Vanguard Canada's Asset Allocation Funds
There is new product from Vanguard Canada that is worthy of inspection. The products are Asset Allocation funds and can be found here. Each product is a full portfolio with equity and safety diversification and ample diversification within each asset class.
Let’s look at the VEQT for a description. VEQT is a fund of fund and is 100% equity or growth. The others have fixed income or safety components. They all can be view as one-stop complete portfolios. The choice of portfolio depends on the degree of safety desired.
VEQT wraps the US Total Market Index ETF, the Canada All Cap Index ETF, the FTSE Developed All Cap ex North America Index ETF, and the FTSE Emerging Market All Cap Index ETF into one product. The target weights are 40%, 30%, 23%, and 7% respectively. Rebalancing among the four funds is done automatically without additional charge. This is a fully diversified growth portfolio for Canadian investors. 30% invested in Canada is a significant overweighting of the Canadian market but home bias is rational.
The MER is capped at 25 basis points. If you bought the four components individually in the same weights, the portfolio MER would be 5 basis points. What do you get for an additional 20 basis point annual cost? You get the convenience of four products being wrapped into one. You can buy all four products with one brokerage transaction fee. And, you get automatic rebalancing. Both features have value and the degree of value depends on you.
Building the portfolio yourself requires more brokerage transactions and therefore greater brokerage transaction cost. Four buy transactions versus one buy transaction with VEQT. Assume a transaction cost of $13.C per transaction, the fund of funds would cost $13 to purchase. Building it yourself would cost 4 x $13 = $52. You would have to rebalance the built portfolio. Let’s say that averages to two transactions
per year so $26 per year.
You can see that building the portfolio yourself makes greater sense as portfolio values grow. At a portfolio value of $30,000, the brokerage transaction cost would approximate 17 basis points. Add that to the 5 basis point MER cost and you get close to 25 basis points. A strong case can be made for the fund of funds ETF below approximately $30,000. On an ongoing basis, let’s assume two rebalancing transactions per year. That is $26 per year or 8 basis points per year on a $30,000 portfolio. MER plus 8 basis points is 13 total basis points per year. That is approximately half the cost of the fund of funds.
A smaller issue is non-US-resident withholding tax on dividends from US companies. The US charges 15% withholding tax on dividends to Canadian investors (sign your W8-BEN form or else the withholding is 30%. Your online brokerage service will prompt you to sign). The 15% withholding tax is waived for RRSP and derivative accounts including RRIF accounts. It is not waived for other accounts including the TFSA. However, for Canadian product that holds US investments, the US government does not differentiate account type and withholds 15%. This is not recoverable in an RRSP account. Should you hold a US product, such as VTI, in your RRSP, the treaty stipulates that 15% will not be withheld. If you hold the Canadian version of the VTI, the VUN, the 15% will be withheld and it is unrecoverable.
The 15% withholding tax is unrecoverable in all other accounts except for the non-registered account regardless of whether you hold the Canadian or US version of ETFs investing in US underlying.
The 15% is recoverable in a non-registered account in the sense that the 15% will reduce what you owe to the Canadian government due to the US dividend. For example, on 100 shares of VTI, the March 28, 2019 dividend of $.772 per share results in $77.20 – 15% x $65.62 = $65.62US entering a Canadian investor’s brokerage account (ignoring conversion). The US government withheld $11.58. Am I out $11.58? No. Because I owe the Canadian government tax on this transaction and it depends on my marginal tax rate. At 24.15% MTR for example, I owe $18.64. I get credit for the $11.58 and pay the Canadian government $7.06US after I convert it to Canadian dollars.
To sum up, Vanguard Canada Asset Allocation products are interesting. Using VEQT as the example, you pay 20 basis points more in MER compared to building it yourself, but you get convenience and fewer brokerage transactions and therefore lower brokerage costs. On portfolios (per account) over $30,000ish or higher the lower MER from building it yourself overwhelms the cost savings on fewer brokerage transactions. Only you can determine the value of convenience. One thing is certain. Vanguard’s asset allocation funds at a cost of 25 basis points is more than 5 times less expensive than comparable actively managed funds with the same allocation.