Retiring early is challenging, but there are some options you can take with your portfolio that might help ease the process.Yuri Arcurs peopleimages.com/iStockPhoto / Getty Images
A close friend describes feeling “nauseous” when he gets ready to go to work. He and his wife (I’ll call them Dave and Lisa) find it increasingly tough to do their jobs.
Dave works as a building and engineering development manager for a city in British Columbia. “As an introvert, it feels like it’s killing me,” he says. “I always have to deal with conflicts, and I’m losing a lot of sleep.”
Lisa’s health care position is also taking a toll on her well-being. “The health care system is broken in so many ways, and I’m starting to hate going to work,” she says.
The couple, now in their early 50s, could retire and collect full pensions in five years.
Retiring earlier, they say, would help their mental health. But taking their pension early would mean accepting a much lower pensionable income. With a mortgage remaining on their 80-year-old home and leaky plumbing that will require expensive work, the couple can’t afford to collect that pension now. They’ve considered deferring their pensions for five more years and living off their investments.
Dave and Lisa began investing with Manulife’s actively managed mutual funds when they were in their early 20s. Today, they have a combined $200,000 in registered retirement savings plans (RRSPs). Lisa says that would cover three years of living costs, which wouldn’t be long enough. The couple wonders if investing in ETFs, instead of actively managed funds, would have made a difference, providing them with enough money to live off for the next five years. Based on probabilities, that answer is yes.
The Globe and Mail’s Ian McGugan introduced Canadians to the Canadian Couch Potato more than 20 years ago when he was editor of MoneySense magazine. It called for a three-way split between the iShares S&P/TSX Index ETF (XIU-T), iShares Core S&P 500 Index ETF (XSP-T) and iShares Core Canadian Bond Index ETF (XBB-T). With MERs of about 0.25 per cent (they have since become cheaper), this portfolio offered salvation to investors paying high investment fees.
In 2014, I published a series for the Globe and Mail comparing the performances of actively managed funds to ETFs and TD’s e-Series index funds. I started with RBC’s funds and wrapped up the series comparing Manulife’s funds. Each fund company that I profiled had some actively managed funds that beat their benchmark indexes. But most of their funds underperformed. And because fund companies often change the names of their funds, close them, or merge them with other funds, listed performances on fund company websites only show the flowers after taking out the weeds.
For example, Manulife had more than 400 actively managed mutual funds in 2014. But despite offering mutual funds for decades, 93 per cent of Manulife’s funds didn’t exist 10 years earlier. In fact, most of the funds on Manulife’s website today are younger than Prince William and Kate Middleton’s kids. In an industry that rakes bad performers under fences, that’s normal. According to SPIVA Canada’s Mid-Year 2022 report, 40 per cent of Canadian actively managed mutual funds disappeared over the past 10 years.
If you’re wondering how high investment costs and switching funds impacts Canadian mutual fund investors, researchers Juhani Linnainmaa, Brian Melzer and Alessandro Previtero give us an idea. In 2018, they published “The misguided beliefs of financial advisors” in The Journal of Finance after assessing data from more than 4,000 Canadian financial advisors and about 500,000 clients between 1999 and 2013.
They found that financial advisors underperformed their benchmark indexes by 3 per cent a year on a risk-adjusted basis. High fees were partly to blame. Performance-chasing hurt as well. For example, when an adviser chooses actively managed funds, they often select funds based on past performance. And when those funds underperform or disappear, they typically select other funds based on their recent past performance.
But that’s a bad strategy. According to the SPIVA Persistence Scorecard, actively managed funds that perform well during one time period typically underperform the next.
If Dave and Lisa underperformed an equal-risk adjusted benchmark by an average of 3 per cent per year, they would have to work longer than they otherwise might. For example, Dave and Lisa added about $250 a month for 27 years to their RRSP. Today, they have $200,000. That works out to a compound annual return of 5.9 per cent.
If they were invested in a diversified portfolio of low-cost ETFs, they could have beaten the average Canadian mutual fund investor by about 3 per cent per year. In that case, they would have about $330,000, not $200,000. For Dave and Lisa, $330,000 could cover living expenses for five years, allowing them to quit their jobs today and defer their pensions for five more years.
It could have put an end to their stressful days at work.
This isn’t meant to be a fruitless tale of what might have been. Instead, building a portfolio of ETFs is something plenty of younger investors could do right now.
As for Dave and Lisa, they can’t retire as early as they otherwise might have done. But they are transferring their Manulife funds to a balanced portfolio of ETFs. For simplicity, they’ll choose an all-in-one fund, like Vanguard’s Balanced ETF Portfolio (VBAL-T). Its MER is just 0.24 per cent a year. Or, they could own similar holdings with BMO’s Balanced Index Portfolio (ZBAL-T) or the iShares Core Balanced ETF Portfolio (XBAL-T). Each charges an MER of 0.20 per cent. Currently, Dave and Lisa pay about 11 times more than that for their actively managed funds.
If you want to retire earlier, you might consider following in their footsteps now.
It could improve your health and help you live longer, especially if your job dishes out a lot of stress.