Millionaire Teacher
Page 15
Step 3: Identify the Price Per Share
Find the unit price (also known as the share price) for your ETF. Your online brokerage platform should show a price. If it doesn’t, look it up. Americans could use Morningstar USA, Canadians could use Morningstar Canada, and Australians could use Morningstar Australia. When purchasing an ETF, enter the ETF’s symbol where it asks for ticker, unit, or symbol.
Unit prices for different ETFs will vary. But that doesn’t mean one ETF is cheaper than the other. If two ETFs track the exact same market (Vanguard isn’t the only ETF provider), then the underlying values of the ETFs would be the same, even if one trades at $10 per unit and the other trades at $15 per unit.
Think of two 20-inch pizzas. Each of them costs $20. You’re happy to buy $20 worth of pizza. One of the pizzas is cut into 10 different slices. The other is cut into 15 slices. Only a knucklehead would say, “I’m buying the pizza that’s cut into 15 different slices because I get more pizza for my $20.”
It’s the same for ETFs that track the same market. The true cost variations can only be seen when looking at each respective ETF’s expense ratio.
If I go to Morningstar Canada, I can see that Vanguard’s FTSE Global All Cap ex Canada Index ETF (try saying that with a mouthful of cheese and pepperoni) traded at $28.24 on June 29, 2016. It’s shown in Figure 6.1. The ticker symbol is VXC.
Figure 6.1 Vanguard Canada’s Global Stock Market ETF Price
Source: Morningstar.ca
Ignore everything else that you see on the page. Just focus on the last price. In this case, it was $28.24 per share.
Step 4: How Many Shares Can You Buy?
Determine how much you’ll be investing. Keep commissions in mind. If you want to buy an ETF with $100 but the commission price is $9.99 per trade, you would be giving up almost 10 percent in commissions. Anyone who does that twice should be tossed in a padded room.
Try to keep commissions below 1 percent. If it costs $9.99 per trade, don’t invest less than $1,000 at a time. Let’s assume that a Canadian investor has $4,000 to invest in Vanguard’s global stock ETF. If the price is $28.24, the investor can afford 141 shares. The investor may want to round down to ensure that they have enough money to cover the commission for the trade. They should also determine a margin of safety in case the ETF’s price jumps before the trade is executed. To be safe, they could choose to buy 130 shares.
Using the Canadian brokerage QTrade Investor, here’s how it would look. Other international (and US) brokerages have similar looking trading platforms. When you understand how to make a purchase off one brokerage or exchange, you can do it anywhere. It’s just like riding a different bike.
You can see what the trading platform looks like in Figure 6.2
Figure 6.2 Order Purchase Sample.
Because this ETF trades on the Canadian market, I entered Canada for the market.
I then entered the ticker symbol for the ETF, VXC.
I placed an action to Buy.
For the quantity of shares, I entered 130.
For Order Type, I selected Market. This means I am willing to accept the market price. I might also select Limit. Please see the sidebar explanation for the difference.
Then I selected submit or confirm.
Not everybody has to buy ETFs. Americans, for example, can invest just as cheaply with traditional index funds. Here’s an example.
Should You Choose A Market Order Or A Limit Order?
When investors buy an ETF, they are asked to determine an order type. The two options will be a limit order and a market order. With a limit order, investors can enter the maximum price that they would pay that day. If, for example, the price opens for the morning at $45 per share, and the investor places a limit order to pay $44 per share, then they’ll automatically pay $44 if the price dips to $44 during trading hours.
Investors shouldn’t initiate a trade if the market isn’t open. But if the ETF price closed at $45 the previous day, and the investor places a limit order before the next day’s opening bell, to pay no more than $44 per share, and if the ETF opens its price for the day at $43, then the order might be filled at $43.
Many investors prefer limit orders. But they have to do it right. They shouldn’t set low limit prices. That’s like gambling. If their order doesn’t get filled, the investor could end up chasing an ever-increasing price, day after day. In the August 2010 edition of The Journal of Finance, Juhani T. Linnain-maa published “Do Limit Orders Alter Inferences about Investor Performance and Behavior?” The researcher found that investors who use market orders usually do better than those who place limit orders.1
PWL Capital’s Dan Bortolotti says there’s a smarter way to do it. He places numerous limit orders on behalf of his clients every day. He confirms that investors shouldn’t place any kind of order when the market isn’t open. Dan always uses limit orders when trading ETFs on behalf of his clients. He says investors should get an up-to-date quote and then place a limit order a penny or two above the ask price (when buying) or below the bid price (when selling). Orders like this should get filled immediately at the best available price.
Sometimes, ETFs get mispriced. This means investors who place market orders could be in for a surprise if an ETF’s price goes a little haywire during trading hours. They could end up paying an unusual, inflated price.
Historically, I’ve preferred market orders. I’ve liked knowing that my order will get filled and that I won’t ever have to chase a higher price the next day. But Dan Bortolotti makes some excellent points. They’re concepts I could learn from. They’re especially important if you invest large amounts or if your ETF is thinly traded.
Indexing in the United States—An American Father of Triplets
When Kris Olson’s wife, Erica, had triplets in 2006, she single-handedly gave birth to a quarter of a soccer team. Suddenly, there were three more mouths to feed, a minivan to buy, and three college educations to save for.
I’m not suggesting that anyone would hold a charitable benefit with accompanying violin music for a well-paid specialist in pediatrics and internal medicine. But if you’re American and suddenly more aware of your own financial obligations, Kris’s story of opening an indexed investing account could provide some direction.
The 46-year-old doctor realized that investing money was similar, in many ways, to the global health work he does in the poverty-stricken, tsunami-affected regions of Sumatra, Indonesia, where he occasionally flies to train midwives. This latest passion comes on the tail of his volunteer work along the Thai-Burmese border, as well as in Darfur, Cambodia, Kenya, and Ethiopia.
Realizing that donations to developing countries are best done in person, he and his wife Erica (a registered nurse) often brought their own medical supplies to the countries they visited. Simply sending supplies was an invitation for third-world middlemen to plunder the goods before they arrived.
In 2004, he recognized that something similar was happening to his investments at home, which had been laboring in actively managed mutual funds for years.
“My financial adviser was a really nice guy, but I realize that he skimmed money off me like guys at a third-world country border. I was flushing money down the toilet in tiny sums that were adding up,” he said.
On a trip to Indonesia, Kris made a stopover in Singapore, where he purchased cardiopulmonary resuscitation (CPR) training material to take to midwives in Aceh. I met him for lunch at a Japanese restaurant. Over sushi, he asked me what indexes he should buy for his investment account.2
The largest index provider in the United States is Vanguard. If you go to their website, the array of indexes can be confusing. But I suggested that Kris—who was 35-years-old at the time—should keep things simple: buy the broadest stock index he could for his US exposure, the broadest international index he could for his “world” exposure, and a total bond market index fund that approximated his age. I call it the Global Couch Potato Portfolio. Here’s the allocation I recommended:
35 percent Vanguard US Bond Index (Symbol VBMFX)
35 percent Vanguard Total US Stock Market Index (Symbol VTSMX)
30 percent Vanguard Total International Stock Market Index (Symbol VGTSX)
I gave my advice on this basis: Vanguard doesn’t charge commissions to buy or sell; he would be diversified across the entire US stock market and the international stock markets; and he would have a bond allocation that would allow him to rebalance his account once a year.
“Kris,” I said, “Don’t listen to Wall Street, don’t read financial newspapers, and don’t watch stock-market-based news. If you rebalance a portfolio like this just once a year, you’ll beat 90 percent of investment professionals over time.”
When Kris got back home to the United States, he put his old mutual fund investment statements on the dining room table. He then logged on to the Vanguard site and telephoned the company from the website’s contact information.
A Vanguard employee walked Kris through the account opening process as they navigated the website together. She simply asked for his existing mutual fund account numbers—for both his IRA account (a tax-sheltered individual retirement account) and for his non-IRA mutual funds.
Over the telephone, the Vanguard representative then transferred his assets from his previous fund company to Vanguard where he diversified his money into the three index funds. Then, after taking his regular bank account information, she set up automatic deposits into Kris’s index funds according to the allocation he wanted.
At the end of each calendar year, Kris took a look at his investments. “It didn’t take much,” he said. “I just rebalanced the portfolio back to the original allocation at the end of each year [as seen in Figure 6.3], selling off a bit of the ‘winners’ to bolster the ‘losers.’ It was the only time I ever looked at my investment statements—just when it was time to consider rebalancing.” I was able to confirm Kris’s investment returns (in US dollars) using the fund-tracking function at portfoliovisualizer.com.
Figure 6.3 Kris Olson’s Account Allocation
January 2007
Kris noticed that the portfolio he established one year earlier had gained 15.4 percent during the course of the year. Most of the gains came from his international and US stock market indexes. He called Vanguard on the phone, logged on to his account online, and the Vanguard representative guided him through the process of selling off some of his stock indexes to buy his bond index. This brought his portfolio back to its original allocation.
January 2008
Worldwide, stock markets continued to rise from 2007 to 2008. At this point, Kris’s profits had really increased, gaining 25.86 percent from the initial 2006 value and 9 percent for the 2007 calendar year. Fighting the urge to buy more of what was propelling his portfolio (his stock indexes), Kris sold off portions of his international and US stock indexes to buy more of his bond index with the proceeds. It didn’t require any judgment on his part. He just adjusted his account back to its original allocation.
January 2009
When Kris looked at his statements at the beginning of 2009, he noticed his total portfolio had dropped in value as the biggest stock market decline since 1929–1933 was starting to take its toll. His portfolio had dropped 24.5 percent. But Kris just rebalanced his portfolio again, selling off some of his bond index to buy falling US and international stock indexes, bringing it back to the original allocation.
January 2010
Kris knew the stock markets took a beating during the previous year—everyone was talking about it. But because he sold off some bonds the previous year to buy stocks, he benefited from the low stock market levels. By January 2010, his account had increased 23.14 percent for the year thanks to the rebounding stock markets. Once again, Kris took 10 minutes in January to rebalance his account, selling some stock indexes to buy more of his bond index. When Kris was finished, he was back to his original allocation.
January 2011
By January 2011, Kris’s account had gained another 11.6 percent over the previous 12 months. From January 1, 2006, until January 1, 2011, his account’s profits had increased by 30.7 percent, despite going through the worst stock market decline (2008–2009) in many years. Rebalancing once again, he sold off some of his stock indexes to buy some more of his bond index.
January 2016
If Kris had continued this process over the next five years, his portfolio would have grown by 73.09 percent over the 10-year period. That’s impressive, considering that the decade included the worst stock market crash since 1929.
Don’t Forget the Enemy in the Mirror
Some investors might notice that Scott Burns’ original Couch Potato portfolio (mentioned in Chapter 5) would have beaten Kris’s Global Couch Potato portfolio over the 10-year period ending December 31, 2015.
Table 6.2 shows how the portfolios compared.
Table 6.2 $10,000 Invested: Global vs. Classic Couch Potatoes, 2006–2016
Average Annual Return
End Value
Kris Olson’s Global Couch Potato Portfolio (35% US stocks, 35% bonds, 30% International stocks) 5.64%
$17,309
Couch Potato (50% US stocks, 50% bonds) 6.09%
$18,148
Couch Potato (60% US stocks, 40% bonds 6.43%
$18,741
Couch Potato (70% US stocks, 30% bonds) 6.72%
$19,274
Source: portfoliovisualizer.com
Scott Burns’ Couch Potato portfolios won. That’s because the original Couch Potato portfolios didn’t contain international stocks. US stocks trounced international stocks for the decade ending December 31, 2015.
But that won’t always happen. The stock market is cheeky. It lures investors toward a “better performing” asset class or geographic sector. It waits. And it waits. Then it conducts a bait and switch. One decade’s better performing sector can become the next decade’s loser.
Check out the five-year period ending January 2016 in Figure 6.4. US stocks crushed international stocks.
Figure 6.4 US Stocks Triumphed, 2011–2016
Source: © The Vanguard Group, Inc., used with permission
During the five-year period ending December 31, 2015, Vanguard’s US Total Stock Market Index (VTSMX) gained 104 percent with dividends reinvested. Vanguard’s International Stock Market Index (VGTSX) gained just 33 percent.
It’s easy to give up on international stocks after seeing this performance. But investors shouldn’t. Every sector has its day. From December 2000 until January 2006, (as seen in Figure 6.5) US stocks were losers. Vanguard’s US Total Stock Market Index gained 10.2 percent. Vanguard’s International Index gained 32.9 percent.
Figure 6.5 International Stocks Triumphed, January 2006–January 2011
Source: © The Vanguard Group, Inc., used with permission
Trying to guess which geographic sector will outperform another is a fool’s errand. Nobody can see the future. Results could be disastrous if investors try to guess. Whether investors choose one of Scott Burns’ Couch Potato portfolios or whether they choose a Global Couch Potato Portfolio, they should stick to their strategy like barnacles to a boat. Over an investment lifetime, results should be similar if you rebalance once a year and ignore the media’s sirens. The added diversification of an international stock market index can also reduce volatility.
Table 6.3 shows some model portfolios for investors with different risk tolerances. As investors grow older, many prefer balanced or cautious models, increasing their bond allocations to increase their portfolios’ stability as they age. Note that I’ve included Vanguard’s Short-Term Bond Fund instead of Vanguard’s Total Bond Market Index. As I mentioned in Chapter 5, such a fund should beat inflation over any 3-year period, no matter what happens to interest rates or bond prices.
Table 6.3 US Global Couch Potato Model Portfolios: Vanguard Index Funds
Fund Name Fund Code
Conservative
Cautious
&n
bsp; Balanced
Assertive
Aggressive
Vanguard’s US Total Stock Market Index VTSMX
15%
25%
30%
40%
50%
Vanguard’s International Stock Market Index VGTSX
15%
20%
30%
35%
50%
Vanguard Short-Term Bond Index Fund VBISX
70%
55%
40%
25%
0%
Investors with defined benefit pensions or trust funds (lucky devils) can afford higher-risk portfolios. Long-term, higher-risk allocations should produce higher returns.
Many investors, however, don’t want to spend any time thinking about investing. They would prefer to have somebody manage their money for them. Fortunately, Americans can do this far more cheaply than anyone else in the world.
Read about how in the following chapter.
Indexing in Canada
TD e-Series Index Funds
In 2014, I wrote an article for The Globe and Mail titled “How Do TD’s Mutual Funds Stack Up Against Its Index Funds?”3 TD, like all of Canada’s banks, loves to promote their actively managed funds.
I compared all of TD’s actively managed funds with 10-year track records to the bank’s e-Series index fund counterparts. I made apples-to-apples comparisons. For example, I looked at all of TD’s actively managed Canadian stock market funds. I averaged their 10-year returns and compared them with TD’s e-Series Canadian index fund. I did the same thing with all of TD’s actively managed US and international stock market funds, comparing them with their index fund counterparts. The index funds won.