Millionaire Teacher (15 page)

An array of Vanguard's Target Retirement Funds, with their respective bond allocations and portfolio turnover rates is shown in
Table 6.2
. Remember not to get too concerned by the target date in the name. If you're a 50-year-old without a pension, it's wise to select a portfolio (or a fund, in this case) that has a bond allocation somewhat equivalent to your age. If, however, you're expecting to enjoy a generous pension upon retirement, you can afford to take greater risks by choosing a target fund with a lower bond component.

Table 6.2
Turnover Rate of Vanguard's Target Retirement Funds

Source:
Morningstar.com
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The United States is one of the easiest countries from which to build an investment account of indexes. And the options are rapidly growing for non-Americans as well.

Indexing In Canada—A Landscaper Wins by Pruning Costs

Originally from Rotorua, New Zealand, a beautiful city built at the bottom of an old volcanic crater, Keith Wakelin's family moved to British Columbia, Canada, when he was a teenager.

As a keen, long-distance runner, he made a name for himself as a tough competitor who has been racing toward finish lines for nearly four decades. When he was 42, he won Vancouver's body-destroying 50-kilometer Knee Knackering Mountain Race in 2000. At 52, he's still a competitive force to be reckoned with.

Keith soon recognized that investing and distance running shared common ground. You can't carry excess weight if you want to be fast over long distances. And if you want to increase your odds of growing rich, you can't carry the burden of excess financial costs.

Wanting to diversify across all markets, Keith bought a total international stock market index, a Canadian stock market index, a U.S. stock market index, and a Canadian bond market index.

He simply followed
MoneySense
magazine's global couch potato performance concept, suggesting that you can split your money in the allocations as shown in
Table 6.3
.
MoneySense
tracks this portfolio online.
5

Table 6.3
The Global Couch Potato Portfolio

At the end of each year, Keith looked at his account's allocation. Each of his indexes performed slightly differently. Taking a few minutes once a year, Keith rebalanced his account back to its original allocation.

By selling off bits of the winners to add to the losers each year, Keith earned a total return of 28.5 percent (in Canadian dollars) from January 2005 to January 2011. This includes the drumming that the world's stock markets took in 2008–2009.
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How did Keith's portfolio stack up?

In Canada, there are five main banks, and they have the lion's share of the actively managed mutual fund business:

The closest actively managed funds we have to Keith's portfolio (in terms of how the assets are placed) are with the “Balanced Funds” and each of the Canadian banks above has its Balanced flagship constituting both stocks and bonds.

How did Keith's account perform compared with the banks?

Of the funds in
Figure 6.3
, the only one that beat Keith was the Bank of Montreal's NB Balanced Fund. Over a six-year period, Keith beat four out of five of Canada's most respected balanced mutual funds without even trying. Of course, there will be actively managed balanced funds that beat Keith over time, but there's no way of knowing which ones. Next year, for example, the Bank of Montreal Fund, which is in first place now, could find itself trailing all of the other funds. That's how it often works in the fund industry. There's only one thing for sure: Thanks to its low-fee structure, Keith's portfolio will outperform at least 90 percent of actively managed balanced funds. And if his money were held in a taxable account, he would extend his lead over the majority of Canada's actively managed funds.

Figure 6.3
Keith's Account vs. Balanced Funds at the Canadian Banks (2005–2011)

Source:
Globeinvestor.com Fund Performances
6

How can Canadians invest like Keith?

If you want to invest like Keith, you have two low-cost options:

Let's focus on the bank indexes first:

Toronto Dominion Bank currently has the most competitively priced index funds in Canada. But if you try walking into a bank and buying them, one of two things might happen to you:

The low-cost indexes are called e-Series Funds and you can only purchase them online at <
www.tdcanadatrust.com/mutualfunds/perf_EF.jsp
> <
www.tdcanadatrust.com/mutualfunds/tdeseriesfunds/index.jsp
.
>
7

The TD bank e-Series index funds

Table 6.4
reveals that TD Bank's e-Series index funds cost an average expense ratio of just 0.4 percent annually, compared with more than 2.5 percent annually for the average Canadian actively managed fund.
8
Canadian fund costs are reported to be higher than those in any other country, so it's best to avoid getting fleeced.
9
If you want to invest using the global couch potato strategy with the cheap, e-Series funds, here they are with their respective identification symbols and hidden annual expense ratios.

Table 6.4
TD Bank's e-Series Fund Fees

You'll need a $100 minimum to open the account. If you want to automatically deposit a set amount into each index from your bank account, follow the online procedure. The minimum purchase for automatic deposits is $25 a month, and there are no fees associated with the account—except a two percent withdraw penalty if you sell within 90 days of opening the account.
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For the investor looking for low costs and convenience, these funds are the answer, and you can reinvest your dividends for free.

Remember that a good rule of thumb is to be consistent with your allocations. Choose a percentage for each index and balance it annually.

To blend the couch potato formula with the idea that a bond allocation should represent a person's age, I recommend that you choose one of these age-related breakdowns in
Table 6.5
.

Table 6.5
Recommended Age-Related Portfolio Allocations for Canadians

Canadian indexed investing with exchange traded funds

When Keith first opened his indexed investment account, Toronto Dominion Bank didn't offer e-Series Index Funds. Instead, Keith built a portfolio of exchange traded funds (ETFs), which are index funds that are purchased off the stock market exchange using a brokerage firm.

Investing with ETFs might be worthwhile if you're not going to invest regularly in your account or if your account balance is fairly large.

The costs associated with four exchange traded index funds (such as Keith owns) would amount to annual fees of 0.3 percent each year. This is slightly cheaper than TD bank's e-Series Funds, but the savings might not be worth the trouble. You can decide by weighing the relative size of your account with the savings.

On a $100,000 account, ETFs such as Keith's cost $300 a year in hidden expenses.

On a $100,000 account, e-Series indexes would cost $400 a year in hidden expenses.

The $100 annual savings on a $100,000 account wouldn't be worth the hassle if you were adding regularly to your account. Here's why:

If you invest every month, you'll have to pay a brokerage fee of $9.99 for each online purchase with ETFs (and more than that if your account value is below $100,000).

That monthly $9.99 adds up to nearly $120 a year. So if your account value doesn't easily exceed $100,000, you're better off with the e-Series Index Funds because they don't charge a commission to buy or sell.

Table 6.6
shows the costs associated with buying monthly e-Series indexes (which have higher expense ratios but no commission fees) versus buying exchange traded funds (which have lower expense ratios but charge purchase commissions)

Table 6.6
Total Costs of an ETF Portfolio vs. a TD Bank e-Series Portfolio