I started investing in individual stocks shortly after the Great Financial Crisis ended in 2009. I picked an investing strategy that closely resembled the Dogs of the TSX, buying the 10 highest yielding Canadian dividend stocks. As you can imagine, the share prices of these companies got hammered during the stock market crash so I was able to scoop up shares in banks, telecos, pipelines, and REITs on the cheap.
Stocks came roaring back right away and my portfolio gained 35% by the end of 2009. Investing is easy, right?
It took me a while to figure out that my portfolio returns had less to do with my stock picking prowess and more to do with market conditions, luck, and the timing of new contributions. The rising tide lifted all ships, including my handful of Canadian dividend stocks.
I started comparing my returns to an appropriate benchmark to see if my judgement was adding any value over simply buying a broad market index fund. My portfolio outperformed for a few years until it didn’t. In 2015, I had enough and switched to an index investing strategy. Now I invest in Vanguard’s All Equity ETF (VEQT) across all of my accounts.
Related: Exactly How I Invest My Money
New investors who started trading stocks recently may have had a similar experience. After an “everything is down” year in 2022, stocks have rallied big-time over the past 20 months.
For the period of January 1st, 2023 to August 31st, 2024 the S&P 500 (represented by Vanguard’s VFV) is up 50% including dividends. The Canadian market (represented by Vanguard’s VCN) is up 28% including dividends. And a portfolio of global stocks (represented by Vanguard’s VEQT) is up 36%.
Those are specific market indexes, mind you. Over the same time period, individual stocks like NVIDIA and Super Micro Computer are up 717% and 433% respectively. Tesla (+74%), Microsoft (+76%), and Apple (+78%) continue to shine. Even meme stock darling GameStop is up 27%.
No doubt, unless they’ve done something disastrous, new investors participating in this market have seen incredible returns so far.
This can lead to overconfidence – when people’s subjective confidence in their own ability is greater than their objective (actual) performance.
Overconfident Investors
Larry Swedroe says the biggest risk confronting most investors is staring at them in the mirror. This is the first type of overconfident investor.
Overconfidence causes investors to trade more. It helps reinforce a belief that any investment wins are due to skill while any failures are simply bad luck. According to Swedroe, individual investors tend to trade more after they experience high stock returns.
Overconfident investors also take on more uncompensated risk by holding fewer stock positions.
Furthermore, overconfident investors tend to rely on past performance to justify their holdings and expectations for future returns. But just because stocks have soared over the past 20 months doesn’t mean that performance will continue over the next 20 months.
In fact, you should adjust your expectations for future returns – especially for individual stocks that have increased by 100% or more. No stock, sector, region, or investing style stays in favour forever. If you tilt your portfolio to yesterday’s winners (US large cap growth stocks) there’s a good chance your portfolio will underperform over the next decade.
The second type of overconfident investor is one who makes active investing decisions based on a strong conviction about how future events will unfold.
Related: Changing Investment Strategies After A Market Crash
Think back to the start of the pandemic. As businesses shut down around the world it seemed obvious that global economies would suffer and fall quickly into a massive recession. The stock market crash reinforced that idea. Investors hate uncertainty, but this time it seemed a near certainty that stock markets would continue to fall and remain in a prolonged bear market.
Markets quickly turned around as central banks and governments doled out massive stimulus to keep their economies afloat and their citizens safe at home. Now it became ‘obvious’ that investing in sectors like groceries, cleaning supplies, online commerce, and video technology would produce strong results.
Fast forward a year or two when high inflation became a chief concern. Some investors, overconfident in the outcome of sustained higher inflation, shifted their portfolio into so-called inflation hedges. These could include gold, cryptocurrency, inflation-protected bonds, commodities, or real estate.
But as Ben Felix pointed out in this episode of the Rational Reminder podcast, the ultimate inflation hedge is a globally diversified and risk appropriate portfolio (and even that’s not really a hedge).
Finally, there are the perma-bears who claim the next great crash is right around the corner. These overconfident investors aim to avoid losses and protect their downside by making active bets with their portfolio. This could include selling stocks and moving to cash, using alternative investments that have low correlation to stock performance, buying put options, or short selling stocks.
The point is, they claim to know what’s coming and how to avoid it.
Reasonable critics (like me) would agree that stock valuations, especially US stocks, are high. We would agree that there’s always the possibility of a stock market crash. What I’d disagree with is what to do about it. If you’re invested in a globally diversified and risk appropriate portfolio, the answer is to lower your expected future return assumptions and do nothing else.
Final Thoughts
Overconfidence is something that most investors have to deal with at some point in their journey. I argue that there are actually two types of overconfident investors.
The first type is when you believe your past investing performance has more to do with your skill and decision making than with luck, timing, and market conditions.
The second type is when you believe you can correctly predict a future (macro) outcome and you make active decisions with your investments to support that belief.
You can avoid the first type of overconfidence by diligently comparing your investment returns with an appropriate benchmark index. I did this with my Canadian dividend stocks by comparing the performance to the iShares Canadian Dividend Aristocrats Index ETF (CDZ).
This process helped open my eyes to how difficult it is to actually beat the market on a consistent basis. I eventually gave up stock picking and switched to indexing – accepting market returns in exchange for a tiny fee.
The second type of overconfidence is much more difficult to overcome. We can’t help but make predictions about the future, or listening to pundits who make a living sharing their predictions. Even if we don’t have strong convictions about the future, we can easily be swayed into doing something with our investments to stickhandle around future outcomes.
This is where I find comfort investing in an asset allocation ETF. When I invested in individual stocks I could see plain as day which ones were in the red (looking at you, oil & gas stocks). Even with a multi-ETF portfolio you can see which one(s) are underperforming and you can easily second guess your holdings or target asset mix.
With an asset allocation ETF you don’t see the underlying holdings. It all moves together in a perfectly balanced and targeted mix. This way, I find myself less likely to want to tinker with my portfolio when it’s all rolled up into one investment.
It might seem counterintuitive to spend down your own retirement savings while deferring government benefits such as CPP and OAS past age 65. But that’s exactly the type of strategy that can increase your income, save on taxes, and protect against outliving your money. Indeed, the key to more lifetime income for many retirees is to defer CPP until age 70.
Why Take CPP at age 70?
Here are three reasons to take CPP at age 70:
1. Enhanced Benefit – Take CPP at 70 and get 42% more!
The typical age to take your CPP benefits is at 65, but you can take your retirement pension as early as 60 or as late as age 70. It might sound like a good idea to take CPP as soon as you’re eligible but you should know that by doing so you’ll forfeit 7.2% each year you receive it before age 65.
That’s right, you’ll get up to 36% less CPP if you take it immediately at age 60 rather than waiting until age 65. That alone should give you pause before deciding to take CPP early. What about taking it later?
There’s a strong incentive for deferring your CPP benefits past age 65. You’ll receive 8.4% more each year that you delay taking CPP (up to a maximum of 42% more if you take CPP at age 70). Note there is no incentive to delay taking CPP after age 70.
Let’s show a quick example. The maximum monthly CPP payment one could receive at age 65 (in 2024) is $1,364.60. Most people don’t receive the CPP maximum, however, so we’ll use the average amount for new beneficiaries, which is $758.32 per month. Now let’s convert that to an annual amount for this example = $9,100.
Suppose our retiree decides to take her CPP benefits at the earliest possible time (age 60). That annual amount will get reduced by 36%, from $9,100 to $5,824 – a loss of $3,276 per year.
Now suppose she waits until age 70 to take her CPP benefits. Her annual benefits will increase by 42%, giving her a total of $12,922. That’s an increase of $3,822 per year for her lifetime (indexed to inflation).
2. Save on taxes from mandatory RRSP withdrawals and OAS clawbacks
Mandatory minimum withdrawal schedules are a big bone of contention for retirees when they convert their RRSP to an RRIF. For larger RRIFs, the mandatory withdrawals can trigger OAS clawbacks and give the retiree more income than he or she needs in a given year.
The gradual increase in the percentage withdrawn also does not jive with our belief in the 4 percent rule that will help our money last a lifetime.
You can withdraw from an RRSP at anytime, however, and doing so may come in handy for those who retire early (say between age 55-64). That’s because you can begin modest drawdowns of your retirement savings to augment a workplace pension or other savings to tide you over until age 65 or older.
Related: When Should Early Retirees Take CPP?
Tax problems and OAS clawbacks occur when all of your retirement income streams collide simultaneously. But with a delayed CPP approach your RRSP will be much smaller by the time you’re forced to convert it to a RRIF and make minimum mandatory withdrawals.
With careful planning (and appropriate savings) your retirement income streams by age 70 could consist of CPP and OAS benefits, small RRIF withdrawals, plus – the holy grail – TFSA withdrawals, which do not count as income and won’t affect means-tested benefits like OAS.
3. Take CPP at age 70 to protect against longevity risk
Here’s where the counter-intuitiveness comes into play. Most default retirement projections will have you taking CPP at age 65 (or earlier) while delaying withdrawals from your RRSP and/or LIRA until age 71.
As I suggested above, the idea is to spend down some of your RRSP before age 70 to fill the gap left by deferring your CPP benefits. Good luck getting your commission-paid advisor to buy into this approach. I doubt many advisors would like the idea of spending down your savings early in order to maximize retirement benefits from CPP.
“Spend your risky dollars first because they may not be there for you in your 80s, depending on how your investments do. A bigger CPP cheque, however, will definitely be there for you.” – Fred Vettese
Spending down your RRSP in your 60s while deferring CPP until age 70 is like converting your risky assets (personal savings in the stock market) into a guaranteed income stream for life.
Related: 5 ways to save your retirement
Think about it. Will you still have the required mental faculties at age 80 or 90 to continue managing your own retirement assets? Or would you prefer to enjoy spending those assets in your 60s and 70s, knowing you still have an enhanced (and guaranteed) income stream to last a lifetime?
If your biggest fear in retirement is outliving your money then why not design your retirement income streams to protect against that very fear? Instead, most retirees take their CPP benefits the first chance they get – leaving additional money on the table and giving up a portion of that longevity risk protection.
Let’s hear it: Retirees, when did you take CPP? Soon-to-be retirees, have I given you a compelling argument to take CPP at age 70?
It’s generally not wise to voluntarily take up to a 36% reduction in income, especially if that income is paid for life. But that’s exactly what happens when retirees choose to take CPP at age 60.
I’m a big proponent of delaying CPP up to age 70 to help protect against longevity risk and enhance your monthly pension benefit in retirement. Only a small percentage of retirees do so, however, as many prefer to take CPP as soon as they’re eligible.
Why Take CPP at Age 60?
Taking CPP early may not be the most optimal financial decision but there are a few cases where it can make sense. Here are three reasons to take CPP at age 60:
1). You Need to Eat and Pay the Bills
Maybe you were laid off in the latter stages of your career and struggled to return to the workforce, or you had to retire early due to poor physical health. Whatever the case, you’re about to turn 60 and need to build an income stream.
Simply put, without sufficient income or personal savings to carry you through your 60s you may have no choice but to take CPP as early as possible.
The earliest you can take your CPP benefits is one month after your 60th birthday. Doing so means a 36% permanent reduction in your monthly benefit, but that’s still money in your pocket today.
The maximum payment amount for taking CPP at age 65 is $16,375.20 per year (2024). That amount would be reduced to $10,480.13 per year if you elect to take CPP at 60.
Taking that extra $10,000 at age 60 could mean the difference between meeting your retirement income goals or not, and that needs to be weighed against having to wait five years for an extra $5,900 (or so) a year.
Finally, if you’re sure that you will be eligible for the Guaranteed Income Supplement (GIS) once you reach 65, it’s generally a good idea to take CPP at age 60.
2). You Have a Reduced Life Expectancy
The biggest mystery in retirement planning is that we don’t know how long our money needs to last because we don’t know when we’ll die.
By age 60 you may have some idea. Whether it’s genetics, poor health, or the results from your 23andMe test, if you have any reason to suspect a shortened life expectancy then taking CPP at 60 can make good financial sense.
Understand your breakeven point for taking CPP early. For instance, you’ll be ahead financially if you take CPP at age 60 and don’t live past age 69. If you make it to 85, then the optimal age to take CPP is 69.
For context, a 60-year-old Canadian, on average, can expect to live another 25 years. So if you’re playing the averages then it’s best to delay CPP.
Lastly, if you’re thinking about taking CPP early because of poor health, you should apply for a CPP disability pension instead. If approved, the CPP disability amount will always be higher than a retirement pension and it will convert to a full retirement pension at 65.
3.) You Have No Contributions from age 55 to 60
Did you retire at age 55? Or maybe leave your career as a salaried employee to start a business in your fifties? Business owners can choose to pay themselves dividends rather than a salary, and therefore would not have to make CPP contributions. How do those years of zero contributions affect your CPP retirement benefit?
Related: When Should Early Retirees Take CPP?
When you take CPP at 60, your benefits are based on your best 35 years of earnings, rather than your best 39 years of earnings if you were to take it at 65. Depending on your earnings from age 18 to 54, your CPP payments might still be close to the maximum if you take it at age 60, but it will definitely be reduced if you wait until age 65.
Two reasons not to take CPP at age 60
Forget the notion of taking CPP early and investing. This idea, likely brought to you by your friendly neighbourhood financial sales person advisor, sounds compelling in theory but can be a disaster in practice.
Remember, the CPP is taxable income so you won’t be able to invest the full amount unless it’s in an RRSP. Then take investment fees into account and consider how much will you need to earn to beat the guaranteed 7.2% return that comes with delaying CPP by a year?
No, it’s better to defer and receive a larger pension that’s guaranteed and inflation protected for life.
Finally, if you’re concerned about whether CPP will be around when it’s time to collect, or whether the government of the day will raid the fund to pay its debts, let’s put that idea to rest.
The Canada Pension Plan Investment Board (CPPIB) is independent of the CPP and run at arms length of federal and provincial governments. The fund has been audited by an independent actuary and found to be sustainable for at least the next 75 years (using conservative projections).
CPP will be there for you in retirement. The question is when do you plan to collect your benefits?