This article is sponsored by BMO Exchange Traded Funds.
What is Asset Allocation?
Ever wondered what the most important aspect of investing is? It’s the asset allocation of your investment portfolio. The mix of stocks and bonds as well as cash and other asset classes in your portfolio that are the key drivers of returns.
Studies, such as the influential Brinson, Hood and Beebower paper, “Determinants of Portfolio Performance,” suggest that the long-term strategic asset allocation of a portfolio accounts for over 90% of the variation of its return.
According to the study, the portfolio’s strategic – or target – asset allocation will have a greater impact on its performance than security selection or any short-term active or tactical asset allocation shifts.
What is an Asset Allocation ETF?
Asset Allocation ETFs, also called “all-in-one” ETFs, are an investment solution built to follow particular index weightings, which aim to provide investors with an ETF that is low-cost, easy to access and simple to use.
Canadian All-in-one ETFs were first introduced in 2018 and have skyrocketed in popularity as investors became aware of the extensive benefits they provide.
How does an Asset Allocation ETF work?
Instead of the investor individually selecting their ETFs, determining the percentage allocated to each one and having to manage them, an asset allocation ETF can do it all for you in a single click.
These ETFs invest in a different blend of approximately 7-10 underlying core ETFs. They offer regular rebalancing which will maintain the asset mix for the investor (effectively taking the emotion out of it).
You don’t have to stress about what country or geographic region is going to outperform, or which asset class you should be over or underweight on. Just a single ETF provides access to the broad market.
What is portfolio rebalancing?
As I have always stated, it’s important to understand your risk tolerance and construct your portfolio around it. However, market movements, especially in times of high volatility, can impact your asset allocation and cause your portfolio to become weighted in a way that does not suit your risk tolerance.
Few investors can take time out of their busy days to maintain strict allocations. As a result, this can put your portfolio at risk.
Asset Allocation ETFs on the other hand will follow a disciplined approach to asset allocation. These ETFs will rebalance quarterly back to their target asset allocation weights. What I mean by this is if you want a portfolio made up of 60% stocks and 40% fixed income, it will maintain this on a quarterly basis.
Each ETF holds a basket of underlying ETFs that provide exposure to Canadian, U.S. and International equities and bonds.
Rebalancing often requires a multitude of actions individual investors will struggle with. The main one being we will need to be selling our top performing stocks or fixed income investments and re-allocating it to our weaker performing ones. If you’re someone who lets emotions get in the way of investments (which, who doesn’t?) this can be difficult to pull off.
However, over the long term, it has proven to be a strong strategy. Effectively, rebalancing may allow you to buy low, and sell high, repeatedly, and stay on track with your financial goals. The asset allocation ETFs remove the emotions and do it for you.
What is the difference between asset allocation ETFs versus individual ETFs?
Asset allocation ETFs are a package of individual ETFs. They are an all-in-one portfolio providing access to approximately 7-10 ETFs that are managed for you.
Once you figure out your risk tolerance, you can pick an asset allocation ETF that suits it. You can always buy the individual underlying ETFs and build the portfolio yourself, but it will end up costing more time and money, as you will need to pay commissions along with rebalancing the portfolio yourself periodically.
Along with this, if you buy individual ETFs you will then need to remember to be disciplined in your rebalancing and remove emotions to keep you on track to your financial goals and in line with your desired risk level.
However, using individual ETFs allows you more customization in terms of the portfolio. For example, you can add in a low volatility or a dividend approach to your equities if you wish. So, it’s important to weigh the pros and cons.
What are the different types of Asset Allocation ETFs?
Most Asset Allocation ETFs are based on a desired strategy or return, ranging from Conservative, Balanced, Growth, and All-Equity Asset Allocation Portfolios.
The decision between a conservative, balanced, growth and all-equity portfolio reflects an investor’s overall risk tolerance. Each investing goal has its own unique asset allocation.
If you have been a reader here at Stocktrades for any amount of time, you will know I am a huge fan of BMO ETFs, often highlighting them on our posts. This is no different when it comes to BMO ETFs Asset Allocation solutions. They cater to various asset mixes that investors may need based on their goals.
Lets go over some examples.
If you’re a more conservative investor, you may want to check out the ZCON – BMO Conservative ETF. This portfolio contains 60% exposure to fixed-income and 40% exposure to equities.
If you’re looking for a bit more growth and willing to take on more risk, ZBAL – BMO Balanced ETF is a 60% equity, 40% fixed income makeup.
Moving into higher equity based portfolios, ZGRO – BMO Growth ETF is built with 20% fixed income and 80% equities. It still provides a nice touch of income, but also enough equity exposure that you won’t miss out on the long-term appreciation of the stock market.
And finally, if you’re looking for potential long-term growth with 100% Equity, ZEQT – BMO All-Equity ETF captures a mix of Canadian, U.S., International, , Emerging market, and Small/Mid Cap equities.
The above are your typical, traditional asset allocation ETFs. However, there are some niche-ETFs that BMO provides that I thought I’d highlight in this article as well.
ESG asset allocation ETFs
There are ESG (environmental, social, governance) focused asset allocation ETFs, where investors can align their investments with their values with an approach that aims to mitigate risks associated with ESG considerations. ZESG – BMO’s Balanced ESG ETF is ESG focused and designed for investors looking for a growth and income solution that aligns with their values.
Income or retirement ETFs
A more recent innovation in the space is T units of Asset Allocation ETFs which are focused on Income/Retirement. T Units were first introduced on mutual funds and are now available on some Asset Allocation ETFs.
An example of a T6 unit would be one that will pay a fixed 6% annual cash flow in the form of monthly distributions over the year.
It is important to note that these fixed distribution T units may pay out a component of Return of Capital (ROC). For example, if the underlying portfolio is yielding 4.5%, then 1.5% would come from ROC to ensure the investor maintains that 6% annualized distribution. It is very important to investigate the overall makeup of an ETFs distribution.
BMO’s ETFs Retirement Solutions and Asset Allocation ETFs are an easy all-in-one investment vehicle that allow investors to target a specific risk level based on their investment goals and income needs.
Whether you are looking for a growth-based allocation (ZGRO.T – BMO Growth ETF) or more of a balanced approach (ZBAL.T – BMO Balanced ETF), these two Retirement solutions have an annual payout of 6%, monthly.
Let’s take a peek at some of the features of each below.
These two solutions are very similar to another fund offered by BMO, the ZMI – BMO Monthly Income ETF which launched over 10 years ago. An added benefit of this fund is the fact it’s offered in USD as well. It trades under the ticker ZMI.U.
How to choose an Asset Allocation ETF?
The overall makeup of stocks/bonds/cash you have in your portfolio, or your Asset Allocation ETF, depends on your risk tolerance. So, what exactly is your tolerance for risk? Let’s go over a few key elements.
When do you need the money? Are you planning on buying a house next year, or send your kids to university? Or is this money for longer term goals like retirement?
If you have over a 10-year time horizon, then you are more likely going to be able to withstand fluctuations in the value of your portfolio over the shorter term. If you need the money in the next 3 years, you are more likely looking for a lower risk solution because you want to avoid the impact of sudden, unexpected market declines when it comes to your portfolio.
If you are forced to sell during a down period in the market due to a shorter time horizon, you could potentially do so at a loss.
Your Personal Comfort with Risk
Think about your investment experience. If you’re new to investing, then think about if you are more comfortable starting with a lower risk solution and working your way up.
Understanding your own behavior can go a long way in helping you stick with your goals. Remember sticking with your plan is not easy, but it’s the most important way to reach your goals. As you continue through your investing career, you will naturally figure out your tolerance for risk.
Your Financial Situation
Do you have an emergency fund? Do you have a significant amount of debt? Your financial situation also has an impact on your ability to take on risk because these funds may need to be used if you are in a pinch.
Ex. If you have a mortgage, consider whether its variable or fixed. If interest rates rise, are you able to meet those payments?
Benefits of an Asset Allocation ETF
Ever turned on your GPS in your vehicle and just followed the directions? Not a thought to the traffic or the route you’re taking? This is kind of like owning an asset allocation ETF.
Choosing the right asset allocation may help to maximize your returns for your level of risk tolerance.
- Simplified Investing – All-in-one Investment Solution that provides instant diversification.
- Broad diversification – Consisting of a basket of ETFs that hold many securities
- Professionally constructed – Leverage the knowledge of industry professionals for a low cost
- Automatic Rebalancing – Keeps one’s investment portfolio on track when it comes to your risk tolerance and return goals
- Transparency – Knowing what is in the ETF can help reduce duplication when complementing an existing portfolio.
- Liquidity – Able to buy or sell the basket of holdings at any time
- Lower cost – ETF based solutions tend to charge lower fees than other diversified investments
- All-in-one cost structure – Most popular Asset Allocation ETFs only charge the one top fee without charging the underlying ETF costs
- No need to be an experienced investor - An option for investors who are just starting out or have small portfolios.
How much do Asset Allocation ETFs cost?
These are low-cost solutions that provide a range of benefits for investors. Fees on asset allocation ETFs in Canada range, but generally fall between a 0.18%-0.22% management fee, but some may go to 0.5%. This means you can pay anywhere from $1.80 to $5 per $1000 invested on an annual basis.
Ensure you are looking at the ETF Facts to understand the total Management Expense Ratio (MER) of these ETFs. It is updated each year and includes all underlying costs of the ETF.
How can these solutions be used in a portfolio?
Asset Allocation ETFs can be a one ticket solution that you can purchase on its own or it could be used as a core to a portfolio in a core-satellite approach.
Core-satellite investing involves using a core portfolio to anchor the portfolio’s strategic asset allocation and adding satellite investments to enhance returns and/or mitigate risk.
Investors growing adoption of Asset Allocation ETFs over the past five years in Canada is a testament to the benefits these ETFs provide investors. A simple to use, all-in-one solution that is low cost and well diversified, these ETFs have changed investing for the better.
 These T6 units are Fixed Percentage Distribution Units that provide a fixed monthly distribution based on an annual distribution rate of 6%. Distributions may be comprised of net income, net realized capital gains and/or a return of capital.
This communication is intended for information purposes only. This update has been prepared by Dan Kent and represents their assessment at the time of publication. The comments contained do not necessarily represent the views of BMO Global Asset Management. The views are subject to change without notice as markets change over time. The information contained herein is not, and should not be construed as, investment advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.
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