Is VEQT Costing You? (& Other Questions) | #416

25:49It's actually interesting, just like a good company in the stock market, like a really good business like Google or Nvidia or whatever, they get really big because they're good companies, because they're profitable. They've got low discount rates because the market perceives them as not being risky, good growth prospects and all that stuff. You end up with a big stock. It's similar in the market for manager skill where a really, really skilled manager that's really good at identifying opportunities in the market, they can command a larger fund before they have a negative alpha, at which point assets would leave and things would go in the other direction.

26:23So skilled managers do benefit from their own skill by being able to manage larger funds, but the investors in the funds don't get to benefit. I love this model because it's like, we don't have to say active managers are not smart or skilled. They are, but they're in a competitive market for manager skill and investors have a hard time benefiting unless they can identify winning managers before the fact, just like with picking stocks. It's interesting because that there's such a strong theoretical basis for that. It's an intuitive argument. I think we all kind of understand it at that surface level, but the fact that there's that sort of empirical data and theoretical argument behind it is compelling.

27:02I love it because like I said, it's easy to say, well, active managers are just dumb. They're not smart, but I think that's wrong. They are smart, but they're competing with other smart people and investors are competing to benefit from their skill. And so you get an equilibrium where investors don't benefit, but managers do. I'll read the next one. Portfolios are comprised with some allocation of equity and fixed income, stocks and bonds. How should defined benefit pension plans be treated in this context? They ultimately become an annuity, but in terms of portfolio construction, can they be treated as fixed income?

27:33Your TFSA could be a hundred percent equity like in XEQT, that's the iShares Equity Asset Allocation ETF. And then the pension would be the fixed income component. Furthermore, does having a defined benefit pension increase one's risk appetite? Say an individual's risk tolerance suggests they should have a 40 % equity, 60 % fixed income portfolio. Would having a defined benefit plan shift the makeup to 60 % equity, 40 % fixed income? And that's from freaking Fresh. That's their name in the rational reminder community? I really like this question and it's one that I've got from clients many times.

28:07I guess my first comment on it would be, I often hear people say, well, my pension is like fixed income. And I said, well, I don't think that's a helpful way to think about it, at least not in terms of portfolio construction and management. So let's say, for example, I'm working with a client and they have a million dollars in their TFSA, RSP, whatever, and they have a DB pension. and our target asset mix is 50-50. Let's keep it easy, right? So they have 500 ,000 in stocks. They have 500 ,000 in bonds, GICs. Well, how am I factoring in the DB pension? Am I taking the present value of their DB pension, which is A, not necessarily easy to calculate and B, not very useful.

28:52I can't rebalance by selling half of their pension and deploying it in a different way. So it's just not really a useful framework for thinking about this. So if we use what the framework for discussing risk appetite, which is Larry Suedro's ability, willingness and need to take risk, which I really like using, you could look at it and say that a defined benefit pension plan, it increases your ability to take risk because you've got this potentially stable source of income that will be there even if markets crash. So you have more ability to take risk. You have less need to take risk, presumably, because you've got this guaranteed income source as well.

29:39So if you will, they kind of cancel each other out. And now really the main variable is your willingness to take risk. And that is temperamental. That is not really about the numbers here, right? So when the person asks, for example, you know, does having a defined benefit pension increase one's risk appetite? Well, as I said, it increases your ability to take risk, but that doesn't mean you're going to react to stock market volatility any differently. Potentially, I suppose it could. I can hear an investor sort of saying to themselves, well, yes, the market crashed 20%. I lost how much money in my portfolio, but at least I have my pension, it can reduce or sorry, increase your willingness, I suppose, to take risk in some way.

30:24But I think at the end of the day, you have to put this into the software and you have to just include it as part of a financial plan. And if you see that the presence of a pension increases your likelihood of reaching your retirement goals with a less risky portfolio, then you have the option to reduce the risk in your portfolio. And by the same contrast, you also have the option to increase it if your thought process is, well, I want to maximize my state, for example, and I'm willing to tolerate a bit of volatility because all of my main expenses are met by my defined benefit pension plan. So maybe it's a long way of saying it, but see the pension in context of your financial plan and not think about it as a fixed income asset, because I just don't think that that's a helpful way to frame the question.

31:21Yeah, I agree with most of what you're saying, Dan. It comes down to risk capacity, not risk tolerance. Risk tolerance is almost a state of mind, like how much willingness you're able to take on in your portfolio and having a pension may not change your perspective on how your portfolio goes up and down. That being said, I think it also comes down to investors individual circumstances like i've had clients where their pension covers all of their regular expenses therefore the portfolio is just for any ad hoc expenses or possibly even just earmarked for the next generation so then if there's a case like that where you're talking about there's a different objective for your portfolio that gives you the ability and maybe the willingness to take on that risk because you're no longer looking at it as I need this money to cover my retirement needs.

32:15Like I'm more than covered. In some cases, people are actually saving money from their pension income and not spending it all. So that gives them the ability to take on more risk in their portfolio. Or on the flip side, if everything's covered and people have a more conservative risk tolerance, they may say, no, I actually want to take on less risk in my portfolio because I know that I'm covered. It gives you the flexibility on both sides of the equation. It is an interesting question. It comes up a lot, especially being in Ottawa, where we are lots of folks employed by the government who have those types of pensions.

32:50We do a behavioral risk tolerance assessment on our clients when we're figuring out how to invest their money. And if someone comes back as a very conservative investor with the risk tolerance questionnaire, maybe it was affected by the fact they had a pension. I don't know. But if it spits that out, we're not going to say, well, no, you should take a whole bunch more risk because your pension says you should. That behavioral piece is not going to change. And interestingly, this is just anecdotal, but what I've seen is people with pensions tend to have a bit more of a conservative risk profile anyway.

33:23And maybe that's because their portfolio tends to be smaller than someone that has to save it all on their own. So they may actually be more inclined to maintain a smaller allocation to equities in their portfolio because they've built this habit of contributing to their pension and they feel comfort with that. There could be even a selection bias where people who choose to build a career at a place that has a defined benefit pension may be more risk averse in general. Very possible. You want to read the next one, Ben? Yes. Next question. I'm confused about how fiduciaries work in Canada. I've seen in one of your videos in a brief clip explaining that Canada does not have a statutory fiduciary standard for financial advisors.

34:06However, PWL Capital website homepage Q &A outlines fiduciary duty for their clients. Does a fiduciary duty exist at the firm level for companies registered as portfolio manager? Does this apply to individual advisors registered as advising representatives? Or is this something that a court determines in a legal dispute? Would love to see you expand on this in a future AMA episode or a dedicated video. Love the podcast. Looking forward to see how you guys grow with OneDigital. And this question is from Phil. It is a good question. And it's one of those tricky ones where there's not like super, super clear guidance on it, but there was a discussion paper from the Canadian Securities Administrators back in 2012 that I think did a really nice job discussing the issues and outlining what probably applies.

34:54So PWL's client facing advisors are typically registered as portfolio managers through Ciro, which is one of the regulatory bodies here in Canada. And if they're not themselves registered as portfolio managers, they're going to be supervised by a portfolio manager. So we have some folks who are associate portfolio managers, for example, which is one step before becoming a portfolio manager, and they will be having a portfolio manager sign off on everything that they're doing. And then the other important piece here is that PwS client accounts are discretionary accounts. So if you are a portfolio manager, you can manage discretionary accounts, which means that as the portfolio manager, you can make changes to the accounts without calling the client for permission in order to keep their portfolio in line with their investment policy statement.

35:36That discretionary piece ends up being really, important to this distinction or definition of whether the fiduciary standard applies in Canada. As the question said, we do not have a statutory fiduciary standard. There's no specific law saying that portfolio managers must act as fiduciaries, but based on the setup, based on the fact that the accounts are discretionary and there's a high level of delegation and trust, the courts would interpret POBL's portfolio managers as having a fiduciary duty to clients. Again, that's outlined in lots of very nerdy detail in that 2012 consultation paper from the Canadian Securities Administrators.

36:18The other interesting thing about this, about the fiduciary duty idea as it pertains to financial advisors is that saying that you are a fiduciary will more than likely result in courts holding you to that standard. If you say you're a fiduciary, you will be expected to act in that capacity. To add some context there, like the question asked about manager versus advising representative or registered representative. I think the case you're describing is if someone is not a portfolio manager where you're held to that standard based on the portfolio manager code of ethics, and you're a registered representative with either CERO or an ICPM firm, or even an MFDA advisor, you could hold yourself out as a fiduciary advisor, partly as marketing, partly as just like, I'm going to do the best thing for my clients.

37:09This is where you're saying the courts could hold you to that standard if you hold yourself out as being a fiduciary. Yeah. One of the financial planning associations in Canada that issues a designation, they recently came out with this where their designation holders have to say that they are fiduciaries from a financial planning perspective. And it's just interesting to think about what does that actually mean? Because there's no law saying they're fiduciaries. There's no way for the credentialing body to really enforce it other than taking away the credential. But I think that what it does create is that if you are saying, I'm a fiduciary, I'm acting your best interest or I'm committing to act in your best interest, you will be held to that standard when push comes to shove.

37:54PWL does something similar, I guess. We do have the portfolio management piece, the discretionary piece, which highly likely does hold us to that standard, but we take the additional step of getting independently certified as acting in a fiduciary capacity for our clients by an organization called CFEX, the Center for Fiduciary Excellence. We're audited annually by them to keep that certification, but I think it also does what I just said, where we are saying that we're held to that standard. We are being audited by a third party to verify that we are acting in that capacity. And I think that does further hold us to that standard.

38:28This will date itself because it refers to Mark. Hi, Ben, Mark, Dan, and Cameron. First, I just want to say thank you for being such an incredible source of information. You've truly changed our lives and my family and I are grateful. question. Ben has made some powerful reasoning as to why index funds outperform active managers. However, some individual investors may feel that active managers are, well, maybe individual active managers are not constrained by investment mandates and larger capital size. Given this, is there a strong argument that individual investors, even educated ones, should still stick to index funds and not pick individual stocks?

39:04Ben's recent videos on index funds are extremely informative, but comparing just to active managers, actively managed funds, might not be the whole picture given their constraints. Thank you. Best wishes on your recovery and treatment, Ben. Best, Michael. That also dates yourself back to when you're going through cancer treatments. It sure does. As I mentioned earlier, this is an interesting question because we just talked about diminishing returns to scale in active management. Talk about Buffett's comments on the same topic. If an individual investor managing a small portfolio does not have that diminishing returns to scale issue because they're not attracting capital from investors.

39:42Maybe they do have a shot at being a persistent winning active manager for their own portfolio. In theory, Buffett does say in his 2016 letter to shareholders that there will be some successful active managers. There are of course, some skilled individuals who are highly likely to outperform the S &P over long stretches. But he also says that in his lifetime, keeping in mind that Buffett's been around for a while, even in 2016, and he's in the investment world as deep as you can be, or he was. In his lifetime, he has identified early on only 10 or so professionals that he expected would accomplish this feat.

40:18Buffett doesn't think there are many folks out there who can do this successfully. So that's one piece. And then the other thing is when you look at studies that have gotten access to individual investor accounts and asked how do individual investors tend to perform, they don't tend to perform very well on average. There are a few, I mean, to Buffett's point, I guess, but I'd say it comes down to conviction, risk management, and investing in the right things at the right points in time in your life. If you really think that you're one of the few investors who can beat the market consistently by picking stocks, and you have the capacity to absorb the downside if you end up underperforming, maybe, hey, shoot your shot.

40:55This is a piece that I don't think people tend to think about as much. You've got to manage the trade-off between managing your portfolio. If you've got a$100 ,000 portfolio and you're spending all your time trying to pick stocks, you got to manage the trade-off between that and investing in other things like career skills or starting a business or just enjoying your life. And then the last thing I'll say on this is that anecdotally, and this is very anecdotal and it's from me spending lots of time reading personal finance stuff online. There are tons of stories online from people who tried picking stocks.

41:28Maybe they were successful for a period of time, but they eventually realize that between the time commitment and often the poor performance relative to the market makes them realize eventually that they should just be investing at least most of their money in index funds. I'm sure there are people out there who have been successful at picking stocks, but most people probably won't be. That has to be part of the consideration when you go into it. I think it comes down to the question that we've talked about before. Is it a question of skill or luck. There's no doubt there's a lot of smart investors and portfolio managers out there, but there's a lot and you're competing against each other and there's all this information.

42:06What's going to give you the information edge over the market? Is someone that has a successful track record picking stocks a skilled manager or more skilled than someone else? Or did they just happen to get right by chance because they were in the right place at the right time? It's hard to know that for certain in any given case, but the statistics kind of indicate that it's more likely luck-based than skill-based. Yeah, there has to be some percentage of active individual investors out there who will outperform just by luck. It's impossible to distinguish those from the truly skilled ones. But I just wanted to go back to something that you had said, Ben Felix, about this idea of having enough time to do the research and that, because I hear this a lot.

42:54I feel like it implies that if you work harder at it, you will somehow have more success. And look, that might be true. Like clearly being a thoughtful investor who does their research is better than being a thoughtless person who throws darts. but this idea that if i only had more time i would be more likely to beat the market i mean when you look at the enormous percentage of professional money managers who failed to beat the market do we believe that any of them failed because they didn't have enough time to do their homework for sure costs are part of it as the questioner did mention like there's no question before costs, more active managers beat the benchmark than after.

43:41And yes, they can have constraints in terms of too much capital, as we've already talked about. But there's also an extremely important factor, which is it's really hard to do, even if you have a reasonable scale and your fees are very low. So let's not give people the impression that if you just had several hours a week, you know, to research stocks that you would somehow have a better than average likelihood of outperforming because I just don't think you would. An analogy that I just thought of is like a hockey pool. People that participate in hockey pools, there's some that are experts on the sport, know all the players, all the ins and outs of the team and who's more likely to win.

44:24But there's things that you don't anticipate there, whether it's injuries or drive or just by chance goal goes in. Often the people that win hockey pools are not the most knowledgeable in the sport. It could be just someone that literally threw darts at the wall and picked. These are the teams that are going to win and end up picking the right choices to get the Stanley Cup. Doesn't throwing darts actually beat a lot of investors down? There have been some famous, at least jokes about it. I'm not sure how much research involved dart throwing, but it does feel like that. The Wall Street Journal has done stuff on that where they've actually done it.

44:59I'd have to go and read what the results were. Maybe we can talk about that in a future episode. I'll take the next one. What are the reasons for underperformance of international stocks for such a long time? For the last 30 years, the US market return was 7.96 % inflation adjusted and ex-US international market return was just 2.37%. 30 years is a pretty long time horizon for any person. And the last 30 years includes a lost decade for US stocks as well. Psychologically, it's very hard to stick with international stocks. PS, I'm already international diversified and not planning to switch. And this question is from DJ.

45:40It has kind of sucked not being 100 % in US large caps, but that's the, one of the costs of diversification is that you always own whatever is losing at the time. This question is a really interesting time capsule. This is one of the benefits of, even though I feel guilty about not answering so many people's AMA questions, it's kind of fun answering questions from the, well, not too distant, but distant past, more than a year ago in this case. It's kind of fun because the context of the question is often different from our current context, which makes discussing the question, I think in many cases, more interesting.

46:13This was submitted in March, 2025. Since then, the iShares MSCI ACWI X US ETF, that's all country world index, excluding the US ETF, so US listed ETF, it has outperformed the iShares core S &P total US stock market ETF by just under 10 percentage points annualized. Staying in your seat is important. That's a big difference over a short period of time, but still it turned around relative to when the question was asked. The other relevant data point that I think speaks more directly to the question is one of my favorite posts from Cliff Asness from a while ago. It's a 2021 post that he did based on 2020 data.

46:53So it's a little bit dated now, but at the time he showed that, well, the US stock market had just crushed the rest of the world as it continued to do for years afterwards, using the EFI index to proxy for non-US developed market equities, a lot of that performance difference was explained by increasing valuations for US stocks. So Cliff shows that from 1980 to 2020, the US outperformed EFI by 2.1 % per year, but when adjusting for the change in relative valuations, the return differential shrinks from an economically significant 2.1 % per year to 40 basis points. A big portion of that performance difference was explained just by US valuation multiples expanding more than international developed, excluding the US stocks.

47:42Cliff explains that the victory of the US market over the EFI for the last 40 years is almost entirely coming from it getting relatively more expensive, from the US market getting relatively more expensive. He's using the Schiller-Cape ratio, which is measure of how expensive stocks are relative to their real 10-year trailing earnings, at the time was 33.77. And at the time of recording now, it was 41.54. So the US market has continued to get more expensive. Now, Shiller Cape is not a perfect predictor of future returns by any means, but there's theoretically and empirically generally a relationship between current valuations and future returns and expected returns.

48:24So when stock prices are really high, Future returns will tend to be, now it's very noisy, but it's still a relationship that exists. The point of Cliff's post and the point that I think it's important to make in answering this question is that when returns come from multiple expansion, it's hard to infer that the outperformance should be expected to persist. Stock prices went up relative to their fundamentals. Even if fundamentals got better, if a lot of that return came from increasing valuations, you might not expect that extreme positive performance to persist in the future. Now, maybe that would have seemed like a crazy thing to say even back in March, 2025, when the US stock market was crushing, but we've since seen a big reversal with ex-US stocks outperforming.

49:10The future of course is uncertain, but I think you have to be diversified. Something's always going to be sucking. There have been periods like the question mentioned the last decade where Canadian investors for 14 years were flat in US stocks. The last decade was longer than a decade for Canadian investors because of the currency portion of the return. We've talked with this before. There were many Canadian investors who were like, who would ever invest in the US market? Why would I diversify outside of Canada? There's always going to be a market doing that, right? Yeah. Looking back to March, 2025, a lot of people in a similar line of questioning would be thinking like, why would I use a factor tilted portfolio?

49:50Like broad market index funds have been crushing like for the last decade. Why would I do that? But you look now, only takes one year of really good returns to flip the annualized return going back many years. You got the next one? Yeah, I got the next one. So I'm sold that the right asset allocation for a long-term investment horizon like retirement is a diversified equity heavy portfolio, provided you can stomach the volatility. But what should you hold if you're saving for a down payment over a three to five year horizon? I'm currently holding a 25 % allocation to equities with the rest in GICs.

50:26Is this sensible? What would you hold? Big fan of the show, guys. Questions from Gerard. It's always a tricky question. I think it depends almost entirely on how certain the down payment need is. If you know for certain that you're going to need$100 ,000 in two years, six months, and three days to buy the home of your dreams and you have no other sources of liquidity, you should probably use GICs to exactly match the date when the funds are needed and earn as much interest as you can over that period. On the other hand, if you think you might maybe, if the time is right and the house is right, buy a house sometime in the next five or so years, if it's a pretty uncertain objective and you're happy continuing to rent if the timing isn't right, you could choose to take more risk with a down payment if it's a more flexible cash need.

51:17I think the same is true if you have lots of liquidity, like if you have a$10 million portfolio and you might need$100 ,000 down payment at some point to buy a house or a cottage or whatever, I would not worry too much about what the market is doing when you need the cash in that case because the liability that cash need is so small relative to the overall portfolio. personally when we started thinking maybe we would look to buy a house I didn't touch my portfolio it was 100 % in equities we did not make any changes until we put a deposit down we found a house committed to buying it and at that point we took the amount that we would need for our down payment out of equities but leading up to that before we had selected a house and committed to buying it we were super flexible on the timing like we were sort of casually looking for the right house and figured if we found one, we would do something, but we're also super happy in our rental situation and there was really no rush.

52:11Now, I'm not saying that's what everybody should do. Someone might hear that and be sad because they want to buy a house when the stock market's down. I'm just saying that's what we did, but I think it really comes down to how certain the goal is and how fixed the cash need is and how significant it is relative to your overall liquidity. I think the flexibility is key though. And the emotional aspect is pretty high when it comes to searching for a home. Like some people have very specific needs or wants when it comes to a house. And if the perfect house comes up on the market, if you know for certain, I'd be willing to pass up the best house if the market's down by X percentage points, you need to make that distinction up front.

52:52But if you think you will do that and then the perfect house comes up and the market's down 20%, you may be able to still afford it, but you could be making a decision that locks in some amount of losses. You got to take that into account. There's opportunity costs for sitting in GICs or high interest savings account, but there's also comfort in stability when you know for sure we are going to buy. The timeline is uncertain, But if something came up in three months, we would jump on it. I think you got to evaluate how flexible you want to be versus how much you want to optimize your market returns.

53:30The uncertainty of the goal, the reason I'm thinking about this is this issue has come up with RESPs, for example. Now, the goal there is more certain. Like if I have a child, I'm pretty confident they're going to go to university at a certain age, and I'm pretty confident what it's going to cost. But to your point about what other sources of liquidity you have, if I've scraped and saved for my RESP and I don't have a lot of other cash available, and I put that in triple leveraged NASDAQ and I lose 60 % of it six months before my kid's going to go to school, they might not be going to school. Whereas for most of our clients, They're going to have other sources of cash.

54:14And so they could probably afford to take a little more equity risk in their RESPs, even when the kid's only a couple of years away from school. Because if they do happen to have a downturn, they can make a smaller withdrawal from the RESP and make up the difference with other cash. I do think that you have to consider your overall net worth and your overall liquidity before you consider that decision about whether you want to put all of your short-term savings in cash and GICs. the RESP is a really interesting example because you gave the example of one child, but if you have multiple children in a family RESP, that further extends your time horizon.

54:54You could cover the first child's expenses from other sources, but leave it in the RESP to grow and take it out in the next child's name. Yeah, that's a good point. Some of it. You got to manage the grants though. They can't all come out. The grants need to be managed for sure, but on the growth portion, you've got more flexibility. Our ESPs are definitely another one of those tricky middle time horizon asset allocation questions.

55:22All right, we do have one review from Apple Podcasts. Under SEC regulations, we are required to disclose whether a review which may be interpreted as a testimonial was left by a client, whether any direct or indirect compensation was paid for the review, or whether there are any conflicts of interest related to the review. As reviews are generally anonymous, we are unable to identify if the reviewer is a client or disclose any such conflicts of interest. And we would never pay for a review anyway. So this reviewer says, best personal finance podcast, absolutely best personal finance podcast, research-based, avoids hyperbole, marketing, et cetera.

55:55Please keep it up. Thank you. And that is from Lumen in the United States. Excellent. That concludes our AMA. Anything else for you guys to add? I don't think so. Just lots of good questions, fun conversation. Well, good to see you guys. And thanks everyone for listening. See you next time.

56:40Digital Investment Advisors LLC. One Digital and PWL Capital are affiliated entities, and they mostly get on really well with each other. However, each company has financial responsibility for only its own products and services. Nothing herein constitutes an offer or solicitation to buy or sell any security. Occasionally, we tell you not to buy crappy investments in the first place, but that's not the same thing as telling you to sell them. This communication is distributed for informational purposes only. The information contained herein has been derived from sources believed to be truthy, but not necessarily accurate.

57:16We really do try, but we can't make any guarantees. Even if nothing we say is fundamentally wrong, it might not be the whole story. Furthermore, nothing herein should be construed as investment, tax, or legal advice. Even though we call the podcast your weekly reality check on sensible investing and financial decision-making, you shouldn't rely on us when making actual decisions, only hypothetical ones. Different types of investments and investment strategies have varying degrees of risk and are not suitable for all investors. You should consult with a professional advisor to see how the information contained herein may apply to your individual circumstances.

57:51It might not apply at all. Honestly, you can probably ignore most of it. All market indices discussed are unmanaged, do not incur management fees, and cannot be invested indirectly. Which is a shame. because it would be awesome if you could. All investing involves risk of loss, including loss of money, loss of sleep, loss of hair, and loss of reputation. Nothing herein should be construed as a guarantee of any specific outcome or profit. Past performance is not indicative of or a guarantee of future results. If it were, it would be much easier to be a Leafs fan. All statements and opinions presented herein are those of the individual hosts and or guests, and are current only as of this communication's original publication date.

58:36No one should be surprised if they have all since recanted. Neither One Digital nor PWL Capital has any obligation to provide revised statements and or opinions in the event of changed circumstances. See you next time.