It’s not easy being a Canadian investor, is it? Given recent elections, we’re unlikely to see a pro-business surge anytime soon … to say the least. (It’s not investable info, but did you notice I happened to accurately forecast this?)
Plus, we’ve had to watch other countries’ stock markets beat the pants off our own during the past decade. U.S. glamour or FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) have been living especially fat and larger than life lately.
It’s no wonder I’ve been fielding questions about how to best allocate among the global equity markets these days. How much is too much in Canada? Should we just dump everything into the U.S. market? Is diversification dead?
My short answers are: It depends. No. And, I wouldn’t bet on it. This is an admittedly incomplete response, so let’s consider four points and counterpoints to fill in the blanks.
1.) Canada’s market cap is tiny, and concentrated
While we’re rich in land mass, Canada represents just 3% of the world’s stock market capitalization. Plus, that 3% isn’t very well-diversified, with relatively heavy exposures to banking and natural resources.
2.) Canadians and everyone else have a home bias
Home bias means we prefer familiar objects close to home. If (like me) you’re rooting for your kid’s hockey team, cheer on. But in the markets, this tempts most investors – and many financial professionals – to pile too heavily into their own countries’ stocks.
For example, despite recent underperformance, the typical Canadian still allocates 60% of their investments to Canadian stocks. The Behavioral Investor author Daniel Crosby reports that U.S. investors typically allocate 90% of their holdings to the U.S. market; U.K. investors allocate about 80% of their holdings to the U.K. No matter where you roam, home bias is right at home.
3.) Markets are unpredictable
Before you ship all your investments across the border or overseas, remember: Markets can turn on you, abruptly and without warning. While it might seem like a distant memory, it should be noted, from 1999–2009, Canadian stocks (S&P/TSX composite) returned 7.7% per year, whereas U.S. stocks (S&P 500 in Cdn$) seemed cursed in the new millennium, delivering –2.5% per year … yes that is a negative return for 10 years! Continue Reading…
As many of you know, we have been busy adding new capital and buying dividend paying stocks over the last few years. During the COVID-19-caused short recession last year, our portfolio was down as much as $250,000. We didn’t panic and liquidate our portfolio. Instead, we saw the recession as an opportunity to buy discounted stocks and we added $115k to our dividend portfolio.
I’m a believer in time in the market, rather than timing the market. Therefore, we try to be fully invested in the stock market as much as we can. We use our monthly savings to add new shares and take advantage of any downturns. We also strategically move any long term savings for spending account to buy dividend paying stocks whenever there are enticing buying opportunities. We then “put back” money in the LTSS account over time.
Although we are in the accumulation phase of our financial independence retire early journey, I have done a few calculations and scenarios to plan out our early withdrawal strategies and plans. But they are what the names suggested – strategies and plans. Nothing is written in stone and things can certainly change by the time we decide to live off our dividend portfolio.
Recently Mark from My Own Advisor appeared on Explore FI Canada to discuss FI Drawdown Strategies. Since Mark is a few years ahead on the FIRE journey than us, or FIWOOT (Financial Independence Working on Own Terms) as Mark calls it, it was great to hear about what Mark is thinking and the considerations he has.
Speaking of living off dividends and early withdrawal strategies, it was really awesome to be able to pick on Reader B’s brain on this topic:
After listening to the Explore FI Canada episode, I thought about our early withdrawal strategies. Are there effective ways to minimize taxes so we get to keep more money in our pocket?
For Canadians, we can receive CPP and OAS when at age 65. I have not included CPP and OAS in our FIRE number calculation because I always considered them as the extra income and didn’t want to rely on them during retirement. Having said that, are there things we can do to receive the full CPP and OAS amounts without clawbacks?
A few things to note before I go any further…
We plan to live off dividends and only sell our principal if we absolutely have to.
We plan to pass down our portfolio to our kids, future generations, and leave a lasting legacy.
Ideally it’d be great to be able to pass down our portfolio to future generations. But we also don’t want them to take money for granted. Therefore, we are also not against the idea of not passing anything to future generations.
I also have an RRSP account through work. Every year I have been moving my contribution portion to my self-directed RRSP at Questrade. I can’t touch my employer’s contribution portion until I leave the company.
Neither Mrs. T nor I have work pensions so that may make the math slightly simpler.
The only complication I need to consider is what to do with income from this blog. This blog now makes a small amount of money. For tax efficiency, it might make sense to consider incorporating. Many bloggers I know have gone down this route for tax efficiency reasons. This is something I will have to consult with a tax specialist in the near future and crunch out some numbers to see what makes the most sense.
Shortcomings of RRSP
As the name suggests, the RRSP is a great retirement savings vehicle. But there are three important caveats people often skim over:
RRSPs must be matured by December 31 of the year you turn 71. You can convert an RRSP into a RRIF or purchase an annuity. Most people convert their RRPs into RRIFs.
A RRIF has a mandatory minimum withdrawal rate each year.
The minimum withdrawal rate increases each year (5.4% at age 72 and jumps to 6.82% at age 80).
RRSP and RRIF withdrawals are counted as normal income and taxed at your marginal tax rate.
Personally, I don’t like the restrictive nature of the RRIF. Imagine having $500,000 in your RRIF and having to withdraw a minimum of $27,000 at 72. If your RRSP/RRIF has a bigger value, it means you are forced to make a bigger withdrawal!
By plugging the amount currently in our RRSPs into a simple RRSP compound calculator, assuming no more contributions and an annualized return of 7%, I discovered that we’d end up with more than $2M in each of our RRSP!
At 5.4% minimum withdrawal rate, that means we’d have to withdraw at least $108,0000 each. This would then put both of us into the third federal tax bracket. More importantly, we’d get hit with OAS clawback (more on that shortly).
Therefore, it makes sense for Mrs. T and me to consider early RRSP withdrawals and perhaps consider collapsing our RRSP before we turn 71.
CPP Clawbacks
Contrary to many Canadian beliefs, there are no clawbacks for CPP.
You pay into the Canada Pension Plan (CPP) with your paycheques. Each year that you contribute to the CPP will increase your retirement income. Therefore, the amount of CPP you will receive at 65 depends on your contributions during your working life.
In 2021, the maximum CPP benefit at age 65 is $14,445.00 annually or $1203.75 monthly. The CPP benefit is taxed at your marginal tax rate.
But not everyone will get the maximum CPP amount since it is based on how long and how much you pay into the CPP.
You must contribute to CPP for at least 83% of the CPP eligible contribution time to get the maximum benefit. You are eligible to contribute to CPP from 18 to 65, so 83% would mean you need to contribute to CPP for at least 39 years.
In addition, you also need to contribute CPP’s yearly maximum pensionable earnings (YMPE) for 39 years to qualify for the maximum CPP amount. For 2021, the YMPE is $61,600.
Since we plan to “retire early” eventually, it’s unlikely that we will qualify for the maximum CPP benefits.
OAS Clawbacks
Unlike the CPP, there are clawbacks or a pension recovery tax for OAS. If your income is over a certain level, the OAS payments are reduced by 15% for every dollar of net income above the threshold. In 2021, the OAS clawback threshold starts at $79,845 and maxes at $129,260. So, if you’re making over $79,845, you will receive reduced OAS payments. And if you’re lucky enough to have a retirement income of over $129,260, you get $0 OAS payments. Continue Reading…
This article has been sponsored by BMO Canada. All opinions are my own.
I’m on record to say that the vast majority of self-directed investors should simply use a single asset allocation ETF to build their investment portfolios.
What’s not to like about asset allocation ETFs? Investors get a low cost, risk appropriate, globally diversified portfolio in one easy to use product. It’s a fresh take on an old idea – the global balanced mutual fund – updated for the 2020’s using low-cost ETFs.
Investors don’t even have to worry about rebalancing their portfolio when they add or withdraw money, or when markets move up and down. Asset allocation ETFs automatically rebalance themselves regularly to maintain their original target asset mix.
This article looks at BMO’s line-up of asset allocation ETFs, which include a conservative (ZCON: 40/60), balanced (ZBAL: 60/40), growth (ZGRO: 80/20), and balanced ESG (ZESG: 60/40) option.
These BMO asset allocation ETFs are available for self-directed investors to purchase through their online brokerage account. Notably, these ETFs can be traded commission-free through BMO InvestorLine and Wealthsimple Trade.
What’s inside BMO’s Asset Allocation ETFs?
Launched in February 2019, BMO’s core asset allocation ETFs are made up of seven underlying ETFs representing various asset classes and geographic regions.
ZMU – BMO Mid-Term US IG Corp Bond Hedged to CAD Index ETF
Altogether these seven ETFs represent nearly 5,000 individual stock and bond holdings from around the world.
In terms of geographic equity allocation, the BMO asset allocation ETFs hold 25% in Canadian stocks, 25% in international stocks, 40% to 41.25% in US stocks, and 8.75% to 10% in emerging market stocks.
BMO reviews their portfolios quarterly and will rebalance any fund that is more or less than 2.5% off from its target weight. In reality, these funds are rebalanced regularly with new cashflows from new investors.
BMO’s Balanced ESG ETF (ZESG) is made up of six underlying ETFs, including:
ESGY – BMO MSCI USA ESG Leaders Index ETF
ZGB – BMO Government Bond Index ETF
ESGA – BMO MSCI Canada ESG Leaders Index ETF
ESGE – BMO MSCI EAFE ESG Leaders Index ETF
ESGB – BMO ESG Corporate Bond Index ETF
ESGF – BMO ESG US Corporate Bond Hedged To CAD Index ETF
The management expense ratio for each of the BMO asset allocation ETFs is 0.20%. There is no duplication of fees or additional charges for the underlying ETFs. Continue Reading…
Many investors have been saying for years that rates can only go up from here, rates can only go one direction, rates will eventually go up. Will they? This begs a question I get from readers from time to time given bonds pay such lousy interest:
Why would anyone own bonds now?
Today’s post shares a few reasons to own bonds including some counter-arguments why I don’t own any – at least right now.
Why own bonds?
Personally, I believe the main role of fixed income in your portfolio is essentially safety– not the investment returns and certainly not the cash flow needs. In other words, if all else fails per se, if/when stocks crash, then bonds should historically speaking offer a flight to safety for preserving principal.
So, they are there for diversification purposes.
As Andrew Hallam, a Millionaire Teacherhas so kindly put it over the years: when stocks fall hard, bonds act like parachutes for your portfolio. Bonds might not always rise when the equity markets drop. But broad bond market indexes don’t crash like stocks do.
Is that enough to own bonds in your portfolio? Maybe.
Here are a few reasons to own bonds in no particular order.
1. Bonds as a hedge for stock market volatility.
Call them parachutes or anchors or use any other metaphor you wish but bonds tend to do their jobs when stock markets tank. More importantly maybe, they provide a psychological edge to avoid tinkering with your portfolio and selling any stocks/equities when stock markets correct.
Many investors, dare I say most investors (?), have a hard time with market volatility. I’m certainly not immune to it. The ups and downs, especially the big market downs, can be gut-wrenching to live through. Owning bonds in your portfolio can help bring the overall portfolio volatility down a few notches through prudent asset allocation. It is however not always necessary to own bonds.
When you own bonds, my experience has been for the last 20+ years you are trading away long-term, more positive, generous equity returns for accepting less risk and less long-term returns.
If you don’t want to take my word for it, check out this page courtesy of Vanguard when it comes to long-term returns. Check out the “worst year” stats as well.
Sure, a 40/60 stock/bond portfolio has hardly done poorly for the last century. But overall, you are absolutely giving up (historically speaking) returns on the table when you own more fixed income in your portfolio. Will the future be the same?
Personally, I’ve tried to learn to live with stocksas much as possible for as long as possible. Depending on your goals, taking into account long-term potential reward against short-term price fluctuations, some investors may not be comfortable with a 100% equity or near-equity portfolio. That’s A-OK. If that’s your case, some bonds in your asset accumulation years could be right for you.
2. Bonds can be used to rebalance your portfolio.
Even though I’m not a huge fan of bonds myself, this might be one of the most compelling reasons to own bonds at any age.
When the stock market sells off, that’s ideally the time you want to dive in and buy your stocks on sale. However, unless you are very comfortable with leveraged investing – you need money to buy such stocks on sale. That can come from cash savings for sure but for many investors, that can also come from bonds within your portfolio.
Mind you, some levels of diversification don’t work very well if you don’t have any asset allocation targets in mind. The process of rebalancing is a systematic way to buy low and sell high; sell your bonds when markets are tanking and sell-off some stocks when markets are euphoric.
In our portfolio, because we’ve largely learned to live with stocks, we tend to buy more stocks when they come on sale and/or we buy stocks periodically during the year to increase our equity holdings. More specifically, to help me gravitate away from my bias to Canadian dividend paying stocks for income we’re owning more low-cost U.S. ETFs for extra growth over time.
Instead of selling bonds to buy our stocks, I use cash savings. I tend to save up cash during the year and make a few lump-sum stock or equity ETF purchases instead.
I will continue to use cash savings to make more equity purchases as I enter semi-retirement.
Last month, I had the privilege of meeting legendary investor Larry Hite.
Larry was born into a lower middle-class family, had a major learning disability, did poorly in school, and was completely blind in one eye and half blind in the other. In his own words, “I was not handsome. I was not athletic. Whatever I did, I sucked at it badly.”
In 1981, after dabbling as a music promoter, actor, and screenwriter, Hite founded Mint Investments. Mint was a true pioneer, eschewing human judgment and instead basing its investment decisions on a purely systematic, rules-based approach rooted in statistical analysis.
By 1988, Mint registered average annual compounded returns of over 30%. In its best year, Mint registered a gain of 60% (1987, the year of the stock market crash), and in its worst year, it produced a gain of 13%. By 1990, Mint was the biggest hedge fund in the world, with a record-breaking $1 billion under management.
When it awarded Larry the Lifetime Achievement Award, Hedge Fund Magazine wrote:
“Larry Hite has dedicated the last 30 years of his life to the pursuit of robust statistical programs and systems capable of generating consistent, attractive risk/reward relationships across a broad spectrum of markets and environments and has inspired a generation of commodity trading advisers and systematic hedge fund managers.”
Although Hite began his investing career in the early 1980s, his philosophy of markets and approach to investing are remarkably similar to our own, which are summarized below.
Failure: A Foundation for Success
Hite maintains that his early failures were instrumental in his eventual success. He believes that accepting that failure is sometimes inevitable led him to develop an investment strategy that would limit losses.
In his book, The Rule, he wrote:
“I believe the success I’ve had arrived because I always expected to fail big. Solution? I engineered my actions so that a failure could not kill me. I won because I expected to lose. Failure became my advantage. Once you understand your potential for failure – that is, there are times you can’t win – you know when to fold your cards and move on to the next. You will do this more quickly than others who stay in the game too long, hanging on and hoping that their losing bet will turn around.”
It’s not all about Being Right
Many investors focus on being right as much as possible – on maximizing their ratio of winning vs. losing investments. On its face, this seems like a good idea – all else being equal, if you win more than 50% of the time, then over time you will make money.
Hite takes a different approach. Whereas he has no issue with trying to be right as often as possible, he is far more focused on maximizing the average magnitude of his winning positions relative to that of his unsuccessful ones, asserting that:
“Becoming wealthy and successful isn’t simply about being right all the time. It’s about how much you win when you are right as well as how much you lose when you are wrong…. The Mint trading system did not prioritize being right all the time. We prioritized not losing a lot when we lost but winning big when we won. But as a result, we were frequently wrong. We understood and expected this and taught our clients the wisdom too.”
Risk: A No Fooling Around game
Hite places a greater emphasis on risk management than on generating profits, claiming that mistakes regarding risk can lead to catastrophic results. He asserts that, “Risk is a no fooling around game; it does not allow for mistakes. If you do not manage the risk, eventually it will carry you out.”
His approach to investing clearly reflects his respect for risk. Specifically, Hite divulges that “We approach markets backwards. The first thing we ask is not what we can make, but how much we can lose. We play a defensive game.”
One of my favorite anecdotes regarding risk is Hite’s reflection on a conversation he had with one of the world’s largest coffee traders, who asked, “Larry, how can you know more about coffee than me? I am the largest trader in the world. I know where the boats are; I know the ministers.” Larry responded, “You are right. I don’t know anything about coffee. In fact, I don’t even drink it.” The coffee mogul then inquired, “How do you trade it then?”, to which Larry answered, “I just look at the risk.”
Five years later, Larry heard that this magnate lost $100 million in the coffee market. Upon reflection, Hite states, “You know something? He does know more about coffee than I do. But the point is, he didn’t look at the risk.”
Larry Hite
Market Predictions, Storytelling, & Good Copywriters
Larry is skeptical that anyone can predict markets. He in no way bases his approach to investing on making predictions, which he believes is an exercise in futility. In his own words:
“I respect the sheer intelligence and devotion of economists who have attempted to develop a unifying theory of market dynamics. But I don’t believe any such theory will hold up to scrutiny in the real world of money on the line. When you start believing you have remarkable market predicting powers, you get into trouble every single time.”
Hite is also critical of Wall Street research reports, claiming that they possess little investment value and are designed to exploit people’s natural tendencies to listen to entertaining narratives, stating:
“Stories began at the dawn of human society to entertain and instruct the next generation. We are wired to learn from well told stories. And unfortunately, Wall Street preys off our basic human weakness to want stories.”
In his typically blunt and straightforward manner, he adds, “When you start following slick reports filled with predictions, you’re just finding out who has good copywriters.”
A Computer can’t get up on the wrong side of the bed in the morning
Larry was a pioneer in his exclusive reliance on a data-driven, systematic approach, using statistical analysis of historical data to develop trading rules, which are the basis of his investment decisions. When he launched Mint Investments in 1981, his goal was “to create a scientific trading system that would remove human emotion from buying and selling decisions and rely instead on a purely statistical approach built on pre-set rules.” Continue Reading…
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