All posts by Robb Engen

Yes, you can retire up to 30% wealthier

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Questrade touched a nerve with financial advisors with a series of commercials highlighting how lower investment fees over time potentially means you can retire up to 30% wealthier.

Financial advisor extraordinaire Jason Pereira acknowledged that Questrade was right to go after do-nothing advisors who collect fat commissions, but he claimed the 30% wealthier promise was unrealistic and borderline illegal.

Mr. Pereira’s argument is a good one. Advisors like him (and others who put a client’s best interests ahead of their own) can add tremendous value for clients, but not in the way you might think.

The old school notion of a financial advisor is of someone who adds value through their stock-picking prowess. But that argument falls flat when you see the evidence that the vast majority of actively managed funds fail to beat their benchmarks.

Indeed, investors are better off buying the entire market as cheaply as possible using index funds or ETFs.

PWL Capital’s Ben Felix once told me, “investing has been solved … The way for advisors to add value is on planning, behaviour, and transformation.”

With that in mind, I can get behind the idea that financial advisors with this mindset do have a net positive impact for their clients, even after fees.

Which brings me to the point of this article. Canadians have $1.6 trillion invested in mutual funds, most of which are of the expensive, actively managed variety. Those actively managed funds aren’t adding value: the vast majority will underperform their benchmark. Furthermore, most bank-advised clients aren’t getting value in other ways: financial planning, goal setting and prioritization, behavioural coaching, etc.

Traditional advisors are still selling (and charging for) investment expertise, but failing miserably at delivering excess returns while offering little-to-no value for things that would truly make a difference for their clients.

The easy answer is to pair a fee-only advisor with a low-cost investment solution (either a self-directed portfolio of globally diversified ETFs, or through an automated portfolio with a robo advisor). This way, you get the planning, coaching, and behavioural nudges you need to succeed financially, plus the benefit of lowering your investment fees. Win-win.

But the sad reality is that financial inertia is powerful and it’s easier to keep your investments at your bank, along with your chequing, savings, and mortgage. I get it.

Retire up to 30% wealthier without moving your investments

What if I told you that you can still retire up to 30% wealthier without moving your investments to a robo advisor or a DIY investment solution? The answer is sitting right there on the product shelf at your bank: yet rarely if ever talked about by your financial advisor.

I’m talking about index funds. That’s right. Every big bank has a suite of index mutual funds available to investors. These funds charge between one-sixth to one-half the cost of the actively managed mutual funds that are typically sold to Canadian investors.

I’ve monitored and tracked the performance of big bank index funds and their actively managed mutual fund cousins for more than 10 years, and in every single case (when comparing to identical benchmarks), the lower cost index funds outperform the active funds.

So, all you need to do is walk into your bank branch, sit down with your advisor, and ask (no, demand) to move your portfolio from actively managed mutual funds to their index fund equivalents.

Below, I’ll show you the exact index funds to buy to build a 60/40 balanced, globally diversified portfolio of index funds at each of Canada’s five big banks. I’ll compare those index funds to the commonly sold actively managed “balanced” mutual fund.

RBC Index Funds

If you’re an RBC client, chances are you have the RBC Balanced Fund (RBF272) in your investment portfolio. The fund has nearly $5 billion in assets under management and comes with a fee (MER) of 2.16%. Returns have been decent, with a 10-year average annual return of 5.3%. Continue Reading…

How (and When) to Rebalance your portfolio

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Setting up the initial asset allocation for your investment portfolio is fairly straightforward. The challenge is knowing how and when to rebalance your portfolio. Stock and bond prices move up and down, and you periodically add new money – all of which can throw off your initial targets.

Let’s say you’re an index investor like me and use one of the Canadian Couch Potato’s model portfolios – TD’s e-Series funds. An initial investment of $50,000 might have a target asset allocation that looks something like this:

Fund Value Allocation Change
Canadian Index $12,500 25% —
U.S. Index $12,500 25% —
International Index $12,500 25% —
Canadian Bond Index $12,500 25% —

The key to maintaining this target asset mix is to periodically rebalance your portfolio. Why? Because your well-constructed portfolio will quickly get out of alignment as you add new money to your investments and as individual funds start to fluctuate with the movements of the market.

Indeed, different asset classes produce different returns over time, so naturally your portfolio’s asset allocation changes. At the end of one year, it wouldn’t be surprising to see your nice, clean four-fund portfolio look more like this:

Fund Value Allocation Change
Canadian Index $11,680 21.5% (6.6%)
U.S. Index $15,625 28.9% +25%
International Index $14,187 26.2% +13.5%
Canadian Bond Index $12,725 23.4% +1.8%

Do you see how each of the funds has drifted away from its initial asset allocation? Now you need a rebalancing strategy to get your portfolio back into alignment.

Rebalance your portfolio by date or by threshold?

Some investors prefer to rebalance according to a calendar: making monthly, quarterly, or annual adjustments. Other investors prefer to rebalance whenever an investment exceeds (or drops below) a specific threshold.

In our example, that could mean when one of the funds dips below 20 per cent, or rises above 30 per cent of the portfolio’s overall asset allocation.

Don’t overdo it. There is no optimal frequency or threshold when selecting a rebalancing strategy. However, you can’t reasonably expect to keep your portfolio in exact alignment with your target asset allocation at all times. Rebalance your portfolio too often and your costs increase (commissions, taxes, time) without any of the corresponding benefits.

According to research by Vanguard, annual or semi-annual monitoring with rebalancing at 5 per cent thresholds is likely to produce a reasonable balance between controlling risk and minimizing costs for most investors.

Rebalance by adding new money

One other consideration is when you’re adding new money to your portfolio on a regular basis. For me, since I’m in the accumulation phase and investing regularly, I simply add new money to the fund that’s lagging behind its target asset allocation.

For instance, our kids’ RESP money is invested in three TD e-Series funds. Each month I contribute $416.66 into the RESP portfolio and then I need to decide how to allocate it – which fund gets the money?

 

Rebalancing TD e-Series Funds

My target asset mix is to have one-third in each of the Canadian, U.S., and International index funds. As you can see, I’ve done a really good job keeping this portfolio’s asset allocation in-line.

How? I always add new money to the fund that’s lagging behind in market value. So my next $416.66 contribution will likely go into the International index fund.

It’s interesting to note that the U.S. index fund has the lowest book value and least number of units held. I haven’t had to add much new money to this fund because the U.S. market has been on fire; increasing 65 per cent since I’ve held it, versus just 8 per cent each for the International and Canadian index funds.

One big household investment portfolio

Wouldn’t all this asset allocation business be easier if we only had one investment portfolio to manage? Unfortunately, many of us are dealing with multiple accounts, from RRSPs, to TFSAs, and even non-registered accounts. Some also have locked-in retirement accounts from previous jobs with investments that need to be managed.

The best advice with respect to asset allocation across multiple investment accounts is to treat your accounts as one big household portfolio. Continue Reading…

Tackling changes to your Retirement Income Plan

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Spending money is easy. Saving and investing is supposed to be the difficult part. But there’s a reason why Nobel laureate William Sharpe called “decumulation,” or spending down your retirement savings, the nastiest, hardest problem in finance.

Indeed, retirement planning would be easy if we knew the following information in advance:

  • Future market returns and volatility
  • Future rate of inflation
  • Future tax rates and changes
  • Future interest rates
  • Future healthcare needs
  • Future spending needs
  • Your expiration date

You get the idea.

We can use some reasonable assumptions about market returns, inflation, and interest rates using historical data. FP Standards Council issues guidelines for financial planners each year with its annual projection assumptions. For instance, the 2020 guidelines suggest using a 2% inflation rate, a 2.9% return for fixed income, and a 6.1% return for Canadian equities (before fees).

We also have rules of thumb such as the 4% safe withdrawal rule. But how useful is this rule when, for example, at age 71 Canadian retirees face mandatory minimum withdrawals from their RRIF starting at 5.28%?

What about fees? Retirees who invest in mutual funds with a bank or investment firm often find their investment fees are the single largest annual expense in retirement. Sure, you may not be writing a cheque to your advisor every year. But a $500,000 portfolio of mutual funds that charge fees of 2% will cost an investor $10,000 per year in fees. That’s a large vacation, a TFSA contribution, and maybe a top-up of your grandchild’s RESP. Every. Single. Year.

For those who manage their own portfolio of individual stocks or ETFs, how well equipped are you to flip the switch from saving to spending in retirement? And, how long do you expect to have the skill, desire, and mental capacity to continue managing your investments in retirement?

Finally, do you expect your spending rate will stay constant throughout retirement? Will it change based on market returns? Will you fly by the seat of your pants and hope everything pans out? What about one-time purchases, like a new car, home renovation, an exotic trip, or a monetary gift to your kids or grandkids?

Now are you convinced that Professor Sharpe was onto something with this whole retirement planning thing?

One solution is a Robo Advisor

One solution to the retirement income puzzle is to work with a robo advisor. You’ll typically pay lower fees, invest in a risk appropriate and globally diversified portfolio, and have access to a portfolio manager (that’s right, a human advisor) who has a fiduciary duty to act in your best interests.

Last year I partnered with the robo advisor Wealthsimple on a retirement income case study to see exactly how they manage a client’s retirement income withdrawals and investment portfolio.

This article has proven to be one of the most popular posts of all time as it showed readers how newly retired Allison and Ted moved their investments to Wealthsimple and began to drawdown their sizeable ($1.7M) portfolio.

Today, we’re checking in again with Allison and Ted as they pondered some material changes to their financial goals. I worked with Damir Alnsour, a portfolio manager at Wealthsimple, to provide the financial details to share with you.

Allison and Ted recently got in touch with Wealthsimple to discuss new objectives to incorporate into their retirement income plan.

Ted was looking to spend $50,000 on home renovations this fall, while Allison wanted to help their daughter Tory with her wedding expenses next year by gifting her $20,000. Additionally, Ted’s vehicle was on its last legs, so he will need $30,000 to purchase a new vehicle next spring.

Both Allison and Ted were worried how the latest market pullback due to COVID-19 had affected their retirement income plan and whether they should do something about their ongoing RRIF withdrawals or portfolio risk level.

Furthermore, they took some additional time to reflect on their legacy bequests. They were wondering what their plan would look like if they were to solely leave their principal residence to their children, rather than the originally planned $500,000. Continue Reading…

Debunking the 4% withdrawal Rule

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The 4% rule is a framework to think about how to safely draw down your retirement savings without fear of outliving your money. It was developed in 1994 by financial advisor William Bengen, who concluded that retirees could safely withdraw 4% annually from their portfolio over a 30 year period without running out of money.

Critics of the 4% rule argue that it doesn’t hold up in today’s environment because, one, bond yields are so low, and two, because it fails to account for rising expenses (inflation) and investment fees (costs matter). We’re also living longer, and there’s a movement to want to retire earlier. So shouldn’t that mean a safe withdrawal rate of much less than 4%?

Financial planning expert Michael Kitces takes the opposite view. He says there’s a highly probable chance that retirees using the 4% rule will come to the end of 30 years with even more money than they started with, and an extremely low chance they’ll spend their entire nest egg.

The problem lies in the data and testing for the absolute worst case scenarios, which in Bengen’s research included the Great Depression. Bengen looked at rolling 30-year periods to test the safe withdrawal rate and found the worst case scenario was retiring right before the Great Depression in 1929. Even with that terrible timing, a retiree could safely withdraw 4.15% of his or her portfolio.

Are FIRE savers bad at math?

Kitces broadened the data set and found two more ‘worst case scenarios’ which included 1907 and 1966. But what was interesting is the average safe withdrawal rate throughout every available period in the data set was 6% to 6.5%. Continue Reading…

Where are you parking your cash these days? GICs vs. High-interest savings accounts

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Cash is king during times of economic trouble. Working families need emergency savings to pay the bills in case of job loss or a reduction in wages. Retirees or near retirees need a cash cushion to avoid selling stocks at a loss. But should you park your cash in a high interest savings account or a GIC?

For a short time, not too long ago, we lived in the golden age of high interest savings. The competition was lively, as online banks and credit unions pushed interest rates well above 2 per cent (LBC Digital briefly paid 3.3 per cent).

Rising interest rates on savings deposits made GICs look less attractive. GICs paid the same rates or lower, yet savers had to lock-in their deposits for 1-5 years. Where did the liquidity premium go?

High Interest Savings Account rates

The situation quickly changed when the coronavirus pandemic forced central banks to take emergency action and cut interest rates. The Bank of Canada lowered its key interest rates by 50 basis points on two occasions. The ripple effect caused high interest savings account rates to plummet.

LBC Digital had already lowered its rate to 2.8 per cent – now it sits at a still respectable 2.25 per cent. Wealthsimple Cash had arguably the worst-timed launch when it came out with a 2.4 per cent interest rate for its chequing/savings account hybrid. That rate was quickly dropped to 1.9 per cent, and then lowered again to 1.4 per cent.

EQ Bank lowered the interest rate on its Savings Plus account to 2 per cent, while motusbank dropped its rate to 1.75 per cent. What a difference a month makes!

Here are the top high interest savings account rates today (March 25, 2020):

Bank Interest rate
LBC Digital 2.25%
Motive Financial 2.20%
Implicity Financial 2.10%
Outlook Financial 2.10%
EQ Bank 2.00%
Oaken Financial 2.00%

 

As always, savers need to look beyond the big banks to maximize the interest earned on their deposits. If inflation averages 2 per cent, then you need to earn at least 2 per cent on your savings to maintain purchasing power. Even still, at best you’re treading water.

Despite the recent drop in rates, a high interest savings account is still the best place to park your emergency savings. You never know when you’ll need to access cash for an unexpected bill, or to pay for your living expenses during a period of unemployment.

A high interest savings account is also a must-have for retirees and near-retirees to stash one year’s worth of spending – the first bucket in the three-bucket approach to retirement income planning.

What this current rate crisis has highlighted is the fact that high interest savings account rates are not guaranteed. Those who eschewed GICs to chase higher yielding savings accounts now find their savings account paying 0.50 – 1.00 per cent less than it was a month ago. Not ideal.

GIC rates

One of my clients recently alerted me to an email sent by Oaken Financial advertising an increase in GIC rates. Its one-year GIC now pays 2.5 per cent, which is a full 25 basis points more than the top-paying high interest savings account. Oaken’s five-year GIC now pays 2.95 per cent interest. It looks like the liquidity premium is back.

You’ll easily find one-year GIC rates paying at or above the best high interest savings account rate.

Bank Interest rate
Oaken Financial 2.50%
Canadian Tire Bank 2.50%
EQ Bank 2.40%
Wealth One Bank of Canada 2.40%
Peoples Trust 2.30%

 

Longer-term rates vary widely so be sure to shop around for promotions. Here are the top five-year GIC rates as of this writing:

Bank Interest rate
Oaken Financial 2.95%
Wealth One Bank of Canada 2.60%
Canadian Tire Bank 2.55%
EQ Bank 2.55%
Peoples Trust 2.55%

 

Readers should know that GICs are typically non-redeemable, so you should be absolutely certain that you won’t need the money when you lock it in for 1-5 years.

That means GICs are ill-suited for an emergency fund, but ideal for a goal with a specific time period.

Using High Interest Savings Accounts and GICs for Retirement Income

For retirees and near-retirees, GICs are best-suited for “bucket two” in your three-bucket approach to retirement income. Bucket two is where you build a GIC ladder with three to five years of annual retirement spending. Continue Reading…