Preferred Shares – Is this the new replacement for fixed income?

Preferred Shares – Is this the new replacement for fixed income?

As readers of my blog you’re probably well aware that common stocks that pay dividends and low-cost, diversified Exchange Traded Funds (ETFs) – are the two primary building blocks of my investment portfolio.

But what about preferred shares?  Why not own them?  What are they in the first place?  Should you consider owning them in this rate environment?  If so why or why not?

I’ve been thinking about writing a comprehensive post about preferred shares for some time.  Thanks to a recent reader request here is it today.  First though, I want to introduce the reader himself who authored most of this post with me – Matthew Wilson.

Matthew Wilson is an entrepreneur, investor, and co-founder of Calgary Beer Week. Having started his first company at age 11, he now works as an advisor to start-ups and early stage organizations, helping to build their business model, sales, and marketing strategies. He currently writes at GRGcollective.com about personal finance, entrepreneurialism, and personal development.

(Editor’s note:  who doesn’t love craft beer?)

Matthew’s bio goes on to say he started his first company at age 11 and sold his last one at age 28.  Now in his mid-30s he continues to love all things money and wanted to write this post – a point counter-point article about preferred shares with yours truly.

Preferred Shares 101

Matthew, this is how I describe preferred shares:  it’s a hybrid between a bond and a stock.  With “preferreds” you get the elements of a bond (through fixed income) but you also get some upside with capital gains.  Thoughts?

Mark, I like that.  We’re all familiar with the term common stock (or common shares). The TSX is full of familiar ticker symbols, like RY (Royal Bank), MFC (Manulife Financial), and ENB (Enbridge), to name a few. But when you search “RY”, for example, have you ever noticed this list?

Preferred Shares

Source: www.tmxmoney.com

This multitude of “RY.PR” symbols refer to various series of preferred shares.

I like this definition of preferred shares:  consider it like VIP shares in a company:

  • As an owner, you get the first crack at any dividends issued by the company ahead of any common shareholders.
  • In addition, when a preferred share is first issued, the dividend yield is both fixed and at a higher rate than the yield for common shares. For example, the common share RY (Royal Bank) is currently yielding around 4%, whereas the preferred share PR.I has a fixed cash dividend of 5%.
  • Lastly, should a company become insolvent, preferred shareholders get paid ahead of common shareholders upon the liquidation of assets.

Fair points Matthew – but I like my income and capital gains from my common stocks.  I don’t think preferreds have as much upside as common stocks do long term.  I also believe companies that increase their common stock dividends can be far better long term investments.  Preferreds offer no such ability.

What’s your take?  Why should I consider preferred shares for my portfolio?

Mark, given your existing holdings with what, 30+ Canadian dividend paying stocks (?) – this is a great question.  Actually, it’s a great question for many folks to ask, particularly Boomers since their search for yield has never been more prevalent.

Before I answer your question – let’s go back to the difference between preferred shares and common stock. Since preferred shares offer a fixed dividend rate they are classified as a fixed income security, and as such, belong to the fixed income portion of your portfolio.

Second, it’s important to note a recent key shift in the structure of the preferred share market.

Prior to the credit crisis of 2008, the majority of preferred shares in Canada were known as perpetual, meaning they had no fixed maturity date and could be called back by the issuer, for par value, at any time in exchange for cash. The high yields protected perpetuals from downside risk, whereas the possibility of getting bought back by the issuer at par value hindered the potential for any upside capital gains. Thus, to your earlier point about limited capital upside, price movements among perpetuals were typically quite minimal, with values remaining close to their initial issue price.

During the credit crisis, however, confidence in the financial sector plunged, and investors were no longer sure if the issuers of these perpetuals would ever be able to buy them back at par value. As a result, the value of perpetuals plunged.

Following the credit crisis interest rates hit all-time lows, and with the only direction to go being up, investors wanted a product that would protect them from rising interest rates. As such, the rate-reset preferred share was created.

In short, the rate-reset can still be bought back by the issuer, but investors now have the option to “reset” their dividend yield every 5 years at a rate equal to the Bank of Canada’s 5-year bond, plus a premium. For example, if in 5 years the Bank of Canada 5-year bond yield is up to 3%, and the preferred share issuer offers a 3% premium, investors will have the opportunity to reset their dividend to 6%. (Note: the value of the premium and time horizon until being eligible for a reset varies depending on the issuer, however, it’s typically every 5 years).

With this new-found protection against rising interest rates, the popularity of rate-resets surged, and the majority of the Canadian preferred share market quickly shifted to the rate-reset format.

However, since the Bank of Canada unexpectedly cut interest rates twice in 2015, rate-reset preferreds got dramatically oversold and their market value got hammered, dropping approximately 33%. Investors who foresaw the eventual rebound of interest rates were able to lock-in dividend yields north of 7% while they waited for market values to return.

Since rates bottomed out in early 2016, and with the Bank of Canada now on pace to raise interest rates for a third time this year (time will tell…) rate-reset preferreds have been one of the best performing asset classes on the market, up approximately 28% from their bottom in early 2016, all-the-while paying an attractive 5%+ dividend.

Preferred Shares 2

Source: www.tmxmoney.com

So, to answer your original question, should you consider them for your portfolio?  I think you should since you can earn an attractive yield while capitalizing on an oversold asset class that will produce capital gains in a rising interest rate environment.

Alright Matthew, a compelling case, but what are the upsides and downsides of owning preferred shares?  With common stocks shareholders don’t have to worry about interest rates as much due to the lack of fixed income component.  Often the elderly, buy preferred shares for “safety” only to see their investments decline significantly in value when interest rates change.  People somehow equate preferreds with the bond component as safe.  That’s hardly true.

Mark, you’ve raised a very important point.  As we can see from the chart above, owning preferred shares in a declining interest rate environment is not conducive for capital gains.  However, we know interest rates will not stay at zero forever.  So, as interest rates (slowly) continue to rebound we will experience additional capital appreciation among rate-reset preferred shares.

So if I was to hold preferreds, at all, I would consider owning them in registered accounts first, to maximize those accounts before non-registered.  What’s your take?

That’s always a good plan – to maximize contributions to your registered accounts first (e.g., RRSP, TFSA, RESP for kids) before investing in a non-registered account.  But it’s worth mentioning for readers unlike bonds, where interest is taxed at your full marginal tax rate, the dividend income from preferred shares qualifies for the Canadian Dividend Tax Credit.  I know that’s something you highlighted here.

So, if your registered accounts are already maxed out, preferreds can have a non-registered home.

Matthew, given the structure of “preferreds”, I really don’t see a compelling reason to own them right now.  I mean, I think it will be decades if/when bond yields are modest.  So why the rush to own them if the capital upside won’t be there?

Your concerns regarding the outlook for bond yields are quite valid Mark. Ultimately, like any type of investment, the decision to own preferred shares will depend on your personal feelings, views on where the market is headed and of course what your financial plan says you should do. 

(Editor’s note:  financial plans should come before financial products).

Back to what I wrote about above, you now know owning old-style perpetual preferred shares is certainly not a great option. However, given the unique structure of rate-resets, these type of preferreds are poised to largely benefit in a rising interest rate environment.

o, my question back to you is:  where do you foresee interest rates going?

Matthew, I really have no idea.  They could go up, down, stay flat, rise a bit, then fall, spike only to dip again.  Like the weather tomorrow, I really have no idea.  So, I don’t speculate on that stuff and I don’t invest in them for this interest rate risk.  If I had to guess, rates will probably go up over time but it’s going to be a very long road (as in decades) largely due to demographic reasons.

Mark, I’ll offer my take.  Looking back, historically the Bank of Canada will typically raise multiple times in a continuous cycle over the course of several years. If we look at the last 4 rate-tightening cycles here’s how the data plays out:

  • 1999–2000: 4 rate hikes over 2 years.
  • 2002–2003: 5 rate hikes over 2 years.
  • 2004–2007: 10 rate hikes over 4 years.
  • 2010: 3 rate hikes in 1 year.

From this data, we can reasonably expect to see approximately 3 to 6 increases over a short period of time.  Will it happen?  Will we ever get back to the days of 16% interest rates? I highly doubt it as well but I suspect it will go up again over time.

BoC Benchmark Overnight Rate – Since 1991

Preferred Shares 3

Looking at the long-term trend, interest rates have bottomed-out.  Things seem to be on the rebound. As long as the Canadian economy continues to outperform, and job growth stays strong, I don’t foresee the Bank of Canada having any reason to abort its tightening cycle anytime soon.

We’ll see though Mark.  After two rate increases already this year, what happens with the next decision will come as soon as October 25th.

BoC Interest Rate Decision Calendar – 2017

Preferred Shares 4

Source

In any event, to your interest rate risk, as long as interest rates aren’t trending downwards I believe there is merit in holding preferred shares.  For sure, you may not realize much in terms of capital gains when compared to common stocks, but you’ll collect a nice dividend, which is more than double the yield on any current bond or GIC.  It’s important to highlight preferreds are not bonds though. 

Absolutely not.  OK, let’s wrap up this essay on preferred shares Matthew.  Do you personally own preferreds and if so, which ones?  (Disclosure – I don’t own any.)

Yes, I do own preferred shares as they make up approximately 45% of the fixed income portion of my portfolio.  Earlier I showed you there are almost endless options when buying preferred shares. For this reason, I strive for simplicity and have opted for some of the various preferred share ETFs available on the Canadian market. The three that I own are:

iShares S&P/TSX Canadian Preferred Share Index ETF

  • Invests in Canadian preferred shares
  • Symbol: CPD
  • Current yield: 5%
  • Distribution frequency: Monthly
  • Geographical weighting: 100% Canadian.

iShares S&P/TSX North American Preferred Stock Index ETF (CAD-Hedged)

  • Invests in a diversified basket of U.S. and Canadian preferred shares
  • Symbol: XPF
  • Current yield:6%
  • Distribution frequency: Monthly
  • Geographical weighting: 50% Canadian, 40% U.S., 10% Global.

BMO Laddered Preferred Share Index ETF

  • Invests in a diversified basket of rate-reset Canadian preferred shares
  • Symbol: ZPR
  • Current yield: 6%
  • Distribution frequency: Monthly
  • Geographical weighting: 100% Canadian.

I own CPD for exposure to the Canadian preferred share market. I also like XPF because it largely benefits from rising interest rates in the U.S and is hedged to Canadian dollars, therefore no need to worry about currency exchanges. ZPR is the newest of the three ETF products, and I purchased it as an experiment to see how it would perform in relation to the others. To my surprise, it has been my top performer.

Preferred Shares 5

Matthew, I want to thank you for this detailed look at preferreds based on your perspectives – and inspiration to get this subject covered on my site.

For the time being, I’m going to stick with my common stocks and some low-cost ETFs for my portfolio.  I believe things remain more simplified within my investment portfolio this way.  Besides, I’m in my asset accumulation years.  In these years, I’m counting on dividend income, and dividend increases, I’m also counting on capital gains as much as possible as well.  I suspect for retirees or folks depending on some fixed income, preferreds can offer some steady income and deliver lower volatility than common stocks – certainly a consideration for some income investors depending upon the construct of their financial plan including their risk tolerance.

Thanks for doing this comprehensive post with me and I look forward to chatting about more personal finance and investing topics with you in the future.

What’s your take on preferred shares?  Do you own them?  Why or why not?

Mark Seed is the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I've grown our portfolio to over $500,000 - but there's more work to do! Our next big goal is to own a $1 million investment portfolio for an early retirement. Subscribe and join the journey!

169 Responses to "Preferred Shares – Is this the new replacement for fixed income?"

  1. This is a fantastic Q&A on preferreds. My understanding on this space has been limited and spent a bit of time learning about preferred shares last year. Who knew, I was looking at it right at the right time and couldve caught the bottom?! Anyway…there were still some aspects that I was not grasping and this article clears it up. Definitely going to take another close look at preferreds for the fixed income portion of my portfolio.

    Thanks Mark & Matthew.

    cheers
    R2R

    Reply
  2. Interesting but I’ll stick with my DG stocks. The term Preferred really doesn’t fit my definition especially if one considers that those so called preferred’s Don’t provide any dividend growth and very little capital growth. RY was mentioned so I looked at some of RY’s at: http://www.rbc.com/investorrelations/preferred-dividend-history.html
    Hit the + beside Series W. You’ll notice the dividend has been 0.30625 since April 25, 2005. Interestingly the dividend of the RY Common stock (click on Common stock at the same site) was 0.275 April 2005 then 0.305 July 2005. The W series ends at July 26, 2016 with the same 0.30625 where as the Common grew to 0.81 over the same period. A 185% growth difference.
    Which would I rather own, or better yet which would you rather have owned over that period?

    Reply
  3. Thanks for your feedback. Some great points you make here. I completely agree that the common stock has done incredibly well over the past decade. Just keep in mind that preferreds are a fixed income security whereas the common stock is an equity, so we can’t expect the same type of performance. Preferreds are best compared with fixed income instruments like bonds or GIC’s.

    Reply
    1. @Matthew: for those who feel the need for fixed income holdings, ok, but I hold none and never have. If one is investing over the long term I prefer to invest for Income and Growth, which I believe is the path to achieve ones secure future.

      Reply
  4. Interesting post. I’ve been down the road of reset preferreds and very unlikely to go back. I still have 1 moderate postion but it will be gone next March. They are very complex animals that have most of the market risk of equities but much less upside, and lack the safety of other true FI instruments that can increase in value during market downturns (bonds). (Not enough of an alternative to equities) For anyone seriously considering them I would agree an ETF is probably a better choice than an individual holding (s), but I would still encourage investors to spend a good deal of time studying and follow someone like James Hymas first. I have but definitely haven’t graduated. Also the rates indicated above aren’t accurate. They’re actually lower and a person also has to consider some hefty MER’s.

    In reference to the comparison comments it is probably fair to say it has been a very favorable period for commons and an unfavorable period for preferred and this may well not always be the case.

    Also I didn’t do a lot of digging but pretty sure CPD isn’t strictly a reset pref. ETF. I believe there’s still a healthy dose of perpetuals in there.

    Reply
    1. I can’t see myself owning preferreds right now for two main reasons: 1) not as much capital upside and no dividend growth and 2) via ETFs the fees are far too high. Looking at 10-year returns (although hindsight is always 20/20) I would have done MUCH better owning common stock and/or low-cost ETFs like VTI, VYM, etc. Thankfully I’ve owned the latter.

      “In reference to the comparison comments it is probably fair to say it has been a very favorable period for commons and an unfavorable period for preferred and this may well not always be the case.” Totally agree. Seasons change!

      Reply
      1. I agree with what you’re saying.

        However, this may well be a time to own resets….if interest rates continue up???, but they are indeed a strange beast to understand and analyze.

        Seasons change for sure.

        Reply
          1. That’s a reasonable question. I’m also more inclined towards that philosophy especially as I age.

            However, the answer is possibly – simple may not always work “best” for every person depending on their goals, investment knowledge, etc.

            A broad market equity ETF may be simplest but is it the “best” for every person?

  5. The only advantage I see with preferreds over fixed income (bonds) is the higher yield. Performance-wise CPD, XPR and ZPR have done ok over the past 20 month but earlier returns were downright miserable. What good is a 5% to 6% yield if your capital is in a long term decline?

    I feel a more defensive solution for the yield hungry crowd are the covered call ETFs offered by BMO. They not only offer good safe yields but also less volatility, better downside protection (via the covered calls), modest dividend growth and greater performance over the long term. If held in a non-registered account they also offer a greater tax advantage than preferreds, because the covered call portion of the dividends are taxed as capital gains rather than dividends.

    Reply
    1. Same Bernie re: “The only advantage I see with preferreds over fixed income (bonds) is the higher yield.”

      You have to watch the financial fees and MERs as well.

      I haven’t read-up or researched much on covered call ETFs offered by BMO but I know those products seem to be popular with retirees. BMO has a partnership with yours truly so I should talk to them about a post here. Definitely advantages for the covered call portion of the dividends taxed as capital gains rather than dividends; lower form of taxation the longer you hold them so I can see the appeal.

      Do you own covered call ETFs Bernie?

      Reply
      1. I own one ETF…a full position, or 2.5% weight by income, in BMO US High Dividend Covered Call ETF (ZWH). It hasn’t performed quite as well this year because its unhedged but regardless covered calls are very good defensive plays. I hold this one in my RRSP along with 34 (soon to be 37) dividend growth stocks and one mutual fund. I’m well aware of the fees & MER. I rarely worry about them because I’m more about quality and performance. As is the case with all funds, fees & expenses are factored in before $ distribution payments and before performance numbers are reported.

        Reply
        1. “I hold this one in my RRSP along with 34 (soon to be 37) dividend growth stocks and one mutual fund.”

          At last count, I’m around 40 stocks – about 30 CDN and 10 U.S. and then VYM for extra diversification. I guess I worry about fees because I’m in my asset accumulation years – fees matter!

          Cheers Bernie.
          Mark

          Reply
          1. Fees matter only when comparing with vehicles of similar holdings. Fees are irrelevant if a low fee fund is outperformed more often than not plus over the long term by a fund with higher fees. Case in point Mawer Canadian Equity Fund and Mawer Balanced Fund vs their equivalent index benchmarks.

          2. “Most funds do not match their benchmark over time.”

            Generally, yes most broad market indexes outside of Canada underperform their benchmarks. Several Mawer funds outperform their benchmarks but they are far from the exception.

  6. I hold fixed income (bonds and cash) in my portfolio for downside protection and for re-balancing possibility when market is down. Looking at preferred down with the common shares when market crushed, I feel it does not serve the purpose of fixed income for me.

    Reply
  7. Had a look at Wilson’s website after reading his contribution. Heads and tails, both in quality and competence, over the last third party interviewee. You don’t get referrals from companies such as Coke and Nestle by being a hack. (side note: I enjoy his website — not necessarily the content, but the layout and navigation is exceptionally clean and easy.)

    A few things I like about his recent interest rate article (which meshes with this pref shr article):
    1 — he took the time to analyze the rate cycles; we have rather short memories so this is a good portrayal of the whole process and where me might be headed.
    2 — he recognizes increased corporate debt costs, which can (and most likely will) effect dividend payouts.
    3 — he notes the “competition between bonds and equities” (mirroring my recent statement that I’d be looking at investing in debt in the future now that rates are on the rise). He’s the first columnist within the PF realm I’ve seen mention this market phenomenon.

    In regards to the topic matter, for most of 2016 I held the CPD ETF (iShares Canadian Preferred). Did ok, nothing spectacular. If one decides to enter in the pref shr market, just know what it is you are buying (e.g. how they function (‘share’ is a bit of a misnomer), what they are and what they are not, etc.). Rate-reset prefs are definitely something to look into — it’s basically an investment in math (vs opinion of the future).

    Reply
    1. Matthew seems to know his stuff, so I appreciated his collaboration on this one.

      Long-term, I simply don’t see how CPD could perform better than a basket of CDN dividend paying stocks. I looked at the MERs and the preferreds CPD holds, and I believe over the last 10 years the performance (favouring common stocks vs. CPD) is a no-brainer. It will likely be the same going-forward for the next 10 years. Just me!?

      Reply
  8. Like to thank you for this article – as I could not have explained it any better. Well done to the both of you. If you are a younger investor in his\her 20’s then stick with common stock. However, if you are in you 60’s than you will want some fixed income and preferreds are great for that. In fact I like them better (now) than bonds. Great solid income – yield – without the volatility of common shares. (i know, i know you can argue this but wait for when we have an over all market correction – you will see the common shares going down more than the preferreds). Look at it as a more stable income stream.
    OK, so now lets move on to why I like common shares (regardless of age – unless your in your 70’s). Like mentioned above – there is more upside in capital gains and Div increases with common shares – BUT…. its the splits that I LOVE with common shares. CIBC (CM) is due for a split ($108), RY ($94), BNS ($79) and others are ripe for a split. (and we all know what happens after a split – up she goes).

    Reply
    1. @mike: “OK, so now lets move on to why I like common shares (regardless of age – unless your in your 70’s).”
      75 and 100% Cdn Equities. Has to one fool in the crowd.

      Reply
        1. I am 75 yrs old and our portfolio is 100% Cdn in 18 stocks. No bonds, etf, funds, preferreds or gic’s. Hold about $35k-$50k in cash. What are suggesting for people over 70?

          Reply
          1. Do you have a pension from previous work? If so, does it cover all your living expenses? What portion of your funds / income come from fixed income like: CPP, OAS, other, etc? How much are you relying on your Divs? Do u need to cash in each year stock for capital gains $$ to pay the bills? How much is in each account (or income that comes from): RRSP, Non-Reg Act (I would presume your TFSA is maxed – correct?) or are you holding most in a RRSP or a Non-Reg Act?

          2. No Co pension just cpp\oas about $30k. We draw down about $20k in div’s from our DRIP’s. If we need more we take a portion of our rrif withdrawal, but mostly the shares get transferred in kind to the tfsa and joint account. Annual dividends from all accounts exceed $100k. Our annual expenses are in the range between $50k-$75k.
            When we began investing we had Mutual funds, bought & sold, tried to take profits and switched our holdings many times. We did not inherit money but saved over time and the income only began to grow when we switched to Income investing, following the Connolly Report strategy. Tfsa is maxed, and about 60% is in our rrif’s.

          3. There is no way I’m expecting to earn $30k per year from CPP and OAS. 🙂 Good for you to have it!

            “Annual dividends from all accounts exceed $100k. Our annual expenses are in the range between $50k-$75k.”

            Your estate is going to be huge!

          4. Cannew, WELL DONE! So you make over 100K in Divs – use only 20K (for living expenses) and roll the rest each year to the TFSA (in kind) and Non-Reg Accounts? Do you have at least 50K in Divs yearly from the Non-Reg Act (so you have little to no-tax)? {Make sure this is a joint Act – Then you can pull out $50K in wife’s name and $50K in your name with little to NO Tax. Plus easy to deal with in case one passes – other carries on}. Sucks if you have Divs in the RRSP and having to pay tax on RRSP withdraws (better in a Non-Reg Act). So many people built up huge RRSP $$$ only to be taxed on Everything when it comes out (including Divs). I hope you have a larger Non-Reg Act than RRSP. I would consider adding Preferreds at your age for the yield and safer | stable income. Have you considered Reits and others that offer a higher yield with ROC?

          5. @Mike: Unfortunately we do have almost 60% in our rrif’s, which means the withdrawals are fully taxed.
            We do own one Reit (which I regret) as it’s cut its div and our income dropped by almost $5k per year. Chased a bit of yield when we bought it. Should have stuck to the core holdings, But we still bring in much more than needed so it’s not a big deal
            As we’ve owned most of our stocks for some time (and added during low’s) and they have increased their dividend consistently so our yield on investment is quite high, more than any preferred or other fixed income source. Even if all our stocks cut their dividend in half I’d still generate more than needed to exceed expense. With FI you get NO growth of income and capital. My portfolio and income has grown every year, even during the financial crisis.

          6. Cannew, I’m in much the same camp as you although I didn’t begin with dividend growth investing until 2008. I’ve done quite well too. Thanks to exponential compounding from reinvesting my dividends I’ve averaged a little over 9% DGR per annum. The past 3 years its risen to a 12.7% DGR. Once I convert to a RRIF I expect the rate to fall to between 7%-8%. I just wanted to say congrats on your success to date. Only 1 dividend cut? Wow! I’ve had 5 including 2 during the 2008-09 downturn. Perhaps I’ve had more because I have a higher percentage of small-mid caps than most DGIs.

          7. @Bernie: Thanks and good for you as well. We hold a small number of Manulife ($10k) which was the other cut. Like you we’ve seen a lot of DG since the financial crisis. I’m not worried when then the next correction comes, as we have a good margin of safety. I believe our core holdings won’t cut their dividends (though some may not raise them).
            We can’t and probably don’t want to convince others, but let them know that, in our opinion and experience, there is an easier way to invest and to be successful.

    2. Mike, I’m with you.

      I LOVE to see my dividend increases 🙂

      CIBC (CM) is due for a split ($108), RY ($94), BNS ($79) and others are ripe for a split. Bring it on. You reminded me to write CIBC again on this!

      Reply
    3. “Sucks if you have Divs in the RRSP and having to pay tax on RRSP withdraws (better in a Non-Reg Act). So many people built up huge RRSP $$$ only to be taxed on Everything when it comes out (including Divs).”

      I prefer dividend growth stocks in my RRSP. The growing dividend income exceeds inflation so there is no need to sell capital.

      Reply
      1. Bernie, no need to differentiate between taking dividends and selling shares. When a dividend is paid, the shares drop by the amount of the dividend, so you have the same number of shares, but there are worth less. If you sell the same value of shares as the dividend, you have fewer shares but they are worth more. The two totals are the same.

        Reply
          1. Mike, I didn’t say that. When the company pays a dividend the share price drops by the value of the dividend payed out. If you sell a few shares (a home made dividend), you have fewer shares but the share price is more. The two totals (shares + dividends in both cases) are the same.

          2. Yes, the two totals (shares + dividends in both cases) are the same at that moment in time but future income and dividend growth will be less if shares were sold.

        1. @Mike. I realize this. I maxed my RRSP & TFSA accounts before adding to my non-reg account. I have dividend growth stocks in both. My strategy was primarily for dividend growth, but as it turned out, I also outperformed the equivalent equity indexes over the period I practiced DGI.

          Reply
          1. @Bernie. Nice! Now the trick is to get that $$$ out of the RRSP fast and let it grow in a non-reg account. That way any future Divs and Gains are taxed less or not at all. (depending on all sources of other income)

  9. Just a few fixes to a good interview:
    -CPD owns all Canadian preferreds not just the rate-reset ones. So it will behave based on what the mix of types of preferreds it holds.
    -XPF owns more than just rate-reset preferreds as the US has no rate-reset preferreds
    – There are Canadian rate-reset preferreds domiciled in Canada, but are priced in USD and are based on the US Gov 5 Year bond market. You still get the Canadian dividend treatment though and no US withholding tax. There exist a total of 6 of these kind.
    -Owning straight preferreds are really good in a declining rate environment as they have infinite duration, but are horrible for raising rate environments. Rate-reset and floating preferreds are horrible in a declining rate environment, but great in a raising rate environment.
    -You don’t have the option to reset the rate-reset preferreds. It happens automatically if the issuing company decides not to call them back for par
    -Par is almost always $25 so if you buy a preferred above par you will have a capital loss, if you hold to call, but the dividend may be much larger to compensate.
    -The option that is common among rate-resets and floaters is to convert your rate-resets to floaters or vice versa, on the reset date.
    -There are also rate-resets with what’s called a ‘floor’. ex. you can have a rate-reset that pays 4.17% above the Canadian 5 year rate or a minimum of 5% whichever is larger. However, these may never reset to a higher dividend because the company would most likely just call them back. Thus these tend to act like 5 year bonds.
    -Rate-resets give you a dividend rate based on the 5 year Gov of Canada bond market for 5 years then resets to a new rate based on the 5 year Gov of Canada Bonds at that time. In between the reset dates their is no change to the rate.
    -Floating Rate preferreds typically are based on the Bank Prime Rate or the Gov of Canada 3 month bonds. These reset their rates mostly on a quarterly bases, every dividend.
    -The preferred market is extremely inefficient and alpha can be generated in excess of the costs through active strategies. If you don’t want to do the research for single line items, I would suggest looking at RPF, HFP, and HPR for active managed ETFs. Don’t invest in them if you don’t understand them. If you do want to look at the individual preferreds, the prospectuses will hold the critical info you need to know. Excel spreadsheets help greatly in organizing that info.
    The preferred share market is complex and very unforgiving to those who don’t understand it, but can be very profitable to those who do.

    Reply
    1. Very detailed comment, thanks!

      re: CPD – yes, owns all Canadian preferreds. Updated post.
      -XPF – kept “Exposure to a diversified portfolio of U.S. and Canadian preferred shares” to align with BlackRock.

      Agreed – owning straight preferreds are really good in a declining rate environment but not a good idea now as rates climb….

      Agreed – “rate-resets” are better in raising rate environment.

      Yes, rate-resets give you a dividend rate based on the 5 year Gov of Canada bond market for 5 years then resets to a new rate based on the 5 year Gov of Canada Bonds at that time. In between the reset dates their is no change to the rate – which is not good since I want my dividends to increase 🙂

      Do you own them?

      Reply
      1. I do have some rate-resets and have been mostly successful with them. Surprisingly most of my gains in them have been capital gains, but because of the rate increases and future expectations of more rate increases. They’ve outperformed my equities portion by a fair bit so far this year.

        Reply
        1. Thanks for sharing. For me, that begs the question – if mostly from capital gains, why not common stock or ETFs then?

          “They’ve outperformed my equities portion by a fair bit so far this year.” That’s because the TSX is largely flat.

          Reply
          1. I believe you answered your own question 🙂 The capital gains are mostly from discounting the future dividends. With anticipated and current rising rates, those higher future dividends make the preferred worth more now. The math on future returns with rate-resets has less variables than commons and thus more predictable. My online discount broker says my trailing 12 month return is 24.71% and I have just over 40% in preferred shares/units. I tend to have a core Canadian portfolio with parts that are alpha seeking. I use ETFs for the US and international parts. Lately I’ve been avoiding bonds, because a 5 year GIC ladder has been yielding more than a 5 year bond ladder. Also, I don’t want to up my duration risk, to get a higher yield, in a raising rate environment. This is in no way a recommendation for others to do as I do, just a poor explanation as to what I’m doing.

          2. Maybe I have 🙂

            I’m just not sure I have much to gain in my asset accumulation years with preferreds. In 10-years, during early retirement, maybe…

            I have 30 CDN stocks (banks, lifecos, pipelines, utilities, etc. – the usual suspects) and then I tending to use VYM more for my U.S. assets and gravitating to owning more IDV in the coming years (vs. VXUS) for my international assets for income. I need to turn on the income taps in another 10 years.

            This is my broad plan:
            https://www.myownadvisor.ca/cash-wedge-opening-investment-taps/

  10. Garth Turner (old finance minister) says:

    Portfolio should have:

    “So, 2% cash in a HISA, 20% in a mixture of government, corporate, provincial and high-yield bonds plus 18% in preferreds make up the safer stuff. Put 5% in REITs, then hold 16% in Canadian equities, an equal amount in US markets and 23% in internationals, for the growth portion. Rebalance once a year. Put higher-taxed stuff (bonds) in a tax shelter. Reserve the TFSA for fast growers (like emerging markets). Enjoy a 50% tax break on capital gains in your non-registered. And don’t forget about income-splitting with your squeeze, which can be done through a spousal plan or maybe a joint account.”

    FYI: My portfolio doesn’t look like that! (not even close)

    Reply
      1. He doesn’t get huge declines when the market tanks and his portfolio bounces back quickly. But averages 6-8% yearly over longer period of time. He is older than you and doesn’t want to stomach looking at huge paper losses over a 1-3 market correction at his age. Conservative, Contrarian. Growth with Fixed = Balanced.

        Reply
        1. I hear ya. FWIW, I’m 100% equities with my portfolio and no fixed income, although to answer your question to cannew, I do have a workplace pension to draw from in my future. 16 years in now. DB. I consider that my “big bond”.

          Reply
        2. This is the portfolio he and his 2 colleagues advocates for clients. Not sure if Garth invests that way himself- doesn’t matter to me anyhow! They claim to aim for 7%. IMHO, that’s high.

          A claimed 60/40 allocation but with FI he tries to beef it up substituting bonds for a lot of preferreds/some high yield, and for a while was pumping RRBs. (not really a true 60/40 as preferreds are a hybrid (not FI) and with 18% that’s a lot more towards the riskier side). For decades he’s had a bias to preferreds pumping them hard even several years ago right when most tanked 30-50%. Easier to push them after that drop and interest rates on the floor.

          For the equity side typical 20/20/20 CDN/US/INT but he tilts one or two of these a few percent depending on what their crystal ball is saying. From following him somewhat over 5 years or so more often than not the crystal ball has been wrong but I think the 2 “real” financial advisors he hired last year may be helping.

          My portfolio is quite close to that but with only a small amount of prefs, no hi yield, much more cash, and geographically more equal balances for the equity with CDN being the largest.

          Reply
  11. One additional note on the BMO etf ZPR. It seems that, in light of the dramatic fall in the price of the rate-reset preferreds due to the 2015-2016 interest rate cuts, many of the issuers of rate-reset preferred shares have taken steps to mitigate the downside risk from such actions by issuing new rate-resets using a similar reset formula as previous but with an additional “floor” rate. Thus, if the reset formula for a particular preferred is BOC 5 yr. rate + 3%, most newer issues will include a floor rate of say 5%. Thus, when the reset occurs in 5 years, it will be the greater of the two components of the reset formula. (Ie: BoC 5 yr rate + 3% OR 5% whichever is higher.

    WB

    Reply
      1. From the tenor of comments I’ve heard from most central bankers lately I’d guess that the majority of them want to move away from the near zero or negative (in some countries) interest rates and get back to rates of a more normal level.

        What that magic normal number is, is anyone’s guess but I’d certainly expect it to be above 2%.
        WB

        Reply
  12. Agree. This seems to be where the world is headed and Canada is likely to follow (especially the US). However, Nafta, oil, CDN’s debt, dollar etc etc are possibly factors.

    My crystal ball is truly hazy but I guess between 2 – 2.5%. That’s going to mean a lot of pain for some people.

    Reply
    1. May def mean a lot of pain for some ppl with big mortgages but on the other hand will make for higher yields on safer investments like gic’s, bonds etc. which should allow a lot of retirees to deleverage out of equities and get back to a more traditional portfolio balance and earn enough to support themselves through a long retirement.

      PS: Some of us can recall having mortgages with rates in the neighbourhood of 15-18% in the 80s and 90s. Even though the Value of the mortgage was less than the average of today it was still a hard pill to swallow.
      WB

      Reply
      1. Hey WB,

        Yes I am retired and with FI so from that standpoint welcome rate increases. Although there is usually a corresponding cooling effect on stocks. 12% or so was the highest I ever saw mid 80’s but had less than 10 years of paying mortgages

        Reply
        1. I purchased my first home in 1982. I used a mortgage broker to get me the best rate…17% over a one year term…boom! The next year I managed to get 11% over three years.

          Reply
  13. re: “This seems to be where the world is headed and Canada is likely to follow…between 2 – 2.5%. That’s going to mean a lot of pain for some people.”

    Which is crazy! Ten years ago when I was looking to buy a house, my research said long-term rates (up to ~2005) averaged ~10%. To quote Matthew Wilson’s research, “Between 1990 and 2017 Canadian interest rates have averaged 5.92%” – basically half of the historical long-term average…and now the new normal might be half of that again.

    The crazy part is that rates increasing to a level 75% BELOW historical averages will still cause “a lot of pain for some people.” We might want to include a few corporations, pension plans, and financial instruments in that “people” demographic.

    Reply
    1. Absolutely 100% correct on all of that!! Good that you actually did research. How many don’t even think of what a couple of percent raise means?

      My 2 personal mortgages ranged I think had between 10 and 12% interest rates. Fortunately they were paid for quickly.

      Reply
    2. “”Between 1990 and 2017 Canadian interest rates have averaged 5.92%” – basically half of the historical long-term average…and now the new normal might be half of that again.”

      While interest rates might slide up – I can’t see them going to the average of 6%!

      Reply
          1. Guilty here too.

            Just got in from a wonderful beach fire, had a number of beers too. What am I doing blogging now??

            Got to head to bed now. I know….lame.

  14. “There is no way I’m expecting to earn $30k per year from CPP and OAS. 🙂 ”

    Mark, we’ve had this conversation before. You may not expect it but that’s probably conservative on what you & working spouse will get (PV) if you stop at 50 and wait until age 65. Ours will be 34K (PV) with ~ equivalent # contribution years as that @65. Around 28K @ 60.

    Plug the CCP numbers into any number of calculators, and add OAS.

    Reply
  15. Mark, I don’t any preferreds as I think it’s just adds an unnecessary level of complexity. This article shows that over the last 10 years, preferreds have actually, at the portfolio level decreased returns and increased volatility.

    https://www.pwlcapital.com/pwl/media/pwl-media/PDF-files/White-Papers/2015-02-20_PWL_Kerzerho-Bortolotti_The-Role-of-Preferred-Shares-In-Your-Portfolio_Hyperlinked.pdf?ext=.pdf

    True, that was during a period of falling interest rates, so the next ten years may look different. As they say, the worst period for any back test is the next 10 years. The way I look at it, everything is a stock or a bond. You own equities for return and high grade bonds to decrease volatility so you don’t panic sell equities in a crash. So I keep fixed income safe, and don’t own preferreds for the same reason as I don’t own junk bonds – they have equity like volatility, so I might as well just own more equities. If you do own preferreds, they ought to be regarded as part of risk side of the portfolio, (they are not bond substitutes), and should not be kept in registered account as you loss the tax advantage in these accounts.

    Reply
    1. Mike, as general rule, if your income is under about $50k, use a TFSA followed by a non- Reg account. If more than about $50k, use an RRSP and put the refund in a TFSA. When both filed up use a non-Reg account. This assumes your marginal tax rate in retirement will be less than or equal to when your are working.

      Reply
  16. ” Sucks if you have Divs in the RRSP and having to pay tax on RRSP withdraws (better in a Non-Reg Act). So many people built up huge RRSP $$$ only to be taxed on Everything when it comes out (including Divs).”

    Mike, that’s not true. Assuming a 50% marginal rate when money goes in and out of your RRSP. Half of the money in the RRSP is yours and half belongs to the government – remember the tax deduction you now have outside the RRSP. Your half of the RRSP grows tax free as does the government’s half. When money is taken out half goes to the government and half goes to you tax free. So the half that goes to you is your half plus all the tax free growth with no taxes payable on your half when it is taken out of the RRSP (just the same as an TFSA), so all the dividends received over the years for your half are not taxed at all, neither the growth or when taken out of the RRSP – better than the dividend tax credit in a non registered account. This is a common misunderstanding about RRSPs.

    Reply
    1. @Grant. Only allowed 18% of income to contribute…..Plus, not the same at all!! But..Its the gains that u are now paying tax on. Ex: say your $$$ that went into a RRSP over time was $250K and over the years your RRSP grew to $750K. That 500K profit (gain) is taxed in an RRSP when withdrawn more than if it was in a non-reg act. Not taxed as much (or at all) if it was in a non-reg act – when pulling out and you know what your doing. As for the Divs….. Pull 50K Divs out of your RRSP act and get taxed. Pull 50K in Divs from your no-reg act and pay no tax!. There is a difference. No matter what you do in an RRSP act YOU are TAXED when you pull money out . But in a non reg act – you could pull out 50K in Divs and your spouse could also pull out 50K and not pay any tax. Thats 100K out of a npn-reg act with no tax! RRSP cant offer this.

      Reply
      1. FYI: I have no RRSP. However, I did have one during my working years, but it was treated as an emergency plan {if wife went on maternity leave or one of us became disabled (and I did for three years) – we would draw down the RRSP when our incomes were lower}. Once we retired, I knew we had to use these funds first and draw them down (pay some tax) – so we could invest more in our non-reg accounts – where gains and divs are taxed much lower or not at all. RRSP also good for people to get them to invest for retirement as the Gov gives you a break on current taxes, but if you know what you are doing (later in life and closer to retirement) – you realize the RRSP is a TAX BOMB! If you have not opened a Non-Reg Trading Account – Go do it this week and start your Div investing.

        Reply
        1. “….you realize the RRSP is a TAX BOMB! If you have not opened a Non-Reg Trading Account – Go do it this week and start your Div investing.”

          Agree to some extent. Our goal is to max out x2 TFSAs and x2 RRSPs and have a healthy non-reg. account churning out; all collectively churning out a few thousand per month in dividends.

          Reply
      2. Mike, I’m afraid that’s not correct. Say your marginal tax rate is 50% when you put money in your RRSP and 50% when you take it out. You put $20k in and you get a tax refund of $10k. Now in your RRSP you have $10k that belongs to you and $10k that belongs to the government, call it the government account, and you also have $10K in your taxable account (the tax refund). Sometime later your RRSP has grown to $100K, $50k is your account and $50k is the government’s account. You take out $100k and will have to pay $50k in taxes. It feels like you are paying a 50% tax rate, but in reality you are giving back to the government it’s $10k plus all the growth (total $50k) and keeping your $10k plus all the growth on it so paying no tax on the growth of your account or no tax when you take it out. Zero tax on the dividends is better than the dividend tax credit in a taxable account. You can read more about RRSPs here,

        http://retailinvestor.org/RRSPmodel.html

        Reply
        1. Grant, Using your numbers above:

          RRSP – put in $20K – get refund $10K. RRSP grows to $100K. Cash in RRSP and pay 50% tax = $50K. You make $50K plus the $10K rebate = $60K for you. (keep in mind you are also taxed on the $20K contribution when withdrawn.)

          Non-Reg Account – put in $20K – it grows to $100K. You cash it out and are taxed on the gains only (not the original $20K). So with the $80K capital gain only 1/2 is taxed = $40K X 50% tax rate (using your numbers above) = $20K tax owing.

          Conclusion: RRSP – you walk away with $60K. ||| Non-Reg Account – you walk away with $80K. However, if some of the $$$ was in divs – you would be walking away with even more from using the Non-Reg Account. NOTE: (With an RRSP you are deferring tax on ALL the $$ in the plan. You are paying tax on ALL withdraws – including the money you contributed with that you have arguably already paid tax on. (that $20K contribution was net $$ from a salary – so you paid tax on it b4 getting the $20K in the first place to use as a contribution. Then taxed again on this $20K when you withdrew it). Looking forward to your reply. Mike

          Reply
          1. Mike, your two examples are apples and oranges. You need to understand that you only own half of the money in your RRSP (assuming 50% tax rate), the government owns the other half. If you the compare an RRSP to a taxable account you need to account for taxes payable annually and state the number of years and compound accordingly, and use the same time period for both accounts.

            To keep it simple, lets use 1 year. You put in $20k, and get $10k refund for you taxable account. Now you have $10k belonging to the government and $10k belonging to Mike in your RRSP and $10k in your taxable account. After one year your RRSP, assuming 5% capital gain 2% dividend, has gone up to $21,400. You cash it out and are left with $10,700. Your taxable account has grown to $10,700 before tax and after tax, $10,475 if in foreign stocks and $10,525 if in Canadian stocks.

            So, in your RRSP the government $10k has gone up to $10,700, but you have to give it all back to government when you cash out, and Mike’s $10,700 is taken out tax free, no tax on the growth or on removal. It feels like you have paid 50% tax but you just gave the government’s money back to the government and kept all your gain paying no tax at all. From Mike’s account in the RRSP you net after tax, $10,700 but only $10,525 in your taxable account. Clearly, paying zero tax on your dividends in an RRSP is better than paying the dividend taxes in a taxable account. You are better of investing in an RRSP (recognizing you own half of the money there), than a taxable account because you pay no taxes on the growth of your part of the RRSP, or when it’s taken out, and invest the refund in a taxable account, or better still a TFSA. I strongly suggest you read the retailinvestor link I included above which deals with other RRSP myths as well as this one.

            Mark, apologies for taking up so much room in your blog, and off topic.

          2. Mike & Grant,
            How and where do you come up with a 50% tax on RRSP income? In BC, where I live, the highest marginal rate is 47.70% and that is for taxable income above 200K. The average individual, 45K-76K pays about 28%. Heck its even below 40% up to 106K.

            Mark, I also apologize for inadvertently hijacking your excellent blog. We’ve kinda gone off topic here.

          3. @Grant. We all know the benefits of the RRSP. Great for people that have high incomes and for those that would not have invested otherwise. My point is very simple. All the growth inside the RRSP is taxable at a higher rate than if the funds were in a non-reg act. As you say: The Gov owns 1/2 – it owns 1/2 off all that growth you do not get that you would get inside a non-reg act. (using your 50%). What would you rather have at age 65 – 3 million in a RRSP or $3 million in a non-reg act? or in other words: What would you rather have at age 65 – 3 million in a RRSP taxed down to 1.5 Mill? or 3 million in a non-reg act that is 3 mill in your pocket? Personally I like to be in control of my money and with an RRSP you have rules (RIFF & Min withdraws, etc). As for the Divs – There is no question holding Divs in a non reg account is much better. Especially ones that grow each year. Pull out $100 K in Divs from your RRSP act and pay that tax! I am happy collecting my 100 K in Divs from my non-reg act and not paying any tax. However, one nice thing about the RRSP is its a better place to hold your USA ETFS (that I know you have, LOL). But, you need to understand its not just about the $$$ in a plan and how it gets in there – its about taxes and how to get your money out without having to pay taxes. Like I said, The RRSP is full of assets that have not been taxed yet and with the non-reg act you control it and can save on paying taxes! I could go on – but I don’t think we will agree. Most Canadians should fill in their TFSA first and depending on their income should consider the non-reg act first if they are going to be a Dividend Growth Investor. However, to be clear – I am not saying not to have an RRSP – there is a use for such a plan. But what I am saying is – once your TFSA is full – consider the tax advantages of the non-reg act!

    1. I haven’t forgotten about capital growth, I’m just not overly concerned about it. I invest for dividend income and dividend income growth. Capital growth comes with the territory but its not what I primarily invest for. If one is selling dividend growth stocks for income in addition to their cash dividends would their total return not be adversely affected over time due to the declining share count?

      Reply
      1. No, because of the capital growth. The size of portfolio may decrease over time (but not the total return) depending on the rate of withdrawal, but that is a planned reduction as one spends down the portfolio in retirement, at a rate (4-5% depending on what particular withdrawal strategy being followed) that will last at least the planned time. You are spending dividends, interest, capital gains and eventually principle. If you restrict yourself to only spending income, you need to save more, or spend less in retirement than with a total return approach, and you will also have a less diversified portfolio as you don’t own any non dividend payers.

        Reply
        1. What I meant to say is…If one is selling dividend growth stocks for income in addition to their cash dividends would their “capital growth” not be adversely affected over time due to the declining share count?

          Yes, a larger portfolio is required if one is to solely live off the dividends but if this policy is strictly adhered to there is zero chance of running out of money during drawdown.

          Reply
          1. Capital growth of the shares you own are not affected. The size of the portfolio is affected.

            Agreed, but there is a price to pay for certainty in just about anything.

        2. @Grant. You do not need to have non-dividend payers to be diversified. Although it could be good to have some growth stocks in one’s portfolio – its not required to be fully diversified.

          Reply
          1. Agreed. Many dividend growth stocks are also growth stocks and due to their greater volatility growth stocks don’t necessarily grow.

          2. Actually, diversification is the only free lunch you get in investing, so you might as well get as much of it as you can. By definition, if you leave out non dividend payers (something like 40-50% of all stocks don’t pay a dividend), you are much less diversified than you could be. To be properly diversified you need to be globally diversified, and not own just Canadian and some US stocks.

          3. Grant – “Actually, diversification is the only free lunch you get in investing,”
            Mike – Wrong!There is no free lunch in investing!

            Grant – “By definition, if you leave out non dividend payers (something like 40-50% of all stocks don’t pay a dividend), you are much less diversified than you could be.”
            Mike – Wrong Again! Diversification has nothing to do with a dividend stock or a non dividend stock. Its to do with asset location, allocation, classes, sectors etc etc.

            Grant – “To be properly diversified you need to be globally diversified, and not own just Canadian and some US stocks.”
            Mike – I agree to some point but thats not all. To be properly diversified, you would want property (home or rental property), a business (for income or a job), Fixed income, etc etc. (not just stocks)

    1. @Grant: We can all find qualified opinions which match our own! I personally like the following by Warren Buffett:

      Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.

      A lot of great fortunes in the world have been made by owning a single wonderful business. If you understand the business, you don’t need to own very many of them.

      We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort level he must feel with its economic characteristics before buying into it.

      Diversification may preserve wealth, but concentration builds wealth.

      Reply
        1. @Grant. ” I agree that works for those very few of the calibre of Warren Buffett. For the rest of us mere mortals, diversification is important.”. No disrespect – but that made me laugh!

          Reply
        2. @Grant: ” I agree that works for those very few of the calibre of Warren Buffett.”
          I disagree that it will only work for the few. Maybe I should add that it can for for many if they take the time to identify good companies and stick with them and avoid the average, ipo’s, rising stars, last years winners and cyclical.
          We may never make the fortune W.B. has but we can gain from his advice and do very nicely.

          Reply
      1. I would largely agree because Buffett wouldn’t have built his wealth on index funds.

        He endorses them now because a) he’s old, b) there is more literature now on the subject and c) it’s good estate planning.

        Reply
    2. @Grant “Clearly if you leave out 40-50% of all stocks, whether they are dividend payers or not, you have a much less diversified portfolio.” Again – with no disrespect – This is just plain B.S!. So clearly you are suggesting that we should not leave out 40-50% of all stocks. Your joking right? Why not than buy all the stocks (all 100% of every stock out there) to be completely diversified? Why only 40-50% and leave out 50-60%? This is getting comical – it really is! You are suggesting to buy 600-800 different stocks (50% of all stocks). I think I will stick with the top 30-40 and leave the 770 low grade, speculative stocks for people like you to buy – who think they need them to be diversified. I guess you love ETFS then!

      Reply
      1. Well, there are a number of stock picking strategies, DGI probably being the most popular, that many investors do very well at and more than meet their financial goals. However, if you look at the financial literature, the data is very clear that a globally diversified portfolio of index funds will give you the best shot at the optimal outcome.

        Reply
        1. “However, if you look at the financial literature, the data is very clear that a globally diversified portfolio of index funds will give you the best shot at the optimal outcome.”

          If past performance is any indication, for the average investor, I would agree – strive to be average and diversify their equities – although I still don’t believe bond ETFs are a good choice for many investors in their asset accumulations years. Just my take Grant!

          Reply
          1. I agree about bonds. They are there mainly to smooth the ride, so if you don’t need the ride smoothed, you’ll likely get a better return without them.

  17. @RBull – why hold so much cash? Invest it and use your LOC for an emergency!

    @Mike, the answer is quite simple. Different strokes for different folks. Eveyones idea of “so much cash” is quite different.

    My cash is “invested” in a HISA generating a satisfactory return for me, and is considered as part of my overall FI component in the asset allocation that I maintain. We are comfortable with our positions and don’t “need” to invest it elsewhere, particularly anymore in equities at this stage of the cycle. Although we do have a HELOC and LOC, I plan for financial “emergencies” without having to use them.

    Reply
  18. Bernie, I used 50% for simplicity, for illustrative purposes only. The principle is the same no matter what your marginal tax rate is.

    Btw, in Ontario, the top marginal tax rate has soared to 54%, the fourth highest marginal tax rate in the world! Thanks, Justin and Kathleen.

    Reply
  19. James Hymas makes a good case that “long-term bonds and preferred shares have characteristics that make them a very useful asset class for retirement portfolios”.
    See: http://www.himivest.com/media/SecurityIncome.pdf
    I think this is true but likely only if you have accumulated a large enough port. such that you don’t need capital appreciation and can live off the income thus generated with bonds in sheltered accounts and preferreds in unregistered.
    I have found that income from the above is more predictable in retirement than stock dividends where companies can more easily cut or reduce dividends than they can their bond interest.

    Reply
    1. Interesting take Jon. So how do you structure your portfolio with preferreds and fixed income to deliver the income you need? What % of each? Do you own any dividend growth stocks at all?

      Cheers,
      Mark

      Reply
    2. Jon, Larry Swedroe, who writes extensively on bonds and consistently uses evidence to back up his recommendations, advises not to own bonds longer than 10 years as you get more risk (volatility) than return and suggests owning a 10 year government bond ladder (which balances term and reinvestment risk) or it’s index fund equivalent, an intermediate term government bond index fund or ETF. He also advises against corporate bonds as the credit premium is minimal and does not diversify equity risk. If corporate bonds are used they should be short term and investment grade, so a total bond fund is a good alternative to an intermediate term government bond fund as it has a similar average term. In other words, take your risk on the equity side and keep your fixed income safe.

      Reply
      1. Hi Grant,
        Theory vs reality! Swedroe’s theory is nice but is based on “evidence” which is retrospective. He can’t do prospective studies! The world is changing. What will a world war do, trade wars, etc? Risk mitigation is a priority for me and fixed income is safer obviously.
        In retirement, risk does not equal volatility. Risk is not having income! Income can be derived in retirement differently depending on one’s tolerance of volatility yes. If you are a total return investor (who needs to sell) than yes don’t do long bonds. But a high equity port. will also be volatile esp. in times of uncertainty.
        Short bonds can’t provide me with the income I need. Dividend stocks are good but again in times of uncertainty realize dividends can be reduced or cut. I need predictability of income going forward which my port. provides (to date!). Hopefully, pending default of Canadian gov’t bonds that will continue :).

        Reply
        1. Jon, Swedroe’s advice is not theory, or his opinion. It’s based on the evidence. Of course, you can’t do prospective studies, but it’s only rational to look at the historical evidence and plan accordingly. Risk in retirement in is loss of purchasing power and running out of money. There is enormous inflation risk in long term nominal bonds, and we are hard wired to better understand short term risk (volatility), not so much long term risks.

          There’s nothing wrong with an 80% bond, 20% equity portfolio if you have enough capital to only need to keep up with inflation (which 20% equities will likely do), but if interest rates rise you are better off with intermediate or short term bonds as you can reinvest the capital at the higher interest as the shorter term bonds mature. If you receive X$ from a 30 year bond, you will receive 0.24X$, assuming trend line inflation of 3%, in real (purchasing power ) in 30 years, and the bond principle you get back will also have that same reduced purchasing power. Do you own individual bonds, or bond funds?

          Reply
          1. Hi Grant, are you retired? Thank you for “There is nothing wrong” with a 80/20 port.
            It’s true income is used to purchase. If the income is insufficient then common sense says purchase cheaper things and live within your means. I’m a minimalist 🙂!
            The difficulty is there is no guaranteed portfolio. Asset allocation based on Modern Port. Theory assumes too much. It is based on efficient markets (not true) infinite time horizon and statistical analysis such as reversion to the mean which depends on long time horizons like for pension funds. Being in a traditional 60/40 may not work in retirement where my time horizon is short and a bear market lasts 5+ years necessitating me to sell capital at a loss. What’s your port. in retirement?

  20. 80% long term bonds: 70% gov’t/30% corp.
    20% equity: 10% preferred/10% large cap dividend stocks
    Principal volatility high (as you would expect with long term bonds) BUT income stable.

    Reply
      1. Long bonds work like your pension does providing stable income to meet living expenses in retirement. The key is “stable income” and to mitigate sequence of return risk. I don’t have a pension. So my bond port. is that. Pensionless folk have a daunting task going forward in retirement. If they don’t have a large enough port. to do “Lots of bonds” they are forced into equities which put them at risk of depleting their port. early given a prolonged bear market since they have to sell for income. It’s daunting in retirement. I’m fortunate to have a large enough port. to do bonds for income and not have to sell anything. Thoughts?

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        1. Jon, I disagree that pensionless folks have a daunting task in retirement. There are numerous ways of dealing with sequence of return risk that avoid selling equities in a down turn no matter when it occurs in retirement.

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        2. Well, we won’t be able to tap our pensions until age 55, with major penalties at that, but I suspect by then conservatively they will be worth about $300k each – so mine should yield a good $15k per year cash for life and my wife’s should be similar.

          “Pensionless folk have a daunting task going forward in retirement.” Absolutely, which is why you have 80% bonds I suspect? Seems very high to me.

          Then again, smart investors only take on the requisite level of risk and nothing more. So, if you’re fortunate enough to have a large enough portfolio to live off bond income, and some dividend income, without selling anything – well – that’s great. You’ve met your goals and risk tolerance this way. No? 🙂

          Mark

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          1. Hi Mark,
            “You’ve met your goals”. Saving for retirement and starting retirement all hang on the most important question to answer: what income you need in retirement? That question is rather abstract in the accumulation phase of life. Financial planners will scare you suggesting you need more and may push you into more riskier assets as a result. Taking risk in these times of media noise regarding world events equals stress. Stress robs you of daily happiness.
            Income affects daily happiness. What’s the correlation there?
            http://www.businessinsider.com/nobel-prize-winners-figured-out-the-perfect-salary-for-happiness-2015-10
            Deaton and Kahneman found that “everyday contentment” increases up to $75,000, but then starts to level off after that. My wife and I would agree :). That works for us in retirement. It’s enough for day to day happiness. Have you and your wife thought hard about this?

          2. Have you read the Kahneman book Thinking Fast and Slow? Awesome.

            Assuming my wife and I are debt-free we’ll be very happy living off $75k per year. We’re just not “there” yet. We have absolutely discussed that.

            Where are we? Only about $50k per year in income in our early 60s assuming the following after taxes:
            1) non-reg. portfolio today
            2) TFSA assets today
            3) RRSP assets today
            4) DB x1 + DC x1 worksplace pensions (~16 years in today)
            5) Small LIRA today (<$35k) 6) CPP x2 + OAS x2 = assuming that will be about $20-30k combined, conservatively. So ways to go I believe.... Mark

    1. Jon, very interesting and probably very unique approach. About 4-5 years ago I was also looking into this type of plan but the volatity and lack of capital growth are issues since I would also like to deplete capital over time. I expect you have an extensive ladder approach set up for the corporates and govt long bonds, holding to maturity. What is duration range in years? With long bonds you must see some serious price valuation fluctuation when rates change and probably harder to see with rates rising!!! Are your preferreds and dividend stocks all individual picks?

      If you don’t mind sharing I’m curious just what your overall approach currently yields. Without details I did some quick mental math and was thinking 3 – 3.3%.

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      1. @RBull
        Hi, I don’t need “capital growth” nor a current need to sell although I have taken capital gains when interest rates fell. I use ETFs. Mostly XLB and ZMU and CPD. My dividend stock portion is individual stocks numbering 35.
        Yes, currently a yield of 3-4% from the port. is sufficient to meet my income needs. Volatility for sure with long bonds but unless you sell it’s just noise :). As I’ve said above, this is a personal approach and only works for those whose port. is sufficiently large to not need capital growth. My port. is interest rate sensitive but it allows me to sleep nights since I don’t care about the stock market. My equities are there only as an inflation edge. What is your approach? Are you in retirement?

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        1. Thanks Jon. I get it. Interesting with the ZMU.

          Yes, I am retired. My wife has a moderate DB pension but we are not yet eligible for CPP or OAS. I have a typical 60/40 equities to FI allocation.individual dividend stocks for CDN, etf’s for international and US equities and small pref position. FI is a mix -bond ETF, GICs, individual corp strip and corp bonds, HISA cash.

          At this point we live on cash flow generated from investments and work pension. No drawdown…yet. My plan is built on 3.5% total return, 1% real return so this is partly why your strategy interests me.

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        2. We hope to be the same Jon….”My dividend stock portion is individual stocks numbering 35.” Hoping for about 4% yield and nothing more. Certainly having a $1 M portfolio yielding 4% should meet most of our basic needs. Looking forward to that day 🙂

          I assume you own a mix of CDN and U.S. stocks – or is the 35 just CDN dividend paying stocks?

          Cheers,
          Mark

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          1. Hi Mark,
            Mostly frowned upon by financial planners (who major on total return) my port. strategy is income generation of $75000 before tax and principal drawdown only for emergencies. My equity portion is an inflation hedge but also there to generate income to topup the bond interest. Therefore, I only buy large established companies that I know and follow. Only Canadian companies which are easier for me to follow and understand. I need companies that can sustain their dividend payouts and so capital growth is secondary.

          2. Impressive. Like you, I also buy established companies I understand. I desire companies that can sustain their dividend payouts as well – so growth for me in about 10 years or so (early 50s) will also be secondary.

            Thanks for sharing.

    1. Hi MIKE,
      I’m not planning to sell my Long Bonds, but just live off the interest which won’t go down with rising short term interest rates and perhaps my interest will go up as some of my long bonds mature and new ones with higher coupons get added :).
      Your situation may be different. Realize that if you’re into ETFs, then even VAB has about one third of its holdings in long term bonds and some would say don’t buy VAB for exactly your reasoning. But, it depends always on your own situation. Thanks for your reply MIKE :).

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  21. @Jon. It appears you have invested to preserve your $$$ (while making income that you are happy with) – and that you may not like risk as much as others. Q: have you looked back over the past 7 years and wished you had some more of that growth the stock markets have provided? I know you have 10% in equities buy what if you had 30 or 40% in equities? and…. thanks for contributing to the conversation – very refreshing 🙂

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    1. Mike, financial journalist is not the same thing as financial expert. With interest rates low, returns on bonds will be low. If interest rates do go up there will be a price drop for bond funds, but it is temporary. If you hold a bond fund for it’s duration, you will get your money back due to maturing bonds being rolled over to new bonds with higher interest rates. Even with interest rates low, the “flight to safety” that occurs (investors buying high quality bonds) when stocks crash will still occur causing these bond funds to rise in price, thereby reducing the volatility of your portfolio and giving you more money to rebalance and buy equities at depressed prices, the main reasons for holding bonds in the first place.

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  22. @grant, If we brought into a room 100 so called financial experts / advisers and asked them all the same question: :Where should I invest my money?” We would get different answers (diff stocks, bonds, mutual funds, etfs and so on). IMO a financial journalist is the same as a financial adviser. Why I say this? Because there’s terrible financial advisers as well as terrible financial journalists. Both do research in the same area and both try to move an audience in their direction. (just in different ways and have diff educations)
    Ask a realtor broker what is best to invest in – a rental property or stocks? You know what their answer is and why. Now ask a financial adviser the same question and what would he say? Both make commissions off of what we do with our money. However a financial journalist might offer a more balanced view. I have sat down with a few financial advisers (and so called financial experts) over the years and my first question is always the same: How much money do you have invested and where? Most of the time, they do not want to answer this simple question properly and when they do, I say “show me”. The meeting ends. I like hearing from older experienced investors or even better, I have learned from experience (over the years). My guess is from reading your comments in this thread is that you are a Financial Adviser? that reads a lot of books / blogs etc and form your opinions from what you read. In my case, I have Experienced what works and made it. People like me do not need a financial adviser but rather enjoy reading from financial journalists.

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  23. Mike, I agree there are some terrible financial advisers out there (as well as some excellent ones) who put their interests ahead of their clients, but an adviser is different from an expert. An expert bases their advice on evidence from the financial literature, not someone’s opinion. The financial expert I have learnt the most from is Larry Swedroe, who always references the evidence in his many books and articles. In fact, whenever he states his opinion, he always precedes the comment with IMHO, so it is clear to the reader.

    I am not a financial adviser. I’m just someone who has an interest in investing and personal finance and read fairly widely around the subject. We use peer reviewed evidence in many aspects of our lives. It just makes sense to me to practice evidence based investing. It’s interesting to hear diffferent investors opinions, especially those with experience, but when it comes to putting my own money at risk, I prefer to go where the evidence points.

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  24. Grant. Evidence is good and so are Opinions and Literature. But, there is no one right way to invest. But many wrong ways. As for Experts – IMO there are none! I cant find one person that has been right all the time or could call a market crash every time. For me, I never looked at investing in stocks etc as a way to make a lot of money. Although, I have beat the TSX many years in a row. (a lot of money to me is a return of 100% or more in one year). It really is a place for me to park money while I decide where is a better place to leverage my $$ in a better way.
    It was not fun being an average investor (many years ago) and I cant understand why people continue to follow each other and are happy with average predictable results. So many people are scared of losing – while people like me are wired not to lose. Of course we lose (learn) along the way – but making mistakes were only temporary and (i guess) required to get me to where I wanted to be. But let me tell you something – if you stick with the way you think – that being evidence, evidence, evidence – you will be held back from some of the best investment opportunities that will come to you. You will let pass by – because evidence (history) doesn’t support a decision to pull the trigger.

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  25. Innvesting is not about timing the market or finding the next big winner. That requires predicting the future which no one can do consistently. Investors who do that remember their winners, but conveniently forget about their losers, and most don’t benchmark their portfolios, so don’t even know they are underperforming market. I’d take market returns any day because market returns are better than what the vast majority of investors actually get. That’s what the evidence shows.

    Some investors find indexing too boring so won’t be able stick with it, and certainly there are several other strategies that work well and will get you where you want to go. So you are better off to go with a strategy you can stick with rather than one you can’t.

    Reply
    1. Great reminders for DIY investors. So far….I feel our strategy is working. Stick to the plan: 30 CDN dividend payers; 10 U.S. and index the rest from U.S. and international. Cheers!

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  26. Grant. Who said anything about trying to time the market? Who said you have to be consistent all the time? But finding the next big winner or thinking what the future may hold or bring – YES! that is exactly what brings in the 100% plus (and beats the averages). IMO there isn’t much we can control in the markets. They will act the way they want to. Average investors will always be average because they are happy with what the market returns (just like you). Play it safe and hope & prey for an average return. Not me! Lets say you have a million invested. Would you take 100 K and invest it in something that could or might give you 1,000% return? while the rest ($900 k) is invested in the safe stuff (the stuff your evidence tells you to invest in). And would you be happy if that actually turned out to net you only 100%?. The toughest thing for investors to do once inside that box is to get out and think differently than the masses. You are in a closed box (with your market returns and evidence). Open it up and climb out. You will enjoy the better views. BTW – I have never forgotten about the losers. They were painful and I don’t want to feel that pain ever again – and so I do everything I can so that doesn’t happen. One last point regarding your claim to “evidence, evidence, evidence”. I once sued a company that provided all the evidence showing that they must be right (again). But lost the case. People (like you) were shocked that they lost because all that evidence was factual and was used in a previous case that they had won. But they lost and they lost big! Although evidence is important – it is not everything.

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  27. Grant. If you stride to be average – you will end up being no better than average. If you copy others – you probably will end up with similar results.

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  28. Mike, I think you are confusing market returns and average returns. Indexers, get the market return (minus the small cost of the ETFs), but the average investor gets much less than market returns because of various behavioural errors such as buying high, selling low and overconfidence. In fact the data shows that the vast majority of investors fail to beat the market, so getting market returns is better than the vast majority investors. I don’t strive to be average, I strive to get market returns which is way better than both the average investor and better than the vast majority of investors.

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  29. Grant. No confusion here. We just think differently. IMO- You are average if you are only getting market returns. (add that to your data as evidence to use next time). {of course this is looking from where I stand – not where you are today}. People who become average investors (like you) are stuck in that box (with your data and evidence). Missing out on better returns. In fact your earlier advice was that others should hold 40% of non paying dividend stocks – just to be diversified. (you claim). To me – that is average thinking and not something I would do. Reading your last comment – it is very clear you are indeed an average investor. Nothing wrong with that – if you are happy with the market returns they give you. For me – I would not be happy with just market returns.

    Reply
    1. Mike, because indexes are buoyed by roughly equal amounts of money from buyers and sellers the index level is more about the median money, or the “median investor/trader”. If we consider all the investors and traders in the market the “average investor/trader” would fall somewhere south of the index because the majority of them are small money and have little clue of what they’re doing. Many advisors also underperform due to the exorbitant fees they charge to sell pseudo-index funds.

      Reply
      1. Bernie, actually, the majority of investors/traders are not “small money and have little clue of what they’re doing”. In fact 90% of all trading in the market is done by institutional investors. Only 10% are retail investors. I don’t think retail investors, buying individual stocks, can expect to be on the winning side of the trade when there’s a 90% chance that they are up against the professionals with all their computing power.

        Reply
        1. Grant, I’ve heard these stats from you before but I just can’t buy them. I am, by no means a sophisticated investor. Heck, I don’t even aim to beat the market. I invest in dividend growth stocks for a reliable, predictable growing income stream. I’ve done very well with my strategy. My dividend growth has averaged 9.05% since inception in late June of 2008. While I don’t try to beat the market I do keep tabs on my TR performance. My CAGR over the period with my 70% Cdn stocks, 30% U.S. stocks is 9.98%. A 70% XIU, 30% SPY mix over the same period only returned 5.58%. I don’t consider my performance exceptional at all. I feel its about average for a DGI. IMO its not terribly difficult to beat market on average long term, especially the Canadian Equity Index performance.

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        2. @grant – With all the self directed plans out there now – I would think it is more than 10%. However, the institutional investors would be moving larger amounts of $$$ in and out.

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    2. Mike, what you are missing here is that market returns are the same, of course, as the market averages, but the average investor does not get market returns – he/she gets below market returns. In fact the vast majority of investors get below market returns. That is what the data shows.

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      1. @Grant. What I am saying is that (to me) market returns is not good enough. You seem to be happy with them. I am not! I throw in market returns as average investing. (people are average investors (to me) if they get less than or market returns).

        Reply

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