There are two outstanding benefits on which the success of exchange-traded funds have been built – low fees and simplicity.
A recent e-mail from a retired reader highlights how the benefit of simplicity is eluding some people. This reader previously used a conservative investing approach based on guaranteed investment certificates and a savings account. Frustrated at low returns, he diversified using a collection of 23 exchange-traded funds.
Now, after a serious decline in the value of his portfolio, this reader is worried. “I … keep seeing the term ‘bear market,’" he wrote. “How long might I have to wait before I get back to Square One, let alone make better money than my GIC did?”
I’d say it takes five years at minimum for a diversified portfolio to have a reasonable chance of outperforming a GIC, and possibly 10 years. But this investor first has to position himself to benefit from the demonstrated long-term outperformance of stocks over safe investments. That means simplifying his portfolio.
The ETF industry bears some responsibility for this reader’s situation. Not for the losses – that’s just normal stock market volatility. The real problem is that ETF companies are swamping people with funds and not providing enough information on which are key portfolio component as opposed to fringe funds. This reader ended up with 23 funds because he was convinced there were that many must-have products.
In fact, the right number of ETFs for a rookie investor is much closer to 2.3 than 23. All you really need is a bond ETF, a Canadian equity ETF and a global equity ETF, which includes U.S. exposure. Check out the Freedom 0.11 Portfolio – it gives you a fully diversified portfolio with exposure to bonds and stocks from around the world using four ETFs. The 0.11 in the name refers to the superlow average management expense ratio for these four funds.
ETF companies have done some good things to help novice investors, notably the recent introduction of fully diversified balanced funds tailored for conservative, balanced and aggressive investors. But more needs to be done to help investors understand which ETFs are essential portfolio building blocks and which are for speculation.
As for investors eyeing ETFs, they need to remember the two outstanding benefits on which the success of ETFs has been built. Low fees and simplicity.
Rob Carrick