Saturday, January 9, 2016

Year End Review 2015 - After 3 Years of Retirement - Surviving the Economic Downturn

The conclusion of 2015 marks the end of our third full year of retirement.  It is time once again to review how my husband Rich and I did in the year and to track our progress against the retirement plan that we created as a benchmark when we retired in May 2012.  I described our process for this annual review in significant detail in the previous years so I won't repeat it now.  If you are interested, I have included links to the earlier blogs at the end of this one.

2015 was a brutal year for the value of stocks as share prices tanked across the board.  For the first time since we retired, after taking out our annual income requirements, the year-end total of our portfolio was lower than it was at the beginning of the year.

Before removing dividends and RRIF payments to use as income, we just about broke even with an increase in value of less than 1%.  This is compared to almost 15% increases in our portfolio totals at the end of the previous two years.  After removing our annual income, our 2015 year-end balance was 2.2% lower than our total was at the start of the year.  This result is actually not so bad when compared to the TSX as a whole, which was down 11% for the year.  We were buffered from the worst of the carnage because we have limited exposure to the oil and gas industry, which comprises of only 6% of our holdings.

 As documented in our book Retired at 48 - One Couple's Journey to a Pensionless Retirement, our portfolio is primarily made up of Canadian dividend stocks since our strategy is to live off the dividends while preserving the capital for as long as we can.  Being retired with almost no fixed income goes against most conventional wisdom,  although the old rules of increasing the amount of fixed income as you age has been softened by most experts given the dismal rates of return over the past few years.  Since we mostly care about the dividends and not the transient value of the stock, this lessens the risk significantly, but holding only equities is still a relatively risky prospect.

Accordingly, as additional contingency we purposely chose very conservative parameters for our retirement plan.  We picked a relatively low annual investment rate of return while specifying a higher retirement spending than what we initially planned to spend.  This would allow us to grow faster than plan during the good bull market years, building up excess value that would be used to buffer the bear market years that were sure to come, as historical trends show. 

This is exactly what happened over the past three years.  By the end of 2013, we were 12.4% ahead of our original plan and by the end of 2014, this value had climbed to 25%.  The dismal results of 2015 ate slightly into this significant cushion so that we ended the year at 22.5% above the original plan.  So we can absorb a few more bear market years and still stay on track or even be ahead of the game relative to our retirement plan.  Based on how the start of 2016 has been going, we may need to use more of this cushion before the year is done.

Much more important than the value of our portfolio is the amount and the reliability of the dividends that we receive, since we count on these dividends for our annual income.  Surprisingly, despite the weak performance of the stock market in 2015, our total dividend payout still increased, abet by less than in previous years–by 8% as opposed to 14 and 17%.  Imagine the chance of getting an 8% raise from your employer at all, let alone in a poor performing year?

Out of our 35 different stocks, 27 raised their dividend this year (which is actually more than last year), with 10 of them increasing their dividends more than once. The sizes of the dividend raises must have been smaller to account for the lower rate of dividend increase overall.  Also, many of the companies raised their dividends early in the year, before the apex of the stock crash was reached.  So unless the markets improve, it is possible that dividend growth will continue to be reduced in 2016.

Luckily, none of our stocks have cut or eliminated their dividend payments so far, unlike several of the smaller oil and gas stocks that we don't own.  The closest we have come to a dividend reduction is with Husky Energy (HSE), who has announced that for the next dividend payout, to preserve capital, it will pay dividends in shares as opposed to cash–in other words, a forced DRIP.  This decision will be reevaluated at each quarter depending on how things go for the company.  As an aside, many companies are reducing or eliminating the discount that they offer on DRIPs as a further cost cutting measure.

I hold Husky Energy in my RRIF where I need to maintain sufficient cash flow to support my monthly RRIF payments, so losing the quarterly HSE dividend will be a slight blow.  Luckily the average yield from the stocks in my RRIF is over 5% while my minimum RRIF withdrawal last year was 2.5%, so my remaining dividends should still cover the monthly withdrawal requirements.  One side effect of having the value of my RRIF account decrease is that the new minimum withdrawal for 2016 decreased as well.  At the beginning of each new year, the new amount is calculated by  "1 / (90-age) * value of account at the end of Dec. 31 of previous year)".  The expectation of this formula is that the RRIF withdrawal amount should increase each year to account for inflation, but this year the value of my account decreased so much that the RRIF withdrawal amount is actually a few dollars less than last year.

Just in case any other stock decides to cut its dividend, we plan to carry a larger amount of excess cash within our RRIF accounts.  While it is tempting to use the cash to buy more "bargains" while stock prices are so low, common sense dictates that we should build up our emergency cash reserves instead.  We can then use this cash as contingency in case we encounter more unexpected expenses like we did last year when we found out that we had to replace defective Kitec pipes in our condo.  Last year, we each took out an extra RRIF withdrawal from some of the excess cash that was building up in our RRIF accounts and allocated the money to our long-term expense "kitty" where we are saving up money for the pipe repairs that will occur towards the end of 2016.  I withdrew $3000 above the minimum and had to pay 10% withholding tax for a net deposit of $2700 while Rich withdrew $4000 and paid $400 in tax.

Overall, our spending for 2015 came in about the same as 2014, despite non-discretionary expenses like our condo fees, electricity bill and property taxes continuing to rise.  Considering that we planned for 2% inflation increases each year, we're doing well in keeping the expenses down.  We were lucky last year that our 2005 Toyota Matrix still ran smoothly with no major repairs required, but it will only be a matter of time before that changes.  Our appliances are all over 10 years old now so we are keeping an eye on them as well.  Our discretionary expenses (vacations, dining entertainment) came in about the same as the previous year as well, and there is plenty of room there to cut back if we need to tighten our belts for 2016.

So after three full years of retirement, we are still doing well financially, and due to a solid retirement plan that included good contingency strategies for bad market years, we were able to roll with the punches to survive 2015.  Let's see what new challenges 2016 brings us.

2014 Year End Review
2013 Year End Review
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