Index Investing - My Own Advisor

Indexing

June 16th, 2013

Part of my investment strategy is index investing. I index part of our portfolio because over time markets rise to the tune of about 7% year over a few decades of investing. I index mainly because:

I can achieve market performance less minuscule management fees.
I get great diversification.
I can “set and forget” part of my retirement portfolio.

I figure indexing part of our retirement portfolio in addition to the following should set up me nicely for retirement expenses:

My defined benefit pension at work.
Our paid off home.
Our passive dividend income.

My objective is to have portfolio of $1 million CDN and a paid off home to retire on. When both of those objectives are met I intend to stop working.

My Index Investing Approach:

With the right products it produces near market returns.
I get great diversification.
I use Exchange Traded Funds (ETFs) in my portfolio.
I ETFs to keep our money management fees dirt cheap.
I ETFs because of their high transparency.
I reinvest all distributions paid from ETFs to buy more units every month or quarter.
I use it to complement my defined benefit pension plan at work.
It’s simple.
It works.

Check out my articles on this subject:

April 2013 – Top Canadian Dividend ETFs.

June 2013 – Top Canadian Equity ETFs.

2011:

My Asset Allocation Strategy

Diversification is great but it comes at a cost unless you put your ETFs in the right location. This is because many countries levy taxes on ETF distributions paid to foreign investors. You can read more here. Here is a summary of what I’ve learned and how I try and manage my portfolio to keep taxes in check.

1. Canadian ETF that holds international stocks, examples: iShares International Fundamental (CIE) or Vanguard Canada S&P 500 Index ETF (VFV)

I don’t own this ETF but I know in a non-registered account withholding taxes apply (15%) but are recoverable when investors file their income tax returns. In an RRSP or TFSA withholding taxes apply and you cannot claim a credit for this.

2. Canadian ETF that holds US stocks, example: Vanguard MSCI U.S. Broad Market (VUS)

I don’t own this ETF but I know in a non-registered account withholding taxes apply but are recoverable. In an RRSP or TFSA withholding taxes apply.

3. US ETF that holds US stocks, example: Vanguard Total Stock Market (VTI)

I own this ETF but US ETFs make the most sense in RRSP. This is because U.S. listed ETFs like VTI held inside an RRSP escape withholding taxes. You should know that foreign dividends are taxed at your marginal rate. With U.S. listed ETFs the Internal Revenue Service will take a 15% withholding tax on all dividends received. The other key point is that Canada has tax treaties with the US and many other countries that have agreed to waive withholding taxes on U.S. stocks or U.S. ETFs held in registered retirement accounts such as RRSPs, RRIFs and Locked-In Retirement Accounts (LIRAs).

TFSAs don’t apply to this Treaty. In a TFSA you must pay 15% withholding taxes on a U.S. ETF like VTI.

4. US ETF that holds international stocks, example: Vanguard MSCI Emerging Markets (VWO)

I don’t own this ETF but it would make the most sense in an RRSP. A U.S. listed ETF like VWO that holds international stocks will be subject to withholding taxes but the withholding taxes do not apply in an RRSP.

5. Canadian Bond ETFs, example: iShares DEX Universe Bond Index ETF (XBB)

I prefer to keep bond ETFs exclusively in my RRSP since the interest paid is taxed at your marginal tax rate just like employment income. I pay enough taxes. Another good home for Canadian bond ETFs is a TFSA.

Here are some of my favourite ETF products.

Canadian Fixed-Income – own in RRSP or TFSA

iShares DEX Short Term Bond Index Fund (XSB)

iShares DEX Universe Bond Index Fund (XBB)

Canadian Equity & Dividend Equity – own in RRSP or TFSA

iShares S&P/TSX 60 Index Fund (XIU)

iShares S&P/TSX Capped Composite Index Fund (XIC)

iShares Dow Jones Select Dividend Index Fund (XDV)

BMO Canadian Dividend ETF (ZDV)

U.S. & International Equity – own in RRSP

Vanguard Total Stock Market ETF (VTI:US)

Vanguard Total International Stock ETF (VXUS:US)