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Solid Portfolios for Frugal Investors
09/26/2012 8:30 am EST
These three model portfolios can help you find your path, writes Rob Carrick, reporter and columnist for The Globe and Mail.
There is no one right path to being a fee-conscious investor. Exchange traded funds get a lot attention because of their low fees, but you can invest frugally in mutual funds and index mutual funds as well.
In this edition of the Portfolio Strategy column, we'll prove this in three simple model portfolios designed to be cheap to buy, cheap to own, and low maintenance as well.
These portfolios have several different potential uses:
- You're a pure do-it-yourself investor who wants a cheap, manageable portfolio.
- You have a fee-based advisor who charges an advice fee of 1 to 1.5% and you're looking for cheap investments to put in your portfolio (fund fees are in addition to the advice fee).
- You hire a fee-only planner to build a financial plan that you use to guide your own investing.
Let's look at three paths to cheap investing.
1. The Low-Cost Mutual Fund Portfolio
Funds were selected for use here on the basis of blending low fees and solid returns. These are not necessarily "the best" low-fee funds—just examples of what's available for cost-conscious investors who understand that it's an over-simplification to dismiss all mutual funds as being overpriced.
The funds selected here pay little or nothing to advisors or dealers who sell them—that's a major reason why they're so comparatively inexpensive to own. If you have a fee-based account with an advisor, make sure funds like these have been considered for your portfolio.
Products from big fund companies don't typically appear on lists like these, so you might be wondering what gives with RBC US Dividend Series D. RBC Asset Management offers a low-fee version of its products to do-it-yourself investors, and it may be the only large, high-profile firm to do so.
Unfortunately, RBC's D-series funds aren't widely available. You need an account at RBC Direct Investing to buy them, and you need a minimum of $10,000. That's typical of low-cost funds—upfront minimum investment requirements are between $5,000 to $10,000 to limit administrative costs of serving tiny accounts.
One proviso regarding most low-cost fund families—they stick to the basics in their fund offerings, and thus don't often include niche products such as precious metals or real estate funds.
2. The Index Fund Portfolio
Index funds—they track major stock and bond indexes—are sold mainly by the big banks. As a general rule, they're no great bargain when it comes to fees.
One notable exception is the e-series of index funds from TD Bank. You can assemble a balanced portfolio of e-series TD index funds and pay well less than half a percentage point in fees.
The best way to set up an e-series account is through TD's own online brokerage firm, TD Waterhouse. You can also buy them over the Internet through TD Asset Management, but they're not sold in TD branches. The selection of funds is modest, but there's just enough to build the sort of portfolio that can carry you for decades while keeping fees to a minimum.
A higher cost but still reasonably priced family of index funds is available through National Bank of Canada's Altamira lineup. One plus here is that you can buy these funds through most dealers.
One of the best things about index mutual funds, TD's e-series included, is that it costs nothing to buy or sell them. This makes them ideal for pre-authorized contribution plans, where you contribute every month or on payday.
3. The ETF Portfolio
The goal in building this portfolio was to squeeze fees as low as possible while enhancing diversification by investing in widely recognized, broad-based indexes with as many constituent stocks and bonds as possible. In a couple of cases, this meant forgoing the cheapest ETF to target a more varied index.
For example, the lowest cost Canadian stock market ETF is the Horizons BetaPro S&P/TSX 60 Index ETF (HXT), with an MER of about 0.08%. That's a bit less than half the cost of the ETF used here, the BMO S&P/TSX Capped Composite Index ETF (ZCN).
Why pay more? Because the BMO fund (formerly the BMO Dow Jones Canada Titans 60 Index ETF) tracks a much broader index—the S&P/TSX Capped Composite. About 246 stocks are included here, compared to 60 for HXT. By the way, the term "capped" in the BMO ETF's name means that no stock accounts for more than 10% of the underlying index.
HXT has a couple of other features that may affect its attractiveness to less experienced investors. One is that it uses derivatives to generate its return, and that, in turn, creates a little extra risk. Also, HXT doesn't pay dividends—instead, its share price reflects both share-price gains and dividend payments.
There are a few bond ETFs that give you exposure to both government and corporate bonds in a single package, and the cost is comparable to dividing the two categories into separate ETFs. So why buy two funds when one might do?
The reason is to get a more even balance between government bonds, which have a high level of vulnerability to rising rates, and corporate bonds, which will drop somewhat less in price in a rising-rate world. The two ETFs used here add an additional level of defense here by focusing on short-term bonds.
It's important to note that we've been looking here at the cost of owning investments. ETFs are traded like stocks, which means you have to pay brokerage commissions when buying and selling.
Two low-cost Canadian brokerage choices for ETF investors are Virtual Brokers, where you can pay as little as 99 cents per trade, and Questrade, where you pay as little as $4.95. At other firms, you generally pay $10 if you have $50,000 or more in your account, and $29 with less. Virtual Brokers waives trading commissions on a limited number of ETFs, as does Scotia iTrade and Qtrade Investor.
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