# Early Start, Early Retirement? Critique my initial portfolio.



## brajington (Jul 8, 2016)

Hello All,

I hope this is the right place to post this, I am looking to have some wiser investors critique my plan for investing over the next 10-15 years. I hope to eventually retire early, or earlier than most.. I track my monthly expenses and currently am aggressively saving and plan to invest as per the following plan. Please critique as necessary, I appreciate any input.

Age: 25
Gross Income: $50k
Initial Investment Amount ~ $20k
I have a TFSA and un-registered account open with Questrade and plan to open an RRSP with them as well.

My preliminary plan is as follows;

(Canadian) Bonds - VSB - 10%
Domestic Equity - VCN - 30%
US Equity - VUN/VOO? - 30% (US Market or S&P500?)
International Equity - XEF/VIU? - 24% (difference between Blackrock & Vanguard?)
Emerging Markets Equity - XEC/VEE? - 6% (difference between Blackrock & Vanguard?)

Since I am starting young I feel as if I should worry little about a downturn as it would allow me to invest in a cheaper market. I am relatively sure I can stomach the volatility although no one really knows until it happens. I plan to invest throughout the year, as it costs nothing for me to buy ETFs with Questrade. I have a relatively high savings rate at the moment, and look to invest spare monies.

Additional Questions:

PREFERRED'S - Would it be wise to include CPD which is a Canadian Preferred Share Index and replace a portion of Canadian Equity with it to increase yield? My thought would be to replace (VCN - 30%) with (VCN - 20%, CPD - 10%).

REITs - Would anyone recommend including REITs? Up to what % (I am thinking 5-7%). I am looking to increase yield. I would strictly look for REITs focused on apartment rentals which I think is relatively safer in comparison to the majority. 

The other peculiarity which I am unsure how to tackle is how I should allocate these investments in the TFSA / RRSP / un-registered. I am not really sure when this starts to make an impact in respect to taxes but I would rather learn this and implement it sooner than later as it will likely smooth adjustments required down the road.

I really appreciate any input, and once I start with this portfolio I will start posting the 'Money Diaries' forum with progress throughout the years.


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## kelaa (Apr 5, 2016)

It seems like you will be able to put everything into your TFSA for a few years before you run out of contribution room.

Is this influenced by the Garth Turner model portfolio in any way? Personally I like to own Canadian stocks directly. But with only $6k of room, you would only have room for one stock. I would pick rather pick four blue-chips to start and add in diversity (ex-Canada funds) over time. US exposure I get through SP500, DOW, and NASDAQ100 funds (last two to go extra overweight in large-caps).

But within your approach, I would skip the bonds give the room to other things, including REITS. Preferred shares are okay for cash-flow, but with so much time on your side I think you can aim for better than the 5.5% or so yield of the preferred shares.


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## mordko (Jan 23, 2016)

1. Keep as simple as possible. 

2. Given your age and that you pay will likely go up, put everything into TFSA.

3. Stick to stocks, avoid REITS/prefs. 

4. Given that your first 3 categories are all Vanguard, you might as well use Vanguard rather than Blackrock for 4 and 5. Using the same provider allows you to avoid overlaps.


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## james4beach (Nov 15, 2012)

brajington said:


> I am looking to increase yield.


Why?

Yield is a measure of the cash that some investment spins off. This is popular among retired people because they have a bunch of capital (say $1 million of investments) and they want to live off this capital. For example a retiree might design a portfolio that yields 4% so that they can automatically extract $40,000 from their capital every year.

But you're young and this money is going to be locked away for a long time. There is absolutely no need for you to focus on yield. A critical thing to realize is that YIELD is not the same as RETURN. For bonds, yes the yield is approximately equal to the return. But for all this other stuff the yield does NOT boost the return. Meaning, it's not some kind of additive effect that enhances returns. You could even end up with something that yields a lot, but has a negative return.

That's what CPD has done for years. Its return since inception nearly a decade ago is 0.12% annual return (this can be seen on the iShares ETF site, click Returns on this web page). So even though it "yields" over 5%, it has returned nothing -- zero. This total return is the more important number.

Because you have a long investment time horizon, *what you need is the best possible total return*. This generally means some sensible allocation to standard stock and bond indexes, nothing fancy. Basically all you need is these three: VAB, VCN, VXC. Though personally I'd prefer the iShares TSX Composite, so my suggestion would be: *VAB, XIC, VXC*

VAB are the bonds, XIC is the Canadian TSX index, and VXC is all non-Canadian stocks (mostly US and rest is international)

It really is that simple -- three ETFs will do the trick. Everyone -- including myself -- overcomplicates their lives by adding more, but you don't really don't need any more than these. Check out the model portfolios at the couch potato web site, under Model Portfolios Option 3 — Vanguard ETFs. There you will also find the annual returns of this portfolio going back 20 years.
http://canadiancouchpotato.com/model-portfolios-2/


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## james4beach (Nov 15, 2012)

brajington said:


> My preliminary plan is as follows ...


That's the right idea. It can be simplified down to:

25% VAB
25% XIC or VCN
50% VXC

Why increase the bond allocation to 25% ? Because as you can see from historical performance figures, going higher than 75% equities doesn't gain you any additional performance. And I suggest VAB instead of VSB (short-term bonds) because VSB is intended more for shorter term time horizons. You have a very long time horizon and would likely get a higher total return with VAB over the decades to come, even if interest rates go up.

The 20 year performance of this portfolio was 7.1% annual return to the end of 2015. And even higher if that number was up to date for today. For the amount of effort this kind of investment takes (nil effort inside a TFSA) that return is unbeatable.
http://canadiancouchpotato.com/wp-content/uploads/2016/01/CCP-Model-Portfolios-Vanguard-2015.pdf


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## Argonaut (Dec 7, 2010)

James, your hindsight vision continues to be a perfect 20/20. All historical performance figures are based on a period where bond yields have fallen from double digits all the way down to near nothing. Do you expect interest rates to hit -10%? That's how we'd get similar performance for bonds in the future. Cash in a "high-interest" savings account is just fine for safety in this day and age. In investing you have to be forward thinking and not backward thinking. Also, looking for yield is fine as long as it is high-quality yield.

As for the OP, the important thing is that you have an investing mindsight and a willingness to stick to your plan. Starting at 25 is good news. I'm not a fan of the alphabet-soup investing cult myself but it does work fine for a lot of people.


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## AltaRed (Jun 8, 2009)

There is a lot debate about 'going forward' performance of bond ETFs. I think one has to look at the annual peformance of something like VAB or XBB (similar but has a longer historty) to see the trends on both returns (the important factor) and current/distribution yield to see where the ETF may be headed. YTW is the usual way to look at bonds but bond ETFs don't behave the same as single bonds. So YTW is simply a trend marker that will change each month/quarter/year. All we do know is that annual returns of bond ETFs have been higher than anyone would have imagined otherwise and holding XBB or VAB for the past 8-10 years would be way ahead of having been in a GIC ladder or a HISA. It is a complete unknown what the bond yield curve is going to be in the future.

The question I'd have for the OP is to have enough fixed income (in some form) to provide a suitable sleep-at-night factor, i.e. to avoid panic selling in say, a 30% equity market downturn. For a young investor, that is the major test. Whether that is a 10% weighting, a 0% weighting, or a 25% weighting... I have no idea. The OP needs to look at some historic stock charts for the TSX and DJIA/S&P500 to figure out how the OP might have felt in 2008-2009 if s/he had $500k in July 2008 and that reduced to $300k in March 2009.

One other comment. The OP should look at XAW as a competitive alternative to VXC. XAW, I believe, is slightly more tax efficient. Beyond that, I agree keeping it simple with a 3 factor ETF portfolio.


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## james4beach (Nov 15, 2012)

Argo, your criticism applies equally to stocks: we've been in the longest running bull market in history, starting in 1980. It's a simultaneous bull in stocks and bonds. Somehow you're looking at this dual bull market and only criticising the bonds. _Both_ have had outlandish returns. Sure, bonds are overvalued. So are stocks. They've both been in a 34 year bull market! Stocks have the potential to decline much more than bonds - always. Stock indices have crashed 50%, twice since 2000.

As for bond fund performance, I showed in a different thread that it's not as simple as the YTM for the remaining maturity. See
http://canadianmoneyforum.com/showt...vidual-bonds?p=1261121&viewfull=1#post1261121

To summarize that answer: *the bond fund is not a single bond* so it's not as simple as the YTM figure. As an investor you pick a fixed maturity length (e.g. VAB at 10 years) and thus are _continually exposed_ to the risk of that maturity, and potential reward comes with that. Time horizon is everything here. The OP may be holding this for 40 years. In that time range, interest rates could rise, in which case VAB has a poor return for the first 10 years. But every time its underlying bonds mature, the fund picks up new bonds at higher yields. By 40 years, VAB (10 yr) performance should exceed VSB (3 yr) performance. _There will be_ periods where VAB declines more than VSB.

While it's true that a bond fund's performance has a high correlation with the YTM, they are not equal. Let's look at real examples:

A 10 yr bond ETF returned 6.5% per year, when the YTM at purchase time was 5.2%
http://canadianmoneyforum.com/showt...vidual-bonds?p=1257410&viewfull=1#post1257410

XSB has continually returned more than its YTM for subsequent 3 year periods
http://canadianmoneyforum.com/showt...vidual-bonds?p=1261153&viewfull=1#post1261153

Note in the XSB example that the 3 year period starting 2012-11-23 was a *rising* rate environment. Despite the rising rates, the bond ETF still returned 2.09% annual, vs the (YTM-MER) estimate of 1.28%.

Here's my projection with VAB. Let's say interest rates start rising from here on. Assuming they rise mildly, VAB will still return 1.7% (its quoted YTM) and likely a bit better, maybe closer to 2% for the first 10 ish years. I don't see any problem with this. Unless rates rise very sharply -- in which case I guarantee you that your stocks will perform much worse than your bonds.


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## james4beach (Nov 15, 2012)

Argo, I will agree that the OP should also have savings account and GICs too. In my own investment, I have target allocations not only for "stocks" and "bonds", but also a separate "cash" category (where I include GICs)

e.g. could do 10% cash, 20% bonds, 70% stocks

Just realize that over the 40 year time horizon, the bond category will outperform cash.


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## kelaa (Apr 5, 2016)

If a blue-chip on the TSX can pay 3.5% dividends on a 50-60% payout ratio and has mid-to-high single-digit growth prospects, I don't see how the market can be considered outlandishly overvalued from the fundamental point of view. I can see rising interest rates will make capital more expensive in the future, but I don't see it destroying future earnings.


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## gibor365 (Apr 1, 2011)

> Just realize that over the 40 year time horizon, the bond category will outperform cash.


 not sure! With big number of online banks who offers several times higher interest than major ones, who knows?!


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## Oldroe (Sep 18, 2009)

At your young age it's great to see some planning.

You need new money every ten years after retirement . Inflation will kill a great retirement.


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## Argonaut (Dec 7, 2010)

james4beach said:


> Argo, your criticism applies equally to stocks: we've been in the longest running bull market in history, starting in 1980. It's a simultaneous bull in stocks and bonds. Somehow you're looking at this dual bull market and only criticising the bonds. _Both_ have had outlandish returns. Sure, bonds are overvalued. So are stocks. They've both been in a 34 year bull market! Stocks have the potential to decline much more than bonds - always. Stock indices have crashed 50%, twice since 2000.


The difference is, bonds have a limit to how high they can go given interest rates. The exception is the negative interest rate environment that much of the developed world is in now, but forgive me if I do not want to participate in that buffoonery. Stocks on the other hand are not terribly overvalued at current levels, and can always go higher with more profits, more efficiency, and better technology.

Bonds are such a silly investment right now because they are the worst of both worlds: relatively high risk and low return. Again, would rather have cash for this portion of a portfolio. Those bond funds you mentioned have only outperformed their YTMs because rates have come crashing down.


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## james4beach (Nov 15, 2012)

gibor365 said:


> not sure! With big number of online banks who offers several times higher interest than major ones, who knows?!


If bonds don't return more than cash, then there's no reason for the $82 trillion bond market to exist. I still think that in the 40 year time horizon, a bond fund like VAB will outperform cash.



Argonaut said:


> Those bond funds you mentioned have only outperformed their YTMs because rates have come crashing down.


No, I also showed a period where XSB outperformed its YTM during a rising rate environment, period starting 2012-11-23


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## brajington (Jul 8, 2016)

Interesting to see the discussion, the reason I include bonds is specifically to lessen the volatility of any major crashes. A few weeks ago I went ahead and pulled the trigger with $10k at the following allocation;

- 20% VAB
- 50% XAW (cheaper than Vanguards option..not sure of overlaps to be honest)
- 30% VCN

I have still a large portion in cash and as of now an emergency fund does not need to be large for me at all. This was me sort of testing the waters and acclimatising myself to investing and seeing the market value go up and down. 

My next decision is how much should I add in monthly if I have around $20k cash right now / plus earning $1.5k a month on top of that. I'm unsure should I just throw another $10k in there? Or should I just invest all I have and leave a small cash buffer for purchasing opportunities when markets are down? Essentially I want to be able to have enough cash to take advantage of markets that have dropped.. I think I should just invest around $2k a month from now on at the end of every month and further acclimatise myself.

I thank you all for the solid discussion here. I know Argonaut has his starter pack, and honestly I probably would have ended up replacing VCN with that if it wasn't for fees payed on stock. ETFs are free to purchase for me.


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## mordko (Jan 23, 2016)

The more time invested the more money you will make on average. Personally I would invest all cash which you intend to invest.


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