How to Pick an All-in-One Fund?

Ruth Saldanha: There's been a lot of talk of balanced funds or all-in-one ETFs recently. These funds take the work of asset allocation away from investors and in the ETF form are cheap and easy to buy. But as an investor, how do you pick a fund that works for you and when and how should you decide to swap between these funds? Morningstar Director of Investment Research, Ian Tam, is here today to talk about this. Ian, thank you so much for being here today.

Ian Tam: Thanks for having me, Ruth.

Saldanha: First up, what are some of the things that investors should keep in mind when deciding whether or not to invest in these funds at all?

Tam: Yeah, great question. So, if you decided to at least look at these funds, you probably already considered buying individual securities and decided that's probably too much work for you as an individual investor, so you're going to buy a fund. Now, when it comes to buying a fund that's appropriate or multiple funds for your asset allocation, the first thing you want to decide is whether you're going to be able to actually do the work of, number one, finding an appropriate mix between stock funds and bond funds and number two, and more importantly, frequently rebalancing those every so often just to make sure it's matching with your risk tolerance. So, that's the first thing you want to consider. Ask yourself is that work that you really want to do yourself. If it is, then for sure, certainly consider buying individual component funds.

Second thing you want to consider is whether you want to take an active approach. Now, all these new all-in-one ETFs, they come at a very low cost to you as you mentioned, Ruth, but they do typically use index funds as their components, which means that you're going to get index-like returns, and if that's okay for you, then certainly it might be a worthwhile choice to make. But if you wanted to take a more active approach, you can also seek out more traditional balanced funds that use active components within the overall asset allocations.

Saldanha: So, how should an investor decide which balanced fund or all-in-one ETF to buy?

Tam: First and foremost, Ruth, you want to, of course, have a good sense of what your risk tolerance is, and the more risk you can handle, the more allocation you're going to have to stocks. Now, each fund family, or each of these manufacturers of all-in-one ETFs typically have three or four different, conservative, moderate, and growth oriented all-in-one ETFs. So, you want to decide which family is right for you or which allocation is right for you to begin with.

Second thing you might want to consider is the quality of the parent company. Now, at Morningstar, one of the three pillars that we use to assess the forward-looking prospects of a fund is to look at the parent. And essentially, at a high level, what we do is we decide whether the fund company as a whole, so not just the one fund but the entire library of products as well as the company itself, typically aligns their products in the best interest of investors. So, for you as an investor may be consider looking at all the funds within that company, just to consider whether that's going to be the right choice for you.

Saldanha: Sometimes what could happen is that your goals may be a little closer or a little further away. In these circumstances, when and how should an investor decide how to swap between these funds or ETFs?

Tam: So, the thing you want to look for is any substantial change in your financial situation, which of course will equate to a change in your risk tolerance. So, things like a change in your employment, perhaps there's a job loss and you're amidst a change in this sort of family situation, maybe you have a dependent that now requires some financial support. That will reduce your risk tolerance.

The second thing, of course, is the closer you are to your investment goal, whether that be saving towards a house or retirement, the close you are, the lower your risk tolerance becomes. So, it's up to you to decide when that happens to reassess your risk tolerance and then if your risk tolerance drops, may be consider dropping to a more conservative version within the fund family, or maybe just shop for a different fund altogether. But certainly, reducing your exposure to equities at that point would make sense if your risk tolerance has indeed changed.

Saldanha: Now, fees are super important as we always tell investors. Finally, what are some of the costs that investors should be aware of at the time of buying or selling these funds?

Tam: So, in the world of all-in-one ETFs, it's actually pretty straightforward. The main cost to you as the investor is the management expense ratio. Now, remember that that MER, you're going to pay that regardless of whether the fund performs well or performs poorly and again, this can be typically index-like returns, at least at the individual component level of each fund. So, that's really the main cost. Nowadays, in Canada, the costs to trade ETFs have gone down substantially. So, some discount brokers just even offer free ETF trading, so that's really negligible at this point. So, MER is really the main thing you want to focus on in terms of costs. Now, if you do have a more traditional balanced fund, of course, you want to take into account if there are any trailers or deferred sales charges that come into play. So, if you're in a more traditional mutual fund, maybe keep a lookout for those types of additional charges. But in the all-in-one ETF world, certainly MER is really the main thing, not too much else you need to worry about there.

Saldanha: So, MER, your own risk tolerance, and of course, your financial goals, these are things to keep in mind. Thanks so much for joining us today, Ian.

Tam: Thanks, Ruth.

Saldanha: For Morningstar, I'm Ruth Saldanha.