Solving The Home Bias In My Portfolio

Canadian investors tend to suffer from home bias – a preference to hold more domestic stocks over foreign equities. This is actually true of investors in most countries, but it’s particularly troubling in Canada where our stock markets are highly concentrated in the financial and energy sectors.

The federal government could be partially to blame for our home bias tendencies. As recently as 2005 the government imposed a limit on the amount of foreign content allowed in RRSPs and pension plans. This cap was introduced in 1971 to help support the development of Canada’s financial markets but was scrapped in the 2005 federal budget, freeing Canadians up to invest abroad.

Sizes of World Stock Markets

It’s well known that Canada makes up less than 4 percent of global equity markets (2.7 percent, to be exact), yet 60 percent of the equities in Canadian investors’ portfolios are in domestic securities.

Even most model ETF and index fund portfolios have Canadian investors overweighting domestic equities, holding anywhere from 20-40 percent Canadian content.

Canadian home country bias

The result is a portfolio that is more volatile and less efficient than one with international equity diversification. Indeed, investors with a Canadian home bias are taking risks they could have diversified away by increasing their allocation to global equities.

My two-ETF portfolio

So how does my portfolio stack up? When I switched to my two-ETF solution, made up of Vanguard’s VCN (Canadian) and VXC (All World, ex-Canada), I chose to have an allocation 20-25 percent Canadian stocks and 75-80 percent international stocks.

That allocation would be relatively easy to monitor and rebalance if it was simply help in my RRSP. Whenever I added new money to my RRSP, I’d simply buy the ETF that was lagging behind its initial target allocation.

But I complicated things recently when I started contributing again to my TFSA. I wanted to treat my TFSA and RRSP as one total portfolio and keep the same asset mix in place. Since my RRSP was much larger than my TFSA, I decided to hold mostly foreign content (VXC) in my RRSP while putting Canadian stocks (VCN) in my TFSA.

This worked out great for several years but now I’ve run into a second problem; I’m contributing to my TFSA at a much faster pace than my RRSP. That’s because I’ve maxed out all of my unused RRSP contribution room and, due to the pension adjustment, I get a measly $3,600 per year in new contribution room.

Meanwhile I still have loads of unused TFSA contribution room and so I’ve been socking away $12,000 per year for the past two-and-a-half years. I hope to continue at that pace for many more years until I’ve completely caught up on all that available contribution room.

The result is a portfolio that is becoming increasingly more tilted to Canadian equities. At this rate, if I continue filling my TFSA with VCN, my portfolio will have more than 30 percent Canadian content in five years, and nearly 40 percent Canadian content in 10 years.

My Home Bias Solution

I’m considering a change to my two-fund portfolio. With the introduction of Vanguard’s new all-equity asset allocation ETF – VEQT – I could turn my two-fund solution into a true one-fund solution and make investing even more simple.

Not so fast, though. When I looked under the hood of VEQT to see the underlying ETFs that it holds, I noticed a heavy tilt towards Canadian equities:

  • Vanguard US Total Market Index ETF – 39.1%
  • Vanguard FTSE Canada All Cap Index ETF – 30.1%
  • Vanguard FTSE Developed All Cap ex North America Index ETF – 23.3%
  • Vanguard FTSE Emerging Markets All Cap Index ETF – 7.5%

I don’t want a portfolio made up of 30 percent Canadian equities. If anything, I want to reduce my exposure to the Canadian market.

Here’s what I’d like to do: Replace VCN with VEQT.

What that means is my RRSP will hold nothing but VXC, while my faster growing TFSA will hold VEQT.

At the end of 2019 my new two-ETF portfolio would look something like this:

Account ETF Ticker Market Value Percentage
RRSP VXC $180,000 83.7
TFSA VEQT $35,000 16.3

Because VEQT is made up of 30 percent Canadian equities I would have approximately 4.9 percent of my overall portfolio weighted to Canadian markets (much more aligned with its global weight).

But as I continue making larger TFSA contributions each year the percentage of Canadian content will gradually increase (just less quickly than if I had been contributing straight to VCN each time).

At the end of 2024 my portfolio would look like this:

Account ETF Ticker Market Value Percentage
RRSP VXC $262,392 68.8
TFSA VEQT $118,542 31.2

The Canadian content from my ever-rising VEQT would still make up just 9.4 percent of my overall portfolio.

By then I’ll have caught up on my unused TFSA contribution room and so I’d only be able to put in the annual TFSA maximum.

The growth of VEQT as a percentage of my overall portfolio slows, and so the percentage weighted to Canadian equities only creeps up to around 12 percent by the year 2040.

Final thoughts

I want to tame my home bias for Canadian equities while keeping my portfolio as simple as possible.

By replacing the Canadian equity ETF (VCN) with the new Vanguard 100 percent equity asset allocation ETF (VEQT) I’m able to keep my simple two-fund solution intact.

Meanwhile I solve a potential diversification problem by reducing my home bias to Canadian stocks and maintaining proper global diversification inside my portfolio.

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22 Comments

  1. rikk2 on March 4, 2019 at 6:09 am

    So … if your RRSP room is a measly $3600, then your yearly pension contribution must be let’s say ~$10K matched by your employer I would guess for ~$20k/yr or whatever the limit is. For completeness/correctness, and if significant, should you not include your pension plan’s holdings bias in determining your overall weighting/bias?

  2. Jaycee on March 4, 2019 at 6:22 am

    Won’t there be unrecoverable withholding tax with VEQT in the TFSA?

    • Dividend Earner on March 5, 2019 at 10:02 am

      @Jaycee
      There comes a day where focusing on the dividend withholding tax restricts investing in good long term investment. A 15% tax on a 1% dividend or 2% is still very low.

      As Robb highlights, the Canadian stock market is highly concentrated in 2 sectors, our largest company is Royal Bank at 140B or so and it achieves that by being in the US and the rest of the world.

      Embrace the tax and profit from the other markets.

  3. Robb Engen on March 4, 2019 at 9:58 am

    Hi rikk2, I treat my pension as the fixed income portion of my retirement plan since it is backstopped by the provincial government and payments will be more “annuity-like” as opposed to being subject to market risk like my individual investments.

  4. Robb Engen on March 4, 2019 at 10:04 am

    Hi Jaycee, yes that is true. Although the withholding tax on VEQT is estimated to be around 0.24% versus VXC which would be 0.48%.

    While the fees and taxes would be higher holding one of these international ETFs instead of my current VCN holding, my rationale is that expected returns would be higher and less risky with a global ETF than they would be if I continued to hold an ever-increasing Canadian weighting.

    • Bryan on March 4, 2019 at 6:22 pm

      Great article Robb! I’m going to be in the same boat soon since I also get pension-adjusted RRSP limits each year and playing catch-up. What do you estimate is your new overall portfolio cost between the two ETFs? Just MERs, not including trading costs. Thanks!

  5. Judy on March 4, 2019 at 10:20 am

    I’m actually gradually moving away from holding foreign stocks so that I don’t have to fill in the T1135 form where I have to tell the gouvernmente my foreign holdings. Yes, it’s a trivial reason, but it is so irritating!

  6. Dale Roberts on March 4, 2019 at 10:39 am

    Great post, thanks Robb. I like that allocation in VEQT. Too much international for my liking but that’s a personal bias.

    I know we’re not supposed to think too much but there’s been zero GDP growth in Europe over a decade. I’ll have to try and find that study I read.

    I have very light international exposure in my model ETF portfolios.

    I’ll admit to zero international in my personal RRSP portfolio. That said US multinationals offer some international exposure. I use Canadian div payers with a US component. I like US stocks to counter Canadian sector concentration risks.

    And all said I’m in a semi-retirement stage. I would approach this a little differently if I was in the accumulation stage. I did use developing markets and growth oriented US when I was accumulating.

    Great post. The main take away being Canadians need to diversify away from our concentrated market.

  7. Peter Guay on March 4, 2019 at 10:50 am

    Hi Robb, Great post, as always! It is worth pointing out that your new portfolio with only 4.9% in Canada will be strongly influenced by the movement of the Canadian dollar with respect to other currencies. If the dollar shoots up like it did in 2009 and 2010, your portfolio might not feel so great in Canadian dollar terms. Be ready for this possibility and make sure that years like that don’t derail your plan.

  8. Albert Wilson on March 4, 2019 at 6:13 pm

    From a tax perspective to qualify for the benefits from your TFSA the securities in it must be Canadian….so does VEQT qualify as Canadian? It may be possible that the provider (Vanguard) provides a breakdown of the gains & div’s pd from the Canadian component of VEQT (Vanguard FTSE Canada All Cap Index ETF) & that Canadian portion is what would qualify for the TFSA benefits…..you would want to be sure you are getting the TFSA benefit…..csan you address where I may be wrong or what I am missing?

  9. Grant on March 5, 2019 at 5:44 am

    I think you’re over complicating things, and would just go with VEQT in both accounts. The one fund asset allocation ETFs are a game changer for DIY investors, so why mess with the simplicity of them? There are good reasons to have some home bias anyway – we spend in Canadian $s so it’s not great to have too much exposure to foreign currency risk, especially in retirement and about 30% home bias has historically been the sweet spot for reducing portfolio volatility

    https://www.pwlcapital.com/overweight-canadian-stocks-model-etf-portfolios/

    • MIwo on March 9, 2019 at 6:22 pm

      I am using these asset allocation funds because I know that the biggest risk is me!!! Thus I best NOT tinker with them.

  10. alana on March 5, 2019 at 10:55 am

    I looked at VEQT as well but in the end it wasn’t for me for the reasons you outlined above, 30% Canadian allocation is too much, decided to stick to my 2 fund XAW/VCN portfolio as I can control the asset ratios. If you’re looking to reduce your Canadian bias, why not just adjust your existing preferred VCN /XAW allocations? Is there a particular tax advantage/ fee advantage by switching to VEQT? VEQT covers the same markets as XAW PLUS has Canadian holdings which, if I read the article correctly, you were looking to reduce. What am I missing here?

  11. Christina on March 5, 2019 at 11:59 am

    FYI Canada is kicking US stocks butt so far this year. I read part of the reason the Canadian Couch Potato organizes his portfolio is regret minimization.

  12. christina on March 5, 2019 at 12:05 pm

    Also just a comment i think there is some recency bias going on with your portfolio as i think the US had a real slump awhile back although i don’t remembe r the time frame. Although perhaps your main concern is volatilty?

  13. christina on March 5, 2019 at 12:35 pm

    It actually looks like they only had a slump from 2000-2003. I am struggling with the issue of home bias myself, just not sure i want to tie my fortunes to a crazy country like the states. I’m also cognizant of mean reversion and that anything could happen in the future. I gues s for me the concept of regret minimization works. Excuse all the comments, interesting topic!

  14. Tom on March 5, 2019 at 1:08 pm

    I think this is the slump you were referring too
    https://seekingalpha.com/article/4137982-s-and-p-500-gained-3_4-percent-per-year-since-2000

    This article argues the last 9 years was a reversion to the mean.

  15. Bop on March 20, 2019 at 1:29 pm

    You say that having a Canadian home bias creates “a portfolio that is more volatile and less efficient”, but that’s not really true. On overweight to Canadian equities *reduces* volatility in general. The maximum reduction in volatility is having about 30% of your equities in Canadian, which is why the Vanguard asset allocation funds have that. However, even up to around 60% in Canadian is less volatile than the 4% you are suggesting.

    See Figure 4 in https://www.vanguardcanada.ca/documents/global-equities-advisor.pdf

  16. Bryan on March 27, 2019 at 2:15 pm

    Hey Robb, Just re-upping this since I think it got lost in the mix…What do you estimate is your new overall portfolio cost between the two ETFs? Just MERs, not including trading costs. Thanks!

    • Robb Engen on March 27, 2019 at 9:56 pm

      Hey Bryan, no worries. It’s 0.22%

  17. Chris Keener on October 15, 2019 at 9:25 am

    Hi Robb,

    Great article. Any particular reason you choose VXC over XAW? I decided to put XAW in my RRSP (lower MER) and will be using VEQT in TFSA for my Canadain, and other exposure.

    The one key difference I noticed in VXC vs XAW is VXC has more weight in financials.

    In this case, I won’t get a benefit on Foreign tax withholdings, but I wanted to keep things simple.

    • Robb Engen on October 17, 2019 at 12:01 pm

      Hi Chris, when I made this switch XAW had not yet hit the market. I think it’s structured slightly better than VXC, to be honest, but I had already made my choice and was hesitant to move.

      You’re smart to keep things simple and not second guess yourself.

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