A copy of this article originally appeared on Seeking Alpha.
With respectable profitability over the past 10 years, and an incredibly strong dividend history, SNC-Lavalin (SNC.TO) would be a worthwhile addition to any dividend growth portfolio. However, its current valuation measured against its price-to-book, and price-to-earnings ratios, as well as when compared to its peers, demonstrates that even with strong dividend performance it is still overvalued. Investors would be better off putting this stock on their watch list, and adding when the price drops below C$40.00.
SNC-Lavalin is a Canadian based engineering firm, which derives its income from six key streams, outlined below.
Collectively, the Mining & Metallurgy, Oil & Gas, Power, Infrastructure & Construction, and Operations & Maintenance, are referred to as the Engineering & Construction segment. Running parallel to this is the Capital Investments segment, which enters long term agreements which use either fixed cost or equity method accounting to record revenue.
Profitability and Stability
Beginning in F2013, SNC started reporting its revenue broken down between engineering revenue and capital investment Revenue. Except for F2009 and F2013, year over year (YoY) revenue growth has been positive, with the most recent year’s revenue coming in at +16% at over $9billion.
The share price has generally trended upwards over the past 10 years, with minor dips in F2008, F2012, and F2014:
The F2008 dip may be attributed to the Kerala Hyderoelectirc Dam Scandal, and the F2012 and F2014 dips may be attributed to the Libya business probe. Of course, this is speculation, but given the negative press it is a plausible explanation, especially since the underlying fundamentals relating to revenue remained consistently strong during that period.
One other financial stability figure to review is the current ratio. Typically, one would hope to see a current ratio of at least 1.50 (i.e. current assets more than covers current liabilities). As of the most recent fiscal year, the current ratio is 1.02 when comparing net current assets to net current liabilities. However, this number quickly climbs to 1.54 once you consider the ratio of short term assets to short term debt (i.e. vs. aggregate short-term liabilities). This is illustrated in the below chart, which breaks down short-term liabilities into its components of debt vs. de-facto liabilities.
Dividends are an interesting metric when compared to share price. Provided the dividend payout ratio (i.e. the portion earnings paid to dividends) remains low, and the dividend remains consistent or increasing, a drop in a company’s share price often represents a buying opportunity. It is for this reason that I feel dividends can be observed separately from share price: whereas share price represents capital appreciation, dividends represent (immediate) realized gains to shareholders. That said, over the past 10 years, SNC’s dividend has risen from $0.23 in F2005 to $1.01 in F2015, representing a 14.40% compounded annual growth rate of dividends.
Overall, the dividend payout ratio has been consistently below 50% since F2010, and prior to that, it was consistently below 40%. Overall this indicates that there is still plenty of room for SNC to continue to raise dividends, even in the face of revenue headwinds.
SNC’s current valuation is where it falls short in my view, based on the following:
- Trailing-twelve-months (“TTM”) EPS of 2.03/share
- Book value of $25.03 based on the most recent fiscal quarter results
- Current share price of $56.52 (as of February 3, 2017)
Given these numbers, the stock has a price-to-earnings of 27.8, and a price-to-book of 2.2, yielding a Graham number (i.e. P/E × P/BV) of 60.8. SNC’s meaningful peers (Aecon (ARE.TO), Bird Construction (BDT.TO)) have an average P/E × P/BV of 25.0 for the most recent fiscal year, illustrating that SNC’s Graham number is more than twice that of its peers.
What this translates to, is that SNC is trading at much more than it should be at this time, when compared to EPS and/or book value. At the current TTM trailing EPS and book value, I would expect to see a price of no more than $33.81, if we have an upper limit of 22.5 for our Graham number. This puts SNC’s current price at roughly 1.7× what it should be, based on TTM EPS and book value based on the most recent quarterly results. This isn’t quite as bad as the Graham number multiple compared to peers (SNC’s 60.8 is 2.4× that of the peer average at 25.0), but it is still considerable.
Fundamentally, I like SNC. Its historical performance, even amidst two scandals, is stellar, and its dividend growth is spectacular. However, the valuation concerns me; as much as I don’t mind paying an “okay price for a good company”, at the current valuation it is no longer “okay”, just “bad”. I would consider buying on dips, and will re-review after the F2016 results are out to see where the valuation sits vis-a-vis its updated fundamentals.
All figures are reported in Canadian dollars.
Overall, I have been pretty happy with the January performance when observing paper (i.e. non-realized) gains, but passive income fell short when compared to the benchmark.
Total fund returns were 1.26%, vs. the benchmark of 0.52%, which represents a more than 2× gain over the benchmark! This is also evident when we look at the trailing twelve month performance:
Here, you can see that on a trailing twelve month basis, total fund is up 15.79% vs. the benchmark 9.99%, which represents a 58% differential!
In absolute terms, the biggest gainers were Brookfield, Philip Morris, and BMO, which accounted for 54% of the overall gains in the period. On a percentage gain basis, Sun Life, Bank of Nova Scotia, and Telus, topped the list in gaining 45.42%, 23.49%, and 17.30% respectively.
However, while the non-realized gains were impressive, as I mentioned above, passive income was lacking.
Overall, the benchmark passive income was $1,811.80, and my own passive income was less than half of that; in fact, my passive income came in at 60.50% under the benchmark. But, this was to be expected. Recall from my December 2016 update:
That said, I expect to see a huge spike in January 2017 in the benchmark, mainly due to timing. You’ll notice that December had a very low benchmark income number, and generally speaking, March, June, September, and December, should be roughly equal in benchmark passive income. Because my benchmark is composed of ETFs, those ETFs did not pay anything in December 2016, and instead paid many of their distributions in January 2017 — so any missed income from December should catch up to us in 2017.
So, the spike in January 2017 was to be expected, but I did not expect the spike to be so drastic. This huge upset also affected the TTM passive income numbers:
Not quite as bad as the monthly results, but on a trailing twelve month basis, we are still running at 1.97% less than the benchmark. As I have become more aggressive in investing idle cash in ETFs, I expect this trend to reverse in the coming months.
Finally, starting with this post I will be monitoring my asset mix compared to my target asset mix. As to be expected, I am very heavily weighted in pure equities. You’ll also notice that the majority of my funds are tied up in my RRSP and LIRA. As part of my 2017 goals I mentioned increasing TFSA contributions on the order of $20,000, and I’ll also use these contributions to pair down equity exposure, systematically increasing my fixed income and real estate exposure through ETFs.
Finally, in a previous entry I mentioned that I was running severely over budget for 2017, when comparing my projected spend to my actual income. In fact, I was projecting a deficit of $14,000. To that end, I have been rigorously monitoring my spending habits, and I’m happy to say that in January I came in at 3.51% under budget. This is not a significant amount, but anything under budget is a gain in my view.
|Month||Actual Spend to Budget Variance (lower is better)|
A big chunk of this decrease was due to not having to buy gas in January (hooray for public transit!), and cutting down on entertainment expenses (e.g. music, movies, and books). However, February is looking a little bleak, as some expenses that I avoided in January will definitely come up in the next month (e.g. I will need to buy gas in February!).
And there you have it: the first update for 2017. How did everyone else do?
Onwards and upwards!
My discount brokerage, BMO InvestorLine, only released statements to its clients on January 23; so the update for December 2016 has been incredibly delayed. But was the delay worth it? Given the data we have at hand, I would say yes! Key highlights:
- Passive income of $620, 350% over our benchmark
- Total passive income for 2016 of $6,627, 29% over our benchmark
- Total fund returns for December 2016 of 2.7% vs. benchmark of 1.2%
- Total fund returns for 2016 of 11.0% vs the benchmark 7.8%
Some stellar numbers! Let’s see how this looks on the graphs.
First up, you’ll notice that there is a new portfolio added, that of EPSP. I recently became a full-time employee of a major FI again, mainly to maintain stability of income, and now have access to their Stock Ownership program. This gives me a great way to receive commission free trades on a regular basis, directly debited from my pay, which results in regular, periodic investments into my tax deferred account. The EPSP portfolio is also responsible for the huge retroactive spike in November 2016. Overall, 4 out of 6 of my portfolios beat the benchmark, with only my LIRA and EPSP lagging behind. Overall however, the entire portfolio for December brought in a 2.7% return, whereas the benchmark returned only 1.2%: I effectively doubled the benchmark, and then some.
On a trailing twelve month perspective (i.e. all of 2016), I am generally happy with the results. Because I am heavily weighted in Canadian stocks, I did not experience as much of an updraft as some US investors since Trump won the election in November 2016, but overall my portfolio has been on a positive uptrend all year, ending the year at +11.0%, whereas the benchmark is only up 7.8% for the year; my portfolio beat the benchmark by over 40% in 2016. One point of pride: each and every one of my portfolios beat my benchmark; since each portfolio has a slightly different mandate, this is a great feat, which I hope to continue in 2017.
Of course, I am a dividend investor, so passive income is one of my key measures of success. What follows are the passive income returns for December 2016, as well as for the year.
These graphs look different from previous ones, but I believe they provide a simpler comparison of actual vs. benchmark income. For December we brought in over $600 in income, vs. the benchmark of $138. For all of 2016, we brought in $6,267, whereas the benchmark only brought in $4,859; a whopping 29.0% increase for the year.
That said, I expect to see a huge spike in January 2017 in the benchmark, mainly due to timing. You’ll notice that December had a very low benchmark income number, and generally speaking, March, June, September, and December, should be roughly equal in benchmark passive income. Because my benchmark is composed of ETFs, those ETFs did not pay anything in December 2016, and instead paid many of their distributions in January 2017 — so any missed income from December should catch up to us in 2017. A similar event happened in October 2016, where the benchmark returned zero passive income, but there was much higher passive income in November, when compared to July and August.
With the year at an end, I have also been able to calculate my forward income. In 2017, based on current holdings and current rates, I expect to generate $6,800 in dividend income, roughly 8.50% higher than all of 2016. As I mentioned in my investment goals post, I wish to increase my total income by 5.00%, which means I have to generate another $340 in passive income to make that goal. I feel this should be a realistic goal given the current environment, assuming I do not have to liquidate any holdings in the near term.
So there you have it: F2016 in a nutshell!
Onwards and upwards!
I need $14,000. There I said it. But how did I get here? What the hell happened? Did I go crazy at the tables at Casinorama? Did I pull a not-so-friendly Community Chest card in the real-life version of Monopoly? Did I go long the Mexican Peso when Trump was inaugurated? None of those I’m afraid…
One goal I did not mention in my previous post, was to have a well-defined budget. Truth be told, I had a budget planned out in 2016, and for the most part I stuck to it. Budgeting suddenly became very important when I became an independent consultant: as a contractor, you need to know exactly how much money you need, because this ultimately drives the lowest per hour cost that you can live with. If you charge too low, then you will not make enough to cover your regular expenses; so anything you charge over your minimum per hour rate is butter on your bread. Example: if I know that I need to charge at least $50/hour to cover all of my expenses (this includes my personal expenses, as well as corporate expenses), if I can find a contract which pays me $60/hour, assuming a 7.5 hour work-week and two weeks vacation, this means I suddenly have $18,750 more I can play with. But, if a contract paid me less than $50/hour, say, $40/hour, I would be short $18,750. But, I will save the per hour calculations for another post; today, we are here to speak about budgeting!
So, in 2016 I got into the habit of planning out my personal and corporate budgets to the penny. Budgeting is not easy task. You have to ask yourself hard questions, and you have to keep yourself to your budget. If you only budget $100/month for eating out, then you have to be damn well sure that you spend no more than $100/month on eating out! While this sounds easy in principal, it rarely is: easy access to credit, and convenience payment methods such as credit cards, tap-and-pay, paying with your phone, etc., make it all too easy to lose track of your spending.
The hard questions really revolve around what you need vs. what you want. Sure, I want to go out to a fancy restaurant every week, but is that something I need to do? Moreover, when you actually plan stuff out, you realize how much friction discretionary expenses cost you. Case in point: if you go to see a movie every other week, you can spend easily $390 on tickets alone (26 weeks @ $15/ticket). Factor in dinner that you will likely eat when you go out with your friends, the concession stand, gas/transit, etc., and you can easily get up to over $1,000 per year just on going to the movie! Now, consider what other frivolous items you spend your money on!
Our family is growing this year, with a wee one on the way, which will drive a slew of new expenses (diapers! building a nursery! strollers! diapers! baby food! diapers! did I mention diapers???). We also moved, I am 17 months away from paying off our family vehicle, and 53 months from paying off my rental property. When you take into account all of the negative cashflows (e.g. regular expenses, discretionary expenses, paying off liabilities such as mortgage and car, savings, investing), my net income is $14,000 short of my aggregate cash outflows; e.g. if my net outflows are $50,000, I am only making $36,000, $14,000 short.
What does this mean, practically speaking?
Well, when you are budgeting there are really two types of cash outflows:
- Fixed / required costs
- Discretionary costs
Examples of costs which I cannot avoid–no matter how much I would like to!–include:
- My mortgage, and the interest on my mortgage
- Car payments
- Utilities (gas+water+hydro) and property taxes
- Pet care (food, vet)
Costs which are discretionary–I can simply not spend this money if I don’t need to–include:
- Eating out
- Buying books/movies/music
- Donations (e.g. to the Toronto Humane Society, United Way, Kids Help Phone, etc.)
So, while I am “short” $14,000, this is purely from a budgeting perspective. Simply because I have $600 budgeted towards going to the movies/buying new music/buying new books, does not mean that I will have to spend $600. That said, I believe 2017 will be a year of frugality: instead of buying books, borrowing from the library. Instead of buying CDs, *cough* borrowing *cough* them from friends (or the library!). Driving less, etc. Ultimately, I would like to make a complete reversal, and instead of finding $14,000 in new funds to fund my shortfall, increasing my overall savings by some amount. These guys are hella inspiring in that regard! I would relish the opportunity to save 60% of my regular income, alas, that’s not going to happen anytime soon.
With that in mind, one more metric that I will be tracking on monthly basis is my personal budget, and how well I am tracking to it. My goal is to tighten my belt enough that I can avoid dipping into long-term savings to cover the $14,000 shortfall. One thing that I have gotten into the habit of doing is using cash instead of credit. In fact, the only things I use my credit card for at the moment are gas, and online purchases. But, if I am driving less, that implies I will be purchasing less gas, which means I will be using my card less. If I cut down on buying things online (e.g. books on amazon.ca), then I’ll be able to cut down on that avenue as well. Previously I was drawn to the siren song of bonus dollars and cash-back cards (such as the Tangerine Cash-back card, which gives 2% cash-back on three categories; if you are going to sign up for one, please use my referral ID, 16176076S1). However, the problem with cash-back cards is that you really have no idea what you’ve spent until the bill comes in the (e-)mail; on a regular basis I was getting hit with $1,000 bills without faintest idea as to where my money had gone. That said, my frugality principles for 2017:
- Cash, not credit
- Drive less, transit more; even easier since I have a TTC Metropass
- Borrow, not buy, in the case of books
- If I have to buy, buy used, through craigslist, Kijiji, or eBay (although eBay offers less and less in terms of bargains nowadays!)
- Learn to say no: if a bunch of friends wish to go out, if I don’t have physical cash in my wallet, don’t do it
- Look for cost cutting measures around the house
I’d be curious to hear what methods you are all using to cut costs, and generally have more savings on hand!
Onwards and upwards!
It’s that time of year where we start looking at investment goals for the new year.
I didn’t really have any goals F2016, except to become a member of thediv-net.com, which I’m happy to say that I was successful in accomplishing! I also mentioned in several posts in F2016 that up until recently I had lost focus on my investment portfolio. Well, for F2017, I plan on changing that trend.
To that end, the goals!
Goal 1: Increase TFSA Contributions
I have been an infrequent contributor to my TFSA for the past 2+ years. To pay off my business school loan, and to purchase a new house with my family, I made some significant withdrawals. Taking into account the $5,500 contribution limit for F2017, I have a little over $40,000 in contribution room in my TFSA. My goal for F2017 is to contribute to at least 50% of that limit, or $20,000.
Goal 2: Minimize Taxes
My investments fall into five investment books: a taxable margin account, a tax-free account, a tax deferred account, a certificated account, and a LIRA. My second goal for F2017 is to minimize taxes by consolidating investments into my tax deferred and tax-free accounts, where it is sensible to do so.
Selecting which investments go into tax sheltered accounts is not a trivial task. On the one hand, moving investments from my taxable account will defer any taxes payable (in the case of my RRSP), or eliminate taxes completely (in the case of my TFSA). However, tax sheltered accounts have a disadvantage in that any losses cannot be used to offset capital gains. This means that I will have to take a close look at the investments to ensure they are good fit to go into an account where I am unable to do any tax loss harvesting. Put another way: I have to ensure I am comfortable (financially, and psychologically) to move investments, confident that they will not go down in value to the point where I sell them at a loss.
That said, Goal 1 and Goal 2 are complementary: by moving investments from my taxable margin account to my tax-free account, I can easily come within throwing distance of Goal 1.
Moreover, by moving my US investments from my margin account to my tax deferred RRSP, I will reap an immediate 15% cost avoidance: US based stocks are not subject to the (15%) withholding tax on US dividends, which means I will receive the full amount of dividends from my US holdings.
Goal 3: Rebalance my Total Fund to my Target Allocation
When I started investing in earnest in F2012, I had a very rigid target allocation. The past few years I have deviated very far from that. So my third goal (and arguably the most important) will be to revisit my investment policy statement, and determine the appropriate asset mix for my investments.
Goal 4: Increase Passive Income by 5%
As I am a dividend investor, passive income is my primary goal for investing. Following my December 2016 results, I will be baselining my F2016 income, with a goal of beating that income by 5% this year.
I plan on accomplishing this goal through three key strategic activities:
- Re-allocation. I know for a fact that my portfolio is overweighted in some areas. Once I complete Goal 3, I will be reallocating funds to other holdings, to increase exposure to some of my more successful dividend holdings.
- DRIP Investing. I plan on increasing exposure to DRIP investments, as they provide a frictionless vehicle for quickly growing dividend income.
- TFSA Contributions. As mentioned with Goal 1, I plan on increasing my TFSA exposure. This increase will undoubtedly bring more passive income into the total fund.
Goal 5: Update and Expand Investment Research
Many of my investment research posts are horribly out of date. As the calendar year is starting, many companies I follow will be releasing their annual results in the coming months. I plan on updating all of the companies I follow based on F2016 results. Moreover, I am targeting to analyze at least four new companies this year.
And there you have it; the F2017 goals! I would love to hear what everyone else’s goals are for F2017.
Onwards and upwards!
This is part 3 of a 3 part series I have entitled "The Great Pension Experiment", which details my analysis on what to do with a defined benefit pension plan payout. The first two parts may be found here: Part I, Part II.
It has been one year since I started off on The Great Pension Experiment. I feel that this is a useful experiment because it leverages real world results in a closed environment. Because the funds are in a LIRA, I am unable to add or withdrawal funds, so any losses must be recouped “internally” by better investments.
In Part II I made the claim that, based on the Assertive Couch Potato Portfolio, over a 25 year time horizon I would be able to grow the portfolio to a point where I would be able to generate over $600/month in passive income, assuming a 4.00% yield. It has been 12 months since that claim, so lets see how we’ve done after one year.
When the portfolio was first opened, I set it up with a blend of 25% fixed income, 25% Canadian Equities, and 50% of non-Canadian Equities:
Originally I had intended on re-balancing the portfolio semi-annually (i.e. every six months), and in retrospect, this was a stupid idea. Cash was building up in the portfolio slowly, but sitting there idle until I had a chance to re-balance. Due to the already high number of shares, any dividends and/or distributions from the holdings would be in excess of the current price of those shares. Because of this, I should have been using synthetic drips right from the start! Accordingly, in September 2016 I set up my brokerage to re-invest any dividends received directly into additional shares. This ensures that money is not sitting idle, and because the investments are via synthetic drip, I receive additional shares commission free.
That said, as of October 2016 (one year), the portfolio sits at:
For the year ending October 31, 2016, I received $1,485.24 in dividends/distributions ($123.77/month). The portfolio as a whole has grown from an initial investment of $64,723.32 in cash to $68,468.29, which represents a 5.648% total return. This is actually pretty impressive, since the first half of the fiscal year (From November 2015-April 2016), the portfolio was in negative territory:
|Period Ending||Open NAV||Close NAV||Return %||TTM Return %|
I had bought into the portfolio at a peak in 2015, and the market had a clawback shortly after. As a result, the portfolio lost money for the first six months. I did take the opportunity during that period to top off the VXC shares whilst I had some excess cash from distributions, which in retrospect was a wise choice. Buying when the market is in a downturn helps to dollar cost average down, ultimately increasing future returns.
The portfolio is more or less at the target weighting if you round to the nearest whole number, and because of this I see no need to buy or sell additional shares at this time. Hypothetically, if the portfolio were to keep this pace for another 24 years, even at a 5.000% return we would generate approximately $736/month in passive income. So based on simple extrapolation (i.e. assuming constant returns for the next 24 years), we are right on track.
That said, I am going to ignore the portfolio for another six months, and will revisit in May of 2017 to see if any rebalancing is required. Until then, the next update will not be until December 2017. Here’s hoping that the portfolio continues to provide excellent returns at that time.
Onwards and upwards!
Before I begin, there was a minor issue with the October update benchmark numbers. I had made an error in the benchmark passive income: Vanguard’s VAB declared an October dividend, but the actual payment date was in November 2016. This means that my actual income in October surpassed the benchmark income by an even wider margin.
I’ll jump straight to the chase and say that November was a disappointing month. Odd, because following the winning of president-elect Trump, US markets were on a tear. Unfortunately, my Canadian holdings did not do as well.
The benchmark return was 0.912%, but my total fund was -0.413%, more than a 1% difference. My LIRA portfolio came in at a respectable 0.902%, and the 0.010% variance I can attribute to tracking error. The TFSA portfolio dominated at +2.522%, but my margin account was pummeled at -4.918%! Inspecting the margin account, this somewhat makes sense: it is 2/3 in Canadian equities, which came in at -8.898%, which was the primary source of the losses.
But, as a long-term buy and hold investor, you’ve got to take the bad months with the good months. My TTM is still exceeding the benchmark:
Total fund TTM is 7.989%, while the benchmark is 6.705%: so when you take into account all ups and downs over the past year, we are still doing pretty well.
Of course, let’s remember that I am a dividend investor, and that is where I count the majority of my returns. November was a good month: total income was practically double the benchmark income (97.514% more to be exact), and TTM income is also exceeding the benchmark, by 7.918%.
As I have just started to aggressively focus on my portfolios again, I don’t expect to have stellar returns in the short-term. However, as I plan out my F2017 goals, I expect that to change.
Onwards and upwards!
Earlier this year I was helping my brother out with his financial planning, and one key element of the planning was to cut expenses. Cutting expenses is an important factor of any planning session, since any reduction in expenses boosts your disposable income by an identical amount: save $5.00, and you suddenly have $5.00 to redeploy elsewhere. At the time, he was paying $14.95/month in banking fees at a major Canadian bank, which equates to $179.40/year. When I asked him why he paid the fees, he really didn’t have an answer. Like many individuals, he took fees as a given–albeit a horrible one–and paid them every month. With some nudging, we managed to move all of his accounts to Tangerine, and he now has an extra $14.95 every month in his pocket. By the way, if you decide to open up your own account at Tangerine, please use my referral key: 16176076S1 .
Of course, it is not always possible to move all of your banking. I have the lion’s share of my accounts at Tangerine, however I also have an account at BMO because my mortgage is with them, I have a US Dollar Chequing account there, and I use BMO InvestorLine as my discount brokerage. Having an account there just makes things easier. But, even having an account, there are ways to avoid the monthly fees. For my own plan, if I keep a minimum balance of $2,500 in the account, the fees are waived.
Now, I gave that bit of background, because Bank of Montreal is increasing the minimum balance you require to waive fees as of December 1, 2016. Here is a snaphot (as of November 29, 2016) of the proposed fee increases:
|Plan||Current minimum balance||New minimum balance||Difference $||Difference %|
As with everything, the need to pay for fees is all about opportunity cost. As a consumer, I have two choices:
- Pay a monthly fee, and use the minimum balance as I see fit.
- Do not pay a monthly fee, and lock up the minimum balance with BMO.
Let’s look at the annual banking fees, relative to the minimum balance to avoid paying those fees:
|Plan||Monthly Fee||Annual Fee||Minimum Balance (Old)||Cost Yield (Old)||Minimum Balance (New)||Cost Yield (New)|
In the above, the Cost Yield column represents the percentage cost based on the minimum balance, to avoid paying the fees. So, for the Plus Plan, by keeping $2,500 in the account, I am avoiding $131.40 in fees per year, or 5.3% of the locked in money. Put another way: if I can find an investment that pays me at least 5.3%, I would be better off taking the $2,500, investing it in the investment, and using the proceeds to pay off the monthly fees. However, that 5.3% doesn’t take into account taxes. My marginal tax rate on dividends is 25.38% according to the tables on taxtips.ca, so in reality I need to find an investment that yields at least 7.0% (since 7.0%, less 25.38% taxes, would yield me 5.3%).
Now, years ago when I was faced this decision, it was hard to find an investment that would guarantee me 7.0% return (with an acceptable level of risk). The other wrinkle was that many ETFs or companies pay dividends quarterly, which means the income stream from the investment would be “lumpy” relative to the frequency of payments. But with the increase in BMO’s minimum balance, things change. Here are the updated tables using the December 1, 2016, minimum balances:
|Plan||Monthly Fee||Annual Fee||Minimum Balance (new)||Cost Yield (new)||After Tax Cost Yield (new)|
My specific plan is the Plus plan, so I now have two choices: find an investment which gives me a guaranteed 5.9% return on $3,000 (which would give me $177.00, or $132.07 after taxes), or keep $3,000 locked at BMO, and avoid $131.40 in annual fees. Given that this $3,000 is a good place to stash emergency funds, and I wish to preserve safety of principal, at this point I feel it is still safer to keep the “ransom money” with BMO to avoid the fee. It is because of the savings that I call this the “indirect dividend”: I can either claim a dividend by investing the capital, or I can save the fee by locking the money away. Either way, I am “making” money off of locking away a fixed amount of capital.
Of course, there are ways to improve the above analysis. For one, if I purchased the shares in my TFSA, then there would be no tax implications, so I could focus on the Cost Yield, not the After Tax Cost Yield. Another possibility is preferred shares, which I spoke of in an earlier post. Over the next few weeks I will continue this analysis to see if there is a better way to obtain overall higher returns.
Onwards and upwards!
This is part 2 in a 3 part series I have entitled “The Great Pension Experiment”. This will detail my analysis on what to do with a defined benefit pension plan payout, after leaving my previous employer.
I am a big fan of Monte Carlo analysis (MCA). In a nutshell, when performing an MCA we run a test a fixed number of times, using a controlled set of inputs, and observe the results.
I had mentioned on my previous entry that I felt I could do better than the $600 per month defined benefit pension that OPTrust was offering after I left the company. But, how would I quantify this?
I wanted my LIRA to be as simple as possible, to run virtually effortless. Because of this, I elected to use one of the Couch Potato model portfolios, specifically the one using ETFs. Within these options, given my 25+ year time horizon, I elected to use the Assertive Portfolio, which has the following composition:
- 25% of the Vanguard Canadian Aggregate Bond Fund ETF, VAB
- 25% of the Vanguard FTSE Canada All Cap Index ETF, VCN
- 50% of the Vanguard FTSE All-World ex Canada ETF, VXC
The weighted average expense ratio of this portfolio is 0.18% as of November 2016, and the returns are pretty impressive:
- 1-year return: 7.20%
- 3-year return: 12.61%
- 5-year return: 8.91%
- 10-year return: 6.24%
- 20-year return: 7.10%
- Lowest 1-year return (2008-03 to 2009-02): -24.95% (2008 financial crisis)
To perform my analysis, I elected to take the lump sum from OPTrust, and run an MCA on it to see what the projected monthly income would be in 25 years, if I had used the Assertive Portfolio. To do this, I ran 100,000 iterations on 25 years of growth in the portfolio, using randomized returns. Here is an example of one set of returns:
|Year||Start Value||% Gain||End Value||Implied Annual Income||Implied Monthly Income|
In the above, the % gain is a random gain for the portfolio based on an average return of 8.29%, and a standard deviation of 7.96%. The implied annual income assumes I could take the ending value of the portfolio, and buy an annuity or other similar (set of) instrument(s) to generate 4% of annual income. I believe 4% annual income, if you are not concerned with growth, is incredibly doable in the market.
But wait, where did that 8.29% average return, and 7.96% standard deviation come from? And what do they mean?
If you take 15 years of returns for the couch potato model portfolio, and do some statistical analysis on that data, you will end up with an average daily return of 0.032%, which equates to an average annual return of 8.287%. Moreover, those same daily returns have a standard deviation of 0.503%, which is 7.959% annualized. (For annualizing, I assume there are 250 active trading days in the year: 52 weeks @ 5 days/week, less 10 days for various holidays). Now, because the model portfolio asks for VAB, VCN, and VXC, and those ETFs are relatively new, I used iShares Core S&P/TSX Capped Composite Index ETF (XIC), iShares Canadian Universe Bond Index ETF (XBB), iShares MSCI World Index ETF (XWD), and iShares Core S&P 500 Index ETF (CAD- Hedged) (XSP) as proxies:
- For the period of October 29, 2009 to December 31, 2015, I used a blend of 25% XIC, 25% XBB, and 50% XWD.
- For the period of April 15, 2002 to October 28, 2009, I used a blend of 25% XIC, 25% XBB, and 50% XSP.
The ETFs listed are iShares ETFs. The XWD is the equivalent to VXC, but prior to October 29, 2009, there were no ETFs I could find that were all-world excluding Canada ETFs. Moreover, the period I chose covers the tail end of the dot-com bubble, as well as the massive 2008 financial crisis. Doing this provides more real world examples. In fact, looking at the above table you can see that in this iteration, in years 18 and 20 the sample has massive declines of -14% and -8% respectively! I feel this is an accurate representation of what could happen.
The average and standard deviation play into each iteration of 25 years. In the table above, the “% Gain” column will be, on average, 8.29%, and vary with the standard deviation of 7.96%.
Now, if we pull this all together:
- Create the table above 100,000 times
- Take the final 25 year implied monthly income from each iteration
- Plot a histogram
We get the following:
The above histogram shows that we have a 16% probability of having total monthly income less than or equal to $786. Put another way: we have an 84% probability of having implied monthly income greater than $786. If we take this a little further, we have an approximately 7% probability of making at most $600, or a 93% probability of making at least $600.00. But wait, OPTrust’s defined benefit income would be $600/month. I have only a 7% chance of not beating OPTrust’s defined benefit pension! Screw you OPTrust, I’ll take my chances.
So, based on my Monte Carlo analysis, using 13 years of historical returns on a portfolio of 25% Canadian Equities, 50% non-Canadian Equities, and 25% Canadian Fixed Income, I took the plunge to invest all of my money from OPTrust into my LIRA, using the couch potato portfolio. That was almost a year ago. In my next post, I’ll speak to the first year of actual results.
Onward and upward!