The Calm Seas portfolio is aimed at people with a investing range of about 10-15 years or that are very sensitive to market movements. We are going to be more conservative by buying more bonds and no emerging markets (countries like China, Russia, Brazil) or REIT (Real Estate Investment Trusts). Let’s say that the goal is to save for a down payment on a cottage (in 15 years).
The goal is the cottage itself but more precisely the down payment. In accordance to that, we don’t want to lose too much money but we still want a bit of growth during that 15 years. This, at low MER (Management Expense Ratio). That’s why I decided to use ETFs since ETFs have certainly a lower MER than the mutual funds. Here is what I suggest for an initial investment of 30 000 $ with subsequent additions of 300 $ monthly:
Let’s have a look at the fact sheet of every ETF in this portfolio to make sure it corresponds to our needs. I don’t want it too aggressive so I will be checking particularly for:
- Geographic exposure – I want developed countries in there because they tend to be less volatile.
- Bias towards larger capitalization – since they are bigger companies, they tend to fluctuate less, in other words, they move slower.
- Fixed income (or bonds if you prefer) – they move in a slower pattern normally (depends on the type) and that’s what we want, less volatility because of our time frame.
- Goal that aligns with this portfolio in terms of reduced risk but still have a growth part.
- No specific consideration for taxes since we’re going to keep it in a TFSA.
Here is my estimate on the returns for this portfolio after inflation.
I think 3.5% is about right since bonds might return around 2% after inflation and stocks will be more around 4-6% if we refer to past performance (which is to be taken lightly). Please see below for more information on each portfolio. I am trying to keep a conservative point of view on my numbers.
Note: my estimate takes into account 3600 $ deposited in your TFSA per year, you have to make sure you don’t over-contribute or you will have to pay penalties.
Here are the links to the fact sheets of the portfolios.
VAB – Vanguard Canadian Aggregate Bonds – MER 0.13%
VBU – Vanguard US Aggregate Bonds – MER 0.22%
VCN – Vanguard Canadian All Caps Equity – MER 0.06%
XAW – iShares All Country World Except Canada – MER 0.22%
Canadian aggregate bonds ETF. It is low cost (management expense ratio: 0.13%) and moves slower than the stocks which should temper the fluctuations of the stock market in case everything goes south. It’s still a down payment and I think you need to keep part of the liquidity in safer places.
You don’t need to point out the bad performance compared to stocks, but that’s not why we’re putting bonds in this portfolio. We’re really looking to reduce the volatility because of the shorter term, and bonds can do just that! Also, since we’re in a TFSA, we don’t have to take income tax on bonds into account.
I just want to warn you that it’s not because they are bonds that they are necessarily safer, risky bonds do exist, especially when longer term.
Here is a better look at the details of the fund holdings.
Most of the bonds in this fund have a good credit rating of AAA and AA, which is reassuring to keep this 25% in better shape. Something else I notice is that most of the securities included in this ETF mature in 1 to 5 years which means that they are likely safer as stated above.
Similar to VAB but for US and probably more volatile. Still low management expense ratio of 0.22%.
This graph doesn’t tell us much since we don’t have enough data of past performance. We can either go directly to the Bloomberg index which is the index that’s followed by VBU or we could have a look at the portfolio data tab!
My interpretation is that, since most securities will come to maturity in 5-10 years, it should be a modestly safe choice of ETF. Compared to VAB, this one seems a bit more risky to me because we have fewer AAA (great), a bit more AA(good), As (meh…) and Baas (would not recommend). On the other hand, it contains plenty of bonds from the U.S. government, which makes it safer. See Wikipedia for more information on bond credit rating. It’s all about managing risk and reducing the volatility of our portfolio.
Following the addition of VBU, we now have all north America in the bond side of our portfolio. Diversification, that’s how you call it!
Another great product from Vanguard that comprise all the Canadian market. It should give some speed to our portfolio and is really cheap (MER: 0.06%). Containing the whole market will reduce volatility compared to just buying individual stocks. I will confess that it won’t have much impact on a market crash but it’s still better than owning just a set of stock for us, humans. Patience and time is the most precious asset when investing.
Since the fund was created, it returned 8.70%, but let’s look at the benchmark it follows: 7.82% over 5 years. That should give us a rough idea of how it might perform. Then we can add it to our equation.
Mostly developed countries except for Canada which is what I wanted to start with because VCN is taking care of that part. Something that isn’t too prone to crash like crazy and that will keep the investment high enough to help the down payment grow a bit while you’re saving for 15 years.
What I like about XAW is that it gives easy exposure to everywhere except Canada, this will save a bit of money when rebalancing because we only have 4 parts to our pie. Four parts times 10$ = 40$ per year for rebalancing, not bad! On the other side, I agree that it removes control over the distribution (we don’t have much control on how XAW is distributed inside) but are we looking for simplicity here or not?! Also, emerging markets, yes I said that I would try to not include them in this portfolio but the exposure is not that much (around 11.45%), I hope you can pardon me!
If you really don’t what emerging markets, I suggest replacing XAW with a combination of VUN/XEF which are focused on developed countries only.
I want to focus your attention on the sectors as well because some sectors tend to be more volatile than others.
Financials is normally ok, information technology and cusomer discretionary can be more volatile. Logically, the top things people let go when it`s time to save money, but also what they spend the most when money is good. Non-discretionary are products that people buy continuously like toothpaste or deodorant, so they tend to hold themselves a bit better. To summarize, sectors are something else to look at when managing the volatility of a portfolio, in this case, I’ve got plenty enough bonds to live with it!
Here is the final result after I bought the shares. As you can see it’s not perfect when you buy it but you simply have to be as close as possible.
- VAB 290 shares at 25.84$ – 7500$
- VBU 301 shares at 24.83$ – 7500$
- VCN 190 shares at 31.55$ – 6000$
- XAW 369 shares at 24.40$ – 9000$
Then I made a graph with the date. This is how I keep track of the pie chart, normally I will recreate it every two months or so, but in our case I will do it only every six months.
Calm Seas is a 50/50 portfolio with 50% bonds and 50% stocks. I could have gone with safer bonds but I consider the investing horizon long enough to take a bit more risk. A four parts portfolio will also be easy to rebalance and to understand. The combination of world-wide diversified equity and fixed income funds from iShares (Blackrock) and Vanguard should do a good job at making sure our money will grow while staying in one piece for 15 years.
It goes without saying that nothing is exempt of risk when investing. We must manage it and make sure we take enough but not too much depending on the objective. Finally, I am pretty sure we align correctly with our goal and volatility target, we will see how it turns out in a couple of years.