Tuesday, 8 February 2011

One-Stop-Investing for Your RRSP Contribution(s)

Contributing money to your RRSP is only the first step that gets you the tax refund. It will be a waste of time, since you have to pay the tax back upon withdrawal, unless the funds are invested so that they grow over the years (see our previous post comparing RRSPs with TFSAs, RESPS and non-registered taxable accounts for comments on what makes RRSPs worthwhile). The multitude of investment choices available, uncertainties about the economy, the mechanics of making the investment purchase, all can prove daunting, even too overwhelming, leading to no action and no investment, as we noted in Investing Success: More is Less, Less is More. That's bad, so we offer some solutions - ultra-simple, all-in-one, low-cost, auto-pilot, do-it-once-and forever, well-diversified and, of course(!), online.

First, and very importantly, we assume that the investor will be holding these funds in an RRSP i.e. with the goal of retirement and no selling out for at least next ten years (see our post on Setting Investment Objectives for discussion on how goals should shape the choice of investment) . That allows us to include a healthy dose of highly-variable-in-the-short-term-but-faster-growing-in-the-long-term equities amongst the assets. That also means we do not need to consider tax consequences of equities vs bonds vs foreign income as there are no taxes to pay (even US withholding taxes) while the money is within the RRSP.

The solution we propose is portfolio funds, ETFs and mutual funds, bought through a single purchase, that contain a whole gamut of types of assets and thousands of securities within.

Our Five Portfolio Funds
We have chosen five candidate funds (acknowledgements to Bylo Selhi for his list of low-cost index funds where the mutual fund choices were located) - two ETFs and three mutual funds. Our comparison table got too large for one screen and we had to split the ETFs from the mutual funds into two tables below, but we will do our comparisons of all five together.
Comparison Tables
1) ETFs - CBN and XGR

2) Mutual Funds - TDB965, INI230 and CIB901

Other Funds - There are other low-fee broadly diversified mutual funds that could fit into our criteria e.g. Mawer Canadian Balanced RSP, Mawer Canadian Diversified Investment Fund and RBC Monthly Income. We have focused on funds with an indexing strategy. To compare other funds, do a search in the Tools on Morningstar Canada's Funds page.

Diversification, Volatility and Returns - Diversification means having, a) many under-lying securities from different governments and companies inside the portfolio, to reduce the bad effects of trouble in any one organization, b) many different types of securities, or asset classes, to gain the stability and possibly higher returns, from having investments that do not all move in the same direction, especially when it is downwards, at the same time (see previous posts here and here).

All our funds have literally thousands of holdings within, mostly by holding other funds with lots of holdings, so all do a good job of reducing individual organization risk. All our funds also perform all the internal portfolio management for the investor, buying and selling individual stocks and rebalancing on a quarterly basis to keep within target allocations.

A big caution, since we cannot be sure what kind of long term results it will produce, is that iShares actively manages XGR - it varies its percentage allocation among the asset classes quite a bit instead of the passive indexing of all the other funds.

Asset Classes: CBN and XGR are appreciably superior to the three mutual funds by incorporating a number of important asset classes that are completely absent from the mutual funds - real estate, commodities, emerging market equities (China, Russia, Brazil etc that are not in EAFE) and some distinct sub-groups of fixed income like preferred shares, high-yield bonds, real return bonds and foreign market bonds (all excluded from the DEX Universe bond index definition).

Currency Hedging: The large foreign bond holdings in XGR explain its high percentage of foreign currency hedging - in order to protect the higher foreign bond returns from being eaten up by possible rises in the Canadian dollar, that portion of the portfolio gets hedged. CBN hedges its foreign bonds too while the mutual funds contain no foreign bonds to hedge. On the other hand, none of the funds hedges the foreign equities, which we tend to agree with (see post here). Hedging is thus a neutral factor in comparing the funds in our view.

Equity - Fixed Income Split: This is the most significant factor differentiating the five funds, though it isn't necessarily good or bad if one recognizes and is prepared to live with the volatility effect. The fund with the most equity, CBN, is also the most volatile, overcoming, it is interesting to note, even the stabilizing effect of having more asset classes during the extreme stress period of the 2008 financial crisis, as the chart below vividly shows (we had to omit XGR to do a fair comparison since it only started up in November 2008 after the worst of the crisis). CBN is the blue line and it followed the purple line of the TSX Composite down.

However, on the rebound, it is rising faster than the other funds, as the next chart below of the recovery period since January 2009, shows. The one year returns (see Comparison table) to December 31st, 2010 reflect that as well, with CBN in the lead.

Over the long term of ten years or more, the success of TDB965 and CIB901 will depend much more on the strength of the Canadian stock market due to the much heavier weighting of Canadian equities. INI230 places investor money evenly across its Canadian, US and EAFE equity holdings. CBN and XGR have very little in Canadian equity by contrast; the investor's success depends on how foreign holdings do.

TDB965's track record since its 1998 inception has been solid if not spectacular - 4.7% per year. Founded in the same year, CIB901 lags that at only 3.9% per year. CBN only goes back to mid 2007. That was just before the financial crisis, so it is no surprise that the return since inception is a loss of 3.8% per year.

Costs and Convenience
XGR is the low-cost leader at a Management Expense Ratio of only 0.62% with CBN and TDB965 0.2% higher and INI230 and CIB901 another 0.2% or so above that.

However, XGR lacks all the features to ease the on-going investment work for the investor. In contrast, CBN, TDB965, INI230 and CIB901 all have automatic no fee dividend reinvestment mechanism and automatic pre-authorized no extra fee fund purchase plans for regular small amounts. (Note that not all brokers have opted in to the auto purchase plan for CBN - check this table from Claymore). Reinvested dividends make up a very significant part of the total long term return of equities, as we discussed here, so having it done automatically, instead of the dividends sitting in cash which is too easily neglected and forgotten, is a big plus. The three mutual funds have the additional feature that all the tracking of Adjusted Cost Base is done by the mutual fund company, whereas with CBN and XGR, the investor must do that once a year for him/herself, as we described here.

Bottom Line - We find XGR to be less attractive than the others due to the active management and the lack of automatic features. All four of the other four funds are an effective choice in our opinion (and that is our opinion only, you should always think for yourself and possibly consult others to get alternate views), we like CBN and TDB965 for their low fees. CBN is more for those prepared for the bigger swings from a higher equity content, i.e. those in it truly for the long term who will not get too nervous when markets experience big declines. TDB965 suits the slow and steady crowd who are willing to sacrifice a possible, though not assured, higher end result for interim greater stability.

The most important thing is to invest in something. Comic Woody Allen spoke truly when he said "Eighty percent of success is showing up."

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.


Anonymous said...

Please delete the scam spam comment above.

Anonymous said...

Fantastic post.

I'm curious though about the 1-year returns in your table.

It seems to say that the returns of TD and CIBC were about double that of ING in the last year. But your graph shows that they had pretty much identical curves.

Is there an error or am I missing something?

CanadianInvestor said...

..spam gone, thanks for note.

As far as the graph is concerned, note that it show 2 years of data - Jan 2009 to Feb 2011. But the 1 year difference has to be about portfolio composition - INI230 has much more foreign content and the Canadian dollar went up against most foreign currencies - check out the 1yr chart for CAD at http://www.ratesfx.com/visualizations/maps/map-cad.html - there's a lot of blue showing foreign currencies losing against CAD. None of these funds hedges the currencies. Sometimes it hurts, sometimes it helps returns.