(Click here for Part 1 to see how much we spent this year.)
Alright! 2020 is finally over! We made it! Just barely, but we made it!
At the beginning of this year, we were hanging out in Chiang Mai, Thailand. We were riding high off the surprisingly strong stock market performance of 2019 that saw our 60/40 portfolio return a stunning 16%. And I was sitting in a cafe answering emails from readers asking how I could justify putting money into the stock market when valuations were at such nosebleed levels?
My answer to them turned out to be oddly prescient given what was about to happen. It never, I explained, feels like the right time to invest. Either the stock market’s too expensive, or it’s crashing and scary. If you have the money, just invest.
And then the pandemic hit. From January to March the S&P 500 plummeted a stunning 32%. Only months after I wrote that reply, the first scenario was rapidly and violently replaced with the second. Once again, screaming headlines filled my news feed as stock markets experienced one-day drops the like of which we haven’t seen since 2008. Here we go again, I thought.
FIRECracker and I are known as one of the more conservative people in the FIRE movement. Rather than just going all into equities, we put a great deal of thought into what could possibly go wrong. What would we do if there was a sudden crash in the stock market? And in answering that question, we built a multi-layered system of backups designed to whether any storm we could possibly think of. We had our Yield Shield. We had our Cash Cushion. And we had digital nomadism that we could use to lower our living expenses if the need arose.
So when the stock markets started crashing in February, this was literally the moment we had been preparing for.
Now at the end of 2020, the dust settled, we can look back and ask the question: Did it work? Did our defenses hold, or did they crumble and fall?
The Yield Shield/Cash Cusion
Our Yield Shield strategy, in a nutshell, involves using alternative higher-yielding assets like Preferred Shares, REITs, and high-dividend stocks in order to raise our portfolio’s dividend yield. By doing this, it reduces the likelihood that you’ll need to sell during a downturn which would crystallize the losses. Instead, you could simply harvest the yield, and combine that with the Cash Cushion you left outside the portfolio in order to fund your living expenses. This works because while the stock market’s capital value might swing wildly in a downturn, dividends are far less likely to be cut and are therefore more dependable to rely on.
Did this turn out to be true?
I have to admit, as the pandemic raged across the globe I was a little nervous about this part of my backup plan. I had done copious amounts of research when we wrote about this a few years ago, showing that even during the disaster that was 2008/2009, dividends from the Yield Shield portfolio only went down about 10%, and then recovered fully the year after.
But that was a financial crisis. This was a pandemic. And as horrible as 2008/2009 was to so many people, people weren’t literally dying in the street. Large swaths of the economy weren’t forcibly locked down. Would this time be different?
At the beginning of 2020, our models projected that our portfolio would generate a total yield of about $40,000, or exactly our annual budget. Now that 2020 is offically over, how much did we end up receiving?
$38,284, or a whopping 96% of what we were expecting. In fact, it performed even better than in 2008/2009, when yields dropped more than twice as much.
The Yield Shield worked.
Despite the widespread economic shutdowns occuring all over the world, despite the daily news of yet another corner store or restaurant going bankrupt, despite all the emergency support being handed out by governments with the explicit restriction against using any of it to pay dividends, dividends of the major stock indices did not experience a major cut.
Why is that?
Remember that index funds are market-cap weighted, meaning they own companies in order of their total company value. That means they own more shares of larger companies and less shares of smaller companies. And that also means that the majority of their dividends are coming from huge, multi-national corporations like financials, utilities, and consumer goods producers. Think Bank of America and Johnson & Johnson.
Each recession is different, and this one was unique in that while it took out a huge chunk of the workforce and resulted in massve unemployment, the bulk of that impact was in small businesses. Restaurants, retailers, and local mom-and-pop outfits got decimated. But because those types of businesses weren’t large publicy traded corporations, those companies going out of business didn’t affect dividends coming from index funds since they were never part of of the index to begin with.
If anything, that lost business actually went towards the large multi-nationals, with Amazon and Walmart actually going up. And while some corporations did cut their dividends, on balance the fact that most of the impact was felt by small businesses and the positive effect of that lost income being diverted to big multi-national corporations ended up blunting their effect on overall dividend yield.
The other leg of our backup plan that looked like it was in danger of failing was our reliance on digital nomadism. In short, “if shit hit the fan, we’re going to Thailand.” The thinking was that if stock markets plummetted and our income took a major hit, we could always move to a low-cost country like Vietnam or Thailand to reduce our living costs. But of course during the pandemic, those countries were the first to throw up border restrictions. We were forced to scramble to book a flight back to Canada in February before we were completely trapped, and we’ve been stuck here ever since.
So did this backup plan completely fail?
I had forgotten about this, but during a really bad recession rents tend to fall. As job losses mount, people get behind on their rent and, unfortunately, get evicted. This creates a situation where rental stocks rise as units empty out. And because there are now less people who still have jobs and can afford to move in, this causes prices to decline. I remember this happening (along with rampant foreclosures) all over the place last time during 2008/2009.
This time, the impact on rents was even more pronounced because of two new factors.
First, many rental units in major cities are now being taken up by short-term AirBnb units, which didn’t exist back in 2008. Once borders got shut down and tourism all but stopped, these AirBnb’s all became vacant. Their owners panicked, first by drastically cutting prices, and then by moving them onto the long-term (month-to-month) market.
Second, fear of the virus and lock-down measures caused people to question why they were paying top dollar to live in the downtown core where everything was closed. Instead, many chose to flee for the suburbs, ex-urbs, and neighboring cities. There was no need to commute anymore, so why not get a bigger place out in the burbs?
Both of these effects caused apartments and condos, specifically in the downtown areas of many cities, to drop rapidly in price. As of the time of this writing, rents in Toronto have dropped on average around 20%, with our own experience even more because FIRECracker was able to negotiate with desperate landlords and extract even more price concessions.
Global arbitrage didn’t work, but by replacing it with local arbitrage, and counter-intuively choosing to live in the units and areas where everyone was fleeing from, we managed to live in one of the most expensive cities in Canada while paying SE Asia prices!
At the end of the year, as detailed in FIRECracker’s last post, out of our $40k budget, we managed to spend only $34k.
Put that together with a dividend income of $38k and that means our backup plans managed to work perfectly with each other! In fact, it worked so well that we saved money and don’t even have to take out a full withdrawal for 2021!
Verdict: The defenses held.
So in the end, how did Portfolio A, which is the retirement portfolio we actually live on, do? Note that at the beginning of 2020, we shifted from a 60% equity/40% fixed income allocation to a 70% equity/30% fixed income allocation.
Beginning of 2020 balance: $1,175,000
End of 2020 balance: $1,268,000
That’s right, in a year of a pandemic, a tumultuous (and still ongoing) US presidential election, and a global recession, our portfolio still made about 8%.
This is because buried in all the crazy headlines of the year was a pretty significant bit of financial trivia: 2020 experienced the shortest bear market on record.
A bull market is defined as a trough-to-peak gain of 20% on a stock market, and a bear market is the opposite. In March, the S&P 500 officially broke over a decade bull run and officially entered a bear market. Then in April, it roared into bull territory again. Why?
The reason is that central banks have gotten very good at fighting stock market crashes. When the 2008/2009 recession happened, then-Federal Reserve Chair Ben Bernanke responded by gradually dropping interest rates to near 0%, and then when he ran out of room to keep going he instituted a policy known as quantitative easing where the bank printed money and then used it to buy government bonds. This worked like a charm and was a big reason that the 2008 recession eventually recovered.
In 2020, now-Federal Reserve Chair Jerome Powell did all that again, minus the gradual part. He threw everything Ben Bernanke did at 2020, and he did it all at once.
The result is the fastest, sharpest rebound from a bear market ever. That’s why our portfolio recovered so fast even though the job market is still in the shitter.
This is now the 5th full year of retirement, and even though we’ve now experienced a correction and then a recession, our retirement portfolio is now significantly higher than when we started, even though we’ve been living off of it this whole time. In fact, not only have we not experienced any inflation from our original $40k budget, we’ve actually gone in reverse, with our spending deflating down to $34k! While I’m not expecting our spending to remain this low forever, I am predicting it will take a few years just to get back to our original $40k target.
Inflation? What inflation?
And in our yearly check-in of the overall health of our retirement, if we plug in our spending of $34k into a portfolio of $1,268,000, FIRECalc predicts a…
…100% success rate! In fact, even if we restore our original $40k budget, we still get a 100% success rate. I think we can officially declare sequence of return risk a thing of the past, and as a result we have eliminated one more Yield Shield asset: our REIT positions.
The last Yield Shield asset remaining is our dividend stock ETF, and in all likelihood we will get rid of this at the end of next year as well, which will bring our portfolio back in line with a purely indexed portfolio.
And how did Portfolio B, which contains all our post-retirement income, do?
Beginning of 2020 balance: $210,000
End of 2020 balance: $281,000
Not too shabby at all. But don’t get too excited by that eye-popping ROI. As usual, most of the gains on Portfolio B are from us adding blog/book earnings into the account.
So, after 5 years of retirement, our total net worth is: $1,549,000.
How much exactly did we earn from passion projects in 2020? Great question! FIRECracker is working on that summary right now, and we’ll be ready to share that in the next article.
How about you? How did your portfolio do in 2020? Let’s hear it in the comments below!
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