# Canadian Couch Potato and Bonds questions



## tiffbou2 (Jul 4, 2013)

I am in my mid-30s and just starting out with self directed investing. Please be kind in the face of my relative ignorance. each:

We have some RRSPs with a financial advisor in an account with a high fee MER. We want to get away from investing in that. I have been reading up on the Couch Potato approach and would like to try this model portfolio they suggest:

Option 2: The cheapest index mutual funds in Canada are TD’s e-Series, but these are only available to investors who open an online account with TD Canada Trust, or through a TD Direct Investing discount brokerage account. The total annual cost of this portfolio is 0.44%:

Canadian equity 20% TD Canadian Index – e (TDB900) 
US equity 20% TD US Index – e (TDB902) 
International equity 20% TD International Index – e (TDB911) 
Canadian bonds 40% TD Canadian Bond Index – e (TDB909) 

We are already TD online customers. We have an appointment with our branch on Friday and I hope to purchase these products but I don't know if I can do it there or have to online. We want to invest $3000 right away, then make regular contributions of $600/month. We will increase once our TFSA contributions are maxed out. That's our priority right now as hubby's job may not be stable long term.

My main question is: Does this portfolio seem too high in bonds? People I've spoken with have been warning me away from bonds. Looking at the performance of this Bond, it looks like it has lost in the past year. Should I allocate a higher percentage to US or International equity?


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## eulogy (Oct 29, 2011)

The 40% bonds are just a pretty standard recommendation (60stock/40bonds). It's really up to you to figure out and choose your bond allocation based on your risk factor. If you're going to do the couch potato strategy than just pick an allocation and stick with it. Bonds are expected to get beat up over the next few years, but really I think people look at it way overblown. They're not going to get beat up like stocks would fluctuate. Bonds are paying more interest (which is a good thing), but at the same time the market value of the bonds go down. If you're in it for the long term and buy as they go down to meet your risk tolerance you're going to be just fine.

If you're looking to market time, then there really isn't any reason to even follow the Canadian Couch Potato recommendations.

Another FYI, you have an appointment with TD and they won't help you with e-series. If you're getting the mutual fund account, they'll help you set that up. You need an e-series mutual fund account to buy e-series mutual funds. They won't help you with that. A lot of their representatives won't even know what an e-series fund is. e-series is hands off by staff, so you need to fill out an application and send it in. If you're setting up Waterhouse, they'll set that up for you and you buy it on your own. No one at TD is supposed to help you with e-series.


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## GoldStone (Mar 6, 2011)

Don't talk to the branch about e-series funds. Ask them to set up a regular mutual fund account. They will be happy to help you with that. Put your initial deposit in the money market fund. They will likely go in a hard sell mode to steer you towards their high MER funds. Tell them politely that you need time to think about your investment options.

Once this regular mutual fund account is up and running, and everything functions normally online, convert the account to e-series account. Follow the instruction in this form:

http://www.tdcanadatrust.com/docume...mutualfunds-tdeseriesfunds-convertaccount.pdf

Mail/fax the form to e-funds people. Don't deal with the branch. You will know that conversion is complete when you are able to see the e-funds in the buy menu online.


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## GoldStone (Mar 6, 2011)

eulogy said:


> The 40% bonds are just a pretty standard recommendation (60stock/40bonds). It's really up to you to figure out and choose your bond allocation based on your risk factor. If you're going to do the couch potato strategy than just pick an allocation and stick with it. Bonds are expected to get beat up over the next few years, but really I think people look at it way overblown. They're not going to get beat up like stocks would fluctuate.


I agree.

2013 has been a bad year for bond funds. One of the worst years in a few decades. But let's put things in perspective. TD Canadian Bond Index–e (TDB909) is down 2.3% year to date. Stock markets can easily drop 2.3% *in a single day*.

Don't look at your bond fund performance in isolation. When bonds are doing poorly, chances are that stocks are doing great. And vice versa. The only number that matters is the total portfolio return.


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## tiffbou2 (Jul 4, 2013)

Thank you so much for the advice and the link! I didn't know that the branch had nothing to do with the e-series. I should have known. I have good friends who work for TD - one is a branch manager - and they have to "sell" a certain amount of product per month (eg. credit cards, savings accounts) to meet a quota. 
I wonder if I can get automatic withdrawals to these accounts - or if I would have to have an auto withdrawal to the regular mutual fund account and then go through the transfer process to the e-series every time?


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## GoldStone (Mar 6, 2011)

It's not a transfer. It's a conversion. The account number stays the same.


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## AltaRed (Jun 8, 2009)

tiffbou2 said:


> Thank you so much for the advice and the link! I didn't know that the branch had nothing to do with the e-series. I should have known. I have good friends who work for TD - one is a branch manager - and they have to "sell" a certain amount of product per month (eg. credit cards, savings accounts) to meet a quota.
> I wonder if I can get automatic withdrawals to these accounts - or if I would have to have an auto withdrawal to the regular mutual fund account and then go through the transfer process to the e-series every time?


The e-series funds are cost efficient because of the general lack of human intervention (and no commissions to people). Hence why you need to do the conversion to e-series yourself. Once the mutual fund is converted to an e-series account, you can move funds directly to it from your other TD accounts. That said, why not start directly with an TD e-series account yourself. http://www.tdcanadatrust.com/products-services/investing/mutual-funds/td-eseries-funds.jsp It is a matter of filling out the application forms and sending them in https://www.tdcanadatrust.com/docum...dct-mutualfunds-tdeseriesfunds-newaccount.pdf

I don't do business with TD so cannot tell if you can do auto transfers from bank accounts to your e-series account, but you certainly should be able to do it online yourself with a few mouse clicks via TDEasyWeb.

As for bond allocation, only you can decide if you want to have that much bond allocation at this time. My recommendation would be to hold it to 20% or so for 2-5 more years while longer term interest rates (the yield curve) settles out. Perhaps allocate the other 20% to Canada in the meantime so that your Canadian equity (40%) equals the sum of your US and Int'l equity. Or spread it around to all three (30/25/25). Again, no magic answers.


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## fatcat (Nov 11, 2009)

i disagree with previous posters about bonds
we would have to see another 3 decades like the last three to see bonds perform so well

i think you will see much greater growth in equities over 40 years, which is the time horizon you have
if you are going to just go with e-series i would go to 20% bonds and spread the rest equally among the other three

if you were in your mid-40's i would say 30% bonds
if mid-50's i'd say 40% bonds

but mid 30's i think 20% bonds is plenty and many people will say it's still too much

in the end, nobody knows and you have to place your own bets


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## GoldStone (Mar 6, 2011)

fatcat said:


> we would have to see another 3 decades like the last three to see bonds perform so well
> 
> i think you will see much greater growth in equities over 40 years, which is the time horizon you have


There is no question that equities will outperform bonds in the long run. However, equities may experience 20%-30%-40% declines along the way. The purpose of bonds is to cushion the blows & to smooth the ride. Bonds are not supposed to boost your returns.

Note, I'm not saying that 40% is the right amount. Only OP can decide what is right for him.


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## AltaRed (Jun 8, 2009)

GoldStone said:


> Only OP can decide what is right for him.


Or her, as I inferred from the OP's original post.


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## tiffbou2 (Jul 4, 2013)

AltaRed said:


> Or her, as I inferred from the OP's original post.


Yes, her. 

Thank you again for the advice and links. If I hadn't posted this topic, I may have been talked into a product I didn't want at the branch. I may just cancel that appointment and call TD Waterhouse tomorrow with my questions. 
As for asset allocation, I think I may keep bonds at 20-30% and divide the rest among stocks for now while I don't have too much invested in the portfolio. This isn't the only savings we will have. Our TFSA is all cash (for now), I have over $100K invested in my pension plan so far, and we have RRSPs with Quadrus. I may move that money over to these TD funds so I can stop paying the MER on them but it's all baby steps for now.


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## AltaRed (Jun 8, 2009)

tiffbou2 said:


> but it's all baby steps for now.


Baby steps are good. It's all part of the learning process.


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## GoldStone (Mar 6, 2011)

tiffbou2 said:


> Yes, her.


Sorry OP, I missed the part about the hubby. 



tiffbou2 said:


> I may just cancel that appointment and call TD Waterhouse tomorrow with my questions.


A brokerage account at TD Waterhouse is not the same as e-funds mutual fund account. I gather that you want to open the latter. TD Waterhouse won't help you with that (it's a different part of TD empire). Call TD Investment Services. See 1-866 number at the bottom of this page:

http://www.tdcanadatrust.com/products-services/investing/mutual-funds/td-eseries-funds.jsp


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## My Own Advisor (Sep 24, 2012)

E-funds are good products.

I would also agree with fatcat, lower bond allocation (closer to 20% bonds) to give the long-term bias to equities.

In your 30s, I think 20% bonds is plenty.


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## mrPPincer (Nov 21, 2011)

They will be able to set up the e-series account for you tomorrow at your branch.
I think they still have to create a regular account and then convert it to an online one, but you can still have it all set up at your appointment tomorrow.

It may take a few days for the online e-series account to show up because there is paperwork that has to go to the head office, but in my experience it's faster than trying to set it up online; that process can take weeks (did the regular and registered online, and let my local branch set up the TFSA, much faster).


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## fatcat (Nov 11, 2009)

GoldStone said:


> There is no question that equities will outperform bonds in the long run. However, equities may experience 20%-30%-40% declines along the way. The purpose of bonds is to cushion the blows & to smooth the ride. Bonds are not supposed to boost your returns.
> 
> Note, I'm not saying that 40% is the right amount. Only OP can decide what is right for him.


but, assuming a 40 year horizon and a steady process of adding to all funds the inevitable declines don't really matter (just close your eyes and don't look) ... what matters is the total at the end

i would gradually increase bond holdings as the op and partner get older

of course, this all assumes excellent cash management, you can't be looking at your portfolio as a source of necessary cash during any of the predictable dips

though, i take your point 20% corrections can be stomach churning, but not nearly as bad when you are in your 40's as when you are in your 60's say ...


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## tiffbou2 (Jul 4, 2013)

GoldStone said:


> Sorry OP, I missed the part about the hubby.
> 
> 
> A brokerage account at TD Waterhouse is not the same as e-funds mutual fund account. I gather that you want to open the latter. TD Waterhouse won't help you with that (it's a different part of TD empire). Call TD Investment Services. See 1-866 number at the bottom of this page:
> ...


Thanks, will do. The TD "empire" is a bit confusing. I just assumed if something was under the "TD" umbrella, I could go into any branch and just get it. Had no idea these were all separate entities. 

My appointment at the branch isn't supposed to be until Friday. That's the only day my husband can be available. I may keep it regardless and hope I get someone knowledgeable. I also have questions about spousal RRSP. Right now, our RRSP are in my husband's name. I think spousal may be better since I make a higher income and would claim the contributions, but I don't know that I have much contribution room after my pension payment. Must dig up last year's tax return - it says your contribution room on that, right?


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## My Own Advisor (Sep 24, 2012)

Yeah, check your Notice of Assessment tiffbou2.


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## GoldStone (Mar 6, 2011)

fatcat said:


> but, assuming a 40 year horizon and a steady process of adding to all funds the inevitable declines don't really matter (just close your eyes and don't look) ... what matters is the total at the end


Are you familiar with FPX benchmark portfolios? Financial Post started them in 1996. Take a look at the most recent daily values:

http://www.financialpost.com/markets/data/indices-fpx-daily.html

As of Friday:

FPX Growth: 3014
FPX Balanced: 3099
FPX Income: 3152

Note how the most conservative portfolio leads the race after 17 years.

17 years is a long time to wait to be proven right and not lose faith. Equities are risky. There are no guarantees.



fatcat said:


> though, i take your point 20% corrections can be stomach churning


20% ha ha ha. That's nothing. We saw two bigger crashes in the last decade. 2008 crash was close to 50%.

50% crash with 80% in stocks, 20% in bonds => 40% portfolio drop
50% crash with 60% in stocks, 40% in bonds => 30% portfolio drop
...

Another way to think about this: decide what is the biggest portfolio drop you are willing to tolerate. Multiple by 2. That should be your equity allocation.


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## eulogy (Oct 29, 2011)

It's tough figuring out of your fixed income portion, especially when you're new to this. I've seen people explain that you should have a fixed equity component of "X" amount just because a newbie will never truly know. 

I could say that I could deal with a 50% drop without a freakout or lost sleep.... but it could happen and I could have underestimated how much I could really deal with. I

I do hold a smaller fixed income portion because I feel like I have a high risk tolerance... but as the portfolio has really grown I often wonder if $200k turns to $100k, will I be singing such an optimistic tune.


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## alingva (Aug 17, 2013)

tiffbou2 said:


> Canadian bonds 40% TD Canadian Bond Index – e (TDB909)


 Write it off. Bond funds will go down, down and down more for the next 30 years. Bond funds do not have maturity and you will lose money indefinitely.


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## eulogy (Oct 29, 2011)

alingva said:


> Write it off. Bond funds will go down, down and down more for the next 30 years. Bond funds do not have maturity and you will lose money indefinitely.


False.


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## GoldStone (Mar 6, 2011)

alingva said:


> Write it off. Bond funds will go down, down and down more for the next 30 years. Bond funds do not have maturity and you will lose money indefinitely.


You don't understand how bond funds work. Do some basic reading.


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## tiffbou2 (Jul 4, 2013)

alingva said:


> Write it off. Bond funds will go down, down and down more for the next 30 years. Bond funds do not have maturity and you will lose money indefinitely.





GoldStone said:


> You don't understand how bond funds work. Do some basic reading.


These are essentially the two arguments I've been hearing from people around me. Truthfully I don't really fully understand how bonds work myself and will need to do some more reading and make my choice. I'm nervous right now to deviate too much from the Couch Potato. I'm thinking of reducing the bond allotment to 20-30% but not getting rid of it entirely. 

I'm learning so much from this forum and the articles posted on it. I'm getting a bit excited to get started with it all. I think I'll learn much more once I've had a bit of experience managing my own funds. Funny, I saw my friend yesterday who is a branch manager at TD and I talked to him a bit about my plans. He seemed shocked that I wanted to do self directed investing. He said nobody he knows in "real" life does this. From being on this forum, it seemed to me that everybody does it. But when I think about it, I don't know any people in my circle (who I know of) who are self directed, except my father who only started a few years ago. Makes it seem a bit scary but exciting at the same time.


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## mrPPincer (Nov 21, 2011)

eulogy or Goldstone could either of you expand on those emphatic comments?
alingva is right in saying that bond funds like tdb909 can't be held to maturity like individual bonds can.

Are you both criticising the part about bond funds going down for the next 30 years?
..because I think this speculative statement could very well be right, if interest rates do go up over the next 30 year period


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## GoldStone (Mar 6, 2011)

While bond fund itself doesn't mature, the bonds held by the fund do mature. As they mature, the fund reinvests the proceeds in new bonds. In the rising rate environment, these new bonds will bear higher yields than the old ones.

The key number to look at is the fund *duration*. If you hold the fund for longer than its duration, you will not lose the capital. TD e-fund duration is about 6 years. If your time horizon is longer than that, interim price fluctuations should not matter to you.

Canadian Couch Potato:
*Holding Your Bond Fund for the Duration*


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## mrPPincer (Nov 21, 2011)

Goldstone I was just thinking about that after I posted; holding over the 30 years means a lot of the contained bonds would in fact be held to duration, but for me, it still seems there is not enough incentive to lock my money into bonds or GICs when I can get better in a HISA (3% at PT), as long as I think interest rates are likely to rise, (although that seems to have been postponed for the time being), I'll continue to stick with HISAs, just my perspective.


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## andrewf (Mar 1, 2010)

mrPPincer said:


> eulogy or Goldstone could either of you expand on those emphatic comments?
> alingva is right in saying that bond funds like tdb909 can't be held to maturity like individual bonds can.
> 
> Are you both criticising the part about bond funds going down for the next 30 years?
> ..because I think this speculative statement could very well be right, if interest rates do go up over the next 30 year period


You could do modelling to determine what kind of change in rates would need to occur for bonds to have a negative return over 30 years. My guess is that one way for this to happen would be for yields to fall to zero now, stay there for 29 years, then rise to 5% in year 30. How realistic that is, I leave as an exercise.

If yields only rise, interest rates would have to be well into the 2 digit range in 30 years (like 20-30%, at least) for this to be true.


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## fatcat (Nov 11, 2009)

GoldStone said:


> Are you familiar with FPX benchmark portfolios? Financial Post started them in 1996. Take a look at the most recent daily values:
> 
> http://www.financialpost.com/markets/data/indices-fpx-daily.html
> 
> ...


and of course stocks started to recover eventually all of their losses in march of 2009

it has been a while since i was in my thirties but as i recall, most thirty somethings spend 95% of their time with their job

they tend to take a long distance view of their investments, they go up, they go down ... but they don't do what most of us do, watch their investments daily (it's true they do need to develop discipline to just keep contributing through thick and thin)

your example of the conservative portfolio is looking in the rearview mirror, of course, nobody knows what will perform best in the next 40 years but i would make a heavier bet on equities especially if i were in my thirties

but nobody knows ....


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## AltaRed (Jun 8, 2009)

The conservative (FPX Income) portfolilo has outperformed primarily due to declining bond rates, more or less, since the 1980's and the last of the 30 yr bonds are now maturing as we speak. We are now likely in the trough of bond yields (long and short) and yields of all duration are likely now only to go up (meaning existing bond prices will continue to slide albeit very slowly for awhile yet). 

That said, Goldstone is right. As long as one holds the bond fund longer than its duration, one will NOT be negative on capital. The bond fund will be replacing maturing bonds on a daily basis and once they have turned over enough bonds to pass 'duration', it will contain higher yielding bonds bringing the overall bond fund price back to where it is today on a capital basis (but with the higher yield). Some of the experts, including PIMCO, have suggested the sweet spot for bond duration right now is in the order of 6-7 years (price performance plus yield). Depending on how the yield curve changes over time going forward, this may be the approximate sweet spot for some time. For a long term hold, near term noise in bond fund prices should be ignored. 

Tiffbou2, you may wish to search threads here, or simply Google 'bond prices versus yield' to get to material that provides some understanding of the effect of changing interest rates on bond yields. Generally, bond prices vary inversely to yield and the longer the remaining bond term is, the more sensitive it is to yield prices. The general principle is that if you hold a $10k bond paying 4% and the interest rate rises to 5% today, no one will pay you $10k for your 4% bond today. They will want the equivalent of 5% interest and that means they will pay you only $8k for your bond if you wanted to sell it. In addition to that, price sensitivity depends on how long the bond has remaining with its term. The key though, is that as long as one does not sell, you will continue to get in interest, what you paid for in the first place and your capital back at maturity. 

In short, if you hold your TD bond fund past its duration, you will not 'lose' and if this is part of your long term retirement plan, you should not be selling for decades to come, right?


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## My Own Advisor (Sep 24, 2012)

To Goldstone's and AltaRed's point(s), I think you should hold bonds (in your portfolio) longer than the duration of the bond holdings itself.

For example, if you're holding XBB, and plan to own it for 20 years, that makes sense since the durations are longer.

If you're holding XBB, and only plan to own it for a year or so, that doesn't make sense (to me anyhow).


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## GoldStone (Mar 6, 2011)

My Own Advisor said:


> To Goldstone's and AltaRed's point(s), I think you should avoid holding bonds (in your portfolio) any longer than the duration of the bond holdings itself.


No, it's vice versa. Avoid holding a bond fund if your expected holding period is shorter than the fund duration. Buy a bond fund if you expect to hold it much longer than the fund duration.

Duration is a metric that describes how sensitive a bond fund is to the changes in the interest rates.



My Own Advisor said:


> For example, if you're holding XBB, and plan to own it for 20 years, that makes sense since the durations are longer.


It makes sense because XBB duration is 6 years, much shorter than the holding period of 20 years.



My Own Advisor said:


> If you're holding XBB, and only plan to own it for a year or so, that doesn't make sense (to me anyhow).


Right! It doesn't make sense because the holding period of a year or so is shorter than XBB duration of 6 years.


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## My Own Advisor (Sep 24, 2012)

Crap, I meant to say: hold your bond fund longer than the bond durations.

Thanks for correcting my wording.


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## eulogy (Oct 29, 2011)

mrPPincer said:


> eulogy or Goldstone could either of you expand on those emphatic comments?
> alingva is right in saying that bond funds like tdb909 can't be held to maturity like individual bonds can.
> 
> Are you both criticising the part about bond funds going down for the next 30 years?
> ..because I think this speculative statement could very well be right, if interest rates do go up over the next 30 year period


I know others have sort of summed this up, but it's just a regurgitated fear statement that is flat out false. If you bought every single bond that TDB909 held, you would make money. Bonds pay interest. A bond paying 2% interest, will pay 2% whether interest rates go to 10% or 0%. I don't see anyone dissing on the bond ladder, but a bond fund is sort of like that where things mature and new things are bought. In fact, I've run into people that put down bond funds and at the same time hold bond ladders. The only reason they don't think they're "losing" money is that they don't sit down every day and calculate the market value of their bonds on an open market. If they did that they would be losing. 

Not that people should be doing that. Looking at the maturity or the end value is good. Just do the same with your bond fund. It may be a portfolio of bonds, some maturing and some new, but it's just a portfolio of very simple interest paying products. You can easily sum them up, take the averages and the bond fund will act like just one big bond average, which is the easiest way to look at it.

If you're interest rate sensitive (need the money sooner than later) well pick a duration shorter than when you need the money. Need the money in 30 years, who cares what happens over the next few years? 

I just find this bond fund crap so overblown and it's annoying. Bonds are finally going to start paying higher interest rates and more income for the first time in a long time, and people are just running in fear.


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## mrPPincer (Nov 21, 2011)

Look at it this way..
In a bond fund you will always have your prinicipal or a potion of it locked in, you can never hold to maturity.
Therefore, when you sell, if you are selling in a rising interest rate environment, you will be losing some of that principal, it's unavoidable.

As well, if bonds are paying 2% right now, your return outside of the principal is 2% until the individual bonds within start to expire, even if HISA interest rates have gone to 5% in the meantime.

Third point, inflation.
Historically the rate inflation including the cost food and fuel has been over 3% most years, the average being over 3%, so 2% minus the loss of principal when interest rates are rising, minus the lag cost of locking in just doesn't cut it for me.

Fourth point, dry powder; it's nice to have it on hand for another '08/09 event, and bonds aren't even paying a premium over HISAs right now to give that up for.
And if you need to dip into a bond fund like tdb909 to rebalance in an equity downturn, you run the risk of selling at a loss, which will never happen with a HISA.

eulogy I don't get where you're coming from when you say regurgitated fear; I'm not afraid of bonds I am not advocating excluding bonds from a portfolio, but I personally see no logic in holding them right now and remain to be convinced of any logic in it in the present scenario.


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## Retired Peasant (Apr 22, 2013)

GoldStone said:


> While bond fund itself doesn't mature, the bonds held by the fund do mature. As they mature, the fund reinvests the proceeds in new bonds. In the rising rate environment, these new bonds will bear higher yields than the old ones.





eulogy said:


> I don't see anyone dissing on the bond ladder, but a bond fund is sort of like that where things mature and new things are bought. In fact, I've run into people that put down bond funds and at the same time hold bond ladders.


It is my understanding that the big difference is that bond funds do NOT hold all their bonds to maturity, while a retail investor with a ladder is likely to do so. The funds are trading bonds or have to sell bonds to meet redemptions, etc. I'm not sure what portion of bonds are actually bought at issue and held to maturity by a fund, but I'm left with the impression that it's a small portion.


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## james4beach (Nov 15, 2012)

GoldStone said:


> While bond fund itself doesn't mature, the bonds held by the fund do mature. As they mature, the fund reinvests the proceeds in new bonds. In the rising rate environment, these new bonds will bear higher yields than the old ones.


This is generally true, however many bond funds don't even hold the bonds to maturity. Because they do lots of trading, many bonds are sold back to the market (at a loss) before maturity. I suspect that the result of that is the bond funds will achieve worse-than-expected returns in a rising rate environment.

Then everyone will scratch their heads for 5-10 years about why bond funds did so badly and figure out it's due to the heavy bond trading. After all this is the same reason bond funds did so well in a declining rate environment; they were getting capital gains by trading bonds out before maturity!

But yes I agree, if in the rising rate environment the fund just holds the bonds to maturity it's not a big deal, thanks to the replacement bonds with higher yields. I just don't trust the bond fund to do this; so I do it myself, buying the bonds and holding to maturity.

Myself, I have a big 10 year ladder with a mix of GICs and government bonds. I treat both of them the same way: I buy them today, they mature at a known future value, so the yield is predetermined. No difference throwing GICs vs bonds into my ladder, except the bonds are liquid (a big plus) and the bonds do show a _temporary_ price decline in rising rates.



> The key number to look at is the fund *duration*. If you hold the fund for longer than its duration, you will not lose the capital. TD e-fund duration is about 6 years. If your time horizon is longer than that, interim price fluctuations should not matter to you.


Generally that's good advice, I think.


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## james4beach (Nov 15, 2012)

Let me also clarify, because CC has corrected me before, that my ladder of GICs + bonds does show declines in account value as interest rates rise.

Over this summer I think my portfolio value is down 1% or so, because my bonds have fallen in value. However by holding everything to maturity I know that I will never realize a loss. The returns will always be positive and bonds will never be sold for a loss -- unlike a bond fund, which may sell bonds at a loss.

I really like the ladder approach. I know exactly what my portfolio yields, and it's much higher than any bond fund or bond ETF (due to the very high MERs on bond funds). My "MER" is around 0.05% versus 0.33% for XBB of course much higher for mutual funds.


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## HaroldCrump (Jun 10, 2009)

james4beach said:


> This is generally true, however many bond funds don't even hold the bonds to maturity. Because they do lots of trading, many bonds are sold back to the market (at a loss) before maturity.


Are there bond funds that are required to maintain a certain average term to maturity or average duration as part of their mandate?
If so, then they will be compelled to sell bonds prior to maturity to maintain those requirements.
For example, a long duration bond fund may be required by mandate to maintain an average duration of 10+ years.


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## GoldStone (Mar 6, 2011)

Retired Peasant said:


> It is my understanding that the big difference is that bond funds do NOT hold all their bonds to maturity, while a retail investor with a ladder is likely to do so. The funds are trading bonds or have to sell bonds to meet redemptions, etc.





james4beach said:


> This is generally true, however many bond funds don't even hold the bonds to maturity. Because they do lots of trading, many bonds are sold back to the market (at a loss) before maturity. I suspect that the result of that is the bond funds will achieve worse-than-expected returns in a rising rate environment.


Cmon. Do you think they sell bonds before maturity just so they can incur losses?

*Bond funds sell bonds before maturity to boost their returns*. The strategy is called "rolling down the yield curve" or "riding the yield curve". Google both terms. You will get millions of hits. It's a basic bond trading strategy.

http://www.learnbonds.com/rolling-down-the-yield-curve/

The strategy doesn't work if the yield curve is flat or inverted, which is rare. Normal yield curve is sloped upwards.

Retail investors holding a bond ladder cannot use the strategy because of wide retail spreads.


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## liquidfinance (Jan 28, 2011)

That is one of my concerns with Bond funds. I agree in principal that if you hold beyond the duration then you should never lose.

I guess if you want to be certain of the return then you either build your own bond ladder and buy the bonds directly or buy a target maturity fund.

The target maturity funds don't look very appealing at all.

http://etfs.bmo.com/bmo-etfs/glance?fundId=83029
http://etfinfo.rbcgam.com/exchange-traded-funds/fund-pages/rqh.fs


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## james4beach (Nov 15, 2012)

GoldStone said:


> Cmon. Do you think they sell bonds before maturity just so they can incur losses?
> 
> *Bond funds sell bonds before maturity to boost their returns*. The strategy is called "rolling down the yield curve" or "riding the yield curve". Google both terms. You will get millions of hits. It's a basic bond trading strategy.


And nothing wrong with that but it's not the whole story. These bond funds track indices and as Harold alluded to, they have requirements for certain portfolio average maturities. So they're not only selling bonds in trading profit scenarios.

I don't have full details on this but it seems to me that if the bond ETF tracks a bond index, it is required to trade bonds in and out of its portfolio to match the composition of the index

But you are correct that bond funds have that opportunity to ride the yield curve for extra profit, unlike retail investors.


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## andrewf (Mar 1, 2010)

It's not necessarily true that you can never lose if you hold for longer than the duration. The duration is how long it takes for you to recover from interest rate changes.

As an example, if rates stay at current levels for the duration of the fund, then yields rise dramatically, the capital loss on the fund can more than wipe out the yield received to date. But, with higher yields you would come out ahead if you held for the duration at that point.

Ultimately, the fixation on getting back what you put in over a certain period of time is just an illusion. You can always lose in real terms, even with GICs or Gov of Canada bonds, and real terms is what matters.


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## GoldStone (Mar 6, 2011)

james4beach said:


> These bond funds track indices and as Harold alluded to, they have requirements for certain portfolio average maturities. So they're not only selling bonds in trading profit scenarios.
> 
> I don't have full details on this but it seems to me that if the bond ETF tracks a bond index, it is required to trade bonds in and out of its portfolio to match the composition of the index


I imagine that this can be an issue with long- and mid-term index funds. This concern should not apply to the universal funds (such as TD e-fund) that hold a wide mix of maturities. Universal funds have no reason to sell long- and mid-term bonds long before maturity.

Also note:

When a bond gets close to maturity, it trades not far from par. It yields very little, just like cash or a short-term note. It's really not a big deal if a fund chooses to sell a long bond 6-12 months before maturity,


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## james4beach (Nov 15, 2012)

I just can't shake off the feeling that these bond funds trade and churn a lot. Look at XBB's portfolio turnover rates. It's been 74% and 66% in the last two years!

That's really high turnover, right?

Of course that number may look artificially high if, as GoldStone says, they're just trading out before maturity.


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## andrewf (Mar 1, 2010)

james4beach said:


> I just can't shake off the feeling that these bond funds trade and churn a lot. Look at XBB's portfolio turnover rates. It's been 74% and 66% in the last two years!
> 
> That's really high turnover, right?
> 
> Of course that number may look artificially high if, as GoldStone says, they're just trading out before maturity.


Where did you get those turnover figures? They seem very high.


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## Sampson (Apr 3, 2009)

andrewf said:


> Ultimately, the fixation on getting back what you put in over a certain period of time is just an illusion. You can always lose in real terms, even with GICs or Gov of Canada bonds, and real terms is what matters.


^ This


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## AltaRed (Jun 8, 2009)

The turnover rate comes from the 2012 annual management report of fund performance.


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## My Own Advisor (Sep 24, 2012)

Those turnover rates are scaring me. Are you trying to scare me james4beach?


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## james4beach (Nov 15, 2012)

I'm not trying to scare you, I'm just trying to draw attention to documentation that nobody ever bothers to read 

Download the "XBB - iShares DEX Universe Bond Index Fund Annual MRFP" from
http://ca.ishares.com/product_info/fund/downloads/XBB.htm

Portfolio turnover rate is on page 8.


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## GoldStone (Mar 6, 2011)

iShares blog:

Q&A on Bond Funds and Churn: Why turnover can be misleading


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## james4beach (Nov 15, 2012)

Maybe I didn't understand their main point but I don't see any good excuse there for why XBB has such high turnover.

Their post says that fixed income funds are rebalanced monthly and there are many additions/deletions all the time. Is that supposed to make me feel better? There is high turnover because the index has high turnover. They are churning and trading all the time.

I still think that's a problem, especially in a rising rate environment where your bonds keep declining in value


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## andrewf (Mar 1, 2010)

I don't see what interest rates trends would have to do with it.


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## GoldStone (Mar 6, 2011)

james4beach said:


> Their post says that fixed income funds are rebalanced monthly and there are many additions/deletions all the time. Is that supposed to make me feel better? There is high turnover because the index has high turnover. They are churning and trading all the time.


They are also reinvesting coupons. They are also replacing matured bonds. They are also replacing bonds that got called.

When a bond matures, they *have* to add a new bond, don't they? The new bond will yield more in a rising rate environment.

The post says, don't pay attention to the fund turnover; pay attention to the index tracking error. If the tracking error is low, what's the problem?


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## GoldStone (Mar 6, 2011)

By the way:



james4beach said:


> They are churning and trading all the time.


This is not a fair characterization at all.

Governments and companies issue new debt all the time. Index providers are supposed to add these new issues to the universal index. Or, at the very least, a representative sample of the new issues.

And, as I said, index components mature all the time or get called. They have to leave the index.

What you describe as churning and trading is the natural life cycle of a bond index. Don't like it? Stick to the GICs.


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## james4beach (Nov 15, 2012)

OK so you're saying that this kind of high turnover is inevitable with a bond fund? Maybe that's true... it's probably why you're paying 33 basis points fees instead of just 5 basis points to buy & hold the bonds.

So perhaps it's all natural life cycle of the bond index, as you say. I wonder if it adds value at the end of the day. In my experience, generally the more frequently one trades, the more the small inefficiencies (bid-ask spreads) build up and detract from performance. Especially in the case of a broad bond index, which is heavy in corporate bonds, which tend to have wide bid/ask spreads.


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## GoldStone (Mar 6, 2011)

james4beach said:


> it's probably why you're paying 33 basis points fees instead of just 5 basis points to buy & hold the bonds.


You can pay a bit less if you go with Vanguard Canada. Aside from that, you know very well why Canadian ETF fees do not reach in the 5 basis points territory. It has nothing to do with the bond index turnover. There is no need to misrepresent the facts to advance your fear mongering agenda.



james4beach said:


> I wonder if it adds value at the end of the day.


*Institutions Flock to Bond ETFs*



> Institutional investors are increasing their use of ETFs for fixed income in order to gain exposure to the asset class.
> 
> “As decreased fixed income bond liquidity has driven institutional investors to explore new ways to access fixed income markets, fixed income ETFs are increasingly being used by investors to access liquidity and implement investment strategies,” said Matthew Tucker, head of iShares fixed income investment strategy at BlackRock.
> 
> ...


What do you know, James, that these institutional money managers don't? Please pray tell.


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## james4beach (Nov 15, 2012)

Why do you act as if you're personally insulted when I criticize bond funds?

Don't take offense... I also criticize stocks, real estate, annuities, and bank deposits. It's kind of my thing.


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## andrewf (Mar 1, 2010)

I think the irritation comes from the fact that more people than you might think are reading this, and may not know the context. Kind of like when people claim that in the last budget the government announced a plan to confiscate bank deposits. I feel compelled to contradict that every time I see it, because of the potential harm it could do to people.


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## GoldStone (Mar 6, 2011)

James, I'm not personally insulted but I'm tired of your incessant fear mongering. It's relentless.

Bond funds/ETFs are a basic building block in the couch potato strategy. Lots of people use them. You claim these products are flawed, yet you cannot explain what the problem is.

Criticism is fine if you can back it up by facts and knowledge. And if you can't, then you are just spreading FUD. Fear, Uncertainty and Doubt.


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## tiffbou2 (Jul 4, 2013)

head...spinning...lol...!

I think for now I'll stick with the Couch Potato recommendations. I called the number someone posted on here and they told me to see the branch to set up a regular mutual fund account and then do the conversion form, so we're booked to do that Friday. We may also be able to take advantage of the free money TD is giving for setting up auto withdrawal.


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## Dibs (May 26, 2011)

james4beach said:


> Why do you act as if you're personally insulted when I criticize bond funds?


IMHO the discussion between you and GoldStone has had strong differing opinions, but has remained remarkably civilized. I think this kind of debate, both sides of it, is valuable to the forums. 

Re: some comments from the OP:



tiffbou2 said:


> Funny, I saw my friend yesterday who is a branch manager at TD and I talked to him a bit about my plans. He seemed shocked that I wanted to do self directed investing. He said nobody he knows in "real" life does this. From being on this forum, it seemed to me that everybody does it. But when I think about it, I don't know any people in my circle (who I know of) who are self directed, except my father who only started a few years ago. Makes it seem a bit scary but exciting at the same time.


Yes, most of the people here are self directed investors. I was lucky enough to start off self-directed with help from my father. My brother is also self-directed.



tiffbou2 said:


> The TD "empire" is a bit confusing. I just assumed if something was under the "TD" umbrella, I could go into any branch and just get it. Had no idea these were all separate entities.


I'm not sure if this has been mentioned above, but there are two ways to invest in e-series at TD. The first way is to open a mutual fund account with TD Canada Trust. The second way is to open a brokerage account with TD Direct Investing (formerly TD Waterhouse). There are articles out there that talk about the pros and cons of both, but I can't find them at the moment. I personally use the brokerage account to invest in e-series, because I also invest in stocks.


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## Sampson (Apr 3, 2009)

andrewf said:


> I feel compelled to contradict that every time I see it, because of the potential harm it could do to people.


Just like the myth about 'yield'.
We could probably start a laundry list, ask CC and FT to post a sticky entitled "beware the following misconceptions"


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## AltaRed (Jun 8, 2009)

Dibs said:


> I'm not sure if this has been mentioned above, but there are two ways to invest in e-series at TD. The first way is to open a mutual fund account with TD Canada Trust. The second way is to open a brokerage account with TD Direct Investing (formerly TD Waterhouse). There are articles out there that talk about the pros and cons of both, but I can't find them at the moment. I personally use the brokerage account to invest in e-series, because I also invest in stocks.


It was mentioned already and the OP has decided which way she plans to go. There is no advantage opening an account with TD Direct Investing until either: 1) the minimum threshold is met for zero account fees, or 2) the OP wants to expand investing beyond e-series funds.


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## GoldStone (Mar 6, 2011)

One more point to OP. I don't think it has been mentioned.

You are setting up a new couch potato portfolio. You will be making regular auto contributions. Each contribution will purchase a small amount of e-funds. If you notice any of your funds dropping, _it's really to your advantage_. You will be able to purchase _more assets_ with your future contributions. This is no different from groceries going on sale in the supermarket.

Yes it's true that bond funds can drop in value and stay down for a few years. You should celebrate it (big sale!!!) rather than fear it. The lower price you pay, the better your return will be.

Some of the posters who dismiss bond funds sit on the large portfolios. Their main goal is to protect what they have. They don't want to see any red ink in their account statements, even temporarily. You have a very different perspective.


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## tiffbou2 (Jul 4, 2013)

GoldStone said:


> One more point to OP. I don't think it has been mentioned.
> 
> You are setting up a new couch potato portfolio. You will be making regular auto contributions. Each contribution will purchase a small amount of e-funds. If you notice any of your funds dropping, _it's really to your advantage_. You will be able to purchase _more assets_ with your future contributions. This is no different from groceries going on sale in the supermarket.
> 
> ...


Thank you for all your advice. Your posts have been easy for me to understand and I really appreciate that. 

I will be a REAL couch potato - I won't be stalking my investments. I am lucky that I can retire with my full, solid pension at 55 and plan to do so. The loose plan is for my husband to be able to retire around the age of 60 (he has no pension) and the RRSPs will not be touched until that time or later so I am looking at long term investing of approximately 25 years. I'm not worried about short term investment losses at all. From what I understand, with the couch potato strategy, I just rebalance quarterly to reflect the 20/20/20/40 ratio and then sort of forget about it. I'm good with that for a starting point. 

Husband has another RRSP worth $30K with Quadrus with a high MER (3%). If I can get a handle on self-direction, I may transfer that money into the e-funds as well. I don't think I'm fully going to understand it all until I actually do it.

PS - I LOVE a big sale!! Will there be shoes? No? Oh well.


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## AltaRed (Jun 8, 2009)

tiffbou2 said:


> From what I understand, with the couch potato strategy, I just rebalance quarterly to reflect the 20/20/20/40 ratio and then sort of forget about it. I'm good with that for a starting point.


You shouldn't re-balance quarterly (think about it on an annual basis which is good enough). That said, you shouldn't need to re-balance through selling overbalanced stuff to buy underbalanced stuff. Simply put your new money into the portions that are under-balanced.


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## james4beach (Nov 15, 2012)

GoldStone said:


> James, I'm not personally insulted but I'm tired of your incessant fear mongering. It's relentless.


Well tough beans. Don't have such a low tolerance for contradicting, minority opinions. I don't believe for a second that you are _in any way_ suffering from my bearish, contrarian viewpoints.

If you ever miss the pleasant, reassuring, perpetually bullish happy-talk in your life than it's easy enough. Just turn on the TV, pick up any news paper, open any magazine and you'll see a zillion articles assuring you that stocks always go up, banks never fail, pensions are solvent, mutual fund managers are honest, ETFs are flawless.

99% of the viewpoints out there are along those lines, and I provide some information along the other 1% of the viewpoints. We can't all be surrounded by 100% perpetual bull zen all the time. In this case all I pointed out -- accurately -- was that bond ETFs engage in large amounts of internal trading. It's part of the bond index approach. I'm questioning whether it's such a great thing.


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## GoldStone (Mar 6, 2011)

True to form, your rhetoric is way over the top.


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## AltaRed (Jun 8, 2009)

james4beach said:


> In this case all I pointed out -- accurately -- was that bond ETFs engage in large amounts of internal trading. It's part of the bond index approach. I'm questioning whether it's such a great thing.


It's not a bad thing if costs are kept low. The important thing is to be close to the index (low tracking error). That is the real measure of efficiency and bond ETFs do that fairly well. 

The alternative is a DIY bond ladder with higher bid/ask spreads and commissions, especially in smaller denominations, for retail investors. You can see the differences when you request quotes at $5k, $10k, $20k, etc. Institutional investors pay a fraction of the costs retail investors do. 

IOW, I wouldn't have any cause for concern regarding bond ETFs and for most investors, it is the only way to have an effective bond ladder.


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## james4beach (Nov 15, 2012)

I'll agree that a bond ETF is as good as it gets, for a passive fixed income investment with no effort required. If I was forced to buy a fund product, it would be XSB or XBB.

Still in Canada you're paying some enormous bond ETF fees, like with XBB: the MER is 33 basis points, and yield before fees is 273 basis points. You are throwing away 33/273 = 12% of the interest on management fees! Think of that. 12% of the interest goes to the manager!

AltaRed: those spreads for the retail investor aren't as big as you make them out to be. TD Waterhouse and iTrade revolutionized the market in retail bonds. On bonds the total fee is $25 per trade and on very liquid issues like government bonds there is hardly any noticeable bid/ask spread. So when you throw in these *qualifiers*: that (a) you hold to maturity and don't sell, (b) you buy only liquid bonds and (c) each bond has at least 5 years to maturity ... do the math and you'll see that a retail investor can easily achieve bond portfolio costs as low as *10 basis points* annually, even with those tiny $5k retail purchases!

With slightly larger purchases and longer maturities, like I have, I'm able to achieve as low as *5 basis points* fees annually. Mine is probably more around 4 bp. So a retail investor can have a bond portfolio with something like 5 to 10 bp fees ... dramatically less than the 33 bp of XBB. Of course if you start selling bonds out of your portfolio, your fees will creep up but not as much as you think. Liquid bonds can be sold, if you need to.

Sure a bond ETF is convenient, and it's more liquid (yes), and it's not fair to compare a DIY approach to a fully managed fund like XBB. I agree on that.

But I still can't get over how high the bond ETF fees are. I used to think the ETFs were benefiting from institutional pricing and thus saving lots of trading costs. This is what you are implying too when you wrote about small denominations. But I no longer think so. Now I think the bond ETFs are ripping off investors with unjustifiably high fees. This is why personally I don't hold any bond funds, but instead use GICs, individual bonds, and savings accounts.

Say that someone had a 500k fixed income allocation for 20 years, and accumulating but not selling. Now look at the difference in fees

a) with bond fund/XBB you're paying $1650/yr in fees or $33,000 over 20 years
b) with DIY bond portfolio you pay $250/yr in fees or $5,000 over 20 years
c) GICs also achieve similar performance with $0 fees

To me it's no contest. If you have significant money in fixed income, and you're willing to put in some work, use individual bond purchases or GICs.


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## james4beach (Nov 15, 2012)

By the way, I can see how bond funds make good sense if you're frequently selling fixed income. So if your position keeps growing and shrinking, the fixed income ETF works well as you have trading liquidity. In such a case, even an e-series bond fund could be fine.

But for anyone who is just accumulating savings (e.g. an RRSP account) over long periods, I can't see the appeal of the bond ETF vs the other options I described.


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## liquidfinance (Jan 28, 2011)

james4beach said:


> By the way, I can see how bond funds make good sense if you're frequently selling fixed income. So if your position keeps growing and shrinking, the fixed income ETF works well as you have trading liquidity. In such a case, even an e-series bond fund could be fine.
> 
> But for anyone who is just accumulating savings (e.g. an RRSP account) over long periods, I can't see the appeal of the bond ETF vs the other options I described.


Not even taking advantage of Questrade free etf purchases and reinvesting distributions into a bond fund to build the bond allocation?


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## AltaRed (Jun 8, 2009)

james4beach said:


> By the way, I can see how bond funds make good sense if you're frequently selling fixed income. So if your position keeps growing and shrinking, the fixed income ETF works well as you have trading liquidity. In such a case, even an e-series bond fund could be fine.
> 
> But for anyone who is just accumulating savings (e.g. an RRSP account) over long periods, I can't see the appeal of the bond ETF vs the other options I described.


I would always use the bond ladder approach rather than an ETF (and do), but the vast majority of people do not have the resources (or the desire) to build a 10 year bond ladder which is what they should do. I forget the stats, and don't quote me on it, but I seem to recall the average RRSP is only about $250k in size and only about 2/3 of the population have RRSPs at all. 

Given a lot of CMF readers are novices, or early investors, I am loathe to 'scare' them off index bond mutual funds or bond ETFs and hence the reason I am pushing back. It is much better for them to be in an e-series bond fund, or bond ETF, than to squirrel away the cash in big bank GICs or lowly savings accounts. Those of us with considerably more resources and/or investing sophistication already subscribe to your argument.


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## GoldStone (Mar 6, 2011)

AltaRed said:


> Given a lot of CMF readers are novices, or early investors, I am loathe to 'scare' them off index bond mutual funds or bond ETFs and hence the reason I am pushing back. It is much better for them to be in an e-series bond fund, or bond ETF, than to squirrel away the cash in big bank GICs or lowly savings accounts.


Exactly.

James, remember the context of this thread. The OP is a novice investor. She is taking baby steps to learn the basics of DIY investing. She will use automatic monthly contributions to dollar cost average a couch potato portfolio. Don't scare her with a highly technical discussion meant for advanced investors. E-series bond fund is a perfect product for a novice couch potato. Simplicity is a BIG virtue here.


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## james4beach (Nov 15, 2012)

OK actually you guys are right... I totally lost context here and thanks for bringing me back to reality.

You're right. For the OP, it is a good idea to use the e-series bond fund and yes for this situation, I do endorse the e-series bond fund.

I would still encourage her to consider GICs as they can be purchased in small units ($1000)


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## james4beach (Nov 15, 2012)

I'll have to remember this next time I jump into a thread and forget where the discussion began.

Goldstone & AltaRed: you guys are right


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