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Yes, You Can Retire Up To 30% Wealthier

By Robb Engen | July 23, 2020 |
Posted in
Yes, You Can Retire Up To 30% Wealthier
Questrade touched a nerve with financial advisors with a series of commercials highlighting how lower investment fees over time potentially means you can retire up to 30% wealthier. Financial advisor extraordinaire Jason Pereira acknowledged that Questrade was right to go after do-nothing advisors who collect fat commissions, but he claimed the 30% wealthier promise was unrealistic and borderline illegal.

Mr. Pereira’s argument is a good one. Advisors like him (and others who put a client’s best interests ahead of their own) can add tremendous value for clients, but not in the way you might think.

The old school notion of a financial advisor is of someone who adds value through their stock-picking prowess. But that argument falls flat when you see the evidence that the vast majority of actively managed funds fail to beat their benchmarks.

Indeed, investors are better off buying the entire market as cheaply as possible using index funds or ETFs.

PWL Capital’s Ben Felix once told me, “investing has been solved.” “The way for advisors to add value is on planning, behaviour, and transformation.” With that in mind, I can get behind the idea that financial advisors with this mindset do have a net positive impact for their clients, even after fees.

Which brings me to the point of this article. Canadians have $1.6 trillion invested in mutual funds, most of which are of the expensive, actively managed variety. Those actively managed funds aren’t adding value – the vast majority will underperform their benchmark. Furthermore, most bank-advised clients aren’t getting value in other ways – financial planning, goal setting and prioritization, behavioural coaching, etc.

Traditional advisors are still selling (and charging for) investment expertise, but failing miserably at delivering excess returns while offering little-to-no value for things that would truly make a difference for their clients.

The easy answer is to pair a fee-only advisor with a low-cost investment solution (either a self-directed portfolio of globally diversified ETFs, or through an automated portfolio with a robo advisor). This way, you get the planning, coaching, and behavioural nudges you need to succeed financially, plus the benefit of lowering your investment fees. Win-win.

But the sad reality is that financial inertia is powerful and it’s easier to keep your investments at your bank, along with your chequing, savings, and mortgage. I get it.

Retire up to 30% wealthier without moving your investments

What if I told you that you can still retire up to 30% wealthier without moving your investments to a robo advisor or a DIY investment solution? The answer is sitting right there on the product shelf at your bank – yet rarely if ever talked about by your financial advisor.

I’m talking about index funds. That’s right. Every big bank has a suite of index mutual funds available to investors. These funds charge between one-sixth to one-half the cost of the actively managed mutual funds that are typically sold to Canadian investors.

I’ve monitored and tracked the performance of big bank index funds and their actively managed mutual fund cousins for more than 10 years, and in every single case (when comparing to identical benchmarks), the lower cost index funds outperform the active funds.

So, all you need to do is walk into your bank branch, sit down with your advisor, and ask (no, demand) to move your portfolio from actively managed mutual funds to their index fund equivalents.

Below, I’ll show you the exact index funds to buy to build a 60/40 balanced, globally diversified portfolio of index funds at each of Canada’s five big banks. I’ll compare those index funds to the commonly sold actively managed “balanced” mutual fund.

RBC Index Funds

If you’re an RBC client, chances are you have the RBC Balanced Fund (RBF272) in your investment portfolio. The fund has nearly $5 billion in assets under management and comes with a fee (MER) of 2.16%. Returns have been decent, with a 10-year average annual return of 5.3%.

Here’s how to replicate that portfolio using RBC index funds:

Fund name Allocation Fund code MER 10-yr return
RBC Canadian Index Fund 20% RBF556 0.66% 5.6%
RBC U.S. Index Fund 20% RBF557 0.66% 15.6%
RBC International Index Fund 20% RBF559 0.61% 6.4%
RBC Canadian Bond Index Fund* 40% RBF700 0.70% 3.8%

*Update: You may need to substitute the RBC Canadian Bond Index Fund (RBF700) for the RBC Canadian Government Bond Index Fund (RBF563)

The balanced portfolio of RBC index funds come with a weighted-average MER of just 0.67%. That’s one-third the cost of the RBC Balanced Fund.

The index fund portfolio’s annual returns over the past 10 years would have been 7.04%. Your projected portfolio could potentially be worth $769,809 after 30 years, assuming a starting investment of $100,000.

If you extrapolate the RBC Balanced Fund’s returns over 30 years, your portfolio would be worth $470,815.

A quick word about comparing apples-to-apples: The RBC Balanced Fund is more heavily tilted to Canadian stocks (33%), while holding less U.S. (13%) and International (15%) stocks. Since U.S. equities have outperformed Canadian equities over the past decade, it stands to reason that our index fund portfolio with a 20% allocation to U.S. stocks would outperform.

That said, even if we reduced the expected annual return of the index fund portfolio from 7.04% to 6%, your $100,000 would grow to $574,349 over 30 years. That’s 22% more wealth for your retirement.

TD Index Funds

TD’s e-Series funds are likely the most popular set of bank index funds on the market. But don’t think your TD advisor will tell you anything about them. The e-Series funds are notoriously difficult to buy – and you might just be better off buying them online.

But there’s $8.8 billion invested in TD’s Comfort Balanced Portfolio (TDB886) – a 50/50 balanced fund that comes with a MER of 1.92%. Its 10-year annual rate of return is 5.19%.

Let’s see how that compares to a portfolio of e-Series funds:

Fund name Allocation Fund code MER 10-yr return
TD Canadian Index Fund e-Series 20% TDB900 0.32% 6.0%
TD U.S. Index Fund e-Series 20% TDB902 0.34% 16.2%
TD International Index Fund e-Series 20% TDB911 0.49% 8.1%
TD Canadian Bond Index Fund e-Series 40% TDB909 0.51% 4.1%

 

The 60/40 balanced portfolio of TD e-Series index funds comes with a weighted-average MER of just 0.43%. That’s less than one-quarter the cost of the TD Comfort Balanced Portfolio.

The returns are better for e-Series funds, too, at 7.7% per year over 10 years. Projected over 30 years and your portfolio could be worth $925,701.

Compare that to the TD Comfort Balanced Portfolio, where $100,000 turns into $456,282 after 30 years. That’s less than half the balance of the projected e-Series portfolio.

Again, let’s reduce the expected returns to 6% per year. Over a 30-year period, our $100,000 TD e-Series balanced portfolio would grow to $574,349. That’s nearly 26% more wealth for your retirement.

Scotia Index Funds

The Scotia Canadian Balanced Fund (BNS378) has $2.1 billion in assets and comes with a MER of 1.98%. While it positions itself as a Canadian fund, its mandate says up to 49% of the fund’s assets may be invested in foreign securities, making it a good proxy for a global balanced portfolio. Scotia’s Canadian Balanced Fund has a 10-year annualized return of 5.3%.

Scotia quietly has a decent portfolio of index funds to choose from, and so you’ll see below a 60/40 portfolio made up of four Scotia index funds. Note, I’m using the ‘A’ series funds but there are also ‘D’ series funds available for self-directed investors that comes with slightly lower MERs.

Fund name Allocation Fund code MER 10-yr return
Scotia Canadian Index Fund 20% BNS381 1.00% 5.3%
Scotia U.S. Index Fund 20% BNS382 1.07% 15.2%
Scotia International Index Fund 20% BNS387 1.26% 6.7%
Scotia Canadian Bond Index Fund 40% BNS386 0.85% 3.8%

 

This portfolio of Scotia index funds comes with a weighted-average MER of 1.01%, which is about half the cost of the Scotia Canadian Balanced Fund.

The index funds would have also returned 6.96% per year for the past 10 years. Projected over 30 years and a $100,000 starting portfolio could be worth $752,734.

Compare that to the Scotia Canadian Balanced Fund, which projected over 30 years would be worth $470,816. That’s nearly 60% more for the index fund portfolio.

If we reduce the index fund returns to 6% per year then we know we’ll end up with $574,349 after 30 years. That’s still 22% more wealth for your retirement with the index funds.

BMO Index Funds

BMO has a ton of mutual funds to choose from, but I decided to use the BMO Asset Allocation Fund (BMO70145) and compare it to a suite of index funds.

The BMO Asset Allocation Fund has $1.4 billion in assets under management and comes with a MER of 2.12%. It charges this fee despite its underlying holdings being comprised of – get this – low cost BMO index ETFs. I mean, c’mon!

The fund’s asset mix is approximately 55% stocks and 45% bonds. It has returned 4.76% per year over the last 10 years.

As for BMO index funds, they’re actually listed in name as ETFs but are available on the mutual fund side of the house. Here’s a balanced portfolio of BMO index fund (ETFs):

Fund name Allocation Fund code MER 10-yr return
BMO Canadian Equity ETF Fund 20% BMO144 0.93% 5.1%
BMO U.S. Equity ETF Fund 20% BMO722 1.00% 11.8%
BMO International Equity ETF Fund 20% BMO727 1.05% 5.9%
BMO Core Bond Fund 40% BMO160 1.16% 3.6%*

*since inception Nov 2014

The portfolio of BMO index funds comes with a weighted-average MER of 1.06% – exactly half the cost of BMO’s Asset Allocation Fund.

The index fund balanced portfolio would have 10-year annualized returns of 6%. Extrapolated over 30 years and a $100,000 portfolio would be worth $574,349.

Compare that to the more expensive BMO Asset Allocation Fund, which would only be worth $403,520 after 30 years.

That’s 42% more wealth after 30 years for the portfolio of BMO index funds.

CIBC Index Funds

CIBC’s flagship balanced fund is the CIBC Managed Balanced Portfolio (CIB834). This fund is a 50/50 portfolio with $2.9 billion in assets under management. It comes with a MER of 2.25% and has annual returns of 5.9% over the last 10 years.

CIBC has a surprisingly broad set of index funds, including relatively new “passive portfolios” which are like all-in-one asset allocation ETFs and track global markets using index funds.

These one-ticket solutions only go back two years, and the MER is relatively high at 1.33%, so instead we’ll focus on using individual index funds for each market to build our balanced portfolio.

Fund name Allocation Fund code MER 10-yr return
CIBC Canadian Index Fund 20% CIB300 1.14% 5.2%
CIBC U.S. Index Fund 20% CIB500 1.18% 15.1%
CIBC International Index Fund 20% CIB510 1.25% 7.2%
CIBC Canadian Bond Index Fund 40% CIB503 1.16% 3.6%

 

This portfolio of CIBC index funds comes with a weighted-average MER of 1.18%, so just less than half the cost of the CIBC Managed Balanced Portfolio.

When it comes to returns, this index fund portfolio would have delivered 10-year annual returns of 6.94% – a full percent higher than the actively managed fund portfolio.

That means the expected balance of a $100,000 portfolio of CIBC index funds after 30 years would be $748,523 compared to the CIBC Managed Balance Portfolio which would have $558,314 after 30 years. That’s 34% more wealth for the CIBC index fund investor’s retirement.

Final Takeaway

It’s no surprise (to me, anyway) that the lower the cost of the index fund portfolio, the higher the outperformance.

Costs matter when it comes to investing. But that doesn’t mean you need to ditch your advisor and move to a self-directed portfolio of ETFs, or even move to a robo advisor, to lower your fees and achieve a better long-term outcome. I mean, if you have the time, skill, and temperament to do so then I say go for it.

But for the vast majority of investors who just want someone else to manage their portfolio, but who are also fee-conscious and don’t want to get ripped off, understand that a lower cost solution is available at your bank

Indeed, print off this article, or write down the names and fund codes of the index funds I highlighted for your given bank above, hand them to your bank advisor and ask – no, insist – on moving your portfolio from the expensive actively managed mutual funds to a portfolio of index funds.

And, if you find the financial advice lacking in terms of helping you prioritize goals, plan for retirement, and coach your behaviour, then perhaps it’s time to find a fee-only advisor who will look out for your best interests.

Do this and with enough time you will retire up to 30% wealthier than you would have if you stayed in those expensive and underperforming mutual funds. You can take that to the bank.

Weekend Reading: Low Interest Rates Are Here To Stay Edition

By Robb Engen | July 18, 2020 |
Posted in
Weekend Reading: Low Interest Rates Are Here To Stay Edition
Usually one needs to read the tea leaves to interpret the Bank of Canada’s forward guidance for interest rates and the economy. Not anymore. New Bank of Canada Governor Tiff Macklem was undeniably clear that record low interest rates are here to stay “for a long time.” 

It was no surprise to anyone that the Bank of Canada kept its key interest rate at 0.25% this week. More surprising was the unusually strong signalling that interest rates will stay put until at least 2023.

The Bank’s official statement said it would “hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved.”

Governor Macklem said:

“Canadians and Canadian businesses are facing an unusual amount of uncertainty, so we have been unusually clear about the future path for interest rates.”

This level of clarity is important for homeowners, too, as they think about buying a home or renewing their mortgage. Mortgage rates are incredibly low, with five-year fixed rate mortgages available at less than 2% interest, while 10-year mortgage rates are well under 3%.

Rate Spy Mortgage Rates

A five-year variable rate mortgage is still cheaper than its fixed rate counterpart. Variable rates also come with some degree of certainty that interest rates will hold steady for at least the next three years.

The problem is, with the Bank of Canada holding rates at 0.25%, there’s no upside for variable rate mortgage holders. I happened to benefit when the BoC made its emergency rate cuts this spring – it reduced my own mortgage rate to 1.45%. Variable rate holders won’t be so lucky in the future.

Paying off my mortgage early has never been a major priority in my financial plan. I’d much rather max out my tax sheltered investment accounts first before throwing extra money at my mortgage. Lower rates also mean more of my mortgage payment is going towards the principal balance, rather than to interest costs. That means I’ll achieve mortgage freedom faster without increasing my payments.

This Week’s Recap:

My investment portfolio(s) continue to recover and in some cases climb to new heights. My RRSP is only down 2.51% on the year – a far cry from the decline of -41.41% as of March 22. Hard to believe.

My TFSA is now up 2.14% on the year, thanks to the large lump sum investment I put into the account in mid-April.

I opened my LIRA on May 1st and that account is now up 10.07% since inception. Talk about great lucky timing.

The kids’ RESP account is down 0.32% year-to-date. We contribute $500 monthly (including CESG) to this account.

My RRSP, TFSA, and LIRA are all invested in the Vanguard All Equity ETF VEQT, while my kids’ RESP account is invested in TD e-Series funds.

This week I wrote about making rational versus irrational decisions when it comes to personal finance and investing.

One reader suggested I write an article about how to determine your sustainable spending rate in retirement – or what’s the maximum amount you can spend each year to age 95 without running out of capital. I’ve got some ideas to share with you, so stay tuned for that one.

Promo of the Week / Reader Question

I’ve received a few emails this week asking about how I set up my personal banking system to save on fees and maximize the interest rate on savings. This is how I do it, but your mileage may vary:

My wife and I have a joint chequing account with TD Bank and maintain a minimum account balance to waive the monthly account fees. We have the basic, bare bones account with minimal transactions. That’s because we put all of our transactions onto a rewards credit card and limit the amount of debit transactions and ATM withdrawals.

My wife has a separate no-fee chequing account with Tangerine.

I find Tangerine is still good for no-fee banking, but they’ve really dropped the ball when it comes to offering high interest rates on savings deposits. Outside of short-term promotional rates, the rate on Tangerine’s savings account is a pitiful 0.25%.

That’s why we opened a Savings Plus account at EQ Bank for our emergency savings. The account pays a high everyday rate of 2%, which is at or near the top of the market. Open an account here and fund it with $100 within 30 days and you’ll get a $20 cash bonus for free.

Our investments are held at TD Direct (RESP, LIRA), Wealthsimple Trade (RRSP, TFSA), Wealthsimple Invest (wife’s RRSP), and Questrade (new corporate investment account). 

It would be nice to have all of our banking and investments in one place, but the fact is there’s no one bank or institution that offers every account type we need, doesn’t charge any fees, and pays the highest interest rate on savings deposits. Until then, we spread out our banking to get a bigger bang for our buck.

Weekend Reading:

Sticking with the mortgage theme, Michael James on Money says to think twice before taking a five year closed mortgage due to severe penalties for breaking the mortgage early.

You’re likely shopping online now more than ever. Our friends at Credit Card Genius share the best credit cards for earning cash back and saving on foreign transaction costs.

The Better Dwelling blog reports that Canadian real estate prices grew 29x faster than U.S. prices since 2005.

The Lowest Rates blog presents six personal finance pros on what it takes to become a ‘money expert’.

Here’s a good piece from MoneySense where four single moms get personal about their money matters and ask a pro for help.

Rob Carrick is spot on with this advice to young, app-focused investors treating the stock market like a game:

Free-trading apps are a fad that will fade, probably not without damage done to those who have treated investing like a game. The stock-market surge since March is not a test of anyone’s investing ability – everyone looks like a star trader.

But free-trading apps can also be a force for good investing. Here’s how: Use them to build a super-cheap balanced-ETF portfolio.

Chrissy at Eat Sleep Breathe FI shared a guest post on the Money We Have blog and listed four simple steps to financial independence.

Ted Rechtshaffen says holding cash is a sign of fear, and fear is the worst investment of all.

Downtown Josh Brown and Irrelevant Investor Michael Batnick discuss Gold versus the S&P500, Warren Buffett versus Elon Musk, and more in this entertaining edition of, What are your Thoughts?

An incredibly detailed case study from the Frugalwoods blog on a Canadian family’s plan for the future.

Here’s a great piece from the Wall Street Journal’s Jason Zweig: The South Sea bubble is the classic story of an investing mania. Are investors today any wiser?

Erica Alini reports how this Ontario man was promised a refund – then Sunwing changed its policy.

I loved this article by Des Odjick on how her blog landed her a dream job as a content marketer.

Finally, what many of us have been dealing with for months – the implications of working without an office.

Have a great weekend, everyone!

Are You Making Rational Financial Decisions?

By Robb Engen | July 15, 2020 |
Posted in
Making Rational financial decisions
Economists have long argued that, given the choices available, people will make rational decisions that provide them with the greatest benefit or satisfaction. Then behavioural economics, led by the likes of Daniel Kahneman and Richard Thaler, came along and showed how people behave irrationally all the time due to psychological, cognitive, and emotional factors.

For example, Thaler’s theory of mental accounting reveals how people place greater value on some dollars over others, even though all dollars have the same value. They might go out of their way to save $10 on a $20 item, but not make the same effort to save $10 on a $1,000 purchase.

Looking at my own personal finance views I’ve found a mix of rational and behavioural driven decisions. Here are three that come to mind:

Dividend investing vs. Indexing

In the dividend investing versus indexing debate I’ve tried to (kindly) argue that indexing is what economists would call a rational choice given the overwhelming body of evidence supporting an efficient market that can’t be exploited by investors over the long term. 

On the other hand, it “feels better” to receive a portion of your investment returns in cash and so it’s not surprising to see investors flock to dividend stocks.

Efficient market theory states that investors would be better off buying the entire market for a small fee. Dividend investors might say that sounds great in an academic paper, but in practice they’d prefer to receive regular cash dividends instead of hoping that markets will continue to grow as they have in the past (bird in the hand theory). Dividends also help investors weather the storm during a market crash (provided the dividends don’t get cut or eliminated).

Maybe it’s more about the illusion of control. Active management “feels better” because you’re exercising control over when and what to buy and sell, whereas index investors might appear to have given up control and left their investing fate to the stock market gods.

But is your judgement really adding value and leading to a better outcome? In my case I felt it wasn’t. Even though my portfolio beat its benchmark for five years, I chalked that up to timing – a rising tide lifts all ships. If you started dividend investing in 2009 like I did then you probably had some pretty stellar returns. But over the long-term, I’ve put my money on rational outperforming behaviour.

Debt snowball vs. Debt avalanche

Two popular debt repayment strategies are the debt snowball and debt avalanche.

The debt snowball focuses on the psychological advantage that comes from making progress with quick, successive wins. Start by arranging your debts from lowest balance to highest. It feels better to rid yourself of your smallest debt, and the idea is that the snowball effect builds enough momentum so that you’ll be more inclined to stick with the strategy.

The debt avalanche method suggests that math trumps behaviour. The idea is that you’ll pay less interest and become debt-free faster when you attack your highest interest debts first.

With a debt avalanche, simply list your debts from highest interest rate to lowest – regardless of the balance or minimum payments due. Direct all of your extra cash toward your highest interest rate debt while maintaining the minimum payments on the other loans on your list.

Advocates of the debt snowball method say it’s all about creating momentum to get you motivated to pay off your debt. But I disagree. Once you’ve made the decision to tackle your debt I think you should use the method that gets you out of debt faster and saves you the most money.

Rational 2, Behaviour 0

Credit cards vs. Cash

People are willing to spend more when they use a credit card instead of cash. It’s a fact that has been proven in study after study. Yet I still choose to use a credit card for my everyday spending, despite the evidence that using cash is the more rational choice when it comes to sticking to a budget and saving money.

My excuses for using a credit card are all behaviourally driven:

  • Convenience – It’s easier to pull out my credit card than to take out money from an ATM (or risk not having enough when you need it).
  • Rewards – I earn 2% (or more) back on every purchase. Alternatively, you get nothing back when you pay for items using cash or debit.
  • Tracking spending – Using one credit card for every purchase helps keep tabs on my spending better than using cash and forgetting to get a receipt.
  • Fraud prevention – I can dispute a credit card charge easily enough, or cancel my card if it gets lost or stolen and have a new one shipped to me within days. None of my money is on the line. If my debit card gets skimmed, on the other hand, I’m out of pocket the damages until the bank or authorities get to the bottom of it.

An MIT study suggested that the credit card premium (the amount people were willing to pay for an item with a credit card instead of cash) was between 59 and 113 percent. That’s not for everyday items, mind you, but for things such as concert tickets or dining out at a restaurant.

I get it. Let’s say I took my family out to a restaurant and only had $75 cash in my wallet and no access to credit. Of course this would influence what we ordered from the menu, whether or not we had drinks or dessert, and even how much we’d tip. But since I know we’ll pay by credit card it becomes much easier to order an appetizer, plus a drink (or two), and watch the bill come in over $100.

My personal issue with carrying cash is that I think I tend to spend more when I have it in my wallet. Almost as if it’s found money.

Perhaps I need to do an all-cash challenge for a couple of weeks and see if it a) helps control discretionary spending, and b) is as big a pain in the neck as I think it will be.

For now, score one for behaviour over rational decisions.

Final thoughts

When I switched to indexing, I sided with math over behaviour. But that doesn’t mean all of my investing choices are rational financial decisions.

For example, my one-ticket investing solution consisting of Vanguard’s VEQT is more expensive than other indexing options. The problem is, a less expensive solution involves more complicated workarounds such as using Norbert’s Gambit to convert Canadian dollars to USD (and vice versa).

And, for years, before I switched to Wealthsimple Trade, I paid $9.99 per trade at TD Direct even though cheaper options like Questrade existed. Reason being that I liked having all of my accounts in one place.

We’ve all heard that personal finance is personal. The point of thinking about all of this is not to determine whether you’re a rational or irrational person. It’s about finding a system that helps you achieve the best outcome. Sometimes that outcome will be the “rational” choice, while other times you might forgo the optimal solution and choose simplicity or convenience instead.

Tell me about a time when you made an “irrational” financial decision.