In my blog post It’s RRSP season and managed portfolio traps abound, I said that in a future post, I would explain how to do your own breakdown of a recommended portfolio and build your own DIY portfolio of individual mutual funds that are even less expensive than a balanced index fund. This is that post. Be warned – there is a bit of math to follow in this breakdown. But it’s simple math – nothing more complicated than multiplying, dividing and adding. I haven’t done calculus in a very long time and you certainly don’t need anything like that here.
if you aren’t willing to do the work to make sure your portfolio remains in its allocated proportions, then it may well be worth paying the extra 1% to have the bank’s fund managers do it for you.
Going back to my original example, the CIBC Managed Balanced Porfolio, a quick look at the portfolio’s fund facts and can find the distribution of its underlying holdings, which is pretty simple. It’s basically 35% Canadian bonds, 30% international equity, 19% U.S. equity, and 16% Canadian equity. Which makes its geographic distribution 51% Canada (always a good idea for Canadians), 30% international and 19% U.S. Remember, the overall fund expenses for the CIBC Managed Balanced Portfolio total 2.32%. Which means you are paying $23.20 per $1000 invested every single year for the privilege of owning this mutual fund.
Luckily for us, CIBC also has an extensive series of index funds that we can use to replicate this portfolio. In fact, CIBC very conveniently lists its mutual funds according to three categories: Savings, Income and Growth but then breaks each of those categories down further with managed mutual funds and index funds, which are best used in a passive investing scheme. There are many mathematical and theoretical reasons why passive investing outperforms active management investing in all but a very few cases, which can best be summed up as “no one can predict where the market is going and since it’s a zero-sum game you have the same odds of your active manager underperforming the market as outperforming it.”
Looking at the index bond funds, we see there are two Canadian versions – the Canadian Bond Index Fund and the Canadian Short Term Bond Index Fund. Keeping things simple and to further diversify even our bond holdings, let’s say we put 17.5% of our portfolio into each one, giving us our 35% in Canadian bonds. How does that look cost-wise? The Canadian Bond Index Fund details show the cost for this fund to be 1.16%. Since it’s going to comprise 17.5% percent of our portfolio, that gives it a weighted expense of 0.203 (cost * percent of portfolio/100). The Canadian Short Term Bond Index Fund details show the cost for this fund to be 1.08%. Doing the math again, that gives it a weighted expense of 0.189. Makes sense, it should be slightly less than the Canadian Bond Index Fund.
Now how do we replicate the equity portion of the managed portfolio? Again, we go to the CIBC list of growth funds, and check out their index fund offerings. Our first goal is to find one that will cover our 30% international equity holding. Happily, CIBC has a single mutual fund that fits our criteria, the CIBC International Index Fund. The International Index Fund details show the cost for this fund to be 1.27%. Since it’s going to make up a significant 30% percent of our portfolio that gives it a weighted expense of 0.381.
The U.S. portion of the portfolio can likewise be covered by a single index fund – the CIBC U.S. Index Fund, which it describes as the core U.S. equity component and a fund that will give returns similar to those of the S&P 500. A fund that will behave like the entire 500 stock universe of the S&P 500 – yes, that’s what we’re aiming for. The U.S. Index Fund details show the cost for this fund to be 1.19%, and since it will make up 19% of the portfolio, the weighted expense for this portion is 0.226.
Finally, we need to represent the 16% Canadian equity in our portfolio. And again, the bank has an entirely straightforward Canadian Index Fund, which is representative of the performance of the S&P/TSX Composite Index. The entire TSX. That’s diversified. The Canadian Index Fund details show the cost for this fund to be 1.14%, and since it will make up 16% of the portfolio, the weighted expense for this portion is 0.182.
The most basic of the math activities now takes place: adding up all the weighted expenses for the various portions of the portfolio. The bond, or fixed income portion, is 0.203 plus 0.189 for a total of 0.392%, which equates to $3.92 per $1000 invested. That’s a pretty reasonable fee for management of fixed income products.
The equity portions of the portfolio will cost you 0.381 for the international elements, 0.226 for the U.S. elements and 0.182 for the Canadian elements. Total equity expenses: 0.789%, or $7.89 per $1000 invested. Again, it’s reasonable that it’s about double the cost for management of the equity portion of the portfolio.
Total expenses for the combined bond and equity portions of your portfolio: 1.181%, or $11.81 per $1000 invested each year. That’s a far cry from the managed portfolio expense of 2.32%, in fact it’s about half the cost. So what you say? How does a saving of 1.1% per year really make a difference? Many people have done much more complicated math than what I’ve shown you here to answer that question. If you want to download a spreadsheet to do your own calculations on this, there’s a great article on the impact of mutual fund costs over time. That same article also makes a great point though – if you don’t want to manage your portfolio yourself, if you aren’t willing to do the work to make sure your portfolio remains in its allocated proportions, then it may well be worth paying the extra 1% to have the bank’s fund managers do it for you. Just make sure you understand the actual impact of mutual fund fees on your portfolio over time. It may shock you.