One of the easiest ways to buy a 60-40 balanced portfolio just delivered a 12-month return of 10.5 per cent, and one of its competitors made 11.2 per cent.
The classic balanced portfolio mix of 60 per cent stocks and 40 per cent bonds was considered so dead 18 months ago that funeral arrangements were being made. Stocks were falling, but so were bonds. Hammered from both sides, 60-40 portfolios produced alarmingly bad results.
The 60-40 mix was terrible for 2022 – that is a fact. But the reason now appears to be a result of the unusual financial market conditions generated by the pandemic, and not a fundamental flaw in this particular portfolio mix.
For the 12 months to June 30, the $2.4-billion Vanguard Balanced ETF Portfolio (VBAL-T) made 10.5 per cent, while the $1-billion iShares Core Balanced ETF Portfolio (XBAL-T) made 11.2 per cent. In 2022, both VBAL and XBAL lost a bit more than 11 per cent.
The reason for these double-digit declines can be traced to the awfulness of bonds, which are supposed to support portfolios in years, such as 2022, when stocks are in retreat. The benchmark FTSE Canada Universe Bond Index lost 11.7 per cent in 2022, a phenomenally bad year for bonds that can be blamed on an upward surge in interest rates.
Rates are still rising in 2023, but financial markets believe this is a near-term issue and that rates will be lower in the longer term. For the past 12 months, the FTSE Canada Universe Bond Index was up 3.2 per cent. Global stock markets have been strong during this period, hence the buoyant returns from 60-40 balanced funds.
The lesson of 2022 for 60-40 portfolios is that soaring interest rates will hit returns hard. But periods when interest rates rise as sharply as they did in 2022 are both rare and temporary. If interest rates haven’t hit their peak in the current cycle of increases, then we are very close to that point.
There’s an emerging view that rates will not fall to prepandemic levels, but they will decline from today’s elevated levels as inflation backs down. When that happens, the bond side of the 60-40 portfolio could shine.
-- Rob Carrick, personal finance columnist
More from Rob Carrick: Lower interest rates will bring a ‘wildebeest migration’ of investors into beaten down dividend stocks
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Ask Globe Investor
Question: Following the death of my husband in 2005, I invested for income in a non-registered account with Phillips, Hager & North ... most of it in mutual funds. Since then, I have come to regret my decision because of the distributions associated with the portfolio.
I live modestly and withdraw the minimum from my RRIF. My income would be well below the clawback level of $87,000 per year except that I must declare capital gains distributions and dividends (T3 and T5 slips). This means I must pay more in taxes.
My question is this. Do ETF’s (which have a much lower MER) have the same distributions? I am seriously considering whether it makes sense to withdraw all my money from PHN and invest it instead in ETFs. My total returns are in the area of 5 per cent...not stellar. It does mean that I have a capital gain in total of $300,000+, half of which is taxable. It would cost me a lot in taxes but may be worth it going forward. I would appreciate your comments. - Frances B.
Answer: Let me get this straight. You invested for income but now you feel you have too much of it? There are a lot of people in Canada who would like that problem! But let’s see what we can suggest.
Like mutual funds, most ETFs pay distributions. The amount varies from one ETF to another, as with mutual funds. I would expect if you invested in ETFs that are similar to the PHN funds you now own, you’d receive similar distributions. You’d be taking a big tax hit and end up no farther ahead.
I suggest you talk to a financial advisor at PHN, explain your concern, and ask for advice. For example, you have not mentioned Tax-Free Savings Accounts. It may be possible to move some money each year into a TFSA at a minimal tax rate. Here’s how:
When you sell mutual fund units in a non-registered account, any capital gain is taxable. If some of your funds have a small capital gain that would attract little tax, you could start your selling plan with those. If you have some bond funds, they may even be showing a loss, depending on when you acquired them. If so, selling them will generate a capital loss, which can be used to offset gains.
The financial advisor can be more specific, as he/she will have access to all the facts. Please do not incur huge capital gains by selling everything at once.
--Gordon Pape (Send questions to gordonpape@hotmail.com and write Globe Question on the subject line.)
What’s up in the days ahead
Gordon Pape has long recommended Northwest Healthcare Properties as an investment, but now the REIT is yielding nearly 13 per cent after a selloff - which could be a warning sign of a distribution cut. He’ll tell us what his latest suggestion is on the REIT later this week.
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Compiled by Globe Investor Staff