Creating a retirement portfolio with ETFs is easy.
Creating a retirement portfolio with ETFs is a challenge.
Both of the above statements is true. Building a retirement portfolio is quite simple, just as building wealth in the accumulation stage is quite simple. And if you’re a self-directed investor using ETFs you’re likely keeping your fees at a rock-bottom .10-25% area. That is one of the most important considerations.
2% for you and 2.5% for your advisor and mutual fund company?
If you’re handing over 2%-2.5% annually in various fees you can guess who’s retiring comfortably, and you can guess who’s retiring early. So congratulations, as a self-directed investor you’re keeping the majority of your retirement monies in your pocket.
But there are other pockets that we need to consider; the pockets of the various tax collectors in Canada, the US and around the world where you might hold your investments. We also want to consider the pockets of your discount broker who might charge you currency conversion charges when you take monies out of your US holdings and convert those asset to Canadians dollars.
As much as determining what type of ETF assets to hold and deciding upon your overall portfolio asset allocation we also need to know that goes where with respect to your RRSP, TFSA and Non Registered accounts.
Keep in mind that I have never been a licensed tax professional. It may be more than wise to find a fee-for-service advisor than can help you with the optimal mix of assets, situated in ‘the right place’. They can also help you find the most beneficial order of harvesting your RRSP vs TFSA vs Taxable vs Pension income(s). These decisions could enable considerably greater income and more reliable income over your lifetime.
There are a lot of moving parts when it comes to retirement funding.
Is my Couch Potato Core ETF Portfolio OK for Retirement?
Here’s the good news on the retirement front for ETFers; basic and sensible core balanced portfolios can work wonders in retirement.
We do not need to build an income intensive portfolio. We don’t have to ‘live off of the dividends’.
Your level of retirement income comes down to 2 factors – the growth of the portfolio and the risk level of the portfolio. In retirement the amount or percentage that you can remove to spend from your portfolio is mostly determined by the growth rate of your portfolio. If you’re portfolio is making 7% per year after fees, well you can spend 7% per year and maintain your portfolio value. Of course that tax man is going to get his cut on RRSP and RRIF and LIF withdrawals. Remember, every penny removed for spending is taxed as income. You’re also going to pay taxes on investment income and capital gains realized in taxable accounts.
Total return ETFs are more than fine, and in fact they might end up being more tax efficient in the end. Again you’re success level and spend rate will come down to portfolio growth and managing the sequence of returns risk.
The risks are different in retirement.
In the accumulation stage market corrections did not historically present long-term risk, as markets have historically always recovered to deliver new highs and renewed portfolio growth. In retirement a severe stock market correction could impair retirement, permanently. Selling assets continually when the market is down kills the cow. You’re owning less of the companies. You’ve had to sell large portions of your shares to fund retirement; you’re decreasing your ownership of those companies and profit centres.
That’s why it is wise to hold a Balanced Portfolio of some sort that includes bonds that work as shock absorbers in market corrections. Not only that the bonds have the potential to go up in price when those stocks get hit – there’s that inverse relationship to stocks. You can sell more bonds, meaning you can sell less of those profit centres known as stocks.
Here’s one of my favourite charts of all-time courtesy of Portfolio Visualizer.
Portfolio 1 is the S&P 500 (US Market)
Portfolio 2 is TLT – (US Long Term Treasuries)
We see that wonderful inverse relationship. Of course past performance does not guarantee future returns or future performance characteristics. That said, bonds have been there to do their thing in every recession. That is government treasuries (especially longer dated) have gone up when stocks went down. I like the odds of a repeat in a major market correction.
To get enough growth out of your portfolio with enough risk management you might consider what I’d suggest is the sweet spot for retirees as 40% stocks to 80% stocks. Of course you have to invest within your risk tolerance level. I’d suggest that your tolerance for risk is more likely to decline in your retirement years.
A Sensible Globally Diversified Balanced ETF Portfolio Should Work Well
Now keep in mind that we do need markets to cooperate over the longer term for any approach to ‘work well’. I’m simply suggesting that you might not need to collapse your wonderful and simple couch potato portfolio to go chase dividends and higher yield bonds and more exotic higher yielding ETFs.
But then there’s that issue of what goes where.
To avoid taxation or to have the ability to recoup US withholding taxes on US Dividends you would be best served to hold those ETFs in your RRSP or Non Registered plan types to take advantage of the tax treaty between the US and Canada for certain registered accounts. With Non Registered Accounts you can apply for the tax credit to recoup those taxes paid.
And on that we do need to hold US listed ETFs to qualify. The wrapped ETFs that hold US ETFs in a Canadian dollar fund of funds such as VXC or XAW or XUU would give up those withholding taxes on US Dividends. We are better off with a direct US dollar IVV or total market VTI as examples.
You’ll also have to read up Norbert’s Gambit to avoid currency conversion charges.
If you have large US assets in US dollar funds or stocks you might want to be careful as the IRS may come looking for you. Read up on that subject or nuance. For taxable monies you can also take advantage of The Canadian Dividend Tax Credit, meaning Non Registered accounts would be a good place to hold your Canadian Stock ETF, especially if you go that Big Juicy Canadian Dividend Route. And given that capital gains are taxed more favourably, the Non Registered environment is a good place for your stock, or stock-heavy funds.
Here’s a wonderful synopsis of what goes where thanks to First Asset, who by the way offer ETFs designed for tax efficiency.
Given that bond income and GICs and savings account income is taxed ‘in full’, you want to keep those amounts in RRSP/RRIF/LIF and TFSA accounts, as much as possible. And keep in mind that it is likely impossible to arrange all of your assets in the most tax efficient house as the need to strategically remove funds from RRSP vs TFSA vs Non Registered will come into play. We might need those bonds in the RRSP or TFSA to manage the risks. We don’t always let the tax considerations drive the bus.
Confused yet? Well ya, there are a lot of moving parts. Dan Bortolotti of PWL tells us that most self-directed investors will take a pass on the moves that are necessary to create the most tax efficient portfolio. Most of them will choose to stick with the wrap products for simplicity.
That said, if you are willing to put in the time and energy to learn the basics, you might be able to boost your returns (and income) by some .50%-1.0%.
And if it’s all too daunting, you may also consider to seek out help from a Canadian Robo Advisor such as Justwealth or WeatlhBar. ModernAdvisor also offers more robust advice, including a fee-for-service option. Justwealth offers the most extensive suite of ETF Portfolio models that includes Tax Efficient Portfolios. You can access a full holistic retirement plan, all covered in the regular fee schedule at Justwealth.
Keep Your Core Portfolio But Learn What Goes Where
Net, net, simple ETF portfolio asset allocation works. It’s the ‘what goes where and why’ that complicates the matter.
I’ll be back with retirement Part Deux 2, including some ETF portfolio options. We’ll also look at building that Dividend Growth and Income Model. There is a benefit that can be had by way of generous and growing income, to a point. I’ll admit to having a guilty pleasure of watching those big juicy dividends roll in.
Thanks for reading.
Please make sure that you know what you’re doing before you self-direct. If you don’t know what you’re doing, don’t do it.
If you have any questions please feel free to contact me (Dale) at email@example.com. Better yet, leave a comment on this blog post.
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