There are two primary strategies one can follow with self-directed investing. Growth Portfolios are designed as easy-to-manage strategies for younger investors. High savings rates can be used to buy cheap growth assets when their prices are dropping.
The Retirement Portfolios are designed to provide income and be much more stable. Due to this change in focus, there are typically more components in a retirement portfolio and they are somewhat more complex to manage.
The Strategy & Design
The first part of the retirement strategy is reducing risk. The first step in risk evaluation is to estimate your income requirements and adjust that for inflation. This ensures you have enough money to live in while maintaining that purchasing power throughout your retirement.
When living off your investments, I firmly believe your portfolio value should be 20 times your annual income requirement—at minimum! This translates to an initial 5% withdrawal rate which is adjusted up annually for inflation.
The next step is creating your cash cushion. This is designed to limit portfolio withdrawals during poor markets. A simple rule is to place 10% of your portfolio in this cash cushion. This also forms part of the Protection side of your portfolio. Your cash cushion should be invested in short-term bonds. This is where you will make your withdrawals from when you need cash beyond interest and dividend income.
With your cash cushion, your retirement portfolio is now at least 10% protection. You could get away with 90% growth, but this is too aggressive for most. It's my view that, in a longer retirement, protection should form 30-40% of your portfolio value. The balance should be in growth assets.
Choosing Protection ETF Allocations
Once you've chosen your appropriate growth-to-protection ratio, you can now choose your ETFs on the protection side.
Already 10% of your portfolio will be in short-term bonds. XSB.TO or VSB.TO are good choices.
The remainder of your protection assets will depend on your total allocation. With an 80% growth and 20% protection portfolio, put another 10% in broad bonds such as ZAG.TO, ZBD.TO, or HBB.TO depending on the account type.
With a 70% growth and 30% protection portfolio, put an additional 10% into preferreds shares for stable, tax-advantaged, high yield income. ZPR.TO is the current best in class choice and it yields over 4.5% in dividend income.
With a 60% growth and 40% protection portfolio, put yet another 10% into corporate bonds. Corporate bonds provide higher interest rates and better returns than government bonds, but the risk is also a bit higher. HAB.TO and ZIC.TO may be the best choice with broad U.S. exposure at low fees; it's yielding over 3% currently. Use VCIT, the U.S. listed comparable, when holding in a U.S. dollar RRSP account.
Any higher allocation to protection can just be added to broad bonds.
Choosing Growth ETF Allocations
Normally when considering a Retirement Portfolio the investor would have a large account (high 6 or 7 figures). The growth side is important as it keeps your portfolio moving ahead as life expectancy increases.
Tax efficient income should be the focus here, but it is important not to over-Canadianize your portfolio just because of dividend tax advantages. If lower taxes are an important factor due to higher income, you should use swap-products in Cash/Margin accounts and take advantage of capital gains.
You can also consider taking an investment loan for investing in the Canadian portion of your portfolio that is is Cash/Margin accounts (includes Canadian stocks, bonds, and preferred share allocations). Just don't get too aggressive with this; limit your loan value to less than half of your overall portfolio equity.
The best way to split the growth side of your portfolio is to allocate half of it to U.S. stocks, a quarter to Canadian stocks, and a quarter to International stocks. Hold the U.S. and International parts in your TFSA if you can. U.S. stocks can be held in RRSPs if you are choosing a U.S. Dollar account for that purpose. Otherwise, go with swap-products in your Cash/Margin account for the balance.
REITs can be added into the growth allocation for extra income needs. REITs are known to provide higher income, but they are interest rate sensitive and are as volatile as stocks.
This style of asset allocation gives you broad exposure to global markets, global currencies, and allows re-balancing gains.
Acceptable Retirement Portfolio Examples
The following portfolios are based on the size of the protection component. The growth allocations remain fixed—except when adding REIT exposure.
80% Growth in Retirement for Canadians
The cash cushion and broad bonds form the protection part of the portfolio. The bonds will provide moderate interest income and reduce portfolio volatility. When rebalancing, broad bonds should be treated the same as the growth ETFs—not the cash cushion.
In good market years, re-balance all ETFs to the desired allocation. In poor market years, re-balance all ETFs but don't top up the cash cushion.
70% Growth in Retirement for Canadians
We add Canadian preferred shares to the portfolio to provide tax-advantaged dividend income. Like bonds, rate-reset preferred shares are sensitive to changes in interest rates. They increase in value as interest rates go up.
When rebalancing they should be brought to the correct allocation with the other ETFs—not including the cash cushion.
60% Growth in Retirement for Canadians
We add U.S. corporate bonds to the portfolio. This provides more U.S. currency exposure and better income than broad bonds.
U.S. corporates should be held in your RRSP. If it's a substantial RRSP holding (over $100,000), consider holding the comparable U.S. listed version (trades as VCIT) instead to save on withholding taxes.
Re-balance corporate bonds with the other portfolio components annually. Do not re-balance the cash cushion in poor performing markets.
60% Growth (with REITs) in Retirement for Canadians
This portfolio adds REIT exposure for added income. REITs are interest rate sensitive like bonds, but provide higher income. They are as volatile as stocks and exposure should be limited. REITs affect the allocation on the growth side.
Re-balance with other portfolio components annually. Do not put money into the cash cushion in poor markets.
Less than 60% Growth in Retirement for Canadians
For even more conservative portfolios, you should increase exposure to broad bonds (ZAG/ZDB/HBB), and reduce the growth ETFs in the same proportions.
As we live longer and can expect retirements of 30 years or more, it can be damaging to invest in an overly cautious manner. We need the growth side to propel our portfolios through good markets which increases our downside tolerance in poorer markets.
Even the most complex portfolio, just seven ETFs will do the trick. This is why I am always hesitant when individual investors have dozens of different holdings. I believe most investors, including professionals, would be hard-pressed to consistently beat these portfolios after fees.
The total fees on these portfolios sits in the mid-teen bps. This means on a $1,000,000 portfolio all those holdings are managed for around $150 a month. Unbelievably cheap!
At current prices, these portfolios will generate 2.0 - 2.5% in dividends and interest income. This means the remaining part of your portfolio income will be realized capital gains.
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