Becoming an Indexer

[Apex1]

I'll preface here with the history that I have been an individual stocks Buy and Hold investor (buffet style stocks or so I think) for the last decade. Fortunately, I've avoided big mistakes but the truth is that I don't actually know if I've been able to "beat the market".

I am in the process of converting from individual stocks (B and H) to becoming an indexer. Any pitfalls with this proposed model that I am considering?

40% Canadian Large Cap (mostly banks)
25% S/P 500
25% Berkshire Hathaway
10% Bonds

I'm a 39 year old candian doc possibly within a few years of full FIRE (I'm thinking age 45 would be my latest even though I should be FI in a couple years). I am thinking overweight Canadian equities due to favourable tax treatment of dividends. I am also thinking of a large allocation to Berkshire Hathaway since foreign capital gains only (BRK does not pay dividends) would be preferential over US capital gains + dividends from other US large cap such as I will receive in the S/P 500 ( US dividends are considered foreign dividends here and taxed similar to interest/ordinary income).

I realize my AA appears quite aggressive but I am thinking along the lines of total return and tax minimization/efficiency.

Any alarm bells?

Thanks.

[sengsational]

Fairly aggressive asset allocation, but I'd say that's ok if you don't mind working your way through a market down turn. I read somewhere that not all index funds are alike with respect to fees in Canada. Same here! But apparently something to lookout for. I'd check the total fees of your proposed specific funds against Vanguard, for instance, and make sure you're getting a good deal.

[Meadbh]

Hi Apex. I don't see any international equities in there. Japan and Europe have some potential. I can't disagree with your low bond allocation under present market conditions but I wonder if (a) you will be focusing on high grade corporate bonds and (b) you have some cash/cash equivalents outside this portfolio?

[Onward]

For someone within a few years of retiring,

Way too concentrated in Canadian, and way, way too concentrated in Canadian banks.

25% is far too much to have in any single company (Berkshire Hathaway), even a conglomerate. Reduce to 5% or less.

Add a good chunk of ex-North-America stocks.

Increase allocation to bonds.

[Animorph]

International and small cap. I'd use a wider ranging index, like total stock market, to get better coverage than S&P 500 plus Canadian large-caps. And a separate fund for international.

[pb4uski]

Quote:

Originally Posted by Apex1 ....Any alarm bells?...

I'm concerned you have the tax tail wagging the investment dog. I think you are best off to decide first given your risk appetite what your target AA should be in terms of domestic equities, international equities, domestic fixed income, international fixed income and cash. Then decide the most tax efficient placement of your investment portfolio.

From an investment perspective, you seem too concentrated in banks and BH. Alternatively, perhaps one of the all-world funds like VTWSX would be easier and give you broad geographic equity exposure and then you could add a Canadian tilt through some domestic stock index funds.

[galeno]

We (wife and I) have 30 years of experience investing in the financial markets as a US-NRA.

First 12 years: we used managed offshore mutual funds. Next 11 years: individual stocks. Last 7 years: indexed ETF portfolio.

IMHO, indexing is best. It's cheap. It's easy to manage. It gets spectacular returns. If I may, allow me to suggest this simple but powerful portfolio:

X%VT (equities) + Y%BND (bonds)+ Z%MMF (cash)

Rebalance every time one of the three gets out of wack by 5% or more.

[Meadbh]

Here's how I would approach indexing if I were in Apex's situation.

Desired asset allocation:
Equities 70%
Fixed income 20%
Cash and cash equivalents 5%
Other 5% (could be Berkshire Hathaway, income producing real estate or precious metals)

Equities:
Canadian index fund with lowest MER 30%
US index fund with lowest MER 30%
International index fund with lowest MER 30%
Other 10% (fun portfolio of individual stocks directly invested)

Fixed income:
High grade corporate bond fund
Hold this within RRSP

Cash and cash equivalents:
GIC ladder

[Apex1]

Quote:

Originally Posted by sengsational I read somewhere that not all index funds are alike with respect to fees in Canada. Same here! But apparently something to lookout for. I'd check the total fees of your proposed specific funds against Vanguard, for instance, and make sure you're getting a good deal.

Absolutely. I've realized lately that .5% MER in some of my current index funds is is waaay too high. For example, I have a 7 digit amount in XFN (ishares canadian financials) which means I am paying at least 5K per annum more than i have to compared to a similar but not identical fund in Vanguard Problem is, its not a "no brainer" to just switch funds since I will be then hit with significant realized capital gains. Its a good problem I suppose.

[Apex1]

Quote:

Originally Posted by Meadbh Hi Apex. I don't see any international equities in there. Japan and Europe have some potential. I can't disagree with your low bond allocation under present market conditions but I wonder if (a) you will be focusing on high grade corporate bonds and (b) you have some cash/cash equivalents outside this portfolio?

Currently, all fixed income including high grade corporate bonds are in my RRSP (non-taxable) account. I also have high dividend paying stocks (5%) like Altria (MO) in there.

I recently sold an international index in order to offset some capital gains in individual stocks holdings. The mer on the international index was too high anyways (again, I believe Vanguard has much lower mers) and besides I was getting impatient with the recent ( last 2 years) performance. Also, I was reading somewhere that many of the S/P 500 companies have global exposure anyways but perhaps its not enough?

[Apex1]

Quote:

Originally Posted by Onward For someone within a few years of retiring, Way too concentrated in Canadian, and way, way too concentrated in Canadian banks. 25% is far too much to have in any single company (Berkshire Hathaway), even a conglomerate. Reduce to 5% or less. Add a good chunk of ex-North-America stocks. Increase allocation to bonds.

Quote:

Originally Posted by Animorph International and small cap. I'd use a wider ranging index, like total stock market, to get better coverage than S&P 500 plus Canadian large-caps. And a separate fund for international.

Point well taken. Thank you!

[Apex1]

Quote:

Originally Posted by pb4uski I'm concerned you have the tax tail wagging the investment dog. I think you are best off to decide first given your risk appetite what your target AA should be in terms of domestic equities, international equities, domestic fixed income, international fixed income and cash. Then decide the most tax efficient placement of your investment portfolio.

Yep, I am indeed having trouble deciding on a proper AA going forward. I read here that it was OK to to be more aggressive (90/10) during the accumulation phase (I used to be 70/30) until the RE trigger actually gets pulled.

The favourable tax treatment on the 3.5% dividend of most Canadian banks has indeed skewed my investment decision making. They have done well in the past decade but I realize I am giving up diversification. Again, this is defintely something I need to re-evaluate.

[BigNick]

Quote:

Originally Posted by Meadbh Japan and Europe have some potential.

I'm not sure if I'd be buying European (or Eurozone, at least) stocks right now, with the Euro at US$1.37/C$1.43. I can't believe there is any way but down for the Euro against the $s, which might wipe out any nominal gains in the share price.

Of course, that's also what I said when the Euro hit US$1.25. But right now, the Euro is at an all-time high (which some find amazing, given that for the last three years every story has been about its impending meltdown). If it dropped 10% against the USD I would make 60-80K Euros simply because of the amount I have invested outside my home (Euro) zone.

[eta2020]

Quote:

Originally Posted by Onward For someone within a few years of retiring, Way too concentrated in Canadian, and way, way too concentrated in Canadian banks. 25% is far too much to have in any single company (Berkshire Hathaway), even a conglomerate. Reduce to 5% or less. Add a good chunk of ex-North-America stocks. Increase allocation to bonds.

+1 but I don't care about bonds. 10% is enough IMO

[Animorph]

Quote:

Originally Posted by Apex1 Also, I was reading somewhere that many of the S/P 500 companies have global exposure anyways but perhaps its not enough?

I keep hearing that, but really, does the S&P 500 include foreign companies that do most of their business in North America? No need to arbitrarily ignore companies domiciled elsewhere. Most of my international funds have certainly behaved differently than the domestic funds. Quite a few have a ways to go to hit their old pre-2008 highs. Prior to 2008 many of them were doing way better than my domestic funds. They are different.

[Apex1]

Quote:

Originally Posted by pb4uski I'm concerned you have the tax tail wagging the investment dog

I may also be biased because 90% of my invesments are in taxable accounts.

[Apex1]

Quote:

Originally Posted by Meadbh Here's how I would approach indexing if I were in Apex's situation. Desired asset allocation: Equities 70% Fixed income 20% Cash and cash equivalents 5% Other 5% (could be Berkshire Hathaway, income producing real estate or precious metals) Equities: Canadian index fund with lowest MER 30% US index fund with lowest MER 30% International index fund with lowest MER 30% Other 10% (fun portfolio of individual stocks directly invested) Fixed income: High grade corporate bond fund Hold this within RRSP Cash and cash equivalents: GIC ladder

Thanks again Meadbh for spelling it out for me I'm sold on the need for international exposure although I am still debating my risk tolerance (% of equities).

[photoguy]

Have you looked at the portfolios at Model Portfolios

[seraphim]

Vanguard.

Ours is 52% Vtsax, 8% VTIAX, 15% Total bonds (VBTLX?) and 25% in SV accounts which I can just now access; they're slated for bond funds when bond values drop and SEC yields rise sufficiently. Right now the SVs earn as much income, if not more, than bonds.

[Meadbh]

Quote:

Originally Posted by Apex1 Currently, all fixed income including high grade corporate bonds are in my RRSP (non-taxable) account. I also have high dividend paying stocks (5%) like Altria (MO) in there. I recently sold an international index in order to offset some capital gains in individual stocks holdings. The mer on the international index was too high anyways (again, I believe Vanguard has much lower mers) and besides I was getting impatient with the recent ( last 2 years) performance. Also, I was reading somewhere that many of the S/P 500 companies have global exposure anyways but perhaps its not enough?

Apex1, an RRSP is not a non-taxable account. It's a tax deferred account. Money withdrawn from your RRSP is taxed as ordinary income. Canadians with a large RRSP at age 71 will find themselves with required minimum distributions which will bounce them into the higher tax brackets and will lead to a clawback of OAS. This becomes very important for early retirees because the sudden absence of significant income affords us the opportunity to draw down on the RRSP between ER and age 71 when our income tax rates are low. Yes, we will pay withholding tax, but may avoid the above consequences.

This is all discussed in great detail at Diamond Retirement Planning Ltd. and I recommend that you read his book on The Retirement Income Blueprint. If you want to model the alternatives, here's a software package that you should consider: RRIFmetic - Retirement Math Made Easy. (It's not compatible with Macs).

I intend to start drawing down on my RRSP in 2014 (for a portion of my needs) and will transfer some of the after tax money to my TFSA (which will never be taxed).