One concept Couch Potato investors need to accept is that their portfolio will move up and down with the market(s). Since the essence of passive investing means tracking a particular index, or set of indices, an investor’s returns must closely mirror those of the index (minus a small fee).
That notion can be downright scary for nervous investors wondering when the next stock market crash will occur. Indeed, one of my biggest fears as a passive investing advocate is that there will be a massive correction at some point and all the investors I’ve helped move to a low cost portfolio of ETFs will blame me for their losses.
But I know that’s not rational and there’s a mountain of academic and empirical evidence to support a passive approach. That, and I sleep better at night knowing I give the best advice based on these three principles:
- Future returns are unknowable, but the best and most reliable predictor of future returns is cost. The lower the better.
- Active management, including the idea that market timing can deliver all of the upside while also protecting the downside, sounds better in theory than it works in practice.
- Asset mix matters. You need to be comfortable with your portfolio mix in good times and bad to avoid panic selling and second-guessing.
That last one is important. If you’re thinking about a passive investing strategy, or have recently started one and are nervous about an inevitable correction, it might be helpful to consider the range of possible returns you’d be willing to accept.
For example, a conservative portfolio of ETFs with 70 percent bonds and 30 percent global stocks had 20-year annualized returns of 5.25 percent. Its lowest 12-month return (March 2008 to February 2009) lost 7.93 percent.
Alternatively, an aggressive portfolio of 90 percent global stocks and 10 percent bonds surprisingly had identical 20-year annualized returns of 5.25 percent. However, the dispersion of those returns was much more volatile. The worst 12-month period saw losses of 31.09 percent.
Finally, a traditional balanced portfolio made up of 60 percent global stocks and 40 percent bonds had 20-year annualized returns of 5.38 percent (the highest of the three portfolios), and saw its worst 12-month period lose 19.62 percent.
We’ve lived through an unprecedented bull market going on now for more than 10 years. It’s perfectly normal to feel like you want a more aggressive 100/0 or 80/20 portfolio. But do you have the temperament to hold that portfolio when faced with a 30 percent drawdown? Or will you completely abandon the strategy, thinking “it’s not working anymore”?
There are many ways to implement a passive investing portfolio. I have direct experience with three of those methods, with the one-ticket solution (VEQT) in my RRSP and TFSA, the TD e-Series funds in my kids’ RESPs, and a robo-advisor solution with my wife’s Wealthsimple RRSP.
All three portfolios have had a turbulent year, suffering big losses in May and August, but otherwise gaining steadily throughout the year and more than making up for the short correction at the end of 2018. Here are my personal rates of return so far this year:
- RRSP – One-ticket ETF (VEQT) – up 13.13 percent
- TFSA – One-ticket ETF (VEQT) – up 14.36 percent
- RESP – TD e-Series funds – up 13.69 percent
- Wife’s RRSP – Wealthsimple 80/20 portfolio – up 10.4 percent
As you can see from both the data on long-term returns, and the individual returns of various portfolios, it doesn’t necessarily matter which passive portfolio you adopt. What matters is your behaviour and how you react when markets (and your portfolio) move up and down.
A passive portfolio won’t protect you from a market crash. As investors, we must accept that occasional losses are inevitable. To cope, we need to design a portfolio with an appropriate asset mix for our risk tolerance and time horizon – and have the patience to stay the course.
This Week’s Recap:
This week I wrote about five retirement planning options to help you reach your retirement goals.
Thanks to Jonathan Chevreau for sharing my thoughts in his latest piece for the Financial Post: How investors can navigate the new world of ETF overload.
And Justin Bender from PWL Capital launched his long-awaited podcast this week and included a question from me about the benefits of U.S. dollar ETFs.
An excellent and informative piece from the How To Save Money blog on the 7 best travel insurance credit cards for people over 65.
Which Canadian rewards program is worth the most? Check out this comprehensive guide from the Credit Card Genius team.
Here’s Rob Carrick on how seniors should prepare for the day when they can no longer look after their retirement investments.
Read this complete guide to your RRSP from the Handful of Thoughts blog.
Nobel Laureate Daniel Kahneman explains why trying to convince other people to change their mind is a waste of time. It turns out, the key isn’t to apply more pressure but rather to understand:
Head over to the Farnam Street blog to listen to the full episode.
The Canadian financial advice industry needs higher standards and higher education requirements. It begs the question: Is it unethical to be incompetent?
The evidence is clear that ETFs give the best returns for investors. Here are seven strategies for maximizing returns from ETFs.
A Wealth of Common Sense blogger Ben Carlson gives a eulogy for the 60/40 balanced portfolio.
Nobody wants to lose money, so it is common to wonder what can be done to avoid the potentially negative stock returns that often come with a recession. Ben Felix explains:
Dale Roberts asks what would it take to reach F.I.R.E., and really retire early?
Finally, My Own Advisor Mark Seed answers an age old question of whether to pay down your mortgage or invest.
Have a great weekend, everyone!
There are lots of unknowns when it comes to retirement planning. Most of us focus on how much we need to save for retirement without giving much thought as to how much we’re going to spend in retirement.
A $1 million dollar nest egg can provide you with $30,000 to $40,000 to spend each year with reasonable assurance that you won’t run out of money. But if your ideal retirement lifestyle costs $60,000 per year, your million-dollar portfolio won’t be enough to last a lifetime.
Once you determine your magic spending number, the rest of the variables start falling into place. The earlier you can identify the amount of income you need to live the retirement you want, the easier it is to make your retirement plan and adjust course, if necessary.
Let’s say you’ve analyzed your retirement income needs and find, based on your current financial situation, that you won’t be able to fully fund your desired lifestyle. What to do?
Five Retirement Planning Options
Here are five retirement planning options to help you adjust course and reach your retirement goals.
1. Reduce your lifestyle
A $60,000/year retirement might be out of reach based on your current situation, but perhaps reducing your goal to $45,000/year can still provide a great lifestyle in retirement.
This lifestyle adjustment could mean travelling less often, making sure you retire debt free, downsizing your home, replacing your vehicle less often, reducing your hobbies, or a combination of all the above.
Don’t forget to include government benefits such as CPP, OAS, and/or GIS when projecting your retirement income. It’s worth sitting down with a retirement planner to figure out the best way to draw down your assets and when it makes sense to apply for CPP and OAS.
2. Work longer
It can be difficult to picture yourself working longer once you’ve got retirement on the brain, but a few extra years on the job can drastically alter your retirement projection.
The longer you work, the more you can save (or add to your pensionable service if you’re so lucky to have a workplace pension). But also the more years you’re working and earning a paycheque the fewer years you have to withdraw from your nest egg.
Are you healthy and willing to grind it out at work for a few more years? If so, you might be able to reach that $60,000/year retirement goal after all.
3. Earn more return from your investments
This is a tricky one because you might take it to mean investing in riskier assets (i.e. an all-equity portfolio), when in fact you can earn higher returns by reducing the overall cost of your portfolio. That’s the first place to start.
Imagine your $300,000 retirement portfolio is invested in a typical set of mutual funds that together comes with a management expense ratio (MER) of 2 percent. The cost is $6,000/year but you don’t see the charge directly – instead it comes off your returns.
Switching to index funds and going the do-it-yourself route might reduce your costs to 0.5 percent, or $1,500 per year. That’s an extra $4,500/year staying in your retirement account instead of going into the hands of your advisor.
There might also be a case for increasing the risk in your portfolio. Say, for example, you tend to hold a lot of cash in your portfolio – you’re not fully invested. Or you hold a bunch of GIC’s and other fixed income products.
Dialling up your investment risk to include a portion of equities could help you achieve an extra 2-3 percent per year. The power of compounding can make a huge difference to your retirement portfolio and holding even a small portion of equities in retirement can help your nest egg last longer.
4. Save more
This one is so obvious it should be first on the list. If you’re not able to fully fund your desired retirement lifestyle based on your current projections then you need to save more.
Hopefully your final working years can give you the opportunity to boost your retirement savings. Big expenses, such as paying down the mortgage and feeding hungry teenagers, are behind you.
But an empty nest and paid-off home might tempt you to increase your lifestyle now rather than doubling-down on your retirement savings to boost your lifestyle later. That’s fine: See options 1-3.
That said, there’s no better time to enhance your nest egg by maxing out your RRSP contributions, including unused contribution room, and doing the same with your TFSA, in the years leading up to your retirement date.
Be mindful here, though, of strategies to reduce your taxes in retirement. It makes little sense to go wild making RRSP contributions in your final working years without considering how withdrawals will impact taxes or OAS clawbacks in retirement.
5. Supplement your retirement income
Much like working longer can increase your nest egg, supplementing your retirement income with a part-time job derived from a passion or hobby can prolong the life of your portfolio.
Imagine earning $10,000/year from driving a shuttle, working at a golf course or winery, writing personal finance articles, doing photography, or working a couple of days a week at Home Depot just to get out of the house.
All of a sudden you don’t need to withdraw $60,000/year from your retirement account. You only need to take out $50,000/year. That not only extends the life of your portfolio, but studies have shown that having meaningful work in retirement can extend your life, too.
Retirement planning is critical and the earlier you start planning the easier it is to make these course adjustments and reach your desired outcome.
Even late starters need not despair. The first two options – tempering lifestyle expectations and working longer – are on the table. Everyone can try to save more and earn more from their investments. And, finally, a little retirement side hustle can give your lifestyle a boost and enhance your overall quality of life.