Arguably no one has done more to educate Canadian do-it-yourself investors than the PWL Capital teams of Dan Bortolotti and Justin Bender, and Benjamin Felix and Cameron Passmore.
It began more than a decade ago with Dan’s incredibly popular Canadian Couch Potato blog and podcast. Since then, Dan teamed up with PWL’s Justin Bender, who has his own Canadian Portfolio Manager blog in addition to a podcast and YouTube channel dedicated to helping DIY investors.
More recently, PWL’s Ottawa team of Felix and Passmore launched their own successful Rational Reminder podcast, which complements Ben’s Common Sense Investing YouTube channel (which now boasts nearly 200,000 subscribers).
It’s an incredible amount of content dedicated to helping Canadians become better investors.
Their advice at its core is to follow an evidence-based investing approach that starts (and usually ends) with a low cost, globally diversified, and risk appropriate portfolio of index funds or ETFs. Simplify this even further by investing in a single asset allocation ETF that automatically rebalances itself.
Indeed, Justin Bender says,
“These simple one-fund solutions are ideal for the majority of DIY investors.”
Dan Bortolotti says,
“Since their appearance in early 2018, asset allocation ETFs have become the easiest way to build a balanced index portfolio at very low cost.”
And, Ben Felix says,
“Total market index funds are the most sensible investment for most people.”
Keeping it Simple
Dan’s writing was influential in my own journey from dividend investing to full-fledged indexing. But I took a long-time to switch to indexing because the product landscape was less than ideal.
In the early 2010’s, Dan’s model portfolios often consisted of six to 12 different ETFs. All one had to do was look at the comments left on his articles by investors who agonized over whether to add 5% to REITs, 2.5% to gold, or put an extra tilt to their U.S. holdings. Meanwhile, these were often new investors with less than $10,000 in their portfolio.
Then Vanguard introduced a groundbreaking ETF called VXC (All World, except for Canada). Now a Canadian investor could set up a low cost, globally diversified portfolio of index funds with just three ETFs (VCN for Canadian equities, VAB for Canadian bonds, and VXC for global equities).
I took the plunge and sold my dividend stocks to purchase a two-fund (all equity) portfolio consisting of VCN and VXC. Ben Felix said that, “back in 2017, the simplest portfolio around was Robb Engen’s four-minute portfolio, which consists of only two equity ETFs.”
Then, in 2018, Vanguard again changed the game when it launched a suite of asset allocation ETFs designed to be a one-fund investing solution. That’s when I switched my two-fund solution over to my new one-fund solution with Vanguard’s VEQT.
Tangled up in Plaid
It would be great if the debate ended there, but this is investing and many of us are wired to look for an edge to boost our returns. Accepting market returns is difficult because we’re constantly distracted by shiny objects, and doom & gloom forecasts, not to mention the notion that when markets are booming or crashing we feel like we need to do something.
Index investors are not immune to this. Not content with a total market, all-in-one solution, some indexers look to reduce their fees even more by holding U.S. listed ETFs and performing the currency conversion tactic known as Norbert’s Gambit.
Justin Bender’s model portfolios include ‘ridiculous’, ‘ludicrous’, and ‘plaid’ options designed to squeeze out some extra return by reducing fees.
Bender’s Ludicrous Model Portfolio
|Vanguard Canadian Aggregate Bond Index ETF||VAB||40.00%|
|Vanguard FTSE Canada All Cap Index ETF||VCN||18.00%|
|Vanguard U.S. Total Market Index ETF||VUN||8.27%|
|Vanguard Total Stock Market ETF (U.S. listed)||VTI||16.54%|
|Vanguard FTSE Developed All Cap ex North America Index ETF||VIU||12.44%|
|Vanguard FTSE Emerging Markets All Cap Index ETF||VEE||1.58%|
|Vanguard FTSE Emerging Markets ETF (U.S. listed)||VWO||3.17%|
Bender’s Plaid Model Portfolio
|BMO Discount Bond Index||ZDB||29.29%|
|Vanguard FTSE Canada All Cap Index ETF||VCN||16.85%|
|Vanguard U.S. Total Market Index ETF||VUN||10.71%|
|Vanguard Total Stock Market ETF (U.S. listed)||VTI||16.06%|
|Vanguard FTSE Developed All Cap ex North America Index ETF||VIU||19.60%|
|Vanguard FTSE Emerging Markets ETF (U.S. listed)||VWO||7.49%|
Again, the idea here is to reduce the cost of your index portfolio and reduce or eliminate foreign withholding taxes. The plaid portfolio takes into account your after-tax asset allocation, recognizing that a portion of your RRSP is taxable and doesn’t fully belong to you.
And it’s true. By selecting certain individual ETFs over the all-in-one asset allocation ETF an investor can save a not-so-insignificant 0.28% in an RRSP (VBAL’s MER + foreign withholding tax = 0.42% while the combination of individual ETFs in Bender’s model portfolio costs just 0.09% MER + 0.05% FWT).
WTF (What the Factor)?
The PWL team of Felix and Passmore use funds from Dimensional Fund Advisors to build their client portfolios. These funds target the five known risk factors used to explain the differences in returns between diversified portfolios.
The risk factors include market (stocks beat t-bills), size (small cap stocks beat large cap stocks), value (value stocks beat growth stocks), profitability (companies with robust profitability beat companies with weaker profitability), and investment (companies that invest conservatively beat firms that invest aggressively).
Since it’s not possible for a Canadian DIY investor to access Dimensional Funds, Ben proposed a model portfolio designed to target the five factors.
Felix Five Factor Model Portfolio
|BMO Aggregate Bond Index ETF||ZAG||40.00%|
|iShares Core S&P/TSX Capped Composite ETF||XIC||18.00%|
|Vanguard U.S. Total Market Index ETF||VUN||18.00%|
|Avantis U.S. Small Cap Value ETF||AVUV||6.00%|
|iShares Core MSCI EAFE IMI Index ETF||XEF||9.60%|
|Avantis International Small Cap Value ETF||AVDV||3.60%|
|iShares Core MSCI Emerging Markets IMI Index ETF||XEC||4.80%|
This factor-tilted portfolio is slightly more expensive than Bender’s ludicrous option but the main objective of Felix’s Five Factor model portfolio is to increased expected returns.
Ben does present a compelling case for indexers to tilt their portfolios towards these factors to potentially juice expected long-term returns.
What index investors need to determine is whether that juice is worth the squeeze. I’d argue that it’s not.
The Behavioural Argument To Avoid Complexity
I have a huge amount of respect and admiration for what Dan & Justin, and Ben & Cameron have done for individual investors. But I think these model portfolios should be locked behind a pay wall, only to be accessed by investors who can demonstrate the experience, competence, and discipline needed to execute the strategy. That includes:
- Having a large enough portfolio for this to even matter.
- Using an appropriate investing platform that allows you to hold USD, perform same-day currency conversions, and keep trading commissions low.
- Creating an investing spreadsheet that’s coded to tell you what to buy and when to rebalance.
- Being an engineer or mathematician who not only loves to optimize but who also understands exactly what he or she is doing (and why).
- Having the conviction to stick with this approach for the very long term, even through periods of underperformance.
- Being humble enough to admit that you’re probably not going to execute this strategy perfectly.
Beginner investors shouldn’t worry about U.S. listed ETFs or factor tilts when they first start building their portfolio. It’s only once your portfolio gets into the $250,000 territory that you’ll start to see any meaningful savings in MER and foreign withholding taxes. Focus on your savings rate.
The investing platform matters. Wealthsimple Trade offers commission-free trades but doesn’t allow clients to hold US dollars, making it expensive to buy U.S. listed ETFs. Questrade is a more robust trading platform for DIY investors, and allows for free ETF purchases, but it takes a few days to process Norbert’s Gambit transactions leaving investors exposed to opportunity costs while they wait. Some platforms, like RBC Direct Investing, allow for same-day Gambits but also charge $9.95 per trade.
A investing spreadsheet, like the one Michael James has created for himself, takes decisions like what to buy and when to rebalance away from the investor and replaces them with a rules-based approach. This is critical, as humans are not likely to make good decisions consistently over time – especially in changing market conditions.
“Statistical algorithms greatly outdo humans in noisy environments.” – Daniel Kahneman
Multi-ETF investing models were designed by incredibly smart people who put in the research to create an optimal portfolio. It certainly looks elegant on a spreadsheet to see such precise allocations to emerging markets, international stocks, or U.S. small cap value stocks. But that precision gets thrown out the window when markets open the next day and start moving up and down.
Your carefully optimized portfolio is now live and immediately out of balance. Behavioural questions abound. When to rebalance? Where to add new money? What happens when I run out of RRSP or TFSA room?
In the case of the five factor model portfolio, how will you react if this approach doesn’t outperform a traditional market weighted index portfolio? Small cap value stocks have been crushed by large cap growth stocks for many years. How long will investors wait for the risk premium to come through?
My own investing journey and experience reviewing hundreds of client and reader portfolios tells me that the vast majority should be invested in low cost, globally diversified, risk appropriate, and automatically rebalancing products. Today, the easiest way to do that is with a single asset allocation ETF or through a robo advisor.
Again, one just has to look at the comment sections of their blogs and videos to find that these complicated portfolios lead to many more questions than answers. Dan likely realized this and simplified his Canadian Couch Potato blog model portfolios to include just the single-ticket asset allocation ETFs or TD’s e-Series funds.
But it’s clear that inexperienced investors are trying and failing to implement the more complicated portfolios in real life. In fact, it’s possible we’ll see thousands of Bender and Felix investing refugees flocking back to a one-ticket solution in the years to come.
That’s why the ridiculous, ludicrous, plaid, and five factor model portfolios should have been kept under wraps. Index investors don’t need more complicated solutions when they can beat the vast majority of investors with a simple, single-ticket asset allocation ETF.