Money Bag: Couch Potato Returns, First Investment, Early CPP, and More
Welcome to the Money Bag, where I answer questions and address comments from readers on a wide range of money topics, myths, and perceptions about money. No question is off limits, so hit me up in the comments section or send me an email about any money topic that’s on your mind.
This edition of the Money Bag answers your questions about the performance of index tracking ETFs, what to buy for a first-time investment, clarifying the MER on asset allocation ETFs, taking CPP early, and whether it still makes sense to hold bonds in your portfolio.
First up is Melanie, who likes the idea of investing in low cost ETFs but is concerned about the lack of performance data. Take it away, Melanie:
Couch Potato Returns
Hi Robb, I have read a lot about the ease and benefit of switching to a “Couch Potato” like portfolio. I personally would love to switch to something easier than managing my own portfolio but I rarely have seen real information on the performance of these portfolios and am therefore hesitant to switch.
I’m wondering if you could tell me about the actual performance of these so-called Couch Potato portfolios?”
Hi Melanie, thanks for your email.
It’s common to question the past performance of a portfolio of ETFs, given that many of them are relatively new and don’t have a long track record.
The first thing to understand is that the Couch Potato style ETF portfolios that I’m talking about track specific market indexes like Canada’s TSX, the S&P 500 in the U.S., and other large indexes around the world. Those indexes have been around for many many years and so if your ETF portfolio is simply trying to replicate the performance of those indexes then it should be very easy to perform a back-test and see exactly how they would perform had they existed for the last 25 years or so.
The good news is that Justin Bender at PWL Capital has done the work for us and back-tested all of the Vanguard and iShares asset allocation ETFs to show their theoretical performance over time.
You’ll see, for example, that Vanguard’s 60/40 ETF portfolio (VBAL) has a 25-year annualized return of 6.82%, which is quite good.
I have also tracked the performance of index mutual funds, which typically cost a bit more than ETFs but take a similar approach.
19-Year Old’s First Investment
Next up is Garrett, who wants some advice for his daughter’s first investment:
Hey Robb,
My daughter is a 19-year-old university student. She has not opened a TFSA yet, but she has $12,000 (saved tips from her job) ready to invest. I was thinking of just having her purchase a ETF for Canadian Banks… thoughts?
Hi Garrett, first I’m going to assume that your daughter does not need this money for any other purpose other than long-term investing. Money needed in the next 1-3 years to pay for school, buy a car, or for a house downpayment should be kept in a high interest savings account.
Your question reminds me that there’s a sub-Reddit called “Just Buy VGRO” that sort of tongue-in-cheek answers this question for first-time investors.
VGRO is all about low cost, broad diversification, and no rebalancing required. And, if she opens her TFSA account through a platform like Wealthsimple Trade, she won’t incur any fees or commissions to buy the ETF.
The other go-to platform for first-time investors is Wealthsimple Invest (the robo-advisor platform), where they will simply allocate the $12,000 into a portfolio of low cost index ETFs.
Best thing for her to do is open the account and buy something diversified so that she never has to worry about monitoring or rebalancing.
The problem with a bank ETF like BMO’s Equal Weight Banks Index ETF (ZEB.TO) is that it owns just six Canadian banks – not exactly diversified. And, it comes with an MER of 0.55%, which is relatively expensive for just six holdings.
Compare that to VGRO, which holds 12,649 stocks and 17,209 bonds from all over the world. It costs a measly 0.25%. Now you know why they say, “Just Buy VGRO.”
Asset Allocation ETF Fees
Speaking of VGRO, John wants to know if asset allocation ETFs (like VGRO) charge two layers of management fees:
Hi Robb,
You’re a big proponent of asset allocation ETFs like VBAL, VGRO, and VEQT. My question is this: Since these ETFs contain 6-7 other ETFs, do you get charged the MER for those underlying holdings (in addition to the MER for the asset allocation ETF)?
Hi John, great question and one that I’ve received often from readers. The answer is no, you don’t pay additional fees for the underlying holdings of the ETFs. What you see is all there is.
You’re right that asset allocation ETFs like VBAL, VGRO, and VEQT are “wrappers” that contain several other Vanguard ETFs that represent different asset classes and regions.
VBAL holds these seven Vanguard ETFs:
- Vanguard US Total Market Index ETF
- Vanguard Canadian Aggregate Bond Index ETF
- Vanguard FTSE Canada All Cap Index ETF
- Vanguard FTSE Developed All Cap ex North America Index ETF
- Vanguard Global ex-US Aggregate Bond Index ETF CAD-hedged
- Vanguard US Aggregate Bond Index ETF CAD-hedged
- Vanguard FTSE Emerging Markets All Cap Index ETF
The benefit of investing in VBAL is that it automatically rebalances to maintain its target asset mix. This means you don’t have to buy and sell individual ETF holdings on your own.
Yes, each of the individual ETFs has its own management fee. But Vanguard packaged up all seven of these ETFs into one “asset allocation” ETF and just charges a flat fee (MER) of 0.25%. That’s it.
Taking CPP Early
Here’s Farhan, who wants to know if he should take his CPP early or wait until 65:
Hi Robb, I am 61 years old and retired in March of this year. I am currently drawing a pension from OMERS. My wife is 60 years old and drawing a long-term disability claim from insurance and CPP disability.
My question is, should I take my CPP now or wait until I turn 65? Thanks!
Hi Farhan, thanks for your email. The answer really depends on other aspects of your finances. Do you need the income now, or can you get by on your OMERS pension, your wife’s disability income, and/or some personal savings for the next four years?
The math really favours waiting to take CPP at 65 and, if you can, defer taking CPP until age 70. You’re penalized 0.6% for every month that you take CPP earlier than 65. That means if you take it now you’ll get 28.8% less than you would if you waited until 65.
Now, many people argue that it’s better to take CPP as soon as possible because you never know if/when you’ll meet an untimely demise. But that ignores the fact that a 60-year-old male has a 50% chance of living until age 89, and a 25% chance of living until age 94.
Deferring CPP is a way to ensure that you don’t run out of money if you happen to live a long and healthy life. CPP benefits are indexed to inflation and payable for life.
Why Should I Own Bonds?
Finally, Colin wants to know if bonds still have a place in his portfolio, given that interest rates have nowhere to go but up:
Hi Robb, can you explain why anyone should own a bond fund right now? The unit values have gone up because interest rates have gone down. If rates go back up, unit values will fall.
Perhaps it’s better to hold 25% cash for the fixed component, or to buy GICs
I have 15% of my investments sitting in High Interest Savings, which now only pay 0.5%. Better than nothing but still appalling. Any suggestions?
Hi Colin, it’s certainly counterintuitive to hold bonds when rates have nowhere to go but up, but we’ve also been saying that for quite some time now and bonds haven’t performed that poorly:
Bonds are the ballast that protect your portfolio from the overall volatility of the market. A 60/40 balanced portfolio is still up on the year (2%) and had about half the volatility of an all-equity portfolio. There’s a behavioural component at work there – bonds help you stay the course.
That said, there is a good argument to keep your fixed income in GICs instead of bonds. The problem is that GIC rates aren’t all that attractive either.
High interest savings rates are also abysmal these days, but it’s the best option for a risk-free return. You’ll need to look outside the big banks and towards a credit union or online bank to find better yields.
I use EQ Bank, which pays an every day rate of 1.7%, plus a $20 bonus when you open an account and deposit $100.
Do you have a money-related question for me? Hit me up in the comments below or send me an email.
Hi,
It seems to me that in past years the predominant thinking was to take CPP early but now that’s swung the other way. Regardless having retired early at 56 I took it at age 60 and while I could have done without it I reasoned that I would likely spend more money early in retirement than later once age related ailments began to kick in. Currently 65 no regrets.
Hi Peter, the rules of the game changed fairly recently. Prior to 2016 you would only receive a 0.5% penalty for each month you receive CPP before age 65. Now it’s a 0.6% per month penalty.
Prior to 2013, you would only receive a 0.5% per month enhancement for deferring CPP. Now it’s a 0.7% enhancement.
So the math really starts to favour CPP deferral and discourages taking it early. But recent stats show only about 1% of CPP recipients have elected to defer their benefits to age 70.
There needs to be more awareness around the benefits of deferring CPP. It’s not for everyone, but in many situations it leads to the most optimal outcome.
Check the calculation of your CPP before deciding what to do. Which earning years do you need to include in the calculation? If you retire early and defer, you may have to include low earning years in the CPP calculation, resulting in a lower pension. Also, getting higher CPP later may kick you into Old Age Security clawback territory, especially once you start to withdraw money from a RRIF.
The one thing still I find confusing about the advice to take CPP at 70 vs early is the suggestion that it ensures that you will not run out of money. However, if someone is on a pension they won’t run out of money and taking it early allows the person the ability to augment their pension as early as possible, no ? Unless I am missing something. Would love to know as my wife is a teacher with pension starting next year at age 58 .
Hi TonyC,
CPP makes up one pillar of your retirement income (along with OAS, potentially a workplace pension, and your personal savings). Most retirees need all three (potentially four) of those pillars to meet their spending needs in retirement.
The idea of deferring CPP is to lock in an 8.4% per year enhancement (up to 42% more annual benefit if you defer to age 70). But this counterintuitively means drawing more from your personal savings in your 60s to tide you over. But in almost all projections I have run for my clients, the additional income from deferring CPP more than makes up for that.
Think of it this way: Will your personal savings & investments be earning a guaranteed 8.4% return each year? Not likely. Then, consider that CPP is paid for life and indexed to inflation and you can see why this can be a winning strategy.
If I understand your question right and you can live off of your wife’s teacher’s pension without needing to dip into any savings, then perhaps it could make sense to take CPP early and top-up the pension income.
Thank you Robb. I like the example of the 8.4% guaranteed investment. Appreciate the advice. Thank you.
Tc
I have a question or two about RRIFs. If someone held only GICs in their RRSP, how are they handled when the time comes to convert to an RRIF? A percentage has to be cashed out each year. How does that work if everything is locked up in registered GICs, perhaps in the middle of a term at the time one reaches age 71? Is the onus on you to set up your RRSP prior to the RRIF conversion time with the funds for withdrawal in a savings account or something similar? Is it under your control or is it something a bank just has a set procedure for?
Hi Jo, great question. I found this on Oaken Financial’s website. They’ve shared a helpful guide on how to fulfill your RIF minimum payment requirement:
When determining the annual minimum withdrawal requirements for your RIF, funds are withdrawn from your account in the following order:
1. Interest that has accrued on the GIC investments held in the plan.
2. If the interest amount does not satisfy the minimum annual withdrawal requirement, Oaken will withdraw the outstanding balance from the principal.
If there are multiple GICs in your plan, funds are withdrawn from the principal in the following order:
1. The GIC with the lowest interest rate.
2. If the interest rate is the same between 2 or more GICs, funds will be withdrawn first from the GIC with the earlier issue date.
3. If the interest rate is the same between 2 or more GICs, and 2 or more GICs also have the same issue date, funds will be withdrawn first from the GIC with the lowest balance.
I’d imagine other banks would have similar procedures.
Hi Rob,
What are some options/ideas for keeping USD funds in a non-registered account for a 4-5 year time horizon? Looking to buy a condo in Florida upon retirement.
Thanks
Charlie
Rob on the model portfolio etf breakdown by justin bender i only see vanguard not i shares and also where it shows the annualized rate of return. Not sure if I am missing something or where to further look as I see no links
Hi Kelly, sorry – the image did not show the entire graphic from Justin’s website.
Here is a link to the Vanguard Asset Allocation ETFs: https://cdn.canadianportfoliomanagerblog.com/wp-content/uploads/2020/09/Model-ETF-Portfolios-Vanguard-2020-08-31-Light.pdf
And here is a link to the iShares Asset Allocation ETFs: https://cdn.canadianportfoliomanagerblog.com/wp-content/uploads/2020/09/Model-ETF-Portfolios-iShares-2020-08-31-Light.pdf
My husband just turned 60 and I’m 57, both planning to work another five years, minimum, and retire on rrsps (no pensions). Does it make sense for him to start receiving CPP now at the lower rate and reinvest it back into RRSPs (plus any tax refunds)? Any idea how to calculate this? He has lots of RRSP room left to put the full payments in plus whatever more we can save each year.
Hi Lori, would you expect to earn a 7.2% guaranteed annual return on that investment? Because that’s what you’d be giving up by taking CPP before age 65 (0.6% reduction in benefits for every month you take it earlier than age 65).
Read this article on when it makes sense to take CPP at 60 and when it does not: https://boomerandecho.com/take-cpp-at-age-60/
One thing to keep in mind is if you continue to work while receiving CPP (CPP) and you are between 60 and 65 years old, you must still contribute to the CPP. Your CPP contributions will go toward post-retirement benefits. These benefits will increase your retirement income when you stop working.
Does the needed 7.2% annual return you mention account for a full reinvestment of the tax refund generated for someone in a 25% marginal tax bracket? This tax savings would give it an automatic boost, growth and earnings aside, but I’m likely missing something important here.
Hi Rob,
I enjoy reading your blog and thank you for your efforts. I have been DIY investing since I graduated from university 10 years ago. I know to buy when markets are in the red and avoid (or never) sell when they are in the red. This strategy has worked for me and I have not lost any money over the decade.
Would you be able to help me understand how deep sell-offs happen? I am defining deep sell-offs when the broader indices fall 5-10% in a single day often triggering some “circuit-breaker”. But it’s not electricity so it is likely a metaphor. I imagine there are literally millions of people across the world sitting at their computers selling their investments or people have set stop-loss orders ahead of time and it is a coincidence that millions of people have set the same (or close) trigger for the sell. A penny for your thoughts?
Thanks,
Hi Rob
What are your thoughts on Canadian Bank Auto-callable Notes? I’m looking at ones offer by the National Bank.
In some ways they sound too good to be true.
Thanks Craig
Hi Rob,
Since we are in a very strange era of the market, I have quite a large conundrum: I am 56 with very little RRSP or any other savings invested ( app. 15,000) but I sold my house recently and have 300,000 to invest. My partner wants to retire within 5 years and he is well set up ( managing his portfolio couch potato style quite successfully) , which leaves me light years behind him. We are struggling to figure out how to invest for the next 5-10 years( with my funds). We are looking to do a couch potato style of investing, and have looked at TD e series and quest trade, but I am worried about the volatility of the markets ( since they are on such a high and should be crashing… when?) and the North American (world) economy
I am working full time and have a small profit sharing plan with work.
Thank you for your guidance
Hi Lezlie, when it comes to investing the most important thing to do is identify your risk tolerance and time horizon. That will dictate the percentage of your portfolio that will be allocated to stocks and bonds.
Your investing plan shouldn’t change based on market conditions. The general direction of the stock market is up and so markets are regularly reaching new highs. That shouldn’t concern you and it doesn’t mean a crash is imminent.
The evidence shows that it’s best to invest a lump sum of money all at once for the best outcome. But if you can’t bring yourself to do that then it’s best to set up a systematic and rules-based approach that has you investing a portion of the funds each month until you’re fully invested.
Going back to the risk appropriate portfolio, I understand it can be scary to invest in the stock market and that’s why it’s important to know that you can hold a more balanced portfolio (50-50 or 60-40) to help lower the overall volatility (ups and downs) while still achieving a good return that meets your goals.