Hi everyone, and happy Wednesday! Now normally we’d be doing another buy this week but this happens to be one of those weirdo months where a bi-weekly buy schedule starts to drift away from the typical semi-annual paycheck schedule. So rather than buy on Jan 11th, we’re going to take a break and do our next buy next week on the 18th to get re-synced a little bit closer to people’s paychecks. So what are we going to talk about today? ETF’s. New readers, please click here to start from the beginning.
You know, those things you own (if you’ve been following our workshop).
ETF’s, which of course stands for Exchange Traded Funds, are the single best way for Joe-Shmoe investors like you and me to build a low-cost Indexing Portfolio.
But they aren’t without their confusing quirks.
Our email gets blasted every day with people asking us how to understand these things we own. Specifically,
- How do I figure out what my fees are?
- How do I know this ETF is actually owning the index like it claims it does?
- How do I figure out my ETF’s yield, and how will it be taxed?
Let’s go over these one by one.
How do I figure out what my ETF’s fees are?
I have written before, and will write again, about the toxic, degenerative, and corrosive effect of investment fees on a portfolio. The average Management Expense Ratio (or MER) of an equity mutual fund in Canada in north of 2%, and as proud as I am of the North, I’m not THAT proud. The average cost of an equity ETF is less than 0.2%.
That is one TENTH of the big banks! While owning the same companies!
Why people continue to buy the crap banks sell continues to elude me.
But don’t take my word for it. Figure it out for yourself. An ETF’s MER is easily discoverable. All you have to do find it.
And in case you’re too lazy, we’ve gone ahead and done it for you.
If you’ve been following our Investment Workshop, you will have noticed that we’re using two ETF providers: Blackrock (formerly iShares) and Vanguard.
Both are fine, and both are great. Now let’s see how to see how their fees look.
Let’s start with iShares/Blackrock. If we were to take an ETF that we owned, like XEF, we would just go to the Blackrock site, search for XEF, and get taken to the fund’s website, where we would find this:
In the bottom left corner, you can see the important figure, the MER, sitting at an impressively low 0.22%. Note that the typical Canadian equity fund has an MER of around 2%, or 10X higher while giving you NO extra performance!
So now let’s see what the Vanguard site looks like for our All-American ETF, VTI.
There, on the right, is the Expense Ratio of…0.05%?!?
Wow. Once again you Americans have managed to beat our Canadian asses in terms of investment options.
Here’s where your much higher population density helps you. One ETF like this has a potentially 10x higher market than ours because your population is around 10x ours. Our entire country has less people than the state of California! So the costs of running an ETF can be spread over more people, hence the much lower MER. Good for y’all! We’re not jealous at all.
*grumble grumble grudgingly sips maple latte*
How do I know my ETF is owning the index?
Now let’s talk about what those ETFs actually hold. Remember, ETFs are just baskets of other stocks (or bonds), and the value of the basket is simply a sum of the value of the whole.
But how do you know what your ETF is holding?
Well, if you’re holding some random actively-traded ETF (or mutual fund), I’ve got bad news for you: You have no idea!
Your holdings are basically just made up by whoever your fund manager is, and that manager is free to change their mind at any time.
But with an Index ETF, it’s far easier to figure out whether the fund is doing what it’s supposed to. While actively traded mutual funds have a generously ambiguous mandate of “make money,” passive ETFs like the ones we own have a much more concrete mandate of “track this specific index.”
Funds that have the former, ambiguous mandate are very difficult you evaluate. You can pour over their prospectus, look over their top 10 holdings, and then…what? What have you learned? Nabisco and Pepsi are your top two holdings? What does that tell you?
But on the other hand, Index ETFs have a very clear mandate: Track their index. That is a clear, unambiguous goal. And more importantly, that can be measured very very easily. For example, here is SPY, the oldest and largest S&P 500 ETF brought up on Google Finance.
And here is the actual S&P 500 overlaid on top by typing in the ticker symbol .INX into the “Compare” field.
Nice. The fact that the two lines overlay each other so tightly tells us that the ETF is doing what it’s supposed to. It’s mandate is to track the S&P 500, and it’s price history has indicated that it has done exactly that.
Here’s VTI, the Vanguard Total Stock Market ETF overlaid with the S&P 500:
Again, the two lines are following themselves pretty tightly. In this case, VTI does diverge on occasion because it’s actually a TOTAL stock market fund, rather than just the top 500, so on occasion it will under-perform if small/midcap stocks are dropping faster than the top 500, and on occasion it will out-perform if small/midcap stocks are rampaging ahead, like right now, which is why the blue line is slightly above the index.
You can do this with all of the ETFs we own to see how closely they track their respective index, and before we picked these ETFs for our workshop, this is exactly what we did to make sure they were good Index ETFs. Try it yourself! It’s fun!
What’s my ETF’s yield, and how is it taxed?
And finally, let’s figure out yields.
Each fund distributes, or pays out, a certain amount of sweet sweet cash over a set schedule. This happens because either the underlying bonds pay interest (for a bond ETF) or the underlying companies pay dividends to their shareholders (for an equity ETF).
But how much can you be expected to get? Well for that, let’s go back to the fund summary pages and look for the fund’s yield.
On Blackrock/iShares’ site, just scroll down a bit to the fund’s Portfolio Characteristics section
And you can see that for XEF, we can expect a nice juicy 3.3% distribution yield going forward.
On Vanguard’s site, this info is listed in the fund’s summary under “SEC Yield”
Here we can see that VTI has a projected yield going forward of 1.96%.
But how do we know when these distributions happen, and more importantly, how do we know what TYPE of distribution they are for tax purposes?
Well for iShares/Blackrock, we scroll up to the top of the fund’s info page and find that cute little “Distributions” chart in the left sidebar.
Click on that and a window pops up showing you exactly when each distribution got paid.
Here, we can see that XEF pays semi-annually. Once in December and once in June.
Now, click over to the Calendar Year tab and you’ll see this:
And if you scroll over to the right…
You can see exactly how each distribution is classified for tax purposes. For XEF, we can see that most of the distribution is classified as “Foreign Income,” which is treated as regular income for tax purposes. That’s why we want to hold these in an RRSP or TFSA, if possible.
For Vanguard, just click the “Distributions” tab on the fund’s main page and you’ll see this.
And here, we can see how VTI distributes and how those distributions are classified. VTI paid out quarterly (March, June, September, and December) and those distributions are dividends.
And We’re Done
And that is it for this week. Thanks for tuning in everyone, and hope that answers some of your questions. We will see you back next week, same Bat Time, same Bat Channel!