• Portfolio Construction + Management

Cutting up a 3-ETF Portfolio Into a 5-ETF Portfolio in an RRSP Account

In my last blog post, we worked out the approximate asset class weights for US, international and emerging markets stocks targeted by the iShare Core MSCI All Country World ex Canada Index ETF (XAW). Now that we’ve got our breath back and our allocations in order, let’s sharpen our scissors and start running through what it would take to slice up a 3-ETF portfolio holding a single global XAW fund into a 5-ETF portfolio holding the same positions in individual ETFs.

For example, a balanced 3-ETF portfolio (such as 20% Canadian stocks, 40% global stocks and 40% Canadian bonds) could be recreated into a 5-ETF portfolio by multiplying the 40% global stock target asset allocation by each of the US, international and emerging markets stock allocation weights that we calculated in our previous blog. This would lead us to invest 21.37% of the portfolio in US stocks, 13.89% in international stocks and 4.74% in emerging markets stocks.

Money Makes the World’s ETFs Go Round

Do you remember why in the world we’d want to create a more complicated handful of holdings out of your simple three-part portfolio to begin with? The simple answer: money. In an RRSP account, there can be noticeable foreign withholding tax and product cost savings to be had by breaking up with your global stock ETF. The larger your portfolio, and the higher your allocation to global stocks, the greater the potential savings.

 

By moving to a 5-ETF portfolio, you can potentially save $100s if not $1,000s per year.

 

Have I got your attention? Now to the logistics.

 

Breaking Up for Fun and Profit

Here are what the allocations described above look like in table form:

Stock Asset ClassXAW Weight
(A)
Global Stock
Portfolio Allocation
(B)
Balanced
Portfolio Allocation
(A × B)
Total100.00%40.00%
US53.43%40%21.37%
International34.71%40%13.89%
Emerging Markets11.86%40%4.74%

 

So if you were managing a $100,000 balanced portfolio, you would allocate $20,000 to a Canadian equity ETF ($100,000 × 20%), $21,370 to a US equity ETF ($100,000 × 21.37%), $13,890 to an international equity ETF ($100,000 × 13.89%), $4,740 to an emerging markets ETF ($100,000 × 4.74%) and $40,000 to a Canadian bond ETF ($100,000 × 40%).

Intentionally Familiar Turf

I’ve included the portfolio weights for other asset allocations below (as of September 30, 2017). If you’ve already noticed that these portfolios closely resemble my 5-ETF model portfolios, give yourself a gold star, because this is no coincidence. My model portfolios are meant to approximate these asset mixes, albeit with fewer decimal points to clutter the view.

As of September 30, 2017

 

The Not-So-Fine Print

There’s a catch, of course. Isn’t there always? To score the cost savings that make the exercise worthwhile, you will need to purchase US-listed ETFs in your RRSP account. This requires mastering the Norbert’s gambit strategy for converting your loonies to dollars as cheaply as possible. (I’ve posted step-by-step Norbert’s gambit YouTube tutorials to help with this task.)

If you feel intimidated by the process and would rather stick with your easier 3-ETF portfolio, that’s certainly your call. But before you dismiss the idea entirely, remember: The savings can be as much as the management expense ratio (MER) you’re already paying each year. For example, a balanced 3-ETF portfolio has an MER of 0.14%. The foreign withholding tax and product cost savings of a 5-ETF portfolio in an RRSP account is also about 0.14%. Are you sure you want to leave that much money behind?

To help you decide, check out the table below, showing estimated tax and cost savings for a 5-ETF portfolio. If you have less than $50,000 in your RRSP account, a very conservative asset allocation, or both, you may decide the potential savings – about the cost of a modest meal – just isn’t worth the extra complexity. At the other end of the spectrum, if you can feast on major money spared, you may want to go for the gusto.

Estimated Annual Tax and Cost Savings: 5-ETF Portfolio vs. 3-ETF Portfolio

RRSP Value ($)100% bonds20% stocks
80% bonds
30% stocks
70% bonds
40% stocks
60% bonds
50% stocks
50% bonds
60% stocks
40% bonds
70% stocks
30% bonds
80% stocks
20% bonds
100% stocks
Cost/Tax Savings (%)0.00%0.04%0.07%0.09%0.11%0.14%0.16%0.18%0.23%
$50,000$0$22$35$47$57$69$81$91$116
$100,000$0$45$69$93$114$138$162$183$231
$150,000$0$67$104$140$171$207$243$274$347
$200,000$0$90$138$186$228$276$325$366$463
$250,000$0$112$173$233$285$345$406$457$578
$300,000$0$135$207$280$342$414$487$549$694
$350,000$0$157$242$326$399$483$568$640$810
$400,000$0$180$276$373$456$552$649$732$925
$450,000$0$202$311$420$513$622$730$823$1,041
$500,000$0$224$345$466$570$691$811$915$1,157

 

Number crunching

So now that you’ve seen the potential cost savings and you understand what’s involved with managing a 5-ETF portfolio, are you considering making a change? Feel free to leave your comments below about your experience managing a 3-ETF or 5-ETF portfolio, and why your chosen number works for you.

 

By | 2017-10-30T13:45:38+00:00 October 27th, 2017|Categories: Portfolio Construction and Management|43 Comments

43 Comments

  1. Joel April 19, 2018 at 4:16 pm - Reply

    Hi Justin,

    Thanks for what you do..so i just finished up my 100% stocks portfolio for my wife using QT in her RRSP but i just use the TFSA index funds for simplicity. Anyway, what are you thoughts of having 100% in stocks allocation? My thinking for us is that we will not really need the money until we retire. I’m 35 and my wife 34 and she has about 46k on her RRSP. we have no debt, except mortgage and have our emergency fund..so again these are my reasoning behind having 100% in stocks as per your model portfolio.

    • Justin April 19, 2018 at 4:50 pm - Reply

      @Joel: It would appear that you have the ability to take risk, but do you have the willingness or the need to take this amount of risk? Your need to take risk is best determined by having a financial planner run projections for you to see whether you need to take that much risk with your portfolio based on your personal goals – it usually turns out that you don’t. Your willingness to take risk is trickier to determine, but from my experience, hardly any investors can handle the volatility of a 100% stock portfolio.

      • Joel April 19, 2018 at 6:38 pm - Reply

        Thanks for the quick reply Justin, but really there isn’t any NEED to take this amount of risk except for a little more rewards in return. Maybe i’ll change her investment to 70/30 as she is more conservative. We really have no plans of taking out this money till retirement comes which is probably 20 years from now. Again we are using your Model ETF 100% stock but really because we are indexing they are very diversified just following the market and isn’t that reducing the risk? I also have my own RRSP about 140k and i will probably follow 90/10 from your Model. Thanks again!

  2. Marc February 4, 2018 at 7:13 pm - Reply

    Justin, is there a specific date/period in the year when you typically rebalance?

  3. Rob January 22, 2018 at 6:49 am - Reply

    Justin, Thank you for the great information on your site. I just made the move from a mutual fund portfolio with a bank to 5 ETFs at an online brokerage. I wondered if there’s any chance of you adding a video for Norbert’s gambit at Qtrade? Also, I’m trying to understand the advantages of holding US listed funds in an RRSP. I understand that this is more tax efficient and has lower fees but the currency fluctuations can potentially dwarf any savings. I have worked in the US on and off since 2005 and am probably more aware than most of the impact of exchange rates. What am I missing? Whether you hold US cash or stocks it’s still affected by the exchange rate in terms of value is CAD. Is the idea just that you’re investing long term and will be withdrawing funds over a prolonged period of time? Many thanks

    • Justin January 25, 2018 at 10:53 pm - Reply

      @Rob: I don’t have any plans to record a Norbert’s gambit Qtrade tutorial (I don’t have an account there, and am not planning on opening one – I have too many already 😉

      Holding unhedged Canadian-listed foreign equity ETFs has the same currency exposure as holding US-listed foreign equity ETF (always remember that your currency exposure is that of the underlying stocks, not the currency in which the ETF trades).

      For example, XUU from my model ETF portfolios has exposure to the US dollar (even though it trades in Canadian dollars). It’s US-listed sister ETF, ITOT, also has exposure to the US dollar (but it trades in US dollars). All else equal (ignoring other costs), if you converted your Canadian dollars to US dollars, bought ITOT, held it for 10 years, sold it, converted the US dollar cash back to Canadian dollars, you would be in a similar situation than if you had just purchased XUU with your Canadian dollars (except that in an RRSP account, you do not have the cost of foreign withholding taxes, which is about 0.30% per year).

  4. Ted January 4, 2018 at 8:59 pm - Reply

    Justin, thanks so much for all your hard work on this blog.

    It seems like IEFA isn’t available to trade on TD Direct Investing (I assume this is due to the move to BATS). What do you think is the best alternative to IEFA?

    Alternatives I’ve looked at so far:

    VEA – Fees are okay, but it includes Canada
    EFA – Higher fees, less diversified, probably defeats the purpose of using the US holding in the first place.
    XEF – Higher withholding taxes (if I understand correctly)

    Is there some alternative that I’m missing or do you know why I wouldn’t be able to fine IEFA on TD?

  5. Shane December 14, 2017 at 7:46 pm - Reply

    Justin, thanks for your hard work on the blog. First post so i’m cramming it all in, apologies.
    RRSP is 80/20, 150k. To minimize withholding tax and add a balancing lever (FWIW), I’ve looked at the CAD listed Vanguard ETFs that hold international stocks directly, and split XEF into Asia Pacific and EU with VA and VE. I used VEE vs XEC to avoid Korea double up. I’m using Questrade so US dividends (e.g. from VTI) stay USD to buy more VTI, but i have yet to do Norbert’s (and really should). So here are my questions:

    1. As VE, VA are more thinly traded with a higher spread than XEF, am I just wasting time with this especially given I have to convert to buy VTI anyway? If i can avoid trading for years then the spread wont matter much but that will change if I have to sell. So far, I rebalance with new deposits but that will get harder as the portfolio grows.
    2. Have you considered / advised on foreign ownership issues (e.g. CRA, or ‘closer ties’ for snowbirds) when the total US assets owned gets jacked up by using US listed ETFs? Maybe this is a non-issue? For clarity, I am 36 with a long horizon, the closer ties issue is for my retired parents. I will assume that non-reg should hold CAD listed?

    Thanks!

  6. Bruno November 22, 2017 at 4:02 pm - Reply

    @Justin,
    A little bit off-topic: Is there a way that I can follow the comments on your blog, especially when I post a comment? I have learned a lot from them, but today I need to put it on my calendar to check if there are any new comments or anwsers to my questions.

    • Justin November 22, 2017 at 5:18 pm - Reply

      @Bruno: My web developer (Merian Media) just added this feature – let me know if it works when you have a moment.

  7. Ros November 3, 2017 at 2:06 am - Reply

    Hi Justin,
    Would you be able to explain when (if) it would be wiser to put equities into a TFSA and bonds into a taxable account, when these are the only options ( noRRSP)
    Thanks

    • Justin November 3, 2017 at 1:15 pm - Reply

      @Ros: You generally want to keep your highest growth assets (equities) in your TFSA first, holding your tax-efficient bonds in your taxable account.

  8. Joey October 31, 2017 at 11:17 pm - Reply

    My take on the situation is this: The three options in an RRSP for US and International exposure are: VT, ITOT+VXUS or ITOT+IEFA+IEMG. VT gives you a slightly higher total MER and slightly fewer holdings than the other two options, so it isn’t as good, although it’s simpler. ITOT+VXUS has almost the same MER as ITOT+IEFA+IEMG and similar amount of hodlings. So simpler is better – less money lost on extra transactions, bid/as spreads and rebalancing. Also, your stock allocation would be easier to calculate: 1/3 VCN, 1/3 ITOT, 1/3 VXUS. The only disadvantage of VXUS vs IEFA+IEMG is that VXUS has some Canadian exposure, but when you take into account that VXUS is only 1/3 of your stock allocation, the extra Canadian exposure would be about 1% which should not have any noticeable effect on your performance or risk. This is probably really overthinking an insignificant decision, but for the RRSP, I prefer the 4 ETF portfolio – ZAG, VCN, ITOT, VXUS.

    • Justin October 31, 2017 at 11:25 pm - Reply

      @Joey: Thank you for your thoughts. Years ago, we would build our client equity portfolios in a similar fashion (1/3 XIC, 1/3 VTI and 1/3 VXUS). As you mentioned, any investor that chooses a 4-ETF portfolio instead of a 5-ETF portfolio is still expected to have very similar returns.

  9. Peter October 31, 2017 at 10:40 pm - Reply

    About the Norbert’s Gambit: The Canadian $ seems to be heading lower by the day. So, I am wondering if I should wait until it regains some grounds versus the US $. If I can save another 3-5% on the Gambit scheme, then should I wait before doing it?

    • Justin October 31, 2017 at 10:45 pm - Reply

      @Peter: If you need US dollars now (whether it’s for spending purposes, or for purchasing US-listed ETFs), then I don’t see any reason to wait. The Canadian dollar could go up relative to the US dollar in the short-term or down (no one knows for certain).

    • Joey November 2, 2017 at 2:31 pm - Reply

      This is a misconception. You are not buying USD, you are buying stocks with USD. Whether you buy the Can ETF with CAD or the US ETF with USD, the value of the stock is taken into account with the currency exchange, so it makes no difference. The only difference is if you decided to hedge. There’s no reason to wait.

  10. Phil October 31, 2017 at 10:04 pm - Reply

    Great post Justin, thanks for the effort of creating such quality information. Way back I set my wife’s rrsp (age 45) with vti and vxus. Now 100k each. Do you think it’s worth the switch to itot iefa iemg? I’m not a fan of extra Canadian equity in rrsp space either.

    • Justin October 31, 2017 at 10:38 pm - Reply

      @Phil: You’re very welcome!

      I don’t think it’s necessary to sell VTI/VXUS and buy ITOT/IEFA/IEMG. Your Canadian equity allocation in VTI/VXUS is only about 3.35% (or $6,700 out of $200,000). You’re already benefiting from the lower foreign withholding tax rate by investing in US-listed ETFs within your wife’s RRSP account, so you have 99% of the tax and cost benefit already.

      If you do decide to make any changes, please ensure that VTI and VXUS are being held on the US dollar side of the RRSP account (and not the Canadian dollar side), or any sales could force a currency conversion back to Canadian dollars at the bank’s high FX rates.

  11. Davie215 October 31, 2017 at 12:40 am - Reply

    Thanks, Justin, for clarifying the EM ratio for the Vanguard VT option to XAW. I was aware of the Korea aspect between Vanguard and iShares indexes, but had tried to cobble together the overall EM content from a breakdown that just showed European and Asian EM for the Vanguard (where the 5.6% total came from). The more detailed breakdown I later found properly split off the Korea 1.7%.

    With the 3.2% Canada in VT that makes the XAW elemental ratios you developed very close to the regional breakdown of VT, which on 9/30 is 52.1% USA, 33.7% International (w/o Korea) & 11.0% EM (including Korea). So using VT would be taking that 3.2% away from International (in XAW) & adding Canada, when the two choices are matched.

    Rather than doing the 5-ETF blend, and adding 3 new USD ETFs with ITOT, IEFA & IEMG, I will consider just replacing my XAW with a single one (VT), now clearly knowing the regional differences.

    Thanks also for the article on the DRIP lesser-than-expected benefits with BMO IVL not having USD DRIPs. From your calculations, the MER and tax impact will save me a grand in the RRSP holdings we now have. Norbert’s Gambit here we come!

    • Justin October 31, 2017 at 1:09 am - Reply

      @Davie215: Your decision to use VT instead of ITOT/IEFA/IEMG seems like a very reasonable alternative. Best of luck with the gambit at BMO InvestorLine! (be sure to watch the tutorials first 😉

  12. Rob October 30, 2017 at 7:06 pm - Reply

    Hi there,
    In my spousal RSP, I have VSB ($25k), XAW ($10k), XWD ($53k), VOO ($14k), VTI ($10k) and VXUS ($18k).
    Is it worth it to simplify with the 3- or 5-ETF model? I trade with RBC DI, so there are small trade fees.
    Thanks for any suggestions.

    • Justin October 30, 2017 at 8:04 pm - Reply

      @Rob: Simply switching from XWD (MER of 0.47%) to XAW (MER of 0.22%) would save you about $133 per year in product costs ($53,000 x (0.47% – 0.22%))…which could pay for 13 trading commissions at RBC Direct Investing each year (XAW includes emerging markets, whereas XWD does not, so please ensure that you are comfortable with the difference).

      If you instead switched XWD and XAW to all US-listed foreign equity ETFs, I would estimate that this could save you an additional $220 per year in foreign withholding taxes and product fees (for annual total cost savings of over $350).

      Please ensure that you are using the Norbert’s gambit strategy to convert your CAD to USD, or you could end up in a worse situation (due to RBC charging you FX fees).

    • Joey October 31, 2017 at 11:09 pm - Reply

      XAW and XWD are redundant. VOO and VTI are also redundant, plus you have no Canadian exposure except a small amount in VXUS. I’d recommend selling XAW, XWD and VOO, converting it into US and just having VTI + VXUS. You could also put some money into XIC/ZNC or VCN for some Canadian exposure. In the end it would be something like VSB, VCN, VTI and VXUS.

  13. Davie215 October 30, 2017 at 4:49 pm - Reply

    Hi Justin,

    Another great breakdown. Like @Joey, after consolidating my ETFs, I’m loather to add 3 new ones, but with the max XAW holdings in our newly-formed RRIFs, the tax and cost savings makes enormous sense, as does considering VT as a solution. I know the MER differential would go from 0.06% to 0.11%, which reduces the 0.23% cost/tax benefit when considering only the XAW (foreign) elements.

    Would this mean (roughly) only about 0.16% net total benefits in a RRSP/RRIF for the foreign components of a 100% equity mix?

    I noticed the 3.2% Canada in VT, but the USA ratio is similar to the XAW fraction. The total emerging markets looks like about 5.6% overall when the geographical breakdown gives Europe and Asian values to them.

    I also like the sweeping of distributions into XAW, as BMO IVL does not allow DRIPs for USD-denominated securities. I’ve done Norbert’s gambit there on taxable accounts, and been able to trade for the replacements without waiting for the lag of settlement — keeping fully invested without any market impact while funds in limbo.

    • Justin October 30, 2017 at 6:00 pm - Reply

      @Davie215: The 0.23% cost/tax benefit for a 100% equity portfolio is based on 67% portfolio allocation to global equities. If you use VT instead of ITOT/IEFA/IEMG, the product cost difference of 0.05% (0.11% – 0.06%) would also have to be multiplied by 67% to calculate the reduction in savings. This would only be expected to reduce the cost/tax benefit from 0.23% to 0.20% for a 100% equity asset mix (0.23% – (0.05% x 67%)).

      Vanguard currently shows VT’s emerging markets exposure of about 9.3% (not 5.6%). As Vanguard ETFs follow the FTSE indices, and iShares ETFs follow the MSCI indices, an additional adjustment must be made to compare the two. FTSE considers Korea to be a developed market, while MSCI considers it to be an emerging market. In order to make VT (which excludes Korea as an emerging market) comparable to XAW (which includes Korea as an emerging market), we need to add the weight of Korea to the 9.3%. Korea currently makes up about 1.7% of the FTSE Global All Cap Index (which VT follows), so the total emerging markets (based on MSCI’s methodology) is about 11%.

      The benefits of being able to automatically reinvest the dividends from your ETF securities (i.e. DRIP) is likely exaggerated (as long as you invest the cash at least once each year): https://www.canadianportfoliomanagerblog.com/the-drip-myth/

  14. Gordon Kirk October 30, 2017 at 4:15 pm - Reply

    Justin, Great article. Not sure yet if this scenario makes sense for my financial circumstances but will certainly have my portfolio advisor look into this on my behalf. This is exactly the sort of stuff he loves to do.

    • Justin October 30, 2017 at 4:45 pm - Reply

      @Gordon Kirk: He sounds like a real nerd! 😉

  15. Bruno October 30, 2017 at 3:40 pm - Reply

    Hi Justin,
    Thank you for your sharing your expertise.

    Question: if I have a 100k 3ETF portfolio, should I consider rebalancing costs before moving to a 5 ETF model? I mean, using XAW does not make me save in rebalance fees?
    I am specially concerned with the small portion of IEMG that will probably require more atention for rebalancing.

    Thanks!

    • Justin October 30, 2017 at 3:55 pm - Reply

      @Bruno: You would have to consider rebalancing costs when deciding on whether to use a 3-ETF or 5-ETF portfolio. However, if you are using a low-cost brokerage (like Questrade), you should only have to pay commissions when you sell a portion of the ETFs (which is not expected to be a frequent event – generally once every 1-3 years).

      Remember that XAW is market-cap weighted (and your purchases of ITOT, IEFA and IEMG will also be a similar market cap when you initially purchase them). As markets go up and down, you will not have to rebalance within the 3 foreign equity ETFs (if you are just trying to keep the same weights as XAW).

      Another option would be to invest the bulk of your global equity allocation in the three foreign equity US-listed ETFs (ITOT, IEFA and IEMG), but purchase XAW with any new cash that you deposit (so that you don’t have to keep implementing the Norbert’s gambit on small amounts of cash.

      • Bruno October 30, 2017 at 9:09 pm - Reply

        @Justin: I think I read the last 2 paragraphs 3 times to understand (:laugh:) I understood that if I rebalance once a year or if I am in accumulation phase, it does not matter the volatility of emergent markets (IEMG).

        Question: Why did you warn about implementing Norbet Gambit using large amounts of cash? In my case, I use Questrade. I am assuming even with small amounts I will be able to do NG in reasonable prices, because I will not pay commissions to buy ETFs. Wrong assumption?

        • Justin October 31, 2017 at 12:29 am - Reply

          @Bruno: Depends on how small the trades are. For a few thousand bucks, that shouldn’t be an issue. For a few hundred bucks, the cost of the sell commission could outweigh the cost of the brokerages FX rates.

          • alana January 13, 2018 at 10:27 pm

            Started investing in 2017 with the 3 fund portfolio and I tend to invest CAD$1,000 every two weeks. My portfolio still small, but now that I’ve gotten the hang of investing (via Questrade), I’m looking to maximize portfolio efficiency going forward. This article convinced me that the 5 fund portfolio is the way to go. Questions for you:
            1). Per your Oct 31, 2017 response to Bruno’s question and given my average $1,000 biweekly trade, would you consider it worthwhile to implement Norbet Gambit?
            2) What does one do with current XAW holdings? Should I sell and convert the cash into the recommended 5 ETFs or is it better to keep my current XAW stock and only put new cash going forward into the 5 fund portfolio? Apologies if you already answered this elsewhere. Thanks.

          • Justin January 15, 2018 at 1:02 am

            @alana: Implementing Norbert’s gambit on anything below $3,000 CAD is likely not worth it (but you would have to contact Questrade for a quote and determine which option is cheaper).

            If XAW is held in an RRSP account, it could be worth it to sell the holding, implement the gambit, and repurchase US-listed foreign equity ETFs. Remember that there is always a risk that foreign equities increase in value while you’re waiting for the gambit to be processed (prior to buying your US-listed ETFs).

            If your account is small, you may want to consider just sticking with XAW for now.

  16. Maury October 30, 2017 at 1:04 am - Reply

    Hello I hope I am not missing something totally obvious but why are we buying is listed ETFs? Is there any advantage to going 5 vs 3 with all Canadian listed ETFs? Thank you for any clarification.

  17. Joey October 29, 2017 at 12:29 am - Reply

    Can’t you just buy VT and keep it a 3 ETF portfolio or ITOT and VXUS to make it a 4 ETF portfolio?

    • Justin October 30, 2017 at 1:34 pm - Reply

      @Joey: Those would both be viable options. VT includes a 3.2% allocation to Canada (while XAW does not) and has an MER of 0.11% (while ITOT + IEFA + IEMG have a weighted average MER of 0.06%). ITOT/VXUS also includes an allocation to Canada, but it’s expense ratio would be similar to ITOT/IEFA/IEMG.

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