My Investment Return for 2025
The 2025 investment return for my overall portfolio measured in Canadian dollars was 13.7%, which is below my 2025 benchmark return of 16.0%. There are two main reasons for this difference. The first is that we made a large financial gift, and the timing of our stock sale to raise cash for this gift was unlucky.
The second reason is my decision a few years ago to shift gradually away from stocks when stock prices are high as measured by the cyclically adjusted price-to-earnings ratio (CAPE) of world stocks. This shift is tied to my rebalancing plan that is automated in a spreadsheet. My benchmark doesn’t do any automated shifting away from expensive stocks.
This year, stock prices were high but they gave good returns anyway, and my slightly lower than usual allocation to stocks cost me money. This has happened two years in a row now. But I’m content with this outcome. By shifting modestly away from stocks when they’re expensive, my portfolio risk is lower at a time when stocks are riskiest. I don’t expect my strategy to pay off during normal times. I’m reducing my losses if we have a scenario where stock prices are high, and then they crash. This is a kind of insurance, and it has a price during normal times.
Another reason to control risk is that, in a sense, I’ve already won the game. I retired 8.5 years ago having saved up enough to cover my desired spending for the rest of my life with enough of a buffer to cover a 25% or 30% stock crash shortly after I retired. I was protecting myself from sequence-of-returns risk.
Instead of a stock crash, my compound average annual return since retiring has been 6.5% above inflation. I got the upside of sequence-of-returns risk. As a result, my need to take on investment risk has diminished significantly. It’s comforting to know that I’ll be fine whether stocks keep climbing to the sky or they come crashing back down to earth. I don’t waste any time trying to guess which will happen this coming year.
The following chart shows my cumulative real (above inflation) returns since I began controlling my own investments.
Over this full period my compound average real return has been 8.0%. A big chunk of this is due to some extremely risky bets I made in 1999 that paid off. In normal times, I expect the compound average real return of stocks (for planning purposes) to be 4% less investment costs.
At the current CAPE level of the world’s stocks, my compound average real return expectation from stocks is only about 2.6% for the rest of my life. This is based on the assumption that average worldwide corporate earnings will rise at 4% real, but that the blended CAPE of world stocks will decline to 20 by the end of my life.
Although I look decades out to make a plan, I only commit to this year’s spending level. Whatever happens in the markets makes me update all the planning numbers (all automated in a spreadsheet). This means I adapt my spending level to what the markets do rather than commit to a real spending level for the rest of my life.
This flexibility makes it safer to spend a little more from my portfolio right now. The less flexible you are with your spending level each year in retirement, the lower your return expectations need to be for planning purposes.
"The first is that we made a large financial gift, and the timing of our stock sale to raise cash for this gift was unlucky."
ReplyDeleteI think we rarely plan this kind of thing, so it is somewhat like "forward income averaging" (maybe it is the opposite of it?). Sometimes ya gotta stick a crowbar in your wallet and let Sir Wilfrid Laurier see the sunlight 😂.
I have had the opposite happen, where I cashed out to pay off a debt, and the stock associated with it plummeted shortly afterwards. That kind of move makes you LOOK like a genius, when you know (full well), it was just plain luck (plane?).
Unfortunately for us, we did plan ahead for this gift. We sold stocks early before they went on a tear. I once lent money to a family member many years ago. The stock I sold to raise the cash crashed spectacularly shortly afterward. When the family member paid us back, 0% felt like a great return. But as you say, that was just plain luck.
DeleteI like all your posts .... you have mentioned in the past your stock pics back in 1999-2000 turned out very well ... could you share a few of the stocks you bought back then that gave you such a great start ... thanks ... James D.
ReplyDeleteOne was Nortel, but the main one was Entrust. It's hard to feel good about doing well with these stocks though, because I know so many people who lost money on them.
DeleteNortel did popularize the phrase " don't try and catch a falling knife" and yes lots of staff got hurt who had stock savings plans .... do you recall what finally motivated you to sell either of these winners after a long run up ? ... thanks James D.
DeleteI sold them for risk reduction. By my current standards, I took wild risks holding these stocks too long. At the time, I was thinking about limiting them to a percentage of my net worth, but that percentage was over 50%! Now I don't buy individual stocks, and if I came to own one somehow, I'd likely sell anything over 5% of my net worth. That percentage might even be lower.
DeleteHi Michael. Always enjoy reading your posts and have learned much over the years from you.
ReplyDeleteI have re-read some of your past posts on adjusting your asset allocation with respect to fixed income vs equity based upon CAPE values. It's very mechanical and quite the opposite of arbitrary which I suppose is the point.
My question is about "age-based fixed income allocation". There are a variety of means of computing this starting point including "bond % = age", "bond % = 120 - age", "bond % = age^2 /100", and the list goes on. I have always found these functions to be VERY arbitrary.
I ultimately used "age^2 / 100" as a starting point for myself and my wife (63 and 53 respectively), but struggle to understand why I chose it other than it "felt right". We are in a situation where we should be fine in the event of a prolonged market downturn, but some subtle market timing is not our of the question. Adjusting our asset allocation one way or the other based on CAPE makes sense to me, but less so when I couple it with the fact that my age-based fixed income allocation is largely based on feel to begin with. Not sure if I'm making sense here.
May I ask how you computed your starting point for fixed income allocation?
Hi Alan, I'm glad you've enjoyed my work.
DeleteThe principle I use is that I want to have 5 years of my spending in fixed income. In my case this is an elaborate (but automated) calculation of my safe spending level that takes into account age, future CPP and OAS, and return expectations. However, if you have an idea of your safe spending level, you can just multiply this by 5 or whatever number of years you choose.
This 5-year figure then represents some percentage of my portfolio, say 22%. Then I look at the blended CAPE of world stocks. Let's say it's 34, which is 9 more than my cutoff of 25. Then I add this 9 to 22 to arrive at a 31% bond allocation in my portfolio. This is somewhat arbitrary; I arrived at this formula by imagining stocks at various elevated levels and deciding what bond allocation I'd want in each case. Looking at all the answers, this formula matched them well.
Within a reasonable range, the details of this approach matter to me less than automating it so that my emotions are kept out of it. I want to mechanically take money out of stocks slowly as their prices rise, and then if a fast crash comes, I want to mechanically buy back in.