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:

1. Future returns are unknowable, but the best and most reliable predictor of future returns is cost. The lower the better.
2. 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.
3. 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.

Source: Canadian Couch Potato model portfolio returns

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.

Weekend Reading:

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!

A personal finance workshop held just outside of Toronto last month attracted a group of 75 financial independence seeking Canadians and Americans. This ‘Camp Mustache’ gathering was borne out of the F.I.R.E. (Financial Independence Retire Early) movement made famous by Mr. Money Mustache and has attracted followers from around the world.

The Globe and Mail’s Rob Carrick spoke at the event and came away with a newfound appreciation for the F.I.R.E. movement:

“A super-interesting group at Camp Mustache — really smart, capable people. The critics need to get over the idea that these people want to retire, full stop. They really just want to take back financial control of their lives.”

As one of those critics, my beef with F.I.R.E. has more to do with bloggers who sell the dream that, “I retired early, and so can you,” all while continuing to earn income from blogging, speaking, and book sales. But I am fascinated by real life (non-blogger) folks who are chasing F.I.R.E. and it sounds exactly like Rob Carrick describes: Smart and driven people trying to be mindful of their spending and take control of their lives.

The media in the U.S. has been all over the F.I.R.E. movement for years now, but Canadian news outlets are starting to catch on. The Toronto Star recently featured F.I.R.E. advocate Scott Reickens, who has his sights set on early retirement at age 41:

“The most magical part of the FIRE movement is the community. There are meetups all over the country, Facebook groups and a ton of people talking about this online and scrutinizing things. Impromptu meetings happen. It’s valuable to talk to people who understand this path and it’s incredible to spend time with people who have similar values. Then, you don’t have to do it alone.”

The Globe and Mail took a more critical look at the idea of retiring extremely early. One professor at the Richard Ivey School of Business had a 21-year-old student who came up with a plan to retire in his late 20s. Four years after the student’s graduation, he came back to say he had met his retirement goal through a combination of extreme savings and real estate investing and was ready to stop working at the age of 27.

Finally, a really smart take from MoneySense’s Allan Norman. He answered a reader question from a 49-year-old who found himself unexpectedly “retired” and wanted to stay that way permanently. Not only was his investment advice sound, but he challenged the reader’s early retirement ideas with a tough reality check:

“Simon, at age 49, you still have a lot of life to live. If you’re able, I’d encourage you to find a new job or career. I know you have a lot of money saved, but to stretch it over another 41 years is going to be tough. There are a lot of unknowns, including new cars to buy, trips to take and things to enjoy that will require more money. Waiting a few more years before stepping away from the workforce entirely will provide you with a safety net that will give you the financial peace of mind a comfortable retirement requires.”

I wrote about my own financial independence pursuit last week, sharing my internal struggle with when to quit my day job and go full-time as an online entrepreneur. I appreciate all of your comments, emails, tweets, messages, and words of encouragement (and caution). I’ve circled a date on the calendar and of course will let you know more when I can.

This Week’s Recap:

This week we had Victor Fong guest post about preparing for the next recession – a guide for the Canadian middle class.

In my Smart Money column at the Toronto Star I shared why you shouldn’t invest money that you’ll need in the next 3-5 years.

Promo of the Week:

Every week I get emails from readers asking about how to switch from their high-fee bank mutual funds to a robo-advisor. I’ve got a great post that outlines exactly how to transfer your RRSP to Wealthsimple, one of Canada’s leading robo-advisors.

Boomer & Echo readers get their first $10,000 of investments with no management fees for a year when they sign up for their first account at Wealthsimple.

Weekend Reading:

Stephen Weyman at Credit Card Genius shares the best credit cards of 2019 – the top one has an incredible average earn rate of 3.76 percent!

CBC Marketplace looked into credit scores and why four websites give you four different credit scores. More proof that your credit score is just a small piece of what lenders look for when evaluating loans.

Sticking with credit cards and rewards, here’s Patrick Sojka explaining how to maximize the elite benefits from the American Express Platinum card. I’m taking advantage of one of those perks right now (Gold Elite status with Marriott Bonvoy).

Rob Carrick lists five investment costs that are killing your returns, and what to do about them.

Jason Heath answers a great question – what is a pension bridge benefit and how does it work?

Here’s an incredible chart showing the impact of smartphones on the camera industry:

The iPhone comes out in 2007 and changes the camera industry. Amazing to see a 90% decline in just 10 years after growth for decades

Amazing that something can go from peak to trough in exact 10

Makes you ask- What’s the next product where this will happen? pic.twitter.com/9tMGHyYo2e

— Andrew Chen (@andrewchen) October 8, 2019

Are Canadian car owners being misled about how often a vehicle needs to be serviced? A while ago I wrote something similar about how often should you service your vehicle.

An interesting piece in the Globe and Mail: With baby boomers aging, the cost of long-term care is set to triple in the next 30 years. What’s our plan for dealing with this?

Speaking of preparation, here’s another great video by PWL Capital’s Ben Felix on preparing for the recession:

What Wealthsimple acquiring SimpleTax means and why tax preparers are the urologists of the financial world.

Adam Meyers says most Canadians know the ins and outs of an RRSP, but fewer can tell you about RRIFs, which is what happens to an RRSP when you turn 71.

How often should you rebalance your portfolios, and is now a good time to do it? Dale Roberts at Cut the Crap Investing explains.

Why single seniors get the shaft when it comes to tax breaks, and here’s how to fix this injustice:

“In retirement, couples get to take advantage of a significant tax-saving measure called pension income-splitting. Solo seniors, be they lifetime singles or people whose spouse has died, have no equivalent tax break. Given their longer lifespans on average, women are the primary victims of this discrimination.”

Legendary fighter Sugar Ray Leonard never wanted to be a boxer until his dad got sick. Here’s the incredible money story of the five-time world champion and Olympic gold medallist.

Have a great weekend, everyone!

As a CPA and Licensed Insolvency Trustee, I had a front row seat during the Great Recession of 2009 – 2011. I saw the devastating impact it had on the lives of ordinary Canadians.

These were everyday people who were for the most part honest, hard working, and played by the rules. Yet they found themselves on the short end of the stick when the Great Recession started 10 years ago: some lost their jobs, some had their financial portfolios decimated, some lost their homes and quite a few experienced losing all three.

It’s been more than 10 years since the onset of the Great Recession and Canadians are more indebted than ever. Therefore, in anticipation of the next recession, I thought it timely to write this piece for the readership of Boomer & Echo, which Robb has graciously allowed me to do.

This post will be divided into the following sections:

1. Is a recession imminent?
2. Assessing your economic vulnerability.
3. What can you do to prepare?
4. What are the available solutions if you’re seriously impacted?

Part 1: Is The Next Recession Imminent?

The following current events suggest that another economic downturn is imminent. Let’s examine them.

It’s been more than 10 years since the last recession

We are therefore due for another one. Why do recessions historically occur every 5 to 7 years? This is due to the phenomenon of the short term debt cycle. Here’s a simplified explanation of how it works:

• As individual actors in the economy, we borrow now to purchase or invest in something today. Consequently, as credit expands in the economy so does economic growth.
• However, what we borrow today has to be paid back tomorrow. And as we pay back our debts (also known as “deleveraging”), we have less money to purchase and invest in stuff. Consequently, deleveraging leads to an economic contraction.
• To get the economy going again, the central bank lowers interest rates and makes it cheaper to borrow. So we borrow, spend and invest in goods and services which again triggers economic growth thus starting the next short-term debt cycle. Rinse and repeat.
• We’re in year 10 of the most recent economic expansion. The problem is, because interest rates are already so low, the central bank will have run out of bullets in fighting the next recession unless it employs more unconventional monetary tools such as negative interest rates and Modern Monetary Theory. Some commentators have suggested that the global economy is coming towards the end of the long-term debt cycle. When that happens, standard monetary policy will no longer effective in restarting the economy.
• Here’s why that next recession hasn’t happened yet – interest rates in Canada (as well as in the United States and Europe) will remain low for the foreseeable future – because consumers are so indebted, even a slight increase in interest rates can wreak havoc on household finances and hence the broader economy. For example, the household debt to income ratio in Canada during September 2019 was 177.1 percent. Consequently, central banks in Canada and throughout the Western world are gun-shy about raising rates.
• However, external factors outside of the control of central banks may trigger the next recession. We’ll examine these factors next.

The United States is in an economic war with China

“Trade dispute” is a euphemism for what’s really happening between the U.S. and China, which is a full blown economic war. As of this writing, the Trump Administration is considering the possibility of delisting Chinese companies from U.S. stock exchanges. This is in addition to the tariffs it has already imposed on Chinese imports.

The U.S. intelligentsia sees China as a rising power which must be curtailed because China does not share America’s values. The model that is being used to describe this relationship between a waning U.S. and a rising China is called Thucydides’s Trap. Thucydides’s Trap is the dangerous dynamic that occurs when a rising power threatens to displace an established power. It usually leads to war, which in the case of the U.S. and China, is an economic war rather than a military war – at least for now.

Why is this economic war bad for the Canadian and global economies? Here’s a simplified analysis:

• The United States is our largest trading partner and as American consumers and businesses pay more for Chinese imports (which includes just about everything), they have less money to spend on everything else, including Canadian exports to the U.S. Moreover, Chinese businesses and consumers have less money to purchase Canadian imports because of the negative impact U.S. tariffs have on their economy.
• Because the U.S. and Chinese economies are so hegemonic and our globalized economy is so intertwined, countries throughout the world are similarly affected like Canada. For example, Germany is currently entering into a recession. One of the underlying causes of Germany’s recession is the U.S. – China trade war which has led to a decrease of industrial exports to China.
• Since our other global trading partners are affected the U.S. – China trade war, Canada has less customers for its exports, leading to Canadian eventual business closures, job losses and economic contraction.

Economic inequality and the rise of political extremism

Why has economic inequality exacerbated over the past 10 years?

Are you familiar with the term “quantitative easing“? If you watched the financial news during 2009 – 2011, you couldn’t avoid hearing it. It apparently saved the global economy and staved off the next Great Depression.

What is QE? It’s a euphemism for money printing. The U.S. Federal Reserve increased the supply of U.S. dollars (the global reserve currency) by $4 trillion starting in late 2008 in the hopes that it would get Americans to start spending.

While it did just that, it also created massive inflation. But wait – isn’t inflation at historical lows? That’s what economists and the mainstream media keep telling you, right?

Well no, not really:

• Yes, consumer goods are still relatively inexpensive, but that’s because almost all consumer goods are manufactured in China, which can crank up its manufacturing base on a dime and produce an almost infinite quantity of consumer goods. Hence, the quantity of consumer goods bought and sold globally can keep up with the expansion in the U.S. money supply, which I remind you, is the global currency used to pay for goods internationally. Hence, no inflation in consumer goods.
• Not so with real estate: do you really think that Vancouver and Toronto are the only real estate markets with insane housing prices and rents? Check out Amsterdam. Take a look at Berlin. They have insane housing prices as well. Unlike consumer goods made in China, there’s a limited amount of land available upon which to build real estate but a seemingly unlimited demand for it, particularly from China’s burgeoning middle class of 400 million. The result is asset inflation in the global housing market, both in sales prices and rent, due to all these U.S. dollars chasing a limited supply of real estate around the world.
• Similarly, stock markets throughout the globe have been on a tear since 2009. For example, the Dow Jones index now stands at 26,820 as of this writing. It was at 7,223 in March 2009 during the depths of the Great Recession – an increase of 271% over 10 years. Did the companies on the Dow suddenly become 271% more profitable during that time? Of course not – like real estate, there’s a limited quantity of publicly listed companies being chased by trillions of U.S. dollars, leading to another form of asset inflation.

If you were one of the Fortunate Few (let’s say “The 10%”) who owned real estate and financial assets during the last decade, then you probably made out like a Bandit. Your net worth probably likely increased significantly.

However, if you were one of the Less Fortunate Many (let’s say “The 90%”) who didn’t own real estate or financial assets and didn’t see a significant rise in your income during this past decade, then you probably feel like you got robbed by the Bandits in The 10%. Your net worth likely hasn’t changed or may have even gotten worse; since your income hasn’t increased, you probably took on more debt just to meet your basic living expenses.

Therefore, The 90% are understandably pissed. And in democratic countries like the United States and those in Europe, they appear to have expressed their frustration by voting in political extremists. In the United States, The 90% have elected Donald Trump on the Right (who has initiated a global trade war with China). Likewise, in the United Kingdom The 90% are likely to elect Jeremy Corbyn as Prime Minister. In that event:

A Labour government would confiscate about £300bn of shares in 7,000 large companies and hand them to workers in one of the biggest state raids on the private sector to take place in a western democracy, according to analysis by the Financial Times and Clifford Chance. The UK’s 2.6m landlords would also face a moment of reckoning if Labour won the next general election after shadow chancellor John McDonnell said he wanted a “right to buy” scheme for private tenants as well as higher taxes on landlords.

It goes without saying that today’s political extremists and their economic policies may very well trigger a global recession.

At the risk of using the past as a prediction of the future, I remind the reader that the U.S. stock market crashed in 1929, which led to the worldwide Great Depression. Within the following ten years, fascism rose in Europe resulting in the democratic election of Adolf Hitler as Chancellor in Germany. This led to the subsequent invasion of Poland by Nazi Germany in 1939 which started the Second World War.

Similarly, the Great Recession started in 2009 and events similar to the 1930s have played themselves out so far, so “take that as you will”.

Part 2: Assessing Your Economic Vulnerability

How vulnerable is your employment in the event of a recession? In my opinion, these are the economic sectors that will be hardest hit:

1. The resources sector, such as the oil and gas industry. Alberta in particular will be hit hard as it’s still recovering from the end of the commodities boom.
2. The entire building and real estate industry as well as its suppliers such as lumber, steel and cement companies since demand from domestic and foreign purchasers will dry up.
3. The entire banking sector, including retail, commercial and investment banking due to a decrease in demand for loans and business capital.
4. The retail sector, particularly “brick and mortar” retail which has higher overhead costs due to commercial rents, which are currently at historical highs.
5. The media industry, as advertising revenues dry up. The Toronto media industry was hit hard during the last recession with numerous layoffs.
6. The vehicle industry, including manufacturers and dealerships.

If you’re employed in one of these sectors, I suggest that you take my advice in the next section.

Part 3: What Can You Do To Prepare?

If you’re concerned about losing your job during a recession and being unable to pay your debts, then there’s no better time than now to start repaying your debts now:

1. Create a budget and see where your money is going. Cut out discretionary expenses and use the surplus to pay off your debts.
2. Prioritize your debt repayment by paying off the debt with the highest interest rate while maintaining the minimum payments on all your other debts.
3. Once you’ve paid off the debt with the highest interest rate, repeat Step 2 for the debt with the next highest interest rate until you’ve paid off all your debts.
4. Once you’ve tackled your unsecured debts, try to bring down the balances of your secured debts like your mortgage. Most banks will allow you to double up on your mortgage payments and will also allow you pre-pay up to 15% of your mortgage balance annually.
5. Once you’ve paid off your debts, start saving money in a High Interest Savings Account (HISA) for an emergency fund should you need it. You should save enough to pay for at least six months of living expenses if not more.

In terms of financial investments, speak to your professional financial advisor and ask her to review your investments to make sure that they align with your risk tolerance in light of an impending economic downturn.

Related: What you can do about the upcoming stock market crash

Part 4: Solutions If You Are Seriously Impacted

Let’s suppose that you’ve tried to pay down your debt as described in Part 3 but are unable to pay it all off before the next recession hits and you lose your job when it does.

If that event, there are a few options available to you if you cannot pay your debts as they become due. For the purpose of this discussion, we will focus on unsecured debts (as opposed to secured debts like a mortgage or vehicle loan):

1. You can consult with an accredited credit counsellor who will put you on a Debt Management Plan (DMP). A DMP will allow you to pay off your debts over a longer period of time – usually 60 months. The counsellor may also be able to negotiate a reduction in the interest rate. Despite all these positives, a DMP will have a negative impact on your credit.
2. If you are unable to pay off all your debts under a DMP, the next step is to attempt to settle with your creditors through a consumer proposal. A consumer proposal is a legal settlement with your creditors facilitated by a Licensed Insolvency Trustee under the Bankruptcy & Insolvency Act. Such a settlement can be paid either in a lump sum payment or by periodic payments over a maximum period of 60 months. Upon filing a consumer proposal, the interest stops accruing on your debt and your creditors cannot commence or continue any legal action to recover their debts. Upon paying the settlement in full, you are discharged from the balance of your debts. Like a DMP, a consumer proposal will have a negative impact on your credit.
3. If you’re unable to even settle with your creditors, then your last line of defense in dealing with them would be filing for personal bankruptcy with the assistance of a Licensed Insolvency Trustee. Like a consumer proposal, once a bankruptcy is filed, the interest stops accruing on your debt and your creditors cannot commence or continue any legal action to recover their debts. However, your assets may have to be liquidated by the Trustee depending on the province in which you reside or where your assets are located. Also, you may be required to contribute a portion of your income to your bankruptcy estate – the amount payable (called “surplus income“) would be determined by your net monthly income and the number of dependents you have to support. Upon obtaining your discharge from bankruptcy, a record of your bankruptcy will remain on your credit history for either 6 or 7 years depending on your province of residence.

Conclusion

As the saying goes, “History doesn’t repeat itself, but it often rhymes”. In my view, we are facing a world analogous to that of the 1930s – a financial collapse followed by rapid money-printing, rising inequality, a discontented populace, and the election of political extremists that promise simple solutions to complex problems. We live in dangerous times – I hope that you found this article informative so that you can better prepare yourself and your family for what happens next.

Victor Fong, CPA, CMA, LIT is the founder and President of Fong and Partners Inc., a Licensed Insolvency Trustee based in Toronto, Canada.