Norm Rothery (also featured in this video interview with Jon Chevreau) recently wrote that the ultra-low commissions offered by the discount brokers allow investors with large portfolios to buy the stocks that comprise an index directly and avoid the fees involved in holding ETFs. The concept is interesting but small investors who want to faithfully track an index need a very large portfolio to save money on ETF fees. The simple formula to figure out if it is worth unbundling an ETF is:
Amount at which unbundling an ETF becomes worthwhile = (Number of stocks in the index * Trading commission ) / MER of ETF
XIU, for instance, has 60 stocks, charges a MER of 0.17% and an investor paying $5 at Questrade needs a portfolio in Canadian equities of $175,000 to invest in the underlying stocks directly, assuming he adds money once every year to the portfolio and rebalances at that time. As you can infer from the formula, unbundling becomes practical when the number of stocks in the index is small and the MER is large.
There is one holding in the Sleepy Portfolio that perfectly fits the bill: the iShares CDN REIT Index Fund (XRE). The REIT ETF holds just 12 securities but charges a steep MER of 0.55%. An investor paying trading commissions of $10 only needs to accumulate $20,000 in REITs before he starts to save money by unbundling.
It gets even better — if you are willing to put up with a bit of tracking error, you can hold just three REITs and track slightly more than half the index by putting 50% in RioCan REIT (REI.UN), 30% in H&R REIT (HR.UN) and 20% in Canadian REIT (REF.UN). As REITs are typically a small portion of an investor’s portfolio, the tracking error may not be a huge concern.
Personal Disclosure: We use RioCan REIT as a proxy for the Canadian REIT sector in our personal portfolios.
