Decumulate & Downsize

Most of your investing life you and your adviser (if you have one) are focused on wealth accumulation. But, we tend to forget, eventually the whole idea of this long process of delayed gratification is to actually spend this money! That’s decumulation as opposed to wealth accumulation. This stage may also involve downsizing from larger homes to smaller ones or condos, moving to the country or otherwise simplifying your life and jettisoning possessions that may tie you down.

Renting in Retirement

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By Benjamin Felix, for Boomer & Echo

Special to the Financial Independence Hub

Canadians value few things more than a home that is owned outright. This might be especially true for retirees. The thinking seems to be that once your mortgage is paid off, your housing expenses evaporate. Unfortunately, this could not be further from the truth.

The alternative, renting, is often frowned upon. Renting is seen as throwing money away. The reality is that renting in retirement can make a lot of sense, both financially and psychologically, when it is properly understood.

The first step to accepting renting as a sensible housing choice is understanding the financial aspect of the decision. To compare the financial implications of renting and owning we need a common ground. That common ground is unrecoverable costs.

Unrecoverable Costs

Rent is an unrecoverable cost. It is paid in exchange for a place to live, and there is no equity or other residual value afterward. That is easy to grasp.

Owning also has unrecoverable costs. They are less obvious and usually get missed in the renting versus owning discussion. An owner of a mortgage-free home still has to pay property taxes and maintenance costs, both unrecoverable, to maintain their home. Each of these costs can be estimated at 1% of the value of the home per year on average.

In addition, an owner absorbs an economic cost for keeping their capital in their home as opposed to investing it in stocks and bonds. This economic cost, or opportunity cost, is a real cost that an owner needs to consider. Estimating this portion of the cost of owning is harder to do. It requires estimating expected returns for stocks, bonds, and real estate for comparison with each other.

Expected Returns

Estimating expected returns is not an easy task; it starts with understanding historical risk premiums. The market will demand more expected return for riskier assets, and this relationship is visible in historical returns.

For stocks, bonds, and real estate, the Credit Suisse Global Investment Returns Yearbook offers data going back to 1900. Globally, the real return for real estate, that’s net of inflation, from 1900 through 2017 was 1.3%, while stocks returned 5% after inflation, and bonds returned 1.9%. If we assume inflation at 1.7%, then we would be thinking about a 3% nominal return for real estate, a 6.7% nominal return for global stocks, and a 3.6% nominal return for global bonds.

To keep things simple and conservative, we will assume that real estate continues to return a nominal 3%, while stocks return an average of 6%, and bonds return 3%.

The Cost of Capital

With a set of expected returns, we can now start thinking about the cost of capital. Every dollar that a home owner has in home equity is a dollar that they could be investing in a portfolio of stocks and bonds. A retiree is unlikely to have an aggressive portfolio of 100% stocks, so we will use the 5.10% expected return for a 70% stock and 30% bond portfolio. The 2.10% difference in expected returns between the portfolio and real estate is the opportunity cost carried by the owner.

It is important to note that asset allocation, which is a big driver of these numbers, will depend on many factors including other sources of income like pensions, tolerance for risk, and portfolio withdrawal rate.

Comparing Apples to Apples

Adding up the unrecoverable costs, we now have 4.10% of the home value between property tax, maintenance costs, and the cost of capital. This is the figure that we can compare to rent.

A $500,000 home would have an estimated annual unrecoverable cost of $20,500 ($500,000 X 4.10%), or $1,708 per month. If a suitable rental could be found for that amount, then renting would be an equivalent financial decision in terms of the expected economic impact.

Other Financial Considerations

So far, we have looked at pre-tax returns. Taxes could play an important role in this decision. Increases in the value of a principal residence are not taxed. Income and capital returns on an investment portfolio are taxed. Continue Reading…

How to prepare for a market meltdown

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By Mark Seed

Special to the Financial Independence Hub

The mere thought of a stock market crash gets many investors riled up.

Maybe it shouldn’t, but don’t blame yourself or others.  That’s simply our lizard or caveman brains hard at work. The reality is, we’re naturally wired to be bad investors.

This is because the same area of our brain (the amygdala) that responds to fight or flight for the last 100,000 years sees financial losses as the same way as a big, mean, nasty grizzly bear running after us. So, whether this big bear (a big financial bear at that) is real or just perceived as being real, our brains do not discriminate.  Our hearts will race, our palms will get sweaty and we’re apt to click the keyboard and sell a stock or a bond or anything in between based on our fight or flight response.

Watching what goes up go down, way down

Watching your investment portfolio crash can and would likely be, devastating.  So, with our amygdala fully engaged, we’ll have higher levels of cortisol running through our bodies to fight the stress.

Our risk appetite will sink and during higher periods of market calamity, that means we’ll probably act in the opposite ways we should:

We’ll sell low instead of buying low or holding the line.

Needless to say, I think market volatility and watching your portfolio go down can have detrimental affects on the portfolio you’ve worked so hard to build.  If you’re an investor who might panic and react, when your investments drop in value, you might incur major long-term consequences.

Thanks to a reader question of late (adapted slightly below), I thought I’d highlight some things to consider (and what I think about and do) to prepare for a market meltdown.

Hi Mark,

With all the news of late, I’m really not sure how to prepare my portfolio for a market correction exactly.

Most of my stocks (I don’t have bonds or GICs or fixed-income-oriented ETFs) have unrealized gains. 

My TFSA is full of Canadian bank stocks and Enbridge.  My RRSP has some utilities.

Within my non-registered account, I have a mix of banks, insurance, utilities, CNR (Canadian National Railway), and telecom stocks, ALL with gains. I know if I sell anything in my non-registered account, I will pay tax on my capital gains. If I buy back some of the same stocks when the market dips during or after a correction, I will have a revised adjusted cost base (that I need to calculate).

I do have a cash wedge to use, to buy some stocks when the market corrects, but otherwise everything is tied up.  So, what can I do to help prepare for any correction?  What are you doing?

Great questions!  Boy, lots to unpack there.

In no particular order, here are some key things I would consider (and what I’m doing) to prepare yourself for any market meltdown.

1.) Review your risk tolerance

Will you make a portfolio change, including selling stocks and buying more bonds, when the equity market drops 10%?  20%?  30%?

I think knowing this answer or these answers is key.

The best time to put any plan in place is before you need it.  Financially or otherwise…

That means when it comes to investing, think about your risk tolerance today and identify what you might do in those situations above.  If you think you’ll sell assets when the market is down 10% or maybe 20% (or more!), you probably have too many equities as a % in your portfolio.  And that’s OK!  It simply means you need a more balanced stock-to-bond mix and/or you might need a more global, well-diversified portfolio that you could ride out.

Consider some of these low-cost, highly diversified ETFs to build your portfolio with.

What I am doing?

I’ve reviewed my financial plan a few times over in recent years and I’m rather confident I will not sell any of my Canadian dividend-paying stocks or my U.S. ETFs (disclosure:  I own U.S. dividend ETF VYM) when they are down 20% or even down 30% in price.

I have a plan to live off dividends – to some degree. 

Doing so helps me stick to an investing approach I thoroughly believe in.  Besides that belief, I would be absolutely shocked if some of these companies stopped paying all their dividends, in a prolonged market downturn, all at the same time.XIU August 2019

Image courtesy of iShares.  FYI:  A boring buy and hold strategy with XIU would have earned you ~ 7% over the last decade.  Basically, your money doubled in those last ten years.

2.) Embrace (and learn from) market history

Rather than trying to time the market, beat the market, outsmart the market – the list goes on – I think it’s very helpful to remember that crashes have happened and consequently, they will happen again.

This was a great tweet I found recently – something to remind yourself about when it comes to market history: Continue Reading…

FIRE in moderation: How about the term FIE? [Financially Independent Entrepreneur]

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I write a lot about seeking financial independence rather than early retirement. That’s intentional. I don’t necessarily want to retire – not anytime soon – but what fires me up is the idea of working on my own terms.

My goal is to be financially free by age 45. That means I’d be free to ditch my day job and pursue my passion of helping people with their finances (through educational writing, financial planning, and hosting seminars or workshops). I wouldn’t be retired, since I’d still derive an income from these activities.

Many FIRE [Financial Independence/Retire Early] bloggers have the same idea: work hard, save a large percentage of their salary, and eventually ditch the cubicle life. The dream is to retire early, but more often than not their “work” turns into blogging, book writing, and speaking about early retirement.

Ironically, selling the dream of early retirement tends to be another full-time pursuit. Just look at one of the original FIRE personalities, Canada’s self-professed youngest retiree Derek Foster. He’s written six books and runs a website where he sells his “portfolio picks.” He says “retired,” I say he “quit his job to become a writer.”

To be clear, there’s nothing wrong with pursuing financial independence or wanting to retire early. Any movement that helps people spend less, save more, and strive for a happier life is to be celebrated.

[From Twitter:]

 

 

CutTheCrapInvesting
 ·

Great article. I too am a fan of saving and investing but many FIRE will get wiped out in a real correction. Worse than this article projects. FIRE is out of control, reality may hit. @myownadvisor @esb_fi @RobbEngen @JonChevreau @The_Money_Geek https://seekingalpha.com/article/4277415-f-r-e-ignited-bull-extinguished-bear …

F.I.R.E. – Ignited By The Bull, Extinguished By The Bear

Retiring early is far more expensive than most realize.Not accounting for variable rates of returns, lower forward returns due to high valuations, and not adjusting for inflation and taxes will leave

seekingalpha.com

Boomer and Echo@BoomerandEcho

The safe withdrawal math is easily ignored when the income needed to live is actually earned through blog revenue. The dirty secret of the FIRE blogger movement is they dont have to touch their investments while they’re out there selling the dream. Continue Reading…

I prefer the phrase Financial Independence Work On Own Terms (FIWOOT) over FIRE

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By Mark Seed

Special to the Financial Independence Hub

The Financial Independence Retire Early (FIRE) movement certainly has legs, and maybe rightly so.

Like any good movement, it takes courage to do what others don’t care to do.

Financial independence takes know-how, it takes discipline to hone your financial behaviours; it takes time to remain invested when others are jumping in and out of the market.  It also takes saving your brains out thanks to a good salary and let’s not forget lots of luck.  Regarding the latter, you need a strong bull market – a long one – and we’ve had it for a decade or more.

It’s not that I fully disagree with the FIRE movement and what some folks are striving for.  I think many FIRE principles have great merit and kudos to those that live by these rare principles:

  • Save early and often, in great quantities.
  • Live frugally and avoid financial waste.
  • Avoid long-term debt that is not used for wealth generation.
  • Optimize your investing (i.e., keep your costs low and diversified) to realize your financial goals sooner than later.

I’ve written about FIRE before on this site.  A few times.

I even questioned if FIRE was right for me.  I know that answer.

Why I’m tired of retire early in FIRE

In some circles (not all thankfully), the focus of FIRE is on “retire early” part.  Work hard, make good money with the intention of leaving the corporate rat-race sooner than later.  That’s fine and definitely aspirational – if that was the end of it. However I’ve become tired (and maybe a bit cynical) of some members of the retired early crowd.  Why? Continue Reading…

Cascades retirement planning software: a case study

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By Ian Moyer

(Sponsor Content)

The task of retirement income planning can be overwhelming for Canadians as they get closer to leaving the workforce. Making the right decisions can be difficult with all the possible sources of income they might have, including Old Age Security (OAS) and Canada Pension Plan (CPP), and of course, Canada’s complex tax codes don’t make it any easier. People need help.

Cascades is a Canadian retirement income calculator that takes the difficulty out of retirement income planning. In many cases it saves retirees hundreds of thousands of dollars in income tax, while showing a year-over-year road map guiding them through retirement. Who wouldn’t want to save money? But in some cases, like the one highlighted below, it’s not about extra tax savings: it’s about having enough money to last your entire retirement.

Bob and Ann’s story is based on a real-life case we came across last week, and it’s a great example of why proper retirement income planning is so important.

Meet retiree Bob, 65, and Ann, 56, still working

Bob is currently 65 and has been retired for 2 years. He was self-employed as a cabinet maker and still has his shop at home where he works part time bringing in $12,000 annually. Because he was self- employed, Bob has no defined benefit or defined contribution pensions. He currently holds about $250,000 in his RRSP, $15,500 in his TFSA, and $50,000 in a non-registered account. Bob receives close to max CPP at $12,600 and $7,248 from OAS.

Ann is originally from the United States and met Bob while he was vacationing in Florida. She is currently 56 and plans on retiring at 63 from her job as a logistics coordinator for an auto parts manufacturer. Ann brings in $57,500 annually and has a defined contribution pension currently worth about $140,000. Ann has no other savings apart from her defined contribution pension, but will receive $4,800 in CPP that she plans to start receiving as soon as she retires at 63. Because Ann hasn’t been in Canada for 40 years since the age of 18, she will only receive $3,500 annually from OAS.

Continue Reading…