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Today we are going to talk in more detail about how to manage your retirement portfolio after you give the 9-to-5 the ol’ heave-ho. The topic of how exactly you adjust your portfolio allocations after retirement has been dealt with only peripherally so far on this blog, but that’s mainly because it’s a topic that requires a shitload of diagrams to explain. Diagrams I have been too lazy to produce.
Too lazy to produce, that is, until…NOW!
New readers, please click here to start from the beginning.
The Efficient Frontier
Recognize that? You should. That’s the efficient frontier of the Total US Stock Market vs. the Total US Bond Market. This graph was generated using market pricing data from 2014-2017 to more properly reflect today’s low interest rate environment, courtesy of the good people at www.portfoliovisualizer.com.
To recap: the efficient frontier is a visual representation of the relationship between risk and reward. The X axis is volatility, as measured by standard deviation. The more to the right the line is, the wilder the day-to-day price swings are. The more to the left, the calmer the ride. And on the Y axes is expected return. Higher is (obviously) better.
Got it? Great.
Now let’s add an additional layer. Here, I’ve overlaid the portfolio’s yield on top of the graph. Given that the bond index is yielding about 3% and the equity index is yielding about 2%, we get the following:
On the left where the lines meet(ish), that’s because a 100% fixed income investor is getting nearly all their return strictly from the ETF’s yield, which is to be expected. It’s fixed income. And on the right, the portfolio’s return is much much higher, but most of it’s coming from capital gains rather than dividends.
So conventional retirement planning tells us that when you’re young and a decade or two away from retirement, you want to go high-returns, high-volatility, since you won’t need the money for a while. You also don’t care about the yield, so your portfolio when you’re working and accumulating should look like this.
Yee-ha. Ride ’em, cowboy. 100% equity, bitches!
And as you close in on retirement, you want to dial back your equity exposure to, say, 60% equity/40% fixed income. This is where we were when we retired.
Conventional vs. Early Retirement
So far, we at Millennial Revolution are in agreement. Now here’s where we diverge. Conventional retirement planning dictates that after your retire, you keep dialling back your equity allocation as you get older. Retirement planners use a “Rule of 100,” which states that your equity allocation should be equal to “100 – Your Age,” of course assuming that their client retired at 65 like a normal person. So as they retire and spend down their portfolio, their allocation looks like this.
Obviously, this doesn’t work for us Early Retirees. First of all, we don’t retire in our 60’s, we retire whenever we damned well please. Second, our retirement timeframe is WAY longer. And thirdly, there’s a teeny tiny mismatch between the 4% withdrawal rate we keep yammering about and what bonds actually pay these days.
Yeah. That.
That green line is how much we need to withdraw from our portfolio each year. And there’s a slight problem. It never crosses with the red line.
So if we were to follow conventional retirement “wisdom,” we’d be screwed. We would have moved our portfolio into bonds, only to find that those bonds are wholly insufficient in providing the income we need. This would force us to spend our principal down, and the whole thing would fall apart. In other words…
But the problem with relying on a portfolio’s total return is a significant portion of your income will need to come from capital gains, which is inherently risky. If that higher volatility hits you at just the wrong time and you encounter a couple down years in a row right at the beginning of your retirement, you’d be forced to sell into a storm and you may never recover. In fact, this is exactly the mechanism that causes the 5% of retirement portfolios to fail in the Trinity study on which the 4% rule is based on.
So what can we do? Just stay in the 60/40 portfolio and hope for the best?
HELL no! We do what we always do here on the Millennial Revolution. We math that shit up!
Let’s reset our little dots back to the 60/40 positions. Recall this is the portfolio we personally had when we retired.
Now we’ve alluded to, at times on this blog, about “goosing our yield.” We will now reveal what this means.
What this means is that we replace the safe government bonds we were using in our fixed income side with higher yielding assets. Specifically, Preferred Shares, REITs, and High-Yield Bonds. These are riskier assets since they aren’t backed by a government, but because of this they pay a higher yield. And as always, we never invest in individual companies, we use indexes that track each asset class. For Preferred Shares, we use the ETF CPD. For REITs, we use XRE. And for High-Yield Bonds, HYI.
Note that these are all Canadian ETFs traded on the TSX. For you Americans out there, you’ll have to map it to the equivalents on your side of the border.
As of the time of this writing, Preferred Shares, REITs, and High-Yield Bonds are yielding about 5-6% right now. If you were to replace your fixed income allocation in a 60/40 portfolio with these higher yielding assets, you would bring your retirement portfolio yield up to about 3.5%. This is basically what we did.
HOWEVER, and I cannot stress this enough, that yield ain’t free. The entire point of a balanced diversified portfolio is for the fixed income assets to balance out the day-to-day gyrations of the stock market, and this happens because safe government bonds are anti-correlated with equities. When one moves up, the other tends to move down.
Higher-yielding assets do not have this property. Preferred Shares and REITs tend to be uncorrelated (rather than anti-correlated), and if anything, High-Yield Bonds tend to be correlated to the stock market. So when we move into higher-yielding assets, this happens.
Our portfolio starts to become more volatile. In fact, I’d estimate that our own personal portfolio behaves more like a 75/25 portfolio rather than a 60/40. But in exchange, we’re getting that extra yield.
Yield and Retirement
So what now? We’ve goosed our yield, but we haven’t quite hit our withdrawal line. Well, remember when we told you to build a 3-5 year cash cushion? This is why, so we can do this…
That cash cushion allows you to take the withdrawal pressure off your portfolio. On a $1M portfolio with a spending target of $40k, a cash cushion of just $25k allows us to reduce our withdrawal line by $5k a year for FIVE whole years!
And this is important. Because by reducing our withdrawal line to hit our portfolio yield, we have entered…
This is a magical zone where your spending (or at least, your portfolio withdrawals) falls beneath your portfolio yield. When this happens, you are INVULNERABLE to market conditions. The markets could soar, the markets could crash, and you don’t care because you get paid regardless.
But WAIT, there’s MORE!
As we discovered after we retired, in practice there are other ways to reduce your withdrawal line besides just relying on your cash cushion, which is temporary by definition. Namely:
- Side Hustles. Nobody ever retires in their 30’s and never does anything productive ever again. We ended up writing and doing freelance coding. Both pay money.
- Geographic Arbitrage. You can live anywhere, so why live in a high cost city? Right now, I am typing this lying on a beach in Central America, where it costs just a fraction to live as back home.
Both of these unexpected windfalls has actually caused our spending to go DOWN in retirement, to the point where this happened…
Holy crap! Our withdrawal is actually BELOW our Yield Shield!
So what does this mean? That means this…
Over time, we are actually planning on exiting our riskier high-yield assets like high-yield bonds and plowing that money into more index funds. We don’t need the yield anymore, so why give up portfolio return, right?
And over time, we expect this trend to continue. In retirement, there are actually 3 ways your withdrawal lines goes down.
- Reduced cost via more travel. Spend more time in low cost areas, surprise surprise, your annual spending goes down.
- Increasing portfolio size. This is already happening. Because markets are rampaging higher, we actually find ourselves with a LARGER portfolio than the one we had when we retired. And if your spending stays the same, your withdrawal rate (as a percentage) goes lower.
- Side Hustles. Any money you make over the year means less money you need to withdraw. I know early retirees whose side hustles have been so successful their portfolio withdrawal rate has effectively gone to zero.
And if at any point, your withdrawal line drops below 2%, something interesting happens…
At 2%, you are basically at the dividend yield of the S&P 500. So that means you can completely ditch your fixed income allocation and go 100% into equity…
And at that point, you will have the best of both worlds. You will have your living expenses taken care of by your portfolio yield, and still be able to get the higher expected return of the index. Yes it’ll be super volatile, but you won’t care because you are safely ensconced in the Yield Shield.
And that is how you manage your portfolio when you retire in your 30’s.
Questions? Comments? Let’s hear it in the comments below!
Update
As some readers noticed, today is one of our regularly scheduled buy days yet we didn’t do a buy. Why? Well, long answer short, we were on a boat all day and couldn’t get to our laptops. Please watch this this short film for a more in depth explanation:
Ahem, anyway, now that we’re back on land, we will now proceed with our regularly scheduled buys.
Canadian Portfolio
As always, we add our next slice of money into the account and update our portfolio allocations.
| Asset | Ticker | Unit Price | Units | Market Value | Allocation | Target Allocation |
|---|---|---|---|---|---|---|
| Canadian Bonds | VAB | $25.27 | 56 | $1,415.12 | 34.67% | 40% |
| Canadian Index | VCN | $31.57 | 23 | $726.11 | 17.79% | 20% |
| US Index | VUN | $44.44 | 16 | $711.04 | 17.42% | 20% |
| EAFE Index | XEF | $28.14 | 20 | $562.80 | 13.79% | 16% |
| Emerging Markets | XEC | $24.71 | 6 | $148.26 | 3.63% | 4% |
| Cash | – | $1.00 | 517.94 | $517.94 | 12.69% | 0% |
From here, we figure out how to rebalance to get back on target…
| Asset | Ticker | Target Allocation | Unit Price | Current Market Value | Target Market Value | Current Units | Target Units | Difference |
|---|---|---|---|---|---|---|---|---|
| Canadian Bonds | VAB | 40% | $25.27 | $1,415.12 | $1,632.51 | 56 | 64.6 | 8.6 |
| Canadian Index | VCN | 20% | $31.57 | $726.11 | $816.25 | 23 | 25.9 | 2.9 |
| US Index | VUN | 20% | $44.44 | $711.04 | $816.25 | 16 | 18.4 | 2.4 |
| EAFE Index | XEF | 16% | $28.14 | $562.80 | $653.00 | 20 | 23.2 | 3.2 |
| Emerging Markets | XEC | 4% | $24.71 | $148.26 | $163.25 | 6 | 6.6 | 0.6 |
| Cash | – | 0% | $1.00 | $517.94 | $0.00 | 517.94 | 0.0 | -517.9 |
And finally, we decide on our actual buy orders, taking care not to go over our available cash…
| Asset | Ticker | Unit Price | Action | Fractional Units | Units | Proceeds |
|---|---|---|---|---|---|---|
| Canadian Bonds | VAB | $25.27 | BUY | 8.6 | 8 | $202.16 |
| Canadian Index | VCN | $31.57 | BUY | 2.9 | 3 | $94.71 |
| US Index | VUN | $44.44 | BUY | 2.4 | 2 | $88.88 |
| EAFE Index | XEF | $28.14 | BUY | 3.2 | 3 | $84.42 |
| Emerging Markets | XEC | $24.71 | BUY | 0.6 | 1 | $24.71 |
| Total | $494.88 |
US Portfolio
Similarly, for our American portfolio, we add our DCA cash in and see how it affects our portfolio allocations…
| Asset | Ticker | Unit Price | Units | Market Value | Allocation | Target Allocation |
|---|---|---|---|---|---|---|
| Bonds | BND | $80.54 | 17 | $1,369.18 | 33.48% | 40% |
| US Index | VTI | $122.79 | 9 | $1,105.11 | 27.02% | 30% |
| International Index | VEU | $47.65 | 23 | $1,095.95 | 26.80% | 30% |
| Cash | – | $1.00 | 519.2 | $519.20 | 12.70% | 0% |
We then figure out how to rebalance back onto target…
| Asset | Ticker | Target Allocation | Unit Price | Current Market Value | Target Market Value | Current Units | Target Units | Difference | |
|---|---|---|---|---|---|---|---|---|---|
| Bonds | BND | 40% | $80.54 | $1,369.18 | $1,635.78 | 17 | 20.3 | 3.3 | |
| US Index | VTI | 30% | $122.79 | $1,105.11 | $1,226.83 | 9 | 10.0 | 1.0 | |
| International Index | VEU | 30% | $47.65 | $1,095.95 | $1,226.83 | 23 | 25.7 | 2.7 | |
| Cash | – | 0% | $1.00 | $519.20 | $0.00 | 519.2 | 0.0 | -519.2 |
And finally, we figure out our buy orders, once again being careful not to go over our available cash…
| Asset | Ticker | Unit Price | Action | Fractional Units | Units | Proceeds |
|---|---|---|---|---|---|---|
| Bonds | BND | $80.54 | BUY | 3.3 | 3 | $241.62 |
| US Index | VTI | $122.79 | BUY | 1.0 | 1 | $122.79 |
| International Index | VEU | $47.65 | BUY | 2.7 | 3 | $142.95 |
| Total | $507.36 |
And we’re done!
Continue onto the next article!
WORKSHOP TOOLS
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Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions. The information contained in this blog was obtained from sources believe to be reliable, however, we cannot represent that it is accurate or complete.
Me, commenting two days ago: “TF is a ‘yield shield’?”
You, posting today: GRAPHS + WISDOM
You guys are the best. 😀
We should thank you, Adam. You’re the one who inspired this post. And that’s why our readers are THE best 🙂
Isn’t today a buy day?
Thanks for noticing. Post is updated with our buys now.
How are dividends delivered? I’m a bit of an investing noob but I’ve read all of your investing articles and I don’t think it’s ever been mentioned. I understand why companies pay them out but how do you actually get them? Do they mail you a cheque or is it deposited into your portfolio? I’ve had some 60/40 mutual funds for a few years and I get statements saying the value is going up or going down but there is no indication of dividends getting paid out separately from that. Are ETFs different?
Dividends for the ETFs we’re using get delivered as cash to your brokerage account. If you’ve held the ETFs for long enough and check your transaction list, you should see them.
Melinda, your account may be setup to automatically reinvest dividends. This is how many like to have it setup during the wealth building phase and then change the account to transfer the funds to your bank account during the retirement phase.
Thanks for building the next article I get to share with everyone I know.
Most people’s eyes glaze over when I mention the efficient frontier, the visuals here are awesome. Keep up the good work!
I spent all day in Excel & GIMP, so glad someone’s benefitting 🙂
Yes the Yield Shield is truly a magical thing. We have a fairly hefty portfolio and we are invested 100% in equities. We are planning to pull the plug on employment on July 2 of this year…WHOOP…and will live only off of the dividends earned by our portfolio. I can’t tell you how liberating it is to know that we will not have to sell stocks to survive. My husband is so very risk adverse and would not want to retire if we had to rely on asset sales. Once I convinced him that dividend growth investing was the way to go (many years ago)….and that we could live off of dividends alone….well, he was right on board. And the funny thing is…100% equities does not seem risky to him now!! I should note that our stocks are all high quality blue-chips that are dividend Champions…that helps LOL!!!
“I should note that our stocks are all high quality blue-chips that are dividend Champions”
Care to share that list of stock right here? 🙂
Jonathan, I have no issues with sharing my stock list but it is in my briefcase in the office so tomorrow is the earliest I could get it to you. Note that my stocks (Dividend Champions) are all discussed on seekingalpha.com which is a great compliment to Firecracker’s site!
Dividends are not guaranteed, don’t assume this yield will stay the same over time, so there is an inherent risk in dividend yield as a source of income. Also dividends erode over time, as they are paid per share, not per stock valuation. A 3% dividend on Royal Bank, will be 1.5 if the stock doubles.
Even Dividend company’s collapse, Sears, Nortel, Bear Sterns, all payed dividends, not any more.
You also have no cash at the bottom of a market cycle to buy into the equity markets, which IMHO is the real reason for keeping liquidity in Bonds.
cheers
How did you get the yield curve?
I figured out how to get the efficient frontier curve on portfoliovisualizer.com, but don’t see an option for yield plot there.
I calculated it. Bonds pay 3%, equities pay 2%. So I downloaded the scatter data and added my own points in.
Great write up. Very easy to follow and understand. I haven’t considered creating a yield shield with higher risk bonds and REITs. I’ve mostly considered it by using high quality dividend stocks that have a long track record of increasing dividends. Thanks for sharing a new perspective I hadn’t considered.
That is certainly one way of doing it too. But right now, the dividend aristocrats (tracked by ETF DVY) is yielding 3%, and as a subset of the overall equity market, is completely correlated with SPY. Not sure I’m getting the right tradeoff there…
Can you explain the Return on Capital on CPD? I recently learned that although CPD is paying 5-6% a year, a portion of that is just return of capital, making the actual yield somewhere around 2-3%. So it’s just giving me some of my money back in form of a dividend yield? Can you ellaborate on this?
So how does the return of capital affect the Average cost base (ACB) when I do taxes?
Wayne, that is such a great question. I find the whole “distribution yield” to be a bit of a “scam”. It’s kind of like a sales tactic…hey our yield is 5-6%…buy us..buy us. The reality, as you have found, is that the true earnings yield can be significantly less. That is the reason that I hold individual stocks. I know exactly what my dividend yield is.
You are correct that the fund is simply giving you back your own money (and calling it a distribution to boot!). The effect for tax purposes is that this return of capital reduces your adjusted cost basis (ACB). If you hold your fund in a taxable account you will need to make sure you account for this. The net result is that your ACB is decreased now and when you sell the fund you will realize a larger capital gain (if the share price increases).
You can view the details of each year’s distributions by going to https://www.blackrock.com/ca/individual/en/products/239836/?referrer=tickerSearch#/ and clicking on the distributions graph in the left sidebar.
You are correct, ROC was part of the distributions, but for 2015, dividends were 85% of the distribution, not 50% as you suggest.
ROC is simply the fund returning back uninvested money back to you. You don’t pay taxes on it (since it’s your money), but it lowers your ACB meaning if you later sell it you may face higher capital gains taxes.
Of course, you can dodge capital gains taxes by timing your sell in a year of low income, but that’s the topic of another post 🙂
Woooww..this is really a mic drop post…amazing analysis
Equivalent ETFS for US portfolio using iShares (some better than vanguard):
– PFF (High Yield preferred shares),
– HYG (High Yield corp bonds)
– IYR (Reits)
Thanks so much for this post. I’ve been thinking a lot about what asset allocation I should have in early retirement. I’m not really a big fan of 60/40 portfolio because I’m worried about giving up on growth and worry about inflation. Maybe when I’m older and not able to go back to work, I might move to 60/40.
Regarding your comments:
– Our portfolio starts to become more volatile. In fact, I’d estimate that our own personal portfolio behaves more like a 75/25 portfolio rather than a 60/40. But in exchange, we’re getting that extra yield.
– At 2%, you are basically at the dividend yield of the S&P 500. So that means you can completely ditch your fixed income allocation and go 100% into equity…
What do you think of holding all equities and getting a 2% yield but keeping 10 years of cash cushion or bonds (which means keeping a 20% allocation) and drawing down that in the first decade? Is this what is considered gliding path strategy?
i am researching this also and came across this great article
referring to a cash cushion
let me know what you think ?
http://www.moneysense.ca/save/investing/couch-potato-portfolio-returns-2016/
Two problems with this approach:
1: Are the returns real or nominal? If they are nominal you’d have to achieve a higher expected return than 4% to avoid eroding your purchasing power. You’d need 6% (4% withdrawal + 2% inflation).
2: I doubt that U.S. or global equities have an expected return of 9%+ (certainly not real, most likely not nominal) and a risk of only 11%.
Earlyretirementnow, if you are in the Yield Shield, then the portfolio is giving you all that you need in the first year. In subsequent years the only increase to your return you will need is equal to the inflation rate. I can tell you that the increase to my income due SOLELY to dividend increases by my Dividend Champions has averaged more than 6% per year for the last 4 years. Think about that…I can tell you that I DID NOT receive any 6% increase in my salary for ANY of those years. Dividend growth investing is the ultimate inflation protection if you can get yourself into the Yield Shield.
Thanks! What’s your dividend yield? How certain are you that the dividends will not be cut in the next recession? You could hold the next Sears or Kmart or Enron or Lehman Brothers in your portfolio.
Exxon Mobil, one of the Dividend Aristocrats, has a PE ratio of >40 and a Dividend yield of 3.7%. Probably they will grow out the low profits. But if not the current dividend payments are unsustainable.
You write:
“That cash cushion allows you to take the withdrawal pressure off your portfolio. On a $1M portfolio with a spending target of $40k, a cash cushion of just $25k allows us to reduce our withdrawal line by $5k a year for FIVE whole years!”
Fair enough, and that brings your withdrawal rate below your yield (3.5% in your example.) Super plus good. But after five years you’ve depleted your cash cushion, and your withdrawal rate is back up to 4%. Also you no longer have a cushion, so if markets have a few dystopian years you may find yourself selling assets into a bad place, which is exactly what the cushion is supposed to insure against.
The yield shield makes sense. Using your cash cushion to pad the yield shield seems problematic.
What am I missing?
Using the cash cushion to pay the Yield Shield is temporary. You are correct. The idea is that since modern market downturns don’t last more than 3 years before correcting, your cash cushion should be enough to bridge the gap.
That was our strategy when we retired. What we actually discovered in retirement is that by using global arbitrage and side hustles, we were able to permanently lower our withdrawal line by staying longer in lower-cost locales (like Thailand and Vietnam) and by counting the income we received from various side hustles.
On its own, cash cushion is probably OK. In practice, early retirees have way more options than they realize in lowering their withdrawal line below the Yield Shield. Who knew?
I have a question regarding DCA. I’ve had an IRA-ROTH account with etrade for 3 years and I started using the 60-40 strategy you posted in one of your earlier blog posts (VEU, VTI, BND). Anyhow, my question is regarding trade fees. If I get charged $7 per trade is DCA still a sensible strategy given that I would be racking up trade fees every time I rebalance my account?
Matthew,
E-trade has a good selection of commission-free etfs, inclusing:
WisdomTree Total Dividend ETF (DTD)
WisdomTree LargeCap Dividend ETF (DLN)
WisdomTree SmallCap Dividend ETF (DES)
WisdomTree Emerging Mkts SmallCap Dividend ETF (DGS)
WisdomTree International SmallCap Dividend ETF (DLS)
Their expense ratio is not great. I would recommend opening an account at Ameritrade or Fidelity to get access to ishares/vanguard great core etfs most of them comission free
Thanks Mark. I think I’m going to go with Ameritrade.
Yeah, trading commissions suck and will eat away at your principal if you DCA.
That’s why we use TD Ameritrade for Americans and Questrade for Canadians. Both offer commission free buying of the ETFs we use for this workshop. Maybe consider transferring your account over?
Thanks Wanderer! I am going to transfer to TD Ameritrade.
great article again
Garth mentioned ROC as a way to reduce possible taxes .
such as earning 6% a year as an income from a 1.2 Million balanced portfolio.
however if dividends are about 3 % . then the other 3 % must be achieved by selling some ETF’s ?? to make it up to 6 % .
is this part of the rebalancing process ?
thanks
Some of the gains are reported as ROC, but most are either dividends (which for an early retiree like myself are tax free) or interest (tax-free in an RRSP/TFSA). I don’t think he meant the entire 6% is ROC, that doesn’t make sense. You’ll have to ask him to elaborate.
thanks
he said that the portfolio is set up as ROC distribution . at 6%
which means no tax and you can claim retirement also .
(so this is aimed at a higher age group than yourselves )
but the point is that he says 6 % is set up as one’s monthly income from a balanced portfolio .
what i don’t understand is how you pay yourself the 6% a month . ( i know that this is the normal figure for overall returns in a balanced portfolio )
BUT only a portion is automatic dividends ( monthly , annual etc.)
to get up to 6% surely one must have to sell some ETF’s sometime ??
I don’t see the Preferred or Reit ETF’s in the above chart ?
you mention you hold them as a way to increase the dividends for you
yet i don’t see them .
what am i missing here ?
thanks
I asked wanderer a similar question last week or the week before, and his response was that preferred shares etc cpd (for what I was asking anyways) he recommended more in retirement than in the wealth accumulation stage which is what the workshop is intended for. Hope this helps
As we say in the article, higher yielding securities make more sense when you approach (or are in) early retirement. When you’re accumulating it’s best to stick with a more traditional government bond/Index ETF split.
Great article,
You write:”Our portfolio starts to become more volatile. In fact, I’d estimate that our own personal portfolio behaves more like a 75/25 portfolio rather than a 60/40″.
Why not just have a 75/25 porfolio? What would be the difference?
Thanks
I believe he is implying that he gets a higher volatility and returns similar to a 75/25, but this way he gets a higher portion as yield, which is hopefully all the money he requires in retirement, and does not require to do selling actions of his equity portion.
It make sense! Thanks
Righty-o! Thanks for answering that.
I had to talk this one over with my engineering husband. The tricky part is the $25,000 YIELD SHIELD=$5000/year x 5 years to cover an economic downturn.
$25K doesn’t seem like much to cover our family of four x 5 years in the down years.
“But it’s 12.5% of $40,000,” he pointed out. “It would make more sense for us to have a year’s worth of expenses in cash, just in case.”
Say our expenses were $80K/year. $80,000*0.125=$10,000. So for 5 years, that would be a $50,000 cash cushion not included in our portforlio.
I’m supposed to be doing our taxes right now, but I thought I’d include this for anyone else doing the family math. Good luck to all of us!
Remember that the cash cushion only needs to cover the difference between your withdrawal needs and the portfolio’s yield. So for us, our living expenses are $40k, and our portfolio is yielding 3.5% or $35k. So to build a 5 year cash cushion, we would need ($40k – $35k) x 5 = $25k. That’s how we got that number.
Hi FIRECracker,
Great blog and contents.
You are an inspiration for many millennial, including myself. I didn’t think that it is possible to retire at such a young age. However you have shown that it is totally doable, I thank you for that.
I want to point out that, splitting the portfolio into stock & bonds isn’t the most optimal diversification because sometimes they move together in the same direction.
Having REIT is great for it’s yield – I believe you mentioned in your post.
In addition to REIT, have you tried other ETF like energy or metal, or maybe other instruments (e.g. options) other than the vanilla stocks? Those will help provide even greater diversification.
Good luck and I look forward to reading more stories from you!
Stocks and bonds are anti-correlated so they tend to move in opposite directions. That quality makes them useful in reducing a portfolio’s volatility.
And I see no compelling reason to own commodities directly in an early retirement portfolio at any stage. They’re volatile, they don’t pay me a dividend, and they’re positively correlated with the overall stock market, so what’s the point.
And as for options, that’s just straight gambling. All options are bets on the short-term price movement of a security. These are useful for day-traders, but not for long-term Index investors like us.
Thanks again you two for all your knowledge!
I am, however, a bit confused as to why new investors don’t just start buying preferred/REIT/Hi-yield bonds from day one– as part of the 40% “safe stuff” — instead of buying only VAB and then moving into the higher-yield safe stuff at retirement… wouldn’t this reduce trading costs etc. if we just started buying these ETF’s from day one?
Thanks again.
Ps. I am asking as a new investor myself 🙂 Anyone have any ideas??. Thank you.
Have you noticed that you guys are spiking the charts of your funds when you post your “buys”?
Interesting. Not much, but about 2 cents on average, for a buy day, per fund and it settles out in about two days after with a slight retreat and then a dead bounce.
Weird the stuff you notice when you have the time to watch…….
If I can live w/ a 4% yield on my portfolio, why not invest into 3 or 4 high yield etfs and not hold any bonds or individual stocks.
ETFSs like YYY, PFF, SDIV and HYG for instance would yield more than 4%. It wouldn’t matter what the market does…my yield would be high and most sure guaranteed.
I’m sure I’m missing something otherwise everyone would be doing it…
anyone?
Ok, so let’s say I’m ready to retire and have a million dollar portfolio consisting of registered and non-registered accounts. $100 TFSA, $400 RRSP and $500k non-reg. These accounts have generated a 4% yield of $40k. Because each account type has its own rules, how do you go about extracting that money from each account and using it? Found your blog last week and have been binge reading ever since. Great job!!!
This post explains how to pay no taxes in retirement:
https://www.millennial-revolution.com/invest/workshop-invest/making-investments-tax-free/
This one explains how we withdraw in retirement using “The Three Buckets” strategy:
https://www.millennial-revolution.com/invest/workshop-invest/investment-workshop-15-withdrawing-portfolio/
Thanks. If my portfolio has a 1-year return of 8% does this include dividends/interest? Meaning if I have a $1M portfolio with a yield of 4% then my capital has increased 4%? I use my 40k for to cover expenses and my $1M is now $1,040,000
Also, if you are living off off dividends then what’s your opinion on dividend invested right from the start instead of indexing?
Do you mean “dividend investing instead of indexing”? If so, our thoughts on dividend investing is that it carries a sector risk (especially in Canada where dividend-yielding stocks are heavily weighted in the finance and oil sectors). If we had chased yield and bought individual stocks instead of indexing back in 2015, our portfolio would’ve been creamed by the oil rout. The beauty of indexing is that you aren’t buying individual stocks so they can’t collapse to zero…which is why Warren Buffet advocates index investing for his heirs. It’s also way more passive and wins in the long run compared to stock picking, which is why Warren Buffet made this bet: http://fortune.com/2017/02/25/warren-buffett-scorches-the-hedge-funds/
Yes, that is correct.
Have you read the following article (it seems to strongly refute your arguments for a cash cushion)?
https://earlyretirementnow.com/2017/03/29/the-ultimate-guide-to-safe-withdrawal-rates-part-12-cash-cushion/
The cash cushion idea is central to the main withdrawal program that you layout this post. I’m wondering if you’ve come across any of the alternative withdrawal methodologies that seem to work better like the CAPE variable withdrawal method?
I think you guys are great, but you are making this unnecessarily complicated at the retirement point. There is no need to switch from a total return approach to a yield focused approach. In fact, by doing that you are creating a less diversified portfolio, which will therefore have a wider dispersion of returns which on average will have a lower return than a more diversified portfolio. A more efficient way is to continue with a total return approach. You simply spend the dividends that the portfolio generates, then in years stocks go up (most years) sell off enough, as part of the rebalancing process, to bring you up to your 4%; in years that bonds are up, sell enough bonds for your 4%. It’s a good idea to keep a couple of years of cash needs in cash (counted as part of your bond allocation) for the rare years when both stocks and bonds are down. Bengen’s 4% rule came from total return portfolios, so if you change that to a yield base approach (a less diversified portfolio), the portfolio may not last as long as the Bengen studies. We have a behavioural preference for income, but is better to think in terms of cash flow, consisting of income and capital gains. This article explains the total return approach in more detail.
http://www.moneysense.ca/save/retirement/a-better-way-to-generate-retirement-income/
Recently came across this site and have been binge reading. Thanks for sharing your story and lessons learned!
A question comes to mind as I read this particular posting and try to tie it to some of the earlier ones:
So I understand that a conventional ‘retire at 65’ strategy typically would involve a portfolio mostly in bonds (100 – age approach) upon retirement. The approach you’ve outlined involves a retirement portfolio that is relatively volatile due to the high equity allocation. Even though you are protected by a “yield shield” and your emergency cash bucket, would it not be even more prudent to have another cash bucket with which you would buy stocks during a market crash? In the 2008 crash, your rebalancing by buying stocks led to accelerated returns and a quick portolio recovery. So I am wondering why not hold cash to support repeating this in the next downturn. With your proposed low bond allocation, it seems to me you would not have enough bond gains to really buy into stocks in the next downturn. Looking forward to hearing your thoughts! Thank you!
Best of luck and happy travels!
Hi!
Hopefully I’m not repeating a question here – but it says you ‘replace the safe government bonds we were using in our fixed income side with higher yielding assets’. Does this mean you stopped buying bonds entirely and so were essentially 100% index funds / higher yielding assets? As well at what point exactly did you do this? After you had retired?
Thank you,
Aysha