Baking An Investment Pie

Updated: Dec 2, 2021

A friend from the USA mentioned to me today they had a colleague who only invested in USA assets, and had never considered any foreign investments. She asked if I thought this was a logical approach, to which I said, … “not to me?”.

To start to fully answer this question and form an answer, first we need to take a quick look at the world economies and how they rank in terms of nominal GDP. The simple definition of GDP is, “Gross domestic product (GDP) is the total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period”. This value respresents the breadth and power behind a country's economy, and it’s overall presence and size in the world market.

Below is a list the largest economies in the world.

  1. United States (GDP: 20.94 trillion)

  2. China (GDP: 14.7 trillion)

  3. Japan: (GDP: 5.06 trillion)

  4. Germany: (GDP: 3.8 trillion)

  5. United Kingdom: (GDP: 2.7 trillion)

  6. India: (GDP: 2.62 trillion)

  7. France: (GDP: 2.6 trillion)

  8. Italy: (GDP: 1.88 trillion)

  9. Canada: (GDP: 1.64 trillion)

  10. Brazil: (GDP: 1.45 trillion)

The total GDP of the top 10 economies equals $57.39 trillion. Though the USA stands out as a powerhouse in the pack of 10 at $20.49 trillion, if you add up the next 9 largest economies and consider that they are all outside the USA as foreign assets, you will see together they hold a whopping 64% of the remaining world economy. To not hold some, if not all, of these markets is missing an opportunity to fully diversify your portfolio and take opportunity of growing economies in other countries. This becomes even more obvious living in Canada, as our market is just a small fraction (3%) of the world market. It would be silly for Canadians to not have a decent portion of money vested in the global markets.

So here is where I default to Vanguard products, which is the low cost ETF (Exchange Traded Fund) provider in Canada that I personally like and use, and always gravitate towards as an example. They have platforms in both Canada and the USA, and several ETF offerings to satisfy these demographics in terms of mix and tax efficiencies. Vanguard is one of the largest ETF providers and also has offices in Europe, Asia, Mexico, and Australia. Their products are taylored to the countries they operate in, and their ETFs can be bought and held in that country’s stock market.

Another reason I like the Vanguard suite of ETFs is they don’t offer a huge selection to confuse you (here in Canada anyways). You can pick from their offerings to make your own mix of markets and assets to reduce your costs, or for a bit more fee-wise, you can buy an all-in-one and forget about it. The all-in-one ETFs are designed to deliver to specific fund targets and are balanced for you. Just to give one example of an all-in-one, below is Vanguard’s VBAL, a conservative growth ETF with offered on the TSX (Toronto Stock Exchange).

There are several other asset allocation ETFs offered in Canada, which makes building a diversified portfolio with automatic balancing easier for a marginally higher fee. You just need to find an ETF or mix of ETFs that satisfy your goals and risk tolerance, open a brokerage account, and start buying it.

In the USA Vanguard platform, I could not find and asset allocation (all-in-one) ETFs like they offer in Canada. Maybe I was just looking in the wrong place, but I could not find any? They do, however, offer a number of different total market equity and bond ETFs that you can simply blend together to meet your goals, and all the tools to help you. Here’s a link to some of Vanguard’s top ETFs offered in the USA on the S&P 500.

For a US portfolio, a mix of VTI (US equites), VXUS (global equities), and BND (US bonds) would give you a broad swath of the world’s equity market indices and some US bond exposure, for example.

Vanguard offers online tools to build your own portfolio mixes of their ETFs based on your answers to a questionnaire, and/or alternatively, robo-advisor options. A robo- advisor is a digital platform that uses customer inputs to automatically invest them into a mix of ETFs to meet their goals and risk profiles, then manages their balances and investing for them.

What should your mix be? That’s always a personal question. It depends what returns you expect, the time horizon you are working with, what risk you are comfortable with, and whether you are still working (accumulating wealth) or retired (decumulating wealth). For example, if you are in retirement you likely want a more stable portfolio for withdrawal comfort. While if you are still working, you have income and can let your investments work and grow. Inherently, the more risk you can tolerate, the higher the returns over time. However, if time is not on your side, your risk tolerance might shrink. Below are some model portfolios published by Vanguard to give you an idea of risk versus reward.

The final consideration in building your portfolio is the tax component. There are withholding taxes applied to all investments when they are cashed in and/or removed from tax sheltered accounts. Tax, like death, is inevitable, but it should not worry you or prevent you from diversifying your portfolio. The best practice (very simple version) for managing taxes is to hold foreign investments and bonds in your tax sheltered accounts, and if there’s any excess investment to keep it as sovereign equity investments inside taxable accounts. This is because sovereign equity investments are favored for tax relief to encourage investment in your own countries. In Canada, the tax on Canadian equity investments is 15%, while foreign equity and bond holdings are 20-30%, .. for example.

In summary, diversifying your portfolio with world market exposure is going to give you growth and resilience on a much larger scale. Putting all your eggs in one basket (one country) is an added level of risk. Building a diversified portfolio that you support takes a bit of homework, and all the financial institutions have the portfolio building tools and advisors to help you if you want. Tax should not scare you, but tax strategies and efficiencies should be considered. Arguably, taking more risk while you are young and working will net you better returns over your investment horizon. Dialing down and taking less risk as you enter retirement might be your strategy if capital preservation during your withdrawal stage is your main goal. It’s ok to review and change your investment approach as you become more knowledgeable with investing and comfortable with risk.

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