There’s a common theme in all three segments of Episode 19 of the podcast: the risk-return trade-off between stocks and bonds. This is hardly an original idea, but it remains one of the most important concepts in investing.
It’s a good time to revisit this theme, as we just marked the 10th anniversary of the collapse of Lehman Brothers, which spiraled into the worst financial crisis since the Great Depression. Many of us will never forget those dark days of 2008 and early 2009, when people genuinely wondered whether stock markets might go to zero. Yet for others it seems to have faded from memory. And for those in their 20s and 30s, who haven’t experienced anything more than a few modest corrections, it has about as much resonance as the Second World War.
For the interview segment, I’m joined by Larry Bates, a former investment banker who has become an outspoken advocate for Canadian investors. Larry is the author of a new book called Beat the Bank, which lays out a strategy he calls Simply Successful Investing, with a focus on education, long-term thinking and low costs.
A few years ago, Larry created the T-REX score, a way of measuring the portion of an investor’s long-term gains that are lost to compounding fees. For example, assuming an annual return of 5% over 25 years, an MER of 1.5% would eat up 43% of your total gains. Drop that fee to 0.25% and you’d lose just 8% over the same time period. Use the T-REX calculator on Larry’s site to run the numbers for yourself.
This is low risk?
In “Bad Investment Advice,” I target yet another article that suggests dividend-paying stocks are “low-risk” and therefore ideal for retirees who find GICs and bonds too sleepy. One would have thought the 2008–09 crisis had dispelled that myth once and for all.
The article (from The Motely Fool) specifically recommends Royal Bank and Manulife Financial and as “low-risk stocks that are perfect for retirees whose aim is to generate growing returns.” They leave out the part where, between May 2007 and February 2009, Royal Bank stock lost over half its value, falling from $60 to less than $30 per share.
As for Manulife, in November 2007 it was trading at about $43 per share. Some 15 months later, at the depth of the financial crisis, it fell below $10, for a decline of close to 80%. Moreover, after its share price recovered significantly in 2009, Manulife cut its dividend by half. Investors responded by dumping the stock in droves: it fell more than 14% on the day of the announcement.
Even diversified dividend ETFs were slaughtered during the crisis: the iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (CDZ) holds only Canadian stocks with a history of rising dividends: it lost about 44% of its value in the six months following September 2008. In the US, the Vanguard Dividend Appreciation ETF (VIG) also lost about 40% over the same period.
Dividend-paying stocks are wonderful, and they’re likely to be appropriate for just about any portfolio (as part of broadly diversified index funds, of course). But we need to let go of the idea that they are “low risk,” and that they’re a suitable alternative to GICs and bonds for income-focused retirees.
Do I even need the stock market?
Finally, in the “Ask the Spud” segment, I answer a question from a reader at the other extreme: she wants to know whether she can fund her retirement without any equity risk at all: “I am considering putting most of my investments in GICs. What do you think of this approach?”
When risk-averse investors ask this question, they often get a disrespectful answer. They’re frequently told (usually in a condescending way) that they just need to get comfortable with stock-market risk because that’s the only way to generate growth. To me, that’s like telling someone who is afraid of flying to stop complaining and just get on the damn plane. People who are anxious about flying probably know it’s statistically safer than driving, but the data don’t allay their fears. Risk aversion is emotional, not intellectual, and there’s nothing wrong with being unwilling to lose money.
That said, an investor who wants an all-GIC portfolio does need to accept that they will likely need to save more, work longer, or spend less in retirement, compared with a disciplined investor who accepts more risk and earns higher returns. They will also need to avoid FOMO when they read the news about how stock markets have delivered double-digit returns.
Thanks for another informative session, it reinforces my investment plan that I developed mainly based on the couch potato philosophy
Hi Dan,
Great podcast and thanks for all the info provided and shared – never thought about that a 2% annual fee (for a period of 30 years) gives you only 49% T-Rex Score. With my work, I saw fees going as high as 5% which gives you only a 10% T-Rex Score. I can’t get my head around yet how the 2% annual fee (from your asset) goes as far as 51% (I’m assuming the compound effect — I wish there were more details how the T-Rex Calculation is done.
I do have a question about ETF’s and please tell me if it’s worth or not.
Even a 0.05% in a long run can make a difference. For example, some of the people might opt for a US/International ETF instead of 2 separates ETF’s.
$50,000 portfolio in
Duration 30 years
Extra cost (because of MER higher with 0.05%) $4381; 4381/30 years = $146 years
If you keep your accumulation in TD e-series and make only one trade/ETF/year, it’s worth to have separate ETF and downsize your cost by 0.05%
Thanks
@Ale: Glad you enjoyed the episode. The methodology for the T-REX score is on Larry’s site:
http://larrybates.ca/t-rex-math/
In my view, making a portfolio more complex in order to save 0.05% annually is not usually worth it for DIY investors. Cost is a huge issue for investors when we’re talking about traditional approaches (1.5% to 2.5%, or even more) compared with an indexed approach with fees that are at least 90% lower. But fighting for every basis point beyond that is usually not necessary, especially if it means more moving parts in the portfolio.
From the podcast, Larry say, on long term, Stock provide positive return but i think it’s missing a key point. Being positive is a thing, but how well it compare to let say a 80 Equities/20 bond, 60/40 or 40/60 portfolio over the same period.
If it’s just for 1% or less, i am not sure it’s worth the stress for most people. If it’s 5%, well then people should have the ability to lock their account to prevent selling in panic!!!
Great Podcast as always Dan!
Thanks for keeping it up. Enjoyed the guest and actually just purchased his book on amazon, his T-Rex calculator is something i have never seen before and it was a great visual.
Im already very fee-efficient with my Canadian index portfolio, for me to switch to US listed ETFs to save a few basis points really isnt worth the hastle at this point. Maybe by the time my portfolio is 5x larger Canadian ETF fees will be lower!
Hi Dan,
First off want to say how much I have enjoyed listening to your podcast and how excited I get when a new episode is released. Your hard work is much appreciated.
Wondering if you can comment on Larry’s remark about investing almost exclusively, until recently, in equities. I read about the benefits of a similar approach in a PWL White Paper about an adaptive Target Wealth strategy versus a Target Date strategy. Provided you have a 30+ years time horizon and an understanding that there will be downturns and volatility, this approach seems compelling. Would appreciate your insights.
Cheers.
@Aaron: Many thanks for the comment. It’s hard to disagree with the idea that an all-equity portfolio is likely to deliver higher returns over 30+ years than a more balanced approach. The problem (and this is “the big tradeoff” I refer to in the title of the podcast) is that holding such a portfolio with discipline is much harder than it sounds. It’s not enough to have “an understanding that there will be downturns and volatility.” We all understand that intellectually. But we’re all human, and losing half your life savings in a brutal downturn is incredibly difficult. Very few investors have the stomach for it.
@davidb you can check out the answer to your question about different returns from different asset mixes with the Volatility Meter here:
https://www.steadyhand.com/education/volatility/
@Dan: You write “the risk-return trade-off between stocks and bonds… is hardly an original idea, but it remains one of the most important concepts in investing” and I would argue it’s one of the concepts most overlooked by advisors (purposefully?) and their clients (naively?). It took me 20 years and the Great Recession before I finally got it.
@Aaron: Don’t believe the hype about being young and / or having a long term investment horizon so you can be 100% equities, and NEVER UNDERESTIMATE the importance of being able to sleep at night!
Take a look at the long term results of the different portfolio allocations vs their variances in https://canadiancouchpotato.com/wp-content/uploads/2018/01/CCP-Model-Portfolios-ETFs-2017.pdf, and ask yourself whether the extra variability is worth the extra return?
Even if your answer is “yes”, really think again as you have to get through the medium runs – including Great Recessions – to get there, and I certainly don’t want a repeat of the 2008+ years when everything went to $hit.
Whatever you do, ensure you have a large enough safety cushion to get you through a severe market drop at the same time as both you and your significant other lose your jobs. Yes, low probability of all three, but severe downside if it does.
I have to echo the kudos stated above, but if you’re reading this, you already know them to be true. I’m sleeping much better thanks to the Canadian Couch Potato!