Happy 2023, everyone!
While I have no idea what 2023 will bring, it would be pretty hard for it to match last year’s casserole of crazy. Inflation, war, spiking gas prices, and the fastest interest rate increase in history made last year a true head-spinner. Personally, I’m rooting for 2023 to herald in that goddamned “Roaring 20’s” we were promised when the pandemic ended.
Well, as you know, we here at Millennial Revolution know how to party. So of course FIRECracker and I spent New Year’s Eve knee deep in spreadsheets so we could write this post.
So without further ado, I give you, our portfolio’s 2022 performance review!
The Equity Bear Market
From an investment perspective, 2022 was a *checks notes* total shit show.
The impact of all those different world-shaking events did a number to investor confidence. Not to mention energy prices, inflation, and interest rate policy. Add it all up and the US stock market officially entered bear market territory, declining by a whopping 20%.
2022 was the worst year for the US stock market since 2008. International stock markets did a bit better, with the MSCI EAFE index sinking by 16.6%.
One surprising area of outperformance was the Canadian stock market. After the war in Ukraine made gas prices shoot through the roof, Canada’s stock market unexpectedly benefitted because of how energy-based our stock market is. As a result, the TSX declined by “only” 8.6%.
And because our equity exposure is generally divided evenly between Canada, the US, and international stock markets, our portfolio inadvertently got a cushioning effect from this. However, I can honestly claim zero credit for this. Even as I was watching with horror as the war broke out and gas prices shoot up, I never could have predicted that this would have a positive effect anywhere, let alone one of the main stock indexes I invest in. But an accidental win is still a win!
The bond market, which typically acts as a counter-balance to stock market volatility, also got creamed this year. Bond prices move in the opposite direction of interest rates, so when interest rates rise rapidly (like this year), bonds go down. And boy did they.
An aggregate bond index fund like VAB fell by almost 14% in 2022. Double digit moves in either direction for bonds is extremely unusual, and was caused by the fastest rising interest rates in history. So while bonds dropped the ball as a dampener of volatility, it’s unlikely to continue happening in the future since these kinds of interest rate moves are extremely unusual.
That being said, central banks were nice enough to telegraph the fact that they would be raising interest rates all the way back in 2021. Many people didn’t believe them, but I did, and as a result replaced our aggregate bond holdings with a short-duration bond fund back in June 2021. And I’m super glad I did, because here’s how our short bond fund did relative to the medium-term aggregate bond fund in 2022.
Short-duration bonds are less sensitive to interest rate moves, so doing this meant that our portfolio’s bond holdings declined far less than the main aggregate bond fund. Was this a bit of active trading? Maybe, but come on! Interest rates were at zero and only had one direction to go. I made a judgement call and it turned out to be right in the end.
So put it all together, and here is how our portfolio’s overall performance looked in 2022.
In any other year, a 12% decline isn’t exactly something to celebrate, but in 2022, that technically represents an 8% over-performance over the US stock market. That ain’t too shabby given that we entered 2022 with a 90%/10% allocation.
We had similar performance on Portfolio B, since it’s largely invested in the same ETFs, but because we add money we earn throughout the year to this account, its true performance is not as easy to see.
In our report generated by Passiv, the green line represents total value while the light blue line represents contributions. You can see that while stock market volatility is swinging our portfolio’s value around, its impact is hidden by the infusions of new cash into the account as we move book and blog earnings in throughout the year.
So even though the portfolio was supposed to go down this year, it ended up higher at the end, though this is caused by new contributions rather than anything magical I did to our investments.
When we decided to separate our investments into Portfolio A and Portfolio B way back when, the original intention was to preserve the integrity of the experiment and prevent any post-retirement earnings from “polluting” the FIRE portfolio we built up before retirement.
As it later turns out, this had the added bonus of making it much easier to measure the impact of our investment choices. As many of you who are in the accumulation phase of your FIRE journey have no doubt noticed, when you add money to your accounts throughout the year it’s not actually that easy to see how well or poorly your portfolio actually did because the impact of new money being added clouds your reporting.
Once you stop adding money, it becomes much easier.
Here are our final net worth numbers for 2022.
So that means we ended 2022 with a net worth of $1,762,965, for an overall change of -7.1%.
It does suck that it’s negative, but it could have been a LOT worse. I can pinpoint our year’s financial performance on 3 factors that caused us to over-perform (any by that I mean not lose more money than we should have):
- The Canadian stock market outperforming its sensitivity to oil prices
- Owning short-duration bonds
- New contributions due to book and blog earnings
I do want to take some time to talk about something interesting that also happened this year. At the beginning of 2022, we projected that even after moving to an aggressive 90/10 split, our dividends would match our living expenses for the first time. We projected that we’d receive about $43,500. How did that prediction turn out? Well, according to Passiv’s handy-dandy dividend income report…
Actually, pretty damned well.
This actually demonstrates a rather curious and under-reported phenomenon of the past 12 months. Despite the war, despite record-high inflation, despite the US stock market slipping into a bear market and near-universal predictions of an upcoming recession, dividends held up.
Actually scratch that. Not only did dividend payouts hold up, they actually increased over the year.
This tells us something really important.
Despite stock prices having 20% of their value shaved off by 2022’s market rout, those companies are still making plenty of money. So much money, in fact, that they saw fit to increase dividend payouts. That means that the recent stock market declines are mostly driven by compression of their P/E ratios rather than a decline in earnings.
In other words, stocks went down in 2022 because the news spooked investors. But the underlying companies are still healthy. In fact, earnings actually increased during this time. And that means that there’s potential for a very rapid rebound in the stock market if and when investor sentiment goes the other way.
Another big realization from this year is that we’ve hit a new milestone in our FIRE journey. You may have heard of Lean FIRE, Fat FIRE, Coast FIRE, and even Barista FIRE, but here’s a new type of FIRE you may not have heard of…
This is when the dividends from your portfolio completely cover your projected living expenses.
Normally, the 4% rule assumes that you’ll be funding your retirement out of a combination of harvested dividends and selling shares that have gone up in value. But of course, in some years there are no shares that have gone up in value, like this year. This is when the risk of bad timing (or sequence of returns risk, as we’ve written about in the past) rears its ugly head, and strategies we came up with like the Yield Shield and Cash Cushion were necessary.
But if you use those strategies to successfully survive the first few years of retirement, eventually your portfolio grows to a point where the straight dividend yield is enough to live on. At this point, managing your portfolio becomes trivially easy.
You don’t need a Cash Cushion anymore, since a bad year on the stock market no longer means you have to make up the difference elsewhere.
You don’t need to use Geographic Arbitrage to lower your living expenses in a market downturn (a.k.a our “If shit hits the fan, we’re going to Thailand” strategy). We’re still going to go to Thailand, but because we want to, not because we have to.
And most importantly, the day-to-day gyrations of the stock market really don’t matter anymore.
This has been a huge change for me, but an even bigger change for FIRECracker. As a natural worrier and involuntary-lister-of-all-things-that-can-go-wrong, FIRECracker is usually a bundle of nerves during market downturns that I have to calm down. But this time, every time the news would report something scary about the stock markets, she would turn to me and ask “Are the dividends still OK?” I would check and report back that yes, they were. And then she would go take a nap.
It’s been pretty great, and completely unexpected.
After spending so much energy coming up with backup plans A, B, and C for every possible bad thing that can happen, reaching Dividend FIRE means we can’t really be derailed by the stock market anymore.
Getting a Raise with Preferreds
Which brings us to 2023. Are we planning on keeping the same 90/10 split in 2023, or are we going to make any changes?
After careful consideration, we are planning on changing our portfolio allocation from 90/10 to 75/25, with the 25% fixed income portion replaced with a preferred share ETF, namely ZPR.
Why? As we discussed in a previous post, Preferred Shares can either be issued with a fixed interest rate, similar to a bond, or a floating rate, which adjusts with interest rates. And for some strange reason, floating rate preferred shares have been pulled down alongside fixed rate preferreds as interest rates rose, despite the fact that they’re supposed to go in opposite directions.
This has created a unique value play where an ETF tracking a floating-rate preferred share index (like ZPR) is currently yielding about 6%, which is fantastic value considering that these shares are issued by blue-chip companies like banks and utilities.
So over the next few days, our portfolio will be moving from this:
|Canadian Stock Index
|US Stock Index
|EAFE Stock Index
|Canadian Stock Index
|US Stock Index
|EAFE Stock Index
This move will boost our projected dividend yield from $45,308.20 to $60,425.63, which represents a raise of 33%!
Now, this is not a move that makes sense for everyone, especially if you’re still in the accumulation phase of your FIRE journey. The reason is that dividends are tax-free, but only if you’re not making other income. If you’re still working, a higher dividend income will mean you’ll be paying more taxes for income that you don’t actually need yet. Why pay taxes when you don’t need to, right?
This move makes sense for us, because we have very specific needs. Namely…
- We need the income each year because we’re retired
- We want that income to come from dividends rather than capital gains
- We don’t care about volatility anymore
If these conditions don’t apply to you, then there’s no need to change your portfolio to follow us. Keep it simple and stick with indexing.
2022’s been a pretty crazy year news-wise, but from a financial perspective the biggest adjustment for us has been the sudden appearance of high inflation and rapidly rising interest rates. Millennials have never dealt with this situation before in our lifetimes, and for many people in our generation, that adjustment has been very painful.
People who bought into the hype of home ownership and went into massive amounts of debt assuming sub-2% interest rates would stay around forever got absolutely screwed this year. Rising debt servicing costs and falling home prices meant that homeowners are trapped in a financial vice of their own making, and many are being forced to work multiple jobs just to stay afloat.
On the other hand, our approach of rejecting home ownership and avoiding debt has absolutely worked out to our advantage. Rather than seeing our living expenses squeezed by higher mortgage costs, because our wealth is liquid, it’s easy for us to identify value in the fixed income market and lock in a 33% raise in dividends.
Next week, FIRECracker will be reporting on our 2022 expenses, so stay tuned for that!
How did everyone’s investments perform in 2022? Let’s hear it in the comments below!
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