They are also liquid, meaning you can (if you wish) buy and sell investments on your own timetable (in contrast to, say, guaranteed investment certificates and private assets). At the same time, the greatest benefit comes from a long-term, buy-and-hold strategy. Your returns will vary from year to year, but all you have to do is average a 7% return over 10 years to double your money—which is more than most advisors and actively managed mutual funds do for their clients.
Finally, a couch potato portfolio should be highly cost-effective. By taking over responsibility for asset allocation, you are saving yourself the cost of portfolio management. Even with a modestly priced robo-advisor, this typically costs 0.5% of your assets under management every year. By sticking to index funds, the management expense ratio (MER) on your investments should average anywhere from 0.1% to 0.4%. Now consider that the average Canadian active mutual fund holder is paying close to 2%!
Within that broad framework, there are three basic vehicles with which to build a couch potato portfolio:
Index mutual funds. Some investors feel most comfortable with mutual funds or, rather, uncomfortable with the idea of setting up a brokerage account that charges a fee every time you buy fund units. Index mutual funds can generally be bought without any fees. But MERs still tend to be higher with mutual funds than with ETFs.
ETFs. These are the go-to of most couch-potato investors. All you need is a brokerage account (may be taxable or set up as a registered account, like an RRSP or TFSA). You then buy a handful of index funds to populate it, add money as it becomes available, and rebalance periodically.
Asset allocation ETFs. This has been the simplest way to couch surf since asset-allocation ETFs appeared in Canada in 2019. Just buy a single ETF that holds other ETFs for exposure to bonds and stocks covering various geographic regions. The rebalancing is done for you. So, why doesn’t everybody use these? Two reasons: some investors prefer to tailor their exposure to different assets to suit their situation and/or conviction, and because it’s slightly cheaper to buy index ETFs separately—the MERs for asset allocation ETFs start at around 0.17% of your holdings per year, whereas index ETFs can be had for as little as 0.05%.
In our core couch potato portfolio guide, you’ll find suggestions from all three of these types of investment vehicles. To build an advanced couch potato portfolio, you’ll have to stick to index ETFs.
Asset allocation: a crash course
Asset allocation—the choice of how much of your portfolio to dedicate to stocks, bonds and other assets and from where—consistently ranks as the most important single determinant of investment returns. If you go 100% stocks and a market crash happens, you could lose half of your savings (or more!) in a short time. If you hold only fixed income, you’ll likely preserve your capital but may struggle to keep pace with inflation.
Don’t sweat this decision too much, though. Most portfolios use a little of both. Though it had a historic bad year in 2022, when both stock and bond markets fell, a classic 60% equities/40% fixed income portfolio has served a great many investors pretty well over the years. Split up your stock holdings within the equity allocation among U.S., Canadian, and International index funds, and Bob’s your uncle—you’re fully diversified.
How you split your holdings up, though, is up to you. Remember, Canadian stocks make up less than 3% of global market capitalization while the U.S. market represents more than 50%. At the same time, a Canadian stock index fund can be relatively tax-efficient in a taxable account and, these days, will generate more income.
The important thing: to have a target allocation that matches the purpose of the portfolio, your time horizon, and risk tolerance. Get it in writing (you can change it over time). Get a second opinion on it from a knowledgeable friend or relative or an investment professional, if you think it’s worth the money. Then, once or twice a year, rebalance the portfolio—buy more of the underperforming funds and sell some of the outperforming ones until your allocation is back at its target. (You can usually achieve the same result simply by making new contributions.)
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This may sound counterintuitive and can be hard to do—it takes discipline—but studies show that it’s the best way to hold onto your gains.
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Options and alternatives
When it comes to choosing funds with which to populate your portfolio, you will be faced with a sometimes bewildering abundance of choice. Our best ETFs guide, which we update annually, can help you narrow down your options if you choose the index and asset-allocation ETF route.
There are other considerations, too.
Different versions of foreign equity and fixed-income funds can often be bought denominated in either Canadian or U.S. dollars. Generally, investors saving for a retirement in Canada will want to stick to Canadian dollars. Within that format, though, you may have the option of buying Canadian-dollar-hedged or unhedged versions of the same fund. This is up to you. Some investors think it’s important to diversify their currency exposure as well as diversifying by asset class and geography; they choose to go unhedged, while others use hedged funds as a way to reduce potential volatility.
Likewise, some investors opt for equal-weighted index funds that hold their constituent stocks in roughly equal proportion as opposed to the more common cap- (capitalization) weighted format, whereby a small number of huge stocks can dominate an index. Equal-weight funds tend to come with substantially higher MERs than cap-weighted funds, however. Unless you have a strong conviction in favour of equal weighting, we would not recommend using these funds.
Using ETFs, your brokerage will ask whether you want to apply a dividend reinvestment plan (DRIP) to your account. This will take any ETF income distributions from eligible funds and apply them to buying more units of the ETF (with no commission). That is the easiest way to keep your money working for you, but some investors prefer to set aside this cash for either their own income or discretionary ETF unit purchases.
If you’re feeling out of your depth answering these questions, consider having a fee-based investment advisor or planner review your portfolio. Depending on the level of services they provide, this can cost anywhere from several hundred to several thousand dollars. That sounds like a lot—and it is. But it may be a small price to pay in comparison to the alternatives (such as using a commission-based advisor or wealth manager), especially as your savings grow into the hundreds of thousands of dollars.
For an intermediate option, consider opening an account with a robo-advisor. These online-based advisors mostly use the same methodology of couch-potato investors, building passive portfolios using index funds at the cost of about 0.5% of the value of your assets per year.
