In my last post, I argued that virtually all long-term investors should have a significant allocation to bonds in their portfolio. That raises an obvious practical question: if you’re a Couch Potato investor, which bond index fund should you use?

Let’s begin by looking at the most widely followed fixed-income benchmark in Canada: the DEX Universe Bond Index. It consists of about 70% government issues (45% federal, 24% provincial and 1% municipal) and 30% corporate bonds. About half of the bonds in the index have maturities of five years or less, about a quarter mature within five to ten years, and another quarter extend past ten years. In short, this index has it all (with the notable exception of real-return bonds). If you’re looking for a single fund that covers the Canadian investment-grade bond market, look for one that tracks the DEX Universe.

Your bond fund choices

While there are a swath of fixed-income ETFs in Canada, only one follows this key benchmark, and that’s the aptly named iShares DEX Universe Bond Index Fund (XBB). Launched in 2000 (which makes it ancient by ETF standards), XBB has more than $1.6 billion in assets and an MER of just 0.33%.

The Claymore Advantaged Canadian Bond ETF (CAB) and BMO Aggregate Bond Index ETF (ZAG) track similar indexes and have low fees, but both are less than a year old and don’t have a track record or significant trading volume. I see no point in choosing them over the iShares incumbent.

As for index mutual funds that track the DEX Universe Bond Index, there are four to choose from:

How have they performed?

I waded through the Management Reports of Fund Performances for all of these funds to see how they have fared since 2001. The DEX Universe index is enormous and can’t be fully replicated: fund managers use representative sampling to try to match the index returns as best they can. I expected this to lead to some significant differences in performance, and it seems to have been a factor in few random instances. But over time the variation in returns is largely explained by the MERs:

It seems clear, then, that if you’re looking for a fund that comes closest to delivering the returns of the overall Canadian bond market, iShares’ XBB should be your first choice. By virtue of its low MER, it has consistently outperformed its more expensive peers.

If you’re looking for an index mutual fund rather than an ETF, the e-Series version of TD’s Canadian Bond Index Fund should top your list. The e-Series funds, however, are only available through a TD Mutual Funds account, or through TD Waterhouse. If you use another discount brokerage, consider the Investor Series version of this fund.

As overpriced as the CIBC and Scotia funds are, I can’t resist pointing out that both outperformed the average Canadian bond fund over the last 10 years, according to Morningstar. That’s not surprising, given that active management is useless in the efficient bond market, and that the average MER for Canadian bond funds is an absurdly high 1.70%.

As John Bogle says, when it comes to investing, you get what you don’t pay for.

Back on March 25, I wrote a post called The Bond Dilemma that described how nervous fixed-income investors were in early 2010. The Bank of Canada had strongly suggested that it would raise interest rates later in the year, and I was receiving a number of emails from people who said it was foolhardy to invest in bonds, which seemed almost guaranteed to lose money.

The year isn’t over yet, but once again the conventional market predictions seem to be wrong. We did get two small interest rate hikes this year, and yet bonds have been one of the best-performing asset classes so far in 2010. While stocks in developed markets are treading water, bond index funds are up over 5%. They’re the only reason balanced investors have had positive year-to-date returns, despite all the forecasts about how bonds were certain to get killed.

Bonds have a reputation for being boring, even a bit stodgy. Yet the performance of Canadian fixed income has been excellent for three decades. In the 1980s, steadily falling interest rates created a huge bull market for bonds. During the 1990s, when US stocks were shooting the lights out and getting all the attention, Canadian bonds averaged returns over 10%. Then, through the terrible 2000s, bonds gave investors annual returns around 6%, trailing Canadian equities by only 1% per year, and soundly thumping US and international stocks, which were negative for the decade.

Through it all, it sometimes seemed like bonds didn’t even show up on the radar. When things hit the fan in 2008, how many market commentators proclaimed asset allocation dead because “everything went down together”? They apparently didn’t notice that a conventional balanced portfolio — such as the Global Couch Potato — includes 40% bonds, and the DEX Universe Bond Index was up 6.4% in 2008. Government of Canada bonds topped 11% on the year. Investors with that traditional 40% bond allocation enjoyed a much softer landing: they would have lost about half as much as an all-equity portfolio.

Perhaps most importantly, bonds have delivered these solid returns with a fraction of the volatility of stocks. Since 1980, the broad Canadian bond market has had just two negative years: a loss of –4.3% in 1994, and an even milder –1.1% drop in 1999.

The message here is simple: bonds should be part of just about every portfolio. While it might be reasonable for a very young investor to allocate 100% to equities, I’m not convinced that’s the best strategy. The biggest obstacle in investing is human psychology: we all hate to lose money, and a novice who experiences big losses in an all-equity portfolio in her 20s may abandon the markets altogether. Indeed, that’s exactly what seems to be happening to young people who got shredded during the last decade. USA Today recently reported that found the investors most likely to avoid stocks today are Generation Y (aged 18 to 28) and Generation X (aged 29 to 45).

As an asset class, investment-grade bonds — especially government bonds — have the lowest correlation to equities, especially in Canada. (In the US, commodities also have historically had a low correlation with stocks, but that’s much less true in our resource-based market.) That means they offer a tremendous diversification benefit in a portfolio, smoothing out the volatility that causes so many investors anguish. Maybe someday they’ll get the respect they deserve.

Later this week, I’ll look at Canadian bond index funds, comparing their fees and performance over the past decade.

This will be my only post of the week, as I am currently on a family vacation in New York City. I spent today in the Financial District, approaching bankers and other well-dressed individuals on Wall Street and asking them if they had considered embracing a low-cost indexing strategy. Most ignored me. Some swore colourfully. My children were frightened.

During quieter moments, I’m rounding out my summer reading this week with John Bogle’s Enough: True Measures of Money, Business, and Life. Bogle, as long-time Couch Potatoes will know, is the founder of The Vanguard Group and the father of index investing. This book contains no practical advice for investors; rather, it’s a reflection on everything that has gone wrong in business and finance in recent years. In the world of investing, Bogle sums things up like this:

• Too much cost, not enough value
• Too much speculation, not enough investment
• Too much complexity, not enough simplicity

Amen to all three points. It’s hard to overstate the influence that Vanguard and Bogle himself have had on investing in the United States. Not only is Vanguard now the largest mutual fund company in the world, but the fact that investors have the option of choosing its funds, with their extraordinarily low costs, has changed the mutual fund landscape in that country. If a fund company tried to charge Canadian-style fees in the U.S., they would be run out of town by angry mobs with pitchforks. Rumours have floated around since last year that Vanguard may eventually come to Canada: that day can’t come soon enough.

One final note: Thanks to everyone who signed up to follow the blog on Twitter (@CdnCouchPotato). The winner of the Cutco potato masher is Tim, the blogger behind Canadian Dream: Free at 45.

See you next week. Until then, stay passive, my friends.

This week I beat a group of seniors and took $200 from them.

No, I’m not a purse-snatching hooligan who preys on the elderly. I’m just a guy who loves to play poker, and on Tuesday I took a day off to visit the local casino, where I played poker at a table with several amiable older gentlemen. The experience got me thinking about how poker and investing teach many of the same lessons:

Short-term results are meaningless. I’ve played poker alongside some truly bad players who always seem to hit miracle straights or flushes and scoop big pots. When these players beat you, it can make you wonder whether you should be playing differently — maybe you should start playing more hands, or calling big bets with weak draws, since it seems to be working so well for that guy. Investors fall into this same trap when they second-guess the Couch Potato strategy during every period of poor returns. In both poker and investing, you need to stick to a proven strategy: you will succeed in the long run, even if you have to suffer streaks of bad luck.

Play the percentages, not hunches. Succeeding at poker comes from understanding the odds. I often hear players say they “had a good feeling” about a certain hand, or that they’re “running good,” so they’re going to play a hand they otherwise would fold. This is nonsense. The odds of your pair of sevens beating my pair of kings are always one in five, regardless of whether you feel lucky. In the same way, if you invest based on hunches, intuition or forecasts, you’re likely to fare as well as the poker player with the long-shot hand. You might be one of the small number of active investors who beats the market, but most of the time you won’t.

Overconfidence will kill you. The casino table always includes a few 22-year-olds with backwards baseball caps who watch too much poker on TV. These guys are often good players, but they’re way too cocky. No matter how skilled they are, they can’t control what card the dealer will turn over next. I think of these players when I hear pundits making confident statements about why gold is going up, or the US dollar is going down, or why China is the place to invest. They may be experts in business and economics, but they have no ability to predict where the market is headed.

Success comes in spurts. I have had days when I lost for hours on end—then all of a sudden I drag three big pots and I have a pile of chips. Just as no poker player wins at a consistent rate, equity investors don’t earn slow, steady returns. Buy-and-hold investors will often go months of alternating small gains and small losses, only to enjoy sudden bursts of good returns — usually when they’re least expected. The reason market timing usually fails is that investors are often out of the market during the biggest days and weeks.

Emotional control is essential. It’s hard to endure a run of bad luck at cards, and lot of players simply can’t handle it. They get so frustrated that they start play badly, and they stop caring that they’re losing money. Poker players call this going on tilt. Emotional control is even more important in investing. No matter which strategy you use, success or failure usually comes down to whether you can hold on through the difficult months and years without losing your nerve.

The house always wins. You can have winning days and losing days at the poker table, but there’s  one certainty: the dealer always rakes a few dollars from every pot. If the house’s take is too steep, you may wind up losing money even when you win your share of pots. As all index investors know, even if your fund manager can beat the benchmark by 1% every year before costs (a rare feat, to be sure), he’s not adding value if he’s subtracting a 2% fee and leaving you with below-market returns.

Rob Carrick’s column in The Globe and Mail this Saturday looked at the three dividend ETFs listed on the TSX. Rob asked three bloggers to share their picks: Canadian Capitalist, Million Dollar Journey, and yours truly. I’d like to explain my choice in more detail.

Let’s begin with a review of the three ETFs in question:

Horizons AlphaPro Dividend (HAL) is an actively managed ETF that “invests primarily in equity securities of major North American companies with above average dividend yields.”

Claymore S&P/TSX Canadian Dividend (CDZ) tracks the S&P/TSX Canadian Dividend Aristocrats Index, which focuses on dividend growth. Companies in the index must have raised their dividends in each of the last five years.

iShares Dow Jones Canada Select Dividend (XDV) holds the 30 highest-yielding stocks, though it also screens candidates based on dividend growth and average payout ratio.

I don’t think active management will add value after costs, so that rules out HAL. This ETF currently holds about 10% in cash, reserves the right to hold preferred shares and bonds, and its commentary talks about waiting for the market to reach its targets before deploying that cash. This kind of forecasting is worthless, in my opinion, and doesn’t justify the higher management fee (it’s the most expensive of the three at 0.70%), the inevitably higher turnover, and the perpetual cash drag.

Why not hold two dividend ETFs?

That means the decision comes down to the Claymore and iShares ETFs. My fellow bloggers both chose Claymore’s fund, but I suggested that investors consider splitting their investment between CDZ and XDV. This isn’t because I’m being wishy-washy — it’s because they actually have very different holdings.

Of the 30 stocks in XDV, Claymore’s ETF holds 16 of them, which seems like a lot of overlap at first glance. But the duplication is largely in stocks that make up a small part of each fund. When you look at the top holdings, some big differences emerge.

The iShares ETF is very heavy in banks: overall it’s 60% financials, including 33% in the Big Six banks, which are all in the top eight holdings. That’s a very large concentration in one sector.

Claymore’s ETF holds a more diversified portfolio of 56 stocks, with a much higher weighting in the energy and consumer sectors. While more than a third of its holdings are classified as financials, many are real estate investment trusts (REITs) and income trusts. Banks are a negligble part of CDZ: Scotiabank and TD are the only Big Six names, and together they make up a mere 4% of the fund.

The main reason for this discrepancy is that most banks — despite their high current yields — have not raised their payouts over the last five years and therefore aren’t eligible for the Aristocrats index. While dividend growth is important, does it really make sense for a Canadian income investor to avoid the banks for several more years because they didn’t raise their dividends during the worst financial crisis of our lifetime? If you were assembling a portfolio of dividend payers today, would you ignore the yields of CIBC (5%) and BMO (4.8%) simply because they haven’t raised their dividends every year since 2005?

In my opinion, both of these ETFs have their problems, but they mesh together nicely. The table below shows their average sector weightings. If you held a 50-50 mix, you’d have a nicely diversified dividend portfolio:

One important note: several of CDZ’s top holdings are income trusts. When the new rules take effect next year, the Aristocrats index will boot out any income trust that doesn’t raise its distribution after converting to a corporation. That will change its top holdings considerably, though it won’t change the fact the ETF has very little bank exposure. It will likely just raise the percentage of REITs, utilities and telecoms in the fund. The index is reconstituted every December.

Canadian Couch Potato has finally joined the Twitter universe!

I’d like to encourage readers to add this blog to their Twitter list, and to tweet any individual posts they find interesting. Of course, I wouldn’t ask you to do that for nothing, so I’m offering a little incentive. At the end of this week, I’ll draw a name from all of those who helped spread the word and I’ll send one lucky Couch Potato a potato masher from Cutco!

This is no cheap utensil from the dollar store: it’s a restaurant-quality, masterfully engineered  product that retails for $53. It’s highly diversified — it works on potatoes, squash, pumpkin pie filling, even guacamole. The ergonomically designed handle makes it easy to buy and hold. Best of all, there’s no MER and no deferred sales charge.

Here’s how to be entered into the draw for the potato masher:

• Follow me on Twitter by clicking the link in the sidebar at right. Every new follower will receive three (3) entries in the draw.

• Tweet any past or current article to your followers by clicking the “tweet” icon at the top right of each post. Every article you tweet gets you one (1) entry in the draw.

• Blog readers who started following @CdnCouchPotato before this contest was announced, or who have already tweeted individual articles, will be automatically entered into the draw. We treat old friends just like new friends.

Contest ends at midnight on Thursday, August 26. I’ll randomly choose the winner on Friday. Good luck, and thanks for tweeting. [Update: Congratulations to Tim, the blogger behind Canadian Dream: Free at 45, who was the winner of the draw.]

One more note: Readers of The Globe and Mail will be familiar with the “Me and My Money” column, which briefly profiles individuals and their investment strategies. I revealed the secrets of my own portfolio in this column last year. The paper is looking for subjects for future columns. If you’re interested in sharing your story, please contact Tony Martin.

In a recent post, I shared a reader’s story about how difficult it was for her to open a TD e-Series Mutual Funds account. That elicited responses from dozens of readers who had similarly unpleasant experiences, as well as several who weren’t sure what all the fuss was about.

I contacted TD about the issue and received a response from Maria Leung of Corporate and Public Affairs, TD Bank Financial Group. Her explanations should help clear up some of the confusion surrounding these otherwise excellent index funds.

Many people who commented on the original post said they tried to open an e-Series account at a TD branch, only to encounter staff who had little or no idea what the e-Series funds were. So my first question was about that unfamiliarity:

While TD Mutual Funds offers a broad range of investment solutions, not all are actively promoted in each of our distribution channels. For our TD e-Series Funds, customers purchase the funds online, either through TD Canada Trust’s EasyWeb site, or if they are TD Waterhouse Discount Brokerage customers, online using WebBroker (Discount Brokerage accounts can be opened at any TD Canada Trust bank branch or TD Waterhouse Investor Centre across the country). The efficiencies of purchasing the funds online, combined with the low management fees of index funds allows us to pass the savings on to our customers in the form of lower MERs.

Bottom line for investors, then, is simply to avoid visiting a TD branch if you want to open a TD e-Series Mutual Funds (EasyWeb) account. Instead, go straight to the online application page. If you prefer to purchase the e-Series funds through a TD Waterhouse account, then you can do that either online or at a branch.

It’s entirely reasonable for TD to require customers to open an e-Series account online, but I would maintain that there’s no good reason why branch employees should be unaware of their existence. It would be a simple matter to train staff to say, “Sorry, we don’t do that at the branch, but here’s a brochure with a link to website where you’ll find the application.”

The risk-tolerance questionnaire

My next question was why it is necessary to fill out a rather lengthy risk-tolerance questionnaire when buying -Series funds through a TD Mutual Funds account, but not if you’re buying the same funds through TD Waterhouse.

Customers who prefer not to work with advisors, but decide to purchase the funds online on TD Canada Trust EasyWeb are required to complete a thorough application process for a few different reasons:

When opening an account on TD Canada Trust EasyWeb, customers are in fact opening a mutual funds account with TD Investment Services Inc., the mutual fund dealer affiliate of TD Canada Trust.  Each Canadian bank has a mutual fund dealer affiliate that offers mutual fund products to Canadian customers.  The Mutual Fund Dealers Association of Canada’s (MFDA) rules require mutual fund dealers, including TD Investment Services Inc. to use due diligence to ensure that each order accepted or recommendation made for any client’s account is suitable for the client and in keeping with their investment objectives.

In addition, complete know-your-client (KYC) information is required when opening an account and before trading on behalf of clients. This process is consistent for all investment accounts opened with TD Investment Services Inc.  The MFDA rules apply to all mutual fund dealers that are affiliated with Canadian banks, so a similar account opening process is in place amongst these types of financial services firms across Canada.  The MFDA Rules however, do not apply to dealers that allow customers to purchase stocks, such as in a discount brokerage platform.

Customers who choose self-directed relationships and who hold an account with suitability-exempt discount brokers, including TD Waterhouse Discount Brokerage, are not required to complete a suitability questionnaire.  In these types of accounts, the investor is responsible to ensure their investment decisions are consistent with their investment objectives and risk tolerances.

So there you go. That’s the reason for the risk tolerance  questionnaire. If this part of the process seems daunting, remember that you can always adjust your asset allocation later, once the account is up and running.

Many thanks to Maria Leung at TD for providing clear and complete answers.

Earlier this week I argued that savings accounts and GICs are still the best vehicles for short-term savings, because higher yield comes with higher risk. I thought that was an obvious point, but it seems that even the venerable Kiplinger’s Personal Finance has forgotten this basic truth of investing.

The September 2010 issue of the popular magazine features a cover story called 10 Great Mutual Funds That Deliver High Income, by senior editor Bob Frick. The article itself makes no outrageous claims, but in a podcast interview about the piece (available at iTunes), Frick takes a journey into Fantasy Land. After lamenting the low yields of US Treasuries, and the likelihood that they will fall in value in the near future, Frick recommends a Fidelity fund that invests in emerging market bonds. “You just cannot ignore a fund that is going to pay you 12%,” he says gleefully. Going to pay? The fund in question has posted excellent returns in the past, but no bond fund is going to pay any guaranteed return. For all Frick or anyone else knows, the fund might lose 12% or more next year.

Maybe that was a slip of the tongue, I thought. But then he kept up this nonsense. “When you look what’s in it, you see it’s got the sovereign debt of Russia, Argentina, Mexico, Indonesia, and you think, ‘That can’t be so hot.’ But it also has Brazil and some other developing countries. The thing that people don’t realize is that these countries often have more fiscal discipline than the US, the UK and Western Europe. So they pay their bonds off, and they pay them off on time… Maybe if you just invested in Russia or Indonesia it would be dangerous, but it’s spread over all these different countries, so you’ve got this great diversification, and you’ve got this income that rivals the return of the stock market. And it’s more dependable. It’s like having your cake and eating it, too!”

OK, let’s get this straight. The senior editor of Kiplinger’s Personal Finance believes it’s a given that emerging-market countries “pay their bonds on time.” And therefore he believes that investors in this fund can expect a yield that rivals the return of the stock market with less risk. Perhaps he’s also built a perpetual motion machine or achieved cold fusion, too.

I’m not going to defend the fiscal policies of the US, but I think it’s fair to say that if I buy a US Treasury note, I’m going to get my interest payments, and I’m going to get my principal back. Frick magnanimously concedes this point in the interview when he says, “they’re still the safest investment in the world, blah blah, blah.” That’s a direct quote, by the way.

How can Frick so casually brush aside the differing risks of emerging-market bonds and US Treasuries? Several of the countries he names have defaulted on their sovereign debt in the past, and they may well do so again. That’s why they yield more. And when one country has a financial crisis, investors worry that its neighbors will follow, and their bonds can lose value, too. So diversification does not necessarily offer any protection. Witness the Latin American debt crisis that peaked in the early 1980s, the Asian contagion of 1997, the Russian default of 1998, the Argentine economic crisis  of 1999–2002. This is hardly ancient history.

Emerging market debt may well be a good investment, but its potential returns are commensurate with the risks. When Frick says it’s “having your cake and eating it, too,” he’s implying that the added yield is free. That is irresponsible journalism and terrible investment advice.

Blah, blah, blah.

I occasionally hear from readers who want to know which ETF or index fund portfolio would be a suitable place to stash their short-term savings. Inevitably I disappoint them with my reply: “Short-term savings belong in a high-interest savings account or GICs.”

With even ING Direct and Ally paying just 1.5% to 2% in savings accounts these days, it’s tempting to look at an ETF of real-estate investment trusts (REITs), preferred shares or high-yield bonds and try to pull down 5% to 7%, or more. It’s also a terrible idea for short-term investors.

The Couch Potato strategy works over the long-term because it dramatically reduces fees and provides broad diversification. However—and this is a critical but often misunderstood point—an index strategy offers absolutely no protection from falling markets. Indeed, it may offer less protection, since actively managed funds have the option to move into cash when markets are volatile. Index funds are as fully exposed to the market as a streaker on the TSX trading floor. That’s why index portfolios are not appropriate for people who want to protect their capital for a couple of years as they save for a house, or a vacation, or their child’s education.

Using diversified ETFs and index funds can eliminate the risk that any single security will torpedo your portfolio. Buying a fund of REITs, preferred shares or high-yield bonds is certainly less risky than trying to pick two or three individual winners. But your fund can hold hundreds, even thousands of individual names and still plummet in a market downturn. There’s only way to eliminate market risk, and that is to get out of the market.

Imagine that you were saving for a down payment, or for your 14-year-old’s university education, in early 2007. One-year GICs were paying well over 4%, but you wanted more. So you put your savings in the iShares S&P/TSX Capped REIT Index Fund (XRE) in February 2007, attracted by its generous yield. Well, you would have watched it fall more than 60% in two years.

Had you invested in the Claymore S&P/TSX Canadian Preferred Share ETF (CPD) or the iShares iBoxx High-Yield Corporate Bond ETF (HGY) around the same time, you’d still be down over 16% after more than three years. Dividends and interest would have reduced these losses, but only if you somehow managed not to panic and sell in 2008 or early 2009. Either way, your plans for buying a house or paying for your daughter’s university would have been wrecked.

In general, if you need your money in less than five years, none of it should be in stocks, and that includes equity index funds and ETFs. With interest rates at record lows, it’s possible that even a bond a fund could lose money over a period of a couple of years. Meanwhile, a five-year GIC from Ally today will earn you 3.75% with zero chance of losing your principal. If you prefer, a five-year GIC ladder will earn you about 3% this year and give you an opportunity to take advantage of rising rates in the future.

In a period of 1% inflation, that’s not bad for a guaranteed investment. And like or not, that is the price of safety.

Note: My earlier post about doomsayer Paul Farrell is featured in this week’s Carnival of Personal Finance by Live Real, Now. “End-of-the-world predictions are always fun,” says the site’s author. “I mitigate that risk by investing heavily in precious metals: primarily brass and lead.” Nice!

In Monday’s post, I had some fun at the expense of Paul Farrell, the MarketWatch columnist who champions index investing while at the same time forecasting the coming apocalypse. What got lost in the discussion was that Farrell’s Lazy Portfolios are actually worth a look. They’re all built with an eye toward rock-bottom cost and broad diversification.

There are loads of other model portfolios out there, too. The Oblivious Investor, a US blog that advocates indexing, lists 8 Lazy ETF Portfolios of its own. (Some are the same as Farrell’s.) The site’s creator, author Mike Piper, also includes links to the original sources of these portfolios, many of which include historical returns. Or you can shuffle over to Asset Builder, an advisory firm run by Scott Burns, creator of the original Couch Potato. His site is also packed with model portfolios.

The problem for Canadians is that all of these portfolios are designed for Americans. They typically include about two-thirds of the equity allocation—and all of the fixed income—in US funds. The good news is that adapting them for Canadian investors is quite easy. To show you how, let’s use an example. This is the Coffeehouse Portfolio, created by Bill Schultheis:

Step 1: The bonds

Holding your fixed-income investments in a foreign currency is almost always a bad idea. (A small allocation to US or global bonds is fine, but the currency should be hedged.) So the first step is to replace the Vanguard bond fund with a similar broad-based Canadian bond ETF. iShares DEX Universe Bond (XBB) will do the trick nicely.

Step 2: The real estate

The 10% allocated to REITs is also easy enough to Canadianize. You can simply swap the Vanguard fund with iShares S&P/TSX Capped REIT (XRE), or BMO Equal Weight REIT (ZRE).

If you have a large portfolio and don’t mind a little added complexity, you could add a foreign REIT component. You might put half in the iShares or BMO fund, and the other half in the Vanguard REIT fund or in Claymore Global Real Estate (CGR).

Step 3: The equities

The Coffeehouse Portfolio is half equities: 40% in US stocks and 10% in a global equity fund that includes all developed and emerging markets outside the US. This doesn’t make much sense for Canadians, especially in a taxable account, where you’d be subject to withholding tax and would not be eligible for the dividend tax credit.

There’s no hard and fast rule about how much of your equity allocation should be in Canada, but approximately one-third is reasonable. So we could go with something like 15% Canadian, 15% US, and 20% to the rest of the world.

The Coffeehouse Portfolio gives added weight to small-cap and value stocks, which isn’t as easy to do in Canada. Slicing and dicing Canada’s small market into three or four ETFs is also unnecessarily complicated. To keep things simple, we could put 10% in Claymore Canadian Fundamental (CRQ), since this large-cap ETF has a value bias. Or if you just want large caps at the lowest cost, you can’t go wrong with iShares S&P/TSX 60 (XIU). We can round things off with 5% to iShares S&P/TSX Small Cap (XCS).

US-listed ETFs are impossible to beat for low cost and minimal tracking error, and they’ll do just fine for the US and international components. IVV is great for the S&P 500, but the Vanguard Total Stock Market (VTI) is probably even better, as it covers the entire US market.

Finally, the Vanguard All-World Ex-U.S. ETF that Schultheis recommends includes Canada, which would be redundant in our version. It’s cheaper and neater to split the international component of our portfolio, putting 15% in Vanguard’s Europe Pacific (VEA) and 5% in Vanguard’s Emerging Markets (VWO).

Step 4: Putting it all together

Now it’s time to assemble our Canuck version of the Coffeehouse Portfolio:

In honour of everyone’s favourite Canadian coffeehouse, let’s call this the Tim Horton’s Portfolio. Make mine a double-double.