How to Run The 3% Signal in Canada

The 3% Signal plan (3Sig) is best run with an American small-cap stock index fund and general bond market index fund, in a tax-advantaged account. However, it can be run with any stock and bond funds in any type of account. Wherever you run your plan, the goal is to find the cheapest suitable available to you.

In The Kelly Letter, I run the plan with iShares S&P SmallCap 600 (IJR) and Vanguard Total Bond (BND) and recommend that Americans find these or similar funds in their 401(k)s, individual retirement accounts (IRAs), or other accounts.

Canadians can closely copy the plan with funds and accounts available in Canada to build a sizable nest egg with no stress from investing indecision.

The two main retirement account types in Canada are the Registered Retirement Savings Plan (RRSP) and the Tax-Free Savings Account (TFSA). Contributions to an RRSP are tax-deductible; contributions to a TFSA are not. Investment profit created in an RRSP is not taxed until withdrawal, at which time it’s usually taxed as income. Investment profit created in a TFSA is not taxed, even at withdrawal. In American terms, Canada’s RRSP is similar to a Traditional IRA while its TFSA is similar to a Roth IRA.

As with American retirement plans, the RRSP and TFSA are not investments themselves, they are account types that you can open at many different financial institutions. The list of funds and other investments available to you in your RRSP and/or TFSA will depend on where you open and maintain your account.

In some Canadian accounts (including employer pension accounts), US stocks and funds are available for local trading in Canada, no need to worry about currency fluctuation. In others, they’re not. If your account has access to IJR, BND, or other funds like them without foreign exchange charges, then you’re ready to begin straightaway. If not, you’ll need to find the right puzzle pieces in your account.

The Toronto Stock Exchange (TSX) trades two funds that are widely available in Canadian retirement accounts, which many Canadians have told me they’re trying with 3Sig: iShares S&P/TSX Small Cap (XCS.TO) in place of IJR, and iShares Canadian Universe Bond (XBB.TO) in place of BND. The bond fund is fine; the stock fund is not.

The S&P/TSX Small Cap index significantly underperforms US small-cap indexes, and so does another popular Canadian stock index, the S&P/TSX Capped Composite Index. An ETF that tracks it is BMO S&P/TSX Capped Composite ETF (ZCN.TO). Notice how XCS and ZCN have compared with IJR over the past five years:

IJR, XCS, and ZCN 5-Year Price Chart

Try to find a fund that targets the US mid-cap or small-cap market. One worth considering is iShares US Small Cap Russell 2000 CAD-Hedged (XSU.TO), but it has a high MER (management expense ratio) of 0.36% and investors have complained recently about poor hedging results. For example, Canadian investor Stewart wrote to me on March 11, 2015: “This [XSU] is supposedly the Russell 2000 hedged to Canadian Dollars. Trouble is it hasn’t risen in twelve months, while the exchange rate has dropped considerably so one would have thought that the hedged fund would rise because of this even if the Russell 2000 didn’t move much.” More on hedging below.

If you don’t want to worry about paying your broker’s foreign exchange charges by investing in US-listed funds from Canada, and you want a low MER, then you’ll probably need to choose one of the US large-cap funds that trade on the TSX. Two of the cheapest I’ve been able to find are iShares S&P 500 (XUS.TO) with a MER of 0.15%, and BMO S&P 500 (ZSP.TO) with a MER of 0.17%. Here’s how they’ve fared against IJR and the S&P 500 index over the past two years (XUS and ZSP are only two years old):

IJR vs TSX-Traded XUS and ZSP 2-Year Price Chart

XUS and ZSP provide the same performance profile, so you might as well go with the slightly cheaper XUS. Recently, US large-cap stocks have been performing better than medium- and small-cap stocks, but have not done as well over long time periods (which is why 3Sig works best with small-cap funds). However, large-cap funds do well enough and if they are the lowest-cost way for you to own the US stock market in Canada, then proceed confidently in using either XUS or ZSP on the stock side of your 3Sig plan.

Note that neither fund is currency hedged. In a CAD-hedged fund, your returns will be enhanced when the Canadian dollar rises and diminished when it falls. From Dan Bortolotti, a licensed investment advisor with PWL Capital in Toronto, via his indispensable Canadian Couch Potato site: “If you believe the Canadian dollar has neared its bottom and will begin moving back up, then it makes theoretical sense to use currency hedging, because a rising loonie would harm returns.”

I submit that nobody knows where currencies are heading, so it’s a crapshoot whether one should hedge or not. The cost advantage is on the side of not hedging because the MERs of XUS and ZSP are lower than those of their hedged equivalents. If you do want to use a hedged S&P 500 fund that trades on the TSX, consider iShares S&P 500 CAD-Hedged (XSP.TO) with a MER of 0.25%, and BMO S&P 500 Hedged to CAD (ZUE.TO) with a MER of 0.23%.

Here, we have to toss Vanguard into the mix because its S&P 500 funds that trade on the TSX charge the same 0.18% MER whether hedged or unhedged. If you have access to them, then it’s entirely up to you whether you want to hedge or not because there’s no cost differential to sway your choice. If you can’t decide, go unhedged. Vanguard’s S&P 500 unhedged fund is VFV.TO; its hedged is VSP.TO.

I recommend not hedging. CAD hedging has a lousy record for a couple of reasons. First, the tracking error is large. Second, and more importantly, hedging the loonie is really just a way to let the commodities market exert an unwelcome influence on your stock performance. The value of the loonie is driven largely by oil and other commodities, often in such a way that hedging it adds to profits when stocks are going up and compounds losses when they’re going down. In this sense, hedging the loonie is not a way to offset stock behavior but rather a way to magnify it, exaggerating its volatility.

It’s largely this last point that led the Canadian Pension Plan Investment Board to write a couple of years ago that there’s “no compelling reason to hedge equity-related currency exposure,” and for its president and CEO Mark Wiseman to write this year: “Hedging to manage short-term results has a material financial cost with no expected benefit over the long term.” The following excerpt is from page 26 of the CPP Investment Board 2015 Annual Report: “[T]he Canadian dollar is strongly linked to the price of oil. In principle, it is prudent to diversify away from a currency under such a singular and uncertain influence.”

Here, then, are the widely available funds suitable for use with 3Sig in Canada:

Stock Side:
XUS.TO – iShares S&P 500, 0.15% MER
ZSP.TO – BMO S&P 500, 0.17% MER
VFV.TO – Vanguard S&P 500, 0.18% MER
VSP.TO – Vanguard S&P 500 CAD-Hedged, 0.18% MER
ZUE.TO – BMO S&P 500 CAD-Hedged, 0.23% MER
XSP.TO – iShares S&P 500 CAD-Hedged, 0.25% MER

Bond Side:
VSB.TO – Vanguard Canadian Short-Term Bond, 0.17% MER
VAB.TO – Vanguard Canadian Aggregate Bond, 0.23% MER
XSH.TO – iShares Core Canadian + Maples Short Term, 0.27% MER
XBB.TO – iShares Canadian Universe Bond, 0.33% MER
XQB.TO – iShares Core High Quality Canadian Bond, 0.33% MER
XGB.TO – iShares Canadian Government Bond, MER 0.39%

Run 3Sig in Canada with XUS and VAB

In the following two charts, notice that XUS has followed the same pattern as the other funds since its inception but at a much lower MER, and that VAB has followed the same pattern as the two funds at the top of its chart (XGB and XBB) since its inception. These similar patterns happen because the funds follow identical or similar indexes, so the low-cost winner is your best choice. The reason VAB is preferable to VSB even though it has a slightly higher MER is that short-term bond funds don’t yield enough and the extra price stability they offer is unncecessary in 3Sig.

These are the six stock funds over the past five years, with XUS in bold blue:

TSX-Traded SP500 Funds 5-Year Price Chart

These are the six bond funds over the past five years, with VAB in bold blue:

TSX-Traded Bond Funds 5-Year Price Chart

The following comments were sent to me by Canadian readers.

Several people mentioned that the TD e-Series Funds ( were designed to provide low-cost access to various market segments, including Canadian bonds, European stocks, the Dow Jones Industrial Average, the S&P 500, and US stocks in a currency-neutral fund. While the MERs aren’t cheap by US standards or as low as those in the funds discussed above, they’re not terrible. The TD US Index Fund has a MER of 0.35% compared with 0.15% at iShares S&P 500 (XUS.TO) and 0.09% at SPDR S&P 500 (SPY).

Lee suggests that the “Canadian couch potato portfolio” featuring low MERs consists of Vanguard FTSE Canada (VCN.TO), Vanguard FTSE All-World ex Canada (VXC.TO), and Vanguard Canadian Aggregate Bond (VAB.TO). Not a bad lineup, but 3Sig run with XUS and VAB will almost certainly perform better.

Luc points out that Scotia iTrade offers commission-free ETFs. Unfortunately, neither XUS nor VAB is among them.

Robin adds that Questrade offers commission-free ETF trading. From its website: “you can buy any North American listed-ETF, including Questrade Smart ETFs, absolutely commission-free.” I was unable to find the North American listed ETFs available to Questrade account holders, but it’s presumably an extensive list if the company is promoting the feature this enthusiastically. The Questrade Smart ETFs were launched just this month, and include Russell US Midcap Value CAD-Hedged (QMV) and Russell US Midcap Growth CAD-Hedged (QMG). Unfortunately, their MERs are 0.70%, taking them out of the running in 3Sig’s preference for low-cost vehicles.

John, an American living in Canada, passes along this tip: “As many Canadians have a US denominated account within their RRSPs, I think one can argue that currency risk shouldn’t be an issue. The logic can be that the money can be used for future trips to the US only.”

That about does it. I hope this article helps.

Want to talk strategy over a coffee or barley pop with other Canadians running 3Sig near you? Hop on the comments section below and advertise where you are. Others can chime in for a meet-up. Also feel free to update the information on this page in a comment below. I’ll incorporate helpful comments.

Good luck with your 3Sig plans, my Canadian friends!

The 3% Signal is sold at and as well as at local booksellers.


  1. Thomas
    Posted April 28, 2017 at 4:16 am | Permalink

    Is it suggested to use VAB and XMC for the Canadian portfolio?

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