Have you considered unbundling your Canadian ETF for income?

Index investing using Exchange Traded Funds (ETFs) has become very popular in recent years, and rightly so.  There are huge advantages to index investing:

  • Low money management fees
  • Market-like returns
  • Long-term growth potential
  • Diversification
  • Simplicity

These are great things when it comes to investing.

I believe a case can be made however to unbundle your Canadian ETF over time for incomeOne of the main reasons to do this:  our Canadian economy operates as an oligopoly – a few players that have huge market shares within a few industries. There are only so many blue-chip stocks that fuel our Canadian economy (although a number of smaller-cap stocks will always support some growth).  The other reason is:  by owning Canadian blue-chip companies directly you can receive a healthy dose of dividends for passive income.  Capital gains are also a nice long-term bonus.

“The crux of your success will be selecting leading companies’ stocks and then holding on to them for many years.  While you cannot go to sleep, and there is a place for monitoring, there is no reason to panic if a firm has earnings that fall short in a given year or two.  This is quite a normal phenomenon.”Stephen Jarislowsky, The Investment Zooauthor, billionaire businessman, philanthropist.

Think about our banking industry for a moment.  I bet you can count the number of major players in this sector on two hands.  Banking with Tangerine or PC Bank?  Good for you and smart stuff.  Most of their accounts don’t charge any banking fees.  (Don’t forget those companies are owned by ScotiaBank (BNS) and CIBC (CM) that pay healthy dividends respectively.)

What about life insurance companies and other financials?  No doubt most of you have heard of Sun Life (SLF), Manulife (MFC) and Great-West Life (GWO).  Financials including life insurance companies consistently make up between 30-35% of our Canadian market.  Failure to own any Canadian financial stocks will likely damper your long-term Canadian equity returns – although you shouldn’t put too many eggs into this basket.

The energy sector makes up about 20% (or more) of our Canadian market at any given time.  Companies like Suncor (SU), Canadian Natural Resources (CNQ), Cenovus (CVE) and Crescent Point Energy (CPG) are household names.  They also pay dividends.

What about materials?  Heard of Barrick and Goldcorp, or Potash and Agrium? This sector makes up close to 15% of our Canadian market.  You might want to consider owning a few material stocks although the ride can be bumpy at times due to their cyclical nature.

Within the game of Monopoly, industrial companies like railroads are usually a good core holding for gaming success.  Companies like Canadian National Railway (CNR), Canadian Pacific Railway (CP) and construction companies like SNC-Lavalin (SNC) can help diversify your portfolio.  This sector makes up about 9% of the Canadian market.

Our consumer discretionary sector (think grocery stores and companies like Canadian Tire (and more)) make up about 6% of our Canadian market.

Consider owning the companies you love to hate.  I’m writing about our Canadian telecommunications industry – I’m sure “the big three” come to mind within the moniker “Robellus” – Rogers (RCI.B), Bell (BCE) and Telus (T).  Think of these fine companies every time you pay your internet bill or cell phone bill.  This industry makes up about 5% of our Canadian market.

What about utilities?  Fortis (FTS), Emera (EMA), Canadian Utilities (CU), and Hydro One (H) dominate this sector.

There are other, equally small sectors like healthcare that make up our Canadian economy but I think you get the idea by now – there are a few huge companies who earn very big profits.  These companies are household names.

Fact:  Did you know the top-15 holdings consistently comprise about 45% of the broadly held Canadian ETF XIC?

By unbundling your Canadian ETF such as XIU, XIC, VCN or another popular Canadian equity ETF, into a mixture of stocks held across the many sectors I mentioned above, you can save the money management fees every year and build an income portfolio for retirement income needs.

Want to own more utilities?  Thinking just 3% of this sector held in the ETF XIC isn’t enough?  You can.  Think 5% of your Canadian portfolio is too low for the profits churned out by the biggest telcos in Canada year after year?  I feel this way, maybe you do too.

“I also do not believe in buying companies that do not pay attractive dividends.  Nobody can forecast the future.   But it’s obvious that companies that have a strong uninterrupted record are more interesting than those that have not.” – Stephen Jarislowsky, The Investment Zoo.

I haven’t even mentioned Canadian Real Estate Investment Trusts (REITs) yet.  Instead of paying money management fees close to 0.60% to own the REIT ETF XRE or even 0.39% to own Vanguard’s REIT ETF VRE, I’ve decided to unbundle this product.  I’ve since built my own REIT ETF – owning companies like RioCan, Allied Properties and many other companies directly.

Critics of this article will highlight a few things.  Indexing is simplistic and easy.  Owning individual stocks is not and it can introduce a number of behavioural investing biases that are difficult to overcome.  True enough.  Critics will also say there are too many risks involved in owning a few dozen Canadian companies (like the ones above) instead of owning the 240+ companies that make up Canadian market.  There is more risk.  However no investment approach comes without risks.  Holding cash too long has risks.  Holding GICs has risks.  Dollar cost averaging has risks.  Indexing has risks.  With indexing, one risk is, with all the glory that comes with diversification you’ll own the “the studs and the duds” – companies that do well and companies that will suffer – and you’ll pay a money management fee for those companies regardless.

Don’t get me wrong – index investing is a solid approach for long-term investing success.  Academic studies prove that.  But it’s not the only way to invest.  Ultimately investors will want income from their portfolios someday.  This makes buying and holding Canadian companies that distribute fairly predictable cash flow to shareholders a viable way to get it.

Investors seeking steady income, with some capital appreciation, can consider unbundling their Canadian ETF at some point.  You could consider this approach for our Canadian market only.  Then you can index invest the rest of your portfolio for international exposure – using a few ETFs I’ve listed here.

What’s your take on our Canadian market dominated by a few sectors?  Thoughts on a handful of companies that dominate their sector?

Mark Seed is the founder and editor of My Own Advisor. As my own financial advisor, I've grown our portfolio from $100,000 to well over $500,000. Our goal is to own a $1 million investment portfolio for an early retirement. Come follow my saving and investing journey by subscribing to my site.

44 Responses to "Have you considered unbundling your Canadian ETF for income?"

  1. Once again, one should keep in mind that ETFs are relatively new products. They were not around when I started out investing. One had a choice of mutual funds or individual stocks back then. Now there is a plethora of ETFs and index based funds that one can choose from. It is mind boggling the choices an investor has that can be bought and sold at the touch of a button. ETFs can be great products, no doubt about it. Having said that I only have one true ETF and a couple of TDs e-series funds. I mostly made the leap from mutuals to individual stocks when the portfolios got large enough to have a semblance of diversification. But my holdings would likely be considered to be not diversified enough by many. As an example I have a very large portion in the Brookfield family of stocks. But altogether we only have about 17 stocks and I am comfortable with that.

    Reply
    1. I agree the choices for investors become easily overwhelming. I decided a long time ago that the Canadian market is not very diversified and as such, I would simply hold CDN dividend paying stocks for income. I’ve learned to appreciate the risks of that, but also, how ETFs are a great way to invest for long-term success – riding the coattails of the markets’ returns.

      So, my hybrid system consists of 30+ Canadian stocks and a few well-known U.S. listed ETFs from Vanguard for U.S. and international diversification. I’m also comfortable with this.

      Reply
  2. Hi Mark,

    I think it’s a great idea to unbundle the ETFs, and the only the reason I don’t follow this approach is the commissions (especially since my portfolio is not very large). I think it’s better for someone in my situation (small portfolio) to buy the ETFs commission free until I reach a point where the commission to by individual stocks is only a small percentage of the transaction.

    PS Thanks for the great post. Reading these posts make the Monday commute much more manageable!

    Rob

    Reply
      1. Hi Cannew thanks for the reference link. I actually starting full DRIPing with CST/Computershare back in 2013 but I stopped last year because I didn’t like the fact that my dividends were being taxed when I had an empty TFSA and RRSP. I definitely wish I had seen your post earlier!

        Now that’s I’ve switched to ETF’s I think I’ll stay with this plan for a while. I’m only 24 so growth is my main focus at this point.

        Excellent two part post though, very informative and definitely something I might try when I shift my focus back to income.

        Reply
        1. Don’t deviate from your plan if you have one Rob. All my post is saying is to consider it for income at some point since you’ll eventually want to turn some of your long-term growth into tangible cash. You can do that via the approach I wrote about or many others, including a total return approach by selling off equities and bonds are various times in retirement.

          Good point about TFSA and RRSP – don’t use a taxable account unless your RRSP and TFSA are maxed out!!

          Reply
        2. Rob: No problem. Remember that if your taxable is under $40k you will not pay any taxes on the dividends. Over $40k to $90k taxes are minimal. Great that you’ve started and are working on your long term goals.
          All the best

          Reply
    1. Hi Mark,

      Thanks Rob.

      Commissions are a pain, agreed, but you’ll need to sell some assets at some point to get at the capital.

      As long as you don’t do it often, say a few times per year (at $10 or less each?) that isn’t very much.

      I have nothing against indexed ETFs for the Canadian market, I just prefer Canadian direct stock ownership directly when the portfolio is north of say $100k – for income. ($100k with ETF XIC costs ~ $50 per year every year).

      Reply
  3. Having an un-bundled ETF is exactly what I am doing for my Cdn. portfolio. With a similar aim, and when starting off I looked at what all the large ETF/MF’s were holding in their top 10 and went from there. When I venture into US/Intentional stocks though, I will keep it simple with broad market ETFs though.

    Still, ETFs are great products to get instant diversity. And as Rob above said, they are great for investors starting out, especially with low to no fees to buy them with some brokerages while building up a portfolio.

    Thanks for the post 🙂

    Reply
    1. I’m still tearing down my Canadian ETF and will continue to do so over the next couple of years.

      I find the U.S. and international markets more challenging so that’s where VTI and VXUS are very helpful.

      “Still, ETFs are great products to get instant diversity.” For sure and anyone unsure about direct stock ownership I would recommend they don’t leave the broad ETF market.

      Reply
  4. “…index investing is a solid approach for long-term investing success. Academic studies prove that. But it’s not the only way to invest.”

    Timely article, as I’ve been guiding a senior family member in creating an “unbundled” portfolio. The person has one large-ish lump sum but not a lot of time before they hit retirement age (~5 years). That’s the biggest reason for taking an unbundled approach, lack of time. Indexing is great for long-term investing success, the key being ‘long-term’. If you don’t have the time then you have to assume more risk, that is, invest in the individual components. Once this person retires outright, we might look at moving some funds out of individual stocks and back into index funds/ETFs.

    “What’s your take on our Canadian market dominated by a few sectors? Thoughts on a handful of companies that dominate their sector?”

    Shows just how small a country we truly are and just how at-risk we are to rely on those few sectors and companies.

    Reply
    1. Based on your comments, I had little doubt you help advise friends and family members….

      “That’s the biggest reason for taking an unbundled approach, lack of time.”

      It does take some effort to do this.

      Yes, we have a small country on the world stage. I’m looking to invest more outside of Canada as well – U.S. and international – more so every year I get older.

      Reply
  5. It’s hard to go against the flow and EVERYONE stresses the importance of diversification, asset allocation, International, emerging markets, and no one knows where the market will go… etc, etc.

    All those facts are true but relate to market returns, matching or beating the market. If that is ones goal than following the general advice and using etf’s to own the market will get one close to their goal.

    If your goal is Income and the growth of your income, regardless of market changes, than IMO one is better off holding and owning individual stocks. Further, I personally believe one should limit the number of stocks to 30 or less (I only hold 17). Find the best, build up your holdings and watch your income grow. Our income grew during 2008/2009 with only one dividend cut. It has continued to grow each year since, as has our capital (recovered and surpassed).

    Great post Mark!

    Reply
    1. Thanks cannew.

      If your goal is to get market returns, less small fees, yes please index away. But not everyone is willing to ride market returns, including the downturns. They are looking for income, fairly predictable at that.

      Will they give up some total return? Maybe. If they own the same companies the index does then I doubt it and they will have more control over their portfolio vs. one product that is managed for them.

      As I try to approach semi-retirement I’ve decided I have an income replacement goal.

      Reply
    1. Fair question Ryan.

      I hold US stocks in my RRSP, and US-listed ETFs in my RRSP as well. I feel the US market is much more difficult to unbundle and I’d need many more stocks to have any sort of proxy for the US market. Consistently, owning 5-6 CDN banks, a few telcos, a few utility stocks and some energy companies, along with 3-4 pipelines, rule the Canadian economy. If they go down, we all go down. It’s not necessarily the same for the US economy in my opinion.

      I will probably always own a few US stocks for income though.

      Reply
  6. I like your point here. I use ETFs for U.S. and foreign exposure and selected dividend payers for Canadian income. Some other advantages:
    1. Poor diversification is built in to Canadian dividend ETFs. I can do something similar myself with no fee.
    2. If your ETF holds say POW, PWF, and GWO in its top ten you are triple dipping. Things could get ugly.
    3. Lots of stocks that pass the ETF screener are not ones I wish to own. Triple figure P/E or declining EPS and rising payout ratio are off putting.

    Reply
    1. Thanks Rich. Yes, poor diversification is built into may Canadian ETFs, these are companies you can own directly without paying a fee as you say – I’ve learned this over time. I wrote a brief post about that here:
      http://www.myownadvisor.ca/canadian-dividend-stock-selection-made-easy/

      There are lots of companies in the TSX that are high on debt, low on cash-flow which is not a good recipe. Indexing brings all the studs and duds. Indexing fans will say you cannot predict the future – so your best best is to own the entire market. Partially true – given if the top-stocks in the index all tank, the index is going down regardless.

      Reply
  7. I have been thinking about doing that in my TFSA. About $50,000 split 3 ways. BCE, RY and BIP.UN. Do you think that would provide enough diversification?

    Reply
    1. Probably not with just 3 stocks, although I’m biased. I prefer to have about 30+ Canadian stocks. Those are good ones though – check out their dividend histories, cash flow and capital appreciation as well. I own all of them in various amounts myself and DRIP all of them – but that’s not a recommendation for purchase Mike!

      Do your own due diligence and ensure stocks align with your long-term investing plan.

      Cheers,
      Mark

      Reply
  8. We paid no fees when buying selected ETFs and Mutual funds when buying through a discount broker, but they did charge around $10 for each stock transaction.. Selling the ETFs and buying directly would have come at a cost.

    With our switch to a fee based broker, we are now almost clear of funds. He has pretty much done what you are suggesting and replaced those funds with a diversified group of dividend paying shares as well as a nicely laddered array of bonds.

    Reply
    1. Nice Richard. No doubt your fee-based broker has gotten you out of high priced funds because that likely doesn’t do either of you any good.

      I think your idea of going to a modest cash wedge with dividend paying stocks is a good one – but that’s my plan as well.

      Reply
  9. Mark, good post, and perhaps timely. Yes, I have considered unbundling my Cdn ETF’s for income. This has been on my mind for some time, although I really don’t relish the idea of going from stocks to ETF’s and back to stocks.

    Your reasons listed are valid as the CDN market is somewhat unique regarding companies and sector concentration. Looking at the TSX performance since ’08, languishing interest rates, gloomier impending economy (albeit temporary) the case for a more focused dividend stock portfolio is stronger, and may work into the cash I have been building as FI has been coming due.

    Geez, I’d be a hybrid investor again!

    Reply
    1. Thanks RBull. I’ve been struggling with this decision for some time, move towards more indexing, in Canada at least or stay with my domestic basket of banks, pipelines, REITs, etc. I’ve decided I will unbundle my Canadian ETF over time and hold blue-chip stocks only directly – at least for the foreseeable future.

      With nothing but likely a major downturn to happen in the years to come, and already low bonds yields, I can’t help but think dividends will be the key to keeping some capital intact in the coming decades. I could be wrong but if I’m not – then I’m going to have absolutely the best strategy.

      As for US and international markets – I will continue to index invest more over time. It would be nice to have $500k in VTI for example 🙂

      Reply
      1. Over the longer term it has always been my plan to increase weighting to more equities (looking ahead to CPP, OAS), and in Canada to those that have higher and growing dividends. I want to be “safer” now in early retirement with more FI and perhaps at the longer end of the bull market. It seems to me arguably most everything is expensive now, and the current crop of dividend ETF’s also have high valuations, higher MERs and don’t really meet my criteria. So the likely scenario is we will be more patient if making changes (over time also), as we’re still in a comfortable position meeting our needs with our asset mix and large cash wedge, and ready if some opportunities arise.

        Our 3 annual “drawdowns” in retirement are almost exactly equal to the “income” generated, less than plan, capital is growing as we prepare for possible rainy days but still have have a good lifestyle.

        I may be entirely wrong with all of this, and we’re certainly not “maximizing” our potential “income” but am comfortable right now making these choices.

        Yes, $500K in VTI would be nice as long as a person was also diversified.

        Reply
        1. Interesting paradigm really….the older you get, the more equities with CPP and OAS coming on board. It goes against some conventional wisdom but I agree with what you’re doing. I will do the same. I will keep a high proportion of equities long-term, likely as long as I live.

          Everything is very expensive now. I really don’t want to invest much now. Just in saving mode for 2017 contribution room.

          Yes, $500k in VTI would be very, very good, let’s say with another $500k in other CDN blue-chip stocks 🙂

          Reply
          1. Thanks Mark.

            Yes, it does go against some conventional wisdom. The difficulty is staying patient and making the adjustments when it’s a more opportune time.

            I hear you on the not really wanting to invest more (equities) at this time, although who the heck knows what’s going to happen!

          2. Absolutely. I can be impatient and I’m finding this tough.

            I guess the good thing is, I can simply save between now and the New Year for the 2017 TFSA contribution room!

    1. Some of the Brookfield companies you need to be careful of:
      http://www.myownadvisor.ca/taxation-u-s-stocks-canadian-investors-master-limited-partnerships/

      I would be inclined to hold these stocks inside an RRSP since:
      1) dividends and capital gains are tax-deferred.
      2) dividends are paid in USD, and these companies are inter-listed. So you can journal your CDN stocks to the USD side or your RRSP – so there is no currency conversion costs attributed to dividend paid.
      3) there is no withholding tax on USD dividends paid by US stocks inside RRSP.

      Hope that helps but please do your own due diligence and tax management before making any major investment decisions.

      Reply

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