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Tuesday, April 25, 2017

Don’t Keep All Your Eggs in One Basket

Posted by Tim Stobbs on April 8, 2015

Well the other day I requested a post ideas and I was asked to provide some thoughts around my couch potato portfolio and specifically this article, which points out the good times for that portfolio won’t last forever.  So while I’ll do that,  I also thought I would expand the focus to discuss my overall portfolio approach.

You see I don’t ever believe in putting all your eggs in one basket (yes, it was Easter and eggs are stuck in my head).  Most people believe that statement applies to just one stock or perhaps one stock index.  I instead expand it to also include any given investment style.

That article I previously linked to pointed out rightfully that the couch potato portfolio is going to have some down years.  Now when you saving up for retirement, this isn’t a particularly big issue other than to slow down the rate of savings for a while.  Yet when you are living in retirement these down years can be outright critical.  After all if your portfolio takes a 20% decline one year and you take out another 4% on top of that you just increased the downside to 24%.  If that continued for a few years you would be in some serious trouble as you likely won’t have enough cash to allow you to recover in the long haul.

So what do you do?  Keep multiple streams of income so you can ease off pulling out money during these major dips in your portfolio.  There are multiple options out there for people to have other income streams including, but not limited to: part time work, workplace pensions, government pensions, investment portfolios, cash savings or rental income.  Another less obvious way to expand that list is to also splice your portfolio into different investment styles to balance their risks.  I’ve previously mentioned my plan include all of those above except rental income (I prefer to keep REITs instead of rentals).

In my case, our actually overall portfolio consists of three different subsets of investments: my workplace pension, my couch potato in our RRSPs and finally dividend investing in our TFSAs.  So while the couch potato has a weakness of pulling out money during a big drop, this doesn’t exist in the dividend investing portfolio since I plan to never touch the principle and only take out the dividend income.  Therefore you might be tempted to believe dividend investing is superior to the couch potato, which isn’t true.  The price you pay for that level of security is often lower returns so you often need a MUCH bigger portfolio value to retire if only used dividends.  For example, if your dividend portfolio only generated 3% instead of using 4% withdrawal rate for a couch potato your portfolio to generate $30K in income goes up from $750,000 to $1,000,000 for dividend only portfolio.  So security is offset with much bigger savings targets.

This is why I think you should actually consider a blend of investment portfolio styles to balance out the risks and positives of each.  So in our case, our target spending is around $30K a year.  We plan to generate that income from various streams.  In the beginning of our retirement, for example, my wife plans to continue working for a few years after I quit which should generate at least $6000/year.  Then I’m aiming to have the dividends in our TFSAs generate another $6000/year.  That leaves $18,000 to come out of our RRSPs.

Yet what happens if the stock market tanks just after I quit my job?  I could reduce our withdrawal from the RRSP up to zero by using other income streams instead.  Perhaps I pick up a part time job or contract work for a few months or we could just using our cash savings to fill the void for a given year. For a year, this isn’t a big deal…the issue becomes if all of your portfolio was just in couch potato you would be a much harder spot.  Since you need to take out the full $30K, it would have a bigger one time impact which depending on the size of the drop you may never recovery from.

The other complication for income streams is your access to given stream will vary through time.  So for example, I can’t collect Old Age Security until I’m 67 and my workplace pension is locked until I turn 50.  We could also downsize our house to bring in a one time shot of capital into the investment accounts.  But once some of those time locked steams kick in I need less of my other streams to cover the remaining.  So over time you can over draw from one stream, if you can make it up from another one later on.  So in theory I could take out too much from the RRSP, but I better be damn sure of my offsetting future income stream to cover the difference.

You are likely just realizing that mapping out all the options do get a bit mind numbing with the amount of possible combinations.  So rather than try to do that I would suggest you merely map out fully your default plan and then be prepared to make adjustments as you go.  Predicting the future isn’t a real option so plan for what you expect and be prepared to adjust as you go.

I should also point out while I’ve mainly have been discussing the negative side of your portfolio that upside is just as important.  So for example, this most recent wave of good returns for the couch potato portfolio (9% for the last six years) when you are retired would be a great time to withdrawal a little extra money to increase your cash savings or perhaps add to your dividend portfolio.  Don’t just blindly spend the extra returns as you are going to need those to cover your down years in the future.

So in summary, don’t put all your eggs in one basket.  Be prepared to have multiple income streams and be willing to balance them off each other in the good and bad times.  The details after that are up to you.  Just remember…there isn’t just one right answer, but rather thousands of ways to do it.  Find out what works for you and go with it.

How you balance your income streams?  Do you keep more than one investment style in your portfolio?

Comments

7 Responses to “Don’t Keep All Your Eggs in One Basket”
  1. Free Man says:

    Multiple income streams are a key to good retirement. We retired early and each have small pensions of approximately $30,000.00. We own our house, no mortgage payments; and no other debts. We keep 5 years of cash reserves on hand so hopefully, we won’t need to draw on our investments when the market is down. With that said, my wife still worries about the market dropping; and “loosing” 25 -50% of our portfolio. I guess it is a good problem to have; better than working that’s for sure:)

  2. Martin says:

    Interesting article. I hadn’t considered this aspect of investing yet, though I am still at least 10 years away from retiring (I’m 30).

    I currently have adopted a Couch Potato approach spread out across my RRSP, TSFA and margin accounts, with only one dividend-paying security in my RRSP (Scotia Bank stock).

    I have been juggling with the idea of going with a dividend-investing approach similar to the one espoused by Dividend Mantra (http://www.dividendmantra.com/), and now that I read your post, I might just do that.

    I already reached my full contribution in my TSFA for 2015, but hopefully the feds will soon double the contribution limit in the TSFA. Right now I have a Canadian stock index (VCN) and American stock index (VUN) in my TSFA. I suppose as you say that the TSFA is the best vehicle for a dividend approach as opposed to RRSP or margin accounts?

    Martin

  3. Master Nerd says:

    Nice post! I agree, I think we all need a reminder every now and then and realize the potential consequences the next time we are in a bear market. Even so, I think the trick is to build up enough of a buffer during your working years to cover those periods. Broad market diversification around the world is also key. In a worst case scenario, it’s always possible to supplement your revenue with short term employment in order to offset the need to withdraw during a downturn. Or consider lowering your expenses local or even move somewhere with a lower cost of living.

    @Martin Personally, I’m shifting away from a stock picking dividend portfolio towards an exclusively ETF based portfolio. Research (see http://cashcowcouple.com/investing/stock-picking-always-losing-game/ for a compelling argument) indicates even in a down turn you’re still better off with ETFs than individual stocks. I love dividends, but I trust 40 years of research data and Buffet’s long standing suggestion to just buy low cost ETFs, more than my ability to pick winning stocks. I think I will however keep a dividend oriented ETF to maintain revenue. I particularly like PDF, which is the successor to CDZ.

    In terms of which account for dividends, it largely depends on where they are coming from. Canadian dividends are tax free in a TFSA, but US dividends are subject to withholding tax by the US which you can’t get back. On the flip side, in a non-registered account, Canadian dividends are taxed less than US dividends, but you can recover some of the US withholding taxes (these are on top of the taxes the CRA will charge you) through a foreign tax credit. There’s tons of discussion on Canadian Couch Potato about this, so you may want to take a look. Personally it makes my head hurt, but such is the world of income tax.

  4. Martin says:

    Master Nerd: I’m aware that the stock picking game isn’t a good long-term strategy, but I had more something in mind like the ‘Dogs of the Dow’ strategy, i.e. selecting blue chips with high-yield dividends. Thanks for mentioning the PDF ETF. I was not aware of that fund, but this is the type of ETF that would probably suit my needs.

  5. Master Nerd says:

    @Martin

    Funny you should mention the Dogs of the Dow, as that was also discussed on that other post (in the comments on cashcowcouple). I personally am not super familiar with the dogs of the dow, but my understanding is the basic premise is to buy the top 10 dividend paying stocks of the DJIA on an annual basis (correct me if I’m wrong?).

    That means you’re only investing in a small group of stocks at a time, which limits your portfolio to a very specific segment of the market. I’m all for dividends, but I would consider diversifying beyond the dogs of the dow. For example, you could complement the dogs with etfs for small/mid-cap index (which incidentally have historically outperformed the dogs), as well as some emerging/developed markets.

    Something like this might work for you: 15% dogs, 15% small cap US, 15% mid cap US, 20% Canadian, 15% developed; 10% emerging; 10% bonds.

    Just my 2 cents. Happy investing!

  6. Martin says:

    Master Nerd: Yep, that’s indeed the DOTD strategy.

    Thanks for the tips; I appreciate your insight. Currently my portfolio is 5% Cash, 5% Bonds, 10 % REITs, 25% Canadian, 35% US (small, mid and large cap), 20% International and Emerging markets.

    I think I will complement with the PDF ETF you mentioned. I looked at the companies featured and it looks solid.

    Thanks again.

  7. Master Nerd says:

    @Martin

    Looks like a good spread. It should serve you well!

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