Friday, 6 June 2014

The Reluctant Investor's Lifelong Portfolio - a Portfolio Inspired by, and for, Albert Einstein

"Everything should be made as simple as possible, but not simpler." Albert Einstein
Last week we defined what a portfolio for a reluctant investor should do, and reviewed several alternatives that don't quite do the best job. Now, let's reveal our winner.
This is what we propose, the Reluctant Investor's Lifelong Portfolio and Investing Plan

1) Portfolio structure: The portfolio will consist of two funds -
2) Account setup: Start with a TFSA. Open a TFSA account at a discount broker. If there is less in total to invest than $31,000, which is the cumulative maximum contribution limit up to and including to 2014 that can be invested in a TFSA, put it all in the TFSA. When there is more than $31k to invest put the excess into an RRSP (another account that will need to be opened at a discount broker), up to the cumualtive unused contribution limit shown on tax assessment letter from the Canada Revenue Agency that it sends out after you have filed your taxes every year. It there is more than the total limits of TFSA plus RRSP to invest, open a taxable account.

3) Initial allocation to target: Within each account, buy equal amounts of both XQB and XIC.

4) Automate investing: Set up automatic transfers to contribute to the TFSA/RRSP/taxable account if in savings mode. XQB has the wonderful feature of being part of the Pre-authorized cash contribution plan at iShares, which is free and automatic, so sign up for the amount going into XQB.  Unfortunately, XIC is not part of the PACC so purchases of XIC you will have to do yourself. Leave the money going into XIC in cash until there is at least $1000 to invest. Less than a $1000 for a trade and the commissions start to add up too much and hurt investment returns.

Similarly, during retirement withdrawal when regular amounts are to come out, sign up for the Systematic withdrawal plan for XQB (also not available for XIC). You will have to sell the appropriate amount to leave approximately half each in XIC and XQB.

Note: Not all brokers participate in the PACC and SWP. Check out here the in/out listing of brokers, along with details and forms for all the plans, including the DRIP. If the broker does not do the PACC and SWP, you must carry out buy and sell transactions yourself.

Sign up for the Dividend reinvestment plan (DRIP) for both XIC and XQB. That way, the regular cash distributions will not sit idle and will get reinvested automatically and for free in XIC and XQB.

5) Rebalance: Once a year, perhaps on a birthday to remember more easily, check the latest monthly market values of XIC and XQB holdings totalled across all accounts. If either is more than 5% away from the target 50%, sell the excess amount of the greater value ETF and buy that amount of the lesser. If less than $1000 is at stake to be re-allocated, don't bother, the cost of trading commissions is not worth it.

In the same manner, any large lump sum contributions or withdrawals can be used to even up the 50% allocation to each ETF.
Historical Performance - To see what kind of performance the Reluctant Investor Portfolio would have provided, we again turn to the Stingy Investor Asset Mixer tool. XIC's performance matches exactly with the tool's TSX Composite, while XQB lines reasonably well with All Canadian Bonds. (Note: Stingy Investor has a model portfolio it calls the Simply Canadian ETF Portfolio which has the same composition as our Reluctant Investor, i.e. we did not invent the idea but we are promoting it with a different name to emphasize its potential usefulness.)

From 1961 to 2013 inclusive, our portfolio performed quite well. Compared to more complicated and sophisticated alternatives, the portfolio trades off some performance and some volatility to gain simplicity and convenience.

For a retiree withdrawing 4% a year the worst down year was 2008, when it incurred a 17% loss. The portfolio had fully recovered its loss within two years. Over the whole 53 year time span, despite constant yearly withdrawals, the portfolio gained an average of 4.6% compounded per year and it never dropped below its retirement start date value despite a number of down years (15 out of 53).

For a saver, the fact of making no withdrawals reduces the worst 2008 down to only 13% and there were only 10 down years in total. Recovery from down years never took longer than two years. The compound return was a healthy 9% a year.

Unfortunately the Stingy Investor tool does include inflation data before 1980, so the period of high inflation, and its effects on real after-inflation returns, which is what really matters, cannot be examined. From 1980 to 2013, the real return of the Reluctant Investor Portfolio was 6.1% compounded during the savings no-withdrawal phase, with only 7 years out of 34 showing a decline that never took longer than two years till recovery from a decline. When the added stress on the portfolio of a 4% annual withdrawal was included, the portfolio still managed an average gain of 1.9% annually, but had 11 down years, and a decline of 17.7% starting in 2008 that still has not been recaptured.

Thus, though there is no absolute assurance of never taking a loss by selling out at any time we believe the Reluctant Investor's Lifelong Portfolio is a pretty good balance of the objectives. Overall, we believe the solution works pretty well, delivering 80% or more of the benefits of more time-consuming and complicated investing.

Such a portfolio has value. Not everyone can, or should be, an investor who spends time and effort on investing. That's why our post's title says the portfolio is both inspired by, and intended for, someone like Albert Einstein. After all, could anyone think that Einstein, or the world, would have been better off, if he had applied his time to investing at the expense of physics?

Disclaimer: This post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.


Anonymous said...

Solid choices for ETFs. I have no issue with a 50/50 equity/bond allocation, but I'm not sure about allocating 100% of your equity portion to Canadian equities. We're not the most diversified market out there. Throw in some US and EAFE, but then you have a standard couch potato portfolio.

CanadianInvestor said...

Thanks Anon for raising the point. I'd certainly agree that other more sophisticated portfolios that add other asset classes could add diversification benefit. The trade-off is simplicity, not having to monitor as much and to differentiate across multiple accounts, not need to weight tax issues and rebalancing, making contributing or withdrawing easy. Every additional ETF adds a multiplicative order of complexity. In the end, historically there has not been a huge difference - something like the 80-20 rule. We are trying to be minimalist but still very effective.

Be'en said...


33% XIC
33% VXC
34% XQB

Covers most bases..

CanadianInvestor said...

Be'en, agree that could work, but it just starts to get more complicated.