- Investment Workshop 59: Are Robo-Advisors Compatible With FIRE? - June 22, 2020
- Reader Case: Grounded in Vancouver and Dreaming of FIRE - June 19, 2020
- Real Estate Agent Gets Crushed by Real Estate Math - June 8, 2020
Our 2018 financial review continues after Part 1, where FIRECracker detailed our annual spending. Today, we’re going to talk about how our portfolio did, and the transactions we performed to fund next year’s living expenses.
How did it perform?
At the end of 2018 and the beginning of 2019, the financial media tried to sum up the overall year for stock investors. The more polite ones called it “challenging.” The less polite ones called it a cluster-fuck. And with good reason.
December was an especially wild ride, with the Dow swinging up and down 300+ points more times than I could count. On Dec 24, 2018, the Dow plunged 653 points and the S & P 500 officially entered a bear market in what the media dubbed “Worst Christmas Eve ever.” The next day, the Dow surged 1,086.25 marking its largest one-day point move ever.It was Trump, it was the China trade war, it was the Federal Reserve raising interest rates. Whatever the reason, I haven’t seen volatility like this since the Great Financial Crisis, and by the time the New Year’s Eve ball dropped in Time’s Square, stock markets officially had their worst year since 2008.
Now, I’ve been through shit like this before, so I wasn’t exactly crapping my pants or anything. But I do have to admit I was a teeny tiny bit nervous when I logged into my investment accounts at the end of December to see what the damage was.
Turns out, for the year, our portfolio was down…: -5.66%
So first of all, phew. It looks like the dire predictions of -20% bear-market losses did NOT come to fruition. It turns out the -20% number the media was throwing out was peak-to-trough over a few short months. Doing a January-to-January comparison, markets were still down but not nearly as badly as the media made it seem to be. So that’s good.
But as they say the price of (financial) freedom is eternal (financial) vigilance, so I started digging into how each piece of our portfolio was behaving in this downturn and make sure everything was doing what they were supposed to. If we were to take our boiler-plate Investment Workshop 60/40 portfolio, 2018 would have looked like this.
|VAB||Vanguard Total Bond ETF||40.00%||2.30%|
|VCN||Vanguard Canada All-Cap Index||20.00%||-10.20%|
|XSP||iShares Core S&P 500 Index ETF||20.00%||-6.80%|
|XEF||iShares Core MSCI EAFE Index||16.00%||-6.70%|
|XEC||iShares Core Emerging Markets Index||4.00%||-9.50%|
So our 60/40 portfolio should have gone down a little less than 4%. Yet ours went down closer to 6%. Why?
The answer is: The Yield Shield.
Remember that when we transitioned from working to retirement, we pivoted our portfolio by investing part of it in higher-yielding but more volatile assets. We did this because when you’re retired, you care more about how much income your portfolio is throwing off rather than how much your capital value goes up/down day by day. We called this strategy the Yield Shield, and we wrote a series of posts about it here.
But as we know, this yield ain’t free. With higher yield comes higher risk, and with higher risk comes higher volatility. Here’s what our actual portfolio did in 2018.
|VAB||Vanguard Total Bond ETF||10.00%||2.30%|
|XCB||iShares Corporate Bond||10.00%||0.60%|
|CPD||Canadian Preferred Share Index||20.00%||-8.90%|
|VCN||Vanguard Canada All-Cap Index||10.00%||-10.20%|
|XDV||iShares Canadian Select Dividend||5.00%||-12.50%|
|XRE||iShares Capped REIT Index||5.00%||5.80%|
|XSP||iShares Core S&P 500 Index ETF||20.00%||-6.80%|
|XEF||iShares Core MSCI EAFE Index||16.00%||-6.70%|
|XEC||iShares Core Emerging Markets Index||4.00%||-9.50%|
So we are actually seeing our portfolio swing around more wildly than it should. In fact, I’d estimate that in terms of volatility it’s actually behaving more like a 75/25 or an 80/20 portfolio rather than a 60/40.
So why did we do this?
How Yield Performs in a Downturn
Here’s the thing about Yield. When we first built our Yield Shield in 2015, we were getting a total portfolio yield of about 3.5%, or about $35,000 of our original $1,000,000 portfolio. Over the past few years as stock markets have rampaged ahead, if you were to buy those same ETFs that we bought (Preferreds, Corporate bonds, etc.) you might only get a yield of 3.2%, or maybe 3%, and people have been asking us “What gives? You said 3.5%!”
Under the hood, each ETF is holding a whole bunch of individual bonds, preferred shares, or common shares depending on what the ETF is about, and all those assets are paying shareholders some amount of money per share, either as interest (for bonds) or as dividends (for preferreds or stocks). So a unit of an ETF might be paying you say $0.1 per share every month based on whatever the underlying assets are paying.
The confusing part is that the payout doesn’t change based on the day-to-day fluctuations of the ETF’s price. So for that imaginary ETF paying $0.1 per share a month, or $1.20 per share a year, if you managed to buy that unit at $24 then you’re making 1.20 / 24 = 5% yield on that ETF!
But if the stock market is on fire that day and the price of that ETF went up right before you bought it, you’re not going to make 5%. That ETF is still paying $1.20 per unit no matter what it’s market price is, so if your friend bought that same ETF a month later at $30, then they’re only going to be making 1.2 / 30 = 4% on their money. And they’re going to look at your yield and say “hey, what gives? It’s the exact same ETF! Why are you making 5% while I’m only making 4%?”
Remember: This is because the payout doesn’t change based on the day-to-day fluctuation of the ETF’s price. So the yield you get gets locked in the moment that you buy. And while that may seem a little counter-intuitive, it’s also what makes yield so damn useful to retirees.
The payout doesn’t change based on the day-to-day fluctuations of the ETF’s price. That means that even if that ETF’s price were to soar to $40, or plummet to $10, our shareholders would still be making $1.20 per share. They essentially don’t care about what the market does anymore, they’ll still get paid the same every year no matter what happens.
So let’s see how our portfolio’s Yield Shield is doing, and make sure it’s still intact.
First, I went to each ETF’s info page where each company reports a forward-looking yield, which is essentially what it’s currently paying divided by it’s current share price. We will add this column to our handy little table.
|VAB||Vanguard Total Bond ETF||10.00%||2.30%||2.88%|
|XCB||iShares Corporate Bond||10.00%||0.60%||3.19%|
|CPD||Canadian Preferred Share Index||20.00%||-8.90%||4.68%|
|VCN||Vanguard Canada All-Cap Index||10.00%||-10.20%||2.88%|
|XDV||iShares Canadian Select Dividend||5.00%||-12.50%||5.98%|
|XRE||iShares Capped REIT Index||5.00%||5.80%||4.94%|
|XSP||iShares Core S&P 500 Index ETF||20.00%||-6.80%||2.04%|
|XEF||iShares Core MSCI EAFE Index||16.00%||-6.70%||2.83%|
|XEC||iShares Core Emerging Markets Index||4.00%||-9.50%||4.39%|
So our overall portfolio yield looks like it’s 3.41%. We will then multiply that by our current portfolio value. At the end of December 2018, our portfolio was worth $1,069,000, and after removing $35,000 in yield for 2019 expenses, we are left with a portfolio value of $1,034,000.
In December 2019, to project our yield for 2020 expenses, we will multiply this number by our projected portfolio yield to get…
1,034,000 x 3.41% = $35,259.40
$35k. Just as we were expecting. The Yield Shield has held up and we go into 2019 happy and certain that no matter how badly the market crashes, we will still make $35k in cold hard cash without having to sell a single thing.
That’s why a Yield Shield (combined with a Cash Cushion) is so powerful after you’re retired. It allows you to create a stable, predictable income stream out of something that’s fundamentally unstable and unpredictable (the stock market). And that’s why even thought the markets plummeted this year, and our own portfolio took a dive, we don’t care. We’re still gonna get paid.
Our Portfolio Transactions
So in late December, after we did all this spreadsheet crunching and realized, with some degree of relief, our portfolio was holding up, our Yield Shield was still strong and healthy, and that everything was working exactly the way it should be, it was time to perform some year-end buys and sells. So I thought it would be interesting to all of y’all to reveal exactly what we did and why.
Here we go!
Now normally, December is when I would do my RRSP withdrawals. To the Americans, an RRSP withdrawal is the equivalent of doing a 401(k) conversion as part of a 5-year Roth IRA Ladder Conversion strategy.
My general strategy after retirement is to use our personal exemption room of $12k each to melt down both of our RRSPs. This gets added as taxable income, but as long as I keep my withdrawals limited to $12k each, we can get our money out of our tax deferred accounts tax-free!
Well, that’s not happening this year. Because we made too much side hustle income.
I know, I know. Crocodile tears. When we made Millennial-Revolution.com, neither of us was expecting this thing to become a financially profitable side hustle, and it was even more unlikely that we ended up getting a book published with Penguin this year!
My RRSP withdrawal strategy assumed we would be making no money after retirement, so once that assumption went out the window, the goal of our RRSP withdrawals changed from “pay no tax” to “pay as little tax as you can.” And fortunately/unfortunately this year, the combination of our blog income and part of our book advance being paid out was so high it actually pushed us into a higher tax bracket.
I know, I know. Tiny sad violin. FIRECracker will talk more about our side hustle income in Part 3, but long story short is we’ve decided to skip our RRSP withdrawals this year. Since book advances don’t get paid every year, we’re expecting our income to be lower in 2019 than in 2018, we think it makes more sense to do our RRSP withdrawal next December.
Harvesting our Yield
However, something we do have to do is harvest the yield from our portfolio. Remember, the portfolio yield comes from all the ETFs paying out income in the form of dividends or interest throughout the year, and that income gets accumulated as cash sitting in each account. The challenge comes from the fact that some of this cash got accumulated in our RRSPs, which we can’t easily access unless we do an RRSP withdrawal. And since we’ve decided to skip our RRSP withdrawals this year, how do we harvest that cash?
Fortunately, we do have a way. We call it a Cash Asset Swap. We’ve written about this before, but basically a Cash Asset Swap is a technique where you do matched buy/sell transactions between two accounts to swap cash inside one account for ETFs in another. Say you have a situation like this.
You have $5000 of cash inside an RRSP that you can’t get access to. At the same time, you have 500 units of an ETF at a price of $10 per share in your investment account that you wouldn’t mind living inside your RRSP. So you issue a BUY order in your RRSP to buy 500 units of that ETF. Simultaneously, you issue a SELL order for 500 units of that ETF in your investment account.
If you do them quickly enough, the stock market will match up those orders at the same price and will perform the exchange for you, and you’ll be left with this situation.
Voila! Your cash is now accessible, your portfolio makeup hasn’t changed, and you haven’t triggered a taxable event by withdrawing from your RRSP. However, note that selling the ETF in your investment account may trigger a capital gain/loss, so I like to pick ETFs with a relatively small unrealized capital gain/loss to minimize the tax implications.
This also works for Americans, by the way, to access cash in your 401(k) by swapping in ETFs from your investment account without doing a taxable withdrawal/IRA conversion.
RRSP Cash Asset Swap
OK so in December, the Yield Shield cash that got generated over the year was scattered throughout our portfolio something like this.
Again, the numbers in the box is just the Yield Shield cash. The total balances of each account aren’t shown here because they’re not relevant to what we’re trying to do.
So what we did was we performed 4 Cash Asset Swaps between our 4 RRSP accounts and our investment account.
For historical reasons, part of our S&P 500 holdings are denominated in USD, using the ETF SPY. This is the ETF we chose to swap into our RRSPs, since NYSE-traded ETFs have favourable tax status when held inside an RRSP (specifically, no foreign withholding taxes apply).
Conveniently, SPY was trading at around $250 per unit that day, so our orders looked something like this:
- Wanderer’s RRSP: BUY 24 SPY (24 x $250 = $6000)
- FIRECracker’s RRSP: BUY 12 SPY (12 x $250 = $3000)
- FIRECracker’s Spousal RRSP: BUY 2 SPY (2 x $250 = $500)
- FIRECracker’s LIRA: BUY 2 SPY (2 x $250 = $500)
- Joint Investment Account: SELL 40 SPY (40 x $250 = $10000)
And since we’re using Questrade, ETF buys are free, while sells are just $5. So in total, we paid around $5 in commission to do this! And because our buy/sell orders are perfectly matched (BUY 40 SPY, SELL 40 SPY), our portfolio hasn’t actually changed at all.
After all this was over, our portfolio’s cash balances now looked like this.
Getting money out of our TFSA was much simpler: we simply withdrew the cash. For Americans, this is the equivalent of just making a Roth IRA withdrawal. Remember that contributions can always be withdrawn tax-free, so as long as you haven’t withdrawn more than you’ve put in over the years, you don’t have to worry about any tax or age-based penalties.
After our withdrawals were done, our portfolio looked like this.
All our Yield Shield cash is now gathered in one place, and is ready to be harvested!
Now remember, any amount you withdraw from a TFSA gets added back the next year along with your new TFSA contribution room, so we’re planning on re-contributing the amount we withdrew in the form of an in-kind ETF transfer in the new year, but that’s a topic for another article as this one’s already getting pretty long.
This generally doesn’t apply to Americans, unfortunately. Once you make a withdrawal, that contribution room is gone 🙁
Finally, we complete our Yield Shield Harvest. In 2019, we are projecting our living expenses to be again $40,000. Despite being our 4th year of retirement, inflation hasn’t really affected us at all, and a big part of that is Geographic arbitrage. In fact, since we’re planning on spending more time in SE Asia, I suspect our yearly expenses will actually DROP, but to be conservative let’s stick with the $40,000 number.
Our Yield Shield will provide $35,000 of that amount. Now normally in an up year, we’d realize $5,000 of capital gains to make up the shortfall, but because this is a down year we’ve decided to use up one of the years of our Cash Cushion, like so.
And now our 2019 Expenses are fully funded and ready to go!
This will bring our Cash Cushion down to $10,000, or 2 years worth, but given that I really don’t think this stock market “crash” will last all that long, I’m comfortable doing that and waiting for the rebound. And as always, if our Cash Cushion runs out and we’re forced to live on just the Yield Shield alone, we can easily do that by spending a year in a low-cost zone like SE Asia. After all, If Shit Hits The Fan, We’re Moving to Thailand!
And We’re Done
Phew! What an update THAT was.
I’m not gonna lie, it was a LOT of work to put this post together, but I think it’s important for you in the interest of transparency. Last year, we realized that our various side hustles (blog, books, etc.) started generating a non-trivial amount of money, and we consciously made the decision to segregate the money we made post-retirement into it’s own seperate portfolio named Portfolio B, and to continue living off only our original retirement portfolio, named Portfolio A. We did this to preserve the purity of our retirement experiment and show that yes, this early retirement math does in fact work with or without blog income.
So that’s it for Part 2 of our 2018 Financial Update. Check out Part 1 if you missed it where FIRECracker broke down how much we spent for the year, and stay tuned for Part 3, where we’ll talk about how much post-retirement side-hustle income we made in 2018, and what we’re planning on doing with it.
Questions? Comments? Let’s hear it below!
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