All posts by Robb Engen

Why Robb Engen’s 4-minute RRSP portfolio is tough to beat

I spent a total of four minutes working on my RRSP portfolio last year.

It wasn’t benign neglect:  my two-ETF all-equity portfolio really is that simple! I made four trades, which took about a minute each after determining how much money to invest, in which of the two ETFs to allocate the investment, and how many shares that would buy (plus a few seconds to enter my trading password).

The buying process is easy since I don’t have any bonds in my portfolio. I simply add money to the fund that brings my portfolio closest to its original allocation – 25 per cent VCN and 75 per cent VXC.

I don’t expect my four-minute portfolio to change much this year. I still plan on making four trades this year in my RRSP, and now that I’m contributing regularly to my TFSA again I’ll make an additional four trades in that account. Add 12 monthly contributions to my RESP and that brings my total time spent on investing to just 20 minutes a year.

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Millennials don’t get the Latte Factor

Financial author David Bach introduced the Latte Factor as a metaphor for all the small indulgences we regularly treat ourselves to that add up over time. It wasn’t meant to single out Starbucks as the main culprit for our financial woes, but somehow millennials feel the need to stand up for their beloved coffeehouse and defend their right to buy an obnoxious drink whenever they damn well please.

Helaine Olen (not a millennial) made people feel good about buying lattes again when, in her best selling book, Pound Foolish, she explained how the Latte Factor is a lie and buying coffee every day is not why you’re in debt. No, instead it’s the big things: housing, transportation, health care (in the U.S.) that are more difficult to cut back on.

Related: The worst financial advice ever given to millennials

More recently, this author whined about how millennials were being judged on their spending choices, criticizing a survey that revealed millennials spend more on coffee than on saving for retirement:

“Millennials are continually being accused of wasting money on supposedly frivolous things. In October, an Australian man named Bernard Salt wrote that he had had enough of seeing young people ordering “smashed avocado with crumbled feta on five-grain toasted bread at $22 a pop and more. Twenty-two dollars several times a week could go towards a deposit on a house,” wrote Salt. 

According to my calculation, if millennials were to abstain from their avocado toast three times a week, they’d save around $3,432 per year. Which isn’t all that much, in reality.”

Oh really? And in what reality is $3,432 not that much money? According to the author, life is unfair and millennials should just give up on the idea of owning a home, or saving for retirement, so just let them have their damn latte and $22 toast.

My take on the Latte Factor Continue Reading…

Using Monte Carlo Simulations in your Retirement Planning

 

Wouldn’t it be nice for our retirement planning purposes if stocks consistently gave us eight to 10 per cent returns each year? After all, that’s what stock markets have delivered on average over the very long term.

Indeed, between 1935 and 2016 U.S. stocks returned 11.4 per cent annually, Canadian stocks returned 9.6 per cent annually, and international stocks averaged annual returns of 8.3 per cent.

I have an eight per cent target in mind when projecting investment returns for my own retirement plan.

The trouble is that stock returns are anything but predictable and so while they may average eight to 10 per cent over a 25-or-50-year period, each single year could deliver panic inducing losses, euphoric gains, or something in-between.

Since 1988, the S&P 500 had single-year returns as low as negative 37 per cent (2008) and also gained as much as 37.58 per cent in a single year (1995). Only in three of those 29 years did the S&P 500 deliver annual returns between eight and 11 per cent. The rest of the years are all over the place.

Why does this matter to your retirement planning? Because it’s not enough to just plug “eight per cent” into your retirement projections and call it a day.

What happens if stocks plunge by 35 or 40 per cent in year one of retirement, as they did to those unlucky enough to retire in 2008?

Enter the Monte Carlo Simulation

A Monte Carlo Simulation can reveal a wide variety of potential outcomes by taking into account fluctuating market returns. So instead of basing your retirement calculations on just one average rate of return, a Monte Carlo Simulation might generate 5,000 scenarios of what hypothetically might happen to your portfolio as you draw it down and markets fluctuate.

Let’s look at an example of a 60-year-old who retires with $750,000 invested in a standard balanced portfolio of 60 per cent stocks and 40 per cent bonds. This retiree wants to know how much is safe to withdraw from the portfolio each year and whether it can last 30, 40, or even 50 years.

We can do this with a Monte Carlo Simulation. I used Vanguard’s retirement nest egg calculator. We’ll start with a safe withdrawal rate of 4 per cent per year:

  1. How many years should the portfolio last: 30 years
  2. What is your portfolio balance today: $750,000
  3. How much do you spend from the portfolio each year: $30,000

The results: There’s a 93 per cent probability that this portfolio lasts 30 years.

When I re-run the simulation using a withdrawal rate of 5.3 per cent (spending $40,000 per year) there’s now just a 74 per cent chance the portfolio survives 30 years.

What happens if our retiree lives until 100? We’ll need to make the portfolio last for 40 years instead of 30.

Spending $40,000 each year means the portfolio has only a 62 per cent chance of surviving 40 years. If we go back to our original 4 per cent safe withdrawal rate ($30,000 per year) then our portfolio jumps back up to an 87 per cent survival rate.

In one interesting simulation, I increased the stock allocation to 100 per cent and changed the annual spending to $50,000 (or 6.7 per cent of the portfolio). The $750,000 portfolio has a 50 per cent chance of lasting 40 years. Not something I’d chance to a coin-flip!

How does a Monte Carlo Simulation work? According to Vanguard, they randomly select the returns from one year of the database for each year of each simulation.

Using those values, they calculate what would happen to your portfolio – subtracting your spending, adjusting for inflation, and adding your investment return.

This process is repeated one year at a time until the end of your retirement or until your portfolio runs out of money. After 5,000 independent simulations there’s a broad range of possible scenarios and clear patterns begin to emerge.

Final thoughts

For those of you close to retirement or that have recently retired, I strongly encourage you to speak with your financial advisor about running a Monte Carlo Simulation for your own portfolio using several different inputs that match your goals and projections. DIY investors can find calculators such as Vanguard’s online to run their own simulations.

Err on the side of caution so that you’re comfortable with the outcomes. If there’s only a 50 per cent chance that your portfolio lasts the length of your retirement, that’s not a plan, it’s a gamble.

In addition to running the Boomer & Echo website, Robb Engen is a fee-only financial planner. This article originally ran on his site on January 2nd and is republished here with his permission.

 

 

Boomer & Echo’s Review of Victory Lap Retirement (+ a giveaway)

There’s a growing body of evidence that suggests postponing retirement – even by just one year – can lead to a longer, healthier life. The reality is that we’re living longer and saving less. Something has to give. But another year or two spent pushing paper in a cubicle is probably not the holy retirement grail we’ve been searching for.

RelatedGrowing older in America – The Health and Retirement Study

Indeed, if you’re healthy and can afford to stop working, the idea is to find something else you’re passionate about and do that instead – whether it’s switching to a new career in an unrelated field, writing a book, starting a blog, or simply volunteering at your favourite charity. Call it your work-optional years.

Victory Lap Retirement

Authors Mike Drak and Jonathan Chevreau call it your Victory Lap Retirement. The authors argue that the idea of retirement has to change in the sense that going from 100 percent work mode to 100 percent leisure mode is boring and fraught with risk.

The fact is we might be retired, in the traditional sense, for thirty or forty years – as long, or maybe longer, than we spent during our working lives. That’s too long to spend in an armchair watching Seinfeld reruns.

How do we find purpose and meaning in this third stage of life? More importantly, for some, how do we finance it?

 In Victory Lap Retirement, Drak and Chevreau describe a post-employment lifestyle designed with a unique blend of work and play that allows you to live life to the fullest, on your terms, while you’re young enough to enjoy it.
Financial Independence

 

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Commission-based advice & suitability: a dangerous combination

Smiling confident businessman giving an handshake, agreement and recruitment conceptThe average Canadian investor has little clue how their financial advisor gets paid, or that their advisor is only obligated to provide advice and product recommendations that are suitable, but not necessarily in the best interests of their clients.

Commission-based advice

Why does this matter? Commission-based advice leads to conflicts of interest. Namely, advisors who sell mutual funds are motivated by trailer fees (aka trailer commissions), which is a commission paid by the mutual fund company to the advisor.

According to a recent study by York professor Douglas Cumming, there are three ways that trailer fees cause harm to investors:

1.) More money is steered towards mutual funds that have higher trailer fees;

2.) Money is less likely to be taken out of mutual funds with poorer performance among funds that pay higher trailer fees, and;

3.) Mutual funds that raised their trailer fees experienced a drop in performance, while funds that lowered their trailer fees experienced a rise in performance.

Canadian securities regulators have been mulling a ban of trailer fees or embedded commissions for over two decades. The mutual fund industry, as you can imagine, is vehemently opposed to such a ban.

Why, you may ask? Canadian investors hold more than $1 trillion in mutual fund investments and pay over $5 billion in trailer fees every single year.

Suitability vs. Best Interest

 

What about suitability versus a best interest standard? Most advisors in Canada are held to a suitability standard, which means before recommending an investment he or she must demonstrate that it’s appropriate based on their client’s risk tolerance, goals, and experience.

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