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The FIRE Power of VEQT

If you’ve read my translation of JL Collins ‘The Simple Path to Wealth’, you’ll know I highlight several funds that mimic his advice but for Canadians. The last fund I recommend is VEQT or its bond holding brothers and sisters (VGRO, VBAL and such).

For the purposes of simplicity, I choose Vanguard funds for myself and everything I write about when talking investments, but feel free to replace VEQT with XEQT (Blackrock iShares) or VGRO with ZGRO (BMO). It makes no difference to me. I will say that until Vanguard showed up, BMO and iShares had dramatically higher MERs on ultra-similar funds with different names. They only created those funds out of competitive necessity, not to offer their customers a better deal. They are followers (and not leaders), and for that reason I choose Vanguard.

Home Bias Makes Sense

When thinking about VEQT, I want you to forget the holdings and think of the broader, longer-term picture. According to Vangaurd's informed* opinion, a Canadian investing in Canadian stocks with Canadian dollars is very ideal - to a point. Two of the biggest wealth-killers when investing long-term (which we FIREwalkers are) are taxes and fees. Using the above Canadian criteria, you and I can highly mitigate those two demons from our returns through home country bias.

This is critical to understand. A 30% home bias (give or take 5%) is an excellent strategy for the long-term investor. So Vanguard, iShares and BMO all have funds with heavy home bias. Also, when I say long-term, I’m not referring to 5-10 year investments. That’s nothing to us FIREwalkers. Try 25+ years. Now we’re talking about the future of your money and you can ignore all the recency bias in your decision making. Such as…..

“American tech stocks are SO HOT! Why would I invest in Canada at all? It’s only 3% of global GDP! Energy companies up here are FUCKED! Too many financials! Harr harr, I’m so smart and everybody else is dumb! I’m still gonna live here though and mortgage a $1mil house every 5 years lol.”
                                                                                            - A uneducated donkey

If you think like this, you are not a long-term investor. Or you think Canada has an extremely bad outlook in the future. Perhaps you think Vanguard will drastically increase their fees or the dividend tax credit will be abolished and our country will literally break away from the North American continent and float away ruining our geopolitical strength to the world economy.

Index investing using data from only the previous decade (or even two) is much more risky than you’re letting on. If you believe yourself to be a special individual and can accurately predict the future of our country, by all means, dump Canadian stocks if the future doesn’t please you. Don’t even index at that point. Just remember that crystal ball needs to work elsewhere too. Some people get this right... but most don’t.

How to Use VEQT

So now that I’ve convinced you that 30% Canadian stocks is a good idea and that 70% is cap-weighted to the rest of the world, we should begin breaking down what VEQT means in practical terms. Ladies and Gentleman, this is where the fun begins (no seriously).

Deconstructed, VEQT is: ** These are rounded %’s for sanity **
  • VUN - 40% Total US Stock Market
  • VCN - 30% Total Canadian Stock Market
  • VIU - 20% Total Developed Stock Market (no Canada, US)
  • VEE - 10% Total Emerging Markets
While VCN is anchored to 30%, the rest of those funds are cap-weighted and free to fluctuate based on how much equity they actually represent in the world. If Chinese and Indian stocks continue to rise throughout the 20’s, VEE will continue to increase in overall percentage of VEQT and naturally VIU and VUN will adjust as a result. This is good news since it means your auto-balancing is moving happily along with the world index (the goal of globally diversified index portfolio) and your favourable Canadian bias is left intact to reap the tax and fee benefits.

Let’s talk about fees since this often gets people all hot headed.

Since we know that VEQT has a true MER of 0.50%** (0.25% MER, 0.25% foreign withholding taxes, give or take a few points) it is advantageous for Canadians to split VEQT into its smaller components once the account size grows large enough. I prefer a threshold of at least $100k for any account size before the work involved can show a tangible pay off.

So if you’ve saved your first $100k in one account (let’s say RRSP) then you could split your holdings between your accounts. Let’s say you look like this:

** Sorry, no bonds are included in the scenarios - head to Canadian Portfolio Manager for that **

Scenario #1 (combined MER of 0.50% or $750/year)
  • Taxable - $10k - VEQT
  • RRSP - $100k - VEQT
  • TFSA - $40k - VEQT
So you want to optimize the $100k? Okay let’s do it!

Scenario #2 (combined MER of 0.25% or $375/year)
  • Taxable - $10k - VEQT
  • RRSP - $100k - VTI (40%), VCN (30%), VEA*** (20%), VWO (10%)
  • TFSA - $40k - VEQT
So in this scenario you’ve blown up VEQT and converted 70% of your RRSP holdings to USD, using Norbert’s Gambit (which costs about $20~). And yes, before anybody points it out, I’m leaving it at $100k in value to keep things Canadian - your USD holdings will show it at $75k or whatever the exchange rate is.

You’ve lowered the crap out of your MER! VWO has the highest MER in your RRSP now at 0.10%. There’s still foreign withholding taxes that increase that number a tad but there is no getting around it. Just ignore it and focus on US and Canadian equities for fee and tax reduction, which is easy to do since it will be about 70% of your portfolio. We can still further optimize the RRSP by optimizing the other accounts though, so let’s do it one more time.

Scenario #3 (combined MER of 0.10% or $150/year)
  • Taxable - $10k - VCN
  • RRSP - $100k - VTI (65%), VEA (30%), VWO (15%)
  • TFSA - $40k - VCN
This is again a rounded and fairly rough example of holding VEQT in its smaller parts but the strategy is still holding true. You’ll reap the best MER this way but you’ll have to stay on top of rebalancing as contributions increase. For example, if contributions to your taxable account outpace your contributions to your RRSP and TFSA, you’ll have to sell VCN in the TFSA and replace it with VEQT or VXC assuming you’re buying VCN in the taxable account. Sort of complicated, sort of not. Instead of worrying about this now just roll with the punches as you get the money. Here's a resource to help you rebalance

The Takeaway

All three scenarios reflected the strategy of VEQT. As we optimized, it was a lot less simple on the surface. The truth here is this takes a lot of reading, preparing and getting over your own preconceptions that the MER’s are difficult to optimize. You’ll also need a favourable brokerage (and likely more than one). Having Wealthsimple Trade for your Canadian dollar accounts is incredibly ideal since there are no commissions. Questrade or another big bank will be needed for USD accounts. Staying with VEQT is suboptimal to that amount of work in my opinion - on the path to FIRE we specifically choose to frontload a lot of effort into building efficient systems.

However, there is no shame in keeping it simple. Some people are built for this stuff but most are not. You all know how much I love to gatekeep the FIRE movement and you’ll be pleased to know that kicking it simply with VEQT.tsx in all accounts until the day you die is permissible! You’re still winning by a large margin compared to many other forms of DIY investing and of course the dirty mutual fund industry.

I will say if you do kick and scream over this process - and once it's done - on the other side is simply a rebalancing calculator found here and 30 minutes of work updating that spread sheet, depositing your cash and then buying the appropriate ETFs as per your spreadsheet. Or you can just eyeball it and guess which fund needs cash and then seriously calculate it twice a year or so. So 10 minutes of work every paycheque with that method. Worth it considering the scenario’s $600 annual savings on such a small amount and that’s just the beginning. Put this system into place as early as $150k and reap the benefits over the next million you invest (or whatever it is).

If you have stock options at work, get it as close to VEQT as you can unless that’s impossible in which case don’t try to include it in your overall strategy unless you want to rip your hair out. Take the free money your workplace has offered you and don’t look back.

VEQT is as complicated as you want to make it. Buy the all-in-one fund and win. Buy all its subcomponents instead and win. Keeping it simple costs more money as your assets grow but feel free to kick the can down the road as long as you want. At the end of the day, your FIRE number is within your grasp regardless of how far you want to optimize VEQT.

Ryan Myricks

* Referring to Vanguard's White Paper. Read it here or listen to it here.

** Frugaltrader's calculations of foreign withholding taxes are here. Depending on the amount of foreign equities in a fund, it's usually around 0.25% extra to the annual MER. Holding VTI in USD  in your RRSP/LIRA will negate these fees.

*** VEA is global developed ex USA, which means it holds Canadian stocks! You could adjust this if you wanted by docking 3% off your VCN anchor but I would ignore this small inefficiency and get on with my life.

Additional resource about breaking VEQT into its smaller funds.

Picture: Art by Chris Seaman for the game Hearthstone

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