Stocks, Bonds & Cash: Simple 3-ETF Portfolio for Beginner Investors
Beginner investors can easily mix and match different ETFs to create an ideal starter portfolio.
The Canadian ETF universe is ever-growing, with an increasingly large number of exotic, specialized, and complex funds debuting by the day. Some of the ones we covered last year include thematic innovation ETFs, liquid alternativeETFs, and low-volatility ETFs.
However, I think there's still elegance in a passively managed ETF portfolio that covers the basic building blocks of stocks, bonds, and cash. This approach offers great simplicity, low fees, minimal tracking error, and maximum diversification, all of which help investors capture more returns.
To implement this approach, beginner investors can use the NEO ETF Screener to screen for appropriate ETFs in each of these asset classes. In the meantime, this article will provide an example of a balanced 3-ETF portfolio of stocks, bonds, and cash, along with suggestions for ETFs to use.
The stock allocation
The Canadian equity ETF segment is massive. Investors have access to all sorts of ETFs, including those tracking thematic, sector, and broad-market equities. With this in mind, our goal with the portfolio's stock allocation is threefold:
- Ensure maximum diversification by tracking worldwide equities weighted by market capitalization and capturing all 11 GICS stock market sectors.
- Use a passively managed index ETF to keep expense ratios and fund turnover low.
- Implement a Canadian home-country bias to improve tax-efficiency, lower volatility, and reduce currency risk.
The best candidates here are all-equity asset allocation ETFs. These ETFs hold a mix of U.S., Canadian, international developed, and emerging market equities and rebalance periodically. Clicking on each of the options below will take you to a page that describes their holdings, expense ratios, and other details.
The bond allocation
Bonds may have been a stinker in 2022, but historically they have been an indispensable portion of a diversified portfolio. In the aggregate, an allocation to high-quality bonds can help investors lower volatility and reduce drawdowns, which provides a much smoother sequence of returns.
Many Canadians opt for holding solely Canadian aggregate bond ETFs. These ETFs hold a mixture of Canadian federal/provincial government bonds in addition to investment grade corporate bonds with an intermediate duration. I like this approach for many reasons (see this article for why).
- Vanguard Canadian Aggregate Bond Index ETF (VAB)
- iShares Canadian Universe Bond Index ETF (XBB)
- BMO Aggregate Bond Index ETF (ZAG)
Alternatively, investors looking for maximum diversification can use global CAD-hedged bonds. Just keep in mind that your returns might be slightly lower due to foreign withholding tax and the cost of currency hedging. In addition, many of these global bond ETFs charge a higher expense ratio.
The cash allocation
Cash is the ultimate safe asset. When stocks and bonds fall in tandem (as they did in 2022 when interest rates rose), cash can maintain its value. For retirees, a cash allocation can help ensure safe withdrawal rates. For younger investors, even a small amount of cash can provide psychological comfort.
The downside of holding cash is that it loses value every year to inflation. A way to offset some of this is by investing cash balances in money market ETFs where investors can earn a higher yield on their cash deposits. Commonly, this takes the form of various high-interest savings account (HISA) ETFs.
Putting it together
The actual allocation an investor allocates to each asset class is dependent on their risk tolerance and time horizon. Generally, younger investors who can stomach more risk may opt for a more aggressive allocation of more stocks versus bonds and cash. An example might be an 85/10/5 allocation.
For older investors, a higher allocation of bonds and cash is sensible if capital preservation and income is the goal. In this case, a 50/40/10 allocation might be ideal. Keep in mind that these figures are general rules of thumb and should not be relied on as a one-size-fit-all allocation.
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.
