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So after the enthusiastic reaction to our last post about Withdrawing from our portfolio, I thought I might tackle a few of the follow-up questions we got from that, both from comments and over email. New readers, please click here to start from the beginning.
How does your Yield change as the stock market fluctuates?
Generally, when you make a purchase your yield, as a dollar amount, becomes fixed. For example, if you buy a bond or a preferred share yielding $5 a unit, and your purchase price per unit is $100, you are going to be getting a 5% yield on that asset.
But let’s say that the price of that asset, for whatever reason, swings up or down. Let’s say the price plummets from $100 all the way down to $50. What is your income? Still $5 per unit.
Your yield is determined by your buy point. Any subsequent price fluctuations don’t change the fact that you’re still making $5 a year off every $100 unit your purchased.
What about Inflation? Does your Yield increase to match your increased cost-of-living?
Not on its own.
As we described above, yields are locked in when you buy and generally don’t change with price fluctuations or inflation. There are some exceptions of course, like Real Return Bonds (or TIPS as the Americans call them) which adjust their yield with inflation, but we don’t own any ourselves.
So how do we deal with inflation? Our inflation hedging strategy goes like this:
- Keep a significant equity weighting. Under normal inflationary periods, equities serve as an inflation hedge. This is because as prices rise, companies get to charge more for their products, which in turn means higher profits, which in turn means higher stock prices. We plan to keep an equity weighting of 60% for now, possibly increasing into the future.
- Re-balance. If we just leave the fixed income part alone, the yield won’t keep pace with inflation. So it’s important that as our equity portion increases, we harvest some gains and buy more fixed income. This will increase our yield because there is now more money generating income.
- Use global arbitrage to control inflation. Inflation is always measured per-country. How much of that country’s currency is needed to buy a basket of that country’s goods. But what people forget is that just because your portfolio is in one country doesn’t mean you have to live there. Japan’s been in a deflationary spiral for decades, and from talking to fellow travellers it seems that the cost of living in SE Asia hasn’t increased in the past 20 years at ALL. So even if the price of cabbage spikes in New York, you can always just switch countries to one where your dollar goes further.
What if your 5-year bucket runs out?
If your 5 year bucket runs out, then we’d have to start selling assets to fund our living expenses. And that would be bad. However, keep in mind that the average length of a recession in the 20th century is well below 2 years. In the first half of the century, recessions lasted on average 18 months, and in the 2nd half (as central bankers and policymakers figured out how to better combat recessions), they lasted on average only 10 months (source). The Great Depression of 1929 only lasted 3 years 7 months, with every other recession after that lasting significantly shorter.
So are we going to see a depression lasting longer than 5 years? Maybe. But most likely not. In fact, given the average length of recessions excluding the Great Depression, there’s an argument to be made that 5 years is way too conservative, and that maybe 3 years is more appropriate. But whatever, I’m comfortable with using 5 years as my safety margin. You can decide for yourself how long you want yours to be.
How do you get money out if it’s stuck in your RRSP/401(k)?
Since many of our fixed income assets like bonds are sitting in our RRSPs/401(k)’s, some of the cash that will be generated will collect in those accounts. So how do I actually withdraw it?
Well for this we need to gradually withdraw our RRSPs/401(k)’s, not just to get at the interest income but to melt down our overall assets in that account tax-free. This is because if we don’t, at a certain point (around age 70), the government FORCES you to withdraw your assets as taxable income whether you like it or not, so if you leave everything in there up to that point, you may be forced to pay taxes on it. So either pay no taxes now, or be forced to pay higher taxes later. No brainer.
To learn about how to do this, check out our Workshop write-up here.
So thanks for all the great questions and please feel free to keep ’em coming!
And without further ado, we will now commence our regularly scheduled buy.
Canadian Portfolio
As always, we start with our current portfolio state after our additional cash has arrived in the account.
| Asset | Ticker | Unit Price | Units | Market Value | Allocation | Target Allocation |
|---|---|---|---|---|---|---|
| Canadian Bonds | VAB | $25.21 | 40 | $1,008.40 | 33.14% | 40% |
| Canadian Index | VCN | $32.09 | 16 | $513.44 | 16.87% | 20% |
| US Index | VUN | $42.98 | 12 | $515.76 | 16.95% | 20% |
| EAFE Index | XEF | $27.08 | 15 | $406.20 | 13.35% | 16% |
| Emerging Markets | XEC | $23.79 | 4 | $95.16 | 3.13% | 4% |
| Cash | – | $1.00 | 503.77 | $503.77 | 16.56% | 0% |
Our rebalancing table tells us what we need to do…
| Asset | Ticker | Target Allocation | Unit Price | Current Market Value | Target Market Value | Current Units | Target Units | Difference |
|---|---|---|---|---|---|---|---|---|
| Canadian Bonds | VAB | 40% | $25.21 | $1,008.40 | $1,217.09 | 40 | 48.3 | 8.3 |
| Canadian Index | VCN | 20% | $32.09 | $513.44 | $608.55 | 16 | 19.0 | 3.0 |
| US Index | VUN | 20% | $42.98 | $515.76 | $608.55 | 12 | 14.2 | 2.2 |
| EAFE Index | XEF | 16% | $27.08 | $406.20 | $486.84 | 15 | 18.0 | 3.0 |
| Emerging Markets | XEC | 4% | $23.79 | $95.16 | $121.71 | 4 | 5.1 | 1.1 |
| Cash | – | 0% | $1.00 | $503.77 | $0.00 | 503.77 | 0.0 | -503.8 |
And we round our numbers to integers while making sure not to go into margin.
| Asset | Ticker | Unit Price | Action | Fractional Units | Units | Proceeds |
|---|---|---|---|---|---|---|
| Canadian Bonds | VAB | $25.21 | BUY | 8.3 | 8 | $201.68 |
| Canadian Index | VCN | $32.09 | BUY | 3.0 | 3 | $96.27 |
| US Index | VUN | $42.98 | BUY | 2.2 | 2 | $85.96 |
| EAFE Index | XEF | $27.08 | BUY | 3.0 | 3 | $81.24 |
| Emerging Markets | XEC | $23.79 | BUY | 1.1 | 1 | $23.79 |
| Total | $488.94 |
This is actually a good example of how our rebalancing methodology naturally self-corrects. Remember last buy when we chose not to pick up any XEC because of the way the rounding worked out? Well, that caused XEC to be under-target this week, and as a result our rebalancing spreadsheet picked up on the discrepancy and is instructing us to fix it by buying a unit.
American Portfolio
And now to our American Portfolio. Here’s where we stand after our cash has arrived…
| Asset | Ticker | Unit Price | Units | Market Value | Allocation | Target Allocation |
|---|---|---|---|---|---|---|
| Bonds | BND | $80.65 | 13 | $1,048.45 | 34.30% | 40% |
| US Index | VTI | $120.90 | 6 | $725.40 | 23.73% | 30% |
| International Index | VEU | $46.83 | 16 | $749.28 | 24.51% | 30% |
| Cash | – | $1.00 | 533.47 | $533.47 | 17.45% | 0% |
Our rebalancing table tells us what to buy…
| Asset | Ticker | Target Allocation | Unit Price | Current Market Value | Target Market Value | Current Units | Target Units | Difference | |
|---|---|---|---|---|---|---|---|---|---|
| Bonds | BND | 40% | $80.65 | $1,048.45 | $1,222.64 | 13 | 15.2 | 2.2 | |
| US Index | VTI | 30% | $120.90 | $725.40 | $916.98 | 6 | 7.6 | 1.6 | |
| International Index | VEU | 30% | $46.83 | $749.28 | $916.98 | 16 | 19.6 | 3.6 | |
| Cash | – | 0% | $1.00 | $533.47 | $0.00 | 533.47 | 0.0 | -533.5 |
And we pick our buy orders by fiddling around with the unit numbers until we like what we see…
| Asset | Ticker | Unit Price | Action | Fractional Units | Units | Proceeds |
|---|---|---|---|---|---|---|
| Bonds | BND | $80.65 | BUY | 2.2 | 2 | $161.30 |
| US Index | VTI | $120.90 | BUY | 1.6 | 2 | $241.80 |
| International Index | VEU | $46.83 | BUY | 3.6 | 2 | $93.66 |
| Total | $496.76 |
Aaaand we’re done
Thanks for following along and see you next week! As always, if you have any questions, feel free to leave it in the comments below.
Continue onto the next article!
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Awesome. Great post. Simple to understand and answers a lot of questions !
Congrats Wanderer
Hi Wanderer,
Just wondered if, now that you are fire, do you have this same allocation? I will likely have a chunk after I sell my condo and have some thoughts about leaving the workforce to be with miraclebaby.
Thank you, and wishes good things for you!
Alison and miraclebaby
I’ve shifted some of my fixed income towards higher-yielding asset classes (REITs, Preferred Shares, Corporate bonds, etc.) but my overall allocation remains 60/40. It’s working our pretty well for us.
Are those etfs as well?
Yup. I used XRE for REITs, CPD for Preferreds, and XCB for corporates.
Hi Wanderer,
Great post.
I was wondering about your comment about withdrawing now from your RRSP so that you pay no tax rather than having the government forcing you to withdraw around age 70. If I have no income and begin to melt my RRSP down, I understand that I would do this in annual portions of $15,000. Wouldn’t this still be susceptible to taxation at the lowest tax bracket where I would have to pay $3,000 to the government and only be able to collect $12,000?
Thanks,
Jackson
Don’t forget about the $10k personal exemption. The first $10k of income is tax free, so that allows me and FIRECracker to get out $20k per year.
What if 70% of my assets are not in tax sheltered accounts.
I would still use the “ladder” to get the money from 401K over to ROTH, but unlike you I would not remove the dividends since ROTH has better tax advantage for keeping than investment account. is that right?
So does that mean that my investment account would hold the bonds instead of ROTH?
This five-year bucket business to make it through recessions is a nice concept in theory. In practice, it doesn’t work as well, though.
1: the equity portfolio has to return not just back to its old peak but to its old peak +5 years worth of inflation. Unless you are OK with eroding your purchasing power.
2: But not even #1 is enough. The equity portfolio has to go back to its old peak plus inflation plus the amount necessary to replenish the 5 years worth of living expenses in the cash bucket (probably worth around 20% of the portfolio).
This may work in a garden-variety equity down market like 1991. But none of the major recessions would have delivered a stock market strong enough to get you back to square one after 5 years.
I wrote about this topic before, check out the link if you like:
https://earlyretirementnow.com/2016/10/26/cash-management-in-early-retirement/
I’d agree that a cash cushion in an all-equity portfolio would be a little dicey, but that’s why we have a 40% fixed income portion. The additional yield reduces the size of the cash cushion, and global arbitrage makes it easy to get your annual spend completely below yield which makes your cushion completely optional.
I actually don’t understand how so many FIRE guys go 100% equity JUST as they retire. That seems nutso to me.
Well if you hold 60% equities and then you replace your 40% government bond portfolio with Corporate bonds, Preferred Stocks, High Yield Bonds and REITs, then how much of a volatility reduction would you have compared to a 100% equity portfolio? Do you remember how Preferreds, High Yield and REITs performed during the global financial crisis?
Also, loading up on yield runs the risk of capital losses if global bond yields move up.
If your yield covers most of your living expenses, then an increased volatility is worth it. With 100% equity, I get increased volatility, PLUS I have to worry about harvesting capital gains every year to either fund my living expenses or refill my buckets.
What if the REIT dividends are cut? In fact, the 12M rolling dividend payment in the VNY ETF was $3.91 in 09/2007. It dropped to $1.835 at the bottom of the crisis. Almost a 50% drop. The 12M rolling dividend payment only recently recovered to pre-crisis levels in nominal terms, but the dividends are still below 2007 in real terms.
At the same time, the VNQ price dropped by more than 70%. Even with this yield strategy, you’d have to sell some of the high-yielding asset classes at a very inopportune time.
And I could go on: Preferred Stocks (PFF from iShares) cut the dividend payments (in nominal terms, in real terms even worse) and they are still below pre-crisis levels. And the ETF price is also still below the pre-crisis level. Even in nominal terms, and even more so in real terms.
If the 100% (actually, close to 100%) equity strategy like mine makes me cut my spending by 25-50% for a short time then so be it. But people investing in REITs, High-Yield and Preferred Stocks will have to suffer the same consumption cut.
But again: don’t get me wrong! I hold PFF myself (small amount since recently). I want it to do well. But this high-yield strategy has its risks!
Correction: I meant VNQ (the Vanguard REIT ETF). Cheers! 🙂
http://www.msn.com/en-us/money/savingandinvesting/why-dollar-cost-averaging-is-a-lousy-retirement-investing-strategy/ar-AAmXrvu
https://personal.vanguard.com/pdf/ISGDCA.pdf
Yeah, I’ve read the same articles. But the fact of the matter is, most people don’t have a chunk of money just sitting there in cash. They invest periodically as they get paid, so DCA is basically the only solution that makes any sense for the average investor.
Hi,
I think that it makes more sense to withdraw the amount in equal yearly tranche of tax-exempt from 401K. Action is beter than no action.
Ben
Thank you, I have found these withdrawal posts to be very helpful! I really appreciate that you include information for your American readers. I don’t usually comment, but I am grateful for you and the early retirement community!
Thank you for the great post. I really like the idea of bucket withdrawal strategies.
Another slight variation on this method is to *always* withdraw 4% (from the 25X mix of stocks/bonds) and feed the 5X cash pile. Then divide the 5X cash pile by “5” to get your yearly available spend. Move this amount to a checking account, live off it for the year. Next year, repeat.
The 4% withdrawal from stock/bond portion is done every year, whether the market is up or down. Because of this, you could ensure a stock/bond split in which the bond portion makes up, say, 3X of annual expenses. During normal rebalancing, you’d be pulling from bonds when the market is down, and from stocks when the market is up (and probably also feeding bonds). This would happen “mechanically” or “automatically” just through simple rebalancing.
So, we have a 4 step approach: (1) harvest 4% from stock/bonds (always), (2) add to cash savings, (3) divide cash savings amount by 5, and (4) move 1x from savings to checking; which automates the whole process so you don’t even have to think about the market. For the mathematically minded folks, the cash pile acts as a “filter” for market variability, in that the dynamic returns of the market are averaged or “dampened” by a factor of 5. And having a reasonable stock/bond split dampens volatility further.
Curious if you considered this approach, and if so, found any issues with it.
Thanks again for posting such great content. Keep it up!
Really useful info!
I’ll be opening my Questtrade account soon, and will be able to follow along more directly, rather than nodding my head sagely and saying ‘sounds about right!’. I’m thinking an 80/20 allocation for myself, based on existing math and my age etc.
Still eagerly awaiting the release of that oft-mentioned spreadsheet, too 😀
As someone who is moving from paying off debt to investing, I’ve been loving your site. Just wanted to say thanks for the resource!
Great site, love how much energy you guys have for this!
Quick question for you (sorry if I missed a post about it somewhere). My retirement plans are likely to include travel as being one of the biggest expenses. In my experience Canadian dollar doesn’t really correlate well with international travel expenses, say compared to holdings in USD or Euros. Everyone on the couch potato style sites talks about not introducing currency risk into bond holdings, but if your major expenses are not in Canadian dollars holding 40% of your portfolio in Cdn$ seems like a major currency risk itself? You guys seems to be traveling alot yourselves, have you given this much consideration?
Guys – just curious as to why you are using the VAB & BND aggregate bond ETFs if you know that the interest rates (at least in the US) are going up.
Wouldn’t it be better to use ETFs that only hold short term bonds?
Does rebalancing the portfolio incur commission fees for each transaction? How do we avoid paying those transaction fees?