Question: How do I protect myself from severe market downturns similar to the one we’ve seen as a result of the coronavirus lately?
The way I would like to address this with you is by comparing two asset classes: real estate and income or dividend/distribution producing assets. Many people will suggest that one should diversify by investing out of the traditional ‘market’ by purchasing real estate. As a real estate investor myself, I urge that this can indeed be one way of hedging against a volatile market, but it can still certainly leave you exposed. What happens if masses of layoffs occur and people can no longer afford to pay their rent, which we’ve seen recently. Albeit there’s mortgage deferrals, which should alternatively be passed along to the tenants in the form of rent relief, however these deferrals are only for 6 months. What happens if the virus has a longer lasting impact on industry and people are without work for much longer?
Then there’s the stock market.
Whether you’re invested into traditional stocks or mutual funds, or index funds, it’s a safe guess that you’ve taken a thumping over the past couple weeks like most of us! I’ve looked at my market returns for the past 10 years and 5 of the greatest down days have been in the past two weeks!!! Am I concerned? Not at all… I am quite confident actually, and I’ll unpack for you over the course of this post why!
*I’ll preface this post by saying that I’ll be picking most of the figures I use arbitrarily to make my point, and that these are only for illustrative purposes only and you should confirm your own specific numbers for your situation!
First lets look a the real estate option.
Lets assume that you own a condo that you’ve paid $250,000 for and that it’s currently rented for $1500/month. The condo has HOA/condo fees monthly of $450, taxes are $225 monthly, and condo insurance is $25/month. All utilities are covered by the tenant, so the total expenses to you are $800/month, therefore netting you $700/month in before tax revenue, or $8400 annually. Assuming that this income will be taxed at a rate of 25% (confirm your rate with an actual tax advisor), that means that you’ll net $6300 annually or $525/month by owning and renting this property out.
As any landlord knows, especially during drastic market changes, people end up having changes in their living situations and therefore there’s a bit of churn that must be taken into consideration by renting. That said, there’s no guarantee in the monthly income that we’ve proposed above. In fact, it might be prudent to suggest that it may be almost impossible to find a tenant during a down market and therefore you may be forced to go without rent for a number of months, or settle for a less ‘suitable’ tenant that you’d like to keep the revenue coming in.
Regardless, there’s no guarantee that you’ll see a continual source of revenue as a landlord. While you’re invested to the tune of $250,000 and bringing in a return on your investment of $18,000 annually before expenses, your real return is 3.36% before tax, and 2.52% after tax. These are not very good returns by any stretch of the imagination! I can already hear many of you saying that your returns would be higher if you mortgaged the property at current low interest rates, but I assert that your returns will be the exact same or just marginally higher. Suffice to say that real estate has some risk associated with it the best of times, lets now take a look at an income producing investment for comparison.
I currently own a managed mutual fund from CI investments called Signature High Income. It’s the class A version and it costs me a 1.59% MER (management expense ratio). I realize that self directed index funds will cost alot less in theory, however here in Canada you cannot invest directly with Vanguard and many others so you must still pay self direct brokerage fees for every transaction which makes the point of having lower cost index funds a moot one for me! Canada is alot further behind the rest of the world in terms of low cost investment options with the US offering great low cost or free index funds, and platforms like Vanguard and Robinhood.
Back to Signature High income fund… it first started trading on Dec 18th, 1996 and is a diversified low-medium risk income fund. It’s comprised of mostly US and Canadian real estate and finance equities as well as some energy and industrial services. It pays a $0.07 distribution per unit every month! That’s $0.84 per year for each unit! This figure may not seem like much but let me show you in closer detail why it’s a great return. If it sounds like I may be a bit biased towards this fund, that’s because I am! I must also clarify that I’m not being paid by CI when I say this, and that it’s my sole opinion.
While there is no guarantee that they’ll keep paying this monthly distribution, they have paid it the entire time that I’ve owned it – well over 10 years! It’s comprised of really strong performing equities that have historically weathered market downturns very well! That being said, while the income may not technically be guaranteed, it’s a fairly reliable way to generate income for those of us who prefer this investment approach, or who may be nearing retirement, or already retired.
To quantify this, let’s use the price of this fund at it’s peak just immediately prior to the market crash. On Valentines day this year, just over 4 weeks ago, this fund was trading at its most recent high of $14.01 CDN/unit. For this illustration we’ll again use $250,000 which means that if you’d purchased the entire amount at this high, you would have 17,844.4 units total. With a distribution of $0.07/unit, that means that you get $1,249.11 in gross monthly distributions, or $14,989.29 annually.
Let’s take a closer look at this distribution return. Depending on how you’ve structured your investment (RSP/401K, TFSA/IRA), there’s a good chance that 100% of this amount can be reinvested to purchase more units, making for an even better return! If however, you take this return as cash, again let’s assume a 25% tax rate, then you would net a $11,241.97 return. No tenants, no maintenance worries, no late night phone calls to fix leaky toilets, or noisy complaints by neighbors!! Just good old fashioned income! As a return, the gross return of $14,989.29 provides a 6% return, while if you opted to take it as cash, based on a 25% tax rate you would net 4.5%, again for doing nothing!
After reviewing these numbers, I would suggest that while both of these “income” producing investments have risk associated to them, I would venture to say that the Signature High Income mutual fund by CI is less risky, less hassle, and a great way to grow your portfolio or provide your income needs for today.
How you decide to proceed with your investments and structure your portfolio is entirely your call. I’ve owned many risky investment positions in the past and prefer a tortoise approach as opposed to the hare.
I hope you’ve found this post beneficial! Don’t hesitate to send me a message if it benefited you or you have any questions.
RAFI!
