Aug 312017
 

There’s a general rule of thumb that says if you retire you can safely withdrawal up to 4% of your nest egg every year without it running out before you kick the bucket. Financial advisor Bill Bengen, now retired, came up with this guideline after testing a variety of withdrawal rates using historical rates of returns for stocks and bonds. He published a study in 1994 about how 4% was the highest sustainable withdrawal rate retirees could use.

But 1994 was over two decade ago. How does the 4% rule hold up today, after the great recession? Bill recently did some further research into the topic and according to him, the 4% rule still holds true today. ūüôā In fact, he is even confident that retirees can safely withdrawal not just 4%, but actually¬†4.5% if they are okay with their nest eggs lasting for only 30 years.

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In a Q&A session on Reddit last week, Bill explained the methodology, details, and implications of his findings. He says that 4.5% is the “percentage you could “safely” withdraw from a tax-advantaged portfolio (such as an IRA, 401(k), RRSP, or TFSA) the first year of retirement, with the expectation you would live for 30 years in retirement. After the first year, you “throw away the 4.5% rule and just increase the dollar amount of your withdrawals each year by the prior year’s inflation rate.”

For example, if you had $1,000,000 in an RRIF, you would withdraw $45,000 in the first year of your retirement. Let’s say inflation during this year was 2%. This means in the second year you may withdrawal $45,900. Overall, Bill recommends a 50% equities/50% bonds mixture at the beginning of one’s retirement.

As for how recessions, interest rates, and government policies affect the safe withdrawal rate over time, Bill reassures us that these factors have little bearing on the safe withdrawal rate. There are only 2 major factors that count.

  1. Encountering a major bear market early in retirement.
  2. Encountering high inflation during retirement.

Bill explains that both these factors “drive the safe withdrawal rate down.” His research is based on data going back to 1926. He tests the withdrawal rates for retirement dates beginning on the first day of each quarter, beginning with January 1, 1926. The average safe withdrawal rate for all those 300+ hypothetical retirees is, “believe it or not, 7%! However, if you experience a major bear market early in retirement, as in 1937 or 2000, that drops to 5.25%. Add in heavy inflation, as occurred in the 1970’s, and it takes you down to 4.5%.” So far, Bill has not seen any indication that the 4.5% rule will be violated. Both the 2000 and 2007 retirees, who experienced big bear markets early in retirement, appear to be doing okay with 4.5%.” ūüôā

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Aug 182016
 

Early Retirement 

For professional skiers the best time to retire is when they start to go downhill. But what about the rest of us? Well for most people the question isn’t at what age we should retire, it’s at what income. ūüėČ People who want to retire early¬†seem to¬†have a clear and consistent focus to grow¬†their wealth so that it can provide them with enough passive income to sustain their lifestyles forever. This¬†can be¬†done through a number of ways such as reducing living expenses, increasing income, and making high investment returns. ūüôā

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I recently read a CNBC article that featured a couple, Carl and Mindy, who retired in their early 40s with a million dollars. And they did it pretty much the same way as most other early retirees.

In 2012 the husband-wife duo with 2¬†kids already had $570,000 saved up. But they were inspired to retire early so they set a clear goal to build a portfolio of $1 million and no debt. And earlier this year in 2016, they have accomplished their dream. ūüôā

The CNBC article suggests that “anyone can do the same ‚ÄĒ and you don’t have to be an investment banker raking in millions. All it takes is smart decisions along with intelligent saving and investing.

Here are some steps the couple took to reach their financial goals.

  • Track spending –¬†“My wife and I wrote all of our expenses in a book,” says the husband.
  • Live in an affordable location –¬†¬†The couple resides¬†in a low-cost area in Colorado, and lives on $2,000 a month for the whole family.¬†They mention this would not be possible in San Francisco or Manhattan.
  • Cut bills –¬†“I learned that you don’t need a lot of money,” said the wife. “My quality of life has not changed since we became laser-focused on cutting out our expenses. I don’t need the cable TV. I don’t need a super-expensive phone plan.¬†I don’t miss all this stuff because it didn’t really add to my life,” she said.
  • Invest in appreciating assets – The couple bought a¬†$176,000 fixer upper home that they estimate is now worth over $400,000. They also¬†I bought 2,000 shares at Facebook at $30 a share which is now worth around¬†$120 a share!
  • Consistent savings – They’ve continuously put away $2,000 per month into their investment portfolio.

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Apr 252016
 

How to Think About Retirement Planning

Some people are reluctant to accept change, especially¬†cashiers because nobody likes to count nickels and dimes. But the world is constantly changing and the retirements of generation Y will look very different than generation X.¬†The trend towards a gig economy has only just begun. In the private sector less people are working 40 years at one company, and more are doing contract work, starting side hustles, and becoming self employed. According to Intuit, in just 4 years from now up to 40% of American workers could be independent contractors. Wow, what other changes will we see¬†in 4 years? I don’t know, because I don’t have 2020 vision.¬†XD

So as we adapt to changing economic strategies, by growing our income streams for example, our retirement plans must also reflect this new world of mobile apps, and short-term work that is long on flexibility, but short on benefits. When it comes to making smart retirement decisions today we should separate the things we can control, from the things we cannot.

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We start by thinking about the factors that we have full¬†control over, such as how much we need to save (and therefore, spend) in order to meet our long term goals. For example, I want to reach financial independence by age 35, which means I need to save about 1/3rd of my income right now. Although diet and exercise habits aren’t directly related to personal finance, they’re extremely relevant in the big picture because healthcare can be a major cost, especially for Americans, when we reach retirement age.

According to the National Council on Aging, about¬†92% of older adults have at least one chronic disease. Jeez Louise! Chronic diseases account for 75% of the money America spends on health care. Diabetes alone affects 23% of Americans over the age of 60. According to Statistics Canada, more than half of all Canadian adults are overweight or obese. ūüôĀ Although certain aspects of our health revolves around genetics, we also rely heavily on epigenetics, and the idiosyncratic personal choices we make today to determine¬†how we live our golden years. Just like with a motor vehicle, proper maintenance can extend our life expectancy, and keep the repair costs down in the long run. This way we can save our money and spend it on meaningful experiences rather than on medication and treatments. ūüôā

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Mar 212016
 

Retirement Account –¬†Taxation

Many folks should use¬†tax deferred programs such as the RRSP or 401(k). Contributions made into a¬†retirement account is tax-deductible and can grow tax-free in the account. When it is eventually withdrawn and taxed the plan holder will likely be in a lower income tax bracket. I would personally try to keep¬†investments that produce mostly capital gains or eligible Canadian dividends out of my RRSP. But that’s just my personal preference for tax efficiency. The picture in this link here¬†definitely¬†says¬†otherwise.

Most people expect to be in a lower tax bracket when they retire so contributing money into an RRSP to defer taxation to a later date when their tax rate is lower makes sense. But some¬†experts say it’s probably not a good idea to use RRSPs if we expect to retire in either the same or a higher tax bracket as we are in now.¬†However, there might be another way to look at it. ūüėÄ

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What if it’s still smarter to¬†contribute to an RRSP today even if our marginal tax rate will be higher in retirement? When we make a tax deductible contribution to our RRSP today, the immediate tax relief we get is based on our marginal tax rate. So if our marginal tax rate is¬†30%, then we would receive¬†$300 by contributing $1,000 to a registered retirement account. But when we withdraw money from this¬†RRSP (or RRIF,) the money we take out is only taxed at our average tax rate, not the marginal tax rate. For example, if we request 12 monthly withdrawals a year from our retirement account then these payments would be taxed¬†similarly to receiving work income from a job where each payment reflects our average income tax rate.

This is due to our progressive income tax system. In Ontario for example, the first $45K of income is taxed at roughly 21%, then the next $28K of income is taxed at 30%, and so on. So if we make $100,000, then we actually pay about $26,000 of income tax, which makes our average tax rate 26%, even though our marginal tax rate would be 38%.

So I’m going to continue maxing out my RRSP contributions each year even if there’s a chance my income will be higher in my 60s and 70s than it is now. ūüôā

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Random Useless Fact:

Some¬†people on the internet can’t figure out how many girls are in this picture.

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Mar 172016
 

Start Compounding As Early As Possible

I recently came across a retirement guide made by J.P. Morgan Asset Management. It includes a nifty comparison between those who starts investing earlier vs later. The results show how time can play a significant part when it comes to compound returns. ūüôā

JPMorgan shows outcomes for 4 hypothetical investors who each invests $10,000 a year at a 6.5% annual rate of return over different periods of their lives:

  • Chloe invests for her entire career of 40 years, from age¬†25 to 65.
  • Lyla starts 10 years later, investing 30 years from 35 to 65.
  • Quincy¬†starts to invest early but stops after 10 years, contributing from 25 to 35.
  • Noah saves for 40 years like Chloe from 25 to 65,¬†but instead of being moderately aggressive he simply holds cash, term deposits, GICs or CDs, etc and receives a 2.25%¬†average annual return.

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Let’s break down the results.

  • Chloe begins investing early, plus she’s consistent, which is why she has nearly $1.9 million at retirement. ūüėÄ
  • Even though Lyla started just 10 years later than Chloe, she only ends up with $920K, which means¬†postponing investing for just 10 years while we’re young will cost us almost a million dollars once¬†we’re old.
  • Quincy, who invests for only 10 years, still ends up with $951K at retirement, which is surprisingly more than Lyla’s portfolio, even though Lyla spends 30 years investing.
  • Finally Noah, who has a lower risk tolerance than the others,¬†ends up with only $652K at retirement even though he contributed for 40 years.

Of course no one can guarantee a 6.5% annual return. The¬†chart is for illustrative purposes only and does not represent a¬†real life investment plan. It simply demonstrates how annual rates of return and the passage of time can effect the outcome of a retirement portfolio.¬†The earlier we start investing, the better. ūüôā But just for fun, here’s a look at how the following asset classes performed over the past 10 years.

  • Canadian Equities – 3% annual return
  • U.S. Equities – 6%
  • Fixed Income – 5%
  • Canadian Real Estate – 12%
  • U.S Real Estate – 3%
  • Gold – 9%
  • Farmland – 12%

Depending on our asset allocation it’s possible to have made¬†6.5% annual returns with a moderately aggressive portfolio over the past 10 years.

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