I published “Riding it to the bottom” on July 6, 2022. Shortly thereafter, I ended up selling all my entire bond ETF portfolio and thus converted my asset allocation from an 80/20 stock-bond split, into a 100% stock allocation. I know I had written about staying the course, which is still what I stand by. Whatever your personal investment plan statement instructs you to do, is what you should do, as it is based on your own personal situation, comforts and risk levels.
However, I didn’t just randomly switch over to 100% stocks. I’d been thinking about it for a while, and decided to dust off my investment plan for review. I hadn’t really updated it in a couple of years and the whole situation with both the stock and bond market heavily plummeting caused me to re-evaluate my overall plan.
And I did. I thought about it a lot, and about the pros and cons of keeping or ditching bonds, and what my overall goals going forward should look like.
My 80/20 wasn’t performing as expected. The bonds were generally meant to cushion any blows to the portfolio; to help “smooth the ride” as it has been put before by others. Also, it’s been said before that bonds generally do not correlate with stock performance, allowing for more opportunities of buying low and selling high. Again, this didn’t happen due to a number of market factors, both domestic and global.
Risk + Time = Results
One of the biggest reasons for me to change my plan, was thinking about the best likely outcome for long term market performance. Historically, stocks have largely outperformed bonds. The longer the time frame, the better they do. I’m in it for the long haul. Also, if they perform better, then that should allow one to reach their goals faster (in theory).
Otherwise, if the common opinion was that bonds generally outperform stocks, then wouldn’t the vast majority of investors go all in on 100% bonds? They don’t. Not serious ones anyway. I think only the most risk adverse people would go that route, or perhaps individuals very close to retirement, or in retirement. That would be a fair reason. That’s not to say that bonds haven’t had their time in the sun over the years. There have definitely been notable periods.
But looking at longer periods of time and comparing the performance of a total bond ETF that I had held (VAB), versus a total global stock ETF like VXC, the bond fund had lost 8% of it’s value since 2014, whereas the VXC fund has increased it’s value since 2014 by nearly 100%! It’s not that there hasn’t been any inherent volatility or risk with the stock fund, but more that there’s much more potential reward over the longer time frame given the ETF’s risk category. And with volatility leaning towards the higher end of things, this provides more ample opportunities for purchasing stocks “on sale”, further boosting net worth during their recovery periods.
The goal of early retirement, or extreme early retirement is still a goal I’m working toward. And I believe that 100% stocks are the way to go, for me, especially during the “accumulation” phase of the journey. Getting close to or actually being in retirement is a different story altogether, but I’m not there yet.
An Insignificantly Significant Amount of Money
It’s funny thinking about the beginning of my investment journey (circa 2009). I remember having about ~$6,500 in a couple mutual funds within my RRSP. I remember thinking that I didn’t want it to decrease in value, or lose any of it. Who does? Even when I eventually added more and my RRSP value increased, that line of thinking remained. Yet in the present, where I do have significantly more than when I started, you’d think I’d be even more wary of “Losing” what I had gained. Yet my view point has shifted toward the opposite.
Now I’m more of the mind of, “How can I make my little investment share buddies work even harder and more efficiently!” Especially when using a broad market ETF, you can’t really officially “lose” money unless you panic sell, because there isn’t any one individual stock/company that may go out of business that will affect you significantly. That’s the beauty of whole market ETFs. And when you realize that, it makes you think differently about inherent risk, and the potential benefits of the market.
Another big factor contributing to my asset allocation shift, is that we (me + wife) have a fairly large emergency fund (aka checking account balance), probably equivalent to 8 months worth of living expenses. While this might be seen as a good thing – which it’s definitely not a bad thing – and while it can improve short term financial security, it is hampered by the constant erosion that affects all cash holdings.
Inflation.
A Knock on Cash
Cash does not produce anything, nor increases in value. And as long as there is any instance of inflation, which there usually is, cash’s value is slowly hemorrhaging. And considering the past year or two of inflation rates, it’s not looking pretty for cash’s effective purchasing power. A common thought process is to actually hold a smaller emergency account balance, maybe a month or two of expenses, and put the remainder to work in the market to gain value and returns. And while I would be more comfortable with doing something like that, my wife didn’t share that same comfort as fully, and would rather have the larger balance maintained as a safety net.
So, with that large safety balance, it made even less sense to hold the bond allocation that I did, therefore, I reasoned that I could (and should) take on more risk via the stock side of things.
As well, one of the function of bonds is to help rebalance a portfolio’s levels. However, a 100% stock ETF like VEQT covers multiple global stock markets which don’t always correlate with each other (ie: US, CAD, Europe, Emerging Markets), the fund itself re-balances those portions according to its designated asset allocation. So it’s in effect functioning like a bond rebalance. Just look at the Stingy Asset Periodic Table of Returns (Stingy Investor: Periodic Table of Annual Returns for Canadians (ndir.com) and you can see the potential for rebalancing among global market funds.
Please note that all of this is my own thought process for my situation, and yours is and should be different. Make your own assessment of things and the best decisions possible for your situation.
Predicting the future
When I made the switch to VEQT in August 2022, did I know what was going to happen? No. I did know that I made it through the COVID crash of 2020 without panic selling. Thus knowing my own emotional behavior during that period, I would likely make it through any future crashes as well.
But what did happen? Well, the value dipped to a low in October (2022), then went to a small peak in December, then dipped again in January, then, back up in February, then kind of stagnated until about June, slowly increasing on the way to October, where it has not yet gone up to a new peak. It’s still not as high as it was before the Ukraine War descent, but it’s working it’s way back there.
It has definitely been an interesting year, watching my VEQT portfolio’s value heave and ho with all the market swings. I kept buying throughout, and am now up to a higher value than before. In the midst of the roller coaster of the market, it can be a bit defeating to see account values persistently go down week after week, even while you’re making investment contributions week after week. But that’s why you have your personal investment plan to help keep you on track. It also helped viewing that these constant dips were akin to frequent sale opportunities for the ETF. Buy low sell high, remember? And investing isn’t a week to week thing, it’s a year to year to decade to decade thing. Dips are expected. Along with crashes. It’s all part of the process.
Interest Rates
Inflation has been tricky to get under control. The Bank of Canada has continued to raise rates with relative consistency throughout the past ~21 months. When I published the first article, the overnight rate was at 1.5%. While not a record low, it still wasn’t far off. I had pushed around the idea in my head (and in that article), about potentially taking advantage of the bear market conditions and the super high house property prices via a loan of some kind (personal, or mortgage refinance) to invest it. 1.5% quite a good rate to borrow money from. I had used the example of taking a $200,000 loan out, but had also been wary of the consequences of rising interest rates if using leveraging.
It’s an interesting retrospective exercise now to look back and see what would have happened if I had gone that route. Over the past year, interest rates have risen quite quickly and dramatically, to many peoples’ dismay. The overnight rate is now at 5%, but loan rates are actually upwards of 6% or more in many places.
Perhaps I could have locked in something like a 5 year rate at 1.5 – 2% at the time with a fixed rate mortgage refinance. But if I had gone for a variable rate, and had not changed anything over the past year, using TD as an example, I could have been paying as much as ~7% interest on the loan. And rates will likely go up even further.
Retrospective Returns
What would potential interest payments look like? 2% interest on $200,000 is $4,000/year, whereas 7% interest would be $14,000/year. That’s a big difference, and there’s also the performance of the ETF investment itself to consider. The ups and downs of VEQT would have caused some significant swings over the past year, and some people might have been sweating a little bit during the ride.
Luckily, VEQT increased ~14% since last July. So, a $200,000 value would be up to ~$228,000. However, minus the $14,000 in interest would lower the principle to ~$214,000. And if this amount was also in a taxable account, some more would be lost due to the taxing of any dividend or capital returns over the year. A small amount may have been able to be recovered via claiming the interest of the loan as a cost of investing. However, remember that 14% is a pretty good above average return. Whereas if the last year’s return had been 7%, the investment would have been a wash, and if the investment had returned negative percentage, well, then you’d definitely be in poor shape. A minus 7% return would have put the principle value down to $186,000, and that’s before paying your $14,000 interest out of pocket on the loan, and effectively be “underwater” by another $14,000. So you’d be in the hole $28,000. Yikes!
And that’s just one year. What if there were multiple years of negative returns combined with the high loan rates?!?!
What’s Next?
Leveraging is risky, and it’s not for everyone.
For me, I’m glad I didn’t take that on last year.
It’s also been said, by other wiser people than me, that if someone wants to take more risk on, you should not take on leverage if you’re not 100% allocated to stocks (which i was not at the time).
But now that I am at a 100% stock ETF allocation, am I thinking about ever trying out leveraging as a strategy?
Definitely not in the near future with interest rates how they are. Even long term, I’d be extremely weary of this strategy. But perhaps that’s my own risk tolerance speaking. Or perhaps $200,000 is too much of an experiment to try. Maybe $100,000 would be more suited to this. Or maybe if interest rates get back down to near record lows, and if I’d be able to lock them in for a 5 year period.
Using VEQT’s stock mix plugged in to the stingy asset mixer tool, reveals that the worst 5 year periods since 1988 were the years starting at 2000 and 2007. Both had big double digit losses in their first year, and it took 5 years to fully recover. For a loan of $200,000, you would have just been out the interest after 5 years; perhaps ~$12k on a 1.5% interest rate. Not the worst outcome. But definitely a scary process.
On the other hand, the average return over the last 35 years is 9.18%/year, which could potentially mean a 5 year outcome loan value of up around $310k, leaving you with a net gain of 110k before deducting the 12k interest. So much potential. And so much risk.
I don’t know. It’s tough when it feels like there’s so much equity locked up in your house, just waiting to be used in a better way.
But maybe for me, the best way home equity can be used is by staying exactly where it is, as a “Sleep well at night” tool. At least for now. At the end of the day, whether or not you ditch your bonds, increasing your savings rate as much as you can via personal spending choices and optimizations is the best overall solution to financial security and independence. As well as having a basic, low-cost, grounded investing plan for a close second. All other strategies are icing on the cake.
But even for me, some icings are too sweet. And leveraging may just be one of those overly sweet ones.
