Canadian Investors: Asset Allocation or Target-Date ETFs?
Both of these products make for great investments. Here's the guide on how to make the right pick.
Earlier this month, I covered the new lineup of target-date ETFs from Evermore. In short, these ETFs can provide hands-off investors with a low-cost, diversified, and automated approach when it comes to retirement planning. If you're interested in learning more, give this article a read.
I expect the launch of these ETFs to compete with the popular suite of asset allocation ETFs that have been available on the Canadian ETF market since 2018. Notable fund managers like Vanguard, iShares, and BMO (along with many others) have attracted high inflows when it comes to this product line.
If you're a DIY investor in 2023 seeking maximum simplicity, you now have two options: asset allocation and target-date ETFs. Given the new status of the latter, some investors may be confused as to which one to pick. Here's my breakdown of the asset allocation versus target-date debate.
Asset Allocation & Target-Date ETFs: Similarities
The Evermore series of target-date ETFs and the slew of asset allocation ETFs out there all share similar characteristics when it comes to portfolio construction. With some slight variations, both have:
- A 20-30% overweight to domestic Canadian equities, which is called a home-country bias.
- Market-cap weighted allocations to U.S., international developed, and emerging market equities.
- High allocation to aggregate Canadian government and investment-grade corporate bonds with an intermediate duration plus some U.S. and international fixed-income exposure.
- A "Fund of funds" or "ETF wrapper" structure that is composed of holding numerous other underlying ETFs.
- Excellent relative tax-efficiency and low management fees compared to mutual funds.
Asset Allocation & Target-Date ETFs: Differences
The main difference between asset allocation and target-date ETFs is with regards to whether or not their asset allocation mix remains static or changes dynamically over time:
- The asset allocation ETFs follow pre-determined allocations of stocks and bonds and will rebalance back to that mix based on bands or as scheduled. For example, the Vanguard Balanced ETF Portfolio (VBAL) will target a static 60/40 mix of stocks and bonds at all times.
- The target-date ETFs adjust their asset allocation over time to become more conservative. This is known as a "glidepath.” For example, the Evermore Retirement 2060 ETF (ERGO) is intended for young investors planning to retire around 2060, and currently has an aggressive asset allocation of around 95% stocks and 5% bonds.
If we fast-forward 20 or so years, VBAL will still be 60/40 stocks/bonds, assuming Vanguard's methodology hasn’t changed. On the other hand, EGRO will have shifted its asset allocation to something more conservative like 70/30 stock/bonds.
Finally, it's worth noting that the Evermore target-date ETFs currently charge a higher expense ratio than most asset allocation ETFs. For example, VBAL currently charges an expense ratio of 0.24%, while EGRO has a management fee of 0.35% and targets an expense ratio of 0.45%.
Keep in mind that this can change, and I wouldn’t be surprised if Evermore slashes fees once assets under management grow.
Which is right for you?
The answer to this question depends on your personal circumstances, which means assessing your investment objectives, risk tolerance, and time horizon.
If you don’t mind swapping out ETFs as time goes on, then an asset allocation ETF can be right for you. To decrease risk as you get older, you'll have to sell your asset allocation ETF and buy one with a more conservative mix. Or add extra bond or cash ETFs.
The other straightforward reason to pick an asset allocation ETF is its lower cost. Right now, by opting for an asset allocation ETF you are saving around 0.20% in annual expense ratios. This can add up over time, assuming that Evermore doesn't eventually lower fees.
On the other hand, if you want the ultimate hands-off investment, then a target-date fund is right for you. There's no need to change your asset allocation later. Investment management becomes as simple as buying more shares periodically.
For investors who have a hard time not tinkering, the increased expense ratio of the Evermore target-date funds can easily be worth the peace of mind. Some investors simply cannot resist trying to time the market or chase hot asset classes, and this can cause a significant drag on returns.
In the words of Darcy Howe, a founding member of Merrill Lynch Private Banking: "I've always felt that investing is like a bar of soap. The more you handle it, the smaller it gets."
Sometimes, keeping things simple and staying hands-off is best, and the Evermore target-date ETFs offer the easiest way to accomplish that.
Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.
