Passiv and Unbundling All-in-One ETFs

October 8th, 2020 by Potato

Passiv is a neat tool that helps you manage your portfolio. It plugs into your Questrade account, and can send you email notifications when new money arrives in your account, and can even do one-click rebalancing of your portfolio, either by just distributing un-invested cash to the parts of your portfolio that are under-weight, or by also selling parts that are over-weight.

I should mention that they now have a referral program and I’m part of that — you can find a link over in the sidebar where the advertisey stuff goes.

So they recently put up a blog post comparing the costs of all-in-one ETFs to unbundling them and investing in the handful of underlying funds. Usually you’d also have to consider and weight the extra work and complexity that goes along with the savings of unbundling, but the pitch is that Passiv can manage the rebalancing and multiple purchases for you, so it should just come down to cost.

I’m a big fan of the all-in-one ETFs, in part because they force you to look at your portfolio as a whole, on top of the convenience factor. Even with no rebalancing to do, you can still make use of Passiv to do the purchases for you with one click, and send those emails when new money arrives in your account. And for the moment those services are free to the user.

But if you want to get the lowest possible costs, then sure, you can save a bit by investing in a set of individual ETFs. However, the comparison in the post is missing a few important factors. Yes, you will pay a slight MER premium for the convenience of an all-in-one fund. But that doesn’t mean you should automatically break them apart to seize those savings, even with Passiv to help. Also, the MER premium is a bit smaller than their post makes out — only about 8 bp.

Commission Costs

First off, the article completely ignores transaction costs. While ETFs are nearly free to buy at Questrade, you do have to pay to sell an ETF. And if you’re manually rebalancing, you may sometimes have to do that, especially once your portfolio gets large enough to be hard to rebalance from regular contributions making purchases only.

If you have 3 holdings to sell every 6 months, that’s just $30/yr in commissions, which doesn’t sound like much. But with just 8 bps of savings on the table, you’d need at least $37k invested to break-even. That same comparison also shows how little the convenience of the all-in-one funds costs for smaller portfolios — $30/yr for the convenience on a 5-figure portfolio.

Ok, that’s not a high bar, and below that point you’re almost certainly going to be able to rebalance with new cash rather than having to sell something first anyway. But still, it’s worth pointing out if you are considering using multiple ETFs.

US Funds Complication

A mistake in Passiv’s blog post is comparing a Canadian product to a mix of Canadian and American funds. For example, in saying that you can save 13 bp by breaking apart VGRO, the blog post is putting an allocation toward VTI, the American-listed ETF; similarly for breaking apart the iShares funds, the author is looking at several US-listed funds, which would be more expensive on the Canadian side (ITOT, IMEG) or have no exact analog (USIG, GOVT). But those currency exchanges are going to be tricky (and potentially costly) to handle, and those costs aren’t included in the comparison. Using a Canadian-listed fund would make for a fairer comparison. VUN, for example, rather than VTI. The Canadian versions carry MERs that are a bit higher, reducing the benefit for breaking up VGRO to just 8 bp.

What About Quantization?

Take a look at XGRO’s allocation (which I’m pulling from their post rather than double-checking with iShares myself). It has two components with just a 2% weighting, and then a 3% and 3.9% allocation. Will there be an issue trying to actually hit those small targets, especially if the underlying ETFs can only be purchased in whole units costing say $80 each when trying to invest on your own?

I thought this quantization issue might also be a factor in the decision of whether to break up all-in-one funds, particularly for smaller accounts. While I can really cherry pick and say that if you have $18k, you can’t get within 10% of a 2% weighting with a fund that costs $80 CAD (USIG for example) — 5 shares would be 2.22%, while 4 shares would be 1.78%. I don’t know how Passiv would handle that if you had your rebalancing threshold set at 10% or tighter, would it keep flipping back and forth, buying and selling a share to try to hit an unachievable target allocation? But for the most part, quantization isn’t really a real-world argument for sticking with all-in-one funds. You’re unlikely to run into any issues with it, especially if you’re willing to increase your rebalancing threshold until your portfolio grows larger.

But concerns about buying very small amounts of these funds that the all-in-one ETFs happen to use could lead to a bit of analysis paralysis: should you blindly follow what they have done, or use a 3- or 4-fund canonical portfolio instead?

Summary

I’ve been telling people how to invest in a canonical portfolio for years, and I’m a big fan of the all-in-one ETFs. If you want to save a bit of money and use separate ETFs, be my guest, especially if you have a 6-figure portfolio where the minor cost savings may be worth the extra bit of effort. If you want to use Passiv to help you do that, that’s great. But I don’t like the post’s insinuation that all-in-one funds are costing that much (by framing the extra costs as a percentage difference off a very low base cost) or are “less than ideal”. It ignores the other benefits of simplification (such as better behaviour), and it over-states the benefit by ignoring commissions and currency conversion costs.

What Happens When a Robo-Advisor Shuts Down?

November 18th, 2019 by Potato

Back when robo-advisors were new — who are we kidding, for financial services they’re still new — people had lots of concerns about the new services. Chief amongst those concerns were whether investors’ money would be safe if/when one of the firms went under. We predicted that this would be a risk of inconvenience rather than a risk of losing real money: because of the custodian broker relationship, you would still have your assets somewhere (though those have their own risks), but the firm would no longer manage them. But if a firm went under, you wouldn’t lose your assets with them.

What happens if a firm goes out of business? Then the underlying investments — which are held at a “custodian” — can be transferred to another broker on your behalf. You can ask each firm about the details of their custodian arrangement, but as far as we were able to determine, every firm listed holds your investments at a custodian that is a member of IIROC.

So, aside from the usual risk of the investments themselves and completely unforseen events, investing with the relatively new robo-advisors should be no more risky than traditional means.

Well, we have our first robo-advisor failure! Planswell suddenly shut down operations this month, and we’re seeing those predictions play out in practice. Investors’ assets are still held at the custodian, and other than the inconvenience of having to move them and pay a transfer fee, nobody’s assets went up with the firm — the custodian brokerage relationship is working as predicted.

Planswell customers now have to figure out what to do with their assets. One choice is of course to learn to DIY and move to Questrade for ETFs or TD for TD e-series. Otherwise they can move to another robo-advisor if that’s what worked for them and still the right choice. Planswell is suggesting a few that use the same custodian (e.g. Justwealth and Wealthbar), which saves on transfer fees. Note though that if you ask and have enough assets to move, many firms will cover your transfer-out fees.

As for prognosticating, I’ve been surprised so firms have lasted as long as they have. I keep expecting a wave of consolidation — not necessarily abrupt closures like Planswell, but I’m surprised someone (the big banks and Wealthsimple are obvious acquirers) hasn’t been buying up the other firms. Dale has a post up on the slow growth of the robos which may add to the issues and stress in the future.

TD E-Series Changes

August 28th, 2019 by Potato

You may have received a proxy form in the mail if you’re a TD e-series holder, asking you to for a change in the investment objective of the funds. In case you haven’t seen it, the information circular is on SEDAR.

The main points are that the e-series funds will change the index provider to Solactive, and instead of holding the underlying stocks/bonds themselves (and derivatives), will be able to hold the corresponding ETF. This will come with a 5 bp reduction in management fees.

To break that down a bit, fund companies have to pay a licensing fee to the index creators when they have a fund that tracks that index — they can’t just free-load like I would if I wanted to re-create the S&P500 with an insane number of trades myself. Solactive is an index provider that’s reportedly cheaper to use than S&P/MSCI/FTSE, so the move helps TD save some money. Moreover, it’s the index provider that TD’s ETFs use, which lets the e-series funds start to use those to share some of the work of fund management.

I don’t believe their indexes are different enough from the ones we’re familiar with to worry about it or to have substantially different expected returns. Unfortunately, their site isn’t quite as handy as the other index providers (or Vanguard/iShares) for figuring out what’s in there. Fortunately, TD’s ETF pages list that, for example here’s the Canadian equity index page. It has slightly more holdings (270 vs 239 in the S&P TSX Composite), and some minor differences in sector weightings (e.g. 5.9% vs 7.6% in Technology, though most are closer than that). The US one looks very similar to the S&P500 (even having 500 holdings), as does the new international one to the MSCI EAFE.

The changes are subject to a vote by unitholders, but I don’t foresee that failing.

Remember that MER is backward-looking, so it will take a full year before the new lower management fee is reflected in the MER listed in the fund facts (a year after this is implemented, which may be a few months yet — the vote is late September).

All-in-One ETFs and Changing Asset Allocation

May 27th, 2019 by Potato

So you liked the idea of all-in-one funds when they came out. You like-liked them. Finally, you love the idea of all-in-one ETFs and are going all-in. You’ve rounded off your asset allocation, and stuck it all in a single ETF. All new money that you save, you also stick in this one ETF.

Then about 20 years later*, your risk tolerance has shifted enough that a different all-in-one ETF is appropriate for you (e.g., VGRO now becomes VBAL).

How do you switch? What are the costs and trade-offs? This is one of the remaining sticking points for a lot of potential all-in-one investors (well, that and taming the need to tinker).

RRSP/TFSA: there are no tax issues to worry about, just go ahead and do it in one go. Costs a commission to sell (and depending on your brokerage, one to buy the new fund) — not material. Thanks for visiting, enjoy your all-in-one fund without any worries, you can skip the rest of the post. (And if you’re not sure how to buy an all-in-one ETF and invest and all that, check out the course to teach you just that).

Non-registered: it gets more complicated, as you might expect. When you sell a fund you’ll have to realize the gains (and thus pay tax). Turning over your entire portfolio at once might have some fairly large tax consequences. You can take an alternative approach, like buying a bond fund at some point (perhaps selling a bit of your all-in-one fund) to make a two-fund portfolio later.

That looks like you’ll trade simplicity today for a bit of a headache later, in either complexity at some point or a tax bill. That’s likely still a good move, though you’ll want to go in with eyes open on what the cost of maintaining simplicity is. Fine, let’s math it out to get an estimate.

TL;DR: doing a big switch-over in your non-registered account (like you might in a TFSA/RRSP) may end up adding something like double-digit basis points to your equivalent MER costs in realizing the taxable gains, which may push you towards more complexity later — which to be fair is a problem for future-you to deal with, and is still better than complexity all the way along, though it means at some point you’ll be pushed to learn how to rebalance).

Disclaimer: I did the spreadsheet and wrote the post on the train back from Montreal, so there may be errors. The cost ended up about double what I had guessed it would be, which may just mean the math is a caution to my intuition, and that people who want simplicity in a non-registered account might have to suck it up or look to the e-series funds, or it may be a sign there is indeed an error in here.

How big is your non-registered? Bear in mind that the benefit of simplicity will accrue to all your accounts, though the tax cost may only hit your non-registered. So if you’re planning on heading into retirement with a million-dollar portfolio, odds are that you may have most of that in registered accounts, so even a “big” tax hit to your non-registered may not be big in the context of the work you’re saving by using all-in-one funds for several decades in all your accounts.

Unfortunately, the switching cost is not a simple percentage that you can directly compare to an MER — it’s going to depend on future capital gains, your tax rates, etc. And looking at just the cost of switching an all-in-one fund will over-state things a bit, as you would still have to pay gains to rebalance a 3- or 4-fund portfolio when the time comes (or to sell it and use the money to live off of).

So how much is this going to cost? Let’s use a specific example to try to put some numbers to it. Let’s say you throw $5,000/yr into a non-registered account (remember, this is on top of what you’re saving in your TFSA/RRSP) and buy VGRO. Let’s say the market is well-behaved for the sake of our spreadsheets, and that investment grows at 6% nominal (your real return [which matters for most planning purposes] will be lower due to inflation, but for tax purposes nominal returns matter, and in this case this doesn’t include dividend/interest distributions — those we’ll say are part of our $5,000 annual [nominal] contribution).

20 years later, your risk tolerance has shifted enough that you feel VBAL is a more appropriate choice, and you have to switch over. Your VGRO at that point is worth ~$189k, with a cost basis of $100k. Switching in one big go means realizing a gain of ~$89k, so ~$45k gets added to your taxable income. That feels ouchy, though you’ve reset your cost basis so you’ll pay less tax when you eventually sell the funds for living expenses. Also remember that this is 20 years in the future with nominal dollars, so it’s not quite as bad.

If you have an income of $60k in today’s dollars (~$90k in 2039 dollars), the tax bill of the big bang approach would be (very roughly) $13k (in future dollars). That’s not all an incremental cost of using all-in-one ETFs though, as those gains have to be paid eventually if you don’t have a big switch.

There are some other options to spread the cost out and reduce it a bit, with just a bit of added complexity:

Option 1: spread it over multiple years. One of the issues with the all-in-one big-bang switchover is that it could add a lot of taxable income in a single swoop, which would then run up the marginal tax rates to add insult to injury (in this example, up to the ~38% bracket for someone normally in the ~30% one). You can pay less tax by just spreading the hit over a few years. That’s a bit of extra complexity, but not much. You could do it over a few years, which requires fiddling with your portfolio a few times, but timed right you can spend just a few days focusing on the trade to spread the tax hit over two years (by selling half in the last few trading days of December, then the other half in the first few trading days of the new year).

For a two-year hit, you would save about $600 in taxes as all the capital gain fits into the bracket you’re already in (so there’s also no added benefit to further spreading it out — other situations, like having more gains, may change that).

Option 2: break the simplicity. You can still get ~20 years of simplicity with an all-in-one fund, then sell just enough to buy enough of a bond fund to get you back to your desired asset allocation. You’ll be in for more complexity for the rest of your investing days, but by that point it may be worth it.

Math of that: Sell 25%** of your VGRO, buy a bond fund, and get your 60% overall stock exposure. Then you’d be paying about $3.3k on the smaller realized gain portion (again, nominal dollars).

Our counterfactual is investing in a 4-fund portfolio. In that case, you may be able to keep rebalancing by just buying bond funds with your new money each contribution. (We’ll ignore the potential differences in return from having progressively more/less in equities at different points than the all-in-one discrete route — though to be fair, that should also be open as part of option 2, where you just buy bond funds along the way and break the simplicity of the all-in-one fund earlier without having to realize any gains).

Then you start selling down, perhaps at a lower base income. For simplicity of modelling, let’s say that you want to sell enough to generate $10,000/yr in after-tax income (in 2039 dollars) for 20 years and it’s all in the lowest tax bracket. But because the cost bases will be different, we’ll have to sell different amounts of the portfolio. That is, the now-VBAL portfolio will need us to sell a bit less to get the income we need because with a freshly reset cost basis, it will start off almost all tax-free (but because you paid more in taxes in 2039, you’ll also have less to start with). Let’s also throw 5% nominal growth on that portfolio just to make my job modelling in Excel harder.

Big bang VGRO: take off $13.9k in taxes to start, then model growth, sell-off, and finally final value. In year 1 you have to sell $10,096 to get $10,000 after-tax (just one year of 5% growth to pay taxes on), and by the end you’ve collected $10,000 x 20 after-tax, and have $138.2k left (of which $89.3k is unrealized gains from the new growth).

Two-year VGRO: take off slightly less in taxes ($13.3k), so it comes out pretty similar: an ending value of $139.9k, of which $90.3k is unrealized gains.

Hybrid: Take off $3.3k in taxes for selling just a quarter of your VGRO, which leaves you with a higher unrealized gain as you start to withdraw your funds. To get $10k after-tax, you have to pull out $11.0k in the first year. By the end, the portfolio is worth $145.4k, of which $115.8k is unrealized gains.

4-fund alternative: here we’re assuming that you’ve never had to realize any gains, yet somehow made the same return as VGRO/VBAL. So when you start pulling your $10k/yr income out, you have to sell $11.1k in the first year pre-tax to get that. After 20 years of that, you’ll have $151.7k left, of which $123.3k is unrealized gains.

Then what happens with those unrealized gains can matter a bit. If you just discount them by 10% (half the lowest tax rate), then we find the after-tax value of the portfolio is $10.1k lower for the all-in-one user — the tax hit and lack of continued compounding does hurt, though some of the tax hit at the big-bang rebalance will be made up in later years as the unrealized gains did eventually have to be realized to generate income out of the portfolio. And if this point represented death where all gains are realized at once, then the bigger unrealized gains may push your estate up into a higher bracket, closing the gap further.

Again, it’s hard to put this into MER terms. An ending value that’s something like 7% lower after 40 years would be like 18 bp more in costs, which sounds higher than I was expecting when I started doing the math, honestly. Of course, I may be being overly fair to the 4-fund alternative’s ability to match VGRO’s growth without any selling to rebalance along the way — there likely would be some gains realized along the way. If you accept a 2-fund approach in the future (only selling a portion to buy bonds), the hit would be more equivalent to 10 bp. And you also have to consider how much of your portfolio is non-registered — here I’m considering just the non-registered portion, but if most of your money is in registered accounts (as most Canadians can expect to be the case) and you want to consider spreading that tax hit over a larger denominator, the MER-equivalent type hit might be less than a third of this.

As always, balance any costs against the value: the extra simplicity of an all-in-one fund is practically a no-brainer when the MER is only about 10-12 bp higher than a 4-fund portfolio. If it’s more like 30 bp when you add in the tax hit of a big-bang rebalance, then you may have to think about it a bit more (esp. when you can start getting into TD e-series funds at about that level and automate your purchases — though the all-in-one funds would still work in your registered accounts).

Edit May 27: to clarify, the tax hit is coming from a few sources. First is just realizing the gain and missing out on the ability to continue to defer taxes and compound the growth. Next is the fact that the gain is at a higher tax rate (I’ve assumed here that the hit comes while working, at a minimum of 30% tax rate, and higher for the “big bang” switch, while in retirement gains are realized at a 20% tax rate). So there’s a few factors mixed together in this scenario.

* – Why 20 years in all the examples? If we take the basic rule-of-thumb of basing your asset allocation on your age, that implies that you shift your allocation by about a percentage point per year, and the different all-in-one funds shift by 20 percentage points… Your own case will be your own case, though.

** – Why not 20%, which may be the intuitive first-guess answer? Because you’re selling part of your bonds, too. To get to an overall 60/40 split, you’ll need 75% in VGRO and 25% in straight bonds.

Freelancing Finances – Spreadsheet

May 14th, 2019 by Potato

I mentioned back in the guide to Canadian taxes for freelancers that I don’t use fancy accounting software for my side business, just a spreadsheet. A reader asked to see a sample of how such a sheet would look, and here we are.

TLDR: click here to download the template for Excel.

Click here to view the template in Google Drive (link set to make a copy, which may prompt you to log into your Google account — this one to view the template).

In brief, I like to lay things out into sections to help me keep track of my sources of income and expenses, and this is laid out that way. I can create a new tab for each year.

Everyone’s business and taste in spreadsheets will be different, so this may not suit you. For example, you may not have any inventory to track, or you may have many things to track rather than a single book to sell. In my case, I have a whole separate tab for direct book purchases (and postage) because I may have a hundred in a year (vs. only a few lines for consulting/editing/royalty/other income). And of course, I’m a small supplier, so I haven’t built HST tracking into this.

My One Big Tip is to remember what you’re going to use all this information you’re tracking and calculating in your spreadsheet for. Down the road, you will have taxes to report, so if you’re filling out a T2125, you’ll want to make life easier on yourself by making it clear how your personal tracking methods will map over to that CRA form. You might have other purposes though, such as tracking your own progress, planning your business, cash flow, etc., so you may also track things that aren’t relevant to your taxes alongside information that is, or calculate things in different ways for your own use.

While I’ve spread things out, you might want to track a single column of revenue and expenses (perhaps then with a note for each line). In the end revenue will all go on a single line, but it may be useful to you to see the different sources (and make it easier to cross-check bank accounts or invoices later if you need to double-check). Your own organization will have to make sense to you and your business; another example might be to organize revenue sources by provinces with different HST rates (if you collect HST). For the expense side again you can use a single big column, but different sections for your expense categories can make your life easier come tax time (esp. with notes about how things will work).

I have a net income for personal use calculation, and I note that it’s for personal use because the calculation for taxes will be different, and that’s not what it’s for in the snapshot on the spreadsheet. For example, I don’t include business-use-of-home expenses when looking at my side business income (they’re already in my personal budget that I need the income to pay for), and while only a portion of some costs (like 50% of business meeting meals) are eligible expenses for tax purposes, I consider the full cost when making decisions. You can create your own net income line to either line up with the tax calculation, or to include certain items for your own planning purposes.

When it comes to keeping receipts, I’ll either have a physical folder in my filing cabinet with paper receipts, or they will be electronic receipts that are either sitting in an email folder somewhere or downloaded to a folder on my computer. Likewise for invoices/sales — some have invoices, some are email notifications of income (e.g. royalty income, advertising income) that then shows up in a bank account, and some have other ways of tracking (e.g. WooCommerce for direct website sales). In all cases I want to make my reconciliation easier by having some indication of where to go to find the supporting documentation. Sometimes that’s an explicit note (this is in an email dated X) and sometimes it’s in my head based on the organization — all postage receipts are in paper in the physical folder, all direct book sales are tracked through WooCommerce unless otherwise noted, all consulting gigs have PDFs of invoices in a folder on my computer. So breaking the items up into groups in the spreadsheet works with this system.

And finally, be kind to your future self and leave helpful notes on things. If you have to look something up while filing your taxes, odds are you’ll need to know it again next year (e.g. “yes, every year you check and you can include insurance as a business-use-of-home expense (appropriately pro-rated)” or “the category names are dumb, ‘stationery’ doesn’t actually include stationery, that goes in ‘office expenses’, and I really need to see if the CRA needs a good technical writer who works from home.”) I’m not concerned about my notes fitting in the cells — I don’t generally print this out, so as long as I can see “note” I can then click on the cell to see it. You can also use the comments function if you like, or set up a separate notepad area of your spreadsheet — it’s your spreadsheet, make it work for you!

Anything to add? Anything wrong? Anyone have their own (sanitized) sheets to share?

Rest of the Guide to Canadian Taxes for Freelancers:

I’m not an accountant, and I’m certainly not your accountant. Tracking your finances and reporting your taxes is ultimately your responsibility, and this post & spreadsheet are provided as-is for education and entertainment without any guarantees. Further, remember that tax rules can change and may make this content even more useless.