Want to retire with a million dollars? Here’s a step-by-step guide to building a portfolio you can count on

Building a $1-million retirement portfolio may seem like an impossible goal, but it’s actually well within reach for many of us. With discipline and patience, you can slowly build a nest egg that will provide a comfortable retirement for years.

The best way to get there is to use exchange-traded funds (ETFs) to keep your portfolio diversified and your investing costs low, says Dan Bortolotti, portfolio manager at PWL Capital and author of “Reboot Your Portfolio: 9 Steps to Successful Investing with ETFs.”

An ETF is a fund that holds a diversified mix of assets — such as stocks, bonds and commodities — but trades on stock exchanges like an individual stock. “ETFs provide an opportunity to purchase what is basically an entire diversified portfolio with a single fund,” says Bortolotti. 

It may seem like you’re buying just one product, but “if you lift the hood on these ETFs, there are literally thousands of stocks — in fact, some of them will have upwards of 10,000 individual stock holdings and hundreds of bonds,” Bortolotti explains. “They are more diversified than anything you could possibly build yourself.”

ETFs are similar to mutual funds; the main difference is that ETFs trade like individual stocks. Mutual funds also require more active portfolio management and tend to be more expensive than ETFs. “You can find extremely low-cost ETFs, whereas it’s pretty hard to find extremely low-cost mutual funds,” Bortolotti says.

In a nutshell, an ETF establishes a low-maintenance, diversified portfolio that essentially runs itself while keeping costs low — and it can really pay off over time.

According to Bortolotti, assuming a 5.5 per cent rate of return, you can build a $1-million portfolio with ETFs by age 65 if you start investing $595 a month at age 25; $1,122 at age 35; or $2,332 at age 45.

Why you should choose asset allocation ETFs

There are so many ETFs available that Bortolotti understands why people might be intimidated when trying to choose the right ones for their portfolio. “I think it’s also fair to say that the vast majority of them can be completely ignored by the average investor,” he says.

Asset allocation ETFs, which offer complete, diversified investment portfolios in one product, are the “single most valuable and important product that has come out in Canada in the last decade” and are the best place to start when it comes to setting up a simple long-term investment plan, Bortolotti says.

“There are literally billions of dollars in these kinds of balanced mutual funds out there,” Bortolotti says. “The difference with asset allocation ETFs is they’re extremely low cost,” with fees to compensate the fund company coming in at around 0.18 to 0.25 per cent — that’s roughly one-tenth of what balanced mutual funds have cost in the past.

Robb Engen, advice-only financial planner and personal finance blogger at Boomer & Echo, agrees that asset allocation ETFs are the way to go. “I cannot emphasize enough how much of a game-changer these have been for the do-it-yourself investor,” he says.

All of the major ETF providers, including Vanguard, iShares and BMO, have a family of asset allocation ETFs.

When building an investment portfolio, it’s important to understand how much risk you want to take.

A 60 to 40 balance of stocks to bonds is usually a good starting point. For younger Canadians who can afford to take more risk, an 80 to 20 balance could work.

You can adjust your asset allocation as you get older. By the time you reach retirement, you may want a mix of 50 per cent stocks and 50 per cent bonds.

Bortolotti points out that many younger Canadians have lower incomes, mortgages and kids. “You can’t beat yourself up for not being able to save 10 or 15 per cent of your income when you’re in an entry-level job,” he says.

It’s OK to plan to tackle big expenses like your mortgage when you’re younger and then when you’re in your peak earning years — even if that’s not until your 40s — ramp up your savings. Once your mortgage is paid off, you can redirect all of that money to saving and investing, and that money will compound fast.

If you can only afford to contribute $25 a month, you may not end up with $1 million, but years of compounded interest will still give you healthy returns.

How often should I contribute to my ETF?

If you get a regular pay cheque, set up automatic contributions to your ETFs for every pay day. “It’s just a good habit,” Bortolotti says. “You probably won’t miss the money after a little while, and it’s the best way to ensure that you meet your savings goals.”

There’s nothing worse for blowing up a long-term savings strategy than waiting for a “good time to invest,” Bortolotti says. “A good time to invest is when you have a plan and you have the cash available. You have to be disciplined with your savings and ignore short-term volatility in the market.”

Over time, with consistent contributions, the interest on an ETF will compound significantly. Compounding happens exponentially, which means the real power happens later.

Let’s say your portfolio is $1,000 today and you get a five per cent return. The next year, you’re creating interest on $1,050. “You’re getting interest on interest every year, and that has a really huge effect over time,” Bortolotti says. Once you get up to $100,000 and you get that same five per cent return with the exact same portfolio — now you’re up $5,000 in a single year.

“The earlier you get started, the sooner you start rolling that snowball down the hill, then the larger it’s going to be once you get into middle age and then it becomes really powerful,” Bortolotti says. The tipping point is when the investment growth on your portfolio is more than your annual contribution, or when “your portfolio is doing more heavy lifting than you are,” Bortolotti says.

You can also set up a dividend reinvestment plan (DRIP) where instead of being paid out in cash, dividends from the ETF buy more shares. That way, you’re using your investment growth to buy more shares, which is another powerful way of compounding, Bortolotti says.

Ultimately, successful ETF investing is all about broad diversification, low cost, automating contributions as much as possible and a disciplined strategy, Bortolotti says.

The biggest takeaway? “Just get started,” Engen says, even if you only have $20 a month to invest. The power of compound interest will still work in your favour.

Investing in asset allocation ETFs is known as the “Couch Potato” investment strategy for a reason: it’s all about investing in broadly diversified funds, with no stock picking and no market timing. Once you set it up, you can sit back, relax, and watch your savings grow.