Robb Engen: Hey Justin, it’s Robb Engen from the Boomer and Echo blog. My question to you is about the cost savings of using U.S.-listed ETFs. Right now, 100% of my portfolio is in Vanguard’s all-equity fund, VEQT. There’s about $200,000 in my RRSP, and $50,000 in my TFSA. At what point would you say to me, “Robb, look, you’re absolutely crazy not to break up with your one-ticket fund and switch to a portfolio that includes U.S.-listed ETFs.”

In other words, when it comes to portfolio value, when does math trump simplicity?

 

Bender: Hey Robb, thanks for your question. Let me start off by saying, congratulations on a perfectly sane investment choice. Regardless of portfolio size, there’s absolutely nothing wrong with sticking with a one-fund solution like the Vanguard All-Equity ETF Portfolio (VEQT). This is especially true in your TFSA. If you sold VEQT and repurchased a two-ETF portfolio (comprised of a Canadian equity ETF and a U.S.-listed global equity ETF), you would only save about 0.04% per year, or just $20 on a $50,000 TFSA ($50,000 × 0.04%). This also unrealistically assumes no costs to implement and manage your more complex TFSA.

So, I think we can both agree that VEQT can hang out in your TFSA for the foreseeable future. Enough said.

Security Weight (%) Market Value Total Costs (%)
Vanguard FTSE Canada All Cap Index ETF (VCN) 27.8% $13,900 0.06%
Vanguard Total World Stock ETF (VT) 72.2% $36,100 0.61%
Total 100.0% $50,000 0.46%

 

Security Weight (%) Market Value Total Costs (%)
Vanguard All-Equity Portfolio ETF (VEQT) 100.0% $50,000 0.50%
Sources:  FTSE Russell index fact sheets as of July 31, 2019. CPM Foreign Withholding Tax Calculator

 

But what about the VEQT holding in your RRSP? Here, in the spirit of your own question, I can provide an easy answer … or a mathematical one. I’ll offer both. You decide.

The Easy Answer

Math aside, I would maintain that most DIY investors would be wise to stick like glue to their one-fund solutions, even as their RRSP values continue to grow. Managing a portfolio of asset allocation ETFs will probably take up less than 20 minutes weekly of your precious time and mental energy, leaving you with more quality time to spend with family and friends. I think you’ll agree, it’s hard to put a price on that convenience. And, as I’ll show you in my more detailed take, even if you switch to and perfectly execute a two-ETF portfolio, there’s no guarantee you’ll be in a better financial position down the road.

That said, there is a point at which you’re likely to end up leaving some money on the table by opting for simplicity. If that just doesn’t sit right with you, and you’d still like to know when the numbers might start penciling out in your favor, I feel that an annual cost-savings buffer of at least $500 – or once your RRSP exceeds $160,000 – seems reasonable to offset some of the strategy’s risks. Since your RRSP value has already passed this theoretical threshold, a lower-cost two-ticket portfolio could be worth the hassle, at least if you’re accounting for it in dollar amounts.

The Mathematical Answer

Now, as promised, let’s take a closer look at the math that has inspired my rapid-read buffer. As you already know from your own readings, swapping out VEQT for a Canadian equity and U.S.-listed global equity ETF combo can save you about 0.31% per year in product costs and foreign withholding taxes (0.50% – 0.19%). On a $200,000 RRSP, this amounts to around $620 of savings each year. That’s certainly not chump change.

Security Weight (%) Market Value Total Costs (%)
Vanguard FTSE Canada All Cap Index ETF (VCN) 27.8% $55,600 0.06%
Vanguard Total World Stock ETF (VT) 72.2% $144,400 0.24%
Total 100.0% $200,000 0.19%

 

Security Weight (%) Market Value Total Costs (%)
Vanguard All-Equity Portfolio ETF (VEQT) 100.0% $200,000 0.50%
Sources:  FTSE Russell index fact sheets as of July 31, 2019. CPM Foreign Withholding Tax Calculator

 

Sounds like a pretty sweet deal, but the grass is not always as “greener” as it may seem. Before you start trading, let’s review some of the potential implementation costs of this strategy, along with tips to help you avoid any huge mistakes. I’ll refer to TD Direct Investing throughout these discussions, as I understand this is the brokerage you currently use. To keep things simple, I’ll also assume your new two-ETF portfolio would consist of the Vanguard FTSE Canada All Cap Index ETF (VCN) and the U.S.-listed Vanguard Total World Stock ETF (VT).

1. Currency Conversion Costs

First, if you’re purchasing U.S.-listed ETFs, you’ll need U.S. dollars. A DIY brokerage like TD Direct Investing will be more than happy to exchange your loonies for dollars, but they will insist on getting a piece of the action. How much, you may ask? Well, that depends on how much you’re converting. In your case, you would be converting a large amount, so you should be able to get a decent rate.

When I recently called TD to inquire, they offered to convert $144,400 Canadian dollars to $109,022 U.S. dollars. This figure is basically meaningless until we compare it to the benchmark spot rate at the time, which would have yielded about $491 more U.S. dollars (or about $647 CAD). If you went with TD’s rate, it would take slightly over a year for your annual savings to offset this upfront currency conversion cost ($647 ÷ $620 = 1.04 years). Still, that’s not a bad deal, since you’ll presumably be reaping big cost savings over an investing lifetime.

Rate Amount to convert (CAD) Proceeds of conversion (USD)
TD Direct Investing 0.7550 $144,400 $109,022
Spot (Benchmark) 0.7584 $144,400 $109,513
Difference -$491 USD
Sources: TD Direct Investing and Quotestream, as of July 31, 2019

 

Some savvy investors will correctly note that using Norbert’s gambit, a strategy that allows you to cheaply convert your loonies to dollars, would significantly reduce your conversion costs and breakeven period. Converting $144,400 Canadian dollars to U.S. dollars using the gambit would have cost about $306 CAD ($232 USD ÷ 0.7584 spot rate), or less than half the cost of accepting TD’s FX rate. Please refer to my YouTube tutorial for step-by-step instructions on how to use the Horizons US Dollar Currency ETFs (DLR and DLR.U) to perform the Norbert’s gambit at TD Direct Investing.

Rate Amount to convert (CAD) Proceeds of conversion (USD)
Norbert’s Gambit 0.7568 $144,400 $109,281*
Spot (Benchmark) 0.7584 $144,400 $109,513
Difference -$232 USD

*Assumes an ask price of $13.37 CAD for DLR, a bid price of $10.12 USD for DLR.U, and $9.99 trading commissions
Sources: Quotestream, as of July 31, 2019

 

Unfortunately, at TD Direct Investing, they take a few days to process your RRSP gambit transactions. This leaves you underexposed to global equities (as you haven’t purchased VT with your U.S. dollars yet) and overexposed to the U.S. dollar (as you now hold DLR, which holds U.S. dollar cash and equivalents). If global stocks go down during this holding period, you win. If they go up, you lose. You also win/lose if the U.S. dollar appreciates/depreciates against the Canadian dollar during the same time period.

The potential opportunity costs can be substantial. For example, imagine you sold $200,000 of VEQT on August 14, 2019 and purchased $55,600 of VCN and $144,400 of DLR on the same day. If you were then forced to wait until August 19 to sell DLR.U and purchase VT, you’d miss out on gains of $5,020 CAD on VEQT.

Your VCN holdings would have gained by around $915, and your DLR holdings would have inched up by around $214, but this still would have left you with an opportunity cost of $3,891. The future savings from switching from VEQT to VCN and VT will take over six years to offset the cost from this unlucky Norbert’s gambit transaction ($3,891 ÷ $620 = 6.28 years).

If you’re seriously considering breaking up with VEQT, you may want to also consider breaking up with TD beforehand. There are other discount brokerages, such as RBC Direct Investing, which allow you to implement the entire Norbert’s gambit process in your RRSP on the same trading day, leaving you less vulnerable to these market-timing issues.

Security Exposure ($) NAV
Aug. 14, 2019
NAV
Aug. 19, 2019
Gain/Loss (%) Gain/Loss ($)
Vanguard All-Equity ETF Portfolio (VEQT) ($200,000) $26.0317 $26.6851 2.51% ($5,020)
Vanguard FTSE Canada All Cap Index ETF (VCN) $55,600 $32.4045 $32.9377 1.65% $915
Horizons U.S. Dollar Currency ETF (DLR) $144,400 $13.49 $13.51 0.15% $214
Total Opportunity Cost of Norbert’s Gambit         ($3,891)
Sources: Vanguard Investments Canada Inc., Horizons ETFs

 

2. Bid-Ask Spreads

A second cost to this strategy results from the bid-ask spreads on the ETF prices. When trading ETFs, you buy at the ask price and sell at the bid price. The difference in the two prices is another hidden cost of switching from a one-fund to a two-fund solution. Think of your ETF as a bar of soap – the more you touch it, the smaller it gets.

Although this exact cost is impossible to calculate, you can get a ballpark idea by multiplying the number of VEQT shares you own by about two cents. So, if you hold 7,392 shares of VEQT at the end of July 2019, the estimated bid-ask spread cost to sell these shares and repurchase VCN and VT would be around $148 CAD (7,392 shares × $0.02).

 

3. Trading Commissions

Third, there’s trading commission costs, both during the initial implementation, and on an ongoing basis (as you attempt to keep your two-ETF portfolio in balance). On such a large RRSP, these $10 trading commissions are hardly worth mentioning, but for more modest-sized RRSPs, investors should certainly pay attention to this cost.

 

4. Future Tracking Error Relative to VEQT

And finally, there’s the unknown cost of your new portfolio’s tracking error relative to VEQT. This “cost” can actually be either positive or negative. You would expect your new portfolio to have positive tracking error, due to lower product fees and foreign withholding taxes. However, this could be offset by a number of factors, such as timing differences in portfolio rebalancing.

Vanguard plans to run a tight ship, rebalancing whenever any underlying ETF becomes overweight or underweight by more than 2% of its target. As their asset allocation ETFs are extremely popular with investors, they also have plenty of new daily cash flows they can use to rebalance the portfolio more frequently.

The frequency of your portfolio rebalancing will no doubt differ from Vanguard’s, so expect slight differences in returns going forward. You’ll also experience different performance between your and VEQT’s foreign equity stock holdings. While they’re very close, VT’s and VEQT’s underlying foreign equity exposures are not identical.

 

Final Thoughts

So which answer has inspired you: the easy one or the deeper dive? I don’t think either is universally right or wrong. If you’ve made it this far, I hope I’ve given you a good sense of which one is right for you.