6. Our investments

We have 14 stocks in our portfolio, and no single holding more than 10% of the total. Most of the companies are fairly typical of a Canadian retiree’s portfolio, but there are a few quirky elements that came out of recommendations that I got from a relative when I was setting up the portfolio. (Statistics as of late January 2016.)

Utilities (24%): Innergex (INE-TSX), Algonquin Power (AQN-TSX), Brookfield Renewable Energy (BPF.UN-TSX), Scottish and Southern Electric (SSEZY on the US over-the-counter market)

These four companies offer dividends in the 5-7% range at the moment, and all have grown their dividends over time.

Real estate (19%): Dream Office (D.UN-TSX), Dream Industrial (DIR.UN-TSX), Dream Global (DRG.UN-TSX).

These real estate investment trusts are offering 9%-15% yields (yowza!). They have not increased their distributions over time, but did I mention the 9%-15% yields they are offering now? We have some diversification, but not enough. I like being diversified between office property in Canada (D), industrial property in Canada (DIR), and office property in Germany (DRG), but I am concerned about having all of our real estate eggs in one management basket. I just cannot bring myself to give up on Dream’s glorious yields. Their adjusted funds from operations (AFFO) ratios, which are used to measure the sustainability of cash flow for REITs, are high, but are not dangerously so. This is probably, however, the biggest risk to my financial plan. I have seen speculation about D cutting its distribution. See my comments about stress-testing the plan below.

Retail (19%): Boston Pizza (BPF.UN-TSX), A&W Canada (A&W.UN-TSX), and Liquor Stores (LIQ-TSX)

The first two are restaurant royalty trusts that offer about 8% and 5.5% yields respectively. Boston has raised its dividend in the recent past, while A&W had not for years, but did so in October 2015 – a nice surprise!  Liquor Stores operates in Alberta, BC, Alaska and Kentucky. I like the fact that it is growing by opening new stores, and has a range of formats, which I think makes it flexible in adapting to changing markets. The stock has been battered because it is perceived as being an Alberta company, so its yield is now around 15%. The people who speculate about these things are speculating that LIQ will cut its dividend.

Telecom (17%): Bell Canada (BCE-TSX) and AT&T (T-NYSE)

These should be stable parts of a portfolio, and they grow their dividends. I have bought and sold both as they’ve gone up and down. BCE’s yield is below 5% now, while AT&T’s is closer to 6%. I am trying to train myself to trade less, so I am holding onto these.

Finance (5%): Bank of China (BACHY on the US over-the-counter market) and China Construction Bank (CICHY on the US over-the-counter market)

This is the more exotic part of our portfolio. I believe in China’s long-term prospects despite the uncertainty this year, and have held on as these stocks have lost value. Our positions are not large, but they have yields of 6.5-7% and have grown them over time.

Spouse’s defined contribution employer pension plan (15% or our portfolio) is invested in four mutual funds. Job 1 when he leaves the company is to roll that over into his existing locked-in retirement account and invest it in the companies we already have.

Our geographic diversification is not as good as it should be: we are over-weighted in Canada (71%), in part because of the desire for tax efficiency: Canadian dividends qualify for better tax treatment. But that’s not a good enough excuse. As with many investors, familiarity with the Canadian market has led me to invest more at home. We have 20% in the US, 3% in Europe, and 5% in Asia/other.

So this portfolio provides an excellent stream of income for us. But what happens if companies cut their dividends or distributions? I stress-tested the plan for a 40% cut in D.un distributions, and a 40% cut in LIQ dividends to see what would happen. The plan was still sound, but the margin for error was reduced significantly. I have discussed with Spouse that if things fall apart,

Fire and brimstone coming down from the skies! Rivers and seas boiling! Forty years of darkness! Earthquakes, volcanoes… The dead rising from the grave! Human sacrifice, dogs and cats living together… mass hysteria!

We would have to revisit the spending side of the equation and tighten our belts for a while until things blow over. I think there is enough slack in the spending side that we could do that without giving up things that are really important to us, like travel.

Thank you for reading. Comments are welcome.

6. Our investments

5. My investing style

I’ve gone through various stages in my investing career.

First Stage (mutual funds):

When I started working, I was just leaving money to accumulate in a bank account because I didn’t know where to start. A friend from university told me to go up the street to Montreal Trust (that’s how long ago it was) to open a money market mutual fund account. I don’t remember why I didn’t do exactly that, but it did get my off my duff to start researching mutual funds, and I ended up investing first with Altamira Funds, which had had a couple of good years. I gleefully invested a few hundred dollars a months in a few funds on automatic investment. Sometimes I moved money from one fund to another trying to time the market, but never with much success. As my portfolio grew, I started looking further afield and ended up investing money with AGF, another star performer, but one with higher management expense ratios (MERs), and onto various other companies.

Second Stage (index investing):

Over time I began to realize that I wasn’t really ahead of the market. I had some winners, some funds that moved only a little, and some dogs (hello Japan Fund). As I read more, I began to realize that I am not smarter than the market, so trying to pick winners was a bad idea, especially trying to pick winners on the basis of recent returns. I also began to realize that as it looked like the high returns of the 1980s were coming to an end, the impact of MERs is an important determinant of overall return on investment. I began to shift funds from managed funds to TD’s e-series of low-cost index mutual funds.

Setting up a brokerage account and getting into exchange-traded funds (ETFs) was the next logical step, especially as my portfolio grew larger and the trading costs associated with ETFs would be relatively small compared to the values I was purchasing.

Third Stage (income investing):

The third stage of my investment career began about five years ago when a relative began teaching me about investing directly in companies. This help came along at the right time for me, as my portfolio had grown to a size where it made sense to invest directly, but I need some help to get started. His focus was on dividend-paying stocks, with some more colourful investments on the side. I dipped my toe in the water, and over time began to shift more and more of my portfolio from ETFs to stocks as my comfort level grew and as I found more opportunities that I wanted to pursue.

The settlement of a lawsuit gave me more time to focus on investing, and cash to invest, and it was around then that I disposed of my remaining ETFs and invested the whole portfolio in stocks. I also began investing some of Spouse’s money into the more conservative stocks that I was buying for myself.

This style suits me for my stage in life: with financial independence imminent, it helps me to have an identifiable stream of income to support Spouse and me in the style to which we would like to become accustomed. Dividends and REIT distributions are not the most tax efficient form of income. Indeed, it would make more sense from a tax perspective to have our taxable account heavily invested in non-dividend-paying stocks with a better likelihood of capital gains, which are taxed less. But capital gains simply are not as reliable as dividends and distributions from good companies and REITs. I don’t think I would be comfortable planning financial independence based on assumption about realizing capital gains to fund our lives.

What about bonds? I had some bond mutual funds and then bond ETFs, because I was always told to have a balanced portfolio. When I started investing directly, I really had trouble justifying buying bonds with low interest rates when there were real estate investment trusts (REITs) offer nice juicy returns of 5-6% or even more. And I rationalize it to myself that my defined benefit pension plan is the fixed-income part of our portfolio, so the rest of our portfolio can be held in equities.

Our equity investments are by-and-large, conservative – dividend stocks and REITs are going to be less volatile than other stocks, especially since I focus on those that have not cut their dividends. Of course, there is a first time for everything, but if a company didn’t cut its dividends during the crash of 2008, I think it is probably pretty stable.

In the next post, I will discuss what I have invested in. Thank you for reading. Comments are welcome.

5. My investing style

4. How I achieved financial independence: Vision – Plan – Action

As I explained in my last post, when I started work, I had a vision of life after work. I developed a plan to take a different path from friends and colleagues. The plan to achieve my vision gave me the motivation to take the actions necessary to achieve it.

This was an essential component of my success in achieving financial independence. Having a vision and a plan helped me every time I had to make a decision about spending money. Do I buy the nice shirt that’s not on sale? Do I order the more expensive dish when out at a restaurant? I remember soon after starting to work meeting a classmate from university who was bragging about the Saab that he had just bought. It was used, but being able to buy a spiffy car was clearly important to him. For me, squirrelling away my money was more important.

It can be hard to forego current consumption for the future, especially when friends and colleagues are buying nice cars, taking expensive vacations, splashing out on expensive clothes and entertainment. I don’t want to suggest that I lived like a monk. Travel is important to me, so I made sure that there was always money for travel. And fortunately, I am happy to travel in a modest style. I continued to stay in youth hostels for a while after I started working, before graduating to inexpensive hotels, and then VRBO.com, and now there’s Airbnb. The glitzy hotels do not appeal to me.

Some degree of lifestyle inflation is going to happen to most people. For me, a key thing was to make sure that it lagged my income growth. I continued living as a student when I started working. As my income grew, I allowed myself more of an entry-level lifestyle, and so on. Living in downtown areas meant never having to buy and operate a car. I think that the savings from that more than offset the additional housing costs that come with downtown living. In early retirement discussions, this is known as “living below your means”.

There has been some discussion in recent years about how millennials having been “living above their means”, i.e., accumulating debt during their mid-to-late twenties in order to get all of the toys when they start working with the plan to pay for them later. I don’t know if this is at all true. The millennials I work with seem to be pretty level-headed people.

Now that I am at the end of my path, I do wonder what it would have been like if I had set a more aggressive goal. I aimed for financial independence at 52, and will make it at 50. What if I had aimed for 48? Would I have achieved that? Would I have over achieved at finished work at 46? I’ll never know, and I’m not going to stress over it because there is nothing I can do about it now. I am happy with how my career has gone, and finishing work at 50 is something to be pretty happy about too. I hope to have 15 years of active living and travelling before I start to slow down, and then another 10 years of good health before I start to seriously slow down. Who knows – without the stress of work and with more time to devote to exercise and healthy eating, maybe Spouse and I will be one of those annoying enviable couples who are still living on their own at 85 and power-walking around the neighbourhood every morning.

In the next post, I will discuss my investing style. Thank you for reading. Comments are welcome.

4. How I achieved financial independence: Vision – Plan – Action

3. Getting started

My path to financial independence began when I started my first professional job. I had taken time off during university to travel and work overseas. When I started work, I found that the work was interesting, challenging, and worthwhile, but I kept thinking about all of the amazing places I went and the amazing people I met when travelling. I felt that a few weeks of vacation here and there would not satisfy my wanderlust, and began working on a spreadsheet (so long ago, it was probably in Lotus 1-2-3) to see when I could retire and travel full-time.

By starting with income of A, assuming it would increase at rate B, savings of C, assuming that would increase at rate D, return on income of 8%, income needed at retirement of E, inflation equal to F, etc., I came to the conclusion that I could stop working for money at 52.

This put me on a different path from my colleagues. While I now see a large early retirement/financial independence community online, and a smaller “extreme early retirement” community, when I started working, I only knew the standard model of working until you’re 65, or taking early retirement a few years before that. In the 1990s, London Life was so successful with its “Freedom 55” advertising campaign that it became a catch-phrase for early retirement in Canada, and other financial planners criticized it for promising something the company couldn’t deliver.

In the public service, people work toward their “unreduced pension” date, i.e., the date at which you can retire with a full defined benefit pension. “Factor 90” is an important concept here. When your age (minimum of 55) plus your years of service equal 90, you can retire with a pension equal to 2% times the average of your best five years of salary. It is a pretty good deal. You do pay for it – typically 7-9% of your salary comes off your paycheque to go into the pension plan, but you end up with a fixed, certain and indexed pension.

By planning to leave at 52 in December 2017, I would never qualify for this great pension, but only a fraction of it, delayed, and would have to make up the difference through private savings.

So I began plowing everything I could into a Registered Retirement Savings Plan (RRSP, like a traditional IRA in the U.S.), and some more into a taxable account. The latter was earmarked for taking a year’s leave of absence at some point to travel.

I never wrote out a budget, because I just wasn’t interested. I admire people who do, but I know that I would not follow it. What I did do was set a savings target every year and tracked my progress towards it every month. Every year, I set a higher target than the last, always keeping my eye on the prize at the end – financial freedom.

I bought the hot mutual funds, and paid only scant attention to MERs. I tried to time the markets. I switched back and forth. I put money into a Japanese fund when that seemed to be a good idea (it wasn’t).

Best laid plans… not very much went according to plan. My salary increased faster, through promotions. 8% return turned out not to be realistic. I bought a house to live in and rented out parts of it. I fell in love with a man in another (more expensive) city where I had grown up, and moved there. We bought an apartment together and exchanged rings, so the year’s leave of absence idea went out the window and the travel fund became a general financial independence fund. I got involved in a lawsuit that dragged on and on. I tried my hand at consulting, tempted by the big money. But I didn’t find it fulfilling, so I found my way back to the government, accepting the large pay cut as the price of having rewarding work. The law was changed, so we got married. I finally clued in that mutual funds are a bad deal, stopped chasing the elusive winners, and switched my investments over to exchange traded funds. I began learning about income investing, and started slowly shifting money into dividend stocks and REITs.

When the lawsuit was settled, I took that money, and the remaining money I had in exchange traded funds and put it entirely into dividend stocks and REITs, having developed enough comfort with income investing.

With the legal uncertainty out of the way, and a definitive investment income stream developing, I could now turn my attention to concrete planning for financial independence. I developed a new spreadsheet that factored in pension, OAS, CPP, investment income, withdrawals from different accounts and built in a tax calculator. It is a pretty impressive thing, IMHO. There was no question that Spouse and I would finish work together. I know that lots of couple retire at different times for a variety of different reasons. But since we are both eager to be done with jobs, and we want to travel together, both leaving at the same time makes most sense.

My first cut at our joint financial independence plan had us leaving work in June 2019. Not far off from my original plan. How much money we would need in retirement was a pretty random number, to be honest. I really had no idea how much we would need. (I’ll write a separate post on that issue.) The plan had a lot of placeholder numbers and assumptions in it. As I developed the plan further, and replaced guesses and assumptions with real numbers, I found that we could quit work earlier. Spouse leaves the financial planning up to me (and I don’t have to worry about any technology in our home – yes!), and was quite amused at how long I was spending obsessing over my spreadsheet. He was quite happy though, when every so often I would announce that I had moved our target date six months earlier. And I was increasing our projected income in retirement, too.

In 2014, two things happened. The first was that I got a job I had been pursuing for two years, giving me an opportunity to do something very different and exciting. The other was that I decided I had to stop adjusting the date, and settled on June 2016. That would give me a little over two years in the new job, and allow me to feel that I had fulfilled my commitment to my employer.

Since then, during a couple of times of high-stress, I have a cut a month off, so now we are planning for April 2016.

In the next post, I will discuss how I achieved my vision of financial independence by developing a plan, and taking action. Thank you for reading. Comments are welcome.

3. Getting started