A Two-Fund Solution

While I continue to battle my behavioural biases when it comes to investing, I’ve at least given some thought as to how I’d make the move to indexing from my current portfolio of dividend stocks.  The answer is a two-fund solution.

To make things as simple (and cheap) as possible I’d start by liquidating all the stocks in my RRSP – 23 holdings valued at roughly $100,000 – and then use those funds to purchase units of Vanguard’s All World ex-Canada Index ETF (VXC).

Then, I’d set up monthly contributions to my tax-free savings account (TFSA) and purchase units of Vanguard’s Canada Index ETF (VCE).

What’s behind the two-fund solution?

Foreign content restrictions were lifted on RRSPs a decade ago and yet many Canadians – including me – still keep their holdings close to home by investing in Canadian stocks.

Related: Do you suffer from home country bias?

Of course, Canada makes up just a tiny fraction of the global economy and so it makes sense to diversify as much as possible. Years ago this diversification was only possible by holding several mutual funds or ETFs (U.S., Europe, Japan, Emerging Markets, etc.).

Earlier this year, Vanguard introduced its All World ex-Canada Index ETF. The fund holds over 3,000 small-to-large cap stocks across a wide variety of sectors. U.S. stocks make up 50 percent of the holdings, while the rest is split amongst some 36 countries from around the globe.

How much does it cost to own a small slice of nearly every company in the world outside of Canada? The MER on Vanguard’s All World ex-Canada ETF is just 0.25%.

*Note that holding this fund in an RRSP means paying foreign withholding taxes on international dividends, which has been estimated to add up to 0.45% to the cost of the fund. The only way to improve the tax situation, according to Canadian Couch Potato author Dan Bortolotti, is to use US-listed ETFs in an RRSP.

“Of course this carries the added complexity/cost of currency conversion. So you can choose your poison.”

If an investor decides to stick with Canadian-listed ETFs, Bortolotti suggests that VXC is preferable to holding three separate funds for US, international and emerging markets.

Related: The true cost of foreign withholding taxes

My dose of Canadian content would come from holding Vanguard’s Canada Index ETF (VCE) inside my TFSA. The fund holds 76 of the largest Canadian stocks, although nearly two-thirds of the fund is invested in financial and oil & gas stocks.

VCE has a dirt-cheap 0.05% MER.

I liquidated my TFSA three years ago in order to top-up the down payment on our new house and avoid CMHC fees. I now have $35,000 in contribution room – going up to $40,500 on January 1st, 2015 – and would like to start funding this account again next year.

The ideal allocation for my entire portfolio would be 15-25 percent Canadian and 75-85 percent U.S./International.

Final thoughts

So I’ve got the indexing strategy figured out. The question now is when and how do I start?

Related: 5 lessons learned about investing

The TFSA will be the easy part – just set up the monthly contributions and then periodically purchase units of VCE. The RRSP will be the tougher mental hurdle to climb – swallowing my pride as I abandon my dividend growth strategy (not to mention the cost of selling 23 stocks).

Slowly, but surely, I’ll get there.

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  1. Dan @ Our Big Fat Wallet on November 30, 2014 at 10:46 am

    Hey Robb, that sounds like a good approach. One suggestion would be to continue to hold a small number of your core blue chip dividend growth stocks while switching the rest to indexing (ie. BMO, TD, etc). That way you keep some Canadian stocks that will grow in the future while getting some international exposure through the ETFs.

    As far as holding the US listed ETFs, that can easily be done by purchasing DLR (Canadian) then journalling the shares over to the US version – saving the 2% conversion fee that Questrade charges

    • Echo on December 1, 2014 at 8:38 am

      Hi Dan, I’ve considered that – holding onto a few blue chip stocks – however I’d be duplicating those efforts when I purchase units of VCE.

      I’ll take another look at using U.S. listed ETFs and see if it would be worth the time and effort to save on fees.

  2. My Own Advisor on November 30, 2014 at 1:55 pm

    Seems like a good plan, although I can’t seem to sell some stocks. ENB has a huge run-up since I bought it and I don’t want to sell. Behavioural issue? Maybe. Probably. Just like it was hard to sell my dud (TA) but I did.

    Will I ever be an indexer 100%? I doubt it.

    Long-term I will likely always have CDN stocks non-reg., TFSAs full with CDN stocks and ETFs and REITs, and RRSP almost full of U.S. equities. I’m not far off this model now.

    I’d rather own some CDN stocks and DRIP them, that allows me to stick to my plan vs. indexing where I’d be tempted to tinker with my portfolio more.

    Let us know when you pull the sale triggers…

    • Echo on December 1, 2014 at 8:41 am

      Hi Mark, I have a few stocks like that – Telus, for example – but there are a few duds, too. If I get to the point where my TFSA and RRSP accounts are full, then I’d absolutely look at getting Canadian dividend payers into my non-registered account. That’s a long way off, though.

  3. Robert on November 30, 2014 at 3:12 pm

    I don’t know why you want to do it, but it sounds like a good approach to switch in that direction. I tend to think of going in this direction when I get to a stage where I want to spend less time managing things. Meanwhile I like the feeling of cheering for most my “boys” as individuals.

    • Echo on December 1, 2014 at 8:43 am

      Hi Robert, I totally understand. I guess I’ve moved past the “cheering” phase earlier than expected. I’d rather focus on my side business, which has produced much better returns over the last few years.

  4. Anne-Marie on December 1, 2014 at 8:26 am

    Why? If you are doing well, why change.You have more control with individual stocks. If it ain’t broke why fix it.

    • Echo on December 1, 2014 at 10:30 am

      Hi Anne-Marie, I’ve come to the conclusion that the time and effort spent picking individual stocks is not worth the risk in the long run. Even if I somehow manage to continue outperforming my benchmark by 2-3 percent each year (doubtful), I’m taking more risk than is necessary.

  5. Michael James on December 1, 2014 at 8:29 am

    I think you’re on the right path. It took me a long time to make the transition. Even now I still own one individual stock. Once you pull the trigger, you’ll have to take up a new sport or something to fill the time you used to spend obsessing about your stocks.

    • Echo on December 1, 2014 at 10:44 am

      Hi Michael, it’s not that I spend a lot of time obsessing over stocks – quite the opposite, in fact. My problem is a lack of new ideas and I just don’t have the time to spend researching under-valued stocks.

  6. Jacques on December 1, 2014 at 9:45 am

    I am confused with the question of the foreign withholding tax. I have invested in the Mawer Global Small Cap fund for a number of years for my TFSA. This fund invests in a number of companies throughout the world but when it comes to paying a withholding tax, I was told by Mawer that since I hold this fund in a registered account, I don’t have to pay any tax. And so far I have not received any t-slips for tax purposes. Can you advise how this can happen.

    • Echo on December 1, 2014 at 2:08 pm

      Hi Jacques, thanks for your comment. I reached out to Tanya Ellston, mutual fund services manager at Mawer. She said:

      Hi Robb,

      Hope I can help clarify – it might be clearer using an example:

      • Two clients invest in the Mawer Global Small Cap Fund, each invest $100 ($200 total). Client A invests in a taxable account and Client B invests in a TFSA. The fund earns $10 of foreign income. The fund pays $2 in withholding tax. So the fund is valued at $208, or $104 in each account.

      • Client A gets a tax slip (T3) showing $5 of income and $1 tax credit and reports this on his annual tax return.

      • Client B does not get a tax slip (income earned in a TFSA is not subject to tax) but has in fact paid withholding tax because his investment isn’t worth $105, but is worth $104. He does not need to report anything on his annual tax return.

      The value of units is the same for both clients. The difference is that the taxable client pays tax on his income for the current year whereas the TFSA client does not.

  7. Alan on December 1, 2014 at 10:48 am

    I absolutely think you’re on the right track. You have found a very cost-effective way of maximizing your diversification.

    • Echo on December 1, 2014 at 2:09 pm

      Thanks Alan!

  8. Bernie on December 1, 2014 at 1:15 pm

    I’m very disappointed in you Robb! I suppose one can’t sell a product unless they practice & follow it themselves. As for value to me, I see no point continuing to follow “boomerandecho” articles. I have zero interest in indexing. I’m outta here.

    • Echo on December 1, 2014 at 2:12 pm

      Hi Bernie, that’s a little harsh, no? I’ve always thought your comments added a lot of value to the discussion here over the years so I’m really sorry to see you go.

      Hope to see you again soon.

    • Grant on December 1, 2014 at 5:52 pm

      Bernie, c’mon, we can all learn from different strategies, and it’s good to keep an open mind. As you know, I’m a confirmed indexer, but often read and learn from dividend blogs.

      • Gary on December 2, 2014 at 8:54 am

        boy, am i ever confused? first, do you sell investments robb or is it the fact that perhaps you recommend etf’s rather than individual stocks to your clients? for myself i still own individual stocks but i also hold bond eft’s for my fixed income portion. i think you are over reacting bernie; i don’t think much will change at B&E … still great wisdom for us to mull over.

        • Echo on December 2, 2014 at 9:59 am

          Hi Gary, I definitely do NOT sell investments. I have nothing against holding dividend stocks – I think it’s a fine strategy – but I truly believe that the vast majority of investors would be better off buying a couple of broadly diversified index funds and simplifying their portfolio.

          The more I read and study behavioural finance the more I believe that our behavioural biases do more harm than good.

          I’m happy with a B+ rather than chasing an A and ending up with a C (or worse).

          As for the blog, you’re right, nothing much will change here other than the odd update on this portfolio. Unfortunately, Bernie has already made up his mind and unsubscribed 🙁

  9. Grant on December 1, 2014 at 5:43 pm

    Rob, there’s no question there’s great value in simplicity and this sounds like a great plan.

    A couple of comments. One option to avoid the higher cost of VXC in an RRSP could be to buy VTI and VXUS instead. VTI has an MER of only 0.05%, with no foreign witholding tax and VXUS is 0.14%, with about 0.25% foreign withholding tax. Currency conversion fees can be effectively avoided using Norbets gambit to conver to U$s. But I certainly wouldn’t argue with going with the simplicity of VXC.

    I’m curious as to why you chose VCE instead of VCN which is more diversified as it includes small caps as well as large and mid caps.

    • Echo on December 1, 2014 at 10:09 pm

      Hi Grant, I’ll take another look at the U.S. listed ETFs, although my preference is to keep things ultra-simple. I’d also bet that Vanguard lowers the MER on VXC sooner than later.

      As for the Canadian ETF, I was initially comparing VCE with XIU. I agree that VCN might be a better fit – thanks for pointing that out!

      • Grant on April 20, 2015 at 12:58 pm

        Rob, I think you’ve made the right decision with regard to the ETFs. The more I read about investing, the more I realize the enormous value of simplicity. Jack Bogle calls it the “Majesty of Simplicity”. When anyway asks me now, I suggest going with VCN, VXC and VAB, if they need some fixed income, which I personally think most do, at least 10%, if nothing else but to learn about bonds for when they get near retirement.

        • Echo on April 20, 2015 at 1:21 pm

          Hi Grant, thanks. I like that Vanguard three-fund model as well. In fact, the new model portfolios listed on Canadian Couch Potato are perfect for a wide range of investors, depending on their age and stage (One fund with Tangerine, four funds with TD, or the three Vanguard ETFs).

          I’m comfortable with my all-equity portfolio, but certainly wouldn’t recommend it for everyone.

  10. Barry @ Moneywehave on December 2, 2014 at 2:26 pm

    I’m an index investor and I always told myself that I would like to get into stocks one day. However I realized the timer required was just not worth it.

    Like you, I prefer to spend my time on side projects and family obviously. The only individual stock I own is Rogers, but that’s because I have an employee stock plan.

  11. Tom on December 5, 2014 at 8:43 pm

    Great diversification but would you put half your investment in one etf? Couldn’t the etf fail? A lack of diversification?

  12. Grant on December 6, 2014 at 12:42 pm

    Tom, the worst that could happen to to VXC is that Vanguard could discontinue the product if there were not enough interest from the public. Then your money would be returned to you. The ETF currently has assets of $21M, which isn’t a lot, but it only started in July this year, so it’s unlikely that that would happen.

    The fund has 3012 stocks in it from all over the world – you can’t get much more diversified than that! The fact that they are all in one ETF doesn’t affect that diversification.

  13. The Passive Income Earner on December 8, 2014 at 11:09 pm

    Personally, I don’t disagree with the statistics that indexing is better over time. Unfortunately, there are so many indexes nowadays that I think many are choosing sub indexes which is akin of stock picking.

    With that said, I don’t believe in having an index portfolio works well in retirement. You end up having to sell your investments as income from indexes are probably not enough. An indexer will probably switch to bonds as they get older which is even worse … Timing becomes an issue when you withdraw in a bear market …

    While I statistically agree with the long term abilities of indexing, I still fail to see how it would serves me in retirement. I also don’t believe in the 4% withdrawal rule as bonds don’t provide the income that it used to back when the 4% withdrawal rule was introduced. The question then becomes: what strategy does an indexer have in retirement? When the wealth accumulation phase is complete, what’s the strategy?

    For those with a pension plan, go ahead, index all you want, but if you don’t have a pension plan, there are many questions needing an answer. What do you recommend to your clients?

  14. Peter McNulty on February 1, 2015 at 6:37 am

    Just reading this today, Feb 1st, and noted that you indicated you had $40,500 in TFSA contribution room as of Jan 2015. Is that correct ? I thought it would be $36,000.

    Seven years total 4 at $5000 and 3 at $5500

  15. Peter McNulty on February 1, 2015 at 6:46 am

    My technology has been failing me in terms of trying to edit, it should be $36,500 not $36,000

  16. Bill on February 1, 2015 at 7:24 am

    In one of you’re replies you state:
    “Hi Anne-Marie, I’ve come to the conclusion that the time and effort spent picking individual stocks is not worth the risk in the long run.”
    I’m just curious, but if you’re concerned about risk, why no bond allocation? They are meant to provide a cushion in case of a crash (which will come).

    @Peter McNulty: If your investments in a TFSA grew over time and you withdrew some or all of the funds, you are allowed to replace the investments at market value. This of course raises your future contribution room. If someone had made no withdrawals the max contribution room would be $36,500.

  17. Bo on February 2, 2015 at 9:49 am

    I think that Passive Income Earner may have hit nail on the head with “indexing is better over time”. The indexers can’t tell us how much time it will take for “superior” returns to materialize or whether they will materialize during my lifetime.

    Indexing is like saying it will snow. you will probably be right – eventually.

    • len on April 11, 2016 at 7:52 am

      Perfect !!

      Thanks for expressing this view so eloquently.

  18. Bryan on February 8, 2015 at 3:16 pm

    Hi Robb,
    Really enjoyed this post. Hoping you (or someone, anyone!) can clarify something for me. Is there a difference when holding VXC in your TFSA vs. your RRSP, in respect to “foreign withholding taxes on international dividends”? Or would the costs work out to be the exact same? Thanks!

    • Echo on February 8, 2015 at 5:18 pm

      Hi Bryan, the Canadian Couch Potato blog has done a lot of research on foreign withholding taxes. According to this post – http://canadiancouchpotato.com/2014/09/12/foreign-withholding-taxes-in-international-equity-etfs/

      “When you hold international equities in a non-registered account, you may be able to recover the final level of withholding tax by claiming the foreign tax credit on your return. But there’s no opportunity to recover withholding taxes if you hold the fund in a RRSP or TFSA.”

  19. Brunnenburg on April 20, 2015 at 12:30 pm

    Robb, stay the course with indexing. I switched from a dividend portfolio and have never looked back. The peace of mind alone is worth it, never mind that over a century of research shows that indexing is the superior long term path to prosperity. If anyone doubts that indexing can deliver solid returns to boot, I generally show a recent screenshot of my Questrade USD RRSP account (opened in 2012):


    It’s amazing how emotional dividend investors get sometimes. Many of them are in thrall of confirmation bias and see any other strategy as an implicit criticism of a dividend approach.

    • Echo on April 20, 2015 at 1:29 pm

      Hi Brunnenburg, thanks for your comment. I hear you about the peace of mind – I used to check the markets daily and look at the value of my individual stocks all the time. Now I barely glance at the markets and have zero interest in the daily fluctuations of two ETFs.

      I agree about the behavioural biases that investors have to overcome (not just dividend investors).

      Daniel Kahneman calls it call is WYSIATI – what you see is all there is – and the more concretely you can see it the more compelling it is. You can expect people to prefer the concrete to the abstract, the sure thing against the probable, the present over the future, etc.

  20. mardi on April 26, 2015 at 11:29 am

    I’ve read many times that you should not hold US funds in a TFSA because you can not recover the witholding tax. Rob Carrick wrote an article in Globe and Mail deltailing some of the best funds to be held in registered and non-registered accounts. Worth a read.
    I’ve also read VCN better than VCE.

    • Echo on June 16, 2015 at 9:27 am

      Hi mardi, I did end up buying VCN instead of VCE.

      • Artur on April 6, 2016 at 8:55 am

        Quick question – why not XIC instead of VCN or VCE?

  21. Daniel @ SaveWithDan.ca on June 16, 2015 at 11:47 am

    Hi, Robb. I was wondering… how do you protect your investment from downsides in the stock market this way, since this approach is 100% stocks? Don’t you worry about diversification a bit more? I am just starting to think about this things and would love to hear your opinion on that.

    • Echo on June 16, 2015 at 4:06 pm

      Hi Dan, in the updated Canadian Couch Potato model portfolios an investor can add a third fund (VAB) for the bond component.

      For me, I’ll take the ups and downs of the market in hopes to capture the higher returns that come from holding an all-equity portfolio for the very long term (I’m 35). That said, I know that not many people can stomach 100% equities and so they should balance that by keeping a certain percentage of their portfolio in bonds.

  22. Grant on July 3, 2015 at 10:26 am

    Rob, I can’t believe your market timing skills! Diversifying out of mainly Canadian stocks, just before the C$ tanked, and international stocks took off! Next time I need some market timing tips, I’m coming to you!!

  23. May on July 4, 2015 at 12:16 am

    I hold VSB, VSC and VAB in my RRSP & LIRSP accounts and prefer the first two. All three pay dividends/interest monthly, but VAB is much more volatile than the first two. No surprise really, since the average maturity is much longer. I will be shifting from VAB to the other two the next time I rebalance.

  24. Wh Corbett on July 27, 2015 at 10:07 am

    I have $20,000 U.S. sitting in a US dollar money market account in my RSP. I want to reinvest in US $ listed stock or some equivalent and I like the VXC. I don’t want to convert to Canadian dollars to buy VXC. you mentioned that there is a US equivalent Vanguard fund. What is it? I want to avoid US withholding tax in my RRSP.

  25. Bryan on August 22, 2015 at 12:05 pm

    Hopefully a quick question. Is there any difference in total fees for VXC if it is held in the TFSA vs. RRSP? From my research, the fees are the exact same, but wasn’t 100% certain. Any insight would be great! Thanks as always; planning to execute this same plan for myself, just can’t beat the worldwide exposure.

    • Echo on August 22, 2015 at 10:47 pm

      Hi Bryan, the fees should be identical – holding VXC in a registered account (RRSP or TFSA) will mean paying foreign withholding taxes on international dividends and add roughly 0.45% to its total cost.

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