message here is that unless you have a substantial sum, it may not be worth the time dealing with opening an account with a broker and paying commission for trading ETFs. 

Keep an eye out for Vangaurd, they have recently released new indexes that target specifically Canadian Investors. If Vangaurd was to begin offering investment accounts directly to Canadians, they would clearly become the best option for Index investing. Many more blogs to come expanding index funds, stay tuned!

- Yinvestors.

Notes: 

• Currently Questrade provides free purchases of ETFs (although you still pay fees for selling). If you are looking to get investing in index funds, Questrade may a great starting place due to this promotion.
• The MERs of e-series have actually been increased slightly across the board during June 2015. The fees used to be: TDB905 (0.5%), TDB900 (0.31%), TDB902 (0.33%) and TDB909 (0.48%).  

Key words: ETF, ETFs, Exchange Trade Funds, Index funds, s&p 500 index fund, best index funds Canada, index fund list, low cost index funds, index investing, e-series, Vangaurd ETF, bond index, TSX index fund.