2023-03-08 04:30:00 ET
Summary
- Most retirees will use bonds and cash to manage risks, but we can also layer in defensive stocks.
- Consumer staples, healthcare and utilities stocks were far superior to the traditional balanced portfolio through the financial crisis.
- The defensive stocks also worked much better than the balanced portfolio moving through the COVID correction and recent bear market.
There's nothing like a recession and severe bear market to throw your retirement off-track. The financial crisis of 2007-2009 and beyond offered the greatest stock market decline in our lifetime. Stock markets fell by over 50%. Sequence of returns risk can be managed by creating a portfolio that experiences a lesser drawdown. Mostly, retirees will use bonds and cash to create that lower-risk portfolio. Perhaps a more effective model is using defensive sectors in concert with bonds and cash. The defensive sectors were twice as good as the market and a balanced portfolio through the financial crisis.
Here's a post that outlines sequence of returns risk .
The first question you will likely ask is: “What are the defensive sectors?”
Consumer Staples / Healthcare / Utilities
For the utilities sector, we can also include the modern utilities known as telco (we can’t live without being hooked up in the modern world). Pipelines are also in the mix.
The 3 defensive sectors are products and services that we can’t live without. And we often do not reduce spending in these categories, even during times of recessions and bear markets.
The sectors are more durable and will typically hold up quite well during the bear markets. Of course, bear markets can pull the rug out of your retirement plans if you are not properly prepared and are exposed to too much stock market risk. In retirement, we are looking to grow and protect.
Defensive sectors for retirees vs. the market
Here’s a chart that looks at the defensive sectors in the U.S. vs. the S&P 500. It is a retirement funding scenario, where the portfolios are funding retirement at a 4.8% annual spend rate. That is, a million-dollar portfolio will deliver $48,000 in year one. Spending will then increase at the rate of inflation.
Once again, the defensive sectors are consumer staples ( XLP ), healthcare ( XLV ) and utilities ( XLU ). In the following example, we will equal-weight the three sector ETFs.
Defensive Sectors (Portfolio Visualizer / Author )
The result is truly incredible and surprising. For the end of the period, the defensive sector portfolio value is $2,267,841, while the balanced portfolio value is $1,245,373. A retiree could have pushed the spend rate for the defensive portfolio.
The defensive sector portfolio drawdown was equal that of the balanced portfolio that includes 60% stocks and 40% bonds. And of course, there is greater growth within a portfolio that holds more stocks.
Same drawdown / more growth = Greater retirement success
And let's have a look at the defensive sectors through the COVID correction and the soft bear market of 2022. We'll start in 2019 to give the retirement portfolio some runway, including the pre-market stress period.
Defensive Stocks Through COVID (Portfolio Visualizer / Author )
When the world changed in 2020, the defensive stocks went to work. When the going gets tough, the tough get going.
The CAGR (compound annual growth rate, taking retirement funding into account) is 5.95% for the defensive stocks vs. 3.47% for the balanced portfolio. The drawdown was much less for the defensive stocks. Of course, bonds had their worst year in memory in 2022. Bonds did not provide that portfolio ballast - the defensive stocks did.
Here's the returns of the defensive sector ETFs from 2019 through 2022.
Defensive Sector Performance (Portfolio Visualizer / Author )
We have enough growth and stability in 2022. In retirement, success at times can be found by way of losing less, or even holding steady in troubled markets. Once again, we are looking to grow and protect.
We have a sector reversal in early 2023 as markets started to guess that good times were ahead. Of course, that would take a situation where inflation is under control and we escape a recession. That might be a big ask.
The defensive sectors are at the bottom of the heap in 2023. That said, over the last year, the defensive line holds the 4-6 performance slots as energy and materials do their thing during an inflationary environment.
Sector Recent Performance (Charles Schwab / Bloomberg ) Sectors Year To Date (Charles Schwab / Bloomberg)
Sectors during the dot com crash and GFC
Here's a table that looks at sectors through the dot com crash of 2000-2003 and the financial crisis.
Sectors through major bear markets (Author )
We see that healthcare and consumer staples were true to form during the dot com crash, and utilities held up better than the S&P 500, though it was not a top-performing sector.
All said, the group of defensive sectors would have greatly helped the cause of the retiree through the dot com bear market.
How to use the defensive sectors
We might consider the defensive sectors as bond proxies (replacements). That said, we should remember that stocks cannot do the job of bonds. Bonds have the ability to offer that inverse relationship to stocks - going up in price as stock markets collapse. The yield for investment-grade bonds might also be more reliable than that from equities.
Given that, we might use defensive sectors in concert with bonds and cash. Instead of a 60/40 balanced portfolio, you might hold 80% stocks (to 20% bonds). As an example, within the equity component, you might hold 50% in a market ETF and then 50% in the defensive sectors. And given the growth potential of healthcare, one might overweight that sector within the defensive mix.
- 40% IVV (stock market)
- 20% XLV (healthcare)
- 10% XLP (consumer staples)
- 10% XLU (utilities)
- 20% AGG and cash
That is a simplified example for demonstration purposes. A retiree will likely include some international exposure and will have their own preference for choice of ETFs or individual stocks. They may embrace other forms of income beyond a core bond index.
Canadian Defensive Sector ETFs
These ETFs are Canadian dollar ETFs, suitable for Canadian dollar accounts. Some of the ETFs will offer international exposure.
Canadian Healthcare ETFs
Canadian Consumer Staples ETFs
- BMO Global Consumer Staples Hedged to CAD ( STPL:CA )
- iShares S&P/TSX Capped Consumer Staples Index ETF ( XST:CA )
Canadian Utilities ETFs
- iShares S&P/TSX Capped Utilities Index ETF ( XUT:CA )
- BMO Equal Weight Utilities Index ETF ( ZUT:CA )
- BMO Covered Call Utilities ETF ( ZWU:CA )
- Horizons Canadian Utility Services High Dividend Index ETF ( UTIL:CA )
- Hamilton Enhanced Utilities ETF ( HUTS:CA )
The all-weather models for retirees
Readers will know that I embrace the all-weather portfolio models for retirement. In the above scenarios, the time period is almost exclusively during a period of disinflation. Stock markets and bonds love disinflation. In the defensive portfolio, there would be modest protection from robust inflation. It would need some help on the inflation front.
Given that, I would suggest that you consider adding (bolting on) inflation protection. We can use a basket of commodities ( DBC ), gold ( GLD ), energy stocks ( XLE ) and perhaps some commodities stocks as well.
In Canada, that can be as easy as adding the Purpose Real Asset ETF ( PRA:CA ). That holds a very nice mix of dedicated inflation fighters, from energy stocks to REITs, gold and commodities.
I also continue to like the idea of Canadian oil and gas stocks . The energy sector has the highest success rate for battling inflation. Your pipeline stocks will help in that regard as well.
I would suggest that you consider a 10-15% allocation to dedicated inflation fighters.
Defense + Inflation Protection + Yield
For the retiree, I think the above hat-trick is a winning combination. That’s how I go at it.
I experienced very strong performance with the U.S. stocks in my retirement account . From 2020, I beat the market by almost 6% annualized. I employ a mix of growth and defense by way of individual stocks.
My Canadian Wide Moat stocks provide some nice yield and a defensive slant.
On the inflation-fighting front, I continue to hold and add to our Canadian oil and gas stocks . As you'll see from that post, I have moved to an energy dividend focus to remove the price risk. The dividend growth has been outrageous. I also hold DBC, gold and materials stocks.
Have a look at the all-weather portfolio for retirement .
I can tell you from experience that the defensive all-weather portfolio helps a retiree SWAN - Sleep Well At Night.
Thanks for reading. We'll see you in the comment section.
How do you manage risks in retirement?
For further details see:
Defensive Sectors Were Twice As Good As A Balanced Portfolio Through The Financial Crisis