Blessed by the Potato

One of the great things about TD e-series index funds are their simplicity: with just four low-cost funds you can build a complete, diversified, passive portfolio. There are no sector or specialty funds to distract you, like there are in the ETF space.

That can also be seen as a downside though if you do want to get that exposure. Jeffery writes:

I’m interested in purchasing an index fund focused on the Emerging Markets. However TD Eseries does not offer anything targeted towards the Emerging Markets. After looking around, I found that the CIB519 mutual fund seems to be the best in terms of ratings from Morning Star and it seems to have been around for some time. The MER for this though is quite high, 1.36%.

First of all, I don’t really think it’s totally necessary to chase certain sectors if you’re going for a passive investing strategy. The whole point is to try to not make any unforced errors, as they say, or to try not to let your own (amateur) analysis interfere with a solid middle-of-the-road strategy. It’s also not really necessary in my opinion because you’ll still have some exposure to various sectors through the larger indexes: there’s lots of energy exposure in the Canadian index, and multinationals in all equity indexes will to some extent share in the upside from maturing developing economies. You’ll likely want to keep any “flavour” or “kicker” sector exposure small as well, and if it’s going to be a small part of your portfolio, will you really miss it that much if you just stick with the basics?

That said, what if you do still want to get more specific than the e-series lets you? Well, there are a few ways to go. One is what Jeffery has already found: use a higher-cost mutual fund to get the exposure, and just pay the MER.

If you’re not going to be making many transactions though, a better route would be to look at using an exchange traded fund (ETF) for that exposure, and that’s part of the beauty of using TD Waterhouse for your e-series account over TDMF. If you have $50,000 or more in assets at TD, it’ll be $10/trade, $29/trade otherwise. You don’t want to make frequent transactions for small amounts when you have to pay commissions for each trade, but if you’re just looking for a small bit of flair, that’s fine. You can pay the commission once, and not be too strict about your rebalancing — will it really matter if your emerging market or energy or whatever ETF goes from 4% to 6% of your portfolio (or 4% to 2%)?

The math on the expenses is pretty simple: you’ll have a commission for every transaction, plus the MER of the fund itself. So for example if Jeffery wanted to buy the iShares emerging markets ETF XEM and was investing $3000 in it, and paying $10 in commissions to buy, $10 to sell, and planned on holding for 5 years (without further rebalancing over that time), the overall expense would be: $20/3000 = 66.7 bp/5 years = 13.3 bp per year for transactions, plus the 79 bp of the fund itself, for a total expense of 92.3 bp (or 0.923% if you prefer). That’s a better option than the mutual fund he found, but not by a whole lot — some of these specialty funds are expensive even as ETFs. If he planned on investing a little bit over time rather than a lump-sum up front, then it would make more sense to go with the mutual fund; if he had more to invest, or an even longer time horizon, then the ETF may look more attractive. There are of course lots of ETFs out there by providers like iShares, BMO, and Claymore in Canada, as well as some available on US exchanges by Vanguard. Speaking of which, the Vanguard emerging markets ETF, VWO, has a MER of just 0.22%, but then you have to pay to get your Canadian dollars converted into US ones to buy it on a US stock exchange, which can cost ~1.5% each way at TD (there are some cheaper alternatives, like using a “gambit”, but those generally require larger sums to be worthwhile). For longer timelines, VWO is probably the way to go.

So I don’t think it’s necessary to add emerging market exposure to your portfolio, and if you have less than $50k to invest the slice emerging markets would represent (assuming you’re aiming for something in the ballpark of market weight, ~5-10%) it’s probably not going to be meaningful enough to worry about anyway; you can just stick with the basic e-series. If you have more than $50k, then you’ll get the $10 commissions, and the ETF route is probably the best one to take.

Jeffery also had this detail to add:

I noticed an offer for PCF customers where if they open an investment account through them, they offer a discount of 0.10% off of the MER for any Index fund from CIBC. Which means that the MER would be lowered to 1.26% if I bought it through a PCF account.

I’m all for saving money, but 0.1% off is not a very big savings — if you have $2000 to invest in this particular side pocket, that’s $2/year. $2 isn’t nothing, but I’d be tempted just to pay it rather than deal with the hassle of opening another mutual fund account. And if you have more than $2-3000, then the better option is to use an ETF through Waterhouse.