It’s easy to stick to your long-term investing plan when times are good. Indeed, if your investment portfolio had any U.S. market exposure at all over the past 12 years you’ve likely enjoyed nearly uninterrupted growth.
Of course, there are always bumps in the road. Stocks fell sharply in a short period between February and March 2020, the swiftest decline in history. The world was shutting down in response to the COVID-19 pandemic and investors panicked. But stocks came roaring back and the S&P 500 ended the year with a gain of 18.4%. Things were good again. Until they weren’t.
Investors have been worried about a prolonged stock market crash for years. Those fears are heightened each year that stocks continue to rise. Surely this can’t last forever. Meanwhile, as we come out of the pandemic, there’s anxiety over inflation and rising interest rates, which has put downward pressure on bond prices. Long-term government bonds are down 12% on the year. U.S. treasuries, the ultimate safe haven, are down 3.3%.
In uncertain times we look to economic forecasts and predictions of what’s to come. There’s no shortage of opinions, so it’s easy to find one that fits your narrative. It’s hard not to listen when legendary investors like Jeremy Grantham call this the greatest bubble since 1929.
So, what’s an investor to do when stocks are poised to crash, bonds are in a free-fall, and cash pays next to nothing? Even gold, often pegged as an inflation hedge and portfolio diversifier, is down nearly 10% year-to-date.
Are you properly diversified?
Is your portfolio as diversified as it should be? Does it have a mix of Canadian, U.S., International, and Emerging Market stocks? A mix of short-term and long-term corporate and government bonds?
Are you judging your portfolio as a whole or by its individual parts? It’s never easy to see a specific holding fall in value. It makes you wonder why you hold it at all. Bond holders must be feeling that way right now.
If you hold Vanguard’s Canadian Aggregate Bond Index (VAB), you’re likely not pleased to see this performance:
When you add U.S. and Global bonds to the mix, the results are similar but slightly more favourable:
Now let’s add Canadian, U.S., International, and Emerging Market stocks to the portfolio using Vanguard’s FTSE Canada All Cap Index (VCN), Vanguard’s U.S. Total Market Index (VUN), Vanguard’s FTSE Developed All Cap ex North America Index (VIU), and Vanguard’s FTSE Emerging Markets All Cap Index (VEE):
When you put all seven of these ETFs together you get Vanguard’s Balanced ETF portfolio (VBAL). Each part following its own unique path, but blended together using a rules-based approach that maintains the original target asset mix through regular rebalancing.
Here’s how that looks over a three year period (since VBAL’s inception):
This is what diversification looks like. While some individual parts lag behind, others lead the charge and drive the overall returns. Regular rebalancing helps ensure you always buy low and sell high while managing your risk and return. The result is a compound annual growth rate of 7.3% since 2018.
Perhaps the best way to visualize how diversification works is by looking at the periodic table of investment returns over the past 20 years (source: www.callan.com):
Last year’s winner is often next year’s loser. Every asset class has had its turn at or near the top, including large cap stocks, small cap stocks, emerging markets, real estate, bonds, and yes, even cash (once).
Do you think you can predict which assets will lead the way in 2021 and beyond? Unlikely. That’s why it’s best to diversify broadly so you can capture market returns without trying to guess where to park your money.
What about pulling out all of your investments and moving to cash? Well, cash was the worst performing asset class in eight of the 20 years. Even in 2008-09 bonds were the better bet.
Have you rebalanced?
I’ve written before about investors getting distracted by shiny objects like cryptocurrency, technology stocks, and high-flying fund managers. Even seasoned investors were moving more of their money into U.S. stocks, technology stocks, and Bitcoin to capitalize on rising markets.
Indeed, why hold bonds at all when every other asset class has been soaring?
The result is a portfolio and asset mix that is likely out of step with your original goals.
Rebalancing is counterintuitive because it forces you to sell what’s going up in value and buy more of what’s going down. It’s tough to wrap your head around selling U.S. stocks to buy more Canadian stocks. Or worse, to buy more bonds.
It’s even more difficult in uncertain times. It’s easy to look back at March 2020 or March 2009 as buying opportunities of a lifetime for stocks. But in the moment it probably felt terrifying to even be holding stocks at all.
Today, nervous investors are worried about holding bonds. What should be the stable portion of their portfolio is suddenly underwater and signs of future upside are nowhere to be found.
Damir Alnsour, a portfolio manager at Wealthsimple, has heard from many of these anxious investors in recent days. They’re asking questions like, will bonds keep going down?
“The answer is that no one really knows if it is likely to continue, but we always look at our portfolios with a long-term lens because we don’t allocate our investments based on short-term market performance. We expect that in the future there will be times where stocks are doing well, and bonds are underperforming but also the opposite. We can’t predict these times, and we don’t think anyone else can either,” said Alnsour.
He encourages his clients to take a 30,000-foot view and remember the reason their portfolio includes bonds. Bonds are a long term source of return that improve the stability of your portfolio because they often react to changes in the economic environment differently than stocks.
“During most of the major stock market downturns historically, bonds have increased in value and helped cushion losses,” said Alnsour.
Just like the three-year chart of VBAL’s returns, a well-balanced and diversified portfolio is expected to rise over time – after all, that’s why we invest in the first place. But it’s normal for the same portfolio to suffer minor short-term losses along the way that can sometimes take weeks or months to recover.
Back to Wealthsimple’s Alnsour:
“Also, keep in mind, we would rebalance the portfolio if bonds were to continue to sell-off. What this means is that should the bond allocation drop below our rebalancing threshold, we would sell some equities to add to bonds and therefore pick up more fixed income at a cheaper price and better yields (just as we would have sold bonds to add to your equity position in March of 2020!).”
Don’t Just Do Something, Stand There!
Your portfolio is like a bar of soap. The more you touch it, the smaller it gets. Yet in times of uncertainty we can’t help but feel like we need to do something to curb losses or increase gains.
The better choice, assuming you have a well-diversified and automatically rebalancing portfolio, is to log out of your investing platform, close your internet browser, and do nothing. Focus on your family, friends, hobbies – anything that will prevent you from logging back on and seeing your investments in the red.
As PWL Capital portfolio manager Benjamin Felix says, “your investment strategy shouldn’t change based on market conditions.”
That’s right. You identified your risk tolerance and time horizon, and chose your original asset mix for a reason. You understood that markets fluctuate, often negatively, for periods of time and that is out of your control. Yet when markets are going through their downswing, you feel compelled to change your approach.
Let’s go back to the term, “uncertainty”. Isn’t the future always uncertain? When are we investing in certain times?
Pundits and market forecasters often paint a bleak future, like Grantham’s 1929-style crash or Dr. Doom Nouriel Roubini calling for hyperinflation. The truth is nobody knows how this will play out.
What if you make a tactical shift to your investment strategy and you’re wrong? There are plenty of investors who moved to cash after the global financial crisis and never found their way back into the stock market. Once you convince yourself of a particular narrative it’s nearly impossible to admit that you were wrong and change course.
It’s reality check time for investors. We’ve been in a bull market for 12 years (minus a few blips). Almost everything has worked, which can lead to overconfidence in your investing skills. Meanwhile, many investors have strayed away from their original goals to chase even higher returns from U.S. stocks, technology stocks, and the like.
It’s time to check in on your portfolio and make sure it’s broadly diversified and risk appropriate for your age and stage of life. It’s time to rebalance, if you hold multiple funds, and get back to your original target asset mix. Finally, if you’re already invested in an appropriate asset allocation ETF or robo-advised portfolio, it’s time to do nothing. Don’t change your investing strategy based on market conditions.
Take a long-term view of your investments rather than looking at the daily changes (which can be maddening). That’s how to invest in uncertain times.
It might seem counterintuitive to spend down your own retirement savings while at the same time deferring government benefits such as CPP and OAS past age 65. But that’s precisely the type of strategy that can increase your income, save on taxes, and protect against outliving your money.
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 up to 42 percent more!
The standard 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 percent each year you receive it before age 65.
Indeed, you’ll get up to 36 percent 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 percent more each year that you delay taking CPP (up to a maximum of 42 percent 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 2021) is $1,203.75. Most people don’t receive the CPP maximum, however, so we’ll use the average amount for new beneficiaries, which is $689.17 per month. Now let’s convert that to an annual amount for this example = $8,270.
Suppose our retiree decides to take her CPP benefits at the earliest possible time (age 60). That annual amount will get reduced by 36 percent, from $8,270 to $5,293 – a loss of $2,977 per year.
Now suppose she waits until age 70 to take her CPP benefits. Her annual benefits will increase by 42 percent, giving her a total of $11,743. That’s an increase of $3,473 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.
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?
Bonds are meant to be the ballast that helps smooth out volatility in your portfolio. They act as a cushion – the steady yet unspectacular asset class that balances the unpredictable movement of stocks. But a sudden decrease in bond prices has investors looking for answers.
In short, bond yields are on the rise because investors are optimistic about future economic growth. The U.S. 10-year Treasury yield climbed to its highest level in more than a year. Here in Canada, 10-year government bond yields have more than doubled since the beginning of January.
Rising rates spell trouble for bond prices, though. Long-term bonds are particularly sensitive to changes in interest rates. A good way to measure that sensitivity is by looking at a bond’s duration. A bond with a duration of 5 years will see its price fall by 5% if interest rates rise by 1% (and vice versa).
BMO’s ZFL, which tracks Canada’s long-term federal bond index, has an average duration of 17.94. The price of ZFL fell by 11.08% as of Thursday before a slight uptick in prices on Friday. BMO’s popular ZAG ETF, which tracks the Canadian aggregate bond index, has an average duration of 8.1 years and its price was down 4.81% as of Thursday.
Short-term bond ETFs have a lower yield but they are less sensitive to interest rate movements and more preferable to hold in a rising rate environment.
The iShares Core Canadian Short Term Bond Index ETF (XSB) has an average duration of 2.71 years. Its price is down just 1.10% on the year, compared to the iShares Core Canadian Universe Bond Index ETF (XBB), which has an average duration of 7.91 years and is down 3.87% year-to-date.
The silver lining for bond holders is that you’re still getting interest payments from your bonds, and those payments should eventually rise as new bonds are purchased at higher interest rates. That’s why investors with a long time horizon should stick to their plan and rebalance – buying bonds at low prices and higher yields.
Retirees, on the other hand, should consider the average duration of their bonds and determine if it’s appropriate for their age and stage of life. Clearly, holding long-term bonds when you have short-term spending needs is not a wise strategy.
Fears over rising interest rates have plagued investors for the past decade. As this 2011 article from Canadian Couch Potato Dan Bortolotti explains:
“The key message for investors: as long as your time horizon is at least as long as the duration of your bond fund, you won’t lose any capital. Any price decline from rising interest rates will be offset by higher coupons within that time frame. In fact, history suggests the recovery is likely to be more swift than that: even a three-year period of negative bond returns is extremely rare.”
This Week’s Recap:
Earlier this week I wrote my annual letter to Engen Householders.
Read the Oracle of Omaha Warren Buffett’s annual letter to Berkshire shareholders here.
From the archives: Why I Don’t Hold Bonds in My Portfolio.
Promo of the Week:
The American Express Cobalt Card is arguably the best ‘hybrid’ card in Canada. Cardholders earn 5x points on groceries, dining, and food delivery, plus 2x points on transit and gas purchases.
New Cobalt cardholders can earn 30,000 points in their first year (2,500 points for each month in which you spend $500) plus, you can earn a welcome bonus of 15,000 points when you spend a total of $3,000 in your first 3 months.
Our friends at Credit Card Genius share how you can take advantage of record low interest rates in Canada.
Jim Wang at Wallet Hacks brilliantly explains what you should do with all the financial advice on the internet.
A fantastic piece by Morgan Housel on investing and speculation – when everyone’s a genius.
For Globe and Mail subscribers, Rob Carrick explains that what’s happening with housing and stocks is not normal:
“Gen Xers, boomers and older generations have one benefit young adults lack in making sense of what’s happening now – perspective. If you opened your eyes to personal finance and investing in the pandemic, you’re seeing things that may never happen again. Take advantage, and take care.”
What would Warren Buffett make of this stock market silly season? He’s already told us.
A perfectly timed new video by PWL Capital’s Ben Felix on the pitfalls of chasing star fund managers:
With the 2020 RRSP deadline fast approaching, My Own Advisor Mark Seed shares RRSP facts you must remember this year and beyond.
Michael James on Money explains that the great thing about managing other people’s money (from a fund manager’s perspective) is you can dip into it to pay yourself.
On the Evidence Based Investor, Larry Swedroe looks at the odds of outperformance through active management.
A Wealth of Common Sense blogger Ben Carlson debunks everyone’s favourite hyperinflation scenario.
Of Dollars and Data blogger Nick Maggiulli sold his Bitcoin. Have fun staying poor.
Global’s Erica Alini reports that fixed mortgage rates are on the rise.
Finally, this New York Times article takes an interesting look at how boredom is impacting the economy today.
Have a great weekend, everyone!