Synopsis: This article will provide example ETF model portfolios with a focus on building an ETF portfolio that is both low cost and easy to manage. We will explain the benefits of owning diversified ETFs and how vital we believe it is to invest for the long-term letting compounding do its work.
Wouldn’t you just love to find the way to invest that delivered amazing results with ease? Invest in a way that required little effort, little monitoring and significantly less stress?
What do you suspect might happen if you invested this way over time, such that, your invested money simply gained momentum without you doing anything at all – like a snowball tumbling down a mountain?
We can attest from our personal experiences that given a modest amount of mountain runway (i.e. time), an investing snowball will absolutely grow and compound if your money was invested wisely.
In fact, your money mountain might be so big that in about 30 years, your portfolio could help fund most of your retirement without any other income.
This article will outline the keys to building that money mountain using a set of low-cost, diversified Exchange Traded Funds (ETFs) showing you step-by-step how that can be done.
Your benefits in owning diversified ETFs in a Portfolio
We won’t dive too deep into the merits of ETFs over some mutual funds but we believe it’s important to recall why some ETFs should be considered as part of your model portfolio below – and why we use some of these ETFs for our own portfolios as well.
Simply put, ETFs are baskets of individual securities, much like mutual funds but with two key differences:
1. As the name suggests, ETFs can be traded like stocks, on an exchange, while mutual fund transactions don’t occur until the market closes.
2. Some ETFs tend to have expense ratios (i.e., fees) far lower than those of mutual funds because some ETFs are passively managed – they are funds tied to an underlying index or market sector. Mutual funds, on the other hand, tend to be more actively managed. Because actively managed funds incur costs to chase or attempt to “beat the market”, many mutual funds simply cannot keep up with the performance of the market or index they track due to those costs. Those trading costs and fees are a major barrier to overcome to deliver performance results. Arguably, low-cost, diversified ETFs that track an established index tend to make better wealth-building vehicles than actively-managed, higher-cost mutual funds.
So, combined with low-cost fees we believe the best reasons to own the ETFs we’ll highlight below, is diversification.
For example, purchasing an ETF that tracks the technology sector only (while potentially rewarding at times) will only give you ownership in a basket of tech stocks. As the old cliché goes, you do not want to put all your eggs into one basket. We have no idea if Apple, Microsoft, Amazon, Tesla, or any other tech-related company will thrive long term. By owning an ETF that invests beyond the tech sector into other market sectors like financial services, consumer goods, energy, healthcare, and beyond, thankfully we don’t have to guess!
A diversified ETF can guard against market volatility (up to a certain point) if certain stocks or certain stocks in some sectors, fall. This removal of company-specific or sector-specific risk is a big advantage for many passive investors.
The other huge advantage to using diversified ETFs to build your portfolio is – they can generate tremendous amounts of wealth over time.
Your keys to wealth building
Investing experts, including the legendary Warren Buffett and his teacher, investing author and economist Benjamin Graham, have said for decades the best way to build wealth is to keep investments for the long term.
There’s a simple reason why this works: while stocks are very likely to go up and down in the short-term, with time, keeping them for a long period of time as in decades helps even out these near-term ups-and-downs. In fact, long-term, the growth of stocks more than makes up for any a few months or even a year of market calamity.
Have a look at this chart. You might remember The Great Recession triggered by the financial crisis during 2008-2010.
March 2009 seemed to be a very bad time to be in stocks. Maybe for investors who got spooked, it was.
But look at what happened coming out of that crisis – the S&P 500 index thrived. In fact, if you were an investor, and remained invested, you would have participated in the growth of the S&P 500 index for the coming decade and more than tripled your money in the process.
Keeping investments for the long-term will undoubtedly help you grow your money mountain.
Before we get to the ETFs that can do that for you, here are some takeaways when it comes to wealth-building in general:
- Money invested needs to grow uninterrupted (as we have shared above, your investing strategy must be maintained through through good times and bad – with minimal trading);
- Money invested needs time (your eyes need to be on the horizon and focused on the long-term, ideally measured in years or decades. The secret sauce to growing your portfolio to tremendous heights will be the compounding effects of investing which are most significant in the later years – because money that makes money, can make more money); and,
- Money invested needs the proper conditions (your portfolio needs to be low-cost, diversified and appropriate for your risk tolerance. Your investment selections need to be something that you’ll be confident in adding to whether markets are high or low. In fact, you’ll ideally buy more ETF units during times of market corrections! The key is to invest using a strategy that requires little effort, little monitoring and significantly less stress. You want to avoid being your own worst enemy).
“This focus on the short term is hard to reconcile with any fundamental view of investing. We can examine the drivers of equity returns to see what we need to understand in order to invest. At a one-year time horizon, the vast majority of your total return comes from changes in valuation—which are effectively random fluctuations in price. However, at a five-year time horizon, 80 percent of your total return is generated by the price you pay for the investment plus the growth in the underlying cash flow. These are the aspects of investment that fundamental investors should understand, and they clearly only matter in the long term.”― James Montier, The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy
About our Diversified ETF Model Portfolios
Our suggestions below are just that. The fact is, there are many options that may include a mix of asset classes (your predominant mix of stocks and bonds) and percentages of those asset classes.
Ultimately, you should invest in a manner that is aligned with your risk profile. Very conservative investors should allocate more to bonds in their portfolio than stocks. More aggressive investors, who will not sell stocks when markets go haywire, may want to hold the opposite.
In addition, as you get closer to retirement, you’ll want to reduce the sequence of returns risk by reducing equities exposure. A big equity market drop (think back to that 2008/2009 timeframe) combined with a high equities exposure could spell trouble for your portfolio. Then add withdrawals from your account on top of that drop, that could damage a portfolio beyond repair. A 100% equities portfolio would have seen a 50% drop in portfolio value during the financial crisis which would likely cause the worst-case scenario of all, selling at the bottom. Alternatively, an allocation to a bond ETF acts as a cushion for volatility helping to reduce large portfolio drops (and panic), but the trade-off being that bonds also act as a drag on gains as well.
To put this in perspective here the 25 year long-term annualized returns up to Dec 31, 2020 (from iShares):
- 80% equities/ 20% bonds: 7.23%
- 70% equities/30% bonds: 7.14%
- 60% equities/40% bonds: 6.87%
- 50% equities/50% bonds: 6.80%
- 40% equities/60% bonds: 6.47%
- 30% equities/70% bonds: 6.40%
You’ll need to make your own decision on where you stand in terms of equity/bond allocation, but as mentioned above, you’ll want to decrease equity exposure as you get closer to retirement. As a baseline, financial experts like Dr. Sherry Cooper (Economist and Exec at BMO) believe that retirees should aim to have at least 50% equity allocation in their portfolio.
A recommendation more relevant to 2021, another expert, Frederick Vettese (Chief Actuary of Morneau Shepell), states that with current ultra-low interest rates resulting in much lower expected bond performance going forward, retirees should aim for at least 60% equities (35% bond index, 5% ultra short term bonds).
Keep costs low!
Our table below highlights some of the lowest-cost products available – largely because we also invest this way. Costs are always important, but costs are just one factor to consider. While the ETFs below has some rock-bottom money management fees, just make sure you have the ability to stick to a plan you firmly believe in. Trading in-and-out of ETFs might not only cost you money in transaction fees but it might also lead to poor overall returns.
Ultimately, your savings rate combined with your ability to stick with a well-thought out investing plan will lead to success.
Diversified ETF Model Portfolios
For the most part, we’re going to assume you’re investing in your financial future primarily using the Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP).
We wrote very comprehensive posts about each account we encourage you to read below!
- Everything you need to know about TFSAs including updated contribution room for 2021.
- Everything you need to know about RRSPs including updated contribution limits and the deadline for 2021.
So, while many of these ETF products in our model portfolio options could also fit into your taxable, and your Registered Education Savings Plan (RESP) investing plans, among others, we’ll assume for now you might want to take a slightly different approach.
We’ll cover off those reasons and much more about investing in taxable accounts and the tax-deferred RESPs in other articles.
For tax efficiency discussions, we’ve included some non-registered/taxable accounts below.
Model ETF Portfolio #1 – Canadian Equity Index, ex-Canada Index, and Bond Index – Three Fund Solution
We believe this solution works well for investors focused on using the TFSA and RRSP for multi-decade investing.
You can use a Canadian-listed ETF for your TFSA and RRSP, to avoid worrying about any Canadian to U.S. dollar currency conversions. Simply buy and hold, and keep adding contributions to your TFSA and RRSP every year, buying each fund below periodically to keep your transaction costs low.
Investors should know that two of these funds below (ZCN and XAW) are low are 100% equity ETFs, so you’ll need to ride out short-term market volatility from time-to-time since equity markets can tank 10%, 20% or even 30% or more once in a while.
To help you on your investing journey, we’ve added the consideration for a great low-cost bond ETF like ZAG to help you ride out those equity bumps. We’ll explain more about ZAG in a bit.
This portfolio solution is designed for investors with a long-term investing horizon, as in decades, providing you with lots of compounding to work its magic!
The In-Canada, ex-Canada, and Bonds – Three Fund Solution:
|ETF||MER – TFSA||MER – RRSP||MER – Non-Reg|
|XAW||0.53% (0.22% + 0.31%*)||0.53% (0.22% + 0.31%*)||0.26% (0.22% + 0.04%*)|
Why these funds? Why the asterisk?
Without getting into too many details, you should know that a Canadian-listed ETF that invests in U.S. stocks, or U.S. ETFs, or that invests in ETFs that hold international stocks will have some *foreign distributions withheld based on the tax treaties associated with those countries the ETF invests in.
A quick Google search will highlight lots of articles about Foriegn Withholding Taxes (FWT for short) so we won’t repeat all details here.
Essentially, not all countries manage taxes, investments nor investment accounts the same.
This is why you see the asterisk.
A Canadian-listed ETF like XAW will have some of its foreign distributions withheld. Withheld means you never see part of the ETF distribution. It is withheld at the source (e.g., the U.S. IRS).
The FWT* for XAW is about 0.31% based on our information. *Source: https://www.canadianportfoliomanagerblog.com/calculators/
XAW tracks the performance of the MSCI ACWI ex-Canada IMI Index, which allocates most of its holdings to U.S. equities, a smaller portion to international equities ,then even less to emerging markets equities.
Unless you’re an investor with large 6-figure TFSA or RRSP value, or other tax-deferred accounts, we believe owning XAW is a great way for Canadian investors to diversify away from Canadian borders at a low cost even with FWT taken into account.
We’re a big fan of ZCN because it is one the leading low-cost ways to invest in the Canadian stock market. This way, you don’t have to guess what big Canadian bank will outperform the other or if Shopify will continue to soar to new highs! You own all those stocks for a rock-bottom price.
Because ZCN is a Canadian-listed ETF that invests in Canadian stocks, you won’t need to worry about FWT because you’re not investing in foreign companies.
There are of course many other great Canadian-listed ETFs to consider so we’ve highlighted a few others below by company provider and ETF ticker should you want to explore them beyond BMO’s very popular ZCN:
- iShares – XIC, XIU
- Vanguard Canada – VCN, VCE
To reduce the volatility of your portfolio, especially as you approach retirement, as mentioned above you’ll want to look into a bond ETF. We like BMO’s ZAG bond index ETF, but iShares and Vanguard also offer strong bond index ETFs in iShares XBB and Vanguard VAB.
Disclosure: Both Cashflows & Portfolios owners own XAW in either our TFSA or RRSP or both at the time of this post.
Model ETF Portfolio #2 – Go Global with All-in-One ETF Solutions!
Since the launch of these funds a few years back, these asset allocation ETFs or as we like to call them, all-in-one ETFs have become a very easy and popular way to build an ETF portfolio – at a very low cost.
Based on the product you choose, these all-in-one ETF solutions essentially hold a pre-determined mix of stocks and bonds, in a fund of a fund approach.
By using this packaging structure, you can invest in a globally diversified portfolio in just one ETF.
So, in your all-in-one ETF solution there is no longer a need to rebalance your portfolio amongst funds.
We like that for many investors because that should equate to less trading costs. Less trading and tinkering with your portfolio should ultimately yield better returns.
We have offered a few of those all-in-one solutions below for you to consider, but by no means are these the end of the list.
You’ll also see in our list below, we have options for “balanced” portfolios all the way to 100% equity. We simply believe that most investors (like us!) that are still in our asset accumulation years should hold more stocks than bonds to take advantage of long-term equity growth.
However, we recognize not everyone wants to ride the market roller coaster so some bonds in your all-in-one ETF solution may make some sense to help you ride out that market volatility and stay invested.
In other articles and sections on our site, we’ll share ETF portfolios and strategies that might be more appealing to semi-retirees or retirees. For now, consider more stocks than bonds for portfolio growth.
As long as you are in the mode to grow your portfolio over a multi-decade investing timeline, we don’t think you can stray too far off course with any of these options below.
Which ETF Should I Buy?
Pick a fund that matches your risk tolerance (i.e., a fund that balances your personal risk and reward balance whereby you won’t sell any units regardless of what is happening in the markets). Essentially, the higher the equity percentage, the more volatile the price will be (up and down), but will provide higher returns over the long-term.
|ETF||MER – TFSA||MER – RRSP||MER – Non-Reg|
|VEQT (100% equities)||0.47% (0.25% + 0.22%*)||0.47% (0.25% + 0.22%*)||0.27% (0.25% + 0.02%*)|
|XEQT (100% equities)||0.44% (0.20% + 0.22%*)||0.44% (0.20% + 0.22%*)||0.21% (0.20% + 0.01%*)|
|VGRO (80% equity/20% bonds)||0.44% (0.25% + 0.19%*)||0.44% (0.25% + 0.19%*)||0.27% (0.25% + 0.02%*)|
|XGRO (80% equity/20% bonds)||0.37% (0.20% + 0.17%*)||0.37% (0.20% + 0.17%*)||0.21% (0.20% + 0.01%*)|
|VBAL (60% equity/40% bonds)||0.39% (0.22% + 0.17%*)||0.39% (0.22% + 0.17%*)||0.23% (0.22% + 0.01%*)|
|XBAL (60% equity/40% bonds)||0.33% (0.20% + 0.13%*)||0.33% (0.20% + 0.13%*)||0.21% (0.20% + 0.01%*)|
*Foreign Withholding Taxes (FWT) Apply
Why these funds?
You already know why the asterisk is listed, so we won’t repeat that information.
When it comes to 100% equity solutions, we have a bias to XEQT over VEQT because of the lower fees and XEQT tends to hold less Canadian assets. While investing in Canada is all fine and good (we at Cashflow & Portfolios do that too!), Canada makes up typically 2-4% of the global equity market. So, if you’re going to invest in stocks best invest in literally a world of stocks for global returns.
There are of course many other great Canadian-listed ETFs that are all-in-one products so we’ve highlighted a few others below by company provider and ETF ticker should you want to explore them beyond those above:
- BMO ETFs – ZEQT, ZGRO, ZBAL, ZESG
- Horizons ETFs – HGRO, HBAL, HCON
Disclosure: Mark from Cashflows & Portfolios owns HGRO at the time of this post.
Model ETF Portfolio #3 – The Tax Savvy Solution (most efficient solution)
If you’re an investor with a relatively large RRSP or TFSA balance, you may want to consider replacing XAW or any of your all-in-one Canadian-listed ETFs with a U.S.-listed ETF – especially in your RRSP.
Remember those tax treaties we talked about above? Well, thanks to our tax treaty with the U.S. any U.S. -listed ETF (or U.S. stocks) inside an RRSP, a LIRA (Locked-In Retirement Account), or even a RRIF (Registered Retirement Income Fund) will avoid any FWT.
So, by owning U.S.-listed ETFs inside your RRSP (or LIRA or RRIF) you will get all the ETF distributions they pay out.
How much could that save you on a $100,000 invested asset inside your RRSP? Let’s go through an example.
Say you owned one our favourite low-cost ex-Canada ETF in your RRSP: XAW. While you won’t save any money on the MER of 0.22% by owning XAW in your RRSP, you will save the 0.31% withholding taxes if you “debundle” XAW from its fund of funds, and own the top funds directly as U.S.-listed ETFs they are:
By debundling XAW in this example only, you could be saving hundreds of dollars per year in FWT.
Although you’ll need to factor in the MERs for your new three U.S.-listed ETFs, on a $100,000 allocation to XAW, that 0.31% FWT will no longer consume about $310 per year – money you never see because foreign taxes are withheld.
Our example brings us to this table below, one of the most efficient ETF portfolios you can build today given the low-cost structure of these ETFs, the global diversification these ETFs provide, and the tax-efficiency associated with owning Canadian-listed ETFs that own Canadian stocks in your RRSP or TFSA, and owning U.S.-listed ETFs (if you’re going to own them) inside RRSPs (or other tax-deferred accounts like LIRAs or RRIFs).
|ETF||MER – TFSA||MER – RRSP||MER – Non-Reg|
|VTI (US)||0.29% (0.03% + 0.26%*)||0.03%||0.03%|
|VXUS (US)||0.72% (0.09% + 0.63%*)||0.31% (0.09% + 0.22%*)||0.31% (0.09% + 0.22%*)|
*Foreign Withholding Taxes (FWT) Apply
Why these funds?
We’ve referenced ZCN above for Canadian content.
We’re big fans of U.S.-listed VTI because it owns 3,600 U.S. stocks for just three (3) dollars for every $10,000 invested. That is correct, and not a typo!
By owning VTI, you don’t have to guess if Apple or Microsoft, Amazon or Alphabet, will be the biggest and most successful company over time. You own them all!
VXUS, another Vanguard U.S.-listed ETF, owns over 7,000 stocks from around the world beyond the U.S. border – so you can take advantage of emerging markets, european and also pacific-rim companies from those countries for more rock-bottom fees.
Of course, you do not need to own just U.S.-listed ETFs inside your RRSP for wealth-building. To buy U.S. ETFs you’ll need to convert your Canadian dollars to U.S. dollars to make these purchases.
A process to do that efficiency is also another post (or two) so we’ll cover that on our site at some point as well and provide our personal experiences to help you too.
There are of course many other great U.S. -listed ETFs to consider – so checkout both iShares and Vanguard sites for more options.
Disclosure: Both Cashflows & Portfolios owners own VTI in our RRSP at the time of this post.
Diversified Model ETF Portfolio Summary
For investors with longer timelines (ie. younger investors) – we simply believe the best way to build wealth (over time) is to learn to live with stocks in your portfolio and train your investing brain to celebrate market declines as reasons to buy more of these of your favourite low-cost ETFs. For those approaching retirement, then it may be wise to reduce market volatility by reducing your equity exposure (some experts state that 50-60% equities for retirees may be appropriate).
We recognize there are many ways to slice-and-dice these ETFs for more portfolio versions, let alone there are many more ETFs you can buy and hold.
We wanted to put these options together to demonstrate that successful portfolio building need not be complex, it does not require hours of stock research (like we have done in the past!), nor does the process need to be overwhelming. We want to help you overcome investing paralysis by analysis!
As we watch for trends and even better ETF solutions to help you invest better, we’ll update this post and share new options with you. We’ll also profile different ETFs on our site over time so you can compare what might make sense for your investment path.
In closing, as DIY investors for decades now, we’ll continue with our individual paths that marry a combination of individual stocks (some of our explore) to go along with some of these ETFs above (that form some of our core investments).
At Cashflows & Portfolios, even though our investment plans are similar many of our holdings are actually very different. So, we encourage you to determine an investing approach that matches your tolerance for risk, that aligns to your behavioural temperament, and that helps you reach the financial objectives you’re working so hard for.
We look forward to sharing more detailed posts and financial wealth-building articles with you!