ETFs Help Build Optimal Portfolios

by: Larry MacDonald

Can we still get a good night’s sleep as prescribed in Sleep-Easy Investing (Viking Canada, 2008) yet earn a higher rate of return than set out in the book’s model portfolios? I believe the answer is yes, if we allow the use of equity-based exchange traded fund (ETF) such as the iShares S&P/TSX 60 Index Fund.

Let’s say someone has followed the book’s guidance and constructed a portfolio with low-volatility securities, including a balanced mutual fund (see previous post). For this portfolio, one can replace the balanced fund with a bond ETF and equity ETF, bought in proportions to achieve the same or similar bond/equity mix as the balanced fund.

Such an ETF combination should be able to replicate the same (or similar) level of risk. Yet it should be able to provide a higher rate of return than most balanced funds since the annual management expense ratios on the ETFs will be 1.5% to 2% lower.