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Why Investors Should Embrace Simple Solutions

I stumbled on a thread from Reddit’s Canadian personal finance community where a young investor sought feedback on his investment portfolio.  He held a low cost and diversified portfolio consisting of seven ETFs inside his tax free savings account.  The allocation was broken down like this:

  • Canadian equity (ZCN) – 25%
  • U.S. equity (VUN) – 16%
  • Global equity – developed countries (VDU) – 16%
  • Global equity – emerging markets  (VEE) – 16%
  • Canadian REITs (ZRE) – 6%
  • Canadian Bonds – long term (XBB) – 9%
  • Canadian Bonds – short term (XSB) – 9%

The investor has done a lot of things right here.  His portfolio is built using extremely low cost ETFs purchased through Questrade, the online broker that lets you buy ETFs commission-free.  At 28, the investor has chosen a bond allocation based on 110 minus his age (for a 82/18 stock-to-bond split).  So far, so good.

Related: The beginner’s guide on how NOT to start investing

The problem I see is that the account is only worth $29,000.  It’s a complicated portfolio that may require a lot of fine-tuning to keep the asset allocation in-line with his original strategy.  But to what end?

At this point the investor should be concentrating more on increasing his savings rate rather than tinkering to find the optimal asset allocation.

The Canadian Couch Potato blog has a great list of model portfolios for the novice and sophisticated investor.  For portfolios under $50,000, the recommendation is to keep things simple.  Two proposed solutions include:

  • Tangerine Balanced Portfolio – One global mutual fund consisting of 60% stocks and 40% bonds.  Total cost – 1.07% MER

OR

  • TD e-Series funds – Four mutual funds consisting of Canadian, U.S., and International equities, as well as Canadian bonds.  Total cost – 0.44% MER

Related: Why TD e-Series funds aren’t just for beginners

Focusing too much on the perfect asset allocation and getting the costs as low as possible can become a never-ending chore.  New funds are introduced all the time, and while the costs have become a race to the bottom, realistically, it doesn’t make sense to jump in and out of funds every year to save a few hundredths of a percent on fees.

Embrace simple solutions

A simple solution with one-to-four mutual funds or ETFs can free you up to focus on what really matters – saving more!  How much thought do you want to give to the $1,700 in REITs or $2,600 worth of short-term bonds in your portfolio?

Related: 5 lessons learned about investing

At this stage it just doesn’t matter, not at 28-years-old with $29,000 invested.  Simplify the process.  Ignore what the markets do in the short term, avoid market timing, and stop guessing where interest rates are going or what will be the next hot emerging market.  Stop making things more complicated than they need to be.

I’m not suggesting that fees and diversification aren’t important.  But we need to be more willing to embrace simple solutions.  You’ll build more wealth by increasing your savings rate over a long period of time, rather than trying to slice-and-dice your way toward the perfect asset allocation.

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13 Comments

  1. Mclain on July 6, 2014 at 10:30 am

    I have a similar portfolio in my RRSP except I also have 10% in 4 specific sector ETFs….just for fun 🙂

  2. Richard on July 6, 2014 at 4:26 pm

    That’s a great way to put it. Leaving a small portfolio to grow (slowly) without doing anything to try to increase the returns can be as hard as sitting tight during a market crash.

    But at that size the dollar value of reducing the fees a bit or getting and extra half-percent return will not be as much as putting that time into earning more or saving more. Or just enjoying your life – that can be priceless (especially when you don’t have to worry about your financial future).

    It’s your other financial habits that will give you the foundation of a strong portfolio and even something as simple as Tangerine will make sure they don’t go to waste.

  3. Ashley on July 7, 2014 at 8:54 am

    Small portfolios, as mine is at present, have just a few thousand in each ETF, with a rough asset allocation similar to the story here. Being with Qtrade I move in and out infrequently in their free ETF’s to reduce costs, and own a few companies shares as part of a beginning RRSP portfolio that I trust will grow over time.

    The value at present of my portfolio is even less than the $29000 here but I don’t mind watching over it. Why? Because later in life when the portfolio grows I will have gained invaluable experience working with the smaller portfolio so when it is larger I’ll be able to intelligently manage it. Already I’ve stopped doing some dumb things I did last year, and am learning rapidly thanx to your and other great financial sites.

    The bottom line for me is I like managing my own portfolio and the experience gained from managing (even micro managing) my smaller portfolio will benefit me when the decisions are that much more important 5/10/15 years from now.

  4. Grant on July 7, 2014 at 9:48 am

    I couldn’t agree more that there is a huge benefit to keeping things simple. I’d go with the Tangerine one fund portfolio until the account is in the $50,000 to $100,000 range, then switch to a simple ETF portfolio – Canadian equity (VCN), US equity (VUN), international equity (XEF),(could also add emerging market equity, XEC) and Bonds (VAB). The new World Ex-Canda ETF is due out soon making a simple 3 fund portfolio possible – Canadian equity (VUN), World EX-Canada and Bonds (VAB).

    I wouldn’t call XBB long term bonds – it has a duration of about 7 years so is an intermediate term bond fund.

  5. Andrew on July 7, 2014 at 10:17 am

    In defense of the young investor’s portfolio, I like the additional diversification of REITs, emerging market equities and short-term bonds. While simplicity is certainly a good rule of thumb for young investors, every investor is unique and some may be perfectly comfortable managing seven asset classes. There is no “one-size fits all” portfolio. Even a portfolio of seven ETFs can easily be re-balanced in 20 minutes, once a year if you know what you’re doing.

    To Robb’s point that the investor should focus on saving more: true, although the investor clearly seems to have mastered the art of saving given that he has $29,000 in his TFSA at age 28, which is just $2,000 short of the limit for 2014. According to Yahoo Finance, the average Canadian has a TFSA with a value of $6,900, so he’s doing far better than most in the savings department.

    Furthermore, he uses low-cost ETFs and his ability to buy ETFs for free through Questrade ensures his costs from commissions will be low as well. The point is that he has already developed the good habits necessary for successful investing. By embracing index investing, saving regularly and keeping costs to a bare minimum, this investor is already waaaaaaay ahead of most Canadian investors in his age group.

  6. Echo on July 7, 2014 at 11:11 am

    The point of the story is not to suggest the young investor has it wrong – the portfolio is fine. The red-flag was that he was asking for feedback and seemed quite willing to tinker around, substituting a different bond fund, adding precious metals, playing with the allocation percentages, whatever.

    That stuff just doesn’t matter when the portfolio is so small. Save, save, save, and then fine-tune once it reaches $100,000 or more.

    If it’s a true passion, like Ashley described above, then by all means tinker away. Just understand that while micro-managing the peripheral edges of your portfolio might make you more a sophisticated investor, it can also lead to bad habits like performance chasing and market timing in and out of asset classes.

  7. Stephen on July 7, 2014 at 12:40 pm

    While I agree with Ashley, the learning experience can be invaluable while your portfolio is small if you continue with it over the long run. However, if all you plan to ever have is a couch potato style portfolio, then there isn’t a whole lot to learn anyway.

    I think your advice is solid about focusing on saving more and earning more so you can save more. I spent a lot of time in my late 20s tinkering with investing that was really of questionable benefit. I did learn a lot but a more hands off approach would have probably been better overall.

  8. Dan @ Our Big Fat Wallet on July 7, 2014 at 5:35 pm

    I think a simple portfolio could be a basket of blue-chip dividend stocks with the intention to hold for the long term and reinvest the dividends received. Costs could be kept to a minimum and there could (potentially) be minimal trading activity throughout the year. I agree though in that sometimes investors focus too much on minimizing costs (Im guilty of that sometimes as well)

  9. Barry @ Moneywehave on July 7, 2014 at 6:25 pm

    When I first went DIY, I found myself in a similar situation where I was over diversifying. I eventually realized this was not the idea situation and I started to get obsessed with it which defeated the point of being a passive investor.

    I now do just the 4 main indexes with e-series to keep things simple but I’ll probably switch to ETF’s since my portfolio has grown since I first started investing.

  10. Bernie on July 7, 2014 at 11:29 pm

    A good simple one fund solution would be Mawer Balanced Fund – A. It’s well managed, diversified globally, has a low MER of 0.96% and an outstanding performance record since inception in early 1988.

    • Echo on July 8, 2014 at 7:09 am

      Hi Bernie, I agree – Mawer’s Balanced Fund is a fine one-fund solution. Not sure about the $5,000 minimum, though. That’s pretty steep for beginners.

  11. Ashley on July 8, 2014 at 8:30 am

    @Echo – Yes, I started off right away with chasing market timing strategies, certainly not a bad thing to do in 2013! But I realize the multiple wins I had last year doing that are not sustainable. Focusing on value now, but a long way to go to figure it all out.

    Thanx for the thoughts all, and I do agree. For the bulk of people the Couch Potato approach is the way to go, and about half of my portfolio is set up that way, but the other half I tinker with. The other half is a few stocks and one mutual fund I’ll pump, Fidelity monthly Income, enjoy it for its’ stability. High cost, but good returns.

  12. Gail Genest on October 21, 2015 at 8:27 am

    Saskatchewan Pension Plan is “Simple”. Check out http://www.saskpension.com for information how anyone in Canada can join this simple, professionally managed pension plan that has a 30 history, a solid return average and low fees. “Canada’s Hidden Pension Plan”. ALL businesses can offer this plan as a workplace pension plan for their employees.

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