Financial Literacy Courses – A Bad Idea?

In an interview on CBC The 180,  Daniel Munro, Associate Director, Public Policy at The Conference Board of Canada, and an ethics lecturer at the University of Ottawa, asks the question: Do mandated high school financial literacy courses do more harm than good? I urge you to listen to the podcast of the entire episode, and read the piece he wrote for Macleans on the same topic, but essentially he bases his argument on three points.

1. As usually structured, such courses give an incorrect view that making good financial choices is all that is important (neglecting circumstances). 
2. The evidence suggests that the positive impact of mandatory financial literacy courses is short lived.
3. There may be misplaced over-confidence from taking a single financial literacy course, actually contributing to bad financial choices made later in life.

In March I argued that we need more financial literacy, and I stand by that assertion. I am glad to see that in various parts of Canada there are new initiatives to support enhanced financial literacy.

However, I think that Daniel Munro's interview is a wake up call to make sure that we have the right sort of financial literacy education. Also, we must do the research to make sure that financial literacy courses are actually contributing to improved long term outcomes.  Let us look at the three points from the Daniel Munro interview.

(1)  He argues that courses, at least as currently formulated in the grade 10 course about to become mandatory in Ontario, place too much emphasis on just one element of financial decisions, making good choices.  While clearly good choices matter, he argues that this emphasis in the absence of a consideration of circumstances, is at best incomplete.  Circumstances of many types, including family circumstances and obligations, costs of living in your region, educational opportunities, natural abilities, and much more, all contribute to the right financial decision in a situation. In his Macleans piece Daniel Munro states the case clearly and powerfully as follows:

"...fairness and responsibility argue that while people ought to be responsible for what results from their choices, they should not be responsible for what results from circumstances that are beyond their control..."

(2)   With respect to the long term impact of mandated financial literacy courses, he points out in the Macleans piece that research evidence supports the idea that financial literacy course impact is limited.  He mentions a meta analysis of 168 research papers covering more than 200 studies on effectiveness of financial literacy courses.   While I have not read that analysis in detail, I am familiar with this report by Shawn Cole, Anna Paulson, and Gauri Kartini Shastry that looked at the effectiveness of mandated financial literacy courses in the US, where in some states there is a history of sufficient length to study such effects. The report is a white paper of the Harvard Business School, and is entitled High School Curriculum and Financial Outcomes: The Impact of Mandated Personal Finance and Mathematics Courses. I quote from part of the abstract of the paper that gives a clear indication of the results:

"Financial literacy and cognitive capabilities are convincingly linked to the quality of financial decision-making. Yet, there is little evidence that education intended to improve financial decision-making is successful...this paper answers the question 'Can good financial behavior be taught in high school?' It can, though not via traditional personal finance courses, which we find have no effect on financial outcomes."

Interestingly, the paper goes on to show that more mathematics education can lead to enhanced long term improvements in financial decision making and investment participation.

(3)   We all know that over-confidence can be dangerous, and this certainly applies to financial decision making.  Daniel Munro cites a 2014 study by Marc Kramer that found that

"...confidence in ones‘ own (financial) literacy is negatively associated with asking for help, while actual expertise does not relate to advice-seeking"

While I firmly believe that finance and investment education is a positive, his remarks remind us that part of that education must be a clear understanding of the limitations of understanding, and the value of seeking advice.  As mentioned in my previous post,  I prefer a spiral approach to financial education, starting in elementary school and extending throughout life.

I believe that mathematics education has a longer impact than financial literacy courses due to two factors.  Mathematics education tends to be taught in a very active learning mode: most mathematics educators realize that you learn math by doing math (including discovering some relationships on your own), not by having it explained to you.  There is an important lesson here for financial literacy teachers.

The second reason is that mathematics education emphasizes concepts and techniques with broad application, and through those applications it keeps getting used regularly. I think that a similar approach is necessary for successful financial literacy courses, and "one of" financial literacy efforts will be doomed to failure.

I have been working for some time on a future post that will present my ideas for a different kind of university based financial education course.  That will stress active learning, quantitative reasoning, and the link between financial decisions and positive public policy. Sign up to follow this blog and you will receive each new post directly to your email, complete with all hyperlinks (and no advertisements!).

I would love to hear your opinions, either through the comment section or through an exchange on Twitter.

 The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice.  While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Added note: I have added material to the original posting based on his Macleans article, and the linked studies therein, that I did not know about at the time of the original posting.

International Equity ETFs

Your diversified ETF portfolio should include at least Canadian, US and International equities and a mix of corporate and government bonds (I also argue that it should be further diversified, with some exposure to REITs and perhaps other investment classes - read details here). As part of the series on how to build up a basic well diversified portfolio, we now look at international ETFs available on the TSX.

Global vs International

When I started out investing, I was confused by some funds calling themselves global and others international, since in everyday use those words mean the same thing.  Investopedia differentiate global and international as investing terms. Essentially global includes all countries, while international funds exclude your own country. However, the situation is confused when the perspective is from Canada, and international funds generally mean funds outside North America.  Confused?  We agree it is confusing!  We are going to lump both global and international funds in this posting.

Narrow the Choices

As we have done in the other categories (see Canadian equities, US equities, broad Canadian bonds), we have narrowed the choices, showing some broadly held good international or global ETFs available on the Canadian market below. In narrowing our choices we looked for widely held, low cost, broadly international products.

While costs in this category are reasonable, and going lower, they are certainly not as low as in the Canadian or US equity ETFs. If you hold $10,000 in funds in one of these ETFs your annual ETF fees, not counting any purchase or sale commissions, will be about $22. Considering the number of different markets these products operate in, this seems like a good deal to me. If you went to a similar international mutual fund your costs would typically be 5 to 10 times higher.

It is important to consider the assets in the fund, since funds with relatively small investments usually involve more in trading costs and the difference between bid and ask price will be more significant. Under the assets column we show in millions of dollars the amount invested in each ETF. All of these ETFs are relatively large and heavily traded, so trading margins are not major issues in this category.

It used to be true that ETFs of this type represented only large and mid capacity stocks, but now the four listed here all have broad exposure across different cap sizes.

There are two approaches to building up internationally diversified ETFs, one can either invest directly in a large basket of securities, or one can assemble a 'fund of funds' that holds different ETFs that in total represent a broad international index. The FoF column shows that for each ETF. If costs are comparable, there is perhaps an argument in favour of the fund of fund approach, since it makes the relative weights more obvious. With a 'fund of funds' I have showed the number of underlying holdings in brackets.

It is also important to realize that iShares and Vanguard follow different international indexes – I explain this here.

The main other differentiators between ETFs in the table are whether the fund includes Canadian, US and emerging markets. More on this below.

What is In?

Key questions to ask yourself is whether you want emerging markets within your global/international ETF, and whether you want US  and Canadian equities within the fund, or prefer to hold those within separate ETFs.  In the table the columns c US and c CAN show whether US or Canadian equities are included.  I personally prefer holding US equities outside the world ETF, because the MER ratio on Canadian or US only equities are less than these global ETFs, but work out the costs of each approach for your own situation.

Another differentiator is whether the fund includes emerging market equity exposure, and that is indicated in the c Em column.

The most similar of the ETFs shown are iShares XAW and Vanguard Canada's VXC.  Both include equities from companies of different sizes, emerging and developed markets, and US (but not Canadian) equities.  Either of these, when coupled with a Canadian equity ETF such as XIC or HXT, provides world wide equity exposure.

Some might argue not to include XEF in the table, since it is confined to developed markets outside North America, without emerging market, Canadian or US content. Nevertheless, holding XEF, one US equity fund, one Canadian equity fund and one emerging market fund would allow you to adjust your holdings in each category.

Other Choices

Because of their somewhat higher MER, I have not included in the table so-called 'fundamental index' international ETFs such as iShares CIE. There are definite advantages to these funds, that follow the so called RAFI Index, that takes into account sales, book value, cash flow and dividends, and the MER is still low compared to what you will pay for any international mutual fund. I will look at these funds in a later posting. CBN, which holds a mix of these fundamental funds, is in particular an attractive choice, although at higher cost.

We have not included US stock exchange listed global and international ETFs, although for some that is a good way to go. For example, VEF is essentially VEA, and the MER is lower if you buy it on the US market (0.07% vs 0.22%).  Look into how your discount brokerage handles foreign fund conversions, and whether you can hold cash in US funds within your account, before deciding to go this route.

There are sound arguments for considering low volatility offerings in this category (XMW is one of my favourites), and we will consider those in a future posting.

Final Thoughts

 Rob Carrick's excellent guide to international and global ETFs is available here.  As always, his commentary is clear, direct and valuable.

The Moneysense 2017 guide to international ETFs is out and available here.  They recommend XAW, XEF and VEE (we will cover VEE in a later post dealing with emerging markets ETFs).  I would agree with their choices of XAW and XEF, and add VEF to the list, particularly if you are a Scotia iTRADE customer, since it is on their list of commission free ETFs.  VEE is emerging markets, so not suitable as a sole international/global ETF.

If you want to combine your US and international in a single ETF, Vanguard VXC and XAW are both excellent choices.  VXC is more widely held, while XAW has marginally lower costs.

It should be kept in mind that both VXC and XAW under-represent emerging markets, and therefore you might want to add XEC, VEE to truly represent the global equity markets.

We  have a posting in progress that will look in general at 'funds of funds', a single ETF which holds a number of other ETFs.  In that we will consider other international choices, such as iShares CBN.

The table just provides a snapshot (at time of writing) of some of the characteristics.  You should consult the documents on companies you are considering purchasing.  They are available here: XAW, XEF, VEF, VXC.

As with any major investment decision, you should consult trusted advice before making your choice. Consider risk and reward, costs and tax implications in your ETF choice.

Here are links to ETFs mentioned in this posting:

• CBN
• CIE
• XAW
• XEF
• XMW
• VEF
• VXC

Have comments? As always, don't hesitate to leave them, or to connect with us on Twitter.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  The author of this column holds the following ETFs mentioned in this article in one or more account: XAW, VEF and VXC.  I use Scotia iTRADE discount brokerage. No compensation by any company has been offered, requested or received for writing this column.

US Equity ETFs for Canadians

A while ago we covered ETF options for Canadian equities and Canadian bonds.  In this post we look at choices in Canadian listed US stock index ETFs.  A well diversified portfolio will have Canadian, US and International equities, along with bond and perhaps other offerings.

Why US Equities?

There are several reasons why every Canadian portfolio should hold at least one US equity ETF.
The US stock markets represent by far the biggest single country component in global equity assets, a bit over 36% currently according to a 2016 paper. The US equity markets are much better diversified than the Canadian equity market. If you believe in the school of  holding stocks that dominate their markets, many of the world's dominant companies are listed on US equity exchanges.

To Hedge or Not To Hedge

Many TSX listed US equity ETFs use currency hedging.  Canadian Couch Potato have provided a nice analysis of the issue of whether currency hedging is a good idea or not. Based on analysts' research. they conclude that in the case of US equities hedged to Canadian dollars that hedging "magnifies volatility rather than reducing it." We urge you to read the white papers linked in their posting, and examine commentary from experts in the last year or two, but overall it seems to us that there is no compelling case for hedging US equity ETFs to Canadian dollars. The market seems to support that view, with most twin products having somewhat larger holdings in the unhedged version.

Go Big or Go Mostly Big

Another choice to make when selecting a passive US equity ETF is whether to select a fund based on the S&P 500 index of the largest companies, or a broader index that includes medium sized companies as well. Wondering which companies are listed on the S&P 500? There is a handy S&P 500 list of companies here. I think there are arguments in both approaches - on the one hand the larger index might be argued to offer more complete diversification, while on the other hand a tiny percentage mainly of the largest companies have produced the vast majority of wealth generation over the long term. A really nice analysis by Michael Batnick shows that over the long term (last 15 years) only 8% of large cap US equities beat the index, only 5% of mid cap, and 7% of small cap.  This, and other analysis, suggests that it is not so much the size of the equity, but other factors, that cause most equities to produce zero or negative returns. While within Canada I think the larger index makes sense since the TSX 60 is so concentrated on banks, in the US the S&P 500 is well diversified across industries.

Good Choices

As was the case for Canadian bond and equity ETFs, we are in the fortunate position that there are multiple excellent choices in the US equity category, all with very modest costs. We suggest that you consider first the choices shown in the following table, but certainly other good choices exist.

As can be seen, all have large asset bases and reasonable MER, so any would be a good choice. If already invested in one, the slight differences probably do not justify the margin and commission costs of moving to another offering from the table. If making a first time purchase, I would probably consider VFV, which ties for the lowest MER, is not currency hedged, and has a large asset base.

HXS has one difference from the others that make it a good choice in certain situations.  It is swap based, which means that it does not hold the actual equities, but rather a bank based promise note that is based on those equities.  Dividends and distributions are built into the base price, but not paid directly.  Therefore income is taxed as a capital gain, and is only triggered when the units are sold. Also, there is not foreign withholding tax on income.  This makes HXS a good choice for some in unregistered accounts for those with variable incomes, and also in RESP and TFSA accounts.  HXS is also included in the Scotia iTRADE commission free list, which makes it a good choice for those purchasing in smaller amounts.

Closing Thoughts

We covered only ETFs listed on the TSX in this post.  Of course it is possible to hold US$ ETFs from the American markets within your discount brokerage.  Generally the MER is slightly less on this option, and the trading volume is much larger so liquidity is excellent. Of course you need to take into account the currency exchange costs, and you will need to do an analysis to see which is a better choice for you.

Rob Carrick annually, as part of his ETF series, has a guide to US equity ETFs, with the 2017 guide available to Globe readers here.  Also, morningstar.ca star ratings can be helpful as you make your choice. Moneysense have their 2017 review of US equity ETFs here. They continue to see VUN as an excellent choice for most passive investors, and I would agree. While there is no doubt that the ETFs that concentrate on just the large companies will outperform in some market conditions, overall I see the broader VUN as a better choice, and one that should, in the long run, offer more consistent performance.

As mentioned earlier, I would make a choice centred on the S&P 500 and one which does not use currency hedging.

If your discount brokerage account is with Scotia iTRADE, and you are starting with modest amounts to invest, HXS is a good low cost choice with tax advantages when held outside a registered account. It is also a good choice held within a TFSA, since the foreign agreements that shelter income from foreign tax withholding in RRSP or RIF accounts do not apply to TFSA or RESP accounts.

I have not in this posting considered low volatility US equity ETFs, or international choices that include US equities.  Both of those topics will be considered in future posts.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for their own financial decisions.  The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  The author of this column holds the following ETFs mentioned in this article in one or more account: HXS, VUN.  No compensation by any company has been offered, requested or received for writing this column.

Diversified Income XTR

Income generation becomes a primary goal for your investment portfolio as you enter retirement. Most see bonds and dividend bearing stocks as the primary investment vehicles vehicles for income, although REITs, preferred shares and infrastructure can also play a role in a diversified income portfolio.

While you can purchase a number of individual ETF products to assemble a diversified income portfolio, there can be advantages in  a single fund.  XTR from iShares is one such product, and we review it in this post.

What Does XTR Hold?

iShares XTR is a 'fund of funds' meaning that it holds other iShares ETFs, in this case 11 funds.  I list below in order of weighting the XTR portfolio (including my brief descriptor for each) as of May 2017:

• XHB (Canadian corporate bond) 20.5%
• XHY (US corporate bond) 13.7%
• CBO (Canadian 1-5 y corporate bond ladder) 12.0%
• XEI (Canadian dividend equity) 11.7%
• XRE (Canadian REIT) 8.7%
• XDV (Canadian dividend) 8.0%
• CUD (US dividend equity) 7.4%
• CPD (Canadian preferred share) 5.3%
• XUT (Canadian utilities) 5.2%
• XST (Canadian staples equity) 4.5%
• CLF (Canadian 1-5 y laddered government bond) 3.0%

You can get the details, including current portfolio weightings, of XTR directly from iShares here. To make the chart below I've lumped the funds into corporate bond, government bond, dividend equity, preferred share and REIT categories. While I have included XST with dividend equity, it is probably more properly viewed as a low volatility equity rather than strictly a dividend equity ETF.

The overall holdings in XTR are 76.7% Canadian, 19.7% US, and about 3.7% from all other countries combined. This is good for tax benefits when XTR is held outside registered accounts, but not great in terms of diversification.

As a fund of funds, XTR is diversified over a lot of different underlying holdings, a bit over 2200 at the time of writing.

Costs

The overall MER for XTR is now 0.60% (some sources still quote the audited 0.62% value), and that includes the fees inherent in the underlying funds that XTR holds.  The current TER is 0.02%, so trading within the fund does not add significantly to the overall costs. XTR is widely traded (typically 45 thousand units per trading day), so the spread between bid and ask is usually slight. While this MER may seem high compared to pure equity or broad bond ETFs, it is competitive with fees associated with most dividend and blended funds.

Performance

The performance of XTR is steady but certainly far from spectacular. In the past year it has had a total return of 10.0%, but over 5 years the return averages 4.6% annually, while over 10 years it averages 5.3% annually. The majority of years show positive returns, with only one of the last 5 having a negative return (-5.98% in 2015).

With XTR you are giving up a little bit in return for regular income at modest variability.

Advantages

Especially if you have a relatively modest portfolio, the idea of holing a single product that effectively represents the various components of a well diversified income fund makes sense. You save commission costs of adding US and Canadian dividend ETFs, along with several corporate bond ETFs.

XTR should be more stable than any one of these individual ETFs (e.g., the total yearly range of XTR over the past 12 months has just been 6% from minimum to maximum value), so it will help you reign in temptation to trade too often for your own good.

XTR pays out its distributions monthly, so it works well in a LIF or RIF where you are withdrawing funds monthly.

While the performance has been less than a simple equity and bond couch potato portfolio, the mix of investment products may (but see below under concerns) help cushion some market volatility.  As we move into retirement ages it is natural to worry more about the ups and downs of the market, so anything to reduce this variability is a positive.

If you don't immediately need the income, you can use DRIP to purchase additional units without commission costs.

While we have too many ETFs in my opinion, I don't think we have enough ETFs that are single products well tailored to a need (such as retirement income, or couch potato type portfolios). XTR is a well designed income ETF, and that is why many tens of thousands of units trade daily on the TSX.

Concerns

The bond holdings within the portfolio are not entirely investment grade.  For example XHB (the largest single component of XTR) has essentially none of its portfolio in A, with 80.7% in BBB and the rest in lower investment grades (see the explanation of bond ratings here). That being said, XHB has been remarkably stable - e.g. it has not shown a negative return for any of the past 5 years. While they are not in the high investment ratings of government bonds, the companies XHB holds are mainly household names in Canada. The US corporate bonds held in the XHY ETF within XTR have a similar investment quality range.

Also, the bonds in XTR are mainly corporate, with only a few percent in investment grade government bonds.  It is likely that in a major equity market correction these corporate bonds will not help cushion your portfolio the way that investment grade government bonds would.

Another potential concern is the high Canadian bias.  About 76.7% of the portfolio is held in Canadian products, and only 3.7% are held outside Canada and the US. XTR has essentially no emerging market exposure, in bonds or equities.

A fourth potential concern is that there is little in the way of direct inflation protection in XTR, since it does not hold real return or TIP bonds. Also the REIT component is largely restricted to Canada.

Considering these potential concerns, if seeking the most stability in returns, it makes sense to pair XTR with some holding in products such as CBD or XAL that give you more government bonds, inflation protection, and wider international coverage.  A future posting will consider these groupings quantitatively.

Alternatives to XTR

Perhaps the closest alternative to XTR is BMO's ZMI, which is also a 'fund of funds'. ZMI holds 17 other BMO funds, with the majority being a mix of Canadian and US dividend equity ETFs and corporate bond ETFs, with a little dose of REITs and other income ETFs. Compared to XTR, ZMI has slightly higher equity holdings and slightly lower bond exposure, but the differences are so small they hardly matter.  The BMO ZMI includes some of the option linked products that BMO has made popular, including

I slightly prefer XTR for the following reasons:

1. Longer track record (XTR started in 2005 and ZMI in 2011), with good stability since the end of 2009 (the price did decline in 2015, but has recovered nicely).
2. More widely traded (on a typical trading day ZMI trades a few thousand units, while XTR several tens of thousands of units).
3. Better transparency (the 11 ETFs included in XTR are all easy to understand offerings, while  ZMI include the covered call and put write holdings that many individual investors may not fully understand.
4. Although be careful comparing yields, I do like that XTR has given a very consistent approximately 6% yield (at current price) versus currently just over 4% for ZMI.

That being said, I would point out that if we compare 5 year annualized performances, ZMI has the edge at 5.70% vs 4.54% for XTR. There is also slightly more exposure outside North America in ZMI, an advantage in my opinion. The volatility of the two are very similar - according to Morningstar.ca the standard deviation for XTR is 4.8 while that of ZMI is 4.7.  

If I was grading the two products my overall grade would be very nearly a tie. Morningstar.ca currently also gives the edge to XTR, with *** vs  a ** rating for ZMI.  Either ETF is a good choice. There are of course many other income generating mutual funds and ETFs, although most of them have at least somewhat higher MER than these products.

Those seeking a mutual fund alternative should consider Steadyhand Income Fund.  The MER is slightly higher, but there are no commission charges. It is more conservatively invested than XTR, but returns have in the long run been marginally better (6.0% return per year averaged over the past 10 yr, although only 1.9% per year over the last 2 yr.)  If you are ready to invest at least $10,000, you can open a Steadyhand account directly, or you can buy Steadyhand Income Fund through most Canadian discount brokerages (SIF120).

Another good income alternative would be Tangerine Balanced Income investment fund. Over 5 years it has offered a similar return 5.5% over 5 years, and has been pretty consistent from year to year.  The portfolio is weighted to Canadian bonds, with about 10% in each of US and international equities. Its easy to set up an account with Tangerine,  It does only pay out its distributions once accually (in December), so not as well suited as XTR to directly providing monthly income.

Final Thoughts

XTR plays a major role in my personal retirement LIF, and I think XTR or ZMI make sense for many retirement accounts.  I like that it combines in a single product the components that I want to play a major role in my income funds (bond and dividend funds in US and Canada, REITs), and that it pays a stable monthly distribution.

In investing we should look forward not backward (a central message of the book The 3 Simple Rules of Investing).  If I look backward at returns, I would probably concentrate in an equity and bond portfolio, but if looking forward I see more stability in a broader set of income generating holdings, and XTR fits very nicely into what I want to hold.

That being said, I would not make it the only income product, although it may be the major one. I would consider an additional ETF that helps provide balance outside North America, as well as ideally more government bond exposure and some inflation protection  (such as CBD or possibly XAL that I will cover in a future posts).

Both XTR and ZMI provide a reliable income stream (currently about 5.7% for XTR and 4.0% for ZMI ) that is sufficient for many RIF retirement ratios, and that is paid monthly.  You do give up potential return with these products compared to simple stock plus bond portfolios but in return you obtain slightly more stability across more asset classes.

If considering holding these products outside a registered account, discuss tax implications with your financial advisor.

This posting is intended for education only and should not be considered investment advice. The reader is responsible for his or her own financial decisions.  The writer is not a financial planner or investment advisor, and reading this column should not be interpreted as obtaining individual financial planning or investment advice. For major financial decisions it is always wise to consult skilled professionals. While an effort has been made to be accurate, any statements of fact should be independently checked if important to the reader.

Disclosure:  The author of this column holds XTR (and has held ZMI, although not currently) and CBD. I also hold some SIF120. No compensation by any company has been offered, requested or received for writing this column.