As readers know, I’m strictly1 an index investor. Boring, yet very effective over time. Buy a basket of stocks that are based on public indices (e.g. S&P 500, TSX 60, MSCI World) and forget about it. Since it’s not possible to buy an index directly, ETFs exist to do that for you — you buy the ETF, the ETF managers buy the underlying stocks, and life is good.
This means a few things:
- You don’t actually own the stocks of the index yourself; the ETF manager does
- You rely on the ETF manager to do the work of adding/removing stocks from the index when the index does (and this happens all the time2)
- You rely on the ETF manager to pay out the dividends the underlying stocks hold; this isn’t on the same schedule as the underlying companies themselves — the ETF manager will pay out dividends annually, semi-annually, quarterly or even monthly.
- You are implicitly investing in everything the chosen index invests in. Some folks may have reservations about investing in sectors like defence industries, oil and gas, tobacco and alcohol, gambling or anything involving Elon Musk, etc.
- You pay a (hopefully small) premium to have someone else do this work3
Now. the super cheapskates out there will rightly point out that with commission-free trades on many DIY platforms4, why bother with an index fund? Why not just own all the stocks of an index yourself and cut out the intermediary step (and the associated fees)?
Two of Canada’s DIY providers (Wealthsimple and Questrade) are now offering products that may meet that need. Although I am a client of both providers, I don’t use either of these services.
Wealthsimple Direct Indexing
Wealthsimple was the first to introduce a product that allows investors to own the underlying stocks of an index. The full story is here, but it’s not exactly what you might expect:
- Good: You can buy either the S&P 5005 or the TSX Composite6 (about 200 companies)
- Good: You can exclude stocks from the list if you wish
- Bad: You can only use direct indexing in a non-registered account.
- Good (?): You don’t actually hold all the stocks in the underlying index; sampling is used to approximate the overall index (this is done in order to facilitate tax loss harvesting)
- Good: Trades are done automatically on your behalf to take advantage of tax loss harvesting. The idea being that (for example) an underperforming bank stock is sold and replaced with a different bank stock
- Terrible: Although you can hold the S&P 500, you can’t hold it natively in USD. This means lots of FX fees for Wealthsimple 🙁
- Neutral: Direct indexing costs 0.15% of holdings
- Bad: The service sounds like it will generate a lot of trades, which means a lot of tracking of gains and losses. Wealthsimple helpfully(?) suggests using CRA’s “Autofill my return” feature.
The main value proposition of direct indexing offered by Wealthsimple is the idea of automating tax loss harvesting. For people with large non-registered portfolios, this can be an attractive proposition. Of course, you have to be able to FUND a large non-registered portfolio in the first place. In my case, this would mean liquidating my existing non-registered portfolio and incurring all the capital gains at once. No thanks.
And, I can’t stress this enough: using this service in its current incarnation to buy the S&P 500 is a terrible idea. The FX fees will eat into your returns as sure as the sun will rise tomorrow!
Questrade’s Custom Indexing
This is a brand new product from Questrade. All the details are here.
- Good: You can define your own index, either starting totally from scratch or using one of the existing templates7.
- Bad: It only works for USD stocks8 at the moment. It goes without saying that you should invest using USD and not CAD if you were to choose this route910.
- Good: It can be an RRSP, TFSA, FHSA or non-registered account.
- Bad: It doesn’t include RRIF accounts.
- Neutral: It has to be a new account dedicated to this strategy
- Good/Bad: Rebalancing (with “one click”) is in your hands. Good because you maintain total control, Bad because you can be inclined to try to time the market, which is almost never a good idea.
- Neutral: Your custom index is limited to 600 holdings.
- Good: There’s no charge!
This is a great looking service on paper. I thought that perhaps it would work for my TFSA accounts since I only hold XIC and XEQT in them but I see some limitations in doing that:
- Custom indexing doesn’t (yet) support CAD-listed stocks
- XEQT holds international stocks; custom indexing can’t. I suppose I could use ETFs to get around that.
- XEQT holds ~8500 individual companies, whereas custom indexing is limited to 600 stocks
I suppose I could decompose my all-in-ones (XGRO/XEQT) into their ETF components and build a custom index based on that. This would replace the all-in-one MER with the MER of the individual components, which as I’ve shown previously, would save you money.
I could do this immediately with AOA (my USD all-in-one), but I only hold that in my RRIF account, and direct indexing doesn’t seem to allow RRIF accounts.
Anyway, it’s an interesting offering, and one that I’ll keep an eye on!
My Take
Wealthsimple’s direct indexing might be attractive to someone in the accumulation phase of their investment journey. For me, all the things I have in my non-registered accounts will eventually be sold off to fund my retirement — I’m not adding to that part of my retirement holdings.
Questrade’s custom indexing might be interesting to me once they add support for Canadian equities. Until then, another button to ignore.
