Assuming that their home is paid off, and they end up with the tax-free equivalent of 10 years salary, they might want to look at having the equivalent of eight of those years salary invested into the stock market. All at rates intended to protect the principal from inflation (meaning that it continues to grow), but also allows a decent income to be claimed from the portfolio. The balance might be invested in money market and bond issues, and used to draw short-term living expenses from.
Again, I think using ETFs that track some type of fundamental index (in other words, a index that is based on value-type measures [eg price/book, PE ratios, free-cash flow growth, and dividend growth/payments], such as some of the RAFI indexes) offers a much greater chance for outperformance, and with enhanced safety of capital. (See video, here, on why fundamental indexation is a better mousetrap). In other words, having your cake and eating it too. What could be sweeter?
Again, I think that these type of portfolios can be very robust, and also very simple. For instance, if I was advising my wife, I would probably suggest that the stock portion of the portfolio be weighted toward dividend growth/paying ETFs (given the need for income, and the documented outperformance that these types of stocks have delivered over time) and might look something like this:
The Claymore Canadian Fundamental Index (CRQ) ETF has been designed to replicate the performance of the FTSE RAFI Canada Index, which comprises those Canadian companies with the highest fundamental weightings. The index weights constituents using four accounting factors, rather than market capitalization. These four factors include:
- Total cash dividends (five-year average of all regular and special distributions)
- Free cash flow (five-year average cash flow)
- Total sales (five-year average total sales)
- Book equity value (current period book equity value)
Claymore Canadian Dividend & Income Achievers (CDZ). Weighted to emphasize stocks that both have a relatively high yield, and also have a good track record of raising their dividends. It tracks the Mergent Canadian Dividend Income and Achievers (fundamental) index. Over the past five years, the index has posted a 15.1% annual gain, versus the S&P/TSX Index return of 11.1% annually. Over ten years, it posted an 18.1% annual return, versus an 11.0% return for the S&P/TSX Composite Index. The underlying holdings are around 55-60 stocks typically. I would suggest a 20% weighting for this ETF.
Claymore US Fundamental Index, C$ Hedged (CLU). This ETF also tracks another fundamental index, which tracks the top 1,000 US securities by fundamental value, using the following four factors: cash dividends, free cash-flow, total sales, and book equity. This ETF is also attractive from my point of view, in that I think the US dollar will be lower in 10 years than now, but this ETF hedges against currency changes, meaning that we'll only trap the underlying changes in the index. Over five years, this index has returned a 7.0% rate annually, versus a -3.2% S&P 500 annual return (as converted to Canadian currency). The underlying holdings are around 1,000 stocks. I would suggest a 20% weighting for this ETF.
Claymore BRIC (CBQ) is the final Claymore product, that portfolio manager Roger Nusbaum has also written about. This ETF isn't fundamentally indexed, but is designed to mirror the BNY BRIC Index, which tracks ADRs from Brazil, Russia, India and China, all powerful emerging economies. Over time, this should be a strong growth component, but one which will also be volatile in nature. This index has returned 33.2% annually over the past four years, versus the more widely known MSCI EM Index, which has returned 19.7% annually over the same period. The ETF has 75 underlying stocks with above average concentration in the first ten stocks, with about 53% of the value held therein. This isn't currency hedged or denominated in Canadian dollars, but this could be a plus if these currencies gain strength against the Canadian dollar over the next decade. I would suggest a 20% weighting for this ETF.
Finally, for the fifth ETF, I'll suggest a product that trades on the American exchanges, a Wisdom Tree ETF product that tracks the Wisdom Tree International Dividend Top 100 Index (DOO). This is also a fundamental index, based on dividend yield of large and mega cap international companies. Currently, about 80% of the companies in the index are domiciled in Europe, with about 20% in Australia, Singapore and Hong Kong. The index has returned 16% annually over the past five years, as denominated in US Dollars. Conversion to Canadian currency over that time would have considerably diminished these returns to about 8.5% annually (which is still respectable, although not outstanding). While the currency issue may be slightly negative over the next decade, I don't think it's going to weigh down returns like it did over the past five years, or like it might for an unhedged US stock situation going forward. I would suggest a 20% weighting in this ETF.
Well, that's it. A relatively simple portfolio, with ample geographic representation, and wide corporate representation. The one noteworthy thing about this portfolio is that it's definitely weighted to the financial sector, but I've never considered that a particular problem, since I consider this sector as the backbone of the entire economic system. My theory here is that if this sector suffers some sort of serious long-term decline, so will virtually every other sector of the economy.
Finally, the other noteworthy aspect is the ability of high-dividend paying stocks to resist market downturns, something that might make this particular portfolio even more attractive; certainly, it makes it easier to sleep at night.
Now, the only thing that would need to be done by your proverbial widow, is simply to "re-balance" this portfolio back to the same 20% weightings, about every three years or so. This allows the winners to run for a while, and also to take advantage of longer-term "reversion to the median" and relative underpricing in the portfolio.
Of course, the widow would want to check out other sources of fundamental ETFs, such as Claymore Investments, Wisdom Tree and Power Shares in case she prefers a slightly different weighting using fundamental indexed ETFs. Finally, she should of course take the whole idea to a fee-only financial planner for critique and tweaking.
The Confused Capitalist